By The Gold Report, on February 7th, 2012
 The market isn’t rewarding fundamentals just yet for precious metal miners, according to Byron King, editor of Daily Resource Hunter, Outstanding Investments and Energy & Scarcity Investor. But in this exclusive interview with The Gold Report, King maps out when rising gold prices will actually lead to rising stock prices for companies with quality projects and solid treasuries.
The Gold Report: Byron, anyone who reads your reports knows two things: you like to tell stories and you like precious metals. The gold price has spent the last 11 years trending higher. Do you see it continuing upward?
Byron King: I anticipate that gold, silver and platinum will all continue to rise in price. There are currency-driven reasons why metal prices are going to keep rising, as well as other issues with overall supply and falling production.
In terms of production, the gold and the platinum production spaces are very precarious. A few very bad things could happen at random and knock global production for a loop and seriously impact supply. Think in terms of a major mine accident in, say, South Africa. Supply could fall off a cliff overnight.
In terms of politics and monetary issues, precious metals create an outside limit on people’s political power. Thus I expect massive amounts of manipulation as we roll along, too. The dollar value of gold, silver or platinum will tend to rise over time, but we could see price spikes up and down due to that manipulation.
TGR: The junior precious metals sector fell hard in 2011. You tend to stick toward the midtier and major precious metals producers with strong cash flow. Those names often have lower risk, but risk can rear its head in that space, too. Major gold producer Kinross Gold Corp. (K:TSX; KGC:NYSE) watched about $3.1 billion (B) of its market cap get buzz sawed off in mid-January after it announced that it would take a $4.6B write-down on its Tasiast gold mine in Mauritania. Kinross spent $7.1B acquiring Tasiast and other assets in the September 2010 takeover of Red Back Mining. Does this serve as a warning to the other majors?
BK: It might be 15 years past the Bre-X scandal, but when it comes to buying and selling gold mines, no amount of due diligence is too much. It gets back to Mark Twain’s comment about how to define the term gold mine. It’s a hole in the ground with a liar standing at the opening of the shaft.
The Kinross writeoff is scary. They’re supposed to be better than that. So when you own physical gold, you can go to bed and close both your eyes. With gold mining shares, you still need to keep one eye open.
TGR: Were you recommending Kinross?
BK: Kinross has been in the Outstanding Investments portfolio for over four years. I’m hanging on to it in the hopes that it will go higher, but it’s been disappointing. It’s not been able to get the share price up and keep it up despite a gold price that has quadrupled.
TGR: Its strategy was to grow through acquiring assets. Apart from buying Red Back Mining, Kinross bought Underworld Resources in the Yukon and Aurelian Resources in Ecuador. Do you believe that was the wrong strategy?
BK: Much of the gold mining investing business is about takeovers. The large companies with, say, 10 million ounces (Moz) a year of output couldn’t discover that much just by sending out their own geologists with rock picks. Gold mining requires an entire process of prospect developers, generators and joint ventures. The better assets get picked up by the larger companies. In fact, Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) just announced a takeover of Minefinders Corp. (MFL:TSX; MFN:NYSE). Minefinders is a one-trick pony, but it’s one heck of a pony. It’s the Dolores play in Mexico.
TGR: Sure, acquisitions are key, but many analysts believe that Kinross paid too much for Red Back and it’s now writing down three-quarters of what it paid. Will companies be more loath to spend big dollars in takeovers now?
BK: The acquiring companies have to be smarter and cheaper about takeovers. They have to pay less. Then again, you’re lucky if you get what you pay for, and you never get what you don’t pay for.
The news from Kinross could serve as a wet blanket for the rest of the intermediate and junior mining space. Future takeout plays might see more lowball offers.
It gets back to the idea that an allegedly savvy company like Kinross could make as bad a mistake as it did—at least in retrospect. It’s a wakeup call to the industry. I suppose in the boardrooms of the big mining companies they’re sitting around saying, “We’re much smarter than those guys at Kinross.” All I can say is to be careful of admiring yourself too much in the mirror because I’m sure Kinross thought it was doing the right thing, too.
TGR: In an ironic twist, some analysts are now speculating that Kinross could become a takeover target. Keith Wirtz, chief investment officer at Fifth Third Asset Management, said, “Every dollar lower pushes the stock higher up the list of potential takeovers. That will attract the sharks in the water.” Do you think Kinross will be taken out in 2012?
BK: Kinross has made a big mistake. Now the company has a big bull’s eye pinned on its back. Kinross has some very strong assets. I’m sure other companies are looking at these assets and thinking they could do a much better job at managing them than the guys running the show right now.
TGR: Something else of note in the large-cap gold space is the increase in dividends as gold companies jockey for investor attention with other instruments like real estate investment trusts, exchange-traded funds and even master limited partnerships. One company in particular, Goldcorp Inc. (G:TSX; GG:NYSE), recently raised its dividend again. Do you prefer gold companies with a significant dividend or are other factors more important?
BK: All things considered, I like companies that pay dividends. I like the idea that they bring the shareholders into the equation by sharing some of the wealth. There’s a certain capital discipline in running a company that comes with the knowledge that it has to write a check to the shareholders as well.
TGR: What are some of the major gold producers that are running a dividend that you like?
BK: Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:TSX; ABX:NYSE), IAMGOLD Corp. (IMG:TSX; IAG:NYSE) and Goldcorp are nice dividend players.
TGR: Which one has the strongest growth profile?
BK: Goldcorp. Five years from now, it could be the best overall return.
TGR: Are you following any midtiers?
BK: I’ve been following Minefinders, but it just got bought. I’m waiting for the development at Donlin Creek, Alaska, to come through for NovaGold Resources Inc. (NG:TSX; NG:NYSE.A). Investors are going to have to be patient with this one. It’s over 30 Moz of gold. It’s partnered up with Barrick, but the development has been slower, longer and more painful than I expected. However, over enough time, NovaGold could be quite rewarding to a patient resource investor.
TGR: What undervalued junior or midtier producers could rebound in 2012?
BK: Carlisle Goldfields Ltd. (CGJ:CNSX) at Lynn Lake, Manitoba. It’s an old copper-nickel producing area, but it has had a very aggressive drilling program. I am waiting for an updated NI 43-101 to come out, which could show an expanded resource base.
Reservoir Minerals Inc. (RMC:TSX.V), a spinout of Reservoir Capital Corp. (REO:TSX.V), is a play on mineralization in Serbia. Reservoir Capital was a hydropower and geothermal company with some mining assets as well. Last fall, it spun out the mining assets into Reservoir Minerals.
It’s now a copper project that is joint ventured with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). It has had extremely good drilling results in a historic gold producing area in Serbia that was one of the richest gold mines in Europe in its day. It was sealed up just before World War II and not unsealed until about two years ago.
Reservoir also controls numerous other mineralized areas in Serbia, which is a very well-run, mining-friendly jurisdiction. That is, we’re not dealing with the Serbia of the 1990s. This isn’t the Serbia that NATO bombed in 1999. This is a modern, European country that is looking desperately for investment. Reservoir Minerals is a key part of the future of Serbia.
TGR: Carlisle has the historic MacLellan mine. What stood out when you visited that project?
BK: It’s in Precambrian greenstone in a shear zone, in a known mineralized district. The greenstone and the shearing outcrop at the surface. Carlisle has great land position in terms of following the strike. It has a very aggressive drilling program, and while results aren’t out officially, from what I can gather from my own examination of the cores, there is a very nice consistency of mineralization all along the strike. I think that when Carlisle gets done with its analysis we’re going to see a very nice resource number at very respectable, mineable grades.
TGR: What investment themes do you expect will be prevalent in the gold space this year?
BK: The gold price should continue the 11-year trend of increasing nearly every year with the possibility of a big jump if a one-off type of event, such as a mine accident, chokes off a large amount of the world’s gold supply. I know accidents aren’t ever supposed to happen—nuclear plants in Japan and cruise ships in Italy are failsafe, right? We have to watch that.
TGR: What about increasing tension in the Middle East?
BK: Tension in the Middle East always seems to drive up the price of oil and the price of gold. People move their resources from one jurisdiction to another, from one form of investment to another. I went to one of the gold souks at the grand bazaar in Istanbul about two years ago. I was astonished that people were mobbing the gold souks, throwing money down and grabbing all the gold coins that they could get their hands on. I saw Russians and people from across Europe just peeling out these €500 notes and buying as much gold as they could take. It was fascinating.
TGR: Surreal.
BK: It was surreal to literally watch people scoop up gold, put it in their pockets and walk out of the stores. People were trying to get rid of cash and buy gold. There’s an entire gold-buying culture that a lot of people in the West are not used to seeing.
TGR: What about the protests, violence and economic sanctions being brought to bear on certain Middle Eastern countries? It seems like the tensions there are certainly hotter than they have been since the early ’80s.
BK: War is bad for business, but the rumors of war are sometimes good for business. I think if the Strait of Hormuz closed or if there was a shooting war in the Middle East, it would drive the price of gold upward. As the price of gold goes up, it’s going to lift the share price for the miners that have good fundamentals.
Right now the stock market is barely paying for fundamentals. It really doesn’t respect stories, let alone blue sky. But if the price of gold keeps going up, the companies with decent fundamentals will also rise.
TGR: Thanks for your insight, Byron.
Byron King is the resident energy and natural resource expert at Agora Financial, LLC. A geologist by training, he worked for the former Gulf Oil Co. and has followed oil industry developments for over 30 years. King’s career path also took him into the U.S. Navy, both in active duty and reserve. In the 1990s and 2000s, King engaged in a vigorous private law practice. For the past five years, King has been writing about energy and natural resource issues for an international audience. Currently, King writes and edits Daily Resource Hunter, Outstanding Investments and Energy & Scarcity Investor. He holds degrees from Harvard, the U.S. Naval War College and the University of Pittsburgh.
By The Gold Report, on February 6th, 2012
 Economics and politics. Accretion and repletion. Mergers and acquisitions. Joe Mazumdar, senior mining analyst with Haywood Securities, sees all of these as catalysts for a rebound in the junior gold space in 2012. In this exclusive Gold Report interview, he reveals the names of companies he expects to take off.
The Gold Report: What is the consensus among Haywood analysts on what 2012 will bring for mine commodities, particularly precious metals?
Joe Mazumdar: Last year, risk aversion was a common market theme. In 2012, some of the same global economic concerns, such as the ongoing Eurozone crisis and the future of the euro, will continue to draw attention. But we also believe there is potential for positive economic indicators, primarily from the U.S., where there have been upticks in manufacturing and GDP growth. Also, unemployment in the U.S. is down to 8.5%, generating some consumer confidence. Recently, GDP growth for Q411 came in at 2.8%, which was slower than consensus forecasts—3%—but still the strongest in over a year.
Political factors will play a role in 2012. There could be a change in leadership among four of the five permanent members of the U.N. Security Council. The presidential election will be a key focus of the U.S. and global market. There are also presidential elections in Russia, France and Mexico. There also may be a changing of the guard in China in the latter part of 2012. The potential for changes in leadership in these key nations will generate a bid to market volatility in 2012.
Beyond gold and silver, our preferred commodity sectors include copper, iron ore and coal. Gold continues to be adversely affected by its own volatility, which continues to tarnish its reputation as a safe-haven asset. We note that during 2011, U.S. Treasury securities, the most liquid safe-haven asset, was a preferred recipient of capital investment, providing a ~10% return, its highest annual return since 2008 when it was 14%.
TGR: Will the strengthening American economy have an adverse effect on the gold price?
JM: Yes, the gold price quoted in U.S. dollars will be hindered by any U.S. dollar strength based on economic growth and increasing consumer confidence. In the current environment, gold, quoted in U.S. dollars, is still holding up well at price levels over $1,700/ounce (oz).
We note that the Federal Reserve said recently that it remains concerned about the “vigor” of U.S. economic growth and pledged to maintain low interest rates until at least 2014. The latter is a positive for gold prices.
In the medium to long term, increasing confidence levels in U.S. economic growth we believe will drive higher capital investments domestically and potentially raise inflation expectations, which would be a positive for gold.
TGR: What about silver and copper?
JM: We see copper on the brink of a rebound in 2012. The London Metals Exchange inventories are at low levels and Chinese imports of refined copper accelerated in the latter part of 2011. Copper is covered by Stefan Ioannou/Kerry Smith of Haywood Securities and they highlight a structural tightness in the copper market as supply growth remains constrained while a portion of future production growth resides in higher geopolitical risk jurisdictions. They note that the GFMS has estimated a deficit of 372 Kt copper in 2011 and forecast yet another deficit for 2012, 101 Kt.
Chris Thompson covers the silver sector for Haywood Securities and has commented that despite the growth in investment demand over the past five years, silver is still very much an industrial metal. Volatility, he believes, will be underpinned by potential contradictory moves by those who see silver as an industrial metal and others who seek it as an investment asset.
TGR: Did the junior mining sector hit bottom in 2011?
JM: Within the current cycle, I think it has hit bottom. For me, the question remains: What are the catalysts that will move individual stocks up within the sector?
For a number of the majors, growth has been increasingly difficult to achieve given the higher amounts of reserves they must replete on an annual basis. Companies such as Newmont Mining Corp. (NEM:NYSE) have been offering higher and more levered dividend payout structures to attract investors.
In 2012, we see the potential for more merger and acquisition (M&A) activity, specifically in the junior to intermediate sector, given the plethora of small-cap stories in the gold sector. Producers have performed better with respect to their paper in 2011, compared to development stocks, and boast healthier balance sheets. M&A activity will be driven not only by a desire for growth but also motivated by financing risk to capture any synergistic opportunities such as sharing infrastructure and the potential to merge critical skill sets. There is a paucity of people who can bring projects into production and operate them. Merging structures and management is very important right now in the junior and intermediate sector. Without it, a lot of these companies with development assets may continue to struggle.
TGR: Do you expect the Kinross Gold Corp. (K:TSX; KGC:NYSE, Not Rated) write-down to have an adverse effect on M&A?
JM: Large projects that are required to move the needle in the growth strategy of a large gold producer have a scale and scope that naturally expose them to significant execution risk. So, in a nutshell, escalating capital costs for projects of this magnitude are nothing new.
The M&A opportunities I refer to are at a scale that would be accretive to a junior to intermediate company from a growth perspective and offer opportunities to capture synergistic value. From a valuation perspective, many companies with development stage assets are trading well below their underlying asset valuations. M&A activity allows also for some consolidation in the junior sector given the plethora of small-cap gold plays.
TGR: Did you make any adjustments to your investment thesis following the dip in precious metals equities late in 2011?
JM: In our top picks, which we put out on Jan. 9, we focused on producers generating cash flow and developers with permitted or on a clear path-to-permitted projects in low geopolitical risk jurisdictions.
One pick was Midas Gold Corp. (MAX:TSX, Not Rated), whose flagship asset, the Golden Meadows project, hosts a global resource of 5.8 million ounce (Moz) in the Yellow Pine Stibnite area on a large land package (11,600 hectares) in west-central Idaho, a re-emerging gold district. The company is working toward an updated gold resource estimate before the end of Q112, leading to a preliminary economic assessment (PEA) by Q312.
TGR: Can you give us another name on your list?
JM: Yes, Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.A, Sector Outperform, CA$3.25 Target Price). It has the Spring Valley gold project, an intrusive-hosted gold deposit with a global resource, we estimate at over 5 Moz, in a district close to Lovelock, Nevada, where Barrick Gold Corp. (ABX:TSX; ABX:NYSE, Sector Outperform, CA$61 Target Price), is earning in up to 70% by 2013 by cumulatively spending US$38M.
From a metallurgic perspective, the gold is free, not occluded in pyrite and potentially amenable to be economically extracted via a heap-leach process. Barrick, the joint-venture operator, is currently drilling the edges of the deposit to find out how big it could be. This means the near-term news flow will be linked to drilling results and less about a resource update in 2012.
Midway has a portfolio of projects that it is capable of bringing on-line. Its Pan project, a low strip open-pit, heap-leach gold project in Nevada, has submitted a completed bankable feasibility study and a plan of operations. Its Gold Rock project, only 8 kilometers from Pan, is in an earlier stage where we anticipate a resource by Q112 with additional drilling in Q2–Q312, leading to another resource update by Q412 and a PEA by 2013. Additionally, Midway is working a low-sulphidation, high-grade gold project in the Tonopah District.
Midway has a portfolio of projects and is assembling a team to build and operate them. Its COO, Ken Brunk, formerly with Newmont and Romarco, is very familiar with the permitting process and developing/operating projects in Nevada. I believe the company can manage this project pipeline of financeable projects in the low geopolitical risk jurisdiction of Nevada.
TGR: Your target price for Midway is $3.25, up $0.25 from your last report. With that many projects in the development stage, it seems that Midway would be a prime takeover target, especially given its joint venture with Barrick.
JM: Barrick is looking at a number of projects in Nevada, some of which are billion-dollar-plus projects that would add significant ounces to its production profile including Spring Valley, Goldstrike and an expansion at Turquoise Ridge. I believe that Spring Valley may be a target for Barrick going forward as it has potential to contain a +5 Moz global resource and lies in Nevada where Barrick has a significant infrastructure and asset base.
However, the other components of the company’s portfolio, which include smaller open-pit, heap-leach projects, such as Pan and Gold Rock, that could potentially produce between 70–90 thousand ounces (Koz)/year, would not move the needle for most majors. These smaller projects do generate cash flow and are more readily financeable by a company the size of Midway. They could also be attractive to an intermediate operating group looking at accretive transactions with junior developers.
TGR: You cover Orvana Minerals Corp. (ORV:TSX, Sector Outperform, CA$2.25 Target Price), which is in production at its Don Mario mine in Bolivia and its El Valle-Boinás/Carlés (EVBC) mine in Spain. From June to October 2011, gold grades there increased incrementally from 1.4 to 2.17 grams per tonne (g/t). Nevertheless, Orvana’s throughput at EVBC is below your forecast. Results at Don Mario in Bolivia also were below estimates. Is this a make-or-break year for Orvana?
JM: It is a critical year for the company. Bill Williams, formerly Orvana’s vice president of corporate development, is now the CEO. He is an ex-Phelps Dodge vice president and has been instrumental in generating the revised technical reports on both operations, EVBC and Don Mario Upper Mineralized Zone (UMZ), while advancing the Copperwood project. We believe his appointment reflects the company’s focus on getting the operations back on track.
Orvana is currently in the process of re-benchmarking both EVBC and Don Mario UMZ. For Don Mario—an open-pit mine with an upper mineralized zone containing a lot of copper, as well as gold and silver—Orvana has delivered a new life-of-mine forecast that addresses the difficulty of getting copper out using a leach precipitation flotation circuit on a much bigger scale than has been used before. The Don Mario operation also has been troubled by high costs of reagents for the circuit, which has raised the processing costs.
We had originally forecast an annual production profile of 10–15 Koz per year of gold and 10–15 million pounds (Mlb) of copper. We are now looking at a production profile of 9–10 Mlb copper and 8–9 Koz of gold, whereas Orvana is still signaling 13 Mlb of copper and 12 Koz of gold. In Q411, the Don Mario UMZ operation produced 2.5 Mlb of copper and 2.3 Koz of gold, which is a positive. Now, it has to consistently achieve its new benchmarks over the next few quarters so the market can gain confidence in its operational abilities.
At Orvana’s flagship, the EVBC gold-copper project in northwest Spain, the operational issues have been related to head grades. Underground bottlenecks have hindered the company’s ability to blend higher grade feed to the processing plant. We anticipate that a shaft will be in place by April/May 2012, which should alleviate some of the bottlenecks. We had originally forecast that the feed grade, at steady state levels, would be in the area of 5 g/t. However, revised guidance indicated that it would be lower, 3–3.5 g/t gold, which also conspired to lower our target. We anticipate a revised technical report for EVBC prior to March 2012 with updated life-of-mine forecasts.
Orvana’s Copperwood project in upper Michigan is a 50 Mlb/year copper project, now in bankable feasibility study, and Orvana is seeking to permit this year. Even with up to 800 Mlb of copper reserves, we believe that the Copperwood asset is not being valued at its current price levels as Orvana has been heavily discounted in the market due to poor operational performance.
TGR: Given the lower recoveries and production estimates at Don Mario UMZ released in late January, you lowered your target price by $0.15 to $2.25. Yet you still give it a sector outperform rating. Why?
JM: Due to the heavy market discounting related to disappointing results from both operations over the past few quarters, Orvana still provides about a 100% return to our target from where it is trading right now. I continue to believe that management can redeem themselves by achieving the revised benchmarks consistently over the next few quarters. As Orvana meets its goals, I believe the market will appreciate the cash flow being generated, worry less about its working capital position and give the company credit for its advancement of the Copperwood project.
TGR: Prodigy Gold Inc. (PDG:TSX.V, Sector Outperform, CA$1.20 Target Price) recently published an updated PEA on its flagship Magino gold project in northern Ontario. Your model for Prodigy, using the updated PEA, projects a 20,000-ton/day operation, producing 222 Koz of gold per year over 13 years at total cash cost of roughly $775/oz. That would generate annual earnings before interest, taxes, depreciation and amortization margin of more than 50%. Yet, your target price of $1.20 is only about 40% above where Prodigy is trading. Why so conservative?
JM: Given that gold indices provided a negative return in 2011 ranging from 13% to 20%, I think that a positive 40% return to target is probably not conservative in the current market environment. With respect to the valuation, I have adjusted for the technical and execution risk of the study level (PEA) and the fact that I have modeled a larger mineable resource base than that used in the December 2011 PEA. As a company derisks the project from PEA to a feasibility study, I revise the multiples applied to the asset valuation.
Prodigy is planning a significant drill program of 60,000m in 2012 to infill/upgrade and expand the resource base while condemning areas for locating site facilities. We also anticipate an updated resource by Q312 leading to a feasibility study by Q412.
TGR: Do you expect a takeover offer for Prodigy?
JM: I try not to work off the takeover model because it is highly uncertain but focus on the underlying valuation. While I do believe that the Magino asset would be a good takeover candidate for an intermediate, I think that there are opportunities for consolidation and capturing some synergies with Richmont Mines Inc. (RIC:TSX; RIC:NYSE.A), which has an underground operation that abuts Prodigy’s land package. Consolidation would probably be a good idea, given that Prodigy could have underground targets within the same host rocks as Richmont, which has a fully permitted and functional process plant.
TGR: In your last interview with The Gold Report, you talked about Revolution Resources Corp. (RV:TSX; RVRCF:OTCQX, Not Rated). You said it was looking for analogs of Romarco Minerals Inc.’s (R:TSX, Not Rated) Haile Deposit in the Carolina Slate Belt. What’s happening with Revolution now?
JM: Revolution still occupies a significant land package of 7,500 acres along a 25-kilometer corridor within the Carolina Slate Belt at its Champion Hills Gold project in North Carolina. It drilled 19,150m in 2011 and is working on a resource estimate in 2012. Currently, gold equity plays exploring in the Carolina Slate Belt are strongly tied to news flow from Romarco’s multimillion-ounce Haile gold development project in South Carolina and its ability to permit it. In an effort to diversify its portfolio, Revolution acquired a significant land package (~400,000 hectares) in two prospective regions in Mexico from Lake Shore Gold (LSG:TSX, Sector Outperform, CA$3.50 Target Price) in 2011. These assets host high-level low-sulphidation epithermal, gold and silver mineralization and we anticipate news flow from drilling results by Q1–Q212. The company wanted to present the market with multiple catalysts from a diversified asset base and this project has allowed it to achieve that goal.
TGR: In late December 2011, Eldorado Gold Corp. (ELD:TSX; EGO:NYSE, Sector Outperform, CA$19.00 Target Price), made a takeover bid for European Goldfields Ltd. (EGU:TSX; EGU:AIM), which has gold exploration and development properties in Greece, Turkey and Romania. Last year, you discussed Carpathian Gold Inc. (CPN:TSX, Sector Outperform, CA$0.90 Target Price) and its Rovina Valley copper-gold-porphyry project, which contains about 10.7 Moz gold equivalent in Romania’s Golden Quadrilateral. Does the proposed European Goldfields takeover make Carpathian Gold more attractive to larger suitors?
JM: Barrick’s private placement in August 2011 into Carpathian to fund additional drilling at Rovina Valley already speaks to the attractiveness of these gold rich porphyry systems to larger suitors. Mining activity in Romania is heavily linked to news flow on the permitting activities at Rosia Montana operated by Gabriel Resources Ltd. (GBU:TSX, Not Rated).
Eldorado Gold’s proposed takeover bid for European Goldfields does put in a bid for assets in Europe, however, the majority of European Goldfields’ assets are located in Greece (Olympias/Skouries) and less so in Romania (Certej). For me, the takeover trigger was related to the receipt of permits to develop its Greek projects in July 2011. Permitting of those projects took an extended period of time. A positive permitting environment in Europe bodes well for Carpathian at Rovina Valley and it will benefit from any positive news flow from Gabriel. The risks include royalty increases and potential free carried interest that the government wants to negotiate.
TGR: Royalties are going from 4% to 8%. That certainly is not positive, but to get those revenues the government has to permit the mines.
JM: Herein lies the rub. On Jan. 3, we lowered our target by $0.10 on Carpathian to $0.90 to accommodate an increase in the gold and copper royalties to 8% at Rovina Valley. However, on the positive side, by defining the mining royalty rates and the tax structure and negotiating a free carried interest, the Romanian government has shown its desire to have these companies invest in these projects and generate the revenue streams within a restructured rent-sharing framework. We note that the local government is also looking to privatize some state-owned mining assets to raise revenue.
TGR: What do analysts, investors and companies need to look out for in terms of geopolitical risk?
JM: I would highlight countries—emerging or developed—that are in economic dire straits with prospective geology whose mining sector is underdeveloped and has untested mining laws and poor infrastructure. Geopolitical risk carries a few facets including outright expropriation to creeping nationalism, which is linked inextricably to a company’s ability to develop/permit the project. These countries will continue to seek foreign direct investment to explore/develop these assets. Outright expropriation is difficult in countries where there is no mining history and a paucity of critical skill sets locally, unless of course it is looking to sell the asset to another bidder. Alternatively, the country may alter its mining laws to increase its share of resource rents derived from the exploitation of these assets. We have observed higher rent sharing globally via increased royalty payments, higher taxes and/or the introduction of windfall tax structures in countries such as Peru, Argentina and Romania, to name a few.
Assets in higher geopolitical risk jurisdictions must provide the investor a high return and quick payback commensurate with the elevated risk profile. Note that assets within higher geopolitical risk jurisdictions may be more difficult to finance and there may be a limit on potential takeover suitors, depending on their risk appetite. To properly risk adjust and quantify these uncertainties remains a challenge.
TGR: Is that because it is not going away?
JM: Let’s not forget that mining is a great way to get an injection of direct investment into an economy and generate employment. For example, high rates of unemployment in developed countries such as the U.S. and European countries are driving mining activity in places where permits have historically been difficult to attain.
TGR: Joe, thank you for your time and your insights.
Joe Mazumdar is a senior mining analyst with Haywood Securities in Vancouver. Previously, he served as director of strategic planning at Newmont Mining and was the senior market analyst for Phelps Dodge. He has held a variety of geologist positions with other mining companies including RTZ, MIM, North and IAMGold working in South America, Australia and Canada, rounding out ~20 years industry experience. He holds a Bachelor of Science in geology from the University of Alberta, Canada, a Master of Science in exploration and mining from James Cook University, Australia, and a Master of Science in mineral economics from the Colorado School of Mines, U.S.
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By The Gold Report, on January 31st, 2012
 After a tough year in 2011, there is definitely a good selection of underpriced junior resource stocks available for astute investors to focus on before the rest of the herd finally wakes up and smells the gold. In this exclusive interview with The Gold Report, Matthew Zylstra, mining analyst at Northern Securities, reviews the gold, silver and PGM markets and tells us why he believes that better times are ahead for junior miners in 2012 and which ones he particularly likes at current price levels.
The Gold Report: When you last spoke with The Gold Report in early March of last year, gold was trading around $1,420/ounce (oz) and silver was around $36/oz. Silver peaked about $49/oz in late April and then gold hit around $1,900/oz in September. Now we’re back up above $1,700/oz on gold and about $33/oz on silver. Where do you see these prices going this year, after it appears that they have likely bottomed out?
Matthew Zylstra: We’re long-term bulls on both metals. Gold has been correcting since September and it looks like it bottomed out around $1,500/oz. We believe the recent decline is a normal pullback in a longer-term uptrend where nothing has really changed to the outlook. We see a perfect environment for the metal—concerns over our currency debasement, negative real interest rates, geopolitical friction, etc. I expect gold will reclaim the 2011 highs and could reach $2,000/oz.
For silver, the picture is less clear. Silver is, in part, an industrial metal accounting for around 50% of demand and less of a currency. Silver peaked at almost $50/oz in April 2011 and the price has been very volatile. We think the move is a correction, again, in a longer uptrend going back to 2003. I expect silver will trade around the mid-$30/oz range this year.
We actually feel platinum has a lot of potential. South Africa, Zimbabwe and Russia account for about 90% of platinum production and there’s a scarcity of good platinum metals group (PMG) projects outside those countries. We expect increased investment demand and believe that supply disruptions, as well as resource nationalization concerns, will drive the price higher. We note that Sprott Asset Management has formed a physical platinum and palladium trust, which could boost investment demand.
TGR: So, what really happened to the platinum market? Historically, platinum traded at a 30–40% premium over gold. Does it have to do with industrial demand or what happened to cause it to trade below gold?
MZ: The main industrial use for platinum/palladium is automotive catalysts. With fears of a global slowdown, their prices came off. But our view is that supply is not going to be able to meet the demand going forward. And, as you mentioned, platinum has historically traded at a significant premium to gold but the value is now only about 95% of the price of gold.
TGR: Getting to the actual equities, the gold and silver stocks certainly didn’t track the metals prices very well the last year. What’s been the problem?
MZ: Gold stocks have performed poorly compared to the metals. We believe this has to do with investors being leery about another period similar to what occurred in 2008 when credit markets froze. Exploration and development companies, in particular, are sensitive to what’s going on in the capital markets since they require capital to continue exploration. Take, for example, Trade Winds Ventures Inc., which was acquired last year by Detour Gold Corp. (DGC:TSX). Shares of Trade Winds traded down to $0.03 in the 2008 crisis. Trade Wind shares were later bought for cash and stock, which at the time amounted to about $0.45 a share. My point is that people are nervous but that creates opportunity especially with what I believe will be a catch-up in equity prices.
TGR: I hope with metals prices staying up, the credit markets will be a little more optimistic and will loosen up a bit.
MZ: We certainly don’t expect another period like 2008. I think that was an aberration.
TGR: So, I hope the stocks start picking up here and not continue acting like gold is $800/oz and silver is $15/oz.
MZ: That is what we expect and the precious metals stocks could really get a boost on QE3 or other stimulus programs.
TGR: So, what do you think is going to be some sort of catalyst to get people more excited faster? Or is this just going to have to be a gradual progression and we are going to have to wait for $2,000/oz gold and $50/oz silver for people to really get into this market?
MZ: The disconnect between gold/silver prices and mining company equities has grown considerably. The sector is cheap by historical standards when you consider the price of gold miners’ shares relative to the price of gold. The Philadelphia Gold and Silver Index (XAU), which is an index of 16 precious metals and mining companies, is close to the lowest level it has been since the 2008 crisis relative to gold. We expect this ratio to gradually work its way back to the average. If we see gold mining stocks move up to even the low end of their historical range versus gold, it will mean a significant gain for many of these companies.
Increased merger and acquisition (M&A) activity in the sector will get people interested in a lot of these companies. As the price of gold and silver continues to rise, the economics become very compelling, especially for large- and mid-cap companies to acquire smaller players.
More interest in precious metals will help too. With what I see as a developing currency war—a race to devalue—I think more investors are going to turn to precious metals and related equities.
TGR: It certainly seems like there are a lot of smaller companies out there with some interesting looking projects that may be sitting ducks for being taken over. If they have to keep going back to the market to raise more money and create more dilution, that could be a problem. What’s your thinking on that?
MZ: Small exploration companies are going to continue to need funds to advance their projects, and costs have been increasing. That’s a major problem. The need to raise capital isn’t going to change but we are seeing alternative ways of financing such as gold and silver streams, alternative debt arrangements and joint ventures, which mean less dilution.
TGR: A lot of companies that were able to load up with plenty of cash at reasonable prices are obviously happy in this market. Do you think they’re going to get pushed to go out and do acquisitions?
MZ: I think what we’re seeing now are mining companies with the ability to acquire languishing juniors taking advantage of the environment. The seniors and intermediates, which have filled up their treasuries with robust gold and silver prices, certainly have the ability to do the same. At the end of the year we saw companies like Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) acquiring Grayd Resource Corp, AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) acquiring Northgate Minerals, and New Gold Inc. (NGD:TSX; NGD:NYSE.A) acquiring Richfield Ventures Corp. and Silver Quest Resources Ltd. We see this trend intensifying, especially if mining company valuations don’t keep pace with rising metals prices.
TGR: That brings us to a little follow-up on some of the companies that you talked about last time. A couple of the junior producers you talked about were Barkerville Gold Mines Ltd. (BGM:TSX.V) and Orvana Minerals Corp. (ORV:TSX). Can you tell us what’s going on with them?
MZ: The market has been disappointed with production from both companies. Barkerville recently got a boost after receiving a permit for its Bonanza Ledge property, which is a high-grade open-pittable gold resource. The delay in getting that permit meant that production was not what we had originally expected. Updated resource calculations for the company’s Bonanza Ledge, Cariboo Quartz and B.C. vein zone in the first half of 2012 could be a positive there.
Orvana has two properties that were both put into production in 2011. In Spain, the company’s El Valle-Boinás/Carlés is an operating gold mine, which is not seeing the head grade we had expected. Grades are slowly increasing from around 2 grams per tonne (g/t) to an expected 3.5 g/t. Its other project in Bolivia, the Don Mario mine, has a different problem. It’s an open-pit, copper-gold mine where recoveries have been less than expected—around 50% versus 70–80% for copper. We look for recoveries to improve and think a lot of the bad news has been priced into the shares. We’re also encouraged by the fact that Bill Williams has now taken the helm of the company. Bill has exceptional operational technical expertise.
TGR: So you feel both of those are reasonable values at this point?
MZ: On Barkerville we’re taking a wait-and-see approach and have the stock rated as a hold. On Orvana we believe the negative news has been priced into the shares and valuation looks compelling.
TGR: So, how about some of the near-term producers that you follow, such as Canadian Zinc Corporation (CZN:TSX; CZICF:OTCBB)?
MZ: Canadian Zinc is a situation where the valuation has not kept up with the project. The company recently passed the major hurdle for environmental approval of its Prairie Creek mine. It’s a really interesting story—an old Hunt Brothers mine that could be in production in 2014 or maybe even as early as 2013. For readers who don’t know the history of the Prairie Creek mine, it is in the Northwest Territories and was just a few months away from going into production when silver prices collapsed in the early 1980s and the Hunt Brothers went bankrupt. It’s a high-grade silver-lead-zinc mine with much of the infrastructure in place that we think has a lot of potential. We actually believe this is an ideal time to own shares of the company since fundamentals have improved and the share price has drifted lower with the sector.
TGR: So that’s another one to watch closely and this may be a good time to be picking some up. What about some of the other junior explorers that you like and have talked about in the past?
MZ: For very near-term production I have followed but do not cover Armistice Resources Corp. (AZ:TSX). The company expects to produce 25,000 oz gold in 2012. At around $0.22/share, which is about 50% less than last year, valuation looks interesting. Two that I cover, which are exploration stories, are NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK) and Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE). NioGold continues to drill at its Marban project in Val-d’Or, Québec. This is a joint venture with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A) where Aurizon is funding $20 million for exploration. We think the resource could grow fairly significantly from the current 960,000 oz to 1.4–1.5 million ounces (Moz). We actually think Marban could give Aurizon’s other project, Joanna, some competition. I think the valuation looks fairly attractive here, trading at about 60% lower than our calculated net asset value.
We’re also excited about the potential of Prophecy Platinum. Prophecy has the Wellgreen deposit in the Yukon, which contains 12 Moz of combined PGMs and gold plus 2.4 billion pounds (Blb) of nickel and 2.2 Blb of copper. The in-situ value is around $50 billion and we think a preliminary economic assessment due out in Q112 will show some strong economics for an optimized open-pit. The company is carrying out other work to derisk the project, including metallurgical studies and additional infill drilling for which we’ll start seeing results early this year.
TGR: So, that one is well priced at this point and a buy as far as you’re concerned.
MZ: Absolutely. The price drifted down after the excitement over the updated resource estimate, but it’s come down to a level where we think it offers very good value. We have a $6.40 target price.
TGR: So then, let’s look at some silver juniors. One that you follow is Cream Minerals Ltd. (CMA:TSX.V; CRMXF:OTCBB; DFL:FSE). What’s going on with that one?
MZ: Cream is a company I cover and which I visited late last year. It’s an exploration company with a 41 Moz silver deposit called Nuevo Milenio. It also has about 300,000 oz gold. We believe the company has the potential to really expand the current resource. Cream completed about 20,000 meters (m) of drilling in 2011 and we expect an updated resource out late Q112. This should actually upgrade a fair amount of the Inferred resource to Indicated and could add about 30% to that resource. We also see it doing another round of drilling of 20,000–30,000m in 2012, which we think has the potential to more than double the current resource.
TGR: That sounds promising.
MZ: Another one I don’t cover but I think is very interesting is Oremex Silver Inc. (OAG:TSX.V; OARGF:OTCBB; OSI:FSE). This is a small-cap silver exploration company with assets in Mexico. The company recently moved up on good initial results on its Chalchihuites project. The project is in the same area as First Majestic Silver Corp.’s (FR:TSX; AG:NYSE; FMV:FSE) Del Toro project, and we understand First Majestic is aggressively acquiring property in the area. The company’s flagship property, Tejamen, has a defined 51 Moz silver deposit. We think the president and CEO is also a real asset for a company with a market cap of around $20M. He’s been manager of exploration and development for Barrick Gold Corp. (ABX:TSX; ABX:NYSE) in South America.
TGR: So, are you expecting that 2012 is going to be the year that mining stock investors finally wake up and smell the gold and realize it’s time to get into this market?
MZ: I think this is the year! Investors have been cautious and focusing just on the downside, holding their money in cash. I think investors should be opportunistic and look for well-run companies with strong management and great assets.
TGR: Well, we’re certainly hoping for that also. We appreciate your joining us today and look forward to talking with you again.
MZ: Thank you and I appreciate the opportunity.
Analyst Matthew Zylstra joined Northern Securities in 2010 after having worked at Sprott Resource Corp. and investment counsel firm Foyston, Gordon and Payne Inc., a unit of Affiliated Managers Group Inc. He is focused primarily on junior precious metals producers and also follows some base metals miners. Zylstra has worked in the finance sector since 1999.
By The Gold Report, on January 30th, 2012
 Kwong-Mun Achong Low, an analyst with Northern Securities in Canada, thinks that copper and gold juniors are in for a better run this year. He’s ferreted out the juniors with the most promising management and assets that are on a path to production—not to mention rising stock prices. In this exclusive interview with The Gold Report, Achong Low discusses why copper may have a slight edge on gold in 2012 and what companies are the crown jewels of his coverage list.
The Gold Report: Kwong, what are some themes or common ground within your Buy recommendations in the junior mining space?
Kwong-Mun Achong Low: When I look to initiate coverage of a company, I go through a checklist of must-haves with emphasis on the management team and the assets. Excelsior Mining Corp. (MIN:TSX.V), Golden Predator Corp. (GPD:TSX), Probe Mines Ltd. (PRB:TSX.V) and Sunridge Gold Corp. (SGC:TSX.V) have solid management teams with proven track records and they’ve either built and sold companies before or they have tremendous experience in the countries that they operate in. All of those companies’ flagship assets are close to infrastructure, and they have a clear path to production. They’re not just speculative stories. They also have good streams of news to keep investors interested and are supported by the commodities that they are focused on, which are gold or copper.
TGR: Even very good news wasn’t really moving share prices a lot in the last half of 2011. Do you expect that to change in 2012? Will good drill results move share prices this year?
KAL: I think so, but a lot of the speculation has come out of the space. Really and truly, things were looking dire at the end of 2011, in part because of redemptions of funds and tax-loss selling. This year, investors will look at the quality projects and, when good drill results come out, they’ll say, “Okay, we’ll reward this company because it continues with good news.” I think share prices will respond to suit.
TGR: Are you more bullish on copper or gold in 2012?
KAL: The underlying fundamentals of both are still pretty good. Gold’s use as a store of value should be of real interest to investors because of the ongoing quantitative easing and the loose monetary policies by central banks that are devaluing major currencies. Historically, gold has responded well to that.
For copper, our bullish case comes from supply-demand fundamentals. Many commodity houses are forecasting a supply deficit for 2012. For instance, stockpiles in Asia as tracked by the London Metal Exchange (LME) are at a two-year low and heading lower, which is likely because China is buying and stockpiling copper again. The broader LME stocks are at a one-year low and also heading lower. That’s really good for copper and gives it an edge over gold this year.
TGR: But copper was down about 3.5% last year.
KAL: It just got caught up in all of the economic worries. When you go back to basics, which are supply-demand fundamentals, copper is still a really good story.
TGR: Northern Securities’ 2012 Top Picks List includes Golden Predator and Probe Mines, but not Sunridge or Excelsior. What factors put Golden Predator and Probe above the others?
KAL: At the time we chose those two names to highlight, the stock market was more volatile and investors were in a real risk-adverse mood.
Golden Predator stood out because it’s in the Yukon, which is a good mining jurisdiction. It has near-term production potential and current cash flow from its royalty portfolio. In a real cash crunch, it would come out OK.
Probe Mines, in Ontario, came on the scene with a really good resource update. It has a good opportunity for more resource growth, which puts it on a short list of takeover candidates.
TGR: Would it surprise you if the companies not on the top picks list outperformed those that are?
KAL: No, not at all. Both Sunridge and Excelsior are solid companies with robust assets. Sunridge has four polymetallic deposits in close proximity to one another. The biggest deposit, Emba Derho, is of world-class size by itself. It’s a 62 million tonne (Mt) volcanic massive sulphide (VMS) deposit with almost 0.6 million ounces (Moz) gold, nearly 1 billion pounds (Blb) copper and 2 Blb zinc. Something that size could attract takeover potential as well.
Excelsior’s preliminary economic assessment (PEA) on the Gunnison copper project in Arizona in December really impressed me. It could advance its project quickly to production and I would put it on a short list for potential acquirers given the project economics.
TGR: What in that PEA did you find particularly interesting?
KAL: It’s expecting annual production of 85 million pounds (Mlb) copper for a capital expenditure of $240 million (M). Not many companies could do that. If it builds a sulfuric acid plant for $85M, it could get its cash costs down from a projected $0.94/pound (lb) to about $0.68/lb. That could make it one of the lowest cash-cost producers in the copper space.
TGR: It plans to use in situ recovery, which involves drilling holes into a land mass, injecting liquid into those holes and then pumping it out and recovering the metals in those liquids. Given the recent concerns regarding fracking in the oil and gas space, do you expect getting environmental permits could pose a problem?
KAL: I’m not concerned with Excelsior getting its permits because the same process has been successfully permitted and used in the past in Arizona during the 1980s and 1990s. In situ recovery is often misunderstood because it’s not commonly used in the copper industry though it is quite common in the U.S. uranium industry. When at full operation, more of the dissolving liquid is removed than is pumped into the ground. That creates a cone of depression where the basic physics of high and low pressure prevents any fluid from traveling where it’s not supposed to go.
TGR: What catalysts are going to push Excelsior, which currently trades around $0.57/share, to your 12-month target of $2/share?
KAL: It intends to do a prefeasibility study by the end of this year. To do that, it will have to continue with its hydrology and metallurgical studies. Even though the initial tests came back positive and show a good case for in situ recovery, investors would be happy to see more detailed tests confirming those results. That should push this toward the target.
TGR: Golden Predator, which is the largest holder of active exploration properties in the Yukon, receives royalty payments from a property portfolio in Nevada. What sort of cash flows are those royalties creating and how is Golden Predator using that cash?
KAL: The land package and the royalty portfolio are two of the best things about Golden Predator. It already has cash flow coming in, which could be used for general and administrative expenses or to offset large financings. We expect about $1M in royalty payments this year, gradually increasing to about $8M by 2015. Also, as the company has done before, non-core segments in the royalty portfolio and land package could be monetized for additional gains.
TGR: Golden Predator released some results from the Sleeman zone on the Brewery Creek project in the Yukon recently. One hole returned 35.1 meters (m) of 1.63 grams per tonne (g/t) gold and 136.72 g/t silver. Within that intercept, there were 20m of an even higher grade intercept. What were your impressions of those results?
KAL: They were quite good. It’s not often that we see a sizable silver intercept at Brewery Creek, but that adds another dimension to go along with the gold. One of the holes on the westernmost part of Sleeman returned some decent results as well, showing that the zone is still open in all directions. That step out hole would not be included in the resource update at the end of January. Because of this, and the over 100 holes to be assayed, the company is planning another resource update for the middle of the year.
TGR: Golden Predator has a number of properties. Do you think as these sorts of results come back that it will begin to focus more on Brewery Creek than the others?
KAL: It already is focusing mostly on Brewery Creek given its near-term production potential possible because of its past-producer status. So Brewery Creek is both an exploration story with the good drill results it keeps returning and also a development story that could see itself in production by the end of the year. The other properties will also see some drilling this year and could add production growth a few years down the line, but they are not the focus now.
TGR: What other catalysts are you expecting to take Golden Predator to your 12-month target of $1.60/share?
KAL: It still needs to come out with some engineering tests on the existing heap-leach pad to see if a quick production start-up is possible. Those are due in the next few months and if they continue to show that it can start production sooner than most people think, that should really push the stock up.
TGR: Golden Predator has made some management changes. Do you think those are positive?
KAL: Definitely. It hired a chief operating officer and a chief mining engineer, which shows that it really is gearing up for production.
TGR: Probe Mines has gone from being primarily a chromite play to a gold play. The junior now sits with a resource of almost 5 Moz at the Borden Lake project in Northern Ontario. In 2009, Osisko Mining Corp. (OSK:TSX) bought out Brett Resources Inc. (BBR:TSX.V), which had a resource of similar size in Northern Ontario. It’s a distance away, but there are some similarities. Do you believe Probe is a takeover target?
KAL: I think so. Probe really has reinvented itself and capitalized on its grassroots Borden Lake gold discovery. It is expecting another resource update later on in this quarter, which should get it past the critical 5 Moz mark and put it on the radar for intermediate and senior producers. The orientation and structure of the ore body are close to ideal for mining a low-grade, bulk-tonnage deposit. A lot of that resource will end up mineable, and that’s what companies are looking for.
TGR: Have you visited that project?
KAL: I have. Dave Palmer, the chief executive officer, really keeps a close eye on what’s going on there and he regularly takes analysts and investors up to the property. What I really like about the project is that it’s about a 15-minute drive from the airstrip and the town of Chapleau, and you can walk straight from the road to the drill rig.
TGR: What are some catalysts we can expect in 2012 for Probe?
KAL: Apart from the updated resource, it also has some further metallurgical studies and drill results coming due. What I like about Borden Lake is that there are some really good geophysics in the northern part of the property that show that it could have another main Borden Lake deposit there. It’s drilling that now and if successful, that could easily double the resource.
TGR: Are you saying it could hit 10 Moz?
KAL: It could, but it may not this year. If it hits some good results up to the north, it could get really big.
TGR: If that’s the case, then it must be a takeover target.
KAL: For sure.
TGR: In a report, you suggest that Sunridge Gold is one of the more misunderstood stories in the junior gold sector. What misconceptions about Sunridge would you like to correct?
KAL: The biggest misconception is that Eritrea is a bad place to do business. I visited the property in November and saw firsthand that it is a very determined country working to put additional business-friendly policies in place. The people are very friendly and hard working. The United Nations Security Council clouded that view when it put further sanctions on the country in December after some neighboring countries accused it of supporting militant groups, but I think the accusations are politically motivated. Russia and China both abstained from the vote. Also, Russia went on record saying that the evidence of Eritrea’s link to the planned attacks in Addis Ababa was not conclusive.
TGR: But there is unrest in the region. Are you factoring that into a discount rate?
KAL: Definitely. Whether it’s true or not, the market does perceive additional risk in Eritrea. We only use a multiple of 0.4x our net asset value whereas other companies in our space could get from 0.5–1.0x.
TGR: What were your thoughts about the Asmara project when you visited?
KAL: It is very close to infrastructure. You can drive to the site in a matter of minutes. The topography is very supportive of open-pit mining as it is very flat with lots of room to put the mill facilities and tailings pond. It’s also very close to a willing workforce.
TGR: Are there any majors operating in Eritrea right now?
KAL: None that I know are active in the area. There are a number of Chinese companies with interest including the Shanghai Construction Group that recently bid for Chalice Gold Mines Ltd. (CXN:TSX; CHN:ASX), though the others have nothing as advanced as Sunridge or Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.A).
TGR: Does Nevsun have the cash flow to pull off a takeover?
KAL: For sure. It is producing a lot of gold at one of the lowest cash operating costs in the industry. Last year it produced about 380 thousand ounces of gold and the cash costs for the first three quarters were about $285/ounce (oz). However, I’m not sure that, if it were to expand, it would want to get another asset in Eritrea.
TGR: On the one hand, you’re saying there’s not as much risk as people think, but in this example, you are intimating that there is still a significant amount of risk there?
KAL: There is perceived risk. If a company like Nevsun has a main asset there and it’s not getting the full value that it should for it, then there’s no need to wait around for the market to clue in. It can just take its cash and go after something that the market will recognize.
TGR: What should move Sunridge stock to your 12-month target price of $1/share?
KAL: Of its four main deposits, it has combined three of them into one prefeasibility study due out in about four months. The fourth deposit, the Debarwa deposit to the south of Asmara, has a feasibility study due in the next couple of months. As the market sees that there is real economic benefit to these projects and there is a clear line to their production, Sunridge should get rewarded for that.
TGR: Debarwa is really the crown jewel here, right?
KAL: It’s the highest grade and it may be the closest to production, though I think the crown jewel is Emba Derho, with 62 Mt of VMS.
TGR: What’s the resource there?
KAL: It’s almost 600,000 oz gold, 1 Blb copper and 2 Blb zinc at Emba Derho.
TGR: What’s the estimated production timeline there?
KAL: It could be as early as 2015. After the feasibility is completed, it could start applying for its permits. Sunridge has already started talking with government officials, so I don’t think that will take as long as it has for other companies, like Nevsun.
TGR: Are there any other companies that you would like to discuss today?
KAL: It’s not one that I cover, but it is in a very stable country: Seafield Resources Ltd. (SFF:TSX.V:). It is advancing its Quinchia gold project in Colombia. It is expecting a resource update at its Miraflores deposit by the end of this month and a PEA in a few months. Quinchia currently has 2.5 Moz in global resource and with the new management appearing settled, the relative valuation and news flow makes this stock one to watch.
TGR: Do you have some parting thoughts for our readers?
KAL: Investors need to take the speculation out and do additional due diligence because it’s a stock-picking market. Investors need to look for companies that have good news flow, really good management and an asset that is good enough to put into production when they invest in it.
TGR: Thanks.
Kwong-Mun Achong Low is a mining analyst with Northern Securities with a focus on both precious and base metal equities. He previously worked at a Canadian bank owned dealer and at a U.S.-based brokerage. Achong Low obtained both his Master of Business Administration and Bachelor of Science degree in mechanical engineering from the University of Toronto.
By The Gold Report, on January 26th, 2012
 Fayyaz Alimohamed, CEO of Altair Ventures Inc. and publisher of the Acamar Journal, offers historical perspective and predictions on the global economic crisis. In this exclusive Gold Report interview, he foresees a “mania” in junior mining stocks and recommends holding physical gold outside the banking system as a safety net.
The Gold Report: Fayyaz, in June 2008, using readily available economic data, you wrote that the global economy was on the verge of financial collapse. What do those sources tell you about where the global economy is headed today?
Fayyaz Alimohamed: In November 2006, I predicted that the U.S. was headed into a recession. Seven months later, the Bear Stearns funds cracked, beginning the crisis. By June 2008 it was obvious to me that the crisis would escalate into a crash.
Today, the U.S. cannot meet its gargantuan future unfunded liabilities. Europe and Japan face debt levels that ensure eventual sovereign debt defaults and declining standards of living. There is potential for all of this unwinding to seriously affect an entire generation.
These economies cannot grow their way out of their problems and the cuts needed to balance budgets would create massive social turmoil because the cuts themselves would lead to sharp drops in gross domestic product, creating vicious negative spirals. The current solution being utilized is more debt and quantitative easing. That can only keep things afloat until it can’t anymore. I would say that we will have the next major crisis within the next two years.
TGR: I would like to flesh that out a bit. What do you believe will trigger the next crisis?
FA: Genuine reform has not been implemented. This crisis was caused by unprecedented levels of consumer and corporate debt and Wall Street greed. When the crisis happened, government rescued distressed debt by massively increasing its own debt. For example, the Federal Reserve and the European Central Bank are using their balance sheets at about a 30:1 leverage. This is the same sort of leverage that Wall Street banks had recklessly indulged in. When government debt was substituted for corporate and consumer debt, the whole system rolled over into a much more dangerous phase.
TGR: Do you think the European debt crisis will remain the dominant theme in 2012 or will other themes take center stage?
FA: The European crisis is simply a proxy for a global debt crisis. It happens to be focused on Europe because Germany has not been as eager as the Federal Reserve to print money. Germany remembers the hyperinflation of 1924, when unbridled money creation led to prices doubling every two days.
Today, governments have a preponderant influence on the economy, while large corporations, through lobbying, have inordinate influence over the government, to the detriment of other stakeholders. As the danger of a deflationary depression increases, governments are attempting to reinflate the economy; they may well overreach and create hyperinflation.
Thus, the broadest theme by far is debt and the reaction to debt. We just saw France’s debt downgraded and a negative watch put on the European Financial Stability Facility. This negative spiral will continue. Even though the U.S. has tepid signs of economic growth, it is at the cost of enormous amounts of stimulus being put into the economy.
Given that the U.S. and Europe are its two largest export markets, China also is headed for a hard landing unless it can increase internal consumption substantially.
TGR: Much of the discussion of the European crisis has centered on Greece. But a recent auction of six-month Italian bonds was priced at an interest rate of 6.5%—the highest rate of a bond auction since Italy joined the Eurozone 13 years ago. What do you make of that?
FA: In literature, readers are invited to enter into a “suspension of disbelief” to go along with the story, even if implausible. Before the 2008 crisis, that was the mindset of investors. Now they want to believe that governments can solve these problems.
Greece was not the primary cause of the European crisis. It was caused by German, French and U.S. banks. These banks are all insolvent if they were to mark their assets to market and not to theoretical models. But, we are suspending disbelief because we all have skin in the game and need things to work out.
The drive for austerity ensures that Portugal, Ireland, Italy, Greece and Spain (PIIGS) will continue to see their economies shrink, leading to lower tax revenues and the continued inability to meet budget targets, which will require larger debt relief. It is a vicious downward spiral that will lead to declining standards of living.
Greece, Portugal and Ireland would be much better off leaving the EU, defaulting on their debts and devaluing their currencies. That is a time-honored tradition. After some pain things will work out, as they did in Argentina and Russia in the 1990s.
Investors want to believe that heavily indebted countries can solve the problems of other heavily indebted countries; that an insolvent banking system can be rescued by governments through more debt issuance and debt monetization.
TGR: The European Central Bank has floated the idea of euro bonds, backed by all 17 members of the Eurozone, as a solution to this problem. But Germany does not want to go down that path unless the indebted countries adopt more severe austerity measures. Do you think we’ll ever see euro bonds?
FA: We are really into the realm of absurdity. For example, the European Financial Stability Facility is a private company authorized to borrow €450 billion (B) from the private sector backed by a guarantee from all the EU members who are already heavily in debt and being downgraded periodically. One proposal I saw was that it would use the €440B of debt as collateral to borrow another €1–2 trillion of debt to lend to the PIIGS!
Can this type of thinking ever end well?
As Europe enters a recession, the problems will only get worse. Euro bonds issued by indebted countries just mean France and Germany are putting their own balance sheets at risk. It may provide time, but it does not solve the problem. The question is, should they bailout the PIIGS or take the same money and bailout their own banks? There are no good solutions.
A final thought on yields: when I studied economics we were taught that U.S. Treasuries were the risk-free asset to be used as an absolute benchmark. Given the recent downgrade and outlook, perhaps the economics profession should start looking for another risk-free benchmark, just as the U.S. dollar replaced the pound sterling.
TGR: Given all of this, how are you protecting yourself?
FA: One of the primary measures of protection is a healthy cash balance. You have to be in a position where you are able to ride out any crisis and also to take advantage of valuations in case of a crisis. If the crisis is as bad as I think it will be, you will be able to find and acquire assets at generationally low prices.
The other way to protect yourself is to invest in precious metals. I believe precious metals will do well whether we continue to stagnate or actually see another crisis. I think silver and gold equities will do very well in the long run.
TGR: Investors have been seeking greater security for at least seven months. How long do you think that risk-off sentiment will last?
FA: Brian, U.S. domestic stock funds have seen net redemptions for five straight years. Due to negative real interest rates, equities are undervalued in historical terms. This is tempered by the dangerous, rising systematic risk. Fund managers are paid to perform or else they face redemptions. So, the bias is for stocks to rally as we are seeing now, unless the second phase of the crisis clearly emerges, which in my opinion is inevitable.
Ironically, in another crisis, governments will likely turn to quantitative easing with a vengeance, which means that, despite a crisis in sovereign debt, we will see a substantial rally in commodities, particularly gold and equities, as substantial sums of newly created money finds its way into the system and money leaves the bond markets. You may find prices rising while the economy is being undermined.
TGR: Fayyaz, your background is in insurance and finance, how did you find your way into the gold and silver space?
FA: From 2001 onward, I realized that the U.S. seemed to lack the political will to deal with its increasing levels of budget and trade deficits. In fact, the Fed was creating asset bubbles that were bound to end badly. At the same time, I knew from history that fiat money generally ends badly, starting with Kublai Khan. I came to anticipate the decline of the U.S. dollar and the rise of gold. I believe that the price of gold will be much higher in the coming years and that gold will become part of the monetary system in some capacity.
Gold is interesting in another way. Throughout history booms have been localized geographically. As an example, the average Canadian investor is unlikely to invest in, say, Argentinian real estate or in its stock market even if they are booming. The Internet bubble was the first time that a global audience became aware of an asset category that was rising dramatically, ironically thanks to the Internet itself. But you could not participate unless you had a U.S. brokerage account. Gold is the first truly global asset boom that investors at all levels can participate in. Today investors are more savvy and more heavily invested across markets and categories but gold is fundamentally money and all investors and savers can buy it. Local yet global.
TGR: Investors also have different tools.
FA: That’s right. They can do a lot of research. They have a lot more liquidity. The potential impact on the market for gold as an asset class is phenomenal. It appeals to all levels of investors. Someone buying a few grams of gold in China creates demand that directly helps the value of your gold holdings. I mean, how many people sleep with a barrel of oil tucked under their mattress?
TGR: Not if you could help it.
FA: Historically, gold and silver equities leveraged the returns on gold. In 2011, mining companies were producing gold at an average cash cost just under $600/ounce (oz) and were getting about $1,600/oz in revenue. Cash flows are very impressive and price earnings are healthy. Mining companies continue to buy juniors with good assets, especially at these low share-price values. I moved into the sector to take advantage of this bull market in gold. And, I believe we will see a mania in junior mining stocks before this is over.
TGR: And, when will that be?
FA: I think we will see this happen within the next two years as people begin to realize that solutions to the global economic situation are not forthcoming. There will be more and more nervousness and gold will find a larger and larger audience.
We now have a situation where central banks, which were net sellers of gold for 20 years, became net buyers in 2009 and are accelerating their buying programs. We are seeing tremendous support for gold from central banks, institutional and retail investors across the world.
TGR: Do you have positions in any gold and silver juniors?
FA: Yes, one is Colombia Crest Gold Corp. (CLB:TSX.V; EAT:FSE). This company has a huge land package in a prolific gold belt, surrounded by several large deposits including Sunward Resources Ltd.’s (SWD:TSX.V) 8 Moz Titiribi project. IAMGOLD Corp (IMG:TSX: IAG:NYSE) took a 19.9% stake in October 2011, which validates Colombia Crest’s exploration program. With many large, prolific gold targets, the company will commence a 5,000m drill program next month. It also has a high-grade gold resource in Bolivia, a $25 million (M) market cap and $6M in cash. There is good upside potential as the company gets decent drill results.
TGR: Is there one project that will attract notice to Colombia Crest Gold?
FA: It has two projects in Colombia called Venecia and Fredonia.
TGR: And are they underground mine systems or bulk tonnage targets?
FA: I think Colombia Crest has a number of prolific targets. Some will be potential heap leachable targets and others are underground and, therefore, higher grade. So, the company has a dual approach in the Antioquia Province.
TGR: As far as management goes, are there people onboard that you are confident in?
FA: I mostly talk to Hans Rasmussen, the president and CEO. He strikes me as being very focused. He is a geologist and geophysicist and has worked with a number of senior companies. He was brought in by a group of investors to sort out various issues and he created the opportunity in Colombia. Rasmussen is the kind of person that you can have confidence in.
TGR: Do you have another junior name?
FA: I would also mention Coral Gold Resources Ltd. (CLH:TSX.V) with a 3.4 million ounce (Moz) Inferred resource. Its Robertson property in Nevada sits adjacent to Barrick Gold Corp.’s (ABX:TSX; ABX:NYSE) 14 Moz Cortez Pipeline mine, which produces gold at a cash cost of $312/oz. The preliminary economic assessment just came out, showing a net present value at a 5% discount at $1,500/oz gold of $147M for just three of its multiple zones. Its market cap is about $15M. Coral is a natural takeover target. I believe there is good value here for a patient investor.
TGR: Coral has not put out any news since February 2011. The lack of news for almost a year has done nothing but erode shareholder confidence. What is the problem?
FA: From what I understand, unlike nearby exploration companies, Coral has had its mine for a couple of decades and is a past producer. The company was given some very rigorous regulatory environmental conditions to meet regarding migratory patterns of birds and insects and such. Coral had to study these for a given period of time, which delayed its drilling permit. I think that situation is now on the verge of being resolved.
If that happens, Coral has the cash and is ready to drill. You should see movement in terms of activity and, potentially, share price appreciation.
TGR: Let’s move to silver. Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A) is led by Bob Archer, a real veteran. The company is producing from its Guanajuato mine in Mexico. In 2012, the company plans to produce 1.72 Moz silver, up from 1.5 Moz last year. It also expects to produce 10–11 thousand ounces (Koz) gold, up from 7.8 Koz in 2011. That news, although good, was not met with much enthusiasm from the market. What are your thoughts?
FA: I think a 20% year-over-year increase is very healthy for any producer. The company’s profit margins are excellent. It has a 30% net margin for the year to date. So, it should generate very decent cash flows going forward. Great Panther has $40M in the bank. It is growing the resource at the San Ignacio project, is looking for acquisitions and it is mining a recently discovered high-grade zone in Cata.
Overall, the junior sector has stagnated over the last few months and I think Great Panther has just been part of that process.
TGR: What are your thoughts on what Bob Archer has done there?
FA: I think Bob has delivered tremendous value for shareholders. He is very competent and is a man of integrity. I think his share price is closely linked to the price of silver, which is generally true for most silver producers. Guanajuato has a rich history. It was mined by the Spaniards and has been in production for 400 years. It was once considered the richest silver mine in the world. Bob has taken it from when silver was down to $4/oz, resurrected it, capitalized it, built out infrastructure and delivered tremendous value.
TGR: In your time in this space, what have you learned that the average retail investor ought to know?
FA: This is a very volatile sector, subject to investors jumping in when there is a bullish trend and a lot of enthusiasm, and those same investors not wanting any part of equities when there’s a pullback in prices.
Given the overall increase in volatility in the markets, investors really should take a look at gold and silver. If they are bullish, any pullbacks in the commodity prices or in the associated equities should be seen as buying opportunities. When there is a lot of enthusiasm, it should be seen as creating selling opportunities.
You also have to have physical gold and silver in your possession. We learned a lesson with MF Global. We saw $1B of segregated funds in clients’ accounts vanish. My understanding is that some of those funds were comingled and used to settle MF Global’s liabilities to other financial institutions. There is this whole issue of counter-party risk, which gold does not have. That should be a cautionary reminder to people. You need to have physical cash balances. You need to have physical gold and silver outside of the banking system as a safety net because, as Warren Buffet said, we are in uncharted waters now.
TGR: You grew up in Pakistan, where gold is part of the culture, given as gifts at weddings and such. Do you think you would have that same opinion about physical gold as a personal asset if you had grown up somewhere else?
FA: Not in my case. I had no involvement or affinity with gold. I was a finance professional. My involvement with the gold sector is purely intellectually driven, from looking at trends within the macro economy and realizing that gold and silver really are hedges against turmoil and currency debasement.
But that is a very good question and it points up the importance of watching out for biases in the commentaries that you read. People have vested interests and they do tend to have agendas, both in the mainstream media and elsewhere. For your own protection, you need to be sensitive to those influences and to study track records at key inflection points before relying on other people’s judgment.
TGR: Fayyaz, thank you for your time and your insights.
Fayyaz Alimohamed is president, CEO and director of Altair Ventures Inc. and publisher of the Acamar Journal. He has over 20 years of experience in investment management, finance and consultancy. He previously worked at the Aga Khan University Hospital, Financial and Management Services Ltd. (a management consultancy set up by Morgan Grenfell & Co. Ltd. and Booz Allen Hamilton Inc.) and as the chief financial officer of the Key Capital Group before becoming director of investments for the Cupola Group, a large operating and investment conglomerate based in Dubai. He holds a Bachelor of Science (Honors) degree in economics from the London School of Economics, University of London, and is a Certified General Accountant (CGA).
By The Energy Report, on January 25th, 2012
 Last year marked the third-largest growth in the potash industry, but hesitancy from India and China may put things on hold in 2012. However, MGI Securities Analyst Corey Dias still expects to see a lot of positive news coming out of the junior potash space. In an exclusive interview with The Energy Report, Dias specifies which companies he’ll be following for progress.
The Energy Report: Total potash demand in 2011 was estimated at 56 million tons (Mt), and the market has traditionally grown at a rate of about 3.5%/year. Do you believe we’ll see a similar increase in 2012?
Corey Dias: I think 3.5% could be at the high end of growth for 2012. I would expect slightly lower growth this year given that India is delaying its potash purchases until the end of Q112. China is also determining its exact needs, and there are rumors that it may reduce its imports this year versus 2011. Everything tends to depend on price. Canpotex (the marketing company for Saskatchewan potash producers) and its Belarusian counterpart are holding out for higher prices than India and the China currently seems willing to pay. With those delays, demand will probably be slightly below the historical 3.5% growth rate.
TER: Potash Corp. (POT:TSX; POT:NYSE) of Canada has shut down two mines in that country, and The Mosaic Company (MOS:NYSE) says potash buying is slow right now as buyers are taking a wait-and-see approach. What do you make of Potash Corp shutting down those two mines?
CD: It is a prudent approach. The company doesn’t want to flood the market with product as it would like to sustain a reasonable potash price that could provide a reasonably profitable return. By shutting down these mines, it’s limiting the output and that should keep the price at a fairly stable level. It’s not a question of shutting down so much capacity that prices are going to spike; it’s simply a way to keep potash prices relatively stable until the moment when a larger buyer comes back into the market, whether it’s India or China.
TER: In 2011, potash had the third-largest price increase among the 32 commodities ranked by the Scotiabank Commodity Index and, over the span of 2011, potash rose about 32%. The leading indicator of potash prices is often the price for corn, which is down significantly after some bumper corn crops in Eastern Europe, Russia, and Australia. What do you believe will be the average price per ton (t) for potash in 2012?
CD: Potash prices seem to be ranging between $450 and $550/t at the moment, depending on the port of delivery. It will probably stabilize around the $500/t level in the short term. I don’t see any reason for a significant spike in the price at this point. Although the corn price has recently seen a dip, it still remains above its historical average. Moreover, given the fact that the U.S. Department of Agriculture said that its stocks-to-use ratio is still well below the historical average, it would take a significant amount of corn production to reach the normal level of 15–20% in terms of that ratio, and reaching that level of production to meet this ratio could be a real challenge, especially when corn demand continues to grow. Therefore, while corn is slightly down, I don’t think there is going to be a downward trend in the corn price, or a complementary downward trend in potash.
TER: You don’t believe that potash will be in the top 10 performing commodities in 2012?
CD: I think it will have a fairly average year. I don’t think it will repeat its price performance in 2012 as it had a relatively low price point from which to start in 2011. It will probably stay somewhere in the middle of the park vis-à-vis other commodities.
TER: In an interview with The Energy Report in May 2011, Dundee Securities’ senior analyst Richard Kelertas predicted that we would see $750/t potash at some point before May 2013. What’s your perspective?
CD: As you said, that was in May 2011. The market looks a little different now than it did then. The fact that India is pushing back on pricing and delaying its purchases and China is reassessing are going to mitigate the potential upside of the potash pricing. Probably $600–650 is a reasonable price going to 2013, but there are a number of different factors that come into play in addition to India and China, whether it is production capacity being added to the market via brownfield or greenfield projects, whether or not there is a recovery in the European market, or whether or not the U.S. recovery continues. The fact that farmers seem to have a lot of money coming out of 2011 could, at worst, bode well for holding a pricing floor on potash at current levels and could potentially even support a higher price. I think that $600–650/t is reasonable.
TER: Tell us about your coverage universe and the types of companies you cover.
CD: I’m now ramping up coverage in the potash space. My first report was about Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX), a name that I’ve followed since early 2011 when I was working in an institutional equity sales capacity at MGI. I really like this story and the fact that it’s in a safe, mining-friendly jurisdiction. An opportunity to build a mine in a potash-rich region—the Holbrook Basin—with only two competitors in the Basin could provide an opportunity for consolidation. It is a story with a great deal of appeal.
Generally, I’m looking at small-cap developers and am not restricted to North America. There are developers in Africa and South America that could be appealing in the same way. It will be up to clients to decide whether or not they have the risk tolerance for assets outside North America.
TER: Is that typically the type of company that MGI covers even in the other sectors?
CD: We tend to cover smaller-cap names. Large-cap names would be a bit more difficult for us to champion in a lot of ways because we wouldn’t necessarily get the mind space from clients for large-cap ideas because clients are well covered by banks and bulge bracket firms that are looking at the Potash Corps of the world, companies like Agrium Inc. (AGU:NYSE; AGU:TSX) and Mosaic.
TER: Passport Potash’s share price took a beating in 2011. It’s currently developing the Holbrook Basin potash project in Nevada. Why do you believe that junior is going to rebound this year?
CD: Part of Passport’s problem this past year was based on the market itself being quite volatile, especially toward the end of the year. In general, small-cap names tend to suffer the most in those circumstances. But management made a few promises to the market that it was unable to keep and probably didn’t realize the extent to which it would be punished by the market by having missed deadlines. However, I believe that the company is starting to right itself. It is in the process of putting together an NI 43-101-compliant resource estimate, which we expect to be released by the end of Q112. Following that, we should see a preliminary economic assessment or scoping study and, further, a prefeasibility study from Passport in order to show the economic viability of its project. In addition, there was an announcement on January 18th that Passport has brought on a new chairman who has significant operational experience gained during his time with Rio Tinto (RIO:NYSE; RIO:ASX). It also has added Ali Rahimtula, who has experience in India, which is key in this type of business because there is the potential for an offtake agreement with an Indian partner. Passport has acknowledged the fact that it needs more relevant experience on the board, and has clearly begun to address this shortfall.
Like most of the names in the junior developer space, there tends to be a rerating—in terms of valuation—of these types of businesses once milestones are met along the road to production. As Passport meets its milestones, the market will likely provide the company with a more positive valuation via a re-rating of its stock. The company’s stock price hit bottom at $0.17 toward the end of last year. Since then, it has been able to at least project to the market that it does have some deadlines, which it intends to meet. Passport has engaged the engineering firm ERCOSPLAN to complete its NI 43-101. ERCOSPLAN has a really good reputation in the marketplace and has done a lot of work for developers in the potash space worldwide. The market now understands that the company is working very hard to meet its current deadline and, once met, Passport will have a potash resource estimate to put to the market. The market at that point will respond favorably, in my opinion.
TER: A competitor operating in the same basin that Passport is operating in, the Holbrook Basin, already has an NI 43-101 resource of 125 Mt potassium chloride (KCl). How large do you expect Passport’s resource to be once it’s published?
CD: The competitor has about 94,000 acres of land, while Passport has about 81,000 acres. If we were to use a ratio of acres to contained tons of KCl for the competitor and apply it to what Passport has, Passport would probably come in somewhere about 100–101Mt of contained KCl. Remember, this is in no way a forecast that I am making as to the size of Passport’s resource. Even if Passport has something like 80% of that number, I think it’s still a decent-sized resource. In my report, I am forecasting that Passport will produce about 1Mt/year over 40 years. That implies about 40Mt of in situ KCl. If we’re talking somewhere between 80–100Mt of contained KCl, there is significant opportunity for Passport to increase the size of production on an annual basis, or it gives a bit more leeway in terms of what the potential resource size could be, on a contained-ton basis.
TER: You have a Speculative Buy on that particular equity. What is your 12-month target?
CD: My 12-month target for Passport is $0.75.
TER: Another junior in that space, Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX), jumped out of the gate in 2011 and slipped above $2 in June 2011 before spending the rest of the year retreating from that benchmark. It now sits well below $1. Will that junior rebound this year? If so, what are the catalysts that are going to make that happen?
CD: I think so. Allana probably jumped up based on speculation more than anything else, but as the actual resource-related numbers come in, then it tends to start trading at some kind of multiple based on its enterprise value (EV), whether it’s EV:resource or EV:ton KCl, et cetera. When the market sees that it’s getting closer and closer to production, that’s when the valuation will start to improve. I think that is something that could happen this year. When one has an asset that doesn’t have any economic information tied to it, it’s very easy to speculate as to what you think the value should be. Obviously, the closer one gets to production, then there are hard and fast numbers that one can start applying some kind of multiple to in order to value a company like Allana Potash. That’s probably why it’s now down below $1. It’s probably more reasonably priced here and as more news comes out that’s favorable to the company, then you should start seeing the stock move back up.
TER: What are your thoughts on the Danakil potash project in Ethiopia?
CD: The Danakil project is interesting because it’s a near-surface project, which means the capex should be low. I think that it will have a fast track to production, which is another positive. And the fact that it’s probably selling to India, and perhaps China, is another positive because there is a quicker trade route to those countries when compared to North American or South American potash producers.
That said, there is no domestic demand for the product in Ethiopia. The companies that I believe have an advantage are those that have domestic demand or significant domestic demand, whether it’s a place like the U.S., which imports most of its potash needs, or South America—Brazil in particular—where 90% of its potash needs are imported. Ethiopia is also landlocked, that is, it has to go through another country in order to reach the port. Moreover, there is a greater possibility of political risk in Africa than in the U.S. or in Brazil. However, if everything remains stable, I think there could be a big opportunity for Allana, especially given its low operational cost base.
TER: What are some other small-cap potash plays that you expect will outperform in 2012?
CD: Verde Potash (NPK:TSX.V) is planning to produce a unique product called Thermopotash. Thermopotash, derived from the combination of glauconite and limestone, is a slow-release potash product with no chloride, which is great for crops like tobacco, coffee and oranges. In addition, the company is exploring the use of a new technology—the Cambridge process—which could potentially convert Verde’s potassium-rich rock to regular KCl. This would be a massive opportunity in Brazil. In terms of available infrastructure, Brazil falls behind North America but is certainly ahead of Africa.
Rio Verde Minerals Development Corp. (RVD:TSX) is another small company operating in Brazil that recently confirmed that it has potash on its property. The stock has moved up a little bit on the back of that news. Once an NI 43-101 resource estimate is released for Rio Verde Potash’s potash asset, we should see another re-rating of the stock.
Karnalyte Resources Inc. (KRN:TSX) is another one. Once again, I tend to favor the junior potash developers that have a bit of a unique element or bring something a little bit different to the table. Karnalyte is focusing on extracting potash from the potash-bearing carnallite layer, which is unusual for Saskatchewan because other producers and developers target the sylvinite layer that is usually closest to the surface. Karnalyte’s deposit is based on an anomaly where there is a significant carnallite layer that is relatively near-surface vis-à-vis the sylvinite layer. The technology that it is planning to use also could provide a magnesium byproduct and sodium chloride byproduct, both of which the Company could potentially market and sell in the future. Karnalyte has a number of things going for it; I think management is very strong. The fact that it has four patents pending for its technology could mean that what it ends up with is going to be very unique. It has a massive land holding and has only conducted advanced exploration on 20% of it. Fnially, it plans to expand its plant by using cash flow generated from its initial buildout.
TER: It has done a nice job of managing its share flow, too, with only about 21M shares outstanding vs. something far greater for a company like Allana.
CD: Yes.
TER: Or do you prefer a larger share count, such as Allana, with its 193M shares verus 20M for Karnalyte?
CD: When you’re in the small-cap space—and especially if your float is small—it becomes a bit riskier for clients to hold when the markets are a bit more volatile. It’s one thing to get into a stock, but when the market is volatile and a client is looking to exit a position, it’s very difficult to do if the trade volumes aren’t there. That’s the risk with Karnalyte. The average trade volume is 34,000 shares a day. So if you have a position that’s 100,000 shares, it’s going to take you roughly three days to get out of that position, and that assumes that you can be 100% of the trading volume over those days. And you could end up driving its price down significantly while you’re trying to exit your position. Having a more liquid position in a stock like Allana that you can get in and out of a lot more easily would likely appeal to portfolio managers.
TER: Could you give our readers an outline of what to look for in the small-cap potash space over the next year or so?
CD: You’ll see a number of companies starting to reach the prefeasibility and feasibility stages. At that point, these companies will start to look for strategic partners, whether it’s to fund the buildout of the products or secure an offtake agreement for the product that’s going to be produced a few years out. At that point, we’ll start to see which projects are going to be viewed as more viable. There probably won’t be enough demand to drive a need for every single junior potash developer that is currently out there to actually move into production. That said, there is also the possibility that some of these companies will be absorbed by larger entities that are looking to enter the potash space given the future, positive fundamentals for potash or those that are currently in the market and are looking to increase potential capacity moving forward. I expect to see a lot of positive news coming out of the junior potash space, especially as a few of these companies meet milestones in order to get a little bit closer to production and production becomes more of a reality.
Corey Dias has worked in the capital markets industry since 2003 and has spent eight years in institutional equity research and institutional equity sales. In addition, he has worked for a U.S. hedge fund, where he shared responsibility for the running of a $400M portfolio and sought out assets for private equity investment on behalf of the fund. Mr. Dias holds a Master of Business Administration from the Richard Ivey School of Business at the University of Western Ontario.
By The Gold Report, on January 24th, 2012
 Annie Zhang, an analyst with Toronto-based investment bank Octagon Capital, is expecting some good stories to come out of Argentina and Canada this year. In this exclusive interview with The Gold Report, she targets several exploration and near-term producing companies with burgeoning results on the horizon.
The Gold Report: The bottom fell out of the junior precious metals sector in late 2011. Why should investors believe that this sector is going to perform better this year?
Annie Zhang: In 2011, gold was up by about 10%, while gold equities underperformed as investors became more risk averse. Junior exploration companies were beaten down pretty badly. We continue to hold a bullish view on gold, but we think 2012 is going to be a volatile year.
Good stories with theme-changing catalysts will outperform in 2012, however. For example, Mega Precious Metals Inc. (MGP:TSX.V) is coming out with a resource update for the Monument Bay project in Manitoba. This resource update will outline for the first time the open-pit resource potential, which will significantly derisk the project and potentially improve the economics.
Premier Gold Mines Ltd. (PG:TSX) will come out with its preliminary economic assessment (PEA) on the Hardrock deposit, which is part of its Trans-Canada project in Northwestern Ontario. The PEA will provide more visibility for the project. Premier will also start exploration drilling sometime this year on the underground high-speed drift system passing through its joint-venture property with Goldcorp Inc. (G:TSX; GG:NYSE) in Red Lake.
TGR: You have a “speculative buy” on Mega Precious Metals and lowered your price target to $2.95 from $3.30. However, Mega has several promising projects, including Monument Bay and the North Madsen gold project in Northern Ontario’s Red Lake camp.
AZ: We recently lowered the price to $2.95 due to the dilution. Juniors are facing financing risk under the current market conditions, especially companies with aggressive drill programs into 2012.
Mega has five projects in its portfolio. Three of them, including Monument Bay, North Madsen and Headway, are currently being actively drilled. The Satterly deposit, which is southwest of Gold Canyon Resources Inc.’s (GCU:TSX.V) Springpole deposit, was just optioned in May and Mega is currently doing the fieldwork there, preparing for preliminary drilling to test some early projects this year. It also has the Blue Caribou high-grade copper deposit in Nunavut, which has been on hold for a couple of years while Mega waits for infrastructure to be developed in the region.
Mega’s management has been focused on Monument Bay and North Madsen, anticipating that they have the best potential to grow gold ounces. They have been delivering results. Through drilling conducted in 2011, North Madsen’s gold resources in Measured, Indicated and Inferred categories increased to 1.3 million ounces (Moz) from fewer than 36,000 ounces (oz) in 2010. At Monument Bay, gold increased to 1.8 Moz, up from 1.2 Moz in 2009.
Going into 2012, Monument Bay and North Madsen will continue to be a focus. Drilling at North Madsen will be targeting growing ounces in order to prove the project will be economical as a standalone project. At Monument Bay, drilling will focus on growing ounces and derisking the project. Drilling at Satterly will depend on the funding availability. Whether drilling will continue at Headway will depend on the outcome of the current deep-hole drilling program.
TGR: You’ve assigned a $20 million (M) value to Headway, Blue Caribou and Satterly. It has done some drilling on those, but I thought that was a little high. Can you tell me why I’m wrong?
AZ: First of all, Mega’s market cap, before it obtained 100% of Monument Bay through the $10M acquisition of Rolling Rock, was about $25M. Back then, it only had about 36 thousand ounces (Koz) in North Madsen, Blue Caribou was already on hold and it had 17% of Rolling Rock. That $25M market cap was mostly based on the Headway project because Headway was a very exciting project for Mega. It was located literally in the shadow of Goldcorp’s headframe, about 600m southwest of Goldcorp’s high-grade zone, 1 kilometer (km) south of the Campbell gold mine. If it hits something at Headway, the potential for stock price appreciation is huge.
TGR: What are you expecting from the Monument Bay resource update?
AZ: Since summer 2011, drilling has been focused on delineating an open-pittable resource at Monument Bay. That’s what the upcoming resource update will be focused on. The current resource estimate is about 1.8 Moz at average grade between 5–6 grams per ton (g/t) and is only for underground potential mineralization. Our target is between 2.3–2.5 Moz.
TGR: What are you expecting from the revised resource estimate for North Madsen?
AZ: That resource update is not coming out until the second half of this year. Management plans to do a little bit more drilling in order to demonstrate another significant resource increase. The next stage is to grow the ounces from the current 1.3 Moz to at least 1.8 Moz.
TGR: Is management at Mega considering spinning off North Madsen into a separate company?
AZ: Not at this stage. It would be an option down the road. When I said standalone, I was referring to its initial strategy for North Madsen. Management believed that Goldcorp would build a super pit in Red Lake. Mega’s early strategy was targeting to find enough ounces to feed the mill. Now Goldcorp is planning to do underground bulk mining in Red Lake. Mega has to prove North Madsen’s economics. North Madsen is a low-grade bulk tonnage deposit, not the typical type of deposit in Red Lake, which was one of the reasons that it didn’t attract a lot of attention on the Street.
TGR: But it’s starting to now.
AZ: Because of the size. Drilling in 2010–2011 increased the resources significantly from 36 Koz to 1.3 Moz. Mega has to change investors’ perceptions and prove the project could be economic.
TGR: Premier Gold Mines has a share of the Rayhill-Bonanza joint venture in Red Lake. It owns the PQ North project not far away in the Musselwhite district, but Premier recently received some positive news from both its Saddle gold project near Elko, Nevada, and the Key Lake project near Geraldton, Ontario. That’s a lot of projects for a junior. Is Premier spreading itself too thin?
AZ: It’s a fair question. We are watching that very closely. In 2011, upon the completion of the GoldStone Resources Ltd. (GRC:TSX) acquisition, Premier was actively drilling on nine projects, totaling 170,000m. It recently announced establishment of a royalty company. There is a lot going on there, but keeping in mind that Premier is not the operator on all projects, and not all projects were being drilled all year round, the main focus was and will continue to be the Trans-Canada project. In addition, in the last six months, Premier has strengthened its management team by adding Paul Huet as the chief operating officer, Brian Morris as its vice president of exploration and Abraham Drost as the head of its royalty company. They, particularly Paul and Brian, brought substantial expertise in mining operations, which clearly demonstrated Premier’s commitment to advancing its project and ensured the company is not spread too thin.
Is Premier going to sell some of its projects? The company has long been perceived as a takeover target, primarily due to the Rayhill-Bonanza joint venture with Goldcorp in Red Lake. Premier’s current market cap of roughly $650M is very different from the Premier of a year ago. It has added more assets, such as Satterly and Key Lake, and the projects are bigger and more advanced, such as the Trans-Canada project. So it is more than just a takeover candidate.
That being said, the takeover premium is always imbedded in its stock price, which is clearly demonstrated in our valuation. Its present net asset value (NAV) per share on a pure comparison basis is roughly $6.20, but the potential takeover valuation could be between $11–12.
TGR: Premier’s chief executive, Ewan Downie, is a bit of a rock star in the mining space. He has done this before. He turned Wolfden Resources into almost $1 billion when it sold its base metals project in the Arctic to Australian company Zinifex Canada Inc. in May 2007. Does that give you faith that he can do it again?
AZ: Absolutely. He has been very successful. Downie is trying to prove that he can move the company forward. He’s not just waiting around for someone to take it over.
TGR: What’s your target on Premier?
AZ: It’s $10.80, based on the ratio 20:80 on NAV/share and the takeover potential.
TGR: Heading south, you’re very bullish on the Santa Cruz district in Argentina. The country is a safe jurisdiction, but it also recently introduced a number of taxes and royalties to mining claims. Does that make you a little less bullish on Argentina?
AZ: One of the recent developments in Argentina is the repatriation of its currency. When it came out, the market did overreact because there wasn’t any clarity on what it means and how it would be implemented. It was out of the blue. Later that week, there was more information available about what it meant. It doesn’t mean that money cannot leave Argentina. It gives the government means to increase the currency liquidity. Money has to be converted into the local currency before it gets transferred out. It would affect the producers more than exploration companies. In fact, some companies came out saying it would affect their costs by about 1%, which is not that significant.
TGR: You’re very bullish on Hunt Mining Corp. (HMX:TSX.V), which is a pure exploration play in Santa Cruz trading around $0.25. It’s unusual for a brokerage to cover a company that small that’s not anywhere close to production. What do you see in that name?
AZ: We like Santa Cruz due to the favorable regional geology for epithermal gold and silver deposits and the attention the region has received from majors recently. We picked three juniors to cover, including Hunt Mining. Hunt is one of the largest land package owners in the region with more than 286,000 hectares, which provides it with a massive hunting ground for gold mineralization, which is why Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) was interested in reviewing and evaluating Hunt’s project.
To put this in perspective, Fomicruz S.E., which is the Argentina government-owned corporation in Santa Cruz, owns about 500,000 hectares and Mirasol Resources Ltd. (MRZ:TSX.V) owns about 315,000 hectares. Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE) owns about 187,000 hectares. We could not put a value on the land in our report, but keep in mind it probably would cost more than what Hunt’s current market cap is to assemble its entire land package today.
Also, Hunt’s project, La Josefina, was awarded to Hunt through public bidding. To earn a 40-year contract with Fomicruz to jointly operate the project, Hunt Mining has to complete a positive feasibility study by the end of 2013, commence project construction in 2014 and start production in 2015. This is a very clearly set timetable, which should establish it as a relevant, potential near-term producer in the region. At this point, we have no reason to suspect that the company is not going to stick to the timeline.
TGR: There could be a potential joint venture with Eldorado. Why is that likely to happen?
AZ: Eldorado previously bid for Andean Resources Ltd. (AND:TSX; AND:ASX) when it was looking for growth potential in a pipeline, so it is clear that that Eldorado likes Argentina. Reasons to justify the likelihood of that happening will be Hunt’s huge land package holdings and low market capitalization. If I have to pick the likelihood between a joint venture and a takeover, I would say takeover, because of Hunt’s share structure; Tim Hunt, the chairman of Hunt Mining, owns over 40% interest in the company. Whether it’s going to be Hunt or not is a separate question.
TGR: Staying in Argentina, what other companies are you bullish on?
AZ: Argentex Mining Corp. (ATX:TSX.V; AGXM:OTCBB) is another junior that has been busy. Its Pinguino silver-gold project is located about 35km northwest of AngloGold Ashanti Ltd.’s (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) Cerro Vanguardia mine in Argentina’s Patagonia region. It hosts two types of deposits: a silver-gold deposit and a polymetallic deposit containing silver, gold, indium, lead and zinc.
The current resource estimate, completed in 2009, shows the project contains an Indicated resource of 14.8 Moz silver equivalent (Ag eq) and an additional Inferred resource of 15 Moz Ag eq. About 60% of this is in silver. The 2009 resource estimate was targeting the polymetallic deposit, which now seems to have challenging economics. About 20% of that resource estimate is contained in the oxidized silver-gold deposit, which has been its focus for drilling since late 2009. Since then, a total of 26,000m of drilling has been conducted. Based on the drill results released to date, we are anticipating 31–45 Moz silver, up from the current 8 Moz.
TGR: That’s a huge increase.
AZ: Yes, it is. It is also a wide range of anticipation because we are not clear how many veins will be included in the geometry of the oxidized silver-gold deposit. Management’s target, which came out at the beginning of the 2011 drill program, is about 14 Moz. We expect the upcoming resource update to beat management’s expectations. We assumed 16 veins would be included in the resource calculation. Only the top 50 meters (m) from the surface is oxidized, so our expectation is relatively conservative.
TGR: Once the resource estimate and a PEA are complete, will Argentex become a prime takeover target?
AZ: We don’t recommend stories based on takeover speculation. We try to identify relatively undervalued, good stories. The current PEA, completed in early 2011, was based on the 8 Moz oxidized silver-gold deposit delineated by drilling up to 2009 —relatively small and low grade. It only served the purpose of demonstrating the positive economics of the project. If the upcoming resource update is in line with what we are expecting, the study would seek to optimize the project, specifically whether the operating scales would be enlarged and the mining sequence would be changed.
The silver production outlined in the study was very volatile, because it’s very small and didn’t have a lot of veins to mine from. If it does have about 16 veins in the upcoming PEA, it could sequence the operation very differently and increase the production in order to be a very meaningful silver producer in the region.
TGR: If the resource estimate climbs to about 30 Moz, as you suggested, do you think it’s reasonable to think that the internal rate of return (IRR) could double?
AZ: Not necessary. The currently PEA arrived at an IRR of 44% assuming capital expenditures (capex) of $20M, total silver recovered of 6 Moz through approximately an 8.5-year mine life at 5% discount rate. We modeled the production scenario assuming annual silver production of 2.5 Moz for 11 years at capex of $100M. So it is a dramatically different production profile. Applying 12% discount rate, the IRR is less than 20%. Keep in mind, this is a very preliminary number, as the sequencing is uncertain without knowing the ore in each vein, and we are expecting at least three considerably big high-grade veins.
Based on our analysis, we believe that the market is not giving any valuation on its polymetallic deposit. The stock is trading at about $0.21/oz silver in the ground compared to about $1/oz for its peers. If we strip out the polymetallic deposit and only base it on the current oxidize deposit, then it would come close to what its peers are trading at. It appears to us that the current stock price doesn’t illustrate any polymetallic deposit at all. Therefore, any increase in its oxidized silver-gold deposit should directly result in price appreciation.
TGR: What is your current target price on that?
AZ: It’s $0.90.
TGR: Any other companies in the Santa Cruz province of Argentina you would like to mention?
AZ: Mariana Resources Ltd. (MRY:TSX; MARL:AIM) just started trading on the Toronto Stock Exchange in June and has not yet become a very liquid stock in North America. However, it is well positioned to capitalize its potential on several opportunities.
Mariana has succeeded in keeping up with multiple projects through joint ventures with majors on Los Amigos in Santa Cruz and two iron oxidized copper-gold projects in Chile. The drilling is conducted by majors on those projects.
Mariana has focused its drilling activities on its Las Calandrias and the Sierra Blanca projects. Mariana discovered Las Calandrias in late 2009 and delivered an initial resource estimate in March, with only about 0.5 Moz gold equivalent at about 1 g/t gold, low grade with 80% in gold. Although relatively small, its delivery timeline was very impressive. It just completed a fourth drill program and will commence the fifth sometime this quarter. Sierra Blanca is located about 50km northwest of AngloGold’s Cerro Vanguardia mine and adjacent to Argentex’s Pinguino deposit.
In November, AngloGold made a 20% strategic investment in Mariana. The upcoming resource update from Pinguino will also draw some attention to Mariana’s Sierra Blanca project. Mariana is currently working on a 5,000m drill program on Sierra Blanca. However, our valuation is only based on Las Calandrias.
TGR: Are there any other companies that you’d like to discuss?
AZ: This year is going to be the end of North American Palladium Ltd.’s (PDL:TSX; PAL:NYSE) transition as it approaches completion of Phase 1 expansion at its Lac des Iles mine in Thunder Bay, Ontario. Starting 2013, it is going to mine from the Offset Zone through a shaft as opposed to mining from the Roby Zone, which will significantly increase its palladium production and lower the cash costs.
We have recently lowered the target price to $3.10 from $4.60, in light of the news on its 2012 production guidance and the closing of the Sleeping Giant mine. The execution risks and the uncertainties at the transition stage are still overhanging the story. But the stock appears to be oversold for the last couple of days. The current price of below $2.40 is a good entry point, if investors are willing to look beyond 2012.
TGR: Do you have any parting thoughts for us on the sector?
AZ: Realizing the uncertainties and the volatilities that we’re facing, this is not a market in which pigs will fly. Investors should stay with good stories with long-term growth potential and companies that have projects with potential good economics, located in safe jurisdictions and led by good management teams.
TGR: Thanks for your time.
Annie Zhang has been an analyst at Toronto-based investment bank Octagon Capital covering precious metals since October 2010; she joined Octagon in March 2007 as a research associate. Zhang holds a bachelors in accounting from Zhongnan University of Finance and Economics in China and a Master of Business Administration from Concordia University’s John Molson School of Business and has been a CFA charter holder since 2006.
By The Gold Report, on January 19th, 2012
 If you’re among the many who consider investing in the junior resource sector nothing more than a crapshoot, look into Ahead of the Herd Publisher Rick Mills’ steps to derisk the inherently risky business of investing in junior resource companies. In this exclusive interview with The Gold Report, Mills not only spells out the steps involved in the derisking process, but also cites specific examples of juniors he especially likes and discusses the features that put them ahead of the herd.
The Gold Report: We have seen some incredible volatility in the market over the last three or four months, with many junior resource stocks on the Toronto Venture Exchange beaten down, even if they have proven resources and substantial cash treasuries. We have also seen some volatility in the price of gold and a disconnect between the price of gold and the price of juniors. In this environment, how should investors approach risk in the junior resource space?
Rick Mills: I agree with Baron Nathan Rothschild who became a legend during the financial crisis right after the Franco-Prussian War. As the story goes, a panic-stricken investor came screaming into his office yelling, “You advise me to buy securities now? Now? The streets of Paris run with blood!” Rothschild replied, “My dear friend, if the streets of Paris were not running with blood, do you think you would be able to buy at the present prices? Buy when there’s blood in the streets, even if the blood is your own.”
I’m pretty sure things today are not as bad as they were back then, but this market offers contrarian-minded investors an opportunity to take huge advantage of discount share prices and, as you pointed out, many are trading below cash in the bank. Many, many are way undervalued compared to what they have in the ground and what they will have. The thing to do is to even further derisk.
Everything we do has some level of risk, from flying in a plane to walking across the street. All our lives we identify and quantify risk, so it’s second nature and part of our makeup. Everyone has his own risk profile, of course. For instance, maybe you won’t bungee-jump off a bridge or willingly parachute from an airplane, but you’ll happily get crazy driving around on an ATV or a snowmobile. You have a risk profile. You will do this; you won’t do that.
TGR: So far, so good. So how do you derisk these stocks?
RM: The way to derisk investments into junior resource companies is to know your risk profile. Then wisely deploy capital into the right management team in the right stage, for you, of company development.
TGR: What steps would investors take to identify companies they’re comfortable with? How can they make better-informed choices and thus create less risk?
RM: The most important things are to know yourself and to know that juniors are inherently risky. Understand how much volatility you can handle and how much patience you have to wait while a story plays out. Develop the discipline not to get faked out of your position or chase after hot tips or listen to the cheerleaders. Have a clear and complete understanding of why you’re here in the first place. Know the different development stages of a junior, because risk lessens as a company moves a project through drilling and post-discovery resource definition, then into the various mining studies, and finally into raising money, building the mine, and ultimately, mining. You really have to know who you are invested with and the story. Monitor the progress of your management team with its project and make sure they’re meeting goals and timelines.
TGR: And when you find companies that suit your risk profile and pass muster in terms of development stage and management performance, you jump in?
RM: You don’t want to just walk in and buy all your shares. Develop a plan to buy shares over time . I don’t use stops, because these stocks can make huge moves down in a day and you could get knocked out just before they move back up and go on a tear the next day. I’m here long term so short-term moves don’t bother me; stops in juniors, for non-traders, create more problems than they solve.
TGR: Could you elaborate a bit on evaluating the various development stages?
RM: The most upside and the greatest risk come with the greenfields, the junior resource companies when they are exploring. It takes a lot of patience with them and with the management teams to let stories play out. Some of these stocks are very thinly traded, so it doesn’t take much to make them jump in either direction. Make a discovery, get some good drill assays and they explode in the share price. Get some bad assays and they implode to the downside—make sure they have a back up play, a plan B, already secured and ready to go. They are the riskiest plays by far, but they offer the highest reward.
Next is what I call the post-discovery resource definition stage. A company at this stage already has found something, its share price has exploded and now the company is undertaking a nice drill program. After the price has settled back, decide on an entry point and start to get in. Let the company build an NI 43-101-compliant resource. The risk has been greatly reduced, and of course there’s no longer any waiting for a discovery.
The study stage comes next. After the company has its NI 43-101-compliant resource, it gets into scoping, prefeasibility and feasibility studies. Companies at this stage are so much further down the development path that much of the guesswork about grade, size, cost and metallurgy has been taken out of the equation for investors. These companies have done sufficient work to give investors a certain level of confidence that they’ll successfully move their projects along.
TGR: Haven’t a lot of companies at this stage also been derisked in the sense that their share prices are depressed as well?
RM: Oh, absolutely. A lot of these companies not only have the value, but they continue working and adding to that value every day. It’s a fantastic opportunity to buy some companies not only on the path to production but also on the path to some pretty decent cash flows.
TGR: Could you talk about any companies you like that are enroute to production and positive cash flow?
RM: Not yet. We haven’t finished derisking. Let’s look at gold mining. Even though the price of gold has gone up roughly six times, global gold production has been falling since 2001, which tells us that higher gold prices are not bringing on more gold supply. The money being spent on gold exploration is finally starting to climb, but very few big new deposits are being found, so gold miners are adding to their resources by buying them from smaller-cap miners and explorers—the companies making the new discoveries. The majors need them to replace their reserves and depend on them for their upstream flow of new projects for development. That’s what juniors do; that’s their function in the food chain. So it removes even more risk from the equation for the juniors that are sitting on existing deposits; they are becoming more valuable day by day.
The majors have gone through mergers for much of the last decade, and every round of mergers obviously leaves fewer majors. That said, large Asian miners have been entering the sector. They love not only the gold deposits, but copper-gold porphyries and base metals as well. All of this makes juniors with discernible deposits moving down a path to production all that much more valuable.
TGR: And less risky. So are you ready to tell us about some of those companies, the ones with discernible deposits that are close to production?
RM: Not quite. What is the biggest risk all junior companies face—not investors, but the companies themselves?
TGR: Running out of money?
RM: Move to the head of the class because that is the absolute major risk, the most serious risk all the juniors face—remember most do not have cash flow. So if the markets look a little wonky and you think juniors will have a hard time raising money, you can further derisk by looking at companies with treasuries full enough to keep them working—to get by for a couple of years. And you can derisk even more by narrowing these companies down to those that have cash now and that will actually get some cash flow from production in the next little while.
TGR: You’ve given us a good group of filters for investors to use.
RM: We’re doing some pretty serious research here and we have a very strong plan in place. We have directly targeted risk with the objective to lessen it yet leave potential major share price upside.
With careful due diligence and by thoughtfully choosing the development stage of companies we invest in, I think we can make some money.
TGR: So are we ready to hear about some of those companies?
RM: Yes. And these are in no particular order. Let’s start with Cangold Ltd. (CLD:TSX.V). This is Bob Archer’s gold company, which is working the Ixhuatan gold project in southern Mexico. Archer also has a silver company called Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A). The Ixhuatan property encompasses seven or eight different zones, all within a kilometer or two of each other, and all viable targets in their own right that Cangold intends to evaluate. So far, the most drilling has been done on the Campamento deposit, so bringing that into production is the main focus.
Cangold has stepped into something that is already well defined, based on 342 holes and 89,000 meters (m) of drilling, so it won’t have to spend $500,000 a year drilling to try to find something or basically drilling this off. This deposit has a Measured and Compliant resource of 1.041 million ounces (Moz) gold and 4.4 Moz silver, with another 0.7 Moz gold and 2.2 Moz silver in the Inferred category. The deal Cangold made with Brigus Gold Corp. (BRD:TSX; BRD:NYSE.A) calls for Cangold to earn 75% interest by taking this through feasibility.
Campamento is at the scoping study level right now, and Cangold plans to move it as fast as it can through prefeasibility and feasibility. The work needed to advance this project to the mine stage is almost all engineering studies. Optimizing the open-pit shell, looking for the best place to locate a plant and tailing ponds has already started. So this is basically a kit mine that Cangold will develop and put into production.
And Cangold already has done a 5:1 rollback. It didn’t have any problem raising money at $0.50, has a very tightly held share structure and has all that gold and silver in the ground to bring out via an open-pit mine. And it’s trading at $0.30/share.
TGR: Why did Brigus make this partnership with Cangold when it already is a producer, running the Black Fox Mine up in Canada?
RM: I really think it’s because of Bob Archer and his experience with Great Panther. He’s well-established in Mexico, has excellent contacts and knows how to work there. Also, major shareholders such as Sprott back this deal up.
TGR: Certainly Archer has had great success with his mine at Guanajuato.
RM: That’s right. I was buying Great Panther years ago in the high $0.30s and talked with him at the time. He laid out what he wanted to do and has basically delivered on everything. He has built a very strong team that works hard and gets the job done.
TGR: What are some of those other companies?
RM: Okay, the next one is Kootenay Gold Inc. (KTN:TSX.V), which has the 100%-owned Promontorio silver project in Sonora, Mexico. Like Cangold, Kootenay already has a significant resource. AGP Mining Consultants’ resource estimate puts Indicated mineral resource at 5.2 million tons, with 8.9 Moz silver, 99 million pounds (Mlb) lead and 111 Mlb zinc. It grades 52 grams of silver, 0.86% lead and 0.96% zinc.
Since that estimate, Kootenay has drilled 53,000m into Promontorio at an average depth of 300m; the results from two-thirds of that drilling will go into a new resource estimate, which is due out in another month or two. Going back through the results on the website, you see some pretty decent assays, and I expect a very definite resource increase—a doubling or even tripling in the new estimate. Then Kootenay will launch another big and aggressive drill program. It wouldn’t surprise me to see 50 Moz silver and quite likely the equivalent to that in lead and zinc after that drilling.
With all of that, plus a very good share structure with heavy management participation, a very healthy treasury, and more news coming, I refuse to believe that Kootenay won’t be revalued much, much higher over the coming year.
TGR: With the flagship property actually focused more on silver than gold, is it odd that this company is Kootenay Gold rather than Kootenay Silver?
RM: The company took its name from the Kootenay region of British Columbia, where it started, and it has eight or nine serious joint ventures (JVs) with some pretty good junior resource companies on gold properties there and in other parts of B.C.—Copley, Red Lobster, Deer Creek, Jumping Josephine and Rosetta Stone.
Kootenay has the best of both worlds, and operates on the prospector generator business model, taking property dilution instead of share dilution. It uses the money that generates along with money raised to work on its 100%-owned Promontorio. I don’t think most people realize that Promontorio, as a standalone, will be able to potentially produce 3–5 Moz silver a year plus another 3–5 Moz silver equivalent over a 10-year-plus timeframe. In the context of other silver producers in Mexico, that’s a pretty significant asset. It usually takes these producers two or three mines to get up to production numbers like that, and Kootenay will get there with a single asset. That’s pretty uncommon and pretty valuable.
TGR: A lot of great silver producers in Mexico certainly would be interested in this project.
RM: Oh, one project with the potential to produce that much silver and silver equivalent in a year has to be on every radar screen. Don’t get me wrong, Kootenay can take this to production. It absolutely can. It’s just a matter of whether an offer is too good to refuse.
TGR: Well, you’ve named two companies with assets in Mexico. It certainly is a great mining location.
RM: It is, but let’s move up north into Nevada and Idaho with Terraco Gold Corp. (TEN:TSX.V). Terraco has two exciting projects—the Almaden, northwest of Boise, and the Moonlight, northeast of Reno.
The Almaden project could go into production today; it’s very similar to deposits such as the Hollister mine and the Ken Snyder Midas mine in northeast Nevada. It has almost 1 Moz of Measured, Indicated and Inferred NI 43-101-complaint resources, based on almost 900 drill holes. Some of the mineralization outcrops, in fact the bulk of the deposit, lies within 100m of the surface. The exciting thing about this deposit, as with the Hollister and Midas mines, is that the deposit has substantial evidence to suggest higher-grade—maybe bonanza-grade—feeder shoots at depth.
I think Terraco will boost the resource quite a bit just due to the type of drilling program it is using and the fact that it is improving the metallurgy. So even if Terraco does not hit any more gold, I expect a significant increase in the resource. But if the model the drilling is based on proves to be correct and Terraco hits these feeder zones, the impact will be huge.
TGR: Terraco’s chart suggests it has been beaten down quite severely, roughly about 50% in the last nine months.
RM: That’s right. But Ken Snyder and Charlie Sulfrian, who are running the drill program, have discovered several mines. Snyder is one of the foremost geologists and explorationists working today and Sulfrian is a mine finder as well and a very good metallurgist. When he says he might be able to work on the recoveries, you have to anticipate a measure of success. When I asked him if the Almaden could be put into production as it is, he said yes. As I said, with the different drill methods and improved metallurgy, you’re going see the resources at Almaden expand, and when you add in the blue sky of the feeder zones, you’re looking at something pretty exciting. The story gets better and better all the time.
As you indicated, it’s a little beaten up and has been a little worked over—who isn’t—but Terraco has money in the bank and continues to increase shareholder value. Management isn’t turtling up and crawling into a hole and crying themselves to sleep at night. When the market turns around—I fully believe the market’s going to turn around—the companies we’re talking about will be ahead of the herd. They’re out there working and building shareholder value.
TGR: How about the Moonlight project?
RM: Moonlight is a call option on gold discovery. It sits directly north of Spring Valley, a resource of 4.1 Moz. Since that estimate, Terraco has secured the Black Ridge Fault property and incorporated it into Moonlight, hired Tom Chadwick to map it and has now started drilling.
TGR: Terraco also closed a very creative financing in December, with the royalty deal it made on the Spring Valley gold project.
RM: Yes. That deal is a hell of an example of how to create value for shareholders. Spring Valley is a JV between Barrick Gold Corp. (ABS:TSX; ABS:NYSE) and Midway Gold Corp. (MDW:TSX; MDW:NYSE.A), where Barrick has the right to earn 60% interest in the project by completing work expenditures totaling $30 million (M) by the end of 2013. But that sliding royalty from the Barrick/Midway JV is really interesting. I did the math.
TGR: Okay, let’s hear about it.
RM: Terraco receives no royalty on the first 500,000 ounces (oz) of production. After that, Terraco pays $12.5M and gets a 2.5% royalty on 76% of the deposit or, as it stands today, 2.15 Moz. A very conservative 70% recovery means 1.51 Moz gold. Using $500/oz as the cost and a very conservative gold price of $1,100/oz means $600/oz net. On 1.51 Moz gold, that adds up to $22.6M. It will cost $12.5M to get that, of course, which takes Terraco down to $10.1M. Terraco has already received $5M as an initial payment for doing the deal. So with the $10.1M coming from the Barrick/Midway JV net smelter returns royalty and the $5M already in the treasury, Terraco is cashed up today and has a future royalty stream.
It’s a good example of a pretty smart, on-the-ball management team increasing shareholder value. I think investors will find some joy in this one.
TGR: Excellent. Heading further north, do you have any Canadian projects to talk about?
RM: VMS Ventures Inc. (VMS:TSX.V) is a solid junior, among the smartest explorers around using all the modern techniques, and it’s a survivor. VMS Ventures has been through the tough times, back in 2000 and again a few years ago in 2008. This company knows how risky it is for a junior to run out of money, and it isn’t going to do it. It has $10M in the treasury to start 2012—enough to keep exploring and going on its own until cash flow starts. Let’s talk about that cash flow.
VMS Ventures has a JV with HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) on its Reed Lake copper deposit that will take the company to production next year. It will get 30% from this operating mine—that’s many, many millions of dollars a year. When you look at the kind of cash flow that this carried-to-production scenario at Reed Lake will give the company, you have to expect an upward revaluation in the share price. Another factor that helps derisk VMS Ventures is HudBay’s Trout Lake Mine is coming offline, its plant in Flin Flon is underutilized, so it needs the feed from production at Reed Lake.
In addition to the JV, HudBay has optioned some of VMS Venture’s properties. One discovery, Reed North, has enormous potential to be an absolute monster of a deposit.
Something like 98% of VMS’s properties are 100% owned. The company did several drill programs last year and will be following up on three discoveries made on three different 100%-owned properties. VMS also owns 45% of North American Nickel Inc. (NAN:TSX.V), which has a possible district-size nickel play in Greenland. With all it has going—its considerable treasury, the cash flow, the exploration upside, the management—VMS Ventures is a poster child for how juniors should manage capital. As we agreed, the most dangerous thing for a junior is to run out of money. This company absolutely doesn’t have that problem. And, as a matter of fact, the closer it moves to production, it’s just going to get better and better.
Fully cashed up with $10M in the bank and financing costs for its 30% of the mine covered, VMS Ventures also focuses on some of the safest areas for investment. It has no geopolitical risk.
TGR: Because VMS is a copper play, you must anticipate somewhat stable demand for copper, too.
RM: We’re never going to see $0.85/pound (lb) copper again. With copper at $3–4/lb, Reed Lake should be wildly profitable. Put $71M into building a ramp down to the deposit and who knows how much more copper it will find? It’s not only that this deposit has 5% copper equivalent over a couple of million tons, but these deposits come in pods. So far, VMS has not drilled off to the side or underneath because it simply doesn’t make economic sense. But once it has the decline into the deposit, it will build side rooms, set up drills and start fan-drilling and see what it gets, right?
TGR: Right. And the idea of diversifying a little bit into base metals makes sense for the typical investor. Any more juniors that you’d like to talk about?
RM: I really like NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK), which is focused in Quebec. These people at NioGold are smart. They can put land packages together, and they have. And look at the deal that they’ve done with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A). Aurizon right now can earn 65% interest in NioGold’s Marban Block property, an initial 50% by spending $20M over three years, completing an updated NI 43-101-compliant mineral resource estimate, which will be done this March, and then making a resource payment for 50% of the total gold ounces defined by that resource estimate.
So far, Aurizon has completed a first phase, drilling 50,000m, spending $6M and identifying two new gold zones. The second phase will be a $5M, 34,000m diamond drill program, updated resource estimate and basic technical studies this year. If it sees what it needs to see in the resource estimate—and I don’t see why it won’t, because it already has two new discoveries—it just doesn’t make sense for Aurizon to do a third year, buy those ounces and carry NioGold with it to production. Instead, I would think that Aurizon would buy NioGold out as soon as it gets a feel for what’s there.
TGR: Aurizon certainly has the capability to do that. It’s had so much success with building the resource base at the Joanna gold project. So yes, that’s very logical.
RM: And the thing about NioGold is it is fully cashed up. It has lots of money in the treasury. It is also going to have this resource payment. And it has a discovery right beside Osisko Mining Corp.’s (OSK:TSX) Malartic deposit. It also looks as if NioGold has the extension of the Marban deposits, Marbanite and Norbenite, on its 100%-owned block of ground just north of where Aurizon’s drilling. So, NioGold has immense blue-sky potential as well as the deal with Aurizon.
TGR: With the stock trading at around $0.35, NioGold would seem to be a bargain at this point. Any more names in that hat, Rick?
RM: One more. And this might be the cheapest safest gold ounces you’ll find on the Venture Exchange and quite an opportunity. It’s a story that’s been dormant for a long time, but revived itself with acquisition of a hell of a property.
TGR: Tell us more.
RM: On Jan. 3, Altair Ventures Inc. (AVX:TSX.V) put out a news release to announce signing a letter of agreement for an option to acquire from Sultan Minerals Inc. (SUL:TSX.V) up to a 75% interest in the Kena gold project, located close to Nelson in southeastern B.C. At 7,600 hectares, this is a fairly large property in a safe jurisdiction with access to infrastructure. But more important, it covers 8,000m of strike length on a district scale gold and copper-gold system. It has a 1.1 Moz gold resource now, with the potential to double or triple that resource. I have a prospector buddy who’s worked all over the area and on this property. He absolutely loves this property, has been following it for years and always wondered why nothing was ever done with it.
TGR: Do you know why?
RM: Well, Sultan spent about $500,000 tying up this property, which is a lower-grade, bulk-tonnage target, between 2000 and 2003, and had the resource defined by 2004. At that time gold wasn’t as high as it is now, and low-grade bulk-tonnage properties didn’t really come into vogue until later.
TGR: I see Bob Archer is involved with this one as well.
RM: Yes he is. I think at around $0.07/share, with 42M shares outstanding, it has to be some of the cheapest gold on the exchange. The property is severely undervalued, and with the exploration potential to double and possibly even triple the resource, this is pretty exciting stuff. Now it is going to rollback three for one and will have to raise some money. So maybe this isn’t as derisked as others we have mentioned, but this is, in my opinion, incredibly undervalued based on the existing resource and exploration upside as shown from results on other areas of the property.
TGR: You’ve given us a lot of interesting ideas, Rick, and investors certainly will appreciate your explanation of how to lessen their risk as they venture into the junior space. Is there anything you’d like to add before we say goodbye?
RM: Maybe just to emphasize the importance of doing your homework. There’s absolutely no way around it. As an investor, you can rely on other people to do some of it—Ahead of the Herd and Streetwise just did by showcasing, for free, several excellent companies to do further due diligence on—but the ultimate decision and the ultimate responsibility for every decision you make rests with you. That’s why you need to satisfy yourself that what you put your money into is run by a competent management team.
Know your risk profile. Pick your stock. Plan your entrance, and have the patience and discipline to let a quality management team go to work for you and build value. But be sure to have an exit plan as well; pick the stage at which you get out, because you don’t make any money until you sell—stick to your plan.
TGR: Excellent. Thank you, Rick.
RM: 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 300 websites, including: The Wall Street Journal, SafeHaven, Market Oracle, USA Today, National Post, Stockhouse, Lewrockwell, Uranium Miner, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FNArena, Uraniumseek, and Financial Sense.
By The Gold Report, on January 17th, 2012
 When it comes to picking gold mining names in the current market environment, John Stephenson, author and portfolio fund manager at First Asset Investment Management, believes that buying the “best of breed” is the way to go. In this exclusive interview with The Gold Report, he explains his reasoning in light of how the current global economic environment is affecting prospects for the metals markets and valuations of mining company stocks. He also talks about his favorite picks in a range of three production classes and why he likes them.
The Gold Report: As a portfolio manager and an author of two books, The Little Book of Commodity Investing and Shell Shocked: How Canadians Can Invest After the Collapse, how do you see the prospects for the resource commodities in 2012?
John Stephenson: I think, in general, my prospects and outlook are very bullish. The story continues to be one of strong demand out of China. I don’t see that story changing. Obviously, there have been a lot of headlines and the Purchasing Managers’ Index data in China recently are not as robust as they were, but its economy is still going to grow at 8.5–9%. That’s pretty darn good. That’s really where demand for most of these commodities will come from. Certainly, any improvement in Europe and the U.S. will be good news for commodities.
TGR: Are there any specific ones you think will do better than others?
JS: I’d have to say that oil will do very well. I think we’ll see oil exit 2012 north of $130/barrel. Certainly, copper looks very strong. I could see that at $4.50/pound (lb) by the end of the year. Gold and precious metals will do well, also. Gold and precious metals are in a different category than the others, but, nonetheless, what I think is going to continue to drive that is Europe, and I think you’ll see $2,500/ounce (oz) gold.
TGR: So in that light, I guess $4.50/lb copper isn’t that far out of line, if you’re expecting gold in the $2,500/oz range.
JS: I think what you’re seeing across the board in commodities is very strong demand and weak supply. Nothing has happened that will improve that situation and the volatility we see daily has only made the situation worse. Suppliers have struggled to keep up. The smaller, more marginal players have had trouble getting financing as the volatility has increased. The eventual supply response, which would normally end a bull market, is going to be a long time coming.
TGR: In this recent semi-panic where gold dropped into the low $1,500/oz range and people were saying it was all over—you’re certainly not a believer in that if you’re predicting $2,500/oz gold.
JS: No. I’m not a believer in it. Gold shares some characteristics with other commodities in terms of supply and demand. Over the last 40 years, the average grade globally was around 9.6 grams/ton (g/t). It’s now around 1 g/t. So, we’re potentially facing a peak gold scenario as we may be in oil.
Look at Barrick Gold Corp. (ABX:TSX; ABX:NYSE). It recently acquired Equinox Minerals Ltd. (EQN:TSX; EQN:ASX), a copper miner. That’s how it’s struggling to find replacement gold reserves. It had no better idea than to buy a copper miner. This is typical across an industry facing very challenging supply conditions.
Gold is really taking on a different characteristic; it tends to be a commodity that is more of a currency than a commodity. I see it going higher ultimately because the solution to what ails Europe will be the need for the European Central Bank to step in line and start to print money. Once we have that, you’re going to see gold move higher. What’s kept gold down in the last few months has been that the U.S. dollar and U.S. Treasuries have become safe havens. But how much worse can things get in the world when you have the 10-year U.S. Treasury trading below 2%?
TGR:: So you’re pretty well convinced that we’ve seen the lows in the gold price?
JS: Yes. There were several reasons why the low price dropped recently. Fund managers facing redemption requests looked around and said, “Well, this has probably been the best-performing asset in my portfolio this year and maybe the last 11 years.” They felt that to meet these requests, they needed to sell. So there were a lot of things that were happening that weren’t really related to gold or to the bigger story of what was happening within Europe. We have an enormous amount of paper money out there being debased. And the solution for these debts really is to debase more of this paper money. In that environment, people around the world are saying, “I want something tangible. I want something real. I want something I can hold in my hand, store, put in the bank or under my mattress.” And the demand is going to remain very strong. I don’t see that changing.
TGR: So regardless of how all these problems evolve, as far as you’re concerned, gold is going higher, no matter what?
JS: No matter what!
TGR: Obviously, you’re a precious metals bull. What’s your preference among the equities, the physical metal and exchange-traded funds (ETFs)? Or is it a combination of all of them?
JS: A combination makes sense. The reason people have held the equities is because they get leverage to the gold price. So assuming that costs don’t increase at the same rate as the metal itself increases, you get increasing earnings and, therefore, on a consistent multiple basis, you get a higher share price and greater leverage to it.
The situation for gold miners has really changed over the last, say, four to five years. If we look back, 12 or even 15 years ago, we saw that for the first three or four years of that period, from early 2000–2004, the actual miners outpaced the metal by a three times multiple. Right now, evaluations have fallen so steadily for the miners that probably the smarter bet is to look at the equities. Certainly, the physical metal has some storage and handling costs associated with it. So I would say if you had to choose between the three, you would probably, at this point, look mainly to the miners, somewhat toward the ETFs and maybe hold a small amount physically for safekeeping.
TGR: In your portfolio management business, what criteria do you consider in selecting companies for your funds?
JS: Valuation is obviously one. We do a fair bit of work in terms of determining what we think the fair value is relative to what particular miners are trading at. We also look for reserve growth and the potential for production growth. Then I think a very important consideration is where in the world they are producing it, because geopolitical risk has taken on a whole new concern. As the traditional supply basins have started to run dry, companies have had to go further and further afield, creating additional problems. So we try to look at stable geopolitical jurisdictions that are attractive and mining friendly. We look for companies that have production histories that are strong and likely to continue, coupled with outstanding management.
TGR: Makes sense, although it is a moving target as things change, and what once appeared to be stable doesn’t look so stable anymore.
JS: That’s right. You can’t just buy and hold. You have to keep following up.
TGR: 2011 was a tough and disappointing year for a lot of investors considering what the metals did and the resource stocks didn’t do. What are you expecting to happen this year with the mining equities? Are they going to finally catch up with the commodities price?
JS: Yes. Our view is that mining equities will outperform the metals in 2012 and that now is a good time to be looking at the mining companies themselves. We think that the commodity itself will be very strong because the Europe situation is coming to a head and will be a catalyst to lift prices higher. The miners will play catch-up and multiples will go from compressing to expanding, or at least not compressing any further.
TGR: You do quite a bit of research and have become quite familiar with a broad range of companies in the mining development and production business. Can you talk about some of the ones you like, maybe starting with some of the seniors and working your way down?
JS: In terms of relative size and scale, you don’t get any bigger than Barrick. The stock is trading at less than 10x earnings, which in itself is phenomenal and less than 1x net asset value (NAV). It has better growth than Newmont Mining Corp. (NEM:NYSE), and it’s the largest producer in the world. It has struggled, there’s no question about it, but if you’re looking for a value play, something that is liquid, well managed and has very strong growth. Going with the largest in the industry at almost 9 million ounces (Moz) per year, you have to look at Barrick.
TGR: Barrick has gotten to be so big. Is it going to be able to grow internally or will it just have to continue making acquisitions?
JS: I think that’s the issue, and you have correctly identified why investors have been a little skeptical on the name. At some point, things get cheap enough that you have to look at it and give it some credit. Looking back over the history of Barrick, it had a hedge book and much of its upside was hedged. Then as gold took off, people said it wasn’t going to get credit for it if it had the hedge book on it. So the hedge book was taken off and unwound. Then people said it needed to show production growth, which it did. At some point, when the chips are down, people are going to say, “Here’s a company that’s delivered.” But, you’re right. It’s hard to see how it can become a 10–11 Moz producer from around 9 Moz and continue to replace reserves, particularly in a world of declining ore values. But, if you think that the world of investments is going to bounce all over the place as the headlines out of Europe dominate trading, then I think you need to be somewhere where they’re printing money, and this is what Barrick is doing.
The next senior I would highlight is Goldcorp Inc. (G:TSX; GG:NYSE). This is the third largest gold producer in North America. What’s unique about Goldcorp is that it offers a blend of things that are almost never found in one company. It has good growth and great production diversity—not just producing from a single mine. It’s the lowest cost major producer, with cash costs at roughly $550/oz. Typical industry average is closer to $875/oz. It has a strong balance sheet, and it’s operating in politically secure parts of the world. So the chance of expropriation is pretty low. And, it’s liquid. So we really like this.
TGR: How about Intermediates?
JS: On the intermediate producers, with production in the 800 thousand ounces (Koz) to 1–1.5 Moz per year range, we like IAMGOLD Corp. (IMG:TSX; IAG:NYSE). It has a number of mines around the world, largely in the Americas, but also in Africa. It has recently brought in a new management team, which is focused on really servicing value. It brought in someone who is not from the industry but a turnaround expert, and it’s looking at really harvesting this value. With its good mines and good operating profile plus a bent toward servicing value, this name should move higher.
Another intermediate that we like is Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE). It has a number of mines in Finland, Canada and Mexico. This was a company that was a Street darling for many, many years. It probably has the best management team out there. It has had a few stumbles lately. It actually closed one of its mines, Goldex in Quebec, and wrote off the asset, so the stock has fallen because people have probably lost a little confidence in management’s ability to deliver. It was essentially trying to bring on five mines in two years’ time, and that’s really just too high an expectation. But at this price level, it has excellent growth and still is a name to look at.
TGR: And then Juniors?
JS: In the junior producer category, there are two names I think are worth looking at. One is Osisko Mining Corp. (OSK:TSX), which is very quickly moving into the intermediates. Until we get robust global growth, a company that is going to make this transition very quickly is obviously desirable for that reason, if nothing else. Osisko is already producing from its Canadian Malartic gold deposit in Quebec even though it just finished the original mine plan. It’s already producing around 600 Koz/year and has some catalysts for growth. Once you start production, you see a re-rating in your shares. This is trading at a discount to its junior and intermediate peers in terms of a multiple basis, but we think that multiple will expand as it continues to produce. It also has another property that gives it some option value and some further upside.
Lastly, we like AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) with three operating mines in Mexico and two in Australia. It recently commissioned a new mine at the Young-Davidson project in Ontario. We think this is another company that has a very strong growth profile and has been a bit in the penalty box, but it’s really too cheap at this point not to be looked at. So we think this is a potential double in terms of per-share value over the course of the next year to year-and-a-half.
TGR: AuRico has somewhat come out of nowhere with a name change and then these acquisitions. It’s actually quite a diversified situation with these properties spread out all over.
JS: Yes, it is. It used to be called Gammon Gold and then bought Northgate. We think that this is a name that should do very well. Given that it’s trading below its NAV at this point, it’s just too cheap to be ignored. It has a heap leach at its Ocampo property that continues to struggle a little bit. But I think all these issues are well known. At this level, this name and really all the others, should be bought, if you believe that gold prices will move higher, which we certainly do.
TGR: You probably look at a lot of other little companies that maybe are not suitable for your portfolio. Do you have any you might like to mention that you think are good speculations but not necessarily investment quality?
JS: Yes. Obviously, lots of gold companies come along that we think are interesting. I’m skeptical to mention some of these names because I think that for most investors, they’re a binary outcome. They either make it or they don’t, and in more cases than not, they struggle. I think, certainly, you could make a case for Pan American Silver Corp. (PAA:TSX; PAAS: NASDAQ) and some of these other names that are smaller, but they’re really a beta play on gold because when you start looking at some of these silver names, they typically trade in a much more volatile pattern than the gold producers. I think for many investors, the volatility isn’t worth the ride.
TGR: What sort of strategy are you suggesting investors use this year for maximizing their gains or not having the same sort of performance we had last year?
JS: We’ve seen mining company valuations trend down for many years. Now is a good time to start building positions by buying the best of breed—the ones that will do well in an increasing gold scenario that have little or no operational risk and are larger-cap names. Besides Barrick and Goldcorp, certainly, Kinross Gold Corp. (K:TSX; KGC:NYSE) would be another name to look at. I think its growth comes a little further out, probably in 2013, but you can start to take a look at that. I think turnaround situations like Agnico-Eagle Mines might be very good to look at. Keep in mind, if you’re buying a mining company, it’s making lots of money at $1,500–1,600/oz gold, but if you buy an ETF or the physical metal, you’re hoping it goes from $1,600/oz to $2,000/oz or $2,500/oz in order to make a profit. In the case of a mining company, you don’t need it to go anywhere. All you need is some recognition that there is value today in these companies, and there will be value tomorrow, as they, it is hoped, find more reserves and produce them.
TGR: Are there any parting thoughts that you’d like to leave with our readers?
JS: I would advise people to keep in mind that if there ever was a time for an investment in gold and gold equities, it is now. We have a very unusual situation in the global economy, where there really isn’t any obvious exit path other than the monetization of the debts. Gold companies have suffered because people have flocked to other safe havens, namely the U.S. dollar, but the U.S. has its problems as well. In general, if you’re with a company that has more than one operating mine in geopolitically safe parts of the world and has a demonstrated track record of increasing reserves and production, then I think those are the things that will, in the longer run, reward you. Short run speculating may be exciting but I think most people need to invest in things that have the potential to be higher a year from now than they are today. I think, right now, this is gold equities.
TGR: Thank you for your thoughts, input and insights. I hope 2012 will be a better year for everyone. We look forward to seeing how all of this comes about.
JS: I hope so.
John Stephenson is a senior vice president and portfolio manager with First Asset Investment Management Inc., where he is responsible for a wide range of equity mandates with a particular focus on energy and resource investing. He has been recognized by Brendan Wood International (BWI) as one of Canada’s 50 best portfolio managers for the past three years. He is the author of The Little Book of Commodity Investing (John Wiley & Sons, 2010), which has been translated into five languages, and Shell Shocked: How Canadians Can Invest After the Collapse (John Wiley & Sons, 2009) and writes a free bi-weekly investment newsletter, Money Focus, which reaches a global audience of more than 125,000 (www.reportonmoney.com).
Stephenson is regularly quoted by Bloomberg News, Reuters, The Associated Press, The Wall Street Journal and The Globe and Mail and is a frequent guest on Bloomberg TV, CNBC, CNN, Fox Business and Canada’s Business News Network (BNN), Sun TV and the CBC. He is frequently the keynote speaker at investment conferences throughout North America. Stephenson holds a degree in mechanical engineering from the University of Waterloo, a Master of Business Administration from INSEAD, as well as the Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) designations.
By The Gold Report, on January 16th, 2012
 Christopher Welch, a mining analyst with Ocean Equities, has been crisscrossing the Atlantic for most of the last year. He tells The Gold Report in this exclusive interview that recent trips have bolstered his conviction that mining plays in Africa are being overlooked, but it’s not too late for investors to get in on the ground floor.
The Gold Report: Most of your coverage universe at Ocean Equities consists of precious metals juniors with exploration- or development-stage projects. Why do you cover these types of companies?
Christopher Welch: It’s the end of the market where our expertise has the biggest effect, particularly since my colleagues and I are either geologists or experienced industry professionals. We can look at ground where we know it’s going to be prospective. We can look at the very early-stage exploration results and know if they are encouraging.
We still cover some big, producing companies. One of our biggest companies under coverage is Kirkland Lake Gold Inc. (KGI:TSX), which is a growing intermediate producer. But we’ve had such an effect on the junior exploration end because that’s where our strengths lie.
TGR: Most of your companies have sub-$100 million (M) market caps with gold and/or copper projects based in Africa, Canada or Nicaragua. What criteria do you use to choose these small-cap companies?
CW: We look at management, the ore body, exploration results, the geology of the region and country risk. We don’t have a mandate to follow specific parts of the world, although we know where we feel comfortable operating. If it’s a country where one of the research teams feels quite happy jumping on a plane, spending a few days in a tent on the ground and looking at the grassroots exploration data, that’s a country we wouldn’t mind doing business in.
TGR: You regularly go and visit these projects?
CW: Taking a job as a mining analyst is essentially getting a ticket on a plane somewhere. I’ve been crisscrossing the Atlantic for most of the last year. Our technical expertise and professional experience mean that when we get to the ground, we know what to look for. It’s not a case of taking drilling results on trust. We look at the drill core and can see what’s good. It’s a lot of gut instinct and knowing what feels right. You can look at the lay of the land and say, “Yes, I can see the deposits here. I can see that this could be an open pit or the plant could go here, and there are no environmental or social issues.” You have to get in and kick the tires to add value.
TGR: Do you believe that African mining stories are underrepresented in investors’ portfolios?
CW: Yes. Over the last 10 years, contemporary exploration techniques have been applied to parts of Africa that were considered high risk, like Eritrea, Ethiopia and Liberia. However, there have been large-scale risk profile changes in these countries. Liberia is one of the best countries in Africa because of its transparency. There is now a combination of overlooked resources with safer governments, so it’s just another scramble to get into these countries and establish companies that can turn natural resources into profits for both the company and the host country. If you’re not exposed to the African mining story, you haven’t missed the boat, but it’s something you should look at quickly.
TGR: Are you concerned about another Charles Taylor, the former president of Liberia accused of war crimes, coming to power in these countries after you’ve invested heavily in them?
CW: Charles Taylor’s regime was definitely a product of ignorance of the Western world to what was going on in that part of Africa. Now there is more free press in Africa and there are a lot of African businesspeople who are involved in making their countries better. I know that all the issues across Africa aren’t solved, but we won’t go to a country where we think there could be a risk. We have a very good understanding of what’s going on across Africa. African risk can’t be painted with a broad brush. Every region globally has its drawbacks. Some might say that laws in British Columbia are perhaps overly onerous on environmental licensing, for example.
TGR: An interesting company in Ocean’s stable is Sunridge Gold Corp. (SGC:TSX.V). Tell us how you came across it and why you picked that one.
CW: It’s definitely one of the more encouraging companies in that region because it’s so undervalued. I constantly ask, “Where am I going to go next to find the overlooked or the best deposit?” That part of the Arabian-Nubian Shield really comes to the fore as the most overlooked part of the globe to find volcanic massive sulphide (VMS) deposits that have good grades. They don’t always have the biggest scale, but the grade means that the mines that get developed can be quite profitable.
If you take just one of the components of Sunridge’s project portfolio, its contained zinc for example, it has a greater gross in-situ metal value than the market cap of the company. So we think that Sunridge offers great potential.
TGR: What were your thoughts after visiting the Asmara gold project?
CW: My colleague was there recently as part of a larger trip around Eritrea and was very encouraged with what he saw. He said it looked very positive. Sunridge is in the prefeasibility stage on the Asmara project, which is part of a group of projects around the capital city.
TGR: Do you think that it will spin some of those assets out into a separate company?
CW: I think it will keep all of them under the same umbrella. It doesn’t have a huge footprint in Eritrea. It’s big, but manageable. Those projects will do very well when they combine and share infrastructure. Eritrea does need a fair amount of infrastructure to get up to the standards required for the mining. The company will likely build something centralized to take concentrate from different parts of its portfolio.
TGR: Is it a takeover target?
CW: It’s definitely enticing. It has ground in a great country with great prospects. Any sort of mid-tier company that’s looking to bolt on some high-grade VMS targets and near-term gold production capacity should be looking at it.
TGR: Are there plans to take Toro Gold Ltd., a private junior with a gold project in Senegal, public?
CW: It’s something the company would like to do, but not at the expense of shareholders. It has quite a market-savvy management team. It has done exceedingly well to get its Mako project on its feet. Recent results for Mako show great grades: 3 grams of turnover into sections of up to 40 meters. It’s one of the best grassroots discoveries in that part of Africa. There are definitely plans to take it to market, but it has to be done at the right time. I hope it will be within the next 12 months, but it’s up to the company to say.
TGR: Initial tests have shown that Toro’s deposits host free gold.
CW: The bottle roll test results are very encouraging, but the ultimate metallurgical process has yet to be determined. It looks like there is very little arsenic in the area, so it should be free gold. Toro has a large amount of ground, but it still has to do early-stage reconnaissance exploration, so there’s a lot of growth there. It’s in a part of Africa, which we call the Kenieba Window, which has been overlooked.
TGR: Many of our readers follow the junior mining sector quite closely, but few would have heard of Nyota Minerals Ltd. (NYO:AIM; NYO:ASX), which is conducting a definitive feasibility study on its Tulu Kapi deposit in Ethiopia. Nyota is about to announce a measured resource for the Tulu Kapi project in H112, as well as a maiden resource for other claim blocks in the area. Tell our readers about that story.
CW: It is in the same geological terrain as Sunridge, on the western half of the Arabian-Nubian Shield, which is very old rocks that have been somewhat agitated by the rift in the area. It’s in a very geologically prospective part of the world, but it’s been overlooked simply due to the historic Ethiopian-Eritrean conflict that’s now resolved.
Nyota is progressing on its Tulu Kapi project. The new chief executive, Richard Chase, who took the reins in mid-2011, really has a good handle on what could be quite a robust open-pit project. It has a mineable grade after internal dilution of over 2 grams/tonne. Tulu Kapi is going to be quite a good story.
Nyota is also going to be the first public company to receive a mining license in Ethiopia. It put in its application in Q311. Ethiopia is very prospective, particularly parts of the western highlands. We’ve seen many major mining companies coming into the country to try and grab ground and capture the essence of the geology of Ethiopia. Nyota has this fantastic, early-mover advantage in that it has a large land package with known targets, but also it has the key to good exploration—high-level operating geologists with Ethiopian backgrounds who can go and do the grassroots exploration very well. Nyota has a great future ahead of it.
TGR: A lot of investors still perceive Ethiopia as a risk. Does it give you a measure of confidence given that a number of larger mining companies are coming into that country?
CW: Yes, it does. The Internal Finance Corp. (IFC) of the World Bank has been a shareholder in Nyota for a long time, and the IFC has perhaps one of the most rigorous sets of due-diligence tests for its investments. The area of Ethiopia that Nyota is operating is lush, green pasture. It poured with rain the entire time we were there. Ethiopia has a good future ahead of it. It acknowledges its natural resources could be a key for developing and expanding its growth prospects. Personally, I don’t think the risk in Ethiopia is that high.
TGR: What are your preferred countries in Africa for mining development?
CW: Ethiopia, Eritrea and parts of Sudan are the most overlooked for ease of operation. Mali and Burkina Faso are developing into good countries to operate in, but my pick of the bunch is Liberia.
Just to give due respect to Ellen Johnson Sirleaf, the president of Liberia, she’s done an awful lot to clean up the country. In particular, the Extractive Industries Transparency Initiative that she’s taken on board in Liberia has really set the country up to benefit from iron-ore price growth. It has potential to be the largest iron-ore producer on the continent.
Liberia also has gold in the north with Aureus Mining Inc. (AUE:TSX; AUE:AIM), which is developing the New Liberty project.
TGR: That really is fascinating given that country’s history.
CW: It just proves the point that the opportunities come up when you have on-the-ground, grassroots operating knowledge from people who go into the country and say, “Look, I know what you think about Liberia, but honestly, go, see, look. Go to the country, visit it and when you get there, you’ll see that it’s open for business.”
TGR: Condor Resources Plc (CNR:LSE) has the promising La India gold project in Nicaragua. The one eyebrow-raising fact about Condor is that it’s just a small junior with a relatively small market cap, but it has about 560M shares outstanding. Are you concerned by a management team that would allow that level of dilution?
CW: The large number of shares is just a legacy and something that the company can do something about quite easily. A chief executive has a lot of techniques in his arsenal to reduce that, and I dare say there will be some form of consolidation in the future. Condor is a company that’s changed dramatically over the last two years. It’s taken a small resource in Nicaragua and grown it to a substantial 1.6 million ounces. In 2009 Condor had a robust resource in Nicaragua but it suffered capital constraints due to the global financial crisis and then the El Salvadoran moratorium on mining. This was when it suffered the dilution. That is now water under the bridge and it is moving forward.
TGR: Perhaps the most promising part of that project is the central breccia zone. Tell us about what the company continues to find there.
CW: It’s one of the largest scale mineralizations. Condor has plenty with a narrow vein, but high-grade, gold currencies cross its property. What is going to make a huge difference for the company is finding the bulk tonnage deposits where it can do either open-pit development or larger-scale underground development.
Condor found the central breccia toward the end of last year when it put in a trench to look at the bedrock. The initial grades of that sampling were very encouraging. Subsequently, it put in two drill holes and the results are likewise encouraging. It also extended the trench, and we’re waiting for an update from the company on those results. All signs are that it found something significant with a larger scale to it.
It’s a very good sign for Condor that it’s found the central breccia, but there are other areas where bulk tonnage of mineralization exist, which it could exploit through larger-scale mining techniques.
TGR: There are also other mines nearby, which could lead to a takeover.
CW: Exactly. Obviously, I don’t think it’s something that Condor is going to aim for immediately. In our discussions with the company, it’s all for just keeping its head down. It has an objective, it has a strategy to achieve that objective and it’s going to take the La India project as far down the development track as it can.
But it’s an interesting part of the world. Obviously, there is a lot of gold in Nicaragua, which in Central America is one of the more stable areas to operate in. There are larger-scale operations in the country. Whether one of the other Nicaraguan players would be the one to take Condor out or whether there might be a rollup by another company, I don’t know. At the moment, Condor has a lot it can do to increase the value of its portfolio.
TGR: Rambler Metals & Mining Plc (RAB:TSX; RMM:AIM) just started producing gold from its Ming mine in Newfoundland and Labrador. It has already forward-sold some of its production to Sandstorm Resources Ltd. (SSL:TSX.V). It’s one of those that quietly came into production. How did you find out about this story?
CW: It has the trifecta of things I look for in a mining project: management, geology and a stable location. Newfoundland and Rambler have it all in spades. It did come into production quietly, but that doesn’t detract from the story. It’s just been overlooked. It’s in a part of the world that has the last of the low-hanging, high-grade fruit for the same reasons that we look at parts of the Arabian-Nubian Shield. That part of Newfoundland has the same VMS deposits with a strong grade. Rambler definitely has that in the Ming mine, which has very good grades of copper, gold and some associated silver as well.
Rambler took on a loan to keep the project moving forward at a time when gold prices were much lower than they are now, and it did seem like a very sound decision for the company to make at the time. Now that gold is at the price it is, you can look back and say, “Well, I don’t think it was a good move,” but you play the cards that you’re dealt. I think George Ogilvie, the chief executive of the company, has done very well to get it up and running. It’s in a gold production phase just because it can produce gold at the higher price. It’s giving some of its revenue of gold away, but the payoff of the gold line is not having a dramatic negative effect on its cash flow. Later on this year, it’s going to go into a copper production phase where it’s going to increase its revenue.
TGR: How did you discover it?
CW: It came in through one of the mine organizers and management of a company that we’ve dealt with for a good time and trust.
TGR: You’re going to keep that a secret.
CW: The mining industry is a relatively small game. There is no better commodity than knowledge and trust in certain mine managers.
TGR: Sprott Resource has put some money into that project as well. When you get players like Sandstorm and Sprott involved, obviously the numbers add up.
CW: I know Sprott did an awful lot of technical due diligence on the project, so it must be very comfortable. It’s a very good deal for Sprott, as well as for Rambler.
TGR: Looking at the small-cap mining sector into 2012, do you expect a rebound or are we going to see more headwinds?
CW: We’re going to get an overall flight to quality. There are a lot of projects out there that are going to stand out from the crowd. We’ll see some re-ratings and some heads pop out from the parapet to show themselves to be above-average mining plays.
The pullback in mining shares and mine management becoming more cautious are going to pay dividends for the mining companies in the mid term. One thing we know is that resources are scarce. It’s getting harder and harder to find the projects, particularly good gold and copper projects. We’ve lost another field season in 2011 and a lot of people brought their drill rigs home rather than overspend during a downturn, so it’s going to be harder to find the projects in the development pipeline that can fill the metal supply gaps that develop.
When demand comes back to Asia or North America, there won’t be a sufficient number of projects in the development pipeline to feed that demand.
TGR: Thanks for your insights.
Christopher Welch holds a master’s in international business management and a Bachelor of Science (Honors) in geology from University College London and an Advanced Certificate in economics from Birkbeck University. Before joining Ocean Equities, Welch spent four years with Bloomsbury Minerals Economics as a copper analyst, prior to which he worked as a geologist in Lesotho.
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