The Gold Report: Michael, the companies you cover read like a who’s who of junior precious metals explorers. But with the junior explorers vastly underperforming the gold price this year, how are you pitching these equities to your institutional clients?

Michael Gray: Other than the strong mergers and acquisitions (M&A) thesis for the majority of our coverage list, we’ve also highlighted to clients what we would call game-changing exploration upside that a number of our stocks are exposed to. One example would be Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:Fkft), an explorer in Santa Cruz, Argentina, which we initiated coverage on in March 2011. At that point, it was trading at $5.09/share. We had a $9.50/share target. It ran to $14/share during the summertime based on its April 2011 Zoe vein discovery at Cerro Moro. Currently, it trades around $7.50/share.

We also believe there’s a strong investor appetite for high-grade, high-margin situations with relatively near-term production associated with low capital costs and short permitting timelines. That’s really reflected in Goldcorp Inc. (G:TSX; GG:NYSE) acquisition of Andean Resources Inc. last year.

Finally, there is significant optionality associated with a number of our stocks that have large gold resources in this gold price environment.

TGR: Your target prices for precious metals explorers are predicated on prevailing forward-curve prices. That is a less than an ideal method given that it doesn’t take into account tightness or weakness in the market, interest rates or inflation-adjusted values. What are your thoughts on that?

MG: It is difficult to accurately predict gold price over the next year, let alone the next five years. We use the forward curve for precious metals adjusted about every quarter on an as-needed basis for our valuations. For the past seven years, we have found it to be a very good predictor of realized future spot prices for gold.

TGR: You recently revised your long-term gold metal price assumptions for five years. In 2017, you’re projecting a gold price of $1,837/ounce (oz) up from $1,714/oz, while your long-term price for silver is $33.42/oz up from $28.97/oz. Do you believe your price projections are aggressive in comparison with other brokerage houses?

MG: Our valuation philosophy is to use a flat 5% discount rate and the prevailing forward curve for long-term prices for gold, silver and foreign exchange. We then apply an operating multiple to the net asset value (NAV) that is less than one times NAV, whereas some banks may use a lower price deck and a different discount rate, but a multiple to NAV that is greater than one times. In the end, the entire valuation picture needs to be looked at to assess aggressiveness. We believe we’re middle of the road.

TGR: What’s your typical multiple to NAV?

MG: Among our explorers, we have a range of 0.35 to 0.85x NAV. Our high-end NAV multiples are associated with companies with high-quality assets that we see as potential takeover candidates like Extorre.

TGR: Extorre and ATAC Resources Ltd. (ATC:TSX.V) have solid potential to be involved in M&A activity in 2012, according to your reports.

MG: Extorre’s Cerro Moro project has Measured, Indicated and Inferred resources of 2.4 million ounces (Moz) gold equivalent (Au eq) that, according to its recent scoping study, are both mineable via open-pit and underground methods. We model Cerro Moro’s high-grade silver resources to have -$1,045 cash operating costs on a silver byproduct basis. This is one of the best high-grade projects out there in our view.

TGR: The Argentinean government recently issued a decree requiring the repatriation of sales proceeds for mining companies in Argentina that could impact a project like Cerro Moro. Has the way that you valued the company changed as a result of those government measures?

Shawn Campbell: We looked at that decree when it came out and the stocks definitely had an initial reaction to it. The explorers and producers, such as Barrick Gold Corp. (ABX:TSX; ABX:NYSE), have all been consistent in saying that they believe the effect of this is an additional cost of 1–2% based on revenue. The mechanics are that companies will have to convert, or repatriate, sales into pesos, but the current system allows them to transfer it back into the U.S. and then send the money abroad. We did a sensitivity study on Extorre and it had minimal effect on our target price and net asset value.

TGR: How big can Extorre’s Cerro Moro get in terms of total ounces in the ground?

MG: The analogy we draw is to AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) vein field at its Cerro Vanguardia gold-silver mine, which has been operating since the late ’90s. Currently, it’s 9 Moz gold in past-production current resources. We hosted a conference in Toronto recently where one of the representatives from Formicruz, who formerly worked with AngloGold Ashanti, suggested that he wouldn’t be surprised if that district will ultimately see more than 12 Moz of gold produced. Extorre’s Cerro Moro project is basically an array of veins in the early stages of exploration that have a number of similarities with Cerro Vanguardia. It already has 2.4 Moz Au eq in resources. We feel comfortable that Cerro Moro could ultimately grow to a +5 Moz number in its life. We currently value Cerro Moro based on 2.7 Moz Au eq.

TGR: Who are the likely suitors?

MG: Companies that have expressed interest in that region certainly are potential suitors. If the production profile can reach the right critical mass, companies such as Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) would be interested, given it had bid for Andean before. Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and Goldcorp, companies with operations down in Argentina that are interested in a high-grade production of a certain size, could also be interested. We also think given that it has high silver content—roughly 50% of the value—some of the midtier silver producers could also be interested.

TGR: Why is ATAC amongst the top group of Macquarie’s list of M&A candidates given that you just cut the 12-month target price to $8.50/share from $11/share?

MG: ATAC is an early call. This is a sediment-hosted gold geological setting similar to Nevada’s Carlin trend. It has all the right signs and signals in terms of geological environment and early success in drill holes from September 2010 documented ore-grade gold mineralization over significant thicknesses. Although our Carlin thesis is intact as far as we’re concerned, it’s clear that the geological risk for defining large resources in the short term has increased due to the high degree of structural control versus lithological controls. We moved our target price down to reflect this geological risk.

We have a strong conviction that the geology associated with the Rackla gold belt is the type of hunting grounds that the seniors have been looking for, but generally haven’t found on a worldwide basis outside of Nevada, and that given the strong geological similarities the Rackla gold belt has good potential for hosting such Carlin-type gold deposit. There are very few tier-one (+20 Moz) opportunities in the world and, with the right amount of success and given its enormous 100%-owned land position, ATAC could be an attractive takeover target.

TGR: Is it any closer to proving the theory that this is a Carlin-style mineralization?

MG: With the empirical evidence of the geological setting, the mineralization style, the signature of elements—antimony, arsenic, mercury, thallium, gold, low silver—and numerous characteristic alteration features, there are not too many people out there who necessarily would disagree with that deposit-type analog. The deposit type is important as it suggests that the potential endowment could be very large given the northern part of the Carlin trend alone has 100 Moz of gold. We’re not necessarily saying that would be the endowment within the Rackla gold belt; however, we certainly see evidence of a big system in place between the Osiris targets, where there’s been a significant amount of drilling, and out 26 kilometers (km) to the west to the Pyramid gold prospect, which also has a number of the indicative geological features. Again, ATAC is an early takeover candidate in our view partly because of the rarity of this type of geology and potential.

TGR: Is there a first-mover advantage in terms of a major coming in early and locking up this belt once it has proven there are significant amounts of gold there?

MG: Some of the senior mining companies have been spending up to $50 million (M)/year on their greenfield worldwide budgets, looking for another Carlin trend or similar tier-one asset. It doesn’t take too many years of spending that amount of money to justify moving early on an asset like this at the right price.

There is no question: ATAC’s Rackla gold belt is still at a very early exploration stage and no resources have been documented. There is also a very short field season in the Yukon to contend with, especially in this particular area, so it certainly would be early and aggressive for a senior to be doing anything right now. This said, it’s a very special situation as there’s just not very many of these Carlin-type environments, especially associated with a large land position, 100% ownership and no royalties, anywhere on a worldwide basis.

TGR: Strategic Metals Ltd. (SMD:TSX.V) is developing the Midas Touch project in the Yukon, south of ATAC Resources’ Osiris discovery. Why is ATAC a takeover target and not Strategic?

MG: Strategic is a potential takeover target. However, its Midas Touch project has not yet documented a discovery drill hole with significant gold grades over a significant length, so ATAC is more likely given that it has confirmed significant gold mineralization. That said, Strategic has documented a fairly extensive +400-meter (m) long zone of arsenic mineralization on its Crag property, which seems to be in the right type of trap rocks (as ATAC’s Osiris targets). Strategic also owns about 9% of ATAC, and its Midas Touch land position is very large and could be a compelling way to gain exposure to the Rackla gold belt in the Yukon.

TGR: International Tower Hill Mines Ltd.’s (ITH:TSX; THM:NYSE.A) Livengood project in Alaska, based on $1,400/oz gold and a cutout grade of 0.22 grams/ton (g/t), has 16.5 Moz of Measured and Indicated resources and 4.1 Moz of Inferred resources. Are we ever going to see a project of that scale developed in Alaska? There are certainly a couple there now that don’t seem to be much closer to development.

MG: Livengood is a tier-one, +20 Moz gold asset, owned 100% by a junior, which is relatively rare. We currently model Livengood using a 0.35 g/t cutoff, a little bit of a higher grade, with life-of-mine grades of 0.65 g/t gold and include a starter pit in the first four years of 0.82 g/t gold. In September 2011, International Tower Hill released a large mill preliminary economic assessment (PEA), which contemplates a 91,000 ton/day (tpd) milling operation with life-of-mine average gold production of 607,000 oz per year. It is a large, low-grade mine proposition in Alaska. Livengood’s key attractive feature compared to some of the other larger development projects is its good infrastructure as it is located on a highway 100km north of Fairbanks along with access to power and water.

TGR: Donlin Creek has 50 Moz and it’s not anywhere close to being developed. Northern Dynasty Minerals Ltd.’s (NDM:TSX; NAK:NYSE.A) Pebble project is about 100 Moz and that’s not very close to being developed either. It does seem that even though the ounces are there and the geology is prospective, they’re not being developed. What is the impediment?

MG: For some of the other projects, there are significant infrastructure challenges. There aren’t necessarily roads or any power infrastructure to these sites. Northern Dynasty also has some stakeholder groups not embracing the project.

Livengood is a brownfield site from former placer mining and it’s next to the Alaska pipeline. It doesn’t have a significant stakeholder group that would be opposing the project. There aren’t obvious challenges in our view when it comes to community relations, First Nations issues or competing interests.

TGR: Rainy River Resources Ltd. (RR:TSX.V) just made a nickel-copper-cobalt discovery at its Rainy River gold project in northwestern Ontario. What do you know about that project?

MG: The Rainy River gold project is part of a new Canadian gold belt. It has more than 6 Moz gold in its global Measured, Indicated and Inferred resources. It’s 100% owned and associated with a large land position—all attributes we like. A recent scoping study documented a combined open-pit/underground mine scenario that would produce 325,000 oz/year over about a 13-year mine life. The economic study estimated initial capital costs and sustaining capital of about $1.5 billion. It resulted in a pretax internal rate of return (IRR) of just less than 20% and a net present value (NPV) of $786,000 using a 5% discount rate. This project has come into greater visibility with this study.

It’s extremely well located near the U.S. border in northwestern Ontario. The capital expenditure estimated in the PEA at $1.4B for initial and sustaining capital is higher than we expected. It is modeled as a 30 t/d operation. It will have a higher than average strip ratio to deal with and have overburden and water management issues to deal with, but certainly is a project that can be permitted. As far as the nickel-copper-cobalt discovery, it’s not important to our valuation of Rainy River at this time as we interpret it to be relatively small with limited size potential.

TGR: It would just be a bonus at best. That IRR is fairly low and a lot can go wrong when bringing a project into production. What does Rainy River have to do to get that IRR up around the 30% range?

MG: It does have a pending resource announcement in January, which would include the majority of the drilling it conducted this year. Analysts are looking at that for visibility on conversion ratios to Measured and Indicated categories and if there is an improvement in the average grades. On a conference call in November when it released the study, it indicated a 10% change in grade had a +30% impact on project NPV. This is a grade-sensitive project and this is the first so-called economic snapshot of the deposit. That pretax IRR of 19%, given the capital costs, needs to be improved for this to become robust.

TGR: Brett Resources Inc. (BBR:TSX.V), which had about 5 Moz in the same area of northwestern Ontario, was bought by Osisko Mining a couple of years ago. Is that the thesis here, too?

MG: Rainy River is on a path where it has to derisk the project vis-à-vis permitting and economic studies to make it a compelling takeover target. It probably is in the gun sights given its size, but at this time, the economic visibility is really going to depend on that resource estimation that’s coming up and the ability to optimize a number of the parameters.

TGR: Heading further south still, Midas Gold Corp. (MAX:TSX) has a 100% interest in the Yellow Pine mining district in Valley County, Idaho, and already has outlined about 6 Moz there. Why haven’t more people heard of this story?

MG: The company just completed its initial public offering (IPO) in July, so it is still a new story. However, its Golden Meadows project, at 5.8 Moz Indicated and Inferred, is probably the largest gold resource in an IPO that we’re aware of.

TGR: What’s ahead for Midas?

MG: There are three resources on the property that have come in through the consolidation of this district. The relatively straightforward increase in resources will involve near-pit expansion, so sketching in the resources lateral and to depth of the existing three deposits, as well as the infill drilling to increase the confidence in the resource categories. Subsequent to that, there is very high potential to expand mineralization along strike of the three deposits. Following that, there are a number of new targets that have never been assessed to depth. A number of the targets on the property were assessed only for oxide gold mineralization. There’s great sulfide-associated gold potential to depth on a number of the targets throughout the property.

TGR: What’s the permitting regime like in Idaho?

MG: Idaho permitting has a bit of a reputation for taking a long time, but it’s a very clear and harmonized process between the state and the federal government. Given that there are a number of examples of successful mines having been permitted in Idaho over the last 15 years, including a number of expansions, if you propose the project effectively and it does not have fatal flaws, our understanding is that eventually the projects get permitted.

TGR: In Guatemala, Tahoe Resources Inc. (THO:TSX) is developing the massive Escobal silver project with roughly a 20-year mine life. But Tahoe needs to convert its exploration license into a mining exploitation license. Will that prove difficult?

MG: In October, Tahoe received its environmental impact statement approval and is able to proceed with construction of a mine. That is a major derisking milestone. It signals that it’s likely we’ll see conversion of its current exploration license to a mining exploitation license. The timing is really going to depend on when the new mining laws are passed by Congress. Guatemala has a new president who will be inaugurated in January. We’re likely looking at the new mining laws being passed after May 2012.

We model Tahoe’s +300 Moz Escobal silver-lead-zinc-gold project at 13 Moz silver/year over a 20-year mine life, including 19 Moz over the first five years, with cash operating costs of about $5.05/oz silver net of byproduct credits.

TGR: How do you account in your valuation for the risks associated with the new mining law coming into effect, and that this is a one-asset company developing a mine in a developing country over the long term?

MG: We try to reflect that as a balance between the world-class nature of Tahoe’s Escobal asset being rare, really part of an emerging silver vein district, and with the political risk. In this type of situation, we incorporate that political risk in our multiple to NAV until we see events unfold otherwise. Goldcorp has been operating the Marlin gold mine in northeast Guatemala for a number of years, which essentially gives us confidence that Escobal will become a mine. If the political situation doesn’t deteriorate, then we’re comfortable with our risk multiple. That said, we appreciate that Guatemala is a country that is moderate to high risk.

TGR: Would you say the management at Tahoe is the kind of management you would want in this situation?

MG: Chief Executive Officer Kevin McArthur and a number of the executives at Tahoe have extensive experience in Guatemala. It makes a difference having a team that’s operated in a country and has that type of development experience. Our understanding is that McArthur is focused on building Escobal, getting it into commercial production, and then may look to build a multi-asset silver company from there.

TGR: In Brazil, Colossus Minerals Inc. (CSI:TSX) plans to bring the high-grade Serra Pelada gold-platinum-palladium (Au-Pt-Pd) project into production and appears to have enough cash to do so. But there could be some problems with Serra Pelada’s metallurgy and some of the ground conditions in the past-producing pit there. Could you tell us about those issues?

MG: Colossus’ 75%-owned Serra Pelada Au-Pt-Pd project, in Para State, Brazil, is one of the highest-grade precious metal deposits on the planet. We conducted a site visit to Serra Pelada in mid-October. On metallurgy, the flow sheet for a conventional gravity recovery plant appears to be in place and would recover about 95% of the gold. Construction for that gravity plant is scheduled to start this quarter. For platinum and palladium metallurgy, the company has been working on the optimal flow sheet, which may involve calcining to burn off the carbon. This metallurgical work is still in progress and will rely on the evaluation of the bulk sample to be collected in the second half of 2012. We’re currently modeling 65% recovery of the platinum and palladium.

As for ground conditions, the decline development for exploration and ultimate extraction of the Central Mineralized zone at Serra Pelada is lateral to the historic pit and initially used road headers, but the poor ground conditions eventually dictated that conventional drill and blast would be required and be more effective. As of early November, the decline was at about 600m and it involved shotcreting the walls followed by rock bolting and screening, then shotcreting again and locally strapping with steel. If advance rates of 4m/day can be achieved, then bulk sample extraction location should be reached toward the middle of 2012. We also expect the ultra-high-grade Au-Pt-Pd mineralization to have challenging ground conditions given the carbonaceous host rocks.

TGR: There have been some changes in management there. Tell us about that.

MG: There have been a number of changes starting with, most recently, Ari Sussman becoming chairman of the board. He was the chief executive of two companies and now he’s focused just on Continental Gold Ltd. (CNL:TSX). Claudio Mancuso was the chief financial officer and now is the chief executive. He will be able to focus all his energies on leading the company. There were certainly a lot of other management changes between Q211 and Q311 when the chief operating officer left. Colossus has hired Paulo de Tarso Serpa Fagundes as its new COO, who previously worked with Yamana as the general manager for its Mercedes Mine in Mexico.

TGR: Doesn’t that make you raise an eyebrow or two at the same time?

MG: Having been on the ground in mid-October, it was a chance for us to meet the entire team and gain an appreciation for its skill set and ability to work together. We were satisfied that the current team is prepared for the challenges that lie ahead associated with the project. This said, the technical risks associated with the project are still not quantified at this time.

TGR: Do you have any parting thoughts on investing in the precious metals explorer space or words of wisdom?

MG: I like the expression Good people do good things with a good capital structure as it certainly applies to the precious metal exploration business where projects come and go. My main comment is that to be successful at picking the winners among the precious metal explorers, especially the early-stage ones, it’s really important to reduce geological risk by looking at the right geology and focusing on high-quality assets. More often than not, they tend to be associated with technically superior management teams that are extremely persistent.

TGR: Thanks for your time.

Michael Gray is a mining equity analyst with Macquarie Capital Markets and covers a range of precious metal explorers and producers with an emphasis on North and South America. He is an exploration geologist and holds a Bachelor of Science in geology from the University of British Columbia and a Master of Science in economic geology from Laurentian University. His career of over 25 years in the mineral exploration business started with senior mining companies including Falconbridge, Lac Minerals, Cominco and Minnova where he worked throughout Canada and the USA. He co-founded Rubicon Minerals in 1996 and helped navigate the company through a series of joint ventures and an asset portfolio build that was eventually centered on the Red Lake gold district, Canada. During this period, Gray was president of the 5,000 member B.C. & Yukon Chamber of Mines for one year and on the executive committee for six years. Gray then joined the mining analyst world in 2005 where he brought to bear his technical skills to identify new precious metal opportunities at an early stage with outstanding exploration potential; he has covered a number of these opportunities that were subsequently taken over by gold producers.

Shawn Campbell is a mining equity associate with Macquarie Capital Markets and supports the analyst covering a range of precious metal explorers and producers with an emphasis on North and South America. Prior to being an associate, Campbell was an auditor with Deloitte for six years where he held key roles in auditing large public mining companies. He has a Bachelor of Commerce degree from the University of Victoria and is a CFA charterholder.

The Gold Report: Gold is down $100/ounce (oz.) and I think investors want some salvo. Is this a buying opportunity?
Steven Butler: Yes, it is. We set a 12-month target at the end of July suggesting a peak of $1,750/oz. for gold and $45/oz. for silver. Gold shot up to $1,900/oz.—a little bit too far, too fast in August given the unchanged macro conditions. The world hasn’t changed dramatically in terms of all the macro conditions affecting Europe and the U.S.

We predicted that there could be a chance for gold to pull back, but we didn’t think that equities would pull back as much because they hadn’t followed the gold price as high. Yet, in many cases the equity pullback was harsher than what we saw in the gold price.

TGR: There’s certainly a whipsaw effect here.

SB: Today, the Global Gold Index is down about 5.3%. But some juniors are suffering even more. Keegan Resources Inc. (KGN:TSX; KGN:NYSE.A) shares suffered a double-digit decrease on its announcement of results of the prefeasibility study at its Esaase Gold Project in Ghana. Two names that I like, Premier Gold Mines Ltd. (PG:TSX) and Atacama Pacific Gold Corp. (ATM:TSX.V), are down 11%. There was some pretty harsh treatment of Silver Wheaton Corp. (SLW:TSX; SLW:NYSE), which is down 10%. Senior gold company Centerra Gold Inc. (CG:TSX) is down about 12% after having been one of the best performers year-to-date. In some cases, there is extra pressure on stocks that had done relatively well earlier in the year.

TGR: How could this impact M&A activity? Grayd Resource Corp. (GYD:TSX.V) recently agreed to be acquired by Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE).

SB: I do think that M&A will continue, although it’s been a bit dry for several months. There are some names in the sector that have “potential M&A” stamped on their foreheads. There has been a disconnect between where spot gold has gone and equities. Companies that used to trade on a premium to net asset value, or at least a premium spread to their junior counterparts, can’t easily afford to buy their junior counterparts because their share price multiple doesn’t allow it. Normally, M&A is always about the expensive senior paper buying the inexpensive junior paper. Companies can show accretion that way.

Premier Gold, Atacama Pacific, Allied Nevada Gold Corp. (ANV:TSX; ANV:NYSE.A) and Detour Gold Corp. (DGC:TSX) have valid M&A arguments behind them. Allied and Detour, a larger-cap producer and non-producer, are a little less certain because some of the easier money has already been made.

Premier Gold’s largest asset is the Hardrock Project in Geraldton, Ontario, a resource of 3.6 million ounces (Moz.) that is likely headed to 4 Moz. with the addition of the assets from the Goldstone acquisition. The greater project is going to be renamed the Trans-Canada Project. We believe that there is upside to the resource and our targeted valuation.

The reason why I say it is an M&A target, primarily for Goldcorp Inc. (G:TSX; GG:NYSE), is because of the Rahill-Bonanza joint venture in the heart of Red Lake. The Rahill-Bonanza joint venture is 49% Premier Gold and 51% Goldcorp.

The other asset in Premier’s portfolio is the PQ North Project, north of Goldcorp’s Musselwhite Mine. There is potential for Musselwhite to continue to strike to the north and eventually run up against a boundary with PQ North.

Premier’s other asset, the Saddle Project in Nevada, is a non-compliant resource that the company is looking to drill by the end of this year, with a chance of a 1.5 Moz. or larger resource. That is in close proximity to Newmont Mining Corp. (NEM:NYSE).

TGR: What about Atacama?

SB: Atacama Pacific recently announced an initial NI 43-101 resource of 3.57 Moz. on its Cerro Maricunga project located in northern Chile. It’s in the same neck of the woods as Kinross Gold Corp.’s (K:TSX; KGC:NYSE) La Coipa and Maricunga mines, and Barrick Gold Corp.’s (ABX:NYSE) Cerro Casale deposit (75%/25% JV with Kinross).

The unique and attractive thing about Cerro Maricunga is that the resource is completely oxide-hosted mineralization, which means it can be low grade. It is grading only about 0.53 grams per ton (g/t) in the current resource. However, since it is oxide that means it is more readily available by a heap-leaching technology. Heap leach deposits would rather be oxide than sulfide, with higher recoveries and lower operating costs.

The best example of low grade but low cost oxide heap leach mining is Argonaut Gold Inc. (AR:TSX), which operates the El Castillo mine in Mexico. El Castillo’s reserve grade is only 0.36 g/t, but site costs are also low at $4–$4.20/tonne (cash costs were $578/oz. in Q211).

Atacama’s upside potential could be a 6.7 Moz. resource, but our target price of $10 is based on a resource potential of 5.1 Moz., the mid-point of the current 3.57 Moz. resource and our upside scenario.

TGR: The stock is at $4.25 today, down 10%. This might present difficulty in terms of liquidity for investors, but it also could present an opportunity to buy.

SB: The stock is not the most liquid entity out there, so there is the potential for a bit more volatility in share price on sometimes fickle volumes. But we quite like the company’s story.

TGR: What’s your thinking on the M&A possibilities for larger companies like Detour Gold and Allied Nevada?

SB: Allied Nevada is operating its Hycroft Gold Mine, which is an oxide heap leach, under an accelerated expansion program that is a modest increase in production from its heap leach production. The bigger kick will come from the approximate $1.3B capital program to develop the sulfide deposit that sits beneath the oxide deposit. The company just completed the feasibility study and booked Hycroft’s total reserve at 10.2 Moz. of gold and 389 Moz. of silver. Most of that is in the sulfide phase, which can be more expensive to process, given the refractory nature of the gold mineralization.

The reason we favor Allied Nevada is primarily for the re-rating potential for the shares under a go-alone approach to building the milling circuit at Hycroft and the optionality upside on its large exploration portfolio in Nevada, highlighted by its Hasbrouck project that is advancing toward a resource increase and preliminary economic assessment early next year. But there is M&A potential here as well. We view Hycroft’s sulfide reserve/resource as a large and strategic resource in Nevada that could be of interest to either Barrick Gold or Newmont. We understand that Barrick needs to supplement its Goldstrike ore feed with the purchase of native sulfur or barren sulfides to maintain optimal sulfur and heat balances in its autoclave/roaster circuits.

TGR: The company has said it could triple production by 2013, which really gets my attention.

SB: Average production from the project could be more than 600 Koz. of gold and about 26 Moz. of silver annually once the milling project is up and running in 2015 and beyond.

TGR: Detour Gold is also a big operation. The whole project has been interesting to watch over the last several years.

SB: It’s already booked a reserve of 13 Moz. and counting. It has raised all the required amount of capital that it needs to build the project. It is substantially advanced. The odds of M&A are not necessarily 100%, of course. For Detour, the attraction is that this deposit is already a large reserve at a conservative gold price and there is potential for Detour Lake to produce over 600 Koz./yr. when the mine starts up in less than two years.

TGR: It’s off of its 52-week high by about 20%. Depending on what happens over the next several months, it might present itself as more of a bargain.

SB: The site construction is well underway. In a Jan. 11 update, the company said average annual production was 657 Koz./year. There is potential for it to be large enough to be of relevance to a number of other companies.

Detour is trading at about 0.5 times net asset value (NAV), while the senior and intermediate group is trading at about 0.9 times NAV. This could be enough of a value spread whereby valuation and production accretion would make sense.

TGR: In the meantime, the company will just keep working its plan and expanding the reserve and resource and moving forward.

SB: Yes, both Detour and Allied Nevada will continue to aggressively move forward on their plans. Both companies have the potential production on full rampup of over 600 Koz./yr., enough to move the dial for anybody.

TGR: Those would be large transactions.

SB: They would not be insignificant transactions! You are right. Detour and Allied Nevada are resources that are open to potential expansions, as well as additions. Both have scoped pretty big levels of throughput in their operations. You might not necessarily be able to get much more than 130,000 tons/day out of Allied Nevada’s mill. That’s a very robust level of milling matching that of Goldcorp’s Peñasquito. Detour may very well look at an expansion beyond its mill throughput assumption of 55,000 tons/day. In fact, we model a modest expansion beyond that level because we believe that the reserve resources will continue to grow. There is some optimization that Detour and Allied Nevada will be able to do with both of their deposits.

TGR: You just attended the Denver Gold Forum. Did you discover some junior stories there that were compelling?

SB: There are a lot of projects out there. There always have been a lot of projects out there. And, at these gold prices, there are that many more, aren’t there?

TGR: There are going to be more.

SB: There is certainly potential for very large resource growth. A lot of these companies are going to be booking over the next year or two. Some companies will push the dial up even further. If there continues to be a divergence between gold and gold equities, I think that value will surface in many of these names. They will drive resource reserve increases. They’ll either be lucky enough to build their own projects, or the M&A will eventually kick into gear and many of these stories will be recognized with an increased level of corporate activity because it has been a little too quiet.

TGR: There are so many compelling, medium-size projects with proven reserves that are essentially, for lack of a better expression, rotting on the vine.

There is a vacuum of experienced management that knows how to put projects into production because no one was going into mining in the 1980s. We don’t have a robust group of younger management that is experienced. Perhaps the lack of talent pool on some of these projects is why they aren’t getting developed. I don’t know if that is something you thought about or not.

SB: It’s a very relevant comment. After I completed my undergraduate geology degree in 1988, the class sizes at the university that I attended kept getting smaller and smaller.

It’s also proven to be a lot more difficult for the companies to raise capital, of course.

TGR: Permitting issues.

SB: Right, permitting and because they are going further and further abroad. I remember visiting a project in 1996 that didn’t see production until about 2008. We thought it would be in production much more quickly. Sometimes it takes a couple of cycles for these things to get going. It’s challenging, but the people element is a big deal. If you don’t have experience, you have to train up a new pool of employees.

One of the most competitive locations for labor has proven to be Australia, because of the number of new projects and so few people with operating experience, developing experience, or experience as millwrights or metallurgists. It’s not just lack of talent in the managerial positions, but back down at the operating level, too.

TGR: I have heard that some Australian companies are bringing in coal miners from Kentucky on three-week shifts.

SB: Right.

TGR: That blows the mind. Steve, thank you so much. This has been great.

Steven Butler is managing director and senior precious metals analyst at Canaccord Genuity. He has spent over 17 years in mining research and has active coverage on 27 precious metals companies spanning the large cap and small cap space. Mr. Butler earned a BS in geology from Queen’s University in 1988 and an MBA from Dalhousie University in 1991.

The Gold Report: The biggest news to rock the copper world for quite some time hit late last month with Barrick Gold Corp. (TSX:ABX; NYSE:ABX) announcing a deal to buy Equinox Minerals Ltd. (TSX:EQN; ASX:EQN) for a cool $7.8B. What do you think about Barrick’s acquisition of Equinox, Kevin?

Kevin Puil: Although many view this acquisition as expensive and say that Barrick overpaid, I don’t think so. I think it’s a good move by Barrick. It was a friendly, all-cash bid of $8.15/share, which trumped Minmetals Resources’ hostile bid of $7/share. With this acquisition, I think Barrick management has clearly stated that its outlook for copper is bullish, and its outlook for the expansion potential at Equinox’s Lumwana deposit in Zambia is definitely bullish.

It’s a good way for Barrick to get back into African copper after having spun off African Barrick last year. The deal is definitely accretive. I saw the C-1 per-pound operating cost at about $1.90 with the average copper price Equinox sold this last quarter at about $4.30/lb. Those are good margins. The impact on net asset value (NAV)/share is negligible to Barrick, while it should increase per-share cash flow by almost 10% this year and close to 20% next year.

TGR: Given this acquisition, do you see more of the seniors that are heavily weighted toward gold following suit and adding more base metals to their portfolios?

KP: I definitely see more M&A in the copper sector, and I also can see more gold companies actively looking for projects that will give them exposure to both gold and copper.

TGR: Will that confuse investors who traditionally have a different reason for investing in copper than they do in gold?

KP: A lot of the senior gold producers have exposure to copper, whether investors know it or not. They typically produce a lot of copper as a byproduct. I don’t have the numbers in front of me, but I’d suspect that close to 10% of Barrick’s revenue comes from copper, especially with copper at $4/lb. At that level, it’s arguably more profitable than mining gold.

TGR: What are your feelings about copper? And where does Encompass Fund stand?

KP: I’m definitely bullish on copper over the medium and long term. The new world reality is increased consumption of raw materials by emerging classes in big countries with accelerated development. Demand is back on track, while supply isn’t. It’s taking longer to repair the damage to the supply side than to the demand side.

A few factors play into this. Companies are mining lower ore grades because new quality projects are scarce. In addition, political instability, as well as mining service and equipment supply problems are becoming major challenges for copper miners.

TGR: As you pointed out, with spot copper prices hovering around $4/lb., copper mining is still profitable for most of the seniors, and several seniors already have fairly significant copper credits or copper assets. Against that backdrop, will we see more juniors entering this space? And where would you expect to see more copper mining?

KP: Definitely. I do see more juniors getting involved in copper exploration and I think the majority of these projects will be found in Latin America, Canada and Australia. We’re seeing more activity—not just in the copper, but the gold/copper combination projects. We’ve already seen a number of acquisitions during the last year.

TGR: Aside from Barrick, what acquisitions come to mind?

KP: Thompson Creek Metals Company Inc. (TSX:TCM; NYSE:TC) acquired the Mount Milligan project in British Columbia from Royal Gold, Inc. (TSX:RGL; NASDAQ:RGLD). Goldcorp Inc. (TSX:G; NYSE:GG) acquired the remaining interest in El Morro, another Chilean copper project, from Xstrata PLC (LSE:XTA). And before Equinox, Barrick acquired the remaining interest in Cerro Casale in Northern Chile from Kinross Gold Corp. (TSX:K; NYSE:KGC).

TGR: Given the level of activity in the sector, could you tell us about any off-the-mainstream-radar companies that may have significant copper assets? Any compelling stories, particularly in mining-friendly jurisdictions?

KP: Yes, we’ve identified a few companies. Exeter Resource Corp. (TSX:XRC; NYSE.A:XRA; Fkft:EXB) has its Caspiche project. Again, it’s one of those copper/gold projects, with about 20 million ounces (Moz.) of gold and about 5 billion pounds (Blbs.) of copper. That comes with its own challenges, however, including lack of infrastructure and a large capital expenditure (capex) requirement.

Closer to home, Nevada Copper Corp. (TSX:NCU) has the Pumpkin Hollow deposit in the Walker Lane mineralized belt of Western Nevada. That deposit has about 9 Blbs. of copper with a couple million ounces of gold as well. Nevada Copper may be facing some permitting and financing hurdles, but it has good infrastructure in a stable political environment.

We also like Candente Copper Corp. (TSX:DNT). Its Cañariaco Norte deposit, with 7 or 8 Blbs. of copper has been significantly de-risked with the completion of a pre-feasibility study. Capex is probably going to be about $1.5B. Cañariaco Norte is in Peru, where the mining sector may see some instability in the post-election period, as both candidates have indicated an intention to increase taxes.

One of our favorites for potential acquisition is located in Arizona—Redhawk Resources (TSX.V:RDK; Fkft:QF7). Its Copper Creek project is located in a mining-friendly district in Arizona, which leads the U.S. as a copper-producing state, with 12 active mines. Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) and Rio Tinto (NYSE:RIO; ASX:RIO) are also operating in the area. The project is within eyesight of Grupo México’s (BMV: GMEXICOB) ASARCO Ray mine and Hayden smelter and BHP Billiton Ltd.’s (NYSE:BHP; OTCPK:BHPLF) now-closed Kalamazoo Mine.

The 100%-owned project is 7 sq. mi. and has had more than 400 drill holes and 160,000m of drilling to date, with more than 75% of the property still unexplored. Redhawk’s deposit has already been adequately de-risked, with an NI 43-101 compliant resource and scoping study identifying approximately 3.5 Blbs. of copper and 50 Mlbs. of molybdenum, with plenty of exploration upside remaining. In addition, more than 400 high-grade breccias appear on the property, although only three have been fully drilled. This definitely has the potential to be a world-class deposit the size of the legendary Resolution or Safford mines.

TGR: When were the tests completed at Redhawk?

KP: They were released last year, and we’re expecting an updated resource estimate, probably in a month or two. It’s a well-positioned resource with a grade of close to 1% copper, a projected operating cost of $1/lb. and capex of less than $500M. I believe Redhawk’s a very attractive acquisition target, too, because it’s well down the permitting path and has great infrastructure. It could be ready for production within 18 months. Not only that, but Redhawk is trading at less than $0.03/lb. copper in the ground, not counting the molybdenum credit, and acquisitions have been more in the range of $0.07–$0.10/lb.

TGR: Is it fair to assume that some of the seniors located in the same district would be interested in an accretive asset such as Redhawk?

KP: Yes, the natural suitors would be ASARCO, Freeport McMoran or Rio Tinto, but I wouldn’t discount foreign nationals such as China and India. Both of those countries have long time horizons and are looking now to nail down supply streams for concentrate 10 to 15 years out. I wouldn’t count them out at all.

TGR: Tell us a little bit about Redhawk’s management, treasury, market cap and so on.

KP: It has a market cap of about $90M, which I think is undervalued by at least 50%. Just by doing easy calculations of copper in the ground, the base case tells me that the project is worth at least $1.25/share, whereas it’s trading at about $0.65 a share.

Redhawk has very strong management, probably more than 40 years of mining experience with one of its top executives coming from BHP. It’s well-capitalized with more than $20M in the bank right now, no debt and no need to go to the market. I think it’s extremely well positioned.

TGR: But no U.S. listing to date?

KP: Not yet, but soon. I believe that they’ll be listing on the OTCQX within a matter of weeks.

TGR: With so much emphasis on gold as it continues climbing to new heights, it might be easy for investors to overlook copper, but you’ve made it clear that the copper space is heating up and there are some exciting stories to tell.

KP: As I said early on, I’m bullish on copper and so are a lot of senior miners. They’re looking to diversify, and for gold miners, copper is an easy way to do it. As companies have to look toward increasingly more difficult geography and geologies to meet demand, it’s going to take more time and a lot more money to bring new copper supply online. We can probably expect more senior miners to get involved with copper as the supply/demand structure holds up for different reasons than the supply/demand structure for gold.

TGR: Thank you Kevin, you’ve given us a lot to think about.

A Chartered Financial Analyst (CFA) with more than 15 years’ experience in the investment management business, Kevin Puil currently serves as portfolio manager at Malcolm H. Gissen & Associates Inc. in San Francisco, and as senior analyst for its Encompass Fund. The Encompass Fund, which focuses on global resource companies exploring for and producing gold and silver, copper, uranium and rare earth elements, racked up a healthy 60% return in 2010, following a spectacular 139% in 2009. Before relocating to California, Kevin worked in Canada, where he also studied economics at the University of Victoria and the University of British Columbia.