Investors who want to play in the iron and copper space should look to small-cap producers for attractive valuations and lower risk, says Matt Gibson, institutional research analyst with CIBC World Markets. In this Gold Report interview, he says he believes iron has found its floor in 2012 and names iron ore and copper companies with upside potential.
The Gold Report: Matt, you cover four companies in the iron space with market caps that range from Cliffs Natural Resources Inc. (CLF:NYSE) at $4.2 billion and Labrador Iron Mines Holdings Ltd. (LIM:TSX) to Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.MKT) and New Millennium Iron Corp. (NML:TSX) with market caps around $200 million. In Q1/12, all of them were worth double what they are trading at today. Why should investors be interested in these companies?
Matt Gibson: We have started to see positive trends in the iron ore space. Chinese port inventories have started to tick down, while capacity utilization globally and in the U.S. has started to tick up for steel companies. Iron ore prices have rebounded from lows of $86/metric ton (Mt) to the $118–120 Mt level.
TGR: Are larger companies like Cliffs being punished for their acquisitions or is the across-the-board share price decline all about low steel prices and global economic fears?
MG: I think most of it has to do with iron ore prices and sentiment regarding Chinese growth.
“We have started to see positive trends in the iron ore space.”
For Cliffs, the slow ramp-up at its Bloom Lake mine, which has led to elevated cash costs at the facility and lower margins, has not helped. Delays to the planned expansion and the downward revision of the mine plan to an ultimate capacity of 14 Mt have not helped either. Finally, higher operating costs put pressure on the company’s balance sheet.
TGR: A recent CIBC World Markets’ research report stated, “Despite elevated inventories of steel and iron ore, Chinese steel mills continue to maintain daily crude steel output near record levels.” As you mentioned, that seems to be changing. But is it changing quickly enough?
MG: I think China’s infrastructure announcement earlier in the fall helped draw down some of the inventories. Certainly, the overcapacity issue in China has a lot to do with the fragmented nature of the industry there, and that will take some time to play out. However, the Chinese government has been putting efforts into consolidating production into larger, more efficient operations.
TGR: The Chinese bought in at much higher prices on several juniors in the iron space. Do you think the Chinese regret that decision or was this always about the long term?
MG: China’s real interest is not so much from an investment point of view as it was about longer-term offtake, securing supply of iron ore and being able to diversify away from reliance on the big three producers.
TGR: In September, you dropped your 2012 near-term iron ore price forecast from $143/Mt cost, insurance and freight (CIF) to $128/Mt CIF. That also caused you to lower your target prices for the four iron companies you cover. Have we reached a bottom to the price drop?
MG: Near term, I believe prices found a floor in the $110–120/Mt level. That’s pretty much where most estimate the average cost of production to be in China.
That being said, the upside or potential price increases will be limited by growth in China and economic growth in Western Europe.
TGR: Would you say your view of global economic growth is reasonably bullish?
MG: There are some positive indications and I am optimistic that 2013 will be a better year than 2012, and that will be good for the iron ore sector.
TGR: Let’s move to your coverage, starting with Alderon Iron. Your 12-to-18 month target price on that company is $5.20, more than double its current share price. What about Alderon and its Kami Iron Project engenders that kind of confidence?
MG: Alderon’s management team has experience developing and building these types of assets. Several people on the management team have a background with Consolidated Thompson or with the Iron Ore Company of Canada, which have operated in the Labrador Trough for a long time.
Copper remains one of the tightest markets from the fundamental supply-and-demand perspective.”
Alderon also has a strong partnership with the largest Chinese steel producer. This is a producer that has only a small fraction of its iron ore supply captive right now.
Finally, there are potential catalysts on the horizon, including the release of definitive feasibility studies, rail agreements and permitting.
TGR: Cliffs Natural Resources went on a spending spree a few years ago, buying Consolidated Thompson, KWG Resources, Freewest Resources and Spider Resources, among others. Earlier, you attributed some of that drop to issues at Bloom Lake. But do you think Cliffs took on too much in those acquisitions?
MG: I think Cliffs got caught in a difficult position when it bought development assets just when prices turned. In retrospect, it looks as if the company may have stretched or overextended itself, but if prices stay stable things will look different a year from now.
TGR: You have a Sector Perform rating on Cliffs and a $55 target price, not quite double its current price. What will it take to get Cliffs from here to there?
MG: Cliffs needs to get up to full production at Bloom Lake. It has been ramping up and doing a lot of predevelopment stripping for a number of different mining phases. In U.S. accounting practices, all of those expenses have to be expensed on the income statement and impact cash costs. In other jurisdictions, those cash costs would be capitalized and amortized over a period.
Now that the stripping is done, Cliffs has multiple phases up and running. When Bloom Lake hits the 7 Mt annualized capacity mark, it should be able to drive its costs down on a per tonne basis.
TGR: Next, let’s talk about Labrador Iron Ore Royalty. It started out as an income trust—a form of company that does not exist in the U.S.—and is now a dividend-paying corporation. Why did the company make that change and how will it affect investors?
MG: As an income trust, Labrador Iron Ore Royalty was basically a flow-through vehicle for the royalty income and dividend stream coming out of the Iron Ore Company of Canada. It was organized that way for tax efficiency purposes. The Canadian government changed its stance on how those types of vehicles are taxed and most of the income trusts converted back into dividend-paying corporations.
“In the near term, small-cap producers offer some attractive valuations and a lower risk way to play copper compared to development companies.”
I really do not think anything has changed in how Labrador Iron Ore Royalty will operate. The company also is expanding annual capacity from 17 Mt to 23.3 Mt on an asset at Iron Ore Company of Canada that is run by Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK). Increased sales volume from that should contribute to higher royalty income and likely a large special dividend from Iron Ore Company of Canada in the latter half of 2013.
TGR: Should shareholders be pleased with this change in structure?
MG: The real impact for an individual investor is the change from getting part of the distributions in the form of interest payment, to getting it all as a dividend. For individual investors in Canada, it is more advantageous to receive everything as a dividend; I’m not sure about the tax implications for U.S. investors.
This actually represents one of the lower-risk plays in iron ore if you want exposure to iron ore while getting paid to hold the stock. Over the last 12 months, Labrador Iron Ore Royalty has distributed $1.50/share to shareholders, which represents about a 5% yield on the current stock price. The distribution could increase to $2.30/share in 2013.
TGR: Is your target price on Labrador Iron Ore still $40?
MG: Yes, it is.
TGR: The fourth company you cover is New Millennium Iron Ore. It is developing the Direct Ship Ore (DSO) project in Northern Québec. Tata Steel Ltd. (TTST:LSE; TATLY:OTC) has already agreed to take 100% of the ore produced, correct?
MG: Yes. The DSO Project is under construction. In 2012, it produced around 300,000 tons of sellable product, and will probably do about 2–2.5 Mt in 2013.
TGR: The total resource at DSO is 125 Mt. How does that compare to other companies of similar size in this space?
MG: The DSO resource base is similar to Labrador Iron Mines Holdings Ltd.’s (LIM:TSX) resource located nearby. Labrador Iron is more of a seasonal operator and delivers its product through Iron Ore Company of Canada.
New Millennium will operate year round in an enclosed structure and sell its product initially through port facilities owned by a local aluminum plant in Sept-Îles and later through the multiuser port that the Port of Sept-Îles is now building. That facility should be completed at the end of 2013 or early 2014.
TGR: Do you consider it an advantage that 100% of the offtake at DSO has been secured by Tata Steel?
MG: I suppose one could see that as a potential risk. But at the end of the day, Tata is the lead operator of the DSO project and New Millennium has a free carry into production. Unless Tata’s view of the Corus steel manufacturing facility in the U.K. changes, this offtake should be fairly secure and on typical commercial terms priced on international benchmarks.
TGR: Do you think New Millennium is secure enough in exchange for that 100% offtake agreement?
MG: The offtake agreement gets New Millennium to the point of generating cash flow; making that transaction positive for any junior.
Whether it is a fair deal or not, getting DSO up and running was really just an entry point for Tata Steel into the Labrador Trough. The strategic value of that will really be reflected when New Millennium starts developing and getting the larger taconite projects into production. That will require further investment decisions by Tata. The cash-flow implications for New Millennium from getting the larger, taconite projects up and running could be a real game changer.
TGR: What is taconite?
MG: Taconite is a colloquial term used to describe banded iron formations.
The investment decision required for the larger taconite project will be predicated on the definitive feasibility study that should be published in the next few months. We expect the investment decision in mid-2013.
TGR: How big an issue is transportation for New Millennium at both DSO and the taconite projects? Does it need a rail agreement to induce Tata to sign on to those taconite projects?
MG: The taconite project requires a slurry pipeline from the processing facility in the north down to a pelletizing facility in Sept-Îles.
There’s potential for New Millennium to sign an agreement with a consortium of the Canadian National Railway and the Caisse de Dépôt that is contemplating building a new rail line to where this project is going to be located. Canadian National Rail will head up construction and the Caisse de Dépôt will provide financial backing.
It signed a rail agreement for DSO with Québec North Shore and Labrador Railway in January 2012.
TGR: What is your target price on New Millennium?
MG: It is $4.30, almost triple where it is right now, based on a discounted cash flow model.
Lately in the Labrador Trough, a lot of players have been painted with the same brush as Cliffs and Labrador Iron Mines, and similar discounts have been applied across the board. But I think New Millennium is operating differently from other startups.
TGR: Is that due to its management team?
MG: Yes, it is due to a solid management team. This team understands how the business operates and the pitfalls of not owning your own infrastructure.
TGR: I would like to move on to copper. Copper traded down in October but looked to be rebounding at the end of November. What is your near-term outlook for copper?
MG: We see some marginal upside to copper prices in 2013, although not materially higher than today’s $3.60/pound (lb). We are forecasting $3.75/lb for 2013; overall, some strength, but limited downside from current price levels.
TGR: What is your central thesis for the primary copper plays you cover?
MG: Copper remains one of the tightest markets from the fundamental supply-and-demand perspective.
Right now, the junior producers are heavily discounted compared to the more senior players. A lot of the juniors have no value reflected in the market for some of their growth projects.
I think development or preproduction plays offer the opportunity to gain a lot of torque to the copper prices albeit with higher risk. They also offer investors the opportunity to participate in derisking projects, growing resources and the potential to rerate when a play moves from development into production.
TGR: Which companies do you cover in the copper space?
MG: Starting at the top of the alphabet, Augusta Resource Corp. (AZC:TSX; AZC:NYSE.MKT; A5R:FSE) is really a permitting story at this point. We expect it to obtain its record of decision early in 2013. This is a very robust project from a capital intensive point of view.
In terms of upcoming catalysts, Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL) should come out with some 2013 guidance in January, along with a new reserve calculation and mine plan. We expect its life-of-mine rates to increase substantially on the back of recent grade reconciliations from production and a previous resource model, as well as exploration results from work done this year.
Rio Alto is also starting a regional exploration program on its land package; we expect those results to boost the stock.
TGR: How did Rio Alto perform against guidance in 2012?
MG: The company revised guidance upward twice in 2012. The original estimate of 100,000 ounces (100 Koz) was revised at midyear to 160 Koz and again to 200 Koz toward the end of the year. We believe Rio Alto will reach 200 Koz, mostly due to positive grade reconciliations.
TGR: Rio Alto’s La Arena is a massive open-pit mine in Peru. What is its expected mine life?
MG: Right now the oxide has an expected mine life of about six to seven years for the material close to surface. The sulfide deposit will have a much longer life.
Those mine lives are based on what the company has drilled off to NI 43-101 standards to date. It has a large land package, so I would expect the mine life to be extended on the gold side through exploration.
TGR: What are your targets on Augusta and Rio Alto?
MG: My target on Augusta is $5/share and Rio Alto is $8/share.
TGR: Finally, what is up with Western Copper and Gold Corp. (WRN:TSX; WRN:NYSE.MKT) and its massive Proven and Probable reserve?
MG: That project has the potential to move the needle for a major copper producer. We expect the results of a definitive feasibility study in the near term to provide some clarity around power options for the project. The investment community and potential joint venture partners have both focused on that issue. Clarifying the power issue should pave the way for the company to find a joint venture agreement with a major copper producer or lead to an outright sale of the company.
TGR: But the big copper producers do not like to share. Which company could swallow something this large?
MG: It would have to be a company the size of a Teck Resources Ltd. (TCK:NYSE; TCK.A:TSX), Rio Tinto, BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) or Antofagasta Plc (ANTO:LSE).
TGR: Do you have any parting thoughts on the infrastructure material space for our readers?
MG: In the near term, small-cap producers offer some attractive valuations and a lower risk way to play copper compared to development companies.
I would look for companies with strong balance sheets, capable management teams and good projected growth over the next five to seven years for near-term returns.
TGR: And would you include the iron companies in that?
MG: Yes, absolutely. The criteria are very similar.
TGR: Matt, thanks for your time and your insights.
Read about Matt Gibson’s ideas for investing in critical metals here.
Matt Gibson joined CIBC’s Equity Research Department in February 2009. He covers the junior base metal, rare earth, uranium and iron ore spaces. His more macro focus and financial acumen have helped to support commodity-related calls and augment the wealth of technical expertise on the mining research team. Gibson holds a Master of Business Administration from McMaster University, where he focused on financial markets and business valuation, and a bachelor’s degree (Honors) in economics from McMaster University.
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When it comes to supply and demand dynamics, Aheadoftheherd.com Publisher Rick Mills does his own math. China may make a show of its alleged copper surplus and Germany may downplay its need for efficient energy sources, but Mills foresees demand spikes in a number of specialty metals. In this interview with The Critical Metals Report, Mills discusses the positions he’s establishing while looming supply shortages remain under the mainstream radar.
The Critical Metals Report: Let’s talk about specialty metals that present opportunities for investors. What’s on your radar screen?
Rick Mills: There are several metals that we’ve taken for granted because the prices are low, such as nickel and uranium. I shake my head that copper is only $3.50/lb. A lot of what’s going on in copper can be extrapolated to the other metals as well.
Let’s start with capital expenditures, or capex. Mining is definitely one of the more capital-intensive businesses. There are large, upfront costs for construction of the mine. As the low-hanging fruit has been picked, companies have to go off the map to find deposits in remote areas with lower grades and more complex metallurgy. There is little to no infrastructure, so it can cost from $5 billion ($5B) to $9B to build today’s mine.
TCMR: That’s true of any metal you might mine.
RM: True enough, but some metals are more supply-side challenged than others. Operational expenditures are also continually increasing. These are day-to-day costs of operation—wages, tires, fuel and camp costs for employees. The average capital intensity, or the capacity to produce 1 ton (t) copper, for a new mine in 2000 was $4,000–5,000 ($5K). Today, capital intensity is north of $10K/t on average for a new copper project.
Some projects that are $5.5B are going to produce 60,000 tons (60 Kt) copper per year. Do the math; capital intensity numbers are scary. Capex costs are escalated because declining copper ore grades mean a much larger relative scale of required mining and milling operations, and a growing portion of mining projects are in remote areas of developing economies where there is little to no existing infrastructure.
TCMR: Could the declining growth of China, which is probably the world’s largest consumer of copper, be contributing to a slowdown?
RM: China recently published figures saying that it has 1.9 million tons (Mt) copper in its inventory. It brought over a bunch of analysts and showed the copper all stacked up, the stacks leaning over and the ground compressing. The analysts came away suitably impressed that China has too much copper when, in fact, nothing could be further from the truth.
China has 1.9 Mt copper. About half of that would be in the supply line somewhere. It’s going to be used. China usually keeps around 600 Kt as a rainy day fund. The bottom line is China needs 50 Mt copper during the next several years. If you needed that much copper, what would you be doing? What kind of games would you be playing if you knew you had to buy it in the open market? You’d be telling everybody that you had way too much. Let’s face it: China needs copper. It’s going to grow 7.7% this year. It has been growing at an average rate of 9–11%/year for 20 years.
TCMR: How does an investor capitalize on increasing copper demand and shrinking copper supply?
RM: Do you invest in an off-the-map area in a geopolitically risky country? I don’t. There’s enough risk in this sector without purposely increasing it. I also want something that’s high quality yet small enough that capex and opex are not going to be a killer.
I look for a company that turns the negatives, the increased capex/opex, the increasing resource nationalism, the increased environmental regulation, etc., into nonexistents. One on my radar is VMS Ventures Inc. (VMS:TSX.V) There’s little risk of resource nationalism on the Reed Lake deposit in Canada. Its well-funded partner, HudBay Minerals Inc. (HBM:TSX; HBM:NYSE), operates several mines in the area. One of them is going to be closing shortly, so the skilled people will become available. Reed Lake is a high-quality deposit. It’s underground, but it already has infrastructure in the area. It already has the mill and the processing facility. Financing is not going to be a problem. Permitting is not going to be a problem because most of it is already permitted. The area is a well-known mining camp. I don’t see any operational issues. There’s little risk from environmental groups and/or labor.
It’s an economically attractive project, because the risk has been removed. The cash flow for VMS is about $100 million (M) over the present mine life. It’s a very attractive position for investors to start taking as this company is going into production next year. It will pay back its partner HudBay from its first year of production. In 2015, VMS is going to have an enormous amount of money in its coffers.
TCMR: Is it still exploring?
RM: Yes, the company is exploring the area around the mine and will drill from underground, trying to increase even further the size of the deposit, and VMS will shortly be releasing its winter drill plans on its 100%-owned projects.
TCMR: VMS’ stock is trading at $0.19 with a $23M market cap. To what do you attribute the lag?
RM: The best time to buy a junior is when it’s still exploring and hope it makes a discovery, or secondly, just before it puts out its first NI 43-101 or just before it goes into production. We’re in that period of time now when there is not really a heck of a lot to report. It’s that quiet time in front of production and its winter exploration program.
TCMR: What other metals are suffering supply shortages?
RM: Investors should be looking at nickel. It’s present in more than 3,000 different alloys used in more than 300,000 different products.
About 65% of nickel is in alloy with chromium and other metals to produce stainless and heat-resisting steels. Another 20% is used in noncorrosive and super alloys. About 9% is used in plating and 6% is used for other uses, such as in coins, electronics and nickel-hydride batteries in cellular phones. Then there are nickel-cadmium batteries to power cordless tools and appliances.
The U.S. Department of Energy is funding research and development of renewable energy sources. That is expected to expand the use of nickel. It’s quite interesting what they’re discovering as new uses and increasing the old uses of nickel.
Nickel used to be produced from laterite deposits. When the Sudbury sulphide nickel camp was discovered in Canada in the early 1900s, it completely dominated global production.
The problem is that nobody is finding those large sulphide deposits anymore. We’re going back to laterites, which are big, layered deposits of often a billion tons or more located close to the surface. Unfortunately, they necessitate different metallurgical applications and recovery processes for each zone or layer.
The processes have enjoyed a highly mixed performance record and can be extremely expensive. It’s a little different for each deposit. A lot of the companies are having major problems with the metallurgy. Because it’s lower grade, they have to go with that economy of scale.
Because the laterites are caused by weathering of ultramafic rock, they typically occur in equatorial zones. That means that a lot these deposits are located in the sketchier countries that carry heightened geopolitical risk versus the sulphides, which seem to happen in places like Greenland and Canada. The same thing that happened with copper is happening to laterites, with capital intensity shooting through the roof. Here’s what’s happening to a few of the deposits many are counting on for future global nickel supply:
Vale S.A.’s (VALE:NYSE) New Caledonia project, which used to be called Goro, is many years behind schedule. It’s almost become the bad boy poster child for problems with one method of nickel mining technologies, HPAL (high pressure acid leach processing). Sumitomo Corp. (8053:TKY; SSUMF:OTCPK) and Mitsui & Co. Ltd. (8031:TKY) have reduced their participation. Vale has problems in its Onca Puma project. It doesn’t even have a return of production yet. It shuttered its Frood mine.
Xstrata Plc (XTA:LSE) has increased the capex at its Koniambo project due to growing labor costs from competition from the oil and gas sector for an extremely limited labor pool on a very remote island. Its first pour was supposed to be earlier this year, but there has been no news from it. Xstrata has closed its Cosmos mine.
BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) has been trimming costs at its Australian operations.
Anglo American Plc (AAUK:NASDAQ) closed its 17 Kt/year Loma de Níquel mine due to disputes over mining concessions.
TCMR: With mines slowing down or shuttering production, have we seen any increases in the basic commodity price for nickel?
RM: The nickel glut is nonexistent and nickel is going to rally. There is no doubt nickel has been the worst-performing metal lately. However, BNP Paribas is now forecasting a much smaller-than-expected supply in 2013. It has cut its projection three times since April. Credit Suisse and Citigroup have lowered their forecasts. They’re saying nickel is going to average 15% more in the second quarter than now.
TCMR: Where can an investor find companies with deposits that are cheaper to process in areas without jurisdictional and geographic problems? How can an investor participate in the nickel market if there’s this kind of a looming shortage?
RM: One of the reasons market watchers are paring the supply forecasts is because all of these projects are falling behind schedule. The market balance is much tighter than everybody, except apparently me, has been predicting. There are a lot of operations and capacity that have run into various issues. Investors have to figure out which companies don’t have these problems.
One that doesn’t have these issues is North American Nickel Inc. (NAN:TSX.V). It owns a nearly 80-kilometer trend of historical nickel mineralization in Greenland. It has done a small drill program this year to start to define one of its almost 80 targets and had some very encouraging assays come back. It is going to be able to put together a much larger program and get at it next year.
The company is well backed by The Sentient Group and a large institutional player. VMS Ventures owns 26% of its shares and doesn’t want to be diluted; financing is not going to be a problem. This is a company in which an investor can start to take a position and slowly increase it, knowing that there is some time to work on it.
TCMR: Are there any other metals that you want to talk about today?
RM: One that investors are missing the boat on is uranium.
TCMR: What’s your take on uranium stocks right now?
RM: The question is: When do you buy? We talk about this all the time. It’s when nobody else is buying, when the herd doesn’t love it. That fits uranium pretty well right now. The fact is that investors aren’t paying attention to what’s going on on the supply side. The demand side is going to increase. Japanese reactors are off-line. Germany took its reactors off-line almost overnight. Chinese demand slowed as they do some serious safety studies.
Fukushima put a dark cloud of negative sentiment over the entire industry. Demand fell through the floor. People were worried, and rightly so. Everybody was watching the spot price. Utilities weren’t buying; they were sitting on the sidelines, waiting for prices to come down.
China has released its new nuclear energy plans. It has moved toward safety. Any reactors currently under construction will be allowed to continue, but the new reactors will have to use the third-generation technology, the European Pressurized Reactor or the AP1000.
This is a huge boost for the demand side. China has 12.5 gigawatts (GW) in operation with 26 GW under construction. It wants 40 GW in nuclear power by 2015 and to reach 80 GW by 2020. China is back in the market. Yes, the Germans are going to sell, but now we’re finding out that Japan is reopening its nuclear reactors, and I have no doubt it is going to build more.
TCMR: And Germany?
RM: Germany is totally green-washing the world. The monkeyshine coming out of Germany today is off the wall. It is importing more and more nuclear-produced electricity from Holland, the Czech Republic and France than it ever was. It touts itself as a poster child for green energy, yet its industry is suffering and leaving in droves because of blackouts or brownouts and the high cost of electricity. Germany is sucking up nuclear-generated power, just not from reactors on its own soil.
A lot of people don’t know that Germany is currently building 23 new coal-fired power plants because it is worried about the increasing costs of electricity and its industry leaving. If you can’t do business because of brownouts and blackouts, you’re going to move to where you can get a steady supply of electricity.
Germany opened a $3.4B, 2,200-megawatt (MW) coal-fired power plant just in August. Instead of the 15 t of carbon dioxide (CO2) the old ones vomited, these new ones, which are 10% more efficient and burn only the cleanest coal ignite, still pump 13 Mt CO2 into the atmosphere. In just one year, this coal burner is going to generate more CO2 than Germany’s entire nuclear fleet would have over 20 years. Germany’s “green energy” plan doesn’t work; the country can’t afford to be without nuclear energy and it’s very obvious that Japan can’t, either.
TCMR: Let’s talk about uranium companies that you like, Rick.
RM: Nuclear power is not going away. In fact, it will increase exponentially. Mine supply is at $40/lb spot price. You need $70–85/lb incentive price to get new mines going. And then it takes 10 years to get a uranium mine up and running.
Let’s focus on the U.S. The U.S. uses 55 million pounds (Mlb) uranium per year. It produces 4 Mlb. Where is the U.S. going to get its uranium? There are two companies that are going into production right away. I’m not going to mention a certain name because I don’t like being negative, but one of the companies might not make it. Apparently, there are some sage grouse nests on its property. We’re going to save the birds.
TCMR: Which one will go into production?
RM: The one that’s going to make it into production next year is Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT) in Wyoming. It is fully permitted. It is building the pads for the first deep disposal well, which should take several months. Then it will need to build a second. The Nuclear Regulatory Commission has to do an inspection. Remember, this is the first uranium mine that’s been opened in the U.S. since 1996, so the NRC’s going to be very thorough. It will probably take about a month to complete the inspection. I expect Uranerz, barring any inspection delays, to be in production by the end of July 2013. It has two offtake agreements already signed at a much higher price than spot. It has Cameco Corp. (CCO:TSX; CCJ:NYSE) doing its processing. It is going to be producing 600–800 Kt/year yellow cake. It’s in-situ leaching and the company is the world’s leading expert on it.
TCMR: I really enjoyed our conversation.
RM: It’s been a pleasure, thank you.
Richard (Rick) Mills is the founder, owner and president of Northern Venture Group, which owns Aheadoftheherd.com, as well as publisher, editor and host of the website. Focusing on the junior resource sector, Mills has had articles appearing on more than 400 different publications, including The Wall Street Journal, Safe Haven, The Market Oracle, USA Today, National Post, Stockhouse, LewRockwell, Pinnacle Digest, Uranium Miner, Beforeitsnews.com, Seeking Alpha, Montreal Gazette, Casey Research, 24hgold, Vancouver Sun, CBS News, Silver Bear Cafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FN Arena, UraniumSeek, Financial Sense, GoldSeek, Dallas News, VantageWire and Resource Clips.
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Charles Gibson, from his vantage point in London, has a unique view of mining companies in Africa. Gibson is the head of mining for Edison Investment Research, which writes unbundled investment research on a range of companies from its offices across Europe, New Zealand and Australia. In this exclusive interview with The Gold Report, Gibson talks about some hidden mining gems in Africa.
The Gold Report: We have a scenario where the price of gold has held up and is trading at about $1,775/ounce (oz), but the share prices of large caps aren’t comparable. What is the reason behind that?
Charles Gibson: Typically, large companies are valued in relation to their margin, the difference between the price they sell gold and the cost at which they mine it. There was a period of margin expansion from about 2009 to 2011 where, by and large, the share prices of big producers did very well. The gold price was rising and costs were under control.
In late 2011, however, this dynamic reversed and the gold price started to tail off at the same time as costs began to pick up. Then there was a period of margin contraction. That’s what’s caused the share prices of the majors to fall.
TGR: Would you factor in the general malaise in the stock market?
CG: Commodities can dance to a very different tune than the broader economy as a whole and the broader stock market. There’s been margin expansion and margin contraction. It won’t go on forever. There is a very close correlation between revenue per ton and costs per ton for mining companies and there are lots of different ways to explain that. But if the commodity price moves, the likelihood is that the cost base will move at some point. That works both downward as well as upward. Commodity price and cost base don’t work exactly in time with each other, but by and large the broad direction is similar. That tends to temper the upside, but it also saves a little bit on the downside as well.
TGR: Given the unremarkable performance in some of the large caps, should investors be looking at small to mid caps for value and growth?
CG: It’s not a question of being small, mid or large cap necessarily. The key question for investors at the moment is: Which companies have costs under control? Perhaps that is due to the jurisdiction they’re in or because of a particular cost basis. If companies have access to hydroelectric power, for example, that often acts as a buffer against rising prices. When costs are under control, margins are under control and companies can benefit from rising commodity prices.
TGR: What’s your view on precious metals prices going forward?
CG: There’s a very strong correlation since 1959 between the U.S. monetary base and the price of gold for fundamental reasons. After the first two rounds of quantitative easing (QE), the implied gold price from that correlation was $1,350/oz. That’s where we were until about a fortnight ago when Ben Bernanke announced QE3, which at the moment is open-ended. Our long-term gold price of $1,657/oz goes through 2013. If QE3 continues to 2014, you’re looking at $1,887/oz and by 2015 it’s more than $2,000/oz.
I stress that this is not a day-to-day trading price. It is the fundamental long-term price. To paraphrase John Maynard Keynes, “Markets can stay irrational longer than you can stay solvent.”
TGR: It’ll be interesting to see what happens in November with relation to QE3. Let’s talk about some names that you’re following in Africa.
CG: Pan African Resources Plc (PAF:AIM; PAN:JSE) is a stock worth looking at with an asset in Barberton, South Africa. However, this is greenstone gold—not conventional South African Witwatersrand gold—in this case, with a 10-year life. It has had a 10-year life for the last 100 years, roughly speaking. It’s a very tight little management structure. It produces about 100,000 oz (100 Koz) every year and has done that for as long as anyone can remember.
Pan African announced its full-year results last week showing earnings nearly doubling compared to the prior year and more than doubling compared to the half-year stage. That is strongly suggestive of a cost base that is well under control.
It also just made a major acquisition of Evander Gold Mines Ltd., which it is buying from Harmony Gold Mining Co. (HMY:NYSE), this time in the Witwatersrand Basin. Pan African’s management has good prior knowledge of operations of Evander. A lot of the board has worked there. Pan African has been able to buy it at a low price. It will be very accretive. The mining plan indicates that it could double Pan African’s earnings in the short term.
TGR: I’m looking at Pan African’s stock chart right now. It’s trading near its 52-week high. There aren’t many North American-based gold producers that could say that.
CG: Pan African’s share price is a testament to the tightness of the management structure and the fact that the company has been able to deliver on its promises half year in, half year out. It has supportive shareholders. There are few substitutes for a good track record in mining circles and Pan African has a very good track record.
I’d like to talk about Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT), too.
Casa Berardi on the Cadillac Fault in Québec is the major asset. Its management has an exceptional track record of delivery. It has roughly 160 Koz/year of production and, with very few exceptions, it hits that. It usually hits its quarterly guidance as well.
There are also relatively few shocks on the cost side. Costs have suffered recently as the mine has moved to lower levels. The costs per ton are moving up, but that’s really a one-off effect. Even after that, it’s still producing gold at about $640/oz. At the moment Casa Berardi has a mine life to 2020, but it’s looking to expand that.
In particular, there have been some remarkable intersections made by underground exploration drilling at Zone 123. If confirmed and continuous, it may be that not only will Casa Berardi’s underground mine life be extended, but it may turn out to be one of those Canadian mines where the grade gets higher as you get deeper. Also, because this zone is off the main Cadillac break, it will require less ground support and therefore the additional costs of being further from the shaft will be offset both by higher grades and lower costs.
TGR: The gift that keeps on giving. It also has exploration potential beyond Berardi with Joanna and other assets.
CG: Joanna is split into the Hosco and Heva sectors. Hosco has a prefeasibility study that came out all right. It is refractory ore, which means there were a lot of additional capital expenditures related to autoclaves etc. Management stuck it on the backburner. The area is very prospective, but it’s clear that the mineralization changes to non-refractory moving west, which means that it should be much less costly to develop.
It pleases me the way that management tackled this. Rather than chasing that very obvious goal of getting Joanna into production, the company said, “Let’s just wait a minute. Let’s see if we can improve this.” It went from a feasibility study back to exploration. But now there is the potential for a much bigger dividend at the end than might otherwise have been the case.
TGR: David Hall is not the chief executive officer (CEO) anymore, but he’s probably the man behind a lot of those decisions.
CG: The new CEO is George Paspalas, who is an Australian with a very long pedigree in underground mining. He managed the South Deep extension of the Western Areas gold mine in South Africa for Placer Dome [now Barrick Gold Corp. (ABX:TSX; ABX:NYSE)]. He’s also a chemical engineer with extremely good experience with refractory ore so, in short, he knows about the two things that he really needs to know about at Aurizon.
TGR: I’m interested in hearing a little bit about Cluff Gold Plc (CFG:TSX; CFG:LSE). I just met the management group of this company at the Denver Gold Forum. They seem very keen to introduce this company in a more proactive way to the market.
CG: Cluff Gold has also literally just changed its name to Amara Mining! That aside, its assets, which are in Sierra Leone, Burkina Faso, and Côte d’Ivoire, run the gamut from exploration to production.
The Burkina Faso asset is Kalsaka, which is a nice, relatively small-scale mining operation that produces about 70 Koz/year at about $900/oz. It is providing the cash flow and the profitability to fund the rest of the company’s operations.
The flagship asset is Baomahun in Sierra Leone. I’m expecting a resource upgrade to be announced this quarter followed by a full feasibility study. It will have 130 Koz or more of production from 2015 onward.
Its exploration asset is Yaoure in Côte d’Ivoire. Now, this is an interesting asset in that it has been mined in the past. It has been known to be very prospective. Cluff has done a lot of drilling there. Our best estimate of the resource is roughly 2 Moz. It could turn out to a very significant asset indeed.
Kalsaka generates the money and some of that is used in exploration in Baomahun and Yaoure. Cluff assumed until recently that it would need an equity raising to fund the capital expenditures of Baomahun. However, management has recently said that, given where its equity price is, it’s not happy with the level of dilution. The company is looking at non-traditional forms of finance. Reading between the lines, what we’re probably looking at is some sort of debt instrument with a coupon that’s connected to the gold price. That route is a much more efficient way of funding as far as existing equity shareholders are concerned.
I think that’s part of the reason that the share price has performed very well over the last couple of months. Nonetheless, it is not valued at much more than the implied value of Baomahun. Investors are getting Kalsaka and Yaoure for free. And the company is already generating profits and cash flow.
TGR: It’s interesting. Its small producing mine is funding the exploration. Sega, Cluff’s add-on acquisition to Kalsaka, should have a preliminary economic assessment soon and then there is the blue sky of Yaoure. Cluff announced a strategic alliance with Samsung. Tell me about that.
CG: It is part of its non-traditional funding. Samsung made a $20M credit facility available to Cluff. That is more than enough for the company in the short to medium term. It is looking in the longer term toward a cornerstone funding arrangement to bring the Baomahun project into production.
TGR: I have not seen any mining company entering into an agreement with Samsung. Are we talking about the same Samsung that is the electronics manufacturer?
CG: It is. This is an example of the increasing scenario where dollars are held in Asia and they’re looking for a home. One of the very obvious places to invest, if you’re long dollars, is in gold. In this particular instance, you’re merely looking at the first derivative of that investment strategy, i.e., gold equities. It’s not wholly unknown though for Asian industrial companies to get involved in mining. The one that leaps to my mind is Mitsubishi.
TGR: We’re also seeing a lot of that in the minor metals and specialty metals space right now, too.
CG: I think that, in general, those investments are aimed toward a guaranteed offtake—they have an industrial logic—whereas I suspect that the Cluff deal is more of a pure investment.
TGR: Cluff seems like a very ripe cherry for a company that would want an African asset.
CG: It’s difficult to comment about where mergers and acquisition activity will fall. I think it’s true to say that there is a keen focus on West Africa and there is an assumption in the market that there are more mergers and acquisitions to come in that particular part of the world.
TGR: What can you tell me about Mwana Africa Plc (MWA:LSE)?
CG: Mwana is an interesting company to talk about because its assets are located in such an interesting part of the world—Zimbabwe and the Democratic Republic of the Congo (DRC). It has a very nice little gold mining operation, Freda Rebecca, which produces about 70 Koz/year for about $850/oz. People hear Zimbabwe and think it sounds like a difficult place to operate. Historically, it has been. But I visited the mine recently and it is operating in good order. The plant is pretty rugged. There are no concessions made to luxury at all but in its own way it does work very well.
It’s an amazing ore body. The mine has been open-pitted in the past, but now it’s moving underground. If you go underground, the size of the voids, because of the competence of the rock, is absolutely unbelievable. The voids are easily the size of a church. It is the perfect engineer’s mine.
Freda Rebecca is funding Mwana. It has a majority interest in another complex, Bindura Nickel Corp. (BNC:ZSE), a bulk massive nickel sulfide ore body. It has been on care and maintenance for several years. Mwana just got an agreement with creditors to raise money via a rights issue in order to restart the operation.
Bindura Nickel is underground. Various assets actually have been open-pitted in the past and could be open-pitted again in the future. There are not many assets like this in the world when the rest of the world is shifting from nickel sulfides to nickel laterites. And the entire infrastructure is sitting there in very good order.
The first part of the restart is to get the Trojan underground mine into operation and to produce a concentrate. In due course, with material from other assets and potentially third-party material as well, the idea will be to smelt and refine the concentrate to a pure nickel product.
Bindura Nickel has a history going back to the 1950s when it was developed by Anglo American Plc (AAL:LON). It ran very solidly and profitably for most of its existence. It’s an exciting time for Mwana.
TGR: I noticed that it had a fairly dramatic jump in its share price this month. What was that about?
CG: That was the closure of the Bindura rights issue. When the announcement came out that an agreement had been reached, the money had been raised and that it was closed, it moved Bindura from an asset that is on care and maintenance and costing the best part of $1M a month currently, to one that should instead be cash-flow positive situation within the space of a couple of years.
TGR: Mwana is a multi-commodity company. What else is it mining?
CG: It has two other major assets in the DRC—one copper and one gold.
The first is Zani-Kodo in northeast DRC. It is an exploration asset with about 2 million ounces (Moz) gold proved up. It’s located between AngloGold Ashanti Ltd.’s (AU:NYSE) Mongbwalu and Randgold Resources Ltd.’s (GOLD:NASDAQ) Kibali prospects. It’s probably some of the easiest exploration that I’ve ever seen. The company expects to be able to increase its resource by 50% a year for the next couple of years. At that point, it will be a very significant resource on a global scale.
The other asset is SEMHKAT in the DRC’s copper belt. It is a vast area that has shown indications of copper mineralization. However, it is almost an asset too far for Mwana. It gets the least attention. At any other company, it would have probably been a lead asset, but in Mwana it has had to queue up behind Freda Rebecca, Bindura Nickel and Zani-Kodo for attention.
The company has done a couple of joint ventures at SEMHKAT. It has an original joint venture with Anglo American and a joint venture with Chinese company Zhejiang Hailiang Co. Ltd., which it announced in August. Hailiang will put about $25–40M into the ground and take a majority interest. Mwana will be left with a non-dilutable 38% interest. As a result, SEMHKAT has moved from an asset that was very difficult to value because it was just prospectivity in the ground, to suddenly an asset that can be valued in pounds, shillings and pence.
TGR: It certainly has a lot for only having a $100M market cap. I’m blown away at the possibilities there.
CG: This management team has a track record of working in these sorts of jurisdictions. Look at Freda Rebecca in Zimbabwe, where the company got a mine it rehabilitated back into profitable production with 70 Koz/year.
TGR: Now they’re doing it again.
CG: That’s the idea. A track record like that is worth a lot.
TGR: Let’s leave Africa and talk about Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL).
CG: While developing and operating a mine in Argentina does currently present some challenges, the Don Nicolas project is in a very mine-friendly province and Minera is halfway through the permitting process. The company also appears to have the support of local communities by recently signing a 10-year surface rights agreement.
I don’t believe there will be nationalization of junior mining companies in Argentina. The government needs foreign investment and is probably not interested in owning and operating mines. More likely, they will do what governments do best and simply take its cut in the form of taxes and royalties.
As for Minera as an investment vehicle, the company has an excellent management team with a proven track record and some fantastic assets within mine-friendly locations.
TGR: Do you have any wisdom for investors on how to navigate the precious metal equity space?
CG: With commodities, you always have a choice in which commodity you’re going to invest. It’s worth being aware of the macroeconomic qualities and profile that those commodities have. There is a spectrum. If you looked in the ’90s, someone would probably think that all commodities dance to the same tune. We’re not in that macroeconomic environment at the moment. The environment we’re in at the moment is one of stagflation, where the economy is struggling to grow and where there are question marks over the value of paper currency. I would strongly recommend that investors be weighted toward the precious end of that spectrum at the current time. The other thing is to spread risk, particularly with the juniors. Be aware of the risk profile of companies; there’s no substitute for research and don’t buy just two or three stocks. That’s fine if you’re investing in the majors, but you need to diversify more than that if you’re speculating in the junior space.
TGR: Well, Charlie, thank you so much. We certainly gleaned a lot of intelligence.
Charles Gibson is the head of mining for Edison Investment Research in London. A chemist by academic training, Gibson spent a decade in the City as a mining analyst at Cazenove and a specialist mining salesman at T Hoare Canaccord, before joining Edison. He has extensive media experience, having written for MoneyWeek and The Business magazines and The Evening Standard. Gibson is a leading authority on mining and guest presents from time to time for LBC radio on financial and business matters.
Investor fears about mining stocks are misplaced, says James Passin, a hedge fund manager with New York-based Firebird Management, especially if those companies are mining in Mongolia. Firebird manages a portfolio of private equity funds that invest in Mongolia, one of the fastest growing economies with some of the most extensive, untapped resources in the world. The country is already home to the largest copper deposit and in this exclusive Gold Report interview, Passin explains why there is potential for dozens more similar finds.
The Gold Report: James, the Bank of England (BOE), the European Central Bank (ECB) and the People’s Bank of China have made moves to boost flagging economies. The BOE added £50 million to its quantitative easing program. The ECB reduced its key lending rate to a record low of 0.75%. China cut its key lending rate for the second time in a month to prevent a further slump in manufacturing and a fall in property values. What effect will these moves have on the gold price through year-end?
James Passin: It’s clear that loosening monetary conditions will stimulate commodity prices generally and will eventually support the beginning of a great inflationary wave. In the short term, it’s impossible to call, as strong deflationary pressures are emanating out of weak economic conditions and deleveraging. Gold, while far less popular than in recent years, is still a widely held asset of hedge funds. The consequence is that it’s harder for gold to have any kind of sustainable short-term reaction to changes in monetary conditions.
TGR: Gold is trading around $1,600/ounce (oz) right now. Will it hold?
JP: It could potentially test the lower ranges, but it feels as if it’s building a strong base and could start to move higher toward the end of the year.
TGR: Will China’s lending rate cut affect the pricing of base metals and other bulk commodities, like copper and iron ore?
JP: China is facing significant domestic economic headwinds. I’m skeptical that the recent move in itself is going to be enough to have any kind of significant sustainable increase in base metal prices. Longer term, I’m optimistic about China’s ability to engineer an economic recovery.
At the same time, my view is that interest rates will remain negative in real terms and will generally be stimulative and supportive to commodity prices, including base metal prices.
TGR: Will China’s rate cut have an impact on the Mongolian economy?
JP: It’s hard to say. The more important question is: To what extent will China’s monetary and credit policy offset the weakening trends in the Chinese economy? The Mongolian economy will be dramatically impacted by Chinese economic conditions.
TGR: What’s happening in Mongolia in terms of growth and opportunities?
JP: Mongolia is the fastest growing economy in the world. The economy has been compounding at almost 20% in real terms. There’s a lot of evidence that the real gross domestic product (GDP) is a lot higher, due to unreported economic activity. The trends underpinning this growth are still intact and the economy is growing from a very low base. It’s likely, if not inevitable, that Mongolia’s economy will continue to compound at an extraordinarily high real rate of return for the next several decades.
TGR: What other countries would you compare Mongolia’s growth trajectory to?
JP: Looking back to the beginning of the great oil boom in the Gulf countries, such as Kuwait, there is similar economic potential and a similar population base, too. Those economies grew from very small bases to become substantial and important from a global perspective. This was driven by the export of oil, but also from sustainable policies of building up sovereign wealth funds and maintaining strong sovereign balance sheets.
“Mongolia is the fastest growing economy in the world.”
Mongolia has other attributes that might even lead to more rapid and sustainable growth, which includes its very strong democratic political system, the breadth of literacy, its natural entrepreneurism and its proximity to some of the most dynamic economies in the world, such as China.
Present day, it’s very hard to find other countries that have similar potential. The countries that look interesting today—Myanmar, North Korea—have various issues and problems, but also very exciting attributes.
Mongolia is an early-stage frontier market with many of the problems typically associated with developing countries. But, it also has a fairly advanced civil and political infrastructure. Its unique setting will enable Mongolia to continue to compound at extraordinarily high rates of growth—rates of growth that are going to continue to attract both strategic and portfolio investors.
TGR: But if China sneezes, Mongolia gets a cold. If China’s growth drops to 7% this year instead of its projected 8%, how much is that felt in Mongolia?
JP: There is a very high correlation between Mongolian exports and Chinese demand. There is a very quick pass-through mechanism from China to Mongolia. Even a moderate slowdown in Chinese growth could have a disproportionate effect on Mongolia.
However, the Mongolian banking system is much stronger than it was during the global financial crisis. The sovereign balance sheet is strong relative to the size of the economy. The likelihood of Mongolia having any kind of severe crisis or systemic existential problems is quite low—even if there is a more dramatic deceleration in the Chinese economy.
TGR: Is China one of the bigger contributors of foreign direct investment (FDI) in Mongolia?
JP: Absolutely, China is a significant contributor of FDI in Mongolia. From 1990 to 2010, China was responsible for about 50% of its FDI.
FDI from China is quite controversial. In fact, a law was recently approved by parliament that is directed at regulating FDI primarily from China. These days, a lot of the FDI is flowing from Canada, Australia, Japan, South Korea, Europe and the U.S. China is a large contributor to FDI, but it’s not the dominant contributor. However, FDI is primarily facilitating the construction infrastructure needed to deliver raw materials to China. So, ultimately, the FDI story is still very much China-driven.
TGR: How would you compare the investment risks in Mongolia with the investment risk in countries like Kazakhstan, Uzbekistan and Turkmenistan?
JP: I know Central Asia quite well, having traveled extensively throughout the region over the last 15 years and having deployed capital in various equity plays in Kazakhstan. While we historically generated significant net returns investing in Canadian-listed companies that were de facto vehicles for the Kazakh elite, we do think that Mongolia alone of all Central Asian countries has the potential to develop a deep and globally significant domestic capital market. One of the key facts to remember is that Mongolia is a democracy. A democracy is arguably inherently more stable than a dictatorship or a de facto kingdom—at least to the extent that greater transparency builds confidence in financial markets and policies enable broader participation in domestic wealth creation.
TGR: One interesting case study on risk in those types of places versus Mongolia is Centerra Gold Inc. (CG:TSX; CAGDF:OTCPK). Centerra has had all sorts of problems with the government in the Kyrgyz Republic, including getting permits for its Kumtor gold mine. Centerra also has two gold operations in Mongolia. It’s diversifying the risk of Kyrgyz by operating in a more favorable jurisdiction.
JP: The political landscape in the Kyrgyz Republic is very difficult to navigate.
Mongolia is the 18th largest country in the world by size. It’s sitting on the continental subduction zone between the Asian and Indian subcontinents. It hosts some of the world’s most prolific mineral belts with some of the world’s largest known undeveloped mineral deposits, some of which are just beginning to get into early phases of production. The exploration is just scratching the surface.
“Mongolia hosts some of the world’s most prolific mineral belts with some of the world’s largest known undeveloped mineral deposits.”
Some geologists talk about the possible existence of 20 or 30 Oyu Tolgoi-type deposits in Mongolia—not to mention the other minerals from iron to uranium to silver to molybdenum. There are also remnants of a sea, the origin of coal-bearing sedimentary basins, with projected 100 billion tons (Bt) thermal coal and 30 Bt coking coal, as well as hydrocarbon potential.
The mineral potential is already in the trillions of dollars and the true value is probably in the tens or even hundreds of trillions of dollars. It really is an incomparable destination for strategic investors.
TGR: Another major factor is that very little of the country has been exposed to advanced exploration techniques.
JP: Many of the existing surveys were conducted by the Soviet Union 50 years ago, when surveying exploration technology was quite primitive. Some of the new tools are very powerful, leading to the ability to make new discoveries and to drill to deeper targets at lower costs. New satellite tools can even conduct imagery from space.
Our private equity business has control of certain mineral exploration licenses and has conducted a number of exploration programs. My personal experience is that the application of modern exploration technology and practices to exploration programs in Mongolia has led to very significant discoveries. The size of Mongolia is so vast that the new generation of exploration is just starting.
TGR: Has the development of Oyu Tolgoi (which translates to “turquoise hill”), by Rio Tinto Plc (RIO:NYSE; RIO:ASX) and Ivanhoe Mines Ltd. (IVN:TSX; IVN:NYSE), put Mongolia on the radar screens of investors?
JP: Absolutely. By following Ivanhoe back in 2004, it led me to look at Mongolia’s long-term potential. Robert Friedland’s success in negotiating a strategic investment agreement with the Mongolian government enabled the financing and development of the project, which is almost close to beginning pilot production.
The long-term increase and capture of new employment and the feedback effects of all the economic activity will have an unpredictable impact on the Mongolian economy. It will cause interest rates to trend down and make funding costs cheaper, which will lower hurdles for businesses and enable them to fund more marginal projects and business opportunities in all sectors. That will result in more tax revenue for the government to build infrastructure, including rail, road and power transmission and distribution, that will help to lower the cost of manufacturing and transportation costs, which will help to boost productivity.
There will be more and more world-class mineral deposits defined, discovered, developed and brought into production. That will trigger the development of all kinds of related businesses that will benefit from the higher level of economic activity. This feedback effect is going to drive the exponential real compounding growth in Mongolia’s GDP. It will also lead to one of the greatest increases in GDP per capita in world history over a relatively short period.
TGR: Oyu Tolgoi is the biggest copper deposit in the world, but it also contains 21 million ounces of gold. Have there been any other significant discoveries besides Oyu Tolgoi that you could tell us about?
JP: A lot of projects that we’re monitoring look quite exciting, for example, Sharyn Gol JSC (SHG:MSE), a Mongolian Stock Exchange-listed company that Firebird took control of in 2010. It was nearly insolvent and had a market cap of $8 million when we took control of the company. We provided a line of credit that enabled the company to drill its license area, resulting in a 12x increase in known resources and the receipt of a Joint Ore Reserves Committee compliant resource of 374 million tons, 80% of which is open pittable.
It’s just one example of modern exploration technology used at a legacy deposit. We’ve had additional success investing in the rehabilitation of legacy brownfield mines. We also have a number of greenfield exploration programs.
Considering the prospectivity of Mongolia and the infrastructure that is starting to be built, it may be worthwhile for professional investors to consider chasing some of these exploration projects.
TGR: You’re chairman of Undur Tolgoi Minerals Inc. (UTM:CNSX), in which your firm has a significant position. Can you update us on its early exploration?
JP: Undur Tolgoi was founded by Firebird. We took the company public through a reverse takeover. The company controls a mineral exploration license of over 9,620 hectors in Mongolia’s Gobi Desert. It’s on the edge of the Devonian arc, which is the right address for potential copper-gold porphyry systems.
It’s an early-stage exploration program. The company has conducted ground samples and gravity and magnetic surveys and is about to launch an induced polarization survey. There’s potential for some high-grade epithermal veins that could be very interesting near surface. However, we are primarily looking for deeper, larger disseminated mineralization systems.
TGR: Are there any other significant companies that are developing gold projects in Mongolia?
JP: There are some interesting gold projects and properties that are privately controlled by Mongolian groups or in partnerships with foreign groups. I can’t point to a particular listed company offshore that has a world-class gold property, but there are some very interesting gold properties in Mongolia.
TGR: What about other metals?
JP: Some well-known properties that look pretty interesting are in various stages of development—some large iron ore deposits and molybdenum.
TGR: The market is of a risk-off sentiment right now. Many investors have taken a defensive strategy in their investment portfolios. Why should they abandon at least a portion of that tact to invest in what’s perceived to be very risky commodity play?
JP: In an environment where people are willing to loan trillions of dollars to governments with returns approaching zero and effectively negative interest rates in real terms, who am I to argue about risk versus return? In an environment where every central bank is in a race to zero interest rates and the solution to fiscal imbalances is to monetize that through printing money, it seems to me that the great risk is hyperinflation. In highly inflationary environments, it’s better to be in equity. And it’s even better to be in mining-related equities. There’s a risk to not being invested in mining companies.
“This might prove to be the historic moment to deploy capital in a country like Mongolia.”
In early-stage frontier markets, like Mongolia or Africa, the risk is to get in too late. Getting in too early, even with small amounts of capital, enables investors to enjoy the initial appreciation before the investment story becomes clear.
During environments of fear, uncertainty and risk aversion, that’s when there are great bargains for those willing to provide capital and to finance deals and transactions. This might prove to be the historic moment to deploy capital in a country like Mongolia.
TGR: Thanks for sharing your insights with us.
James Passin joined Firebird in 1999. He co-founded and manages Firebird Global Fund, Firebird Global Fund II, Firebird Mongolia Fund and Firebird New Mongolia Fund. Passin is a graduate of St. John’s College, where he majored in philosophy and classical literature. He serves on the board of directors of several Mongolian and Canadian companies, including Sharyn Gol JSC, Baganuur JSC, BDSec JSC, National Investment Bank of Mongolia and Undur Tolgoi Minerals Inc. Passin is also the chairman and CEO of Vanoil Energy Ltd., a Canadian oil exploration company focused on Kenya and Rwanda, and the non-executive chairman of Fluormin Plc, a UK company listed on the London Stock Exchange’s Alternative Investment Market. Passin was named “Fund Manager of the Year” at the 2012 Mines and Money Conference in Hong Kong.
Ken Booth has been involved in the mining industry for 30 years and sees the past two decades of quiet, stable growth that Cambodia has enjoyed out of the world’s economic spotlight as an opportunity for investors. The once ignored country has highly prospective geology, an emerging exploration services industry and a mining-friendly legal framework. In this exclusive interview with The Gold Report, Booth discusses why Cambodia should not be ignored by investors seeking first mover advantage and names companies who are poised to profit.
The Gold Report: Why should investors pay attention to Cambodia?
Ken Booth: Because of political forces, Cambodia was forgotten and ignored. The French explored during its colonial period in Vietnam and other parts of Southeast Asia. That information was lost. The Australians explored Southeast Asia, but focused more on Indonesia, closer to its backyard. The political strife that ended in the mid-1980s further stopped foreign investment in Cambodia and it became a forgotten place.
While things were quiet in Cambodia, the past 20 years have seen significant exploration and development in Vietnam, Laos and Thailand. As a result, Laos has a world-class copper mine and a producing gold mine. Those countries share many geological similarities to Cambodia. For now, there isn’t a big database of exploration results for Cambodia. But the country should be on people’s maps for mining exploration. And it is beginning to be.
TGR: What types of deposits are explorers searching for? Gold? Copper?
KB: From a commercially viable point of view, the targets are copper, copper/gold systems and epithermal precious metal systems. That is true of the east and central areas of the country. In the western regions on the border with Thailand, small-scale miners have been extracting precious and semi-precious stones for decades.
TGR: So what’s the situation with regard to exploration in Cambodia right now? Is it a greenfield?
KB: It would be considered greenfields, but some initial work has been done. Some geological maps are available. Initial exploration is not too difficult—it’s fairly easy to get around. We’re not talking about difficult physiography. First-stage exploration can be done rapidly through stream-sediment sampling and geophysics. Modern exploration would be considered greenfield.
Interestingly, on the eastern border with Vietnam, there has been significant small-scale and artisanal mining over the past 10 years. That activity does not appear to be historical and seems to be on the decline. Many of the miners cross the border illegally; it is a fairly porous border. The miners mine the alluvial material down to hard rock.
TGR: In those areas, do companies follow the small-scale miners to the most prospective areas?
KB: Yes. There are many forces at work in this situation. The border is tightening up. A lot of those small miners don’t use the best environmental mining practices and many use mercury. The Cambodian government is in the process of removing many of these people off the properties, pushing them back into Vietnam. The good news is the miners have exposed veins at surface, or they’ve excavated pits and you can get to hard rock or regolith. Clearly, they are extracting gold out of the alluvium and out of the veins, so the miners are also benefiting while doing the prep work for the modern explorers.
TGR: Does this put the mining companies and the government in the path of conflict with the local population?
KB: The Cambodian government is encouraging economic development on all fronts. It looks around the world and sees how mining has benefited a lot of countries. The government is making positive moves toward resource development. With mineral resources, the government is proactive in making sure that illegal miners—especially the ones who have crossed over the border—are moved off the land. That places the government in a good position to work with companies. If a company has a memorandum of understanding with the government on a particular piece of ground, the government will support the company in its endeavors. In those cases, the government will resolve the issues with illegal mining. Most of the small-scale mining is alluvial, which is very different from the mining exploration that public companies are engaged in.
TGR: In the past, you have discussed Angkor Gold Corp. (ANK:TSX.V). What is new there?
KB: Angkor Gold is one of the most active companies in Cambodia. The other significant company is Renaissance Minerals Ltd. (RNS:ASX) from Australia, which recently purchased a 750,000 ounce (750 Koz) gold deposit from OZ Minerals Ltd. (OZL:ASX) Those are the companies that are the most proactive explorers in Cambodia. I’ve heard that there are Chinese-backed private entities working within the country, but I don’t have any knowledge as to who they are or what they’re looking for. Angkor Gold’s main focus is exploration for gold, copper and copper-gold systems while Renaissance Minerals’ main focus is developing its 750 Koz gold resource.
TGR: Angkor Gold is an early-stage exploration company. With so many projects, how do you value the company?
KB: Angkor Gold has a lot of projects. The beauty about going into a country like Cambodia at this stage of the game is you get to be the first mover. The best company to bet on is the first mover that gets in and acquires the most prospective land. Angkor Gold has used its in-country managers, who have had experience in Cambodia over the last decade, to claim or apply for large tracts of land in order to ensure that it is the first mover. Over time, as exploration companies explore their land packages, less prospective areas will be dropped. While Angkor Gold looks as if it has a lot of land, and it does, it’s only from the point of view of saying, “I’ve got six or seven areas here I really think are prospective, I want to make sure I have those.” And as it works those properties, hopefully it will be successful on one or more. But, that land position will change dynamically over time.
TGR: What would be the timeline to get a resource estimate in this situation?
KB: Faster than you might think. Cambodia has four drilling companies and three assay labs. I believe two of those assay labs are accredited for reporting under the Australian reporting system as well as under Canadian NI 43-101 policies. Drillers and labs are busy, but they exist. The large labor force is not a problem; people are available and ready to work. Infrastructure is good and improving.
Getting to a resource is no worse than in a first-tier mining jurisdiction like the U.S., Canada, Mexico or Peru. In fact, you could be slightly ahead just by virtue of not having to compete for labor and potentially less bureaucratic red tape than in more developed countries. If a company is looking at a small vein-style deposit, it can probably develop the resource in fairly short time. If it is trying to drill off a resource in a large copper-porphyry system, that will take a lot longer, just by virtue of it being a much larger target.
TGR: Many sources state that Cambodia has a stable legal and regulatory framework. The mining law was written about 10 years ago, so it is still young. Can you comment?
KB: The legal system was developed with external advisers to ensure that it could be used by foreigners who wanted to invest within the country to protect property and individual rights. For a country that has a fairly new legal system, it appears to be good. The same applies to the mining law.
In creating legal systems, many developing countries rely on the expertise of people and legal systems from other jurisdictions. It seems to work well. It is an open system with clear rules spelled out in the memorandum of understanding. Companies can apply for small acreage or large acreage. But either way, exactly how to make the application and then what companies have to do to keep their tenure are well defined. It is an open and transparent legal system and mining law.
TGR: What are your thoughts on how an investor should participate in Cambodia?
KB: Investors should align themselves with managers that understand resource development in emerging jurisdictions. Investors need to realize that if they are in early, they have the potential for outsized rewards—if they pick the right managers. Early investment in a country like Cambodia needs to be managed by people who understand the initial foray into the country by companies like Angkor Gold, Oz Minerals and now Renaissance Minerals. Those initial prospects may generate gains when sold to developers.
In all these countries, people have their views on where they’ve come from and how bad the situation was. But the most important thing is to understand where they are today. Resource investors who get in early should do well. But they need an appetite for risk.
I consider Cambodia to be in its infancy, and it has not been explored to any great degree. There are similar stories of ignored countries in Africa including Somalia, Sierra Leone and the Democratic Republic of the Congo. We’ve got an example close by in Colombia. Fifteen years ago, exploring for gold in the Colombian jungle would have been considered crazy. Now Colombia is a major destination for exploration.
TGR: At this point, do you have an idea of what fraction of Cambodia has been explored?
KB: Oh, I would put it down to less than 5%.
TGR: There’s a lot of room for exploration still.
KB: A lot of room for exploration. Here is how I think it will play out. Somewhere, there will be a success or a discovery. You will see additional modern techniques applied on a large scale countrywide. How much has been explored? Well, a relatively small percentage, because it’s all being done using tried-and-true methods—feet on the ground, mapping and sampling. When larger surveys, such as airborne geophysics, start to highlight prospective areas, things could really open up.
TGR: What thoughts would you like to leave with the readers?
KB: If investors are looking for a company that’s early stage and prospective, they should look at Angkor Gold. If investors are looking for a country that is early stage and prospective, they should look at Cambodia. It is a mining-friendly jurisdiction. Investment is coming to the country and infrastructure is improving. As an investor or a company, the “first mover” gets the pick of the litter. And I think Angkor Gold has definitely done a good job on that. Investors should pay attention to both Cambodia and Angkor Gold.
TGR: Thanks for taking the time to talk to us.
Ken Booth has more than 30 years of experience in exploration, mining corporate finance and public company administration. In mining corporate finance, he has worked for two of Canada’s largest investment banks executing numerous equity financings for both junior and senior companies and was involved in a variety of significant mergers and acquisitions. While working for resource companies, Booth has held several positions including CEO and vice president of corporate development. He is currently providing financial advice to the junior mining sector and is a director of four exploration companies.
Mongolia, which is not on most investment menus, could soon become famous for much more than Ghengis Khan. Sandwiched between China and Russia, with a land area one-sixth that of the U.S., it has a population of less than three million, yet holds the potential for developing into a major minerals producer. With national elections on June 28, in this exclusive interview with The Gold Report, Eric Zurrin, CEO of Resource Investment Capital Ltd., who lives and works mainly in Mongolia, gives us an insider’s view of what’s going on in this true land of opportunity for investors who recognize its huge potential. He also talks about several of his favorite companies that could profit from the vast mineral riches hidden under the Mongolian steppes.
The Gold Report: Thanks for joining us today, Eric. Mongolia has a population of fewer than 3 million people and most investors don’t really have it on their radar. Why do you think they should and how did you happen to become involved in that country’s investment markets?
Eric Zurrin: Mongolia will be one of the key global mining stories for the next 20 years. It’s a simple story driven by emerging market demand for resources, primarily from China, which accounts for 90% of Mongolia’s exports. The importance for investors is the speed of the country’s growth and how to get exposure to it. In the first quarter of 2012, gross domestic product (GDP) grew by 17% real, 30% nominal (year-on-year Q1 growth). For 2011, real growth was 8%, but we’re expecting to see real growth of 15% in 2012. So as an investment destination, particularly in today’s climate of lower global growth, Mongolia is extremely attractive.
I found myself in Mongolia due to my mining background in investment banking going back for the last 10 years in North America and Europe. I came out of the UBS mining team in London and have been backed by a private equity group called Origo Partners Plc (OPP:LSE), which is a listed investment company with about $125 million (M) of net asset value invested in Mongolia. The group is in Mongolia, led by Luke Leslie, who was a colleague at UBS.
“Mongolia will be one of the key global mining stories for the next 20 years.”
TGR: So what does Resource Investment Capital Ltd. do in Mongolia?
EZ: Resource Investment Capital (ResCap) is a corporate finance advisory boutique linking international capital with domestic investment opportunities. We are also one of the top three securities traders on the Mongolian Stock Exchange (MSE) and recently started investing proprietary capital alongside investors in private deals that we bring to the local stock market. Luke Leslie at Origo Partners made his first investment in Mongolia buying out Oleg Deripaska’s Mongolian coal interests for $15M. The value of this holding has increased 5.8x at the last capital raise. I joined Luke in Mongolia in 2010 after forming Rescap together and seeding it with initial capital. I now spend most of my time in Mongolia and I am long the local property market in Ulaanbaatar, which itself has been a lucrative investment on its own. There’s no better way to get your hands dirty and to fully understand the opportunities than to be on the ground and see the flow of inbound investors and outbound opportunities, both inside and outside of the mining space.
TGR: It seems that Mongolia first got on the horizon when my old friend, Bob Friedland, became involved there through Ivanhoe Mines Ltd. (IVN:TSX; IVN:NYSE) over 10 years ago. He was probably one of the early pioneers in getting Western companies to exploit Mongolia’s natural resources. Then, Ivanhoe came up with that huge Oyu Tolgoi project. What’s happening there?
EZ: Friedland has been involved in Mongolia for about 15 years, and he is undoubtedly one of the early visionaries for frontier resource investors. Ivanhoe Mines owns 66% of Oyu Tolgoi, the world’s second largest, undeveloped copper-gold asset, which goes into production at the start of Q4/12. Oyu Tolgoi is one of the world’s great copper assets. It is the backbone of the Mongolian economy and will be for the next 50–60 years. The capital expenditure bill at Oyu Tolgoi is $7 billion (B), of which 80% has already been spent. It has 100% financing guarantees by the current majority owner of Ivanhoe, which is Rio Tinto (RIO:NYSE; RIO:ASX), the bellwether mining investor and mining company that is underwriting its share of Ivanhoe’s current $1.8 billion rights issue. This gives us comfort that the operation will be there over many decades.
In its first 10 years, Oyu Tolgoi will produce 650,000 ounces gold and 600,000 tons copper annually, and, importantly for Mongolia, will result in billions of dollars of royalties and taxes for Mongolia. Oyu Tolgoi will come to dominate Rio Tinto’s copper portfolio. Rio has over a 50% interest in Ivanhoe, controls the board and the management, and has essentially taken over Ivanhoe. We think it’s probably not too far away from a full takeout of the minority positions as Oyu Tolgoi comes into production and once a new government is formed after the national election on June 28.
TGR: I noticed that Bob Friedland isn’t anywhere to be found on the Ivanhoe website. I thought he would at least be on the board of directors.
EZ: It’s a very recent change. His official title now is Founder of Ivanhoe and Oyu Tolgoi, but he’s no longer in management or on the board. We think there’s still one more really interesting chapter in the Rio Tinto/Ivanhoe/Oyu Tolgoi’s book that’s being written as we proceed—that being the takeover of Ivanhoe.
TGR: Of course, Bob has never been one to turn down a good deal. He can take credit for being the founder, take the money and do something else with it.
EZ: You’re absolutely right.
TGR: It seems as if there was a little finagling last year between Mongolia and this project over how much Mongolia was going to end up getting out of it.
EZ: That is correct. Last October, headlines coming out of Mongolia talked about the Oyu Tolgoi interest increasing to the Mongolian government. A new foreign investment law has been passed, after considerable watering down by local and foreign businesses. A former prime minister and president has been arrested and is on trial. These are important domestic political issues in the context of a national election that takes place June 28. This will be one of the most important events in Mongolian history. It will set the government up for the next four years and, likely, for the next two to three terms of government, as the incumbents ride the tide of what will be incredible growth in one of the fastest-growing countries in the world. This is a fiercely competed election.
TGR: What’s at stake? Are there competing factions that have some drastically different ideas? Or is it just about who gets to pull the strings?
EZ: There are two leading parties, the Democratic Party and the Mongolian People’s Party. Both are pro-business; both share very similar ideologies and a similar mandate. Three of the last four governments became coalitions, despite one of the parties typically having a majority. At the last election, the coalition controlled 90% of the Parliament and set out a framework with consensus decision makers. Although it takes a lot longer to get things done in Mongolia because of this process, it does set out widely adopted and endorsed policies that guide the country forward.
TGR: What’s the level of corruption or lack of corruption in Mongolia? How straightforward is its system?
EZ: In any frontier market, you’re always going to see some issues around corruption. Mongolia’s democracy is only 20 years old and is going through growing pains. It’s setting out rules and being increasingly strict to the letter of the law around keeping all businesses and politicians in line with Western standards. As more foreign investors and money come into the country, those are subject to rules in the U.S., the UK and Australia, which have their own corruption standards and bribery acts. These are now being brought into Mongolia as adopted standards.
TGR: It sounds as if Mongolia actually had an opportunity to build a system from the ground up without decades or centuries of corruption in place.
EZ: It’s obviously a sensitive topic and one that we’ve seen across Africa, Russia, China and Kazakhstan. Because of the size and scale of some of these mining projects, the incentives just become far too distant from the reality of the people setting up policy and rules. What you have are these massive projects being governed by individuals who are sometimes being paid $800/month, and signing off on $1B checks. There’s a massive disconnect there, which is coming into line in Mongolia. The rules being put into place are all great steps forward for the country.
TGR: How strong is China’s influence on what’s going on in Mongolia as far as the development and maybe even the government?
EZ: Mongolia’s lifeblood is essentially China—90% of the exports last year were China-bound, but China is also Mongolia’s Achilles’ heel. Mongolia finds itself land-locked between two of the biggest political giants in the world, Russia and China. To the south, the Chinese share nearly a 5,000 kilometer (km) border with Mongolia and have the strongest hand of anyone because the Chinese are the only consumers at the moment, and likely to be for a while, of Mongolia’s exports. Mongolia is 1,500km from the nearest seaport, which is in China.
To the north is Russia. Ulaanbaatar, Mongolia’s capital, literally means red hero. The Great Wall of China was built centuries ago to keep Mongolia’s national hero, Genghis Khan, out of China. So there’s a long history between the three countries. Unfortunately, China is essentially calling the shots on some of Mongolia’s commodities pricing. Mongolia is a price-taker to the Chinese who pay about $0.50 on the dollar for coking and thermal coal versus what it would pay to the Australians or Canadians for the same seaborne coal delivered to the ports on the Eastern Chinese Coast.
TGR: So China really calls the shots, because it’s the only reasonable buyer in sight at this point.
EZ: It is. Mongolia will finally begin building 5,000km of rail that will provide an alternative route for Mongolian commodities up through the far eastern Russian ports in Vladivostok and Vostochny. When that day comes, the valuation argument on many of the Mongolian commodity companies will be incredible because it will essentially reset the selling price of what they’re producing to a much higher level.
TGR: Let’s talk about some individual investment opportunities that our readers might be interested in taking a look at.
EZ: I’ll kick off with Ivanhoe. I can’t stress it enough. The current share price around $10/share implies about a $7.5B market cap. Put that in the context of the cash flow that is essentially underwritten, fully financed and near term from Oyu Tolgoi, with copper-gold coming out of the ground at next to zero or negative cash costs for the next 50–60 years. This is a near-term production story just months away. Now, put the $5B in revenue this project will see in only a couple of years, as it ramps up, into context with the other assets in the Ivanhoe portfolio.
These include SouthGobi Resources Inc. (SGQ:TSX; SGQRF:OTCBB) and Ivanhoe Australia Ltd. (IVA:TSX; IVA:ASX). Combine those two and some other peripheral assets and the Ivanhoe stable is probably $1–1.5B in value. Adding the sum of the parts, excluding the peripheral assets, it’s essentially valuing Oyu Tolgoi at $5–6B, less than the $7B capital that’s been put into the ground. It’s hard to see how Ivanhoe can get any cheaper. Rio Tinto obviously understands how good this company is and has been out in the market buying shares as high as $25 not too long ago. I don’t think Rio will delay the inevitable by doing a creeping takeover over many years. This will be a play that it just has to get its hands on quickly and at the right time and price. Rio Tinto is really an iron ore company with a mix of other commodities, when you look its commodity portfolio. Some 75% of its cash flow is from its iron ore assets. Oyu Tolgoi is a tier one global mining asset and goes a long way to solving a commodity diversification problem for Rio. So that’s Ivanhoe for you.
TGR: What else do you like?
EZ: In the copper-gold space, there’s one that we know quite well, Kincora Copper Ltd. (KCC:TSX.V), which listed last summer. We are a small shareholder in Kincora. The company holds a former Ivanhoe group of licenses in the South Gobi, about 140km northeast of Oyu Tolgoi and on the same copper-gold belt. Kincora is a vast exploration copper-gold company. It’s well known in Mongolia. It has a known and very large porphyry system, spanning about 7km across. There have now been about 100 holes drilled over the last decade in Kincora’s license area known as Bronze Fox and it was one of the top three priority targets, along with Oyu Tolgoi and one other in Mongolia, which Ivanhoe was exploring five or six years ago, before Ivanhoe was forced to succumb to political pressure to relinquish a significant part of its Mongolian land holding in order to advance Oyu Tolgoi with government support.
Robert Friedland in a famous quote once said that Oyu Tolgoi and Bronze Fox both kept him awake at night. He was not sure which one, if not both, would end up being the next jewel. He’s discovered Oyu Tolgoi, and we think Bronze Fox is on the cusp and is a fantastic target as well. Just a bit about the company—it has a massive continued mineralization zone, across 7km, completely open at depth. Kincora is now drilling for the high grade having identified an incredible copper-gold porphyry footprint spanning several kilometers. The company is drilling throughout the summer, as many others are in Mongolia. Four rigs are on site with a world-class team of geologists both formerly of Rio Tinto and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK).
The risks on junior miners are always that the high grade is never found and the company suffers a painful, slow existence. To mitigate that while continuing to drill for the next Oyu Tolgoi, Kincora is reviewing plans for a small operation to mine out the copper oxide ore and also reviewing a small operation of the gold and copper sulphide ore. That can be done at low capital cost of under $15M. The company is currently working at a scoping study level with indicative results showing a $10M/year cash flow operation for the next 10 years, which would provide funding for continued exploration without dilution to shareholders. It’s by no means definite and by all means risky, but it is unique in the junior mining space.
A third company I’ll touch on briefly, which we know well, is Undur Tolgoi Minerals Inc. (UTM:CNSX), backed by Firebird Funds, which is a New York private equity fund. Firebird has been in Mongolia for about five years and has sizable investments across much of the coal space and has been involved with Undur Tolgoi for the past year and a half. Undur Tolgoi is an early-stage copper exploration prospect in the South Gobi. It has yet to drill, but it is doing sampling and some seismic work. It’s less advanced than Kincora but also could be a very exciting prospect in the near or medium term.
TGR: When might there be some news on Undur Tolgoi?
EZ: The news flow in Mongolia dries up in the winter other than selective M&A because the temperature goes to -50′C. It’s not a very pleasant place to be managing drill rigs and pipes in the Gobi desert. The drill rigs come out in early April and drill through October/November. The lab results come out in late summer/early fall and into early winter. That’s when the news flows out of some of these companies. We would expect to see news from both Kincora, Undur Tolgoi and potentially even Ivanhoe over late summer, if not sooner, providing an extra bit of volatility to get share prices moving and returns for investors.
TGR: Are you seeing much investor interest in Mongolian resources from around the world? Or is it still not that high profile?
EZ: No, it is. We’ve been on the ground floor for the past two years and we see investors who actually want to be there and come and kick the tires on their own. We’ve seen a cross-section of private family offices, high net worth individuals, commodity traders, big and small companies and sovereign wealth funds coming through the office on a regular basis, looking for opportunities firsthand. Some of these individuals and family offices you never knew even existed. You can’t Google these investors. These are very sophisticated people who understand the risks of frontier markets and are very open to taking that risk on and looking for exceptional returns. Last summer, we had six of the world’s top 250 billionaires literally come through our office. That shows that Mongolia is on the radar of some of the big investors, and they’re coming to take a look for themselves. Some are leaving frustrated because they know something is going to happen but they just can’t quite figure out how to get involved. The smart money investors are finding a way in the end.
“Mongolia is on the radar of some of the big investors, and they’re coming to take a look for themselves.”
TGR: How does the average Mongolian feel about all of this influx of capital and interest?
EZ: Most Mongolians understand the value of foreign investment. There was $5B of foreign direct investment last year versus a GDP of only $8B. Mongolians are seeing their lives change. They are seeing roads and apartments being either built, fixed or completely overhauled. They are seeing the value of wages increase and the ability to travel abroad. Improvements in medical standards and social programs will take longer. But these are all improvements that are well applauded domestically. There is always a small minority of disinterested locals who think foreign investors have no business in their country. Sometimes that becomes the more vocal view, but it’s not the case in Mongolia.
TGR: Pretty much everybody has something to gain other than the people who want to continue living in their yurts and herd animals.
EZ: For example, TavanTolgoi, a 7 billion ton (Bt) coal deposit, which is the world’s largest or second-largest coking coal complex globally, is carved into 1 Bt pieces. One of those pieces is called Tsankhi, which will be listed; 20% is being given outright to Mongolian citizens as a birthright in the form of electronic shares in this company. They haven’t turned into cash yet, but there is the clear opportunity for domestic citizens to be able to participate in the Mongolian growth story along with foreigner investors.
TGR: Can you leave us with some parting thoughts on the investment opportunities in Mongolia and what our readers ought to consider if they decide they want to get involved in the region?
EZ: Mongolia is an investment destination that is too good to be overlooked. It should be a piece of any emerging market investment portfolio, providing exposure to a growth story that has 30% nominal growth and 16–17% real growth, at a time when much of the world is in a very fragile state.
There are a number of ways to get that exposure with varying degrees of risk. You can go as far as being a direct investor in the asset. I personally own real estate in Mongolia. You can do it through listed companies. You can do it through private funds. You can do it by holding cash in a high, 12% deposit rate bank account in some of the most secure banks in Mongolia, which are well-applauded by foreign investors and something we do through the MSE Liquidity Fund that I co-manage with Luke Leslie and have seen eight consecutive months of positive investment returns since inception at an annualized rate of 20% to investors.
We think listed companies are interesting. They’re the safest and most liquid. They are obviously further down the chain in that other investors have participated ahead of the listing. Direct investing comes with its own inherent risk of due diligence, property diligence and illiquidity. The various alternatives are really dependent on individual investor appetites.
TGR: It seems the easiest way for most North American investors would be to invest in U.S. or Canadian companies that have projects going on there. I suppose they can also try to buy things that are listed on the Mongolian Stock Exchange, which we really didn’t get into.
EZ: We’re also putting together private domestic bespoke deals that we’re immediately taking public on the MSE and are just completing our first listing with eye-watering returns for our clients and MSE Liquidity Fund that participated in the private round in February. This is another way for investors to participate. Ultimately, it comes down to the individual risk profile, the need for liquidity and taking a long-term view of Mongolia. Cut away the headlines, the rhetoric and the news ahead of the election, and simply look at the growth and the fantastic tier 1 mines in Mongolia that have already caught the attention of some of the best global mining companies. Look at what this is going to do to a population of 2.8M people with a GDP of only $8B. It’s incredible for a small democracy where the rule of law stands, where there are no religious sectarian views and there’s a very young, ambitious population, with a free-flowing currency and market economy. The recipe doesn’t get much better than that for frontier investing, in my view.
TGR: It is a very interesting situation. Thanks a lot for joining us today.
EZ: I appreciate you having me.
Eric Zurrin is director general of Resource Investment Capital, responsible for its operations in Mongolia and coordinating capital sourcing through partner distribution networks in the international markets. Zurrin joined ResCap in 2010 with nearly 10 years of investment banking experience with UBS Investment Bank’s Global Industrial Group in London and BMO Capital Markets in Toronto and London. Zurrin holds a Bachelor of Commerce degree from the University of Manitoba in Canada.
Precious and base metal companies both have to obey the basic laws of physics and economics to be profitable. In this exclusive interview with The Gold Report, geologist turned analyst Vishal Gupta of Fraser Mackenzie shares names of small-cap companies that could successfully take advantage of unique mineralogy to produce profitable mines.
The Gold Report: You are an analyst and a geologist. Can you explain the fundamentals behind investing in base metals compared to precious metals?
Vishal Gupta: The fundamental difference is that base metals can be fairly straightforward in quantification when it comes to supply-demand balances. The world needs a certain amount of base metals to keep up its growth rate. Growing economies like India and China require base metals for their industrialization initiatives. For instance, copper would be required in electrical wiring and zinc would be required in steel galvanization. There is a specific purpose for base metals in industry.
Gold is valued more from a currency standpoint. There are actually very few uses for gold. That is why it is difficult to quantify the supply-demand balances for gold. This leads to the turmoil we see in the gold market. Any material piece of macroeconomic information that hits newswires will have some sort of an effect on the gold price because it is traded as a currency.
TGR: You have talked about how even when there is a downturn in global economies, jewelry demand remains. Why is that?
VG: I am originally from India and I lived in that country for about 16 years before moving to Canada. India is by far the biggest retail market for gold. The Indian wedding season, which runs from September to December, is typically the high time for gold markets. The reason for this traditional demand for gold in India goes back to what I said about gold being used as a currency. People in India treat gold as a commodity that holds its value better than paper currency. So when they give gifts of gold jewelry, it is because they want to invest in something that is going to hold its value. The result is that in lean times, when the markets are down and unemployment is high, people have that reserve in gold that they can take to the market and sell.
TGR: When North Americans think of investing in gold, we think of investing in maple leaves, gold bars, coins or other physical forms of gold. But in India, they think of purchasing a necklace, bracelet or gold earrings. Is it the same investment dynamic in a different package?
VG: That’s absolutely right. Gold has held its value better than paper currency in the past, especially relative to Indian currency. The Indian rupee has devalued significantly over the last few decades, so people put their faith in a physical commodity, such as gold, rather than the paper currency.
TGR: We’ve seen a lot of volatility in the U.S. stock market. We haven’t seen a whole lot of industrial growth, but the price of copper seems to be holding up right around where it is today at $3.74. Turning to the base metals, what is your outlook on the supply and demand fundamentals for copper going into Q212 and through next year?
VG: I always view copper as the leader of the pack when it comes to base metals. You’ll see in the past, whenever the base metals markets have turned around, copper is the one that has led the charge. We are going into a lean time for commodities right now. However, when the commodity markets do turn around in the next five to six months, driven by the traditional surge in demand for commodities during September/October, I would expect copper to again lead the charge for base metals. Copper is the London Metal Exchange’s flagship metal. Whenever we talk about base metals, we first talk about copper and then we talk about everything else.
TGR: What are the copper equities that most interest you?
VG: One is a base metals company, Foran Mining Corp. (FOM:TSX.V). Its flagship McIlvenna Bay project hosts a volcanogenic massive sulphide (VMS) deposit in the prolific Flin Flon belt of Manitoba-Saskatchewan, on the Saskatchewan side of the border. That region is traditionally known as HudBay Minerals Inc.’s (HBM:TSX; HBM:NYSE) backyard because the major miner has been mining zinc and copper there for over 100 years. Most junior explorers in the area typically form partnerships with HudBay simply because of the major’s regional processing power. Because most of the deposits that the juniors are finding contain 3–5 million tonnes (Mt) of very high-grade ore, these deposits are too small to make building their own plant possible. Foran Mining is currently sitting on a 22 Mt, high-grade zinc and copper deposit at McIlvenna Bay. Going forward, I expect the tonnage to increase to 30 Mt, which would make McIlvenna Bay several times bigger than your average VMS deposit in the Flin Flon belt. Therefore, I believe Foran’s deposit is substantial enough to warrant a stand-alone mining and processing operation, and it should not require HudBay’s partnership to go into production.
I also follow Arian Silver Corp (AGQ:TSX.V; AGQ:AIM), a company active in Zacatecas, Mexico. It trades more than 1 million (M) shares/day on the London’s AIM Exchange. Arian Silver has a 120 million ounce (Moz) silver resource in Zacatecas. In the next year or so, I expect the resource to increase to about 140 Moz.
TGR: What’s the market cap of Arian?
VG: Arian’s market cap is about $95M currently.
TGR: So you really do focus on the small caps.
VG: Yes. My educational background and my work experience are in geology. As a geologist, I believe my maximum value add is analyzing companies at a very early stage where I can use my knowledge to estimate which of the junior companies’ assets have the best odds of becoming producing mines and generating cash flow in the future.
TGR: So you think both Foran and Arian have the mineralogy to be successful mines?
VG: Yes. That is why I cover these two names.
I have been to Arian’s property myself. I see a lot of potential. The resource could conceivably go from the current 120 Moz all the way to the 200–250 Moz range. The next catalyst in Arian’s development is going to be a scoping study on a sovereign mill. It is considering mill options ranging from 750 tonnes per day (tpd) up to 2,000 tonnes per day (2 Ktpd). That decision is going to be made in the next two to three months. Once that decision is made, I would estimate about 18–24 months for this large-scale production scenario to be put into operation.
TGR: Are there other juniors in that area that could be potential acquirers that would use Arian’s ore and put it through their own mill?
VG: Mexico is prime silver country. The best possible scenario for Arian to build shareholder value would be to actually put its own mill into production. That saves it all sorts of operating costs. Obviously, the up-front capital expenditure (capex) is going to be significant. For 750 tpd, you’re looking at about $15–20M in capex; for a 2 Ktpd mill, you’re looking at about $50–55M in capex. But once that investment is in place, I think the benefit to Arian shareholders is going to be tremendous. At a 2 Ktpd production scenario, it is looking at producing about 4.0-4.5 Moz silver/year. That is very significant cash flow.
TGR: How is Arian planning to finance that mill?
VG: If Arian settles on the 750 tpd scenario, a $15–20M capex could potentially all be done through equity financing. But if Arian goes for that $50–55M capex associated with a 2 Ktpd mill, then it will probably pay for it through a combination of debt and equity.
TGR: We didn’t really discuss the investing scenario behind silver. Are you equally bullish on the copper, silver and gold commodity spaces?
VG: I think silver is a very undervalued commodity right now. The market seems to follow what the gold price is doing but silver has so many industrial uses that you can view it as a precious metal or a base metal. Many of the silver names, including First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE), are just starting to come into prominence. Very few silver-only production companies exist today. What is out there is starting to get the value that traditionally has been reserved for gold and base metals.
TGR: What other names do you like either because they are potential acquisition candidates or possess particularly good deposits.
VG: There are a couple of companies that I visited down in Arizona about a month or so ago. One is Redhawk Resources (RDK:TSX; QF7:FSE; RHWKF:OTCQX). It has about 3.5 billion pounds (Blb) of copper in the ground currently at its flagship Copper Creek deposit at a grade of about 1% copper. Management is expected to release a new resource estimate in the next couple of weeks that could push the total resource to about 5 Blb copper. That would put Redhawk on the radar screens of all the consolidators operating in the region.
Arizona is prime copper country. Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) has five operations there. In the adjoining state of New Mexico, it has another couple of operations. ASARCO LLC (AR:NYSE) has two to three operations in that area as well. BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto (RIO:NYSE; RIO:ASX) and Quadra FNX Mining Ltd. (QUX:TSX), now KGHM International Ltd.—all of these players are in the area. They are all looking for sizable copper deposits and, at 5 Blb in-situ copper, Redhawk meets this criteria. I think the mineability of it has to be determined by a major and not by Redhawk itself. I don’t think a junior like Redhawk will be the one to actually put Copper Creek into production because the capex requirements for something like this would be well in excess of $1B.
TGR: But couldn’t one of the existing players in the area just truck the ore to its smelter because some operate already in the area.
VG: That’s absolutely right. That would save a lot of capex requirements and one of the reasons Redhawk is a prime acquisition target for a consolidator in the area that can take advantage of operational synergies.
TGR: Do you think permitting will be a problem? Augusta Resource Group (AZC:TSX; AZC:NYSE.A; A5R:FSE) has had trouble getting its Rosemont mine in Arizona permitted. Does Redhawk have aquifer permits in place, for instance?
VG: Yes, Redhawk does have this permit. And, Augusta has had permitting issues in the past, but recently received a key environmental permit—the Aquifer Protection Permit—for its Rosemont development project. Permitting could be an issue in any jurisdiction. You have to take things on a case-by-case basis.
As a jurisdiction, Arizona is full of open-pit copper mines. That says to me that it is a favorable jurisdiction for copper mining. There could be an odd blip here or there, but the overall scenario in Arizona is very mining friendly.
TGR: You’re an unusual analyst in that you’re bullish on gold and silver and copper. Do you have any other names in the junior space that are interesting to you?
VG: I was going to tell you about the second story that I saw in Arizona. The company’s name is Toro Resources Corp. (TRK:TSX.V). It’s a very small company; it’s trading at about a $4M market cap right now. I usually don’t visit a junior explorer that small, but this has what I call an enriched copper deposit; it’s a supergene blanket, which means it has a higher percentage of copper than most sulphides. This is leachable copper, not millable copper. The capex requirements for leachable copper are much lower than for millable copper.
Toro Resources has the Morgan Peak deposit in Arizona. Within a 5-kilometer (km) radius from it is BHP’s Pinto Valley, Rio Tinto’s Resolution copper mine, Freeport-McMoRan’s Miami mine, Quadra FNX’s (now KGHM International Ltd.) Carlota mine. The best part is that it is on a ridge about 800 meters in elevation higher than all of these other major consolidators in the valleys. All it needs is 100 Mt at 0.4% copper and it could put two valley fill leach pads right on top of the ridge, take the pregnant solution from the leach pad, put it into a pipeline and either go to Carlota’s SX-EW plant or Miami’s SX-EW plant just 5km down the hill. That scenario would save Toro on the overall capex requirements tremendously and would improve the economics of a potential future operation on the deposit. The mineability is very compelling for such a small-cap junior exploration company.
TGR: Interesting. That is certainly a new approach. Just do the leaching and then run it down the hill.
Any final words of wisdom about investing in today’s volatile markets?
VG: I know that the commodity markets have been in great turmoil. People say, oh, gold has fallen from $1,750/ounce (oz) down to about $1,670/oz and the commodities have started coming off now. That is not the case. If you compare where the commodity markets were in 2008–2009 and where the commodity markets are now, we’ve gone through a huge growth spurt. We have found a level where things have stabilized. $1,500/oz gold is ideal for a lot of companies and could lead to a lot more production coming online. Anything over $1,500/oz gold to me is beautiful. When you’re looking to invest in the commodity markets, it helps to have a longer term view. If you have a solid, longer term view on gold, copper or silver, you should make a lot of money.
TGR: Thank you so much, Vishal.
Vishal Gupta is an equity research analyst for Fraser Mackenzie, covering resource exploration companies in the base metals and precious metals space. He holds a Master of Science degree in geology from the University of Toronto. Prior to joining Fraser Mackenzie, he worked in the resource exploration industry as a consulting geologist with Noront Resources, Northern Gold Mining and Nuinsco Resources. Gupta entered the financial community in 2009 with Desjardins Securities as a base metals equity research associate, followed by a brief stay in mining corporate finance at Cormark Securities. Most recently, he held the position of equity research analyst at Dundee Capital Markets covering junior mining companies in the precious metals, base metals and uranium space.
Mining companies face risks in Latin America, from nationalization to skilled labor shortages. The Gold Report sat down with several mining executives whose companies stand out among south-of-the-border silver producers. Sharing their thoughts in our “virtual roundtable” are Ross Beaty, chairman of Pan American Silver Corp.; Mike Callahan, president of Silvermex Resources Ltd.; Jorge Alberto Ganoza Durant, president and CEO of Fortuna Silver Mines Inc.; and Lenic Rodriguez, president and CEO of Aurcana Corporation.
“I’m not concerned about nationalization in Mexico,” Mike Callahan says, “but nationalization and increasing royalties are certainly concerns in other countries. There’s continued talk of putting royalties in Chile and nationalization in other places. And, that’s 3–4% right off the top.
In Jorge Ganoza’s opinion, “Argentina is not a mining country; it’s not a mining jurisdiction. At federal, state and local levels and municipalities, the governments have little understanding of the industry, so there are bigger risks. If you take bigger risks, you need bigger rewards.” Noting that “the cost structure in Argentina is much higher than in Peru,” Ganoza says that Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE) would “really need a compelling reason to go to Argentina.”
Argentina, which has hamstrung Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) in its efforts to capitalize on the Navidad property it acquired from Aquiline Resources in 2010, isn’t alone among Latin American countries exposing miners to jurisdictional risk. How about Peru?
Last June, the Peruvian government pulled the rug out from under Bear Creek Mining Corp. (BCM:TSX.V), canceling the concession it had been granted for its Santa Ana operation. The Santa Ana mine was slated to produce about 47 million ounces (Moz) silver over an 11-year mine life starting this year. Bear Creek has two other projects in Peru. Corani, a silver-lead-zinc deposit that’s nine times larger than Santa Ana but located in a jurisdiction where mining is less contentious, is expected to produce more than 13 Moz silver annually starting in 2014 for the first five years of a 20-year mine life. Bear Creek’s flagship project, Corani, represents 80% of the company’s value on a pure silver basis. Corani is proceeding toward permitting and construction.
According to Ganoza, a fourth-generation miner from a Peruvian family that has owned and operated several underground gold, silver, and base metal mines, “Peru has been, is and will continue to be a mining jurisdiction. But that is a generalization,” he admits. “Parts of Peru are very friendly and amenable to new mine developments. Others aren’t, and Santa Ana is in one such location. Bear Creek knew early on that it would face challenges and took a measured risk. We know what happened. I think the government is committed to a resolution of that problem—that is what it has been communicating consistently—but it will take time.”
Fortuna has been operating its Caylloma mine profitably in Peru since 2007, Ganoza says, having purchased it and related concessions in 2005. After a significant upgrading and modernization of the ore processing plant, the company returned the mine to production and the facilities are operating at a rate of more than 1,000 tons per day (tpd).
Commercial operations at Fortuna’s larger San Jose mine, located in Oaxaca, Mexico, achieved commercial production in September 2011 at a rate of 1,000 tpd. The mine produced 491,000 ounces (491 Koz) silver and 4.6 Koz gold in 2011; for 2012, those figures are expected grow to 1.7 Moz silver and 15 Koz gold. When planned mine expansion and processing plant capacity to 1,500 tpd are complete, annual production is estimated at approximately 3.2 Moz silver and 25 Koz gold. By 2014, Fortuna expects consolidated production to reach 6 Moz silver equivalent per year plus base metal credits.
Did jurisdictional risk in Peru or a desire for asset diversification lead Fortuna to the San Jose operation? “Going to Mexico was not driven by asset diversification or jurisdictional risk at all,” Ganoza says. “Mexico and Peru are established, good bases of operation for us. We went to Mexico not to diversify our Peruvian risk but rather because we thought there were good opportunities in Mexico and we had to be there if we wanted to be a world leader in silver production. So we have two anchor assets in these two great mining jurisdictions as a platform for growth moving forward.
“We’re not here to become the leading silver miner in Latin America,” Ganoza stresses, but “a force in world silver production. It is strategic in this stage of our evolution to focus on Latin America. Early on, we said, ‘If we want to be a world force in silver, where are the largest silver-producing countries in the world? Peru and Mexico. So we’ll try to establish ourselves as producers in those countries.’ We’ve been successful at that. So we’re executing a plan we laid out seven years ago. We differentiate ourselves from the pack based on the fact that we have quality assets that operate at low costs.”
Do any of the other executives see jurisdictional risks in Mexico?
Lenic Rodriguez, who became a Canadian citizen but remains a Mexican citizen as well, says, “I can tell you that Mexico’s political stability is wonderful. I don’t see any resource grab coming from the government. Foreign mining companies operating in Mexico in general are very conscious of their social responsibilities.” He talks about Aurcana Corporation’s (AUN:TSX.V) La Negra mine, purchased from Industriales Peñoles, the largest silver producer in the world. “Industriales Peñoles thought there were no more resources there and was not interested in copper, just silver,” Rodriguez says. “But copper comes associated with silver and we’re having wonderful results at La Negra. It still has a very long mine life, and on March 31 we’ll begin the second consecutive year of expansion of La Negra.
“As we inaugurate that expansion,” he continues, “we’ll be donating space for a clinic for the town of Macon, and we’ll be showing people how to build their own permanent housing. We have proprietary technology using concrete blocks whereby they can build houses very inexpensively, maybe $2,000 each.”
Considering the foreign investment mining brings to the country, the jobs it creates and the community support it demonstrates, Rodriguez says, “a politician would have to be quite crazy to do something against the mining industry.”
The highly publicized incidents of violence related to drug cartels and trafficking have presented no problems whatsoever to Aurcana or its people. “We have not had one incident,” Rodriguez says. “I go very often to Mexico, maybe six times a year, and I’ve never experienced any problems. Not me, nor any of our people, visitors, guests, analysts, people who have gone there. Quite the contrary. They find the people of Mexico very friendly and welcoming.”
Ross Beaty agrees heartily. “Mexico is an absolutely wonderful mining country. The drug-related violence is real but has nothing whatsoever to do with Mexico’s strength as a mining jurisdiction. It’s a wonderful country period. I love Mexico.”
But jurisdictional risk isn’t the only peril that these executives and their peers face.
What if financing dries up? “It’s a bit of a struggle to continue raising money to try to move something forward,” Callahan supposes. “If you have a project worthy of the financing, I think you can get it. People are betting on your management team and on the fact that you have a decent asset. If you have those I think financing is available.”
He considers it “a blessing that Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC) probably has more financing available than it needs, and money in the bank.” Furthermore, he indicates that its $25 million (M) in gross revenue is enough to fund Silvermex’s development and exploration plans. We’re generating cash flow so we don’t need an infusion of capital investment now.
“We may or may not have to go back to the market,” he continues, “if we find an asset or a deposit that we want to put into production, but it depends on its scale and size, how far they are from the mine, and so forth. If they use the existing mill and/or tailings facility, we’d have to expand those.”
If Silvermex does find itself wanting to seek outside financing, he isn’t worried. “We have a tremendous amount of support in the equity markets,” Callahan says. “We have people looking to try and invest in Silvermex. We’ve been putting them at bay, saying we’ve got $60M in the bank. The markets are certainly available and open to us. We would just need that leap to the next production level to justify going to the markets.”
Ganoza considers the question of capital availability “a bigger risk for the explorers that don’t have established projects and are just pursuing ideas here and there and looking for seed capital to fund ideas. I think that’s where the main risk resides.” He’s not concerned about Fortuna’s dependence on the capital markets because “we have a low-cost operation and healthy cash flow. If we find an acquisition of sufficient merit, we will be able to fund that acquisition. We are not at a stage where we’re funding high-risk ideas.”
What if oil hits $150 a barrel? According to Callahan, that would be a particular concern in Mexico, “where most things are driven by diesel. That could drive costs up 30–40% for some producers. Thank God, we have electric power at our operations so that isn’t as big as a concern for us.”
What if you can’t find top talent? This is a biggie in Ganoza’s view, particularly as a company grows. “All of a sudden you find out how difficult it is to operate 20 mines, especially when they are small. It’s as if you’re a pilot who flies one of the larger planes and someone asks you to fly a small Cessna on a regional route. That’s not a career upgrade for either a young professional or a seasoned veteran with gray hair. It’s a career downgrade. It’s the same with mines. I hunt all the time for talented professionals, and it’s difficult to attract them to a small asset.”
The top talent “all want a technical challenge, size,” Ganoza states. “Bigger mines mean better mine conditions, more resources to run business and more intellectual capital. At the smaller mines, everything is more humble, more limited, fewer resources. You cannot run a business atomizing your property portfolio in this environment especially, because there are no people.”
Ganoza calls the people issue “a challenge we are clearly facing every day. Human resources (HR) management and organizational development are very crude in the mining industry. Other industries are much more sophisticated. At least among the midsize emerging producers, HR management doesn’t exist.”
To address the challenge, Fortuna hired a vice president of HR and organizational development. Ganoza made it clear to the headhunter that he wasn’t interested in a recruit from the mining industry to handle payroll. He wanted “truly to establish processes that come from industries such as services, banking, insurance, where HR is an established system that adds value to the business. We want to be able to attract good people.”
Ganoza considers the people issue a far bigger concern for the industry than jurisdictional risk. “You manage jurisdiction risk with people and money. There is no shortage of money these days, but there is a shortage of people.
“All of our team is seasoned, not only in mining but also mining in Latin America,” he continues. “They have been doing extensive work. I just hired as a chief project manager for a new project, a guy who has been working in Latin America for 15 years for Gold Fields Ltd. (GFI:NYSE) of South Africa. He’s one of the leading explorers in my experience, a truly tremendous guy, a true discover, excellent with geology, good technical skills, discovery driven.
“We are trying to get the talent that is residing in the bigger companies,” Ganoza says. “And we’re telling them, ‘With us you’ll be able to move quicker with not so much bureaucracy. We’ll give you the funding because we have money and we’ll let you run with your ideas. We will back you. Let’s go pursue those opportunities that you have in your head and couldn’t do.’”
Despite the perils, the opportunities appear boundless. As Beaty notes, “Silver’s gone from $5 to $40 per ounce in the last number of years. I don’t think we have to invent too many things to explain why that’s happening and express the likelihood that it’s likely to continue.”
The Gold Report Publisher Sally Lowder, in some cases joined by Brian Sylvester, conducted the interviews on which this article is based during the 2012 PDAC International Convention, Trade Show & Investors Exchange, held March 4–7 at the Metro Toronto Convention Center. The annual event, sponsored by the Prospectors and Developers Association of Canada, drew nearly 28,000 attendees from 120 countries last year.
Geologist and Entrepreneur Ross J. Beaty, loved by investors for whom he’s created more $4 billion in shareholder value over the years, currently serves as executive chairman of Alterra Power Corp. and chairman of Pan American Silver Corp.—but he’s founded, developed and divested a number of other public mineral resource companies over the course of 38 years in the international minerals industry. Born in Vancouver, Beaty has a degree from the Royal School of Mines, a Master of Science with Distinction in mineral exploration from the University of London, and bachelor’s degree in geology and a law degree from the University of British Columbia. Working in 50-plus different countries over the years, he speaks English, French and Spanish, as well as some Russian, German and Italian. Beaty is a past president of the Silver Institute in Washington, D.C., a fellow of the Geological Association of Canada and the Canadian Institute of Mining, a recipient of the Institute’s Past President’s Memorial Medal and a founder of the Pacific Mineral Museum in British Columbia.
Michael H. (Mike) Callahan has been the president of Silvermex Resources Inc. since November 2010, and began serving as a director a year earlier. Prior to Silvermex, Callahan spent 20 years with Hecla Mining Co. He joined the company in 1989; served as a senior financial analyst, financial manager of its Silver Valley operations in northern Idaho and director of accounting and information services. While serving as president of Minera Hecla Venezolana and leading Hecla’s Venezuelan operations, he also assumed duties as Hecla’s vice president of corporate development, after which he returned to Idaho as vice president of Silver Valley operations.
Jorge A. Ganoza Durant, whose work has earned him a spot among “Casey’s NexTen”—an exclusive collection of the “top 10 rising stars in the natural resource sector,” is president and CEO of Fortuna Silver Mines Inc. since January 2006, and a director of the company since December 2004. Ganoza holds of Bachelor of Science in engineering from the New Mexico Institute of Mining. A fourth-generation miner from a Peruvian family that has owned and operated several underground gold, silver, and base metal mines, he’s a geological engineer who has amassed more than 16 years of experience in exploration, mining and business development throughout Latin America, working for a number of private and public Canadian junior mining companies in Panama, Guatemala, Nicaragua, Honduras, Mexico, Dominican Republic, Haiti, Peru and Colombia.
Lenic M. Rodriguez, a Mexican businessman residing in Vancouver, has been the CEO and president of Aurcana Corporation since May 2009 and has been a director of Aurcana since 2006. He has over 15 years of experience in top management with one of Mexico’s 10 largest corporations. He has also served as a director of Alberta Star Development Corp. Rodriquez is a magna cum laude honors business graduate from one of Mexico’s top Universities, Universidad IberoAmericana. He holds a Master of Science and a Bachelor of Arts in business administration.
Brent Cook, editor of Exploration Insights, describes the past 15 years of change in gold, copper and iron. In this exclusive interview with The Gold Report, he shares what he sees as the fatal flaws and opportunities in this complex industry, details the most important factors he looks for before investing, and names companies he believes have the right stuff.
The Gold Report: In the late 1990s, when the gold price was falling steadily lower, you vetted companies for Rick Rule’s company, Global Resource Investments. Could you give us a comparison of what this space was like then versus what it’s like now?
Brent Cook: During 1997–2002, we were probably in the most unloved sector in the whole investment world. Gold had collapsed to less than $250/ounce (oz), copper was under $0.85/pound (lb) and anything that didn’t have a dot-com to its name didn’t get much respect. The idea of blowing up rocks to make metal out of them was an archaic concept clung to by the remnants of the industrial revolution; it was a brave new world. By contrast, today gold is over $1,600/oz, copper is $3.80/lb and iron ore has gone from $12/ton (t), to $140/t; we’re in the 10th year of a commodities boom. Back then, it was very difficult for mining companies to raise money.
Working with Rick, I was fortunate. He’d put together two funds of about $14 million (M), so we had some money. We were pretty much alone in the sector, hence we were able to put some money into really good projects and people. So in retrospect, that was one of the best times of all to be investing, but at the time, it felt horrible in that we’d invest in these companies that we thought were a good value and see the share price continue to fall for a year or so. We were able to buy a company like Virginia Gold Mines Inc. [now Virginia Mines Inc. (VGQ:TSX)] for nearly cash in the bank yet watch it fall to a 20% discount to that cash, and this was a company run by one of the top guys in the industry, Andre Gaumond. Today, however, you have a lot of money chasing everything in this sector, and it’s subsequently tougher to get real bargains on projects or people. It’s important to recognize that because this is such a risky investment sector that to make money at it consistently, you need to buy companies when they are cheap based on legitimate valuation metrics.
TGR: Is it more difficult for a retail investor to make money today in small-cap mining equities or was it more difficult then?
BC: Both time frames have their challenges. It’s always been about finding quality, high-margin mining projects at any stage and buying those at less than what they’re worth. A high-margin deposit is one whose cost of production is in the bottom third of the total production costs curve for that metal. Say the average cash cost to produce one ounce of gold is $700—ideally you want to own properties that can produce substantially below that cost.
There have been periods in this sector where all the turkeys flew and everybody made money, but we’re back to a period where it’s going to be tougher for retail investors to make money if they’re not very selective and knowledgeable about what they’re buying. The big difference between the late 1990s to early 2000s and now is there’s so much more information immediately available to anyone interested, therefore, investors have to research and understand the details of a mineral project before they buy. They need to know why they’re buying it, what they expect, what it could be worth and what the fatal flaws might be. This level of due diligence is critical because we know that most mineral projects are eventually going to fail. That’s a fact of nature and the Earth’s evolution. So, in a way, it’s a bit tougher now, because you need to be so much more educated on what it is you’re actually buying. Following the stuff that comes in the mailbox doesn’t work anymore.
TGR: What are the most typical fatal, or tragic, flaws that are going to lower a share price?
BC: More often than not, it’s the realization that after the first few good drill holes into a project you start putting it together and the geology or the continuity doesn’t hang together. Bear in mind that it costs money to mine waste and a mine is a terrible thing to waste.
Another typical flaw is metallurgy or metal recovery. You want to find out as much as you can about the metallurgy as soon as you can because that factors heavily into what your production costs are going to be. For instance, is the ore oxidize, sulfide, carbonaceous, refractory etc.? If you’re dealing with Carlin-style sulfide gold mineralization, you immediately know that somehow the sulfide has to be broken down to allow recovery of the gold. That’s going to take a roaster or an autoclave of some sort, which is extremely expensive to build and consumes considerable energy. If the project is in the Yukon, an investor has to think about the cost of building an autoclave or roaster. That means the grade has to be quite high to cover the capital expenditures (capex) and power costs. However, in Nevada there is excess capacity for refractory ores, you don’t have to factor in the cost of an autoclave.
TGR: You were recently at the annual Prospectors & Developers Association of Canada mining conference in Toronto. More than 600 companies had booths at that event. What are some trends you noticed?
BC: Companies are starting to recognize that it’s not so much about size as quality of mineral deposits. Grade, or more succinctly margin, is getting more and more important. There are a lot of very large, low-grade deposits out there, and the majors aren’t buying these. That’s a real issue and you have to question why. If the majors don’t buy them, these junior companies with these large, low-grade, low-margin deposits are then doomed to build. I think it’s going to be tough to raise the money, or at least the debt portion, to do that. So I think one trend is toward smaller, higher grade, higher margin deposits.
There are still people out there trying to raise money on new deals, new projects as they move from one busted company to the next one. Unfortunately, for companies with average properties, the music has stopped and they are facing terrible share dilution to fund the exploration on their average projects. As I said earlier, average ain’t going to cut it this year.
There is also a severe shortage of technically qualified people—resource estimators, mining engineers, geologists—to do the work. Company presidents and VPs of exploration are in strong demand. Because there is more work than qualified people, I’m seeing a lot of sloppy preliminary economic analysis (PEAs) and resource reports. That’s a serious and financially dangerous trend. You can no longer blindly rely on a company’s scoping study or its PEA. You need to look at the details. I could tell you some pretty scary stories in this regard.
TGR: What are some of the sloppy things that you’re noticing?
BC: In resource estimates, there is a tendency toward plugging it all into a computer and generating a model without going through the time and detail it takes to fit the model to the geology and structural controls. So grade is being put out into an area of the deposit where there isn’t actually that grade. If these mines eventually go into production or they get down to the very detailed work, these resource estimates are going to be cut back significantly because the model is not honoring the geology or the geostatistics. That’s a serious issue I’m seeing. To quote a friend of mine who does resource estimates, these are “faith-based estimates.”
TGR: Do you think that sort of shoddy work is responsible for some of these one-mine or two-mine operations not performing as well as expected?
BC: Definitely, although we have to bear in mind that they are called estimates for a reason. It’s rare these days that a company goes into production and its production costs are what they were supposed to be according to their PEA and the literature they used to raise money. Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.A) at its Bisha mine in Eritrea had to cut its gold reserves by about one-third because of a mistake in the resource estimate that related to how poor core recovery was handled in the estimate. Remember, in a resource estimate we are extrapolating a small amount of data, basically a 3-inch tube of core, across hundreds of feet of complex rock and assuming that we can know the grade of that rock. There’s bound to be some uncertainty.
TGR: While you were in Toronto, you made an appearance on BNN where you discussed the lack of big discoveries over the last 17 years. One chart that you used showed that in 1992, the mining industry discovered roughly 100 million ounces (Moz) gold in both copper-gold and primary gold deposits but by 2009 that amount had dropped to about 23 Moz in both types of deposits despite the fact that the industry was spending almost $5 billion (B) annually on exploration. Tell us about that.
BC: That data was put out by Barrick Gold Corp. (ABX:TSX; ABX:NYSE), so it’s pretty good data that pertains to economic deposits. It shows that over time we are discovering fewer large deposits. Basically, we are mining about 83 Moz gold annually yet only finding in the order of 20–30 Moz a year. So there’s a serious gap between production and discovery that we’re not filling.
It’s getting harder and harder to find quality deposits—and we’re talking economic deposits here, not resources that will never make it. Explorationists have pretty well explored most of the Earth’s surface and then some. Therefore, it’s also getting more expensive because we’re going into blind areas and drilling deeper into more complex geologic settings. That is why it’s getting tougher to find these big deposits. Then add to the increased geological difficulty the fact that social, political and environmental realities are pushing way out the time to permit and build a mine and it becomes pretty easy to understand the decreased discovery rate. I don’t see that changing.
The net result of this discovery gap is that when a company, let’s hope it’s a junior company, finds a legitimate, high-margin economic deposit, it is going to be worth a lot more money than you would normally expect. The dearth of new discoveries means that those of us who invested early in a company that proves up an economic deposit stand to make some serious change. So now I’m focusing, as best I can, on high-margin deposits, or at least mineral systems that show the potential to produce those deposits and mostly avoiding geologic setting that don’t offer that shot at a home run.
TGR: Another reason for the lack of discoveries is the high cost of mining, which has gone up dramatically over the last four or five years, given fuel costs and labor costs.
BC: Yes. In 2004, the capex to build Cerro Casale was $1.4B. In 2011, it’s $6B. That’s a huge increase in capital costs that throws a lot of uncertainty onto any big capex project a company is considering. That’s happening across the board. Your average cash cost to produce one ounce of gold 10 years ago was on the order of $340/oz. Today, cash costs alone are closer to $740/oz and your all-in costs, according to a Randgold Resources Ltd. presentation (GOLD:NASDAQ), are closer to $1,200/oz. Cash costs are just what it costs to produce at the mine. They don’t include exploration, depreciation, amortization, royalties, G&A etc.; so it’s gotten a lot more expensive to produce all metals.
TGR: How would you respond to someone who says it’s easier said than done to find early-stage companies with drill results that hint at the potential for high-margin, multimillion-ounce deposits that majors want to buy?
BC: I agree 100%. It is hard to find projects in an early stage that offer the potential of coming up with a major deposit that shows the profit margins and the size that a major company needs to buy. That’s just a function of geology. As the Earth evolves it changes and those changes are recorded as anomalies in the earth’s surface. A volcano forms, erupts a few times, cools down and is covered by the next volcano, over and over again. This process is responsible for millions of geochemical and geophysical anomalies that provide the stories the Vancouver resource market is founded upon. However, very few of these anomalies combine the right geological, geochemical and hydrological characteristics to produce a concentration of metal that has the tons, grade and metallurgy located near surface in a favorable jurisdiction to form an economic deposit.
TGR: If there aren’t enough early-stage, potentially high-margin deposits, won’t companies take the large, low-grade deposits just because that’s what’s available, and they’d bank on rising metal prices to make those deposits worthwhile?
BC: That’s a valid point and investment strategy. It’s a different investment thesis than I go with, but certainly there are a lot of these large, low-grade deposits that are marginally economic at $1,500/oz gold. If your gold price assumption is $3,000/oz, then these are the things to buy. In my personal portfolio, I don’t need 100 companies—I need 10 that have something that I think is of a high enough margin to be economic today.
Lydian International Ltd. (LYD:TSX) is a company that I’ve owned since I first visited the property. At that time, it was $0.76/share. It’s now about $2.45/share. Lydian owns a nice, simple, high-margin deposit in Armenia. Once the world starts to recognize that Armenia is a good place to do business, then this gets bought by a midtier company. It has about 3 Moz. I reckon its cash costs are about $500/oz. The capex isn’t too bad. So that’s a deposit that I see out there that offers the margin that a company needs to make money on, and it’s selling at a discount today.
Atna Resources Ltd. (ATN:TSX) looks like an interesting company, as well. Its Pinson mine is a good grade deposit, and it should be able to produce at a decent price. So you have a decent, high-margin deposit there. Its capital costs are virtually nil because the infrastructure is there and there are a number of options to ship the ore to, so its capex is minor.
Altius Minerals Corporation (ALS:TSX.V) is a great prospect-generating company that’s been incredibly successful. It owns about 32% of Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.A; ALDFF:OTCQX); at a cost basis of about $2M, it’s now worth about $100M. Alderon owns an iron deposit in Newfoundland that is a good high-margin deposit. Again, the infrastructure costs are low because it is right in an iron-mining district. I think Alderon has a deposit that somebody else will either buy one day or work out a favorable offtake agreement. So you can buy Altius at a slight discount to its cash, royalties and equity holdings and get a management team that has grown a $20M micro-cap company to about $340M with virtually no share dilution. You’re paying nothing for the upside in Altius, which sort of reminds me of the good old days in the late ’90s.
One way to better your odds at finding a true deposit is to invest in the prospect-generator companies. These are tiny exploration companies that recognize the long odds at success and structure their business models accordingly. They’re very good at generating ideas for mineral deposits, but at the point it’s time to start spending big dollars on drilling, they bring in somebody else to spend the money. So your financial risk is cut down quite a bit, and the high-risk, high-dollar part of it is covered by somebody else. These companies go on and generate new ideas and new targets and bring in new partners, thereby providing shareholders with many more shots at a discovery for your buck. One of the companies doing that quite well now is called Riverside Resources Inc. (RRI:TSX).
TGR: It has an agreement with Chile’s Antofagasta Plc (ANTO:LSE) in British Columbia and one with a steelmaker, Cliffs Natural Resources Inc. (CLF:NYSE) in Mexico.
BC: Exactly. And it has other projects being worked by smaller partners. It has on the order of $10M in the bank plus about $2–3M in equities. Again, $12M has been spent on its properties this year, and its market cap is on the order of $30M.
TGR: In those companies, you need above-average management teams because you have to foster all these different relationships and manage all these different relationships.
BC: Exactly. Eurasian Minerals Inc. (EMX:TSX.V) is another company that has done an exceptional job with that. It has on the order of $35M in the bank. It just bought a royalty that’s going to bring it $7M/year, and it has projects in Turkey, Scandinavia, western U.S., Haiti and Australia that are being worked by major companies, including Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), Newmont Mining Corp. (NEM:NYSE) and Centamin Plc (CEE:TSX; CEY:LSE)—companies that are looking for major deposits.
TGR: Having a paying royalty often is key, too. When you were on BNN, you talked about Virginia Mines Inc.; its royalty on the Eleanore mine is being developed by Goldcorp Inc. (G:TSX; GG:NYSE). Does Riverside have a royalty that could start paying in the near future?
BC: Virginia does have a callback to a royalty on its projects but, at present, none of them is producing any money. The company does, however, make money in many of the deals it structures by way of shares and management contracts. This income covers a fair portion of its general and administrative expenses. So it makes money back on these deals by working the project. Really smart.
TGR: What about Gold Standard Ventures Corp. (GV:TSX.V; GDVXF:OTCQX)?
BC: We’re going back to high-margin deposits, or at least high-margin potential. Gold Standard’s property is on the Carlin Trend and is a major, very large, Carlin-style gold system. The key to making a big deposit is having a big system—a simple concept that is all too often ignored. Gold Standard’s most recent drill hole intercepted potentially economic mineralization over 43 meters. If it’s successful, this is a deposit that is big enough and high margin enough to attract the attention of Newmont Mining or Barrick or anyone, for that matter.
This is the important part about why I bought Gold Standard. It’s not because of the next few drill holes. It’s because we recognize we’re into a system that’s large enough to produce a mineral deposit, and we know now that this geologic system can produce the grades we need to see. So, it’s still going to be a hit-and-miss exercise until the geologists can do the science well enough to find the exact core of the deposit, if it’s there. The next results might be fantastic; they might be just encouraging. But we know we’re into a big system. You stick with big systems.
TGR: Do you have any parting thoughts for us, in terms of what retail investors should be on the lookout for throughout the rest of this year?
BC: It’s going to be, in general, a tough market to make money in if you’re just throwing darts. You really have to have a handle on what a company’s looking for in terms of deposit type and what that deposit is worth in terms of a net present value on the deposit, if it is successful. Too many companies are out there exploring projects that even if they’re successful, the real values aren’t worth the risk it took looking for it. So stick with intelligent management looking for high-margin or large deposits. The junior mining and exploration business is such a technical and complex science and industry populated by paid touts, scam artists and people of dubious character, that it is well worth the effort to get good, honest advice. And be very selective in what you buy.
TGR: That sounds like great advice. Thank you.
Read Rick Rule’s strategy for taking advantage of volatile precious metals markets here.
Brent Cook brings more than 30 years of experience to his role as a geologist, consultant and investment adviser. His knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. Cook’s weekly Exploration Insights newsletter focuses on early discovery, high-reward opportunities, primarily among junior mining and exploration companies.
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