Mining companies have lost the trust of investors, says David Baker, managing partner at Baker Steel. Baker sees the gold market as at a watershed point and the miners must change to stay afloat. In this interview with The Gold Report, Baker sets out his prescription for nursing the industry back to health. Will the restrictions his company and other investors are putting on gold companies increase reporting clarity, investor trust and money earned?
The Gold Report: The major gold producers have ceded market share to gold exchange-traded funds and royalty companies and are vastly underperforming those investment vehicles. If you were running a major gold producer, how would you go about restoring the appeal of your company’s shares?
David Baker: Mining companies need to restore trust and give more clarity. They are confusing investors because on the one hand they tell us they have so many ounces of gold in reserves and are producing so many ounces of gold, and then they confuse us by benchmarking all this to dollars—a depreciating asset. We believe the mining companies should be consistent and report in gold; this would then give investors a clearer picture on how much gold it is costing to mine the resource and how many ounces of gold are added to the shareholder vault.
“Holding gold instead of dollars will also preserve the purchasing power of the company.”
There are a number of challenges out there; first is the issue of the dollar cost inflation. When measured in dollars, the capital and operating costs of a mine have gone up, but when measured in gold, costs are fairly stable. Back in 2008 when gold was $800/ounce ($800/oz), a 100,000/oz per annum gold mine would typically cost $80 million ($80M) or 100,000 oz, today that same mine will cost around $170M, again around 100,000 oz. In dollars, costs are up by over 100% but in gold ounces they are steady.
We are using the wrong measure of costs; we are using a depreciating asset—dollars—to measure costs instead of a real asset, gold. So by mixing dollars and gold we are confusing investors. Now if costs in ounces had risen, we would have a serious problem! To compound the issue, analysts are forecasting higher dollar costs and lower future gold prices. Put these together and this spells a potential margin squeeze. Under this scenario, a new gold project has little value, and the shares get de-rated.
Second, the gold exchange-traded fund (EFT) has outperformed the gold equities; how do we reverse this trend and convince investors to sell some of their EFTs to buy a gold share? As it stands today, if you sell your gold ETF to buy a gold share, what you get is a company who digs gold out of the ground, brings it to surface and then converts it back to dollars, which when you think about it, is not what the EFT holder wants. We believe gold miners need to give investors gold, not dollars, and they could start doing this by reporting in gold, holding gold on their balance sheet instead of dollars and paying a gold royalty or gold dividend.
TGR: Even if companies do put their gold production on the books, they’re still going to need to liquidate some of that gold in order to meet day-to-day expenses.
DB: That is exactly right, but the balance should be held in gold. When we analyze a typical gold mine, it takes about 10% of the deposit to build the mine, 40–45% of the deposit to mine it, about 15% to pay government taxes and maybe 5% for sustaining capital. The balance, 20–25%, is the return and instead of selling this for dollars, the mining company should hold these gold ounces on its balance sheet.
“Gold is a currency that can’t be printed.”
Why is this a good idea? First, it makes no sense to sell an appreciating asset for a depreciating one; second, holding gold instead of dollars will also preserve the purchasing power of the company. A mining company with gold in its vault and lucky enough to discover a new gold project will no longer face a problem of capital cost inflation. As explained, capital costs are fairly stable in ounces and account for around 10% of reserves. Holding gold on the balance sheet will also act as a new source of demand, keeping more gold off the market. Gold producers should then start to emulate the ETF.
Companies should review their mission statements; they should change it ”to build and grow shareholder value expressed in ounces of gold.” This will give management more focus and investors greater clarity.
TGR: When you bring up this idea to boards of gold companies, what’s their response?
DB: I would say that overall we are getting a very positive response; they like the logic and it is certainly stimulating debate.
There is clearly an appetite for gold projects: Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) recently raised $1.9 billion to buy a gold stream off Vale S.A. (VALE:NYSE); it risked that amount for a gold stream at a fixed cost. So we can conclude there is a market for this model. Unfortunately, when gold companies sell a royalty to the royalty companies, they have been giving real margin to the royalty companies, and shareholders have ended up with less. Just look at the difference in share price performance of the royalty companies and the gold miners—it says it all. The gold companies don’t give away much and they hope shareholders hardly miss the 1.75–2% of the gold they sell, but the royalty companies have made a great business out of this.
“We’re looking for well-managed companies and companies that are diversified and well capitalized.”
There is an understanding that something has to change, that the business model isn’t exactly working for gold equity investors—we are giving our margin to others. We argue that royalties should also be paid to current shareholders of the mines. It doesn’t have to be much, say 2–2.5% of the gold mined, but this will link the gold in the ground to what the shareholders get; there is then a tangible way to define what an increase in reserves means to the value of the company. After all, I tell the mining companies, “When you’re going down to your pit and you do 20 shovels to put to the mill, all you have to do is one-half to one shovel to shareholders. It’s not too much to ask.”
TGR: How far off is that?
DB: We’re starting small. Korab Resources Ltd. (KOR:ASX), an Australia-listed company, has just announced a gold reporting, gold strategy and gold dividend policy. We have others in mind. We have confirmations that the strategy will be discussed at board level for a number of companies with the view that they will adopt these policies, so we are getting traction. They are listening, but it is hard being the first mover. Our aim is to allocate funds to those companies who adopt our strategies.
In a nutshell we need to restore the trust between the mining companies and investors and we believe our strategies are one way to do just that. The miners have to be held to account.
TGR: There’s precedence for this. After gold reached its all-time high in early 1981, a number of companies started forward-selling their gold so they could better control their costs. Shareholders ultimately were the benefactors of that. They’ve done it once before, so it can be done again.
DB: In the 1980s and 1990s, the gold price was falling and the dollar was rising. It made every sense that once you dug your gold out of the ground, you converted it straight into dollars. It was such a convincing trade that people were selling gold they had yet to mine to convert into dollars, and that was the advent of forward selling. It took about 10 years to get it entrenched that the gold price was falling, and the dollar was rising. We then took 10 years, from 1990 to 2000, for everyone to get on the trade and forward sell. At the bottom of the market, there were well over 3,300 tons gold forward sold.
TGR: Practically all production.
DB: It was over one year’s annual production. Now the situation has reversed; the gold price is rising and the dollar is depreciating, and this should continue as long as the central banks carry on printing more and more money. Over the last 10 years, gold has been rising at around 15% per annum, so we are now just getting the hang of this trend. We have to become gold centric; the miners need to be forward buying gold (holding gold on the balance sheet) instead of forward selling gold. The dollar period was the 1980s to the 2000s; now we’re in a gold period.
TGR: Some countries are doing that. China has dramatically increased its gold imports from Hong Kong, putting it ahead of India as the world’s largest gold consumer.
DB: Many central banks are printing money. They’re trying to get their currencies cheaper than others so they can capture market share and generate growth, the so-called currency wars, but they all know that if everyone is printing money, they cannot all devalue against each other. They have to devalue against something, and gold is a currency that can’t be printed. So these central banks are starting to see the writing on the wall, and they’re buying physical gold, converting dollars and buying gold. That’s a positive. That’s going to carry on. But nothing goes up in a straight line. At the moment, we’re going through this consolidation, which has felt as if it’s lasted forever. It’s probably been about two years. Hopefully, we’re coming to an end of it.
TGR: In early February, a story in Canada’s Globe and Mail suggested that IAMGOLD Corp. (IMG:TSX; IAG:NYSE) could soon be the subject of a takeover bid. Do you believe there’s any substance to that idea?
DB: I’m not convinced. IAMGOLD has purchased a project in Canada that is very low grade with low returns. Maybe that’s the opportunity, but not in our book. Baker Steel separates the wheat from the chaff by looking at the quality of the projects. We analyze returns and how the company is going to finance the development—will it use debt or equity? In a high inflation environment, debt would be the logical choice, but we’re very reluctant to go down the bank route as this normally entails forward selling part of future production. Recently an Australian company raised $50M of debt and had to forward sell over $300M worth of gold to do that. That didn’t seem logical to us.
In the last 10–12 years, we’ve seen cost inflation of 12–15% and the gold price running up at a similar rate. If you forward sell $300M of gold, and gold continues to rise at the same pace it has over the past 10 years, then in a couple of years, the cost of this debt is going to be greater than 100%, simply in the lost opportunity cost of not being able to sell gold at market. A disproportionate share of our projected returns will either end up in money heaven through the lost opportunity of forward selling or to the bank through fees—again shareholders are short changed. Investors have cottoned on to this and are deserting the developers in droves.
TGR: Baker Steel funds have underperformed in lockstep with gold equities. What approaches are you employing to offset the recent dismal performance in gold equities?
DB: The market is very cheap. A lot of resource companies are trading on single-digit multiples, whereas the market as a whole is trading at 15–20 times multiples. Gold equities used to trade at a premium to the general market but are now trading at a significant discount. That’s the opportunity. We’re looking for well-managed companies and companies that are diversified and well capitalized.
Our focus is the mid-cap, 400,000–600,000 oz (400–600 Koz) gold producers that have two or three operations, with potentially a growth asset as well. We’ve built up a nice portfolio of these. Unfortunately they still haven’t caught traction in the market; you can buy these companies for around 6–8 times price-earnings ratio. They’re very cheap.
TGR: Do you visit the companies?
DB: Yes, last year I went to Chile, Sudan and the Democratic Republic of the Congo (DRC) and others in our investment team travelled to Papua New Guinea, Africa, Indonesia and other sites. We do a lot of due diligence.
TGR: You have investments in what would be classified as safer jurisdictions, like Canada, Mexico and Australia, but you also have investments in places with greater risk, like South Africa, Eritrea and Zimbabwe. Would it be fair to say that when Baker Steel is evaluating a potential asset, it doesn’t put as much emphasis on jurisdiction risk as it does on potential return?
DB: We risk adjust all of our investments; we are interested in risk-adjusted returns. For example, we would place a higher discount rate on a mine in Zimbabwe. Zimbabwe producers have been completely de-rated by the market, to the point it probably couldn’t really get much worse. In an effort to survive, many of the Zimbabwean companies have had to modify the way they do business in an effort to make their model work. They’re starting to produce gold at relatively good costs. There are still some political issues, but you can buy these assets for 10 cents on the dollar. We’re putting in just enough money that if we get it right, investors will be glad. And if it doesn’t go right, it’s not going to be so big a deal for us.
South Africa has been a challenge, but Harmony Gold Mining Co. (HMY:NYSE; HAR:JSE), which has been totally de-rated, came out with a result this week that shows that the company is actually performing quite well. We see great value in a number of South African companies.
AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) produces about 42% of its gold in South Africa yet has been sold down as if all its ounces were in that country. And even those South Africa ounces are generating very good cash flow. Those are the opportunities that we’re looking at. AngloGold is trading at a projected seven times earnings; its yield could be higher but it is currently in a capital intensive phase.
Endeavour Mining Corp. (EDV:TSX; EVR:ASX) is one of our bigger holdings; the company is a diversified producer that recently acquired Avion Gold Corp. It’s a low-cost producer that has a reasonable balance sheet and looks interesting.
TGR: Most of Avion’s producing assets are in Mali.
DB: There is obviously a risk, but we believe this is somewhat discounted by the market. Take Resolute Mining Ltd. (RSG:ASX), for example; the company operates the Syama gold mine in Mali and gold mines in Australia and has a market capitalization of $840M. It has $100M worth of gold/cash and investments on its balance sheet and is generating probably $60–70M/quarter—now that is cheap. There’s been no production lost at Syama but the market has sold it down as if the mine faces major disruption. Now, admittedly, the costs have had to increase because Resolute has had to add to security, but the stock does look very cheap.
Also, we manage a diversified portfolio. It’s not as if we’re putting everything into these names. We have around 4% in both Endeavour and Resolute. We can live with the individual company-specific risk, particularly for the price. And while we are waiting for the market to recognize the opportunity, Resolute is paying us a good dividend yield as well, and it is holding some of its profits in gold, which, as we have discussed, matches our strategic objectives.
We have a position in Ivanplats Ltd. (IVP:TSX) across some of our funds. Founder Robert Friedland used to be in Ivanhoe Mines Ltd. Ivanplats has three world-class assets; it just increased its resources at its Platreef project, an ore-body that is around 14 meters in width, compared to 40–150 centimeters for the typical Merensky reef mine, both with similar grades. Ivanplats is going to be a game changer in this industry.
TGR: Are you bullish on platinum?
DB: You have to be positive on platinum, given the problems in South Africa and the challenges that the platinum producers have there. Anglo American Platinum Ltd. (AMS:JSE) has recently cut production. I don’t think there can be a lot of downside in the platinum price. If there’s not a lot of downside, presumably there’s some good upside.
TGR: Do you have any holdings in the DRC?
DB: We have a very small holding in Banro Corporation (BAA:TSX; BAA:NYSE).
TGR: Is its Namoya project on track to begin production later this year?
DB: That is correct but we understand that the company will need $35–45M to complete this. With Banro’s Twangiza project, we’re getting there, but we’re not there yet.
TGR: It produced about 20 Koz gold in Q4/12.
DB: Twangiza needs to be doing much more that, at least 35–40 Koz/quarter and we need to see some consistency of production. Having said this, we did note that the increase in the resources and the oxide is a positive for that company.
TGR: Let’s move to the South Pacific and New Zealand.
DB: Evolution Mining Ltd. (EVN:ASX), OceanaGold Corp. (OGC:TSX; OGC:ASX), Kingsgate Consolidated Ltd. (KCN:ASX), Silver Lake Resources Ltd. (SLR:ASX), Archipelago Resources Plc (AR:LSE) and St. Barbara Ltd. (SBM:ASX) are our key holdings in this region. They all have decent balance sheets and are generating cash. You can buy Evolution under single-digit multiples. It seems incredible.
TGR: What sort of growth should investors expect from Archipelago in 2013?
DB: Archipelago is producing around 120–140 Koz with potential going up to 165 Koz and even maybe 200 Koz per annum, all self funded. It is getting some good results from recent drilling and this will allow the company to upgrade its plant and increase production and profits. Archipelago is generating good cash at the moment, although I would like to see that reported and held in ounces. The challenge for Archipelago is whether the major shareholder allows it to grow through acquisition.
TGR: What’s on your list in North America?
DB: Lake Shore Gold Corp. (LSG:TSX) and AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE), which owns the Young-Davidson mine. Lake Shore reduced its 2013 capital expenditure budget by about $18M, but we need to start seeing some returns. When we see Lake Shore this month at the BMO Conference in Miami, this is what we’re going to be discussing. It sold a royalty to Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), so maybe the company should consider a royalty to shareholders in return for all our patience. AuRico sold off some assets to focus on Young-Davidson, so now it has a better balance sheet. It is looking at potentially paying a high yield. We’d like to see that as a gold royalty as opposed to a cash yield, but that’s a discussion we have to have with the company.
TGR: What about your silver holdings in North America? You have a position in First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE).
DB: We used to, we made a good return on that and moved on. Our main silver holding is Polar Silver (privately held), this company owns a share of a very high-grade silver project in Russia, which we’re valuing at about $0.25/oz silver. We think we can bring that to market for at least $1/oz, if not more.
TGR: Thank you for your insights.
David Baker is a managing partner at Baker Steel and heads the company’s Sydney, Australia, office. Prior to founding Baker Steel in 2001, Baker was part of the award-winning Merrill Lynch Investment Management natural resources team, successfully managing the Mercury Gold Metal Open Fund, the largest precious metals fund in Japan, from its launch in 1995 until his departure in 2001. Prior to joining MLIM in 1992, Baker was a gold and mining analyst for James Capel Stockbrokers in London from 1988 and held a similar role at Capel Court Powell in Sydney from 1986 to 1988. Baker started his career in 1981 as a metallurgist at CRA Broken Hill, Australia. He holds a degree in mineral processing and a master’s in mineral production management from Imperial College, London.
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Low market valuations for junior mining companies have Michael Ballanger, director of wealth management at Richardson GMP, feeling like a kid in a candy store, and equities satisfy his sweet tooth more than the metal right now. Ballanger has had enough years in the business to recognize the advent of gold fever. In this Gold Report interview, Ballanger discusses his personal views and discusses how he looks for “well-incubated” companies that meet budget and timelines and raise funds without diluting shareholder value. He also shares why he sees junior miners as higher reward and lower risk than gold itself.
: Bitterroot Resources Ltd. : Comstock Metals Ltd. : Kaminak Gold Corp. : Kinross Gold Corp. : Tinka Resources Ltd.
The Gold Report: Michael, can you tell us why you believe we are at the psychological and valuation bottom of the trough in the junior mining sector?
Michael Ballanger: Using the TSX Venture Exchange (TSX.V) as a proxy for the junior mining sector, the TSX.V between 2003 and 2007 traded in a range of approximately 1.5 to 3.3 times the price of gold. In the 2008 crash, it went down to 0.8 times the price of gold. Going back 15, 20, 30, 40 years, the TSX.V had traded on a 1:1 correlation with either the oil price or the gold price. Since the 2008 crash, there has been an immense aversion to risk in the junior mining space. At the end of 2012, trading was around 0.71 times the gold price. We have never seen valuations like this in the junior mining sector.
“I am far more bullish on the senior producers and on the junior and intermediate developer/producers and explorers than I am on the physical gold price.”
At the bottom of any bear market, sellers become exhausted so only survivors are left. If you accept that premise, it becomes important to see who has survived or who has the management capabilities, the financing and high-caliber projects to advance. Those are companies that will benefit from what I think will be a normalization of the Venture Exchange’s ratio to the actual gold price. I think a realistic level would be 1.5–2.0 times the gold price.
Unlike most experts, I am far more bullish on the senior producers and on the junior and intermediate developer/producers and explorers than I am on the physical gold price. I think there is a lower-risk, higher-reward potential in the shares than in the metal right now.
TGR: Given the market performance in the junior precious metals sector and in the junior mining sector as a whole over the last couple of years, do you feel like the characters in the film “Groundhog Day,” reliving the same events over and over?
MB: What is peculiar about this cycle is that we have not experienced the “mania phase” that typically happens at the end of a bull market. At the bottom in 2009, again in 2011 and all through 2012, despite near-record gold prices and very high energy prices, it felt as if we were in the post-Bre-X Minerals Ltd. period.
You need to remember that the symbol for crisis in the Chinese language is made up of two symbols: the first one is danger and the second is opportunity. I see tremendous opportunity, but not without challenges.
In my work, I have to be very good at identifying management teams and projects that will survive and will excel in most environments. With market valuations so low, I feel like a little child in a candy store with $10 in my pocket. There is so much to choose from.
Due diligence takes longer, yes, but when I find something, I can hand my clients an awfully big rate of return if they are prepared to take the risks associated with the sector.
TGR: We hear a lot about management teams at junior mining companies. You have said that you prefer management teams that incubate companies to preserve shareholder value. Can you expand on that concept?
MB: The perfect way to incubate a junior mining company requires, first, a private company with a very small group of shareholders who are looking three to five years down the line. The caliber of the shareholder base is paramount. The ideal shareholder is one who has been successful in his or her own business and knows how long it takes to start up, develop and eventually reap the rewards of owning a start-up. Having shareholders with a three-to-five-year timeframe eliminates frequent turnover in the shares, which makes it a lot easier for the management to raise capital for development at progressively higher prices.
“A well-incubated company keeps its financing strategic.”
The second most important thing relates to raising money. If a company needs $3 million (M) for a project, it should not try to raise $10M. If a company raises only what it needs, it avoids diluting shareholders’ equity. Do you remember the old expression “Friend or foe, take the dough”? In the last few years, junior mining companies have taken the dough, which is always associated with larger percentage fees charged by the investment industry, and companies have been trashed by the market. They have diluted shareholder equity.
A well-incubated company keeps its financing strategic, on a needs basis and at progressively higher levels. This minimizes dilution and enhances shareholder value. These companies can go to their shareholders first for financing. If they wrote a check at $0.10/share, they will write another check at $0.35 and another at $0.75 because they understand the business model.
TGR: How does an average retail investor find out who the shareholders are in a junior mining company?
MB: I wish I had a good answer to that. You might start by searching the company’s press releases on its website or through SEDAR. You can cross-reference what the company financed at and measure that against how much it is spending on a month-to-month basis. If the company has executed its business plan and hit its benchmarks of estimated ounces, was that done on time and on budget?
That information will infer the caliber of the shareholder base and the kind of guidance the company is getting from its fiscal adviser. It will tell you how committed management is to preserving and enhancing shareholder value.
TGR: Can you give us a couple of examples of companies that have succeeded with that incubation strategy?
MB: Tinka Resources Ltd. (TK:TSX.V; TLD:FSE; TKRFF:OTCPK) is the best example. Its Colquipucro property in Peru is a great asset. I have been recommending Tinka to Gold Report readers since 2009.
In 2010, we raised a little over $1M and asked management to get the permits in place to develop the silver resource. Just before the meltdown in mid-2011, after the shares had hit a high of $0.75, there was a correction. We were set to do a $0.50/share financing to raise $5M. We scaled that back to $0.35/share to raise $2.25M. This minimized the dilution during a difficult period in the market.
In December 2012, Tinka moved its Zone 1 silver resource from 20.3 million ounces (Moz) to 32.7 Moz, under budget and in a very acceptable timeframe. The share price responded; the market went to $0.75–$0.80/share. The $2.25M raised was within the budget. If the company moves forward over the next 6–12 months to a level representative of fair value relative to its proven resource, it can do a much bigger financing at fair value. This gives the early shareholders a significant lift and, most important, a reason to hold the shares.
Another company that did not get hit in the downturn due to the caliber of its shareholder base is Kaminak Gold Corp. (KAM:TSX.V) in the Yukon, led by Rob Carpenter. It started off in 2009 at around $0.15/share. In 2011, when everybody thought the Yukon would become the next Northwest Territories diamond rush, it moved above $4.50/share. When the European meltdown hit, Kaminak executed beautifully. It minimized dilution and did not issue overly aggressive amounts of paper. The company still has less than 100M shares outstanding and 1.9 Moz or more.
Kaminak’s shareholder base is primarily institutional. The people who run these portfolios are very capable and very sharp, but their hands are tied. If the retail public decides to redeem the fund, the portfolio manager has no choice but to liquidate to meet the redemptions. When they sold Kaminak, it was not because they wanted to, but because they were forced to. In the case of Tinka, no one was forced to sell through redemptions.
Both companies have executed beautifully. Both represent great shareholder value at current levels and have lots of blue-sky potential. Tinka closed at an all-time, 52-week high in 2012, while Kaminak closed at about 35% of its all-time high.
TGR: Tinka’s share price has been trending higher since August. What is its next step? When can we expect a maiden resource estimate?
MB: Tinka has an Inferred, NI-43-101-compliant resource of 32.7 Moz. It has a permit and recently announced a villager agreement.
Tinka’s management team in Lima has a done a superb job. The team has 30-odd years of experience in the mining industry in Peru. They negotiated both the government permits to drill the Zone 1 silver project and the Ayawilca base metal massive sulphide discovery. They also navigated relations with the local communities and what is called the “social contract” in Peru.
It took six months longer than expected to negotiate the villager agreement with the Pillao village, which is associated with the silver resource. It took longer than expected in Yanacocha, where Ayawilca is, as well. But if your shareholder base understands how politics and business co-mingle in Peru, they have the patience to let management do it right. Tinka’s community relations staff used education and fairness to turn the villagers into advocates who are now running around wearing Tinka T-shirts and baseball caps.
TGR: What can you tell us about Tinka’s two projects?
MB: Tinka’s safety valve is its silver resource, Zone 1, which is being expanded rapidly. I expect the infill drilling has the potential to substantially move up that resource’s 32.7 Moz; a resource of about 35–40 Moz is necessary to get on the radar screen and I am confident it will achieve that level in 2013.
The second thing that sets this resource apart is that it is all on the surface; it is in an oxide zone, amenable to leaching, and you get 97% recovery rates after 72 hours using bottle-roll technology. The feasibility of putting something like this into production with a very low capital expenditure is extremely high. This offers a level of security for Tinka’s shareholders—you can get that valuation metric with very little risk.
Ayawilca is a new, massive zinc sulphide discovery made in late 2011. It is my passion. I am a base metal person and massive sulphides are the Holy Grail for me. When Tinka started hitting intercepts of massive sulphides containing economic-grade zinc, the hair on the back of my neck started turning up; this thing has structure. The geophysics say that Ayawilca has elephant capabilities. It is 70km down the road from Cerro de Pasco, one of the biggest zinc mines in Peru, owned by Volcan Compañia Minera SAA (LIN:PE:VOLCAAC1). The number-one marker mineral at Cerro de Pasco is rhodochrosite, and Tinka’s discovery holes contain a lot of rhodochrosite. I am really excited about Tinka and its current share price objective has not factored in Ayawilca.
TGR: Kaminak put out a resource estimate in December of roughly 3.2 Moz Inferred at its Coffee project in the Yukon. What did you think of those numbers?
MB: Rob Carpenter has delivered more than people ever expected. I am bullish on the Yukon. I expect it will be the next major Canadian gold mining camp, not unlike Timmins or Kirkland Lake. And I think Kaminak has above-average potential for people willing to take the risk and have the patience to understand that these businesses take time to develop.
TGR: A lot of investors in this sector are employing strategies that worked in previous cycles in the junior mining sector, but seem ill-suited to today’s market. Why is that?
MB: It dovetails with what we discussed about how you do your due diligence.
In 2000, coming off the Bre-X Minerals Ltd. disaster, junior mining companies could not raise money for any project regardless of its potential. It was easy to make money in the early part of that cycle because valuations were so depressed.
From February 2011 to the end of 2012, we were in what I call a “valuation compression cycle.” Normally, you expect increased gold or silver prices to attract new investors when a company announces a discovery, and that demand will take a share price higher. In a compression period that does not happen. In a compression cycle, you have to make sure that your entry point is at a level that has already wrung out all the early or mid-range investors who bought it at the wrong price.
If you or your adviser has been investing only since 1991, 1998 or 2001, you may think that a company that has been in the range of $0.50 to $2/share, and that if you buy it at $1/share, the worst it can do is go back to $0.50/share. That is not the case; it can go back to zero.
There is an expression in this business, “there’s no fever like gold fever.” No one younger than 35 or 40 has any idea what a “mania phase” is like. And I maintain that we are heading into a mania phase for the junior mining sector.
I am not sitting here with a starter pistol, ready to tell you exactly when the mania will start, but there has never been a time when the gold price has advanced as it has over the last 12 years where the entire mining sector—junior, intermediate and senior—did not move to bubble valuations.
We may see gold at $10,000/ounce (oz) or $5,000/oz, but the lower-risk entry point now is into the abject, stark psychological depression that is the mining shares. That is the lower-risk transaction right now.
TGR: What are some other names you are high on now?
MB: In the Yukon I like Comstock Metals Ltd. (CSL:TSX.V). I have spoken to CEO Rasool Mohammad a number of times; I like his passion and commitment. Kinross Gold Corp.’s (K:TSX; KGC:NYSE) Golden Saddle project is across the Yukon River from Comstock, and Kinross needs to find more resource ounces to rationalize its infrastructure. If Comstock puts any ounces together in its 2013 campaign, it could be absorbed like a minnow in front of a shark because Kinross needs those ounces.
Bitterroot Resources Ltd. (BTT:TSX.V) has a nickel-copper, platinum group metals prospect in northern Michigan tied to Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCP). Bitterroot trades at $0.11-0.12/share. I am just in the due diligence process right now, but it certainly has my attention.
TGR: You follow the Chicago Board Options Exchange Market Volatility Index (VIX) and you track volatility. Should retail investors get used to more volatility as 2013 unfolds?
MB: They certainly should. Howard Marks wrote an article commenting on the high level of complacency in the market. People are buying into the equity markets because they see the Federal Reserve or the Treasury defending equity levels through interest rate policy or open market operations. That is why the VIX has come down so far.
I like seeing the VIX trade at a reasonable level—20 or 22—because it says to me that there is some fear in the market. A VIX under 15 tells me there is too much complacency. I would use VIX to hedge portfolio positions looking six to nine months out, particularly now that it is trading at a multiyear historical low, under 14.
TGR: What wisdom can you share with our readers from your 35 years in the business?
MB: A phrase I learned at the Wharton School has always served me well: “Never underestimate the replacement power of equities within an inflationary spiral.”
All the central banks on the planet are doing their best to re-inflate their way out of their debt problems. When they all are doing their best to debase their currency, it is no different than a company trading on an exchange excessively diluting its shareholder capital. In the equity market, that is a negative for price. In the fiat currency world, currency dilution is punitive to the purchasing power, to the value of that currency. This makes currency the great short sale for 2013.
I recommend that people short sell or sell cash. The inverse of that is to buy assets. The integrity of the purchasing power of cash and cash equivalents is the greatest danger right now. People sitting on a pile of cash for retirement could wake up to a situation like Weimar Germany in 1921–22, instead of paying $1.20 for a loaf of bread, it suddenly costs $5 or $6. Inflation is like toothpaste, once it is out of the tube, it is impossible to get it back in.
Investors should be buying things, investing, taking their savings and making sure that they are selling or shorting cash. That includes owning companies that produce gold, silver, resources, farmland, anything that kicks out a rate of return on commodities and goods that people require.
In nominal terms, that means you could see a much higher equity market 12–18 months down the line without feeling it in the economy, because it is the currency that will have gone down, not the inherent value in the businesses or the shares.
TGR: Michael, thank you for your time and your insights.
Originally trained during the inflationary 1970s, Michael Ballanger, director of wealth management at Richardson GMP, is a graduate of Saint Louis University where he earned a Bachelor of Science in finance and a Bachelor of Art in marketing before completing post-graduate work at the Wharton School of the University of Pennsylvania. With more than 30 years of experience as a junior mining and exploration specialist, as well as a solid background in corporate finance, Ballanger’s adherence to the concept of “Hard Assets” allows him to focus the practice on selecting opportunities in the global resource sector with emphasis on the precious metals exploration and development sector. Ballanger takes great pleasure in visiting mineral properties around the globe in the never-ending hunt for early-stage opportunities.
Gold stocks, especially juniors, have been undervalued for longer than most investors thought possible. The result is what David Skarica, founder of Addicted to Profits, calls a “maximum pessimism trade.” In this interview with The Gold Report, Skarica summarizes his analytical tools and provides clear examples of companies that meet his criteria as “screaming buys.” Gold junior investors might feel as if they live in the movie “Groundhog Day,” but the undervaluation cycle will eventually be broken. Is spring just around the corner for the junior gold miners?
The Gold Report: In your recent newsletter, you wrote about “screaming buys” in gold stocks. Over the past couple of years, many investors have thought that gold stocks have been too cheap to pass up—and have been burned. Is this a new position for you or has your view changed?
David Skarica: Unfortunately for gold investors, historic valuations of gold stocks linked to the price of gold have remained undervalued for too long. If you look at valuation metrics of large-cap gold stocks compared to the price of gold, many of these stocks are historically at very cheap valuations and that has persisted for some time. The AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI), is trading at roughly $420–430. It broke $400 to the upside for the first time back in 2006 when gold was in the $600–700 range. That tells us where we are. In the past year, gold stocks have been undervalued by anywhere from 20–50% based on historical valuation methods. Despite the bargain prices, a rally has failed to materialize.
“When you’re trading the juniors, you need to be very disciplined.”
I have refined my message to focus more heavily on junior mining stocks because they have underperformed compared to the large caps. Juniors will fall harder and faster in a weak market even though there is value in the stocks. I, like everyone else, can learn my lessons from the market. The one thing I’ve really learned the last couple of years is when you’re trading the juniors, you need to be very disciplined. The reason that I’m going so heavily toward juniors now is based on recent history. If you look at the rebound after the last big down market of 2008–2009, there were many juniors that had quality assets that were five-, ten- or twentybaggers. There will be companies that come through this market that will have similar performances.
TGR: Do you have a particular phase that you like—exploration, development or near-term producers? Or are there other factors?
DS: There are a lot of dynamics. If I find an exploration company that’s in the early stages yet has good management and lots of cash in the bank, I will definitely consider it.
I like the stories that have a well-defined resource or can build upon a resource. Near-term production stories often have huge upside potential. They still have execution and financial risk, but near-term producers are the ones that really can take off when the market finally turns. Near-term cash flow coming down the pipeline and the capital investment behind them make them attractive to the market. Such stories can get punished in a market downturn because there’s no news flow. They’re quietly building the mill, building the mine and, finally, when the production starts, it’s. . .wow.
An example that follows this pattern is Avion Gold Corp., a gold producer in Mali. During the financial crisis, it went to $0.05/share. We put it in the newsletter at $0.06/share and the stock went as high as $2/share. Avion was taken out by Endeavour Mining Corp. (EDV:TSX; EVR:ASX) for $0.88/share. The catalyst was production and cash flow.
TGR: Was Avion a near-term producer when you recommended it?
DS: It was on the cusp of starting production when I first discussed it. Buying near-term producers isn’t quite that easy; you still need to look at the fundamentals of the project. A different type of example is Baja Mining Corp. (BAJ:TSX; BAJFF:OTCQX), which is over budget, over budget and over budget. The company response was to dilute, dilute and dilute. As an investor, that is probably not something that you want to get involved with. My strategy is to look for projects that are relatively within budget. A lot of mine building goes somewhat over budget because capital expenditures and basic inputs have increased in price. That is even true in the emerging world, where cheaper labor is not as cheap as it was 20 years ago. Look for projects with costs under control and no delays.
“Near-term production stories often have huge upside potential.”
I also look for companies that are takeover targets. An example is one that I own now, Castillian Resources Corp. (CT:TSX.V). Castillian has the same head geologist as Desert Sun Mining & Gems (DEZ:NYSE.MKT) and Central Sun Mining Inc. (CSM:TSX; SMC:NYSE.A), both of which were taken over by majors. To be clear, we’re talking about a $0.03/share stock with a minimal market cap. Companies of that size could have liquidity and cash concerns, but Castillian has built up a small resource of 0.5 million ounces (Moz). It is a situation where it could grow to well over 1 Moz and build a nice little project. If that works out, it has real upside. (Editor’s note: Castillian currently has 590 Koz Indicated and 548 Koz Inferred.)
Sometimes it is hard to understand the reason why a stock is priced the way it is. Some stocks go to $0.02/share and become $0.02 stocks that won’t rebound in the next cycle higher. But not all stocks are that way—some stocks are simply oversold. As John Templeton used to say, it’s “maximum pessimism.” In some of those cases of maximum pessimism, the stocks are going to turn around and be ten-, twenty- or thirtybaggers. We are talking mining stocks for this interview, but the same market psychology applies to many sectors right now, from solar to coal to stocks in many countries in Europe.
TGR: Because you were describing Castillian, what conditions are needed to improve the share price?
DS: Castillian has used flow-through to finance. Some of that money can be used to drill. There are three factors that are needed to help out its share price:
- Improved market conditions. A lot of financial issues can be solved just if the juniors begin to rally. Looking back to 2008–2009, there was a real V bottom in many juniors because the selling dissipated and most investors left. That set the stage for a turnaround. Overall market conditions are critical for individual companies to succeed.
- Resource increase. If there is new drilling success, it will be reflected in the share price.
- Secure financing. In the current market, it doesn’t make sense to finance at $0.03/share or $0.05/share, because it’s too dilutive. Castillian is under the Forbes & Manhattan umbrella and may be able to tap into corporate resources that other juniors cannot.
The three conditions are related, especially with improved market conditions that could create a snowball effect. With improved market conditions, then the stock goes to $0.10/share. Financing becomes easier and the company can drill. And that creates a positive feedback loop. A lot of times, you just have to wait for the market to turn around to get things moving.
TGR: When evaluating juniors, there are a lot of things that you could look at, but what are the three most important things that you must look at?
DS: I have five, and I call them the Five P’s. And I am paraphrasing from Doug Casey. I first saw him write about these back in the 1990s when I got involved in this industry. The five are:
- People. That is obvious because people do everything. You need solid management, people with a history of getting quality assets, making things work and hiring the right specialists.
- Property. You need good geological properties. You don’t want moose pasture in the middle of nowhere; you need something that can become viable and economic.
- Politics. You want to be in a stable mining country. It could be somewhere in Canada, Nevada or Mexico, which is not a stable country in other ways but is a very solid mining jurisdiction. A lot of countries in South America, especially Chile, have become solid mining jurisdictions where maybe some places in the middle of Africa haven’t.
- Phinancing. You need the ability to raise money. It could even be directors with deep pockets to do a personal loan during a tough time.
- Promotion. Although it sometimes gets a bad name, you need the ability to tell the story. Consider a tree that falls in the forest. If nobody tells the story, then you’re done.
TGR: Your analysis includes considering the Five P’s and looking for “maximum pessimism.” Do you have other companies that fit that model?
DS: Western Pacific Resources Corp. (WRP:TSX.V) is one. It is an exploration company with a mine from Pegasus Gold Inc. in Idaho. The company has solid management. The property has excellent infrastructure and Idaho is a politically safe location. In terms of financing, Western Pacific has $2 million (M) in the bank. When it hit its low, $0.10–$0.11/share, it had a $3M market cap with $2M in the bank. You’re getting everything else in the company thrown in for free. Even after it rebounded to $0.20/share, the market cap was still only $6M. I would call that stock an exploration company even though its flagship property is a past producer. Like many other stocks I watch, it will rise with the overall market. A typical recent pricing pattern for junior stocks would be to go from $0.80/share to $0.20/share in this weak overall market. But when this market turns around, many of those stocks will rise back into the $0.50–0.60/share range. That would be an example of the maximum pessimism trade.
“I believe the breakout will be huge when it happens.”
A similar pattern might fit to another stock I like, which is also under the Forbes & Manhattan group. That one is an iron ore project called Black Iron Inc. (BKI:TSX.V), which is located in the Ukraine. This project will be a massive producer starting in Q4/15. However, at the moment, it is in the “quiet stage” prior to production as the mine and mill are being built. The stock has fallen with the rest of the market. At this point, Black Iron is a $45M market cap, with a potential 16-to-20-year mine life. The infrastructure and the properties are fantastic.
TGR: You like gold, but iron ore is a very different commodity. Does it concern you to pursue a commodity like iron ore that is linked to a healthy economy and financial system? In some ways, isn’t the iron trade the opposite of the gold trade?
DS: One of my best-performing deals was a company called Consolidated Thompson Iron Mines Ltd. (CLM:TSX), which I bought between $1 and $2/share. I sold around $10/share. It eventually got taken over for roughly $15/share. That was an iron ore deal. People tend to forget that something like Diamond Fields wasn’t diamonds; it was nickel.
You have to get back to your belief system in this situation. I like to consider the macro trends, the kind of the things that Jim Rogers talks about and I’ve talked about in my book, “The Great Super Cycle,” where we are in an inflationary stage. The last year or two we haven’t seen a huge move up in commodities, which are digesting huge gains from the last 10 years and especially from the 2008 lows through 2011. It’s perfectly normal to see one-, two- or three-year consolidations on these macro moves higher. I believe we’re in a re-inflation cycle. Things we need, like energy, are going to go up in price. And things we want but don’t need, like flat-screen TVs and cell phones, are going to go down in price. Japan is now joining the money-printing fray, and that should put more pressure for higher commodity prices. It’s the old monetarist arguments by Milton Friedman—too much money chasing too few goods is inflationary. You’re going to continue to see all commodities increase because of that.
I’m a little more bullish on parts of the global economy in the short to intermediate term. Longer term, I feel as if the U.S. is going to have a debt crisis, similar to what happened in the European countries. Most of the economic indicators in Europe, at least in the short term, are positive. Probably in H1/13 we should see a short- to intermediate-term bottom in the Italian, Spanish, Portuguese and Greek economies. Markets may be already discounting that bottom. Interestingly, no one talks about the potential for those markets to recover. From a technical point of view, those markets are looking attractive as they build a base.
TGR: That’s your maximum pessimism trade applied to a set of countries?
DS: The PIGS (Portugal, Italy, Greece and Spain) were the maximum pessimism trade for last year, and they have stabilized. Recent indicators out of China show that China is beginning to stabilize from its slowdown. Similar things appear to be happening in India. My thesis is that the rebound in Europe and China will drag U.S. markets higher.
That same macro analysis can be applied to make a bullish case for precious metals stocks. Recently, the chart of the HUI is not similar to the Standard & Poor’s 500. The HUI is more similar to Italy, Spain or the emerging Asian markets. The gold stocks are behaving as risk-on trades, as have these markets. If the emerging markets are showing signs of stabilizing and climbing, so will the gold and precious metals stocks.
Another index to watch because of positive macros is the S&P/TSX Venture Composite Index (CDNX), which is building a great base. It has a range from $1,120 on the downside to $1,350 on the upside. It’s right in the middle of that range now. The chart appears to be an example of a classic bottoming base. The big money printing that we saw in the U.S. after the 2008–2009 financial crisis is detrimental in the long term. But in the short term, it does boost the economy and I think we are seeing that in Europe. That will stabilize the rest of the world in the short term. Long term, it will have inflationary consequences.
I am a bit of a contrarian on Europe—I’m not as bearish as many. The simple reason is that the European countries are doing some excellent things to modernize the regional economies. In many parts of Europe the economies are 20 years behind Germany. Germany modernized after the fall of the Berlin Wall and went into a production-based, efficiency-based economy. It may not apply to all areas, but the Germans are opposing free market restrictions and want the Spanish and the Italians to do the same. Italy has a large industrial base, so it could probably pull it off. Spain is a little more of an unknown. With austerity, the Europeans are addressing some of the problems of bloated government. There is short-term pain for long-term gain, and that has been something that Americans have not been willing to address. We keep hearing this thing about the fiscal cliff. The fiscal cliff wasn’t a one-day event on Jan. 1, 2013; it’s a permanent condition. At some point, we have to solve these trillion dollar deficits.
Coming back to gold and precious metals, there is flight away from risk assets into bonds and the U.S. dollar. If there is real growth in Europe, the next crisis could be a run on the dollar. All these crises have seen gold stocks fall with the market, but what we could see in the next crisis is the gold stocks rise while the S&P flounders. Again, that’s two to three years off. The next couple of years are the transition period. The U.S. has really led in the last couple of years during this European crisis and Europe will now probably outperform; the dollar will weaken, and that’s another positive factor for gold.
TGR: Are there any other particular stocks that you watch that fit the maximum pessimism trade?
DS: I think that what has happened in Newmont Mining Corp. (NEM:NYSE) and Barrick Gold Corp. (ABX:TSX; ABX:NYSE) is interesting. It’s similar to what happened in Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) in late 2011 when it essentially threw the baby out with the bath water. Agnico had bad earnings; it downgraded the resource on one of its mines and wrote off a bunch of assets. It downgraded future production, future profits, etc. Agnico has performed well since then. It bottomed at roughly $30/share and rallied to the mid- to high $50s, and it’s about $50/share right now. If you look at Barrick and Newmont’s Q4/12 earnings, they did the same thing—wrote off assets, wrote off resources, wrote off future profits. Both of those companies had minor warnings last year, but what they decided to do is throw everything out. Now the expectations are very low. Both Newmont and Barrick trade at ridiculously low valuations. Barrick has a forward price/earnings ratio of 6 or 7, which for the whole mining sector is unheard of. Newmont has a dividend linked to the price of gold. There are many reasons to like each of these companies. Now that expectations are so artificially low, which the companies themselves created, there is a solid base for stock performance in the future.
Another producer I like is Eldorado Gold Corp. (ELD:TSX; EGO:NYSE). Eldorado is in a similar position to where Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) was a few years ago when Yamana was expanding rapidly and issued stock to fund that expansion and mine building. Eventually, the production and profit show up in the bottom line. As a result of that well-timed expansion, Yamana has held up much better than the rest of the mining sector. That is where Eldorado is right now. From a valuation perspective, those are my three top picks of the senior gold producers.
TGR: In The Gold Report interview in February 2011, when gold was at $1,355/ounce (oz), you said, “I think that after the next rally we’re going to see a significant pullback in gold probably in the 2012–2013 period, but that will just be a buying opportunity.” So two years ago, it looks as if you pretty much nailed it. Do you have an update to that forecast or the next forecast to layer on top of that?
DS: From a technical perspective, in mid-2011, we had a big spike in gold prices over $1,900/oz. We are now in the second longest consolidation of the gold bull market. The only one that was longer was the 2004–2005 consolidation, and that was longer by only a couple of months. Technically, a spike high followed by a sideways trading range that builds the base between $1,530/oz and $1,650/oz is a positive development. As the saying goes, “The longer the base, the more the space.” It could also be called a “coiled spring.” The longer we trade sideways, the bigger the break out should be. I don’t anticipate new lows. It appears that we are nearing the end of the base and, though I don’t want to sound like an out and out goldbug, I believe the breakout will be huge when it happens.
One driver of the breakout, which no one is really talking about, is what’s going on in Japan. Japan has now decided to devalue and print for the first time in 20 years. It is going to print more money than the U.S. and Europe combined, even though it is a much smaller economy. That third nation of money printing—counting the Eurozone and the European Central Bank as one nation—is going to be phenomenal for the price of gold. Now you just have to be patient. I don’t know if this breakout is going to start in March, June, September or December, but I really think that 2013 will be the year that we will break out. If you’re looking at a price target, I’ll just use the easy price target of $2,000/oz by the end of the year.
TGR: Fair enough. I hope your forecast for the next year works out. We look forward to checking in with you again.
In 1998, David Skarica started Addicted to Profits, a newsletter focused on technical analysis and the psychology of markets. From 2001 to 2003, Stockfocus.com ranked Addicted to Profits third out of over 300 newsletters for performance. He is also the editor of Gold Stock Adviser and The International Contrarian, which focus on gold and global investing. Skarica has also been a contributing editor to Canadian MoneySaver and Investor’s Digest of Canada.
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The Peruvian mining sector has lots of promising developers and producers, but don’t ignore the smaller companies—2013 may surprise to the upside in Peru. In this interview with The Gold Report, Ricardo Carrión, managing director for capital markets and corporate finance for Kallpa Securities in Lima, Peru, says it is fine to ride the wave with the rest of the market as lower-risk projects advance toward production in Peru. However, smart investors should balance a mining portfolio with smaller and earlier-stage companies that are selling at compelling valuations. Get there before the majors go on a New Year’s shopping spree.
The Gold Report: How’s the mining investment climate looking in Peru for 2013, especially compared to 2012? What are the main trends and what are people looking forward to in 2013?
Ricardo Carrión: Our outlook for 2013 is generally pretty good. That was our assessment at the beginning of last year for 2012 and it has turned out to be a good year. Mining in Peru is set up to have another positive year. There are a lot of projects in the pipeline and the macro situation is strongly positive for the sector. However, in 2013 as projects advance, we are more actively watching project specific factors that control the advancement of individual projects including the environmental impact assessment (EIA) approvals. In addition, we are keeping an eye on the resolution of social situations on the more advanced projects.
“Mining in Peru is set up to have another positive year.”
One key project everyone is watching is the Conga project in the north of Peru, a joint venture between Newmont Mining Corp. (NEM:NYSE) and Compania de Minas Buenaventura (BVN:NYSE; BVN:BVL). That project has been delayed a couple of years and has caught a lot of media attention. Many other projects are quietly making progress in addressing social, environmental and community issues. We are watching these factors on a project by project basis for 2013. Overall, the project pipeline is very strong and in most locations communities are working with companies to explore and develop new mines.
TGR: Is the EIA process new or has it been recently revised?
RC: The EIA process has been stable for some time. The Conga example is a case where investors are concerned about the implementation of the EIA process—specifically, the revision of a previously approved EIA. In that case, the EIA was originally approved by the government, but was then revised after local social activists demanded changes. One result was uncertainty for investors.
TGR: Are EIA approvals at the regional or the national level?
RC: It starts at a regional level and ends at the national government level. In the case of Conga, social movements within the communities near the project resulted in the national government revising the EIA. There are other examples of how the EIA process works. We have three projects that have already submitted EIAs—one by Bear Creek Mining Corp. (BCM:TSX.V; BCM:BVL) for the Corani project , one by Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL) for the Ollachea project and also Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX; SUE:BVL). That process will take up to eight months and will be followed by investors closely.
TGR: In the meantime, while companies await EIA approval, there is no shortage of things they can do including drilling, resource definition, securing financing and so on, correct?
RC: Exactly. In many cases, the EIA process does not slow down the overall project because there is a lot to do to build a mine.
TGR: For those two projects in particular, Bear Creek’s Corani and Minera IRL’s Ollachea, is there strong opposition? Both of those projects are in the south of the country, far away from Conga.
RC: Both projects are in the southern province of Puno. In the past, there have been some social issues with mine development in Puno. In fact, Bear Creek had the Santana project that faced such a problem two years ago. To make a long story short, the government decided to revoke the license to operate the Santa project because of unresolved social and community issues. The Corani project is completely different. For starters, it is located north of Puno. It’s very close to Ollachea, which has good community relations.
“In Peru, the project pipeline is very strong and in most locations communities are working with companies to explore and develop new mines.”
In the case of Minera IRL, building organic community support is a core competency, so we are confident that Corani can follow its example in that area. Minera IRL has set a good example benchmarking local mining projects and we believe that the companies and the communities will win from that investment. At Ollachea, the local community owns 5% of the project and has a clear financial, as well as social, interest in that project succeeding. We believe Corani will follow in those footsteps.
TGR: Bear Creek is listed in Canada and Peru. Are there new dual listings coming out?
RC: Yes, there are several. Last year was a good year for the Peruvian market. For example, three months ago we listed a company named Andean Gold Inc. (AAU:TSX.V; AAU:BVL), which has a small silver project in the north of Peru. Then we had the listing of Duran Ventures Inc. (DRV:TSX.V; DRV:BVL), which is a copper project located in the center of Peru. And now, we are also in the process of getting the listing done for Lupaka Gold Corp. (LPK:TSX), which is also located in the south of Peru. Also, just recently we received the final approval for another dual listed company, Southern Legacy Minerals Inc. (LCY:TSX.V; LCY:BVL). It has a very interesting copper-gold project located in the north of Peru.
TGR: What size market cap do these new listings have?
RC: The new listings in Peru have a variety of market cap sizes. We have small companies the size of Andean Gold with a $5 million (M) market cap all the way to large companies like Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL), which has a market cap over $900M. There is an extensive range of sizes of companies here in Peru.
TGR: We talked about developers and producers. What about earlier in the mining life cycle—are there many companies active in exploration in Peru?
RC: For public companies, there is always interest in all the stages of mining from exploration to production. Notably, the current investment market has undergone a structural change toward later-stage projects that have less risk. Because of current market conditions in the smaller stocks, many advanced projects are very, very cheap. Investors should be migrating to these projects, but in many cases it hasn’t happened yet. By an advanced project, I mean those projects that already have a feasibility or prefeasibility study or are under construction or in development. A good example is Panoro Minerals Ltd. (PML:TSX.V: PZN:FSE; PML:BVL), which has a copper-gold project under development in the south of Peru. It expects to have a prefeasibility study by the end of this year. For a junior company, Panoro is one of the more liquid companies in Peru. Another company that is very interesting is Sulliden Gold. Sulliden just announced that it is fully financed to develop and construct a gold project named Shahuindo.
TGR: We discussed Sulliden six months ago and it was interesting at that time. How much financing did it need to build out?
RC: Sulliden needed approximately $150M and is fully funded. Here again, the company requires approval of the EIA before it can start construction. We expect it will be approved within the next eight months, then mine construction begins.
TGR: The last time we talked, you were looking for some short-term catalysts to potentially start the stock moving upward. Specifically, you were anticipating a revised reserve and the financing. It looks as if Sulliden delivered on both and the stock responded—and then gave up the gains. Is that the general mining equity market conditions or something else?
RC: In the case of Sulliden, there are two things to consider. First are the general market conditions—Sulliden is in the same boat as all the other junior mining companies. The junior mining indexes have been trending down for the past six months and Sulliden was caught in that downdraft. Another consideration with Sulliden was that it defined the Shahuindo feasibility study project as a smaller project than in the prefeasibility study. That conservative approach may have caught investors by surprise. As analysts, we understood the strategy of the company: start small and then ramp up. That is how Rio Alto did it. Soon, Rio Alto will be nearing 36,000 tons per day. In the case of Sulliden, it is also a good strategy. We see it as an undervalued company. The main event that everybody is waiting for is the EIA approval. After that, it will inevitably become a mine.
TGR: For North American investors, we are just finishing up the U.S. presidential election cycle and lots of national budget debate. What is the government situation in Peru? Is the president and legislature stable? Is the government providing a good environment for the companies to build mines and invest in Peru?
RC: The current situation can be summed up “so far so good.” The government of Peru has proven itself to be stable. Not everything is perfect; if you look for problems, you can find them. In the mining industry, you can find community issues that we discussed. But apart from that, much of the rest of the government and political situation has been very stable. The economy is growing at a very decent level considering the global market conditions. Probably we will finish this year with a GDP growth of around 6.3%. That is a reflection of the strategy of the government, which is generally a market friendly government.
TGR: Are there other companies or projects you’d like to mention that are interesting and investors should keep an eye on?
RC: One interesting project from a social and community point of view is Candente Copper Corp. (DNT:TSX; DNT:BVL). Candente is peculiar because it is close to completing final feasibility. However, the company is dealing with social issues that have gotten a lot of attention from local media and some investors. If the company can address the situation, it will have a 9+ billion pound copper project with only a $40M market cap company. That is quite a disconnect and is a project worth watching because of the potential upside.
Last week Candente announced that the government granted the water permits needed for drilling and also announced the commencement of the drilling program. This will allow the company to complete the final feasibility study. Although the social environment hasn’t been solved 100%, we see this as a good sign. Over the last week the share price gained almost 65%.
“All portfolios need diversification, not only focusing on well-developed stories that protect from downside, but also remembering to own some smaller assets that will potentially dramatically outperform if the market surprises in a positive way.”
TGR: Is Rio Alto’s current production sufficient to fund expansion, or does it need additional financing?
RC: It will depend on the results of the studies. The capital expenditure requirements will determine the strategy needed to finance the project. But the current production will greatly assist in raising whatever funds it needs. The cash flow from the oxide gold project will be more than enough to finance the secondary sulfide. On the other hand, from a financial point of view, it’s good to diversify and to find an additional source of financing as well.
TGR: We have been talking a lot about gold. What do Peruvians think of gold or silver as assets? Is there a domestic market for bullion, gold-related financial products or mining equities in Peru?
RC: Domestically, there is not yet a large market for gold investment, but it is growing from a small base. Investors are starting to get interested in securities related to gold, for example gold exchange-traded funds (ETFs). In Peru, we haven’t reached the point where there’s a high demand for physical gold. But things are changing. The domestic gold market is growing. Regarding the mining equities, Peru’s stock market is underdeveloped. The stock market volume traded compared to GDP is around 5%, which is much lower than other Latin American countries such as Chile and Columbia. A mirror of that situation is that Peruvians are starting to be more financially sophisticated. As a country, we are starting to buy ETFs. There is a lot of potential upside for Peruvian financial assets.
TGR: Are there any other special situations that investors in the Peru mining sector should be watching for?
RC: Yes. There is a trend in the North American and European markets away from risk. Investors should be ready for a time when the confidence comes back into the market. Confidence in the market is needed for mergers, and in the past, mergers have rewarded careful risk takers. The last time this happened was 2010 when there were some very interesting stories that alert investors could profit from. In 2010, we had two very good acquisitions with First Quantum Minerals Ltd. (FM:TSX; RQM:LSE) acquiring Antares Minerals Inc. (ANM:TSX.V) and HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) acquiring the Constancia project from Norsemont Mining Inc. (NOM:TSX, NOMFF:OTCBB, N8SA0:FSE).
Those two acquisitions were catalysts for the junior mining sector in general. We did not see anything similar in 2012. Investors with foresight should be positioning themselves for the next acquisitions that take place in 2013 and beyond.
I have been reviewing a lot of analysts’ comments on Peruvian projects that could be targets for acquisitions. There are a couple that are very interesting. One is Panoro Minerals, a copper-gold company that has released a good resource and is continuing to grow that resource over the next six months. Many majors are interested in that project. Another potential target is Trevali Mining Corp. (TV:TSX; TREVF:OTCQX; TV:BVL), which is starting production at its Peruvian asset named Santander. Trevali also produces from a Canadian asset and has become a success story in the zinc environment, which is a tough market to be profitable in. There is a lot of news about zinc mines closing, yet Trevali is starting up. Both Panoro and Trevali look like candidates for a buyout transaction next year.
TGR: Do you have any final comments about what smart investors should look for in 2013?
RC: It is understandable that investors are focusing on risk aversion and more developed stories in the mining sector. Everybody needs to remember that if 2013 becomes an excellent year, as we feel that it might, smart investors should be positioned to capture some of that upside with a portion of their portfolio in early-stage projects as well as in the lower-risk development stories.
All portfolios need diversification, not only focusing on well-developed stories that protect from downside, but also remembering to own some smaller assets that will potentially dramatically outperform if the market surprises in a positive way. That’s the message I tell investors, go with the trend and ride the wave. But if the market is saying “go to the safer assets,” it doesn’t mean you have to allocate 100% to the safer assets. Positioning some of your investable assets in higher-risk, less-developed projects should provide higher overall return.
TGR: Thank you. It has been great to talk to you again.
Ricardo Carrión is the managing director for capital markets and corporate finance for Kallpa Securities in Lima, Peru. He served as a senior analyst of Banco de Credito in the areas of corporate banking, corporate finance and capital markets and was an adviser to Lima’s Stock Exchange. Carrion holds a bachelor’s degree in business administration from Universidad de Lima with a specialization in finance and capital markets.
It is difficult for retail investors to sift the wheat from the chaff in the junior miner sector. In this interview with The Gold Report, Rick Winters reveals how RMB Resources, a resource merchant bank, figures out what projects to invest in and those to pass over and talks about some of the companies that made the cut.
The Gold Report: Rick, RMB Resources invests in resource companies throughout the world. Why is RMB flocking to resource companies when most investors seem to be running in the opposite direction?
Rick Winters: RMB Resources is the resource merchant banking division of the FirstRand Group, one of South Africa’s major financial institutions. We’ve been in the business of providing finance to the junior resource sector for 18 years. We look at junior resource opportunities everywhere in the world outside South Africa.
As resource investors, we’re always in the game, even when the market doesn’t seem to care. Our product mix may change with market conditions, but we stay in the market and are always active.
TGR: With the risk-off sentiment that’s prevalent in the market right now, are you making changes to your overall strategy?
RW: As a merchant banking operation, we look at junior resource finance and focus on relatively higher-risk, higher-return opportunities. In times like this, when junior resource equities and mining equities aren’t in favor, we look more toward quasi-equity and quasi-debt investments as a way of providing finance to companies. We do this when we have confidence in their projects, using their projects as security for a debt structure. This saves companies from dilution in a time of very low share prices.
TGR: Can you talk more about quasi-debt and quasi-equity investments?
RW: We invest all along the spectrum, from pre-initial public offering seed capital through to corporate debt and project finance. When we talk about quasi-equity and quasi-debt, it’s a reflection of the stage that a project or a company is at. Quasi-equity tends to be higher risk.
“We focus first on people and identifying good management that we’ve done business with in the past and that currently has good opportunities.”
One example of such a transaction is Bullfrog Gold Corp. (BFGC:OTCBB). We have funded Bullfrog Gold as a quasi-equity opportunity because it has a very attractive project that’s had a significant amount of work done on it in the past—a feasibility study, initial permitting and the like. But now, it needs funding to confirm what was done in the past and to expand the project. The transaction uses the project as security for the facility. We have a significant warrant package associated with that facility that represents the return we need for the risk profile.
An example of a quasi-debt transaction would be Solitario Exploration & Royalty Corp. (SLR:TSX). It has a project in Nevada, a gold heap-leap project, Mt. Hamilton. That project completed a final feasibility study in 2012, so the project is well defined. Solitario continues to optimize that feasibility study. Once again, the project is used as security for a debt facility but because the project is well defined it has a lower risk profile and our required warrant exposure is consequentially lower than a quasi-equity opportunity. That facility is to provide working capital to complete the permitting process so that the company can go forward with obtaining project financing and put the project into production.
TGR: What is the total amount of your investments in resource companies, both in 2011 and in 2012?
RW: We have a lot of movement in and out of our portfolio but, generally speaking, we have a portfolio of about $100 million (M)in equity and around $200M in debt.
TGR: Do you expect those levels to increase in 2013?
RW: Not necessarily. But we’ll probably see our debt portfolio grow in 2013 because of the nature of the market.
TGR: With all the companies knocking on your door, how do you decide which ones you’re going to invest in and which ones you’re not?
RW: We really stay with the fundamentals. In a buoyant equity time, the spectrum of the projects that we look at is much broader and we do look at exploration and very early-stage projects and seed capital. But we’re doing much less of that these days.
We’re focused now on projects where we can assess the project and the opportunity technically. We assess the tradeoff between what we believe will be the fundamental value and the opportunity for the project to actually become a cash-flow generator. In other words, we’re looking at the feasibility stage and above.
TGR: What are some investment themes that you expect will govern most of your investment decisions in 2013?
RW: The last year and a half has been an unprecedented period for the industry. We expect 2013 to be the same. We seek to patiently invest. We continue to have a minimum three-to-five year investment horizon.
“Retail investors need to look behind the retail promotion and see where serious money is getting invested.”
We focus first on people and identifying good management that we’ve done business with in the past and that currently has good opportunities. We focus on projects and make sure there’s sufficient asset value to justify the risk-return profile. We also focus on our companies’ abilities to promote and raise capital because the mining business is very capital intensive.
TGR: Are your investments geared toward rising commodity prices or are you looking for specific situations that merit your expertise and your cash?
RW: We’re happy to participate in the equity upside that comes along with rising metal prices, but we have more of a banking mindset than an equity investor mindset. We’re always looking for the recognition of fundamental value at rational metal prices, which are often lower than the current price. In other words, we focus on project fundamentals.
TGR: Where do you see metals prices, particularly precious metals prices, in 2013?
RW: Prices will be relatively stable. There will be volatility within the metal prices, precious metals in particular. We’re in an environment where fiat currencies and the major economies in the world are in trouble. The debt situation has to be dealt with, and is not going to go away for at least a few years. That’s why I don’t see a precious metal environment that’s much different than what we’ve seen over the last couple of years.
TGR: RMB Resources is an investor in Sutter Gold Mining Inc. (SGM:TSX.V; OTCQX:SGMNF) and you are a director of that firm. Is it common for RMB to have a position on the board of a company that you’re investing in?
RW: No, it’s not typical for us. One of our most treasured mantras is not to become involved at the board or management level. We believe that if we can’t have confidence in the boards and managements of the companies we invest in, we probably shouldn’t invest in the first place.
“When this market turns, it will come back with a vengeance.”
We became involved in Sutter when the former largest shareholder decided it didn’t want to be in the gold business anymore. We purchased half the company from that shareholder and then sought to move the company and the project in California forward. When we started, we had 49% of a junior public company and had to build a management team and a new board from the ground up.
TGR: Sutter just poured gold, its first doré, at the Lincoln project in northeastern California. Will this news move the share price?
RW: Sutter’s price graph shows that it’s one of the better-performing junior stocks and has been over the last year. With the mine being built and coming into production, the value of the company has more than doubled over the last 12 months.
TGR: But the share price has been roughly the same since March.
RW: Now that the company poured the first gold in the Mother Lode in 54 years, the market is waiting to see the mine start to generate cash flow. The first six months of 2013 will be the ramp-up phase and the mine should be in full production by midyear. Then we’ll see what value the market assesses for the Lincoln-Comet project.
That initial project is based on a five-year resource of about 180,000 ounces (180 Koz). What the market will come to appreciate is the immediate upside for Sutter. There is a second project, the Keystone project, which lies immediately north of the current mining resource. That’s about a 400 Koz resource. The mill has been designed and built so its capacity can be doubled at a cost of about $700,000–750,000.
TGR: Has Sutter provided any production guidance for the first year?
RW: Not yet. It will going forward, but that will be a function of how the ramp-up goes. Once the Lincoln-Comet project is in full production, about 23 Koz/year is anticipated. There will be less than that in 2013 given the ramp-up for half the year.
TGR: Has any of that gold been forward sold?
RW: It has—RMB Resources provided a prepaid gold facility. To fund the project and get the mill built, we sold forward half the production of the current mine plan at a price of $942/oz. Sutter got—this was at a time when gold was around $1,540/oz—$20M in finance to sell 54 Koz forward for which it will receive $942/oz. In effect, it got a price of about $1,320/oz, selling forward in July 2011.
TGR: Do you know its cost per ounce?
RW: It should be around $700–725/ounce.
TGR: What are some other junior mining companies that RMB helped finance?
RW: Another recent one was Bullfrog Gold. It’s a relatively new company and has a current market cap of about $11M. It has an advanced exploration project in Arizona called the Newsboy project.
In the 1990s, an Australian company did quite a bit of work and actually defined a resource of about 5 million tons (Mt) at about 1.5 grams/ton (g/t) gold. It completed a feasibility study and started all its permitting work in Arizona, so the state regulators are aware of the project. It then fell by the wayside in the mid-1990s. A Canadian company had it for a period of time, did a bit of work and then dropped the project in the late 1990s. In the early 2000s, a private group restaked it, and Bullfrog optioned the property from that private group.
Bullfrog is now working hard on it and is doing a lot of drilling to confirm the historic resources. It’s gone a long way in doing that. It started to expand the deposit beyond the limits that were known in the 1990s. We think there is likely a deposit there that will be around 7 Mt at 1.5 g/t. Our facility, which is $4.2M, is to fund work at the project for the next 18 months. The work is intended to do the additional drilling and resource evaluation to complete the initial resource re-estimations and to begin, if not complete, feasibility and get the final permitting under way. It’s a new opportunity that the market hasn’t known about because it was in private hands, but we think it will become a mine.
TGR: Do you think that the management at Bullfrog has what it takes to go beyond what previous operators could do?
RW: Yes. The management is led by a gentleman named Dave Beling, who is a very experienced mining engineer. He’s been involved with several different junior companies and has done lots of consulting work. We see eye to eye with Mr. Beling on what work needs to be done to bring a project to a development decision. Right now, it’s a very lean and mean management team, but that’s by design. At this point, the focus needs to be on the geology of the project area in the drilling and the resource estimation. But Mr. Beling also has all the experience to bring a development team together when the time comes.
TGR: Sounds like a lot of what your job is in this business is not to see what a project is but what it could become. What could the Newsboy gold-silver project in Arizona become?
RW: If it develops as we think it should, it will be a project that should be producing around 35–40 Koz/year and probably generating annual earnings before interest, taxes, depreciation and amortization of about $25M. On paper at $1,700/oz gold, it preliminarily has a net present value (NPV) at a 5% discount of around $90M in comparison to a market cap of around $11M.
It’s a good example of how we try to assess fundamental value. It’s also what allows us to have patience in our investing because with most of the companies that we’re involved in we’re looking at the opportunity for a four or five time increase in value.
TGR: What are some other companies you’re invested in?
RW: Along the same theme is Solitario, which I mentioned earlier. It has a current market cap of about $50M, but its Mt. Hamilton project at $1,700/oz gold has an NPV of $260M. That’s another deep value discount situation.
We recently became involved with Mercator Minerals Ltd. (ML:TSX) out of Vancouver. It has an interest in an operating copper-molybdenum mine in Arizona, the Mineral Park mine, as well as advanced development-stage assets in Mexico. We were a part of an overall balance sheet restructuring of the company. It had to restructure the debt associated with Mineral Park. Mercator just completed a major expansion at that mine to 50,000 tons per day. It’s a large-tonnage, low-grade mine that produces around 40 million pounds (Mlb)/year copper and about 10 Mlb/year molybdenum.
Mercator is currently trading at about $0.58/share, down from over $4/share two years ago. It’s a situation where the market has lost confidence in that company’s ability to service its debt, so it needed to restructure its debt more in line with the long-life nature of the Mineral Park asset.
We refinanced a $30M facility that it had with a group of Canadian investors for its El Pilar project in Mexico, which is a large, low-grade, heap-leach opportunity in northern Sonora, just across the U.S. border. That project, which is where our security lies, has a final feasibility study completed. It’s fully permitted to go into production. It only needs to obtain project finance to move the project forward.
The El Pilar asset really is one of significant value. That project has an after-tax, all-equity NPV8 of $460M at an average copper price of $2.82 per pound over the life of the project in comparison to a current spot price of $3.67 per pound. It’s in a very good location with very good infrastructure, so it has a relatively low $280M capital expenditure requirement to put it into production. But with that sort of NPV after tax and with the current market cap of the company at about $180M, the value of El Pilar is over 2.5 times the current market cap without giving any credit to cash flow from its mine in Arizona or its other projects. That’s another example of the type of things we look at.
TGR: Is El Pilar close to any larger producing companies in Mexico?
RW: Yes, it’s about 45 kilometers northwest of the Cananea mine, the largest copper mine in Mexico. It’s also about 50 miles southeast of some of the large Arizona copper mines, such as Sierrita/Twin Buttes. It’s a unique deposit, but it’s in a very good address for copper mining.
TGR: Another investment you made?
RW: Another one that we put some real equity into is a unique story, Highland Copper Company Inc. (HI:TSX.V). It’s a Vancouver junior that has an interest in copper in the Upper Peninsula of Michigan. Most people don’t remember that the Upper Peninsula was one of the greatest copper belts in the U.S. for some time. It produced over 5 Mt of copper.
Highland Copper did a joint venture with a Houston group, BRP LLC, which holds interest to about 13 million acres of mineral claims in the U.S. It purchased the mineral claims in the Upper Peninsula in a bankruptcy in the late 1990s and really didn’t know what to do with them. To Highland’s credit, it did a joint venture with BRP to earn a 65% interest in the Upper Peninsula mineral holdings by spending $11.5M and producing a feasibility study.
The problem came with the markets over the last 18 months and the company’s inability to finance itself and move forward on the earn-in conditions of the joint venture. We became aware of it when a notable mining entrepreneur, David Fennell, learned of this opportunity and discussed it with us.
It was a restructuring exercise to take this Canadian company, which last May had a market cap of about CA$2M. At that time, Fennell brought in new investors including RMB Resources, new money ($16.5M), new management and renegotiated the earn-in option appropriately to allow it to go forward. We now own about 10% of the company.
The company has, since July, drilled 160 holes and over 24,000 meters. It is focusing on the chalcocite part of the belt. Unlike the native copper, chalcocite as a mineral is much more friendly from a metallurgical standpoint and produces a very high-quality, clean copper concentrate. No one had really focused on the chalcocite part of the belt in the old days.
We would expect that sometime in Q1/13, Highland Copper will come out with its initial resource estimate, and it will probably be on the order of 6–7 Mt initially of 2.2–2.5% copper, most of it open pitable, which is quite significant these days where the average grade of a copper deposit is more like 0.5%.
There was a joint venture by Inco and Homestake Mining Co. in the later 1970s and early 1980s, and they defined three deposits, conducted preliminary evaluations and produced resource and reserve estimates. Highland got an inventory of around 2 billion pounds of historic chalcocite and native copper resource, which needs to be prioritized and confirmed.
Bottom line, Highland has a high-grade deposit near the surface in an area that has a copper mining tradition. It is fully funded to meet its obligations under the joint venture earn-in. It has also been producing fantastic results, but people haven’t really noticed. That said, it currently has a market cap of about $24M, up from $2M, with about $14M in cash and a lot of work going on to get an initial mine going and really explore and evaluate the 13,000 acres of holdings that it has in the Keweenaw project in the Upper Peninsula of Michigan.
TGR: What about permitting in a place like Michigan, which hasn’t seen a lot of mining over the last 30 years or so?
RW: Michigan seems to have quite favorable attitudes toward mining and mining regulations. Most of the project is on private land, so the federal part of the permitting equation is less of an issue. The Keweenaw part of the Upper Peninsula is economically depressed. There is still a history and heritage of mining there, so in general people are very supportive. But time will tell. The permitting anywhere in the world these days is every bit as important as any other part of the job. That work is currently being initiated by Highland Copper.
TGR: Are there any other companies you want to comment on?
RW: Trevali Mining Corp. (TV:TSX; TREVF:OTCQX) is one of the better stories in the marketplace and we are working on it right now. We’ve been mandated to arrange $60M of finance for its mines and its development opportunities in New Brunswick as well as in Peru.
It’s a complicated task because Trevali has a lot going on simultaneously, including three mines and two mills. For investors who like zinc, it’s definitely one to pay attention to. It also has quite an ability to raise capital. But it is at that cusp where quite a bit of money is needed, and we’re one of the groups working on that. We have confidence it will go forward.
TGR: Its biggest project is the Santander base metals project in Peru. That has bounced around from company to company for years. Why does that project make economic sense now?
RW: It makes economic sense for two fundamental reasons. One is that there is already a tremendous amount of capital invested there. There is already a mill at Santander. There is housing at Santander and a complete mining camp. The other factor is that it has good zinc and silver grades in a well-established mining resource.
But it’s a big project. The challenge is getting all the final mine plans in order and properly developing the underground deposit. Santander should start producing metal in 2013. What makes these types of projects successful is that some management groups bring a focus and a commitment to it. That’s what’s happened at Santander. Glencore International Plc (GLEN:LSE; 0805:SEHK) has a major interest there along with Trevali. But it’s Trevali, and the confidence that Glencore has in Trevali to put the mine into production, that will bring it to fruition.
TGR: The junior mining space used to be predominantly the domain of retail investors. Is there still room for retail investors in the sector? Would they be well served to follow the investments made by large companies, such as those made by RMB?
RW: There is always room for retail investors. One of my attractions of getting into the junior sector when I became an analyst many years ago at Robertson Stephens & Co. was the realization of the mining industry in general, but the junior sector in particular, that it’s really a very small sector. There are lots and lots of companies; in Canada, there are around 1,500 listed junior companies.
But if you take the total value of those companies, or even the entire mining sector, it’s not very significant. Apple is probably bigger than the entire global mining sector. So when investor interest flows into the sector, it doesn’t take much for all the boats to rise, and do so rapidly. But when the interest leaves the sector, the inverse is true. The tide goes out, and all the boats fall quickly.
For people who think about fundamental investing, and not trading, there is a lot of opportunity in the junior sector because of this complete disconnect between the current valuations for companies and value of the metal in the ground and even cash flow given the current and expected prices for the commodities that these companies are producing.
I think for a lot of retail investors, it’s very difficult to know who’s who in the zoo. Just because a company is a very good promoter doesn’t mean that it has very good assets. People with a view like ours, which is a bit longer-term, fundamental resource-oriented view, would be well served by looking at what some of the other successful major resource investors do in trying to cull the number of opportunities and focus on those things that provide the best risk-reward. Institutional investors, as a group, typically do not seek market returns. We are looking at higher-risk, higher-reward opportunities. Retail investors need to look behind the retail promotion and see where serious money is getting invested.
When this market turns, it will come back with a vengeance. Everybody will be very happy. The people who will be most happy will be the people who were already invested.
TGR: That sounds like sage advice.
Rick Winters has been president of RMB Resources, the resource merchant banking division of the FirstRand Group, since August 2005. During the previous five years, he served as vice-president of RMB Resources. Prior to his time at RMB, Winters also had stints at Golden Star Resources Ltd., Robertson Stephens & Co., Phelps Dodge and the Colorado School of Mines, where he holds a master’s degree in mineral economics.
There is a war raging behind the scenes among the world’s currencies. Chris Mancini, an analyst with the $400-million Gabelli Gold Fund, believes that gold will emerge the victor. In this interview with The Gold Report, Mancini makes his case for why gold is a currency and not just a relic, and why his fund doesn’t own bullion. He also shares names of companies operating around the world that offer great upside potential.
The Gold Report: You recently wrote, “Gold mining companies are no different from any other company in that company managements must determine the most effective way to return capital to shareholders.”
In an environment where there haven’t been corresponding increases in equity prices to the price of gold, how does a management group effectively grow per-share value for shareholders?
Chris Mancini: If you’re too big and don’t think that you can grow on a per-share basis, the answer is to return some of the cash to shareholders through a dividend. If a company doesn’t have high-quality, high-return-on-capital, low-risk projects to deploy that cash flow into, then a portion should be returned to shareholders as a dividend.
TGR: We haven’t seen a whole lot of that.
CM: Take Barrick Gold Corp. (ABX:TSX; ABX:NYSE) as an example. It had a goal of eventually mining 9 million ounces (Moz) gold and should produce around 7.5 Moz in 2013, which is a difficult thing to do. Barrick has been focused on growing for growth’s sake. It undertook two very capital-intensive projects, Pueblo Viejo in the Dominican Republic, which is complete and should be producing commercially sometime next year, and Pascua-Lama, which is an enormous, capital-intensive project in the Chilean/Argentinean Andes, which the company is doing a poor job of building. That being said, it will be very cash-flow generative once it’s built.
“We are in a positive macroeconomic environment for gold.”
The question becomes at that point, once Pascua-Lama is built, what does it do with its cash flow? We’re getting a sense that it wants to be a leaner, meaner company and that it’s not going to focus on growing its very big production base. That’s a good sign that it might start distributing more of its cash in a dividend.
TGR: A lot of senior producers, and even midtiers, are focusing on grade. Irrespective of all things, the higher the grade, the better the economic return.
CM: That’s the key. A higher-grade deposit means processing fewer tons to get out the same number of ounces without the capital intensity of a big, bulk-tonnage, low-grade operation. The cost per ounce is also lower given that not as many tons need to be processed to recover the same amount of metal.
TGR: You don’t hear many pundits predicting a falling gold price in 2013, yet we continue to see volatility in the space. What’s your forecast for the gold price in 2013?
CM: We’re very constructive on the gold price in all currencies. All over the world, money is being printed, and gold is the one currency that can’t be reprinted or replicated. The money that’s being printed will ultimately lose its purchasing power, and gold should retain its purchasing power. Gold should continue to go up relative to currencies that will be losing their value. More debt leads to more money printing, and more money printing leads to continued devaluation of currency. It’s a positive macroeconomic environment for gold.
TGR: Some investors don’t view gold as a currency. They view it as a metal, a relic.
CM: Historically, gold has been the ultimate currency and, at some point in the future, will again be the ultimate currency. It’s not legal tender, but that still doesn’t mean it’s not something that will hold its value over time relative to paper.
TGR: Utah and a couple of other states have actually passed legislation that gold is considered a currency.
CM: In some states, you can bring in gold or silver and get goods for that gold or silver. The problem with that is federal tax. If you buy gold and it appreciates in value and there’s a gain on that gold, when you sell or transfer that gold, then there is a federal tax on that transaction. Until that goes away, it will be hard to use gold as a real currency in the U.S.
TGR: Even in a world that hasn’t descended to a serious level of crisis, gold can still be appreciating as a currency.
CM: It is a currency war. Currencies are devalued against one another. Recently, the Japanese elected the Liberal Democratic Party leader Shinzo Abe. One of his talking points during the election was that the Japanese economy is uncompetitive because the yen is too strong. Abe’s theme is more monetary and fiscal stimulus, and a weaker yen. He and the Japanese people think that the country needs a much weaker currency in order to be competitive in the world economy. That’s also why the Swiss agreed to their money printing exercise—in order to stop their currency from appreciating more and more.
TGR: It does feel like a race down the hill when you talk about it like that.
CM: If the Japanese, Swiss, and other Europeans print more and more money to make their currencies less valuable, ultimately the U.S. is going to be uncompetitive from a manufacturing perspective. It gives the U.S. impetus to also print more money.
TGR: We’re talking about trillions of dollars of deficit. It’s almost beyond comprehension. Because you value gold as currency, why don’t you hold any bullion in the fund?
CM: Gold miners are undervalued relative to bullion, and investors can get bullion cheaper themselves. They shouldn’t be paying us to own bullion. Bullion is a savings instrument. Gold equities are investments.
TGR: The fund’s No. 1 holding, at about 12%, is Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE), which is heavily involved in Africa. I’ve traveled to Africa and was very impressed with the mineral wealth there. Yet some investors are not comfortable with that location. Why are you?
CM: When a company comes into a community, builds a mine and employs people, it liberates those people from poverty. They’re building skill sets that they have for the rest of their lives.
“While precious metals is an extremely volatile sector, it can be volatile on the upside, as well as the downside.”
A well-respected institutional mining company like Randgold comes into a region, employs people, educates people, liberates people—those people want that company to be there. It greatly reduces jurisdictional risk when you have that much local support.
TGR: Yet, there are places in Africa without that support. There are roving bands of thugs that are creating problems in the Democratic Republic of the Congo and Mali. Do you see these as temporary blips in an otherwise bullish and opportunistic area, or do you see this as a long-term thorn in the side of companies working in those areas?
CM: They’re not necessarily blips, but they’re not meaningful to the operations of Randgold. A place like Mali or the Congo is vast. As long as there are no specific problems near Randgold’s mines, it’s a non-event.
TGR: There are hundreds of kilometers of distance between the places where the problems are occurring and Randgold’s operations, and no connecting infrastructure.
CM: It’s extremely remote relative to political circumstances that may be transpiring around the country.
TGR: Your second largest holding is Fresnillo Plc (FRES:LSE), the No. 1 silver producer in the world. In a report you wrote that one of the things you like about Fresnillo is that it acts like an owner. “Unlike many other large precious metals companies, Fresnillo is an owner-operator company that’s 80% controlled by a family-owned Mexican conglomerate.”
CM: You have to ask yourself, as an investor, what’s the management’s incentive? For a large institutional-type precious metal mining company, their incentives may not be directly with the shareholders, whereas the owner of a company focuses on maximizing returns and cash flow.
TGR: Do you routinely look for companies with a lot of management ownership?
CM: That’s something that’s important to us. We look for skin in the game in the form of shares, not options, because we do want to see companies paying bigger dividends. If managers own shares, then they’ll benefit when dividends are paid out, too.
TGR: Is there another example of a company with vested management that you are particularly excited about going into 2013?
CM: Guido Staltari, the chief executive officer of Australia-based Saracen Mineral Holdings Ltd. (SAR:ASX), is the founder of the company, has an ownership stake in the company and is very invested in the company. Saracen should produce around 115 thousand ounces (115 Koz) gold at a cash cost of around $950/ounce (oz) this year. It’s in the process of expanding its operations. With an incremental spend of around $40 million (M), it should be able to increase its production by around 75 Koz/year and it should also be able to bring its cash costs down to around AU$850/oz.
TGR: That’s a name I’ve never heard of before.
CM: Saracen is producing now. It’s relatively low-risk growth and relatively high return on capital. The company has built a mill that needs some modifications. It has leases on its mining equipment, so it can upgrade the size and benefit from economies of scale that will come with using the new equipment without having to make a large capital outlay.
It also has some very prospective land that is relatively high grade where it is exploring. We hope that it will be able to increase its reserves. One of its deposits, Red October, is a higher grade than what it is currently mining. If it can grow the Red October deposit through exploration, then its average grade should increase, its costs should decline and its production should increase even more.
TGR: Are there any North America-listed names that are piquing your interest?
CM: One that has been hurt this year but has the potential within the next 18 months or so to do well is Kirkland Lake Gold Inc. (KGI:TSX). Kirkland Lake operates a mine in its namesake Kirkland Lake, Ontario, which is along the Abitibi gold belt. It’s an old mine in transition. As it increases its production, it should benefit from economies of scale. Kirkland is also exploring a new, high-grade portion of the deposit called the South Mine Complex. It won’t be without its fits and starts, and it’s not without risk because it’s a very difficult expansion that it’s undertaking. If Kirkland does succeed, its production should grow from around 100 Koz this year to around 250 Koz at full capacity. Its cash costs should decline from around $900/oz to closer to $600–700/oz.
TGR: Assuming operating costs stay the same.
CM: Kirkland Lake’s operational costs are going to go up, but not to the same extent that its production should go up. Right now, it is mining from 800–1,000 tons per day (0.8–1 Ktpd). The goal is to produce up to 22 Ktpd. It has around 900 workers underground now and wants to grow to 1,200 workers. It can more than double its production by just increasing its workforce by about 30%.
TGR: It’s trading near $6/share now, after trading as high as $18/share. This stock has been smacked.
CM: Kirkland Lake’s management has miscommunicated its production goals to the market. It has consistently changed its production guidance. First, it was going to be 2012, then 2013, and then 2014. The market doesn’t trust anything that it is saying. Yet, that’s why, over the next 18 months, it could do well, because the mine will be at a point where we will be able to see whether the company has been able to execute on its plan. The market wants to see consistent growth quarter over quarter and consistent decline in costs quarter over quarter. But given the nature of its operations, it’s going to be lumpy for a while until it gets to a steady state. The operations are at this point essentially paying for exploration and/or serving as a training ground for new underground miners at the operation.
TGR: Have you been there?
CM: Yes, I recently spent a day underground with Chief Operating Officer Mark Tessier getting a sense for the operations and the expansion project. It’s striking how many people go underground every day. It’s only going to ramp from there. A lot of the miners come to the operation without any mining experience. It takes a while for them to get up to speed and to productive capacity. Once they do, the company has the potential to be a midtier producing company in one of the best jurisdictions in the world, producing at reasonable unit cash costs.
TGR: With explorational blue sky.
CM: If the exploration does work out from the South Mine Complex, then its costs should be below average, at about $550–600/oz.
TGR: It did a $69M private placement in November.
CM: Yes, and it did another one in the summer for about $57M. Right now, it has around $120M of debt. That makes it more risky. The balance sheet is more levered. I still like it, but it’s not for the faint of heart.
TGR: What’s another company in a great jurisdiction you can tell us about?
CM: Another North America-listed gold name is Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT).
TGR: That’s another one that’s had great success, but a few bumps in the road.
CM: Aurizon doesn’t necessarily have the growth prospects that Kirkland Lake does. However, it does have downside protection. It has a rock-solid balance sheet with $200M in cash.
“Our hope is that in the coming year, precious metals move fast and furiously on the upside and the environment is more constructive for gold and for gold miners.”
It has had some operational issues recently, but the market is not latching on to the essence of the story. It is mining an old area and it is going to start mining in a new area, Zone 123 at its flagship Casa Berardi mine. Once it starts mining the new area, it should get steady production and generate a good amount of cash flow. In 2014, the company should be producing 135–150 Koz/year gold at cash costs of $700–800/oz, generating a good margin, in a great jurisdiction in Northern Quebec.
TGR: Aurizon is not flashy or sexy, but it sure gets it done. It’s been impressive to watch that company.
CM: It has. The fact that it hasn’t done an acquisition yet with its $200M cash hoard speaks volumes.
TGR: One of the things that is compelling about a lot of midtier producers is that they are nimble. They can pare back a little bit. They’re small enough to decide to stick to where they’re having explorational success with their own assets. We’re seeing that with several of these midtier companies. As an investor, it makes them more attractive in some ways than the seniors.
CM: Yes, I agree. They don’t have the overhead of the seniors. The seniors almost have to buy something in Nevada, for example, because they currently have all of the overhead in Nevada and they have to sustain it. That’s not the case with these small, single-asset companies.
TGR: Let’s go to silver. Could you talk about a couple of silver names that you find compelling?
CM: The one that makes sense to talk about, given that we spoke about Fresnillo, is MAG Silver Corp. (MAG:TSX; MVG:NYSE). MAG Silver has 44% of the Juanicipio project, a property that is near Fresnillo’s namesake mine. Fresnillo has the rest of the project.
Fresnillo is the highest-grade silver mine in the world. Juanicipio has a similar geological structure to the Fresnillo deposits. These are epithermal vein systems. At Juanicipio, the company has delineated a deposit that is around 230 Moz silver at very high grades. It’s a silver equivalent grade of 700 grams per ton; this is an extremely high-grade deposit in one of the best jurisdictions in the world, Zacatecas state. Fresnillo is the best miner and developer of high-grade underground silver deposits in the world.
TGR: What needs to happen with Fresnillo and MAG Silver to unlock the value of MAG Silver for shareholders?
CM: Obviously, for Fresnillo to buy out MAG Silver’s 44% stake of the Juanicipio project. That’s the best-case scenario for both companies and for shareholders of both companies. They just have to sit down in a room, hash it out and come up with something that’s reasonable.
If they can’t agree to a price, MAG Silver could spin out the Juanicipio asset to shareholders, who would then get one piece of paper that’s 44% Juanicipio and another piece of paper that is all of MAG’s other exploration assets, some of which are very prospective. For that 44% in Juanicipio, ultimately the shareholders would get a cash call. They would have the option to either participate in the cash call to fund a portion of the capital expenditures for the project or get diluted down. Once Juanicipio gets built by Fresnillo, shareholders would still have the 44% stake in the cash flow from this operation that would be returned in the form of a dividend.
TGR: That’s an interesting idea.
CM: Yes. I think that it would be valued very highly in that it would be like a royalty company. It would be 44% of the profit from one of the best silver mines in the world, operated by one of the best silver miners in the world.
TGR: It might be easier from both companies’ perspectives if everything is separated that way.
CM: That’s true, too. The first step is separating the assets out. But value can be surfaced for a MAG shareholder even if Fresnillo doesn’t buy it.
TGR: Is this something that’s already on the table?
CM: I’ve spoken about it with management. Director Peter Megaw is a relatively large holder of MAG Silver. He is motivated to do what’s in shareholders’ interests. If it does spin this out, it makes what’s remaining a smaller company. It has to start over again, which is fine because Megaw is one of the best exploration geologists in the world at finding epithermal vein and carbonate replacement deposits.
TGR: It’s not really starting over because what it has outlined in its exploration assets is actually pretty compelling.
CM: That’s true. It’s not starting from nothing. It has delineated some exciting prospects at its Cinco de Mayo project in Chihuahua.
TGR: Do you have some final thoughts for us on the mining space?
CM: It’s been a difficult year. Yet, while this is an extremely volatile sector, it can be volatile on the upside, as well as the downside. Our hope is that in the coming year, it moves fast and furiously on the upside and the environment is more constructive for gold and for gold miners.
TGR: Excellent. Thanks for taking the time to speak with us today.
Chris Mancini is a research analyst at Gabelli specializing in precious metals mining companies. He has over 13 years of investment management experience, including research analyst positions at hedge funds Satellite Asset Management and R6 Capital Management. Mancini earned a bachelor’s degree in economics with honors from Boston College and is a holder of the CFA designation.
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Violent strikes and supply disruptions in South Africa put platinum in the headlines last year, and the metal spent 2012 selling at a discount to gold. Is a platinum discount the new normal? How will the market shift in the labor strike fallout? And will mining asteroids transform supply fundamentals? CPM Group Platinum Analyst Erica Rannestad met with The Metals Report to share her price and cost forecasts for 2013 and discuss the supply and demand trends to watch this year.
The Metals Report: Across the mining sector, investors are concerned with rapidly rising costs. How did the 2012 strikes in South Africa affect operating costs in the platinum group metals (PGM) mining industry specifically?
Erica Rannestad: We expect a 12% decline in PGM output in South Africa. These lower output levels are expected to have the most significant impact on cash costs. Cash costs are a key performance measure used in the mining industry and are typically stated on a per-unit basis. Cash costs mostly refer to direct mining expenses such as labor, fuel and electricity.There are many variations for the calculation of cash costs, so it is important to keep in mind that this measure is not exactly comparable across companies. Because it is stated on a per-unit basis, cash costs can be quite unpredictable, especially if operations are located in high-risk countries. Input costs, particularly labor and electricity costs, significantly increased in 2012, which amplified the already strong increase in cash costs as a function of lower output. In summary, the majority of the increase in cash costs is due to lower overall annual production with the balance coming mostly from labor and electricity cost increases.
TMR: What is the average cash cost for South African producers?
ER: We monitor cash costs on a C1 basis, which standardizes cash cost statistics. C1 cash costs refer to a standard definition of what figures must be used to calculate cash costs, making the measures comparable across the board. Last year, South African cash costs per ounce of PGMs were about $753 per ounce ($753/oz). Cash costs outside South Africa was much lower at about $570/oz. But you need to consider that South African PGM production, or output value, is relatively higher in platinum, which is why the cash cost is higher than the global average.
TMR: Is your analysis based on the combined output of platinum, palladium and rhodium?
ER: Yes. Other metals would be considered by-products.
TMR: What is the trend for cash costs in South Africa next year?
ER: For 2012, we have a preliminary estimate of a ~25% increase in cash costs to $940/oz. The key point here is much of that increase is due to the significant drop in output. The actual increase in cash costs could range between 15–25%. There are several ways companies can mitigate costs, such as mining higher-grade regions.
Cash costs of $925/oz puts some of the high-cost mines in the red in the near term. The near-term cash cost increase doesn’t suggest that these mines will close, because in most cases they were profitable during prior years. This year was unusual and very event driven. However, the current cost environment puts these operators at a higher risk.
TMR: Your report states that two of the five highest-cost PGM mines were already shut down in 2012. What is the story there?
ER: Those are the Everest and the Marikana mines. Both of them are partially owned by Aquarius Platinum Ltd. (AQP:ASX), which had quite an interesting and trying year. Those operations were closed, with Aquarius citing an adverse operating environment and low PGM prices. Management expects to restart operations when conditions improve, which may not be until 2014 at best. Another notable high-cost mine is the Bokoni mine. That operation is undergoing some restructuring between Anglo American Platinum Ltd. (AMS:JSE) and Atlatsa Resources Corp. (ATL:TSXV; ATL:NYSE.MKT; ATL:JSE). Its medium-term success depends on how smoothly that restructuring proceeds.
TMR: Are there other mines at risk for near-term closure either due to labor or infrastructure issues?
ER: Anglo Platinum’s Rustenburg operations may be at risk of temporary closure, or at least some shaft closures. This operation suffered a six-week-long strike that began in September. Costs are expected to increase significantly in 2012. These examples aside, most of the mines in South Africa, while at risk of poor operating performance due to the inherent issues unique to South Africa, are fairly positioned for the current price environment to continue operations in the long term.
TMR: What could happen to prices if output reverts to pre-2012 levels?
ER: This year the market reacted in two different ways. First, supply shocks increased uncertainty about supply, cut off supply flows and drove prices up sharply and rapidly. Platinum had a 24% trough-to-peak price increase during the Lonmin strike, for instance. Second, prices would drop nearly as fast upon the resolution of an illegal strike as investors started focusing on the dismal demand picture once again. My forecast is for a narrower price range in 2013. There’s less uncertainty about supply shocks—we have experienced strikes at all the major operations in South Africa and we have seen how the market reacted. The probability of a repeat of 2012 is low. But there still is a lot of pessimism about demand. As a result, I’m targeting approximately $1,450/oz for platinum as a low and $1,800/oz as a high for 2013.
TMR: What are your expectations for the demand side? Can you explain the major market segments and what is driving them?
ER: The largest user of PGMs is the auto industry. Auto demand will be driven by an improvement in Europe’s economy, possibly in H2/13. Expectations for improvement in the U.S. and Chinese economies this year would also be positive for fabrication demand. Overall, we expect positive, but tepid, demand growth for PGMs from the automotive sector. In auto catalysts there’s very little substitutability outside the PGM complex. Alternatives have been tried, but nothing else is as reliable and efficient. The auto makers are going to be buying PGMs despite the price for the foreseeable future.
The second-largest source of demand for platinum is jewelry. Platinum jewelry demand is dominated by China. We expect a lower growth rate compared to previous years—positive, but growing slower. Lastly, we expect modest growth from electronic fabrication demand, which mostly applies to palladium. Overall, we are looking for modest growth relative to 2012 levels.
Jewelry users of PGMs are much more price sensitive. Platinum is the largest jewelry component in the fabrication demand portfolio. When prices rise, jewelry demand typically comes off. Jewelers try to keep their price points stable for customers and one way to do that is to reduce metal content, which translates to the industry buying in lower volumes.
TMR: Investors are increasingly participating in the PGM markets—how is 2013 market sentiment looking?
ER: Especially in the case of platinum, investors in 2012 looked to the economy in Europe for clues about PGM market direction. That resulted in a very negative view. Currently, there are expectations for improvement in H2/13 for the European economy that should improve the outlook for PGMs. There may be buying activity in anticipation of that economic growth.
Slightly stronger growth in China and the U.S. obviously would also be positive for investor views on PGMs. PGMs are seen as a way to play an overall increase in industrial and economic activity.
TMR: PGM exchange traded products (ETPs) have grown globally in the last few years. Are the ETPs a significant force in the market yet?
ER: The introduction of the physically backed PGM ETPs has helped to expand marketing efforts for these markets. The PGM markets are much smaller than the gold or silver markets. The ETPs have really contributed to an overall expansion of the PGM investor base. Specifically, they have provided retail-level investors with a lot more access to these markets.
TMR: Platinum has been hovering at roughly a $100 discount to the price of gold for the last several months. Is this a transient condition or the new normal?
ER: The run-up in gold prices above platinum makes sense because of all the layers of uncertainty in the global financial markets in recent years. The historically large premium that gold has over platinum at present reflects the unusually high level of uncertainty about future economic growth, fiscal deficits, monetary issues and the host of other problems that came to light during and after the financial crisis. We believe a lot of the run-up in gold prices based on these layers of uncertainty are priced into the market now. Once these layers of uncertainty begin to dissolve, we expect to see the platinum price move above gold once again. In the long term, we see platinum’s fundamentals as more positive than gold, so we expect to have platinum prices rising, whereas we see a lot of potential for gold prices to decline in the medium term. Potentially as early as 2014, we could see the annual average price of platinum exceed that of gold. On a daily basis, this could happen sooner—perhaps by late 2013.
TMR: Besides bullion or ETPs, another option for investor exposure would be mining equities. What companies are you watching?
ER: Despite a lot of exploration spending in Canada, the main area of interest remains South Africa. Approximately 85–90% of the pipeline for future PGM mine production is located in South Africa with the remainder completely in North America.
In North America we expect several miners to develop PGM projects over the next 10 years. Those include Stillwater Mining Co.’s (SWC:NYSE) Marathon project, Polymet Mining Corp.’s (POM:TSX; PLM:NYSE.MKT) NorthMet project and Panoramic Resources Ltd.’s (PAN:ASX) Thunder Bay North project.
TMR: Because prices have been strong for some time, the PGM recycling rate is high. Does PGM recycling compete with mine supply?
ER: At this point it’s not competing (albeit it is a critical component of supply in today’s market), but we expect strong growth in platinum and palladium recycling rates over the next 10 years. Palladium began to be used more in gasoline engines in the late 1990s, with or replacing platinum. Many of those converters are due to be recycled, so growth in palladium recycling is expected to be stronger relative to platinum recycling over the next few years. Secondary supply will account for a much larger portion of total supply in the future. We see it rising from a current 10–15% of supply to 20–30% over the next decade.
TMR: What are the major differences between platinum and palladium in terms of price performance?
ER: Palladium prices respond much more strongly to investor views on industrial activity. Platinum will trade somewhat as a financial asset like silver and gold. Palladium is much more an industrial play.
TMR: At present, are investors or industrial users the main driver of the PGM market?
ER: While investors might be a marginal component in terms of absorbing supply, they are critical in rapidly adjusting the market price. Investors have driven PGM prices this year. The 2012 price chart looks like a roller coaster—clearly influenced by supply shocks when investors were bidding up the price. When the supply shocks were resolved, investors would focus on their views about economic conditions. That resulted in reevaluating fabrication demand expectations, which were very negative based on the state of the economy.
TMR: Do you expect a similar situation going forward?
ER: Yes. I expect investors to attempt to capture any upside in the market that develops due to supply constraints and/or positive demand expectations. That said, we expect volatility to be somewhat reduced from 2012 levels.
TMR: Many or most platinum equities have had dismal stock market performance in 2012 —much worse than their underlying commodities. Is there a light at the end of the tunnel for equity investors in the PGM mining sector?
ER: The PGM mining sector is still the mining sector. It has been a tough time, but especially bad for the PGM miners because of the huge reliance on South Africa. A bad mining industry environment plus illegal strikes and large increases in cash costs equals poor equity performance. One way mining companies have attempted to address this is changing management. The CEOs in the top-four largest PGM companies all changed in 2012. Lonmin Plc’s (LMNIY:OTCBB) Ian Farmer stepped down due to illness and was temporarily replaced by Simon Scott, CFO. Aquarius’ former CEO, Stuart Murray, was replaced by Jean Nel, former chief operating officer for the company. Impala Platinum Holdings Ltd.’s (IMP:JSE) David Brown was replaced by Terence Goodlace, the former CEO of Metorex Ltd. (MTX:SJ). Finally, Anglo Platinum CEO Neville Nicolau resigned and was replaced by Chris Griffith, who was CEO of Anglo’s Kumba Iron Ore Ltd.
TMR: It’s a similar phenomenon to what has been taking place among North American senior gold miners.
ER: It is a sign that the industry is taking a more aggressive position in seeking solutions to its challenges.
TMR: New mining frontiers have made headlines in 2012, both underwater and airborne. Asteroids have come into focus as a potential source for PGMs. What’s your view on this topic?
ER: Asteroid mining is a novel idea. I get asked about novel technologies in the PGM sector all the time. The central point to remember is that these technologies are not near-term potential contributors to the market. In this case, there would be a tremendous amount of equipment development required and staggering logistical requirements. That’s going to take decades.
Commercialization of new and novel technologies takes much longer than many people might think. One example, which is also an emerging application of PGMs, is fuel cells. Fuel cells were developed over 100 years ago, but they’re only now being applied to commercial-scale markets. Mining asteroids for platinum is interesting. . .but is a long way off.
TMR: CPM Group publishes excellent market commentary. How can investors access those?
ER: We produce a monthly Precious Metals Advisory and a Base Metals Advisory, both of which contain price projections, relevant market information and supply and demand tables. It is released in the third week of the month. These are annual subscription products. More casual market participants can join our distribution list to receive free market commentaries. CPM Group also publishes three precious metals Yearbooks that are effectively the “year in review” for the gold, silver and PGM markets, released during the first six months of every year.
TMR: Thanks for your time—it has been interesting.
ER: My pleasure.
Erica Rannestad is a commodity analyst at CPM Group. Rannestad covers the precious metals and agricultural softs markets as well as currency markets. She is responsible for building CPM Group’s supply and demand statistics for the precious metals Yearbooks and Long-Term Outlook reports. Rannestad is currently most closely monitoring the silver and platinum markets, providing near- and medium-term price forecasts for these metals in CPM Group’s Precious Metals Advisory, a monthly publication. Rannestad also often contributes to and supports CPM Group consulting projects and regularly presents CPM Group’s market views at conferences and seminars around the world. Rannestad holds a Bachelor of Science degree in finance from Fordham University’s Gabelli School of Business.
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Gold has been produced in Africa for thousands of years in places like Ghana and neighboring countries whose names have changed over the centuries. One thing that has not changed is that there’s still a huge amount of gold to be found and mined in West Africa. That’s what Mark Lackey likes about the area and in this interview with The Gold Report, he talks about companies that are or will be producing significant amounts of the world’s prized metal.
The Gold Report: When you last spoke with The Gold Report this past March, gold had just dropped from its first peak of the year, from $1,781/ounce (oz) at the end of February to $1,660/oz in a matter of three weeks. Now it’s looking for support at $1,700/oz. The trading range you predicted for 2012 looks good in retrospect. What are you projecting from here?
Mark Lackey: I’m looking at a range from $1,680/oz to $1,850/oz, and moving up over the year so that by December I am expecting to see the gold price at $1,850/oz.
TGR: But you don’t see a big breakout past $2,000/oz that some people are predicting?
ML: It’s possible, but for the gold price to go much higher than $1,850/oz there needs to be a good reason, such as a big decline in the value of the U.S. dollar or major gold buying by central banks. While I expect the dollar will weaken somewhat in 2013, I don’t expect a huge decline. Over the next few years we’ll get above $2,000/oz, but probably not in 2013.
TGR: What do you see as the market drivers for gold at this time?
ML: Significant trade and fiscal deficits remain in the United States and the country is continuing to use quantitative easing, which tends to lower the value of the U.S. dollar. Investors are going to look at the U.S. dollar and the euro and decide that there are other financial options they would rather own. Some investors will buy gold as an investment alternative to paper currencies.
“I believe that jewelry demand will continue to increase as a result of the growing middle class in Indonesia, China and India.”
In addition, I believe that jewelry demand will continue to increase as a result of the growing middle class in Indonesia, China and India. Those are the demand factors that will move the price of gold higher in the short run. We also anticipate that some of the gold projects that are expected to begin production in 2013 will be delayed due to regulatory and permitting issues and this will lower the supply of gold on the world market and therefore push up the price of gold.
TGR: What’s the next concern that might become the focus for precious metals investors?
ML: I don’t think Europe’s problems have gone away after allocating over $300 billion to Greece. We cannot count on Europe to have the kind of economic growth it once did, but as long as it doesn’t crater dramatically, there’s still going to be demand for gold and other commodities. I’m looking at a modest recession in Europe in 2013. I do think the Spanish banking system will be bailed out but as long as Spain’s sovereign debt doesn’t have to be bailed out, Europe will muddle through.
TGR: Despite the relative strength of gold over the past year, the performance of gold stocks has been pretty disappointing. When and how is the turnaround coming?
ML: If you look at the performance of the gold markets, the one area where we’ve actually made some good returns was in the mid-cap gold producers and near-term producers that did rally with the price of gold. The problem for many of the larger producers was that they didn’t reach the production numbers that they had forecast and their production costs were also above what they had planned. Thus their earnings and cash flows were below expectations and this resulted in share prices that did not follow the rising gold price.
“We expect that with gold prices going higher in 2013, investors will be buying the well-run junior companies.”
There are a number of smaller gold companies that do not have much cash left on the balance sheet and found it difficult to raise money in this past year so this prevents these companies from moving their projects forward. The Toronto Venture market has declined from a level of 2,450 in April 2011 to 1,200 at end of 2012, so it is not surprising that many junior mining companies have had a difficult time trying to attract new financing. Many of those companies saw significant declines in their share prices especially at the end of 2012 as they were hit by tax-loss selling.
We believe that there will be share price appreciation in 2013 for those junior gold companies that still have money (or can raise it) and have good projects. We expect that with gold prices going higher in 2013, investors will be buying the well-run junior companies, especially those that may have declined or lagged behind in 2012 due to the overall market conditions.
TGR: Where do you see the best opportunities for investors in gold stocks these days?
ML: We look at three or four factors when we try to make a decision on a gold company. We like to see an experienced management team with a project or projects in a jurisdiction that does not have significant political risk. We also look for companies that have a mining-friendly terrain and have access to transportation, power and water. We prefer the companies to be producers or near-term gold producers. We are concentrating, as we mentioned earlier, on mid-cap and junior companies that have cash in the treasury and are also looking for those companies that are potential takeover candidates. My company, CHF Investor Relations, has several clients in gold.
TGR: Last time you talked mainly about companies active in Africa. We know there is lots of potential there, but it seems that there’s also been some unrest lately that might cause concerns for some investors. How does the current picture look to you?
ML: The gold opportunities tend to concentrate in West Africa, where three of the four countries, Senegal, Ghana and Burkina Faso, are quite stable by anybody’s standards and have had no problems with political unrest or indigenization of resources. In Mali, the problem is with the Tuareg rebels and Islamists in northern Mali. The mining companies are in southern Mali, hundreds of miles away.
“West Africa has a lot of advantages compared to some of the more traditional mining areas.”
Last month the UN Security Council voted to have 3,300 African troops sent to Mali to remove the rebels from the northern part of the country. The mining employees who we have talked to in Mali have told us that their mining operations have not been impacted, either in production or exploration, by the problems in the north. There have been problems in other parts of Africa, but we have been watching West African projects closely. CHF has no clients in West Africa, by the way.
TGR: So what are some of the most interesting stories you’re looking at now?
ML: One we like is Teranga Gold Corp. (TGZ:TSX; TGZ:ASX), which is in Senegal. Teranga says it will exit 2012 with production between 210,000 oz and 225,000 oz for the year and in the third quarter cash costs were down to $594/oz. The company has its own mill, which is the only one in Senegal, and Teranga also has the largest land position in the country. It has a strong balance sheet having cash equivalents of $31.2 million (M) at Nov. 1, 2012, and reported a record high third quarter profit of $21.3M. The company says it will eliminate its hedge book by August and will have increasing gold production along with lowering costs of production. Teranga will focus on producing the gold ounces that will provide the best returns.
TGR: What else do you like in West Africa?
ML: Another one we’ve been looking at is Orezone Gold Corporation (ORE:TSX), which is developing the Bomboré project, the largest undeveloped gold mine in Burkina Faso. It has a strong development team and large near-surface tonnage, so it’s going to be a relatively low-cost producer. It has 2 million ounces (Moz) in oxide resources in the top 50 meters, and 80% of its resources are within the top 80 meters from surface. The property is close to the national highway and has nearby water, power and a large labor force, which should translate into reduced development and operating costs.
TGR: Those are some pretty world-class resources.
ML: Orezone’s recent NI 43-101 released in October 2012 contained 4.1 Moz of Indicated and 1 Moz of Inferred resources. This will be a significant gold producer in the next few years.
TGR: Or possibly get taken out.
ML: That’s certainly possible. Given the increasing drilling activity and the increase in gold reserves in Burkina Faso, Senegal, Mali and Ghana, many major and mid-size gold producers will be looking to acquire some of these companies. Orezone is one of the companies that could be taken over.
TGR: What’s been going on with some of the companies you talked about last March?
ML: Riverstone Resources Inc. (RVS:TSX.V) announced on Dec. 19 that it had completed its takeover of Blue Gold Mining. This will add some very strong talent to an already very good management team working to advance the Karma project, its flagship play in Burkina Faso. Riverstone also has three additional properties. Recent drilling activity has been very good. This is another miner that we think will have production in the next few years.
TGR: Was this a strategic merger?
ML: Yes. I think the idea here was that if these two teams got together, they could make a much stronger company. Combining the management teams and their financial resources will, in our view, lower the execution risk of their projects and significantly improve the company’s ability to finance itself in the future.
TGR: What else do you have here?
ML: We talked about Channel Resources Ltd. (CHU:TSX.V), which has the Tanlouka property in Burkina Faso. We like Channel as it could become a mid-term producer of approximately 100,000 oz by 2018. The present Indicated and Inferred estimate at Mankarga 5 is 1.2 Moz. Channel has some other excellent exploration targets and we believe that the projects at Manesse and Tanwaka have the potential to host gold deposits similar to Mankarga 5. The additional exploration could eventually define a resource above the 2 Moz level. This exploration team has done an excellent job as it has been successful in defining a major gold resource. We like these oxide deposits for their metallurgical properties, since it usually means that the deposits can be mined at a low strip ratio.
TGR: What else looks interesting?
ML: The next one is African Gold Group Inc. (AGG:TSX.V); the company is developing the Kobada property in southwest Mali. We think African Gold can begin production in 2015, and by 2017 we are projecting annual production of 125,000 oz of gold. One of the big advantages in this part of the world is the highly oxidized rock, which is relatively cheap to mine and mill and also lies close to the surface. It has other exploration opportunities with the large sulfide resources below the oxide layers, which can significantly increase reserves.
In addition to the Kobada property, the company has other promising exploration targets at Gossokorodji, Diaban and Foroko North. African Gold has been in Mali for years and has personnel who have developed other gold mines in Mali.
TGR: What’s next on your list?
ML: Volta Resources Inc. (VTR:TSX) is a company that has really moved forward, having nine exploration projects. It is currently transitioning itself from explorer to producer in Burkina Faso, at present to converting its flagship asset, the Kiaka gold project, into a producing gold mine. The present NI 43-101 contains 4.1 Moz in the Measured and Indicated categories, and 1 Moz in the Inferred category. Given the size of the resource, I would think that, down the road, Volta could be a potential takeover candidate. Given its excellent resources and $21M in cash and no debt, Volta will have no concerns about having to raise money anytime soon. That’s a significant plus in this market.
TGR: What else do you have?
ML: A lot of people know Pelangio Exploration Inc. (PX:TSX.V) because, going back in its history, it developed the Detour Lake Gold Mine in northern Ontario and that ended up becoming a big winner for shareholders. It now has two properties in Ghana where it has completed some drilling that has recently started to show some interesting results. Its Manfo property lies between the Ahafo mine, which is operated by Newmont Mining Corporation (NEM:NYSE), and Kinross Gold Corp.’s (K:TSX; KGC:NYSE) Chirano mine. You would think Pelangio has a good chance of being on strike with the producers on either side. If it can continue to do more drilling and produce more similar results, we might see some pretty interesting resource estimates come about for this project.
Pelangio also has another very good property, the Obuasi property in Ghana, located adjacent to AngloGold Ashanti Ltd.’s (AU:NYSE; ANG:JSE; AGG:ASX) Obuasi mine, which has already produced 30 Moz of gold. This is an interesting play because of management’s extremely successful track record and because it has added a number of individuals to the management team who have significant experience with mining operations in Ghana. We’ll have to follow and see how the drilling results go, but certainly it is a very interesting play with major upside potential.
TGR: That’s another one to keep an eye on.
ML: The last one I’ve got in Africa is Roxgold Inc. (ROG:TSX.V), which had a proxy battle last summer. Ultimately a deal was completed and I give credit to Oliver Lennox-King and Rick Mazur. Mazur was the executive handling the restructuring and then left when it was done. They put together a strong board and a good management team. This is important because I’ve seen these sorts of proxy battles in the past that ended up destroying some companies.
Roxgold is presently developing three mining properties in Burkina Faso. The company is advancing a high-grade gold discovery at its flagship property at Yaramoko. At the 55 Zone there is an initial resource estimate of 354,000 oz of gold, that graded 17.8 grams/ton (g/t) in the Indicated category and 306,000 oz of gold that graded 7.7 g/t in the Inferred category. These grade are not typical in Burkina Faso where most projects are big volume but low grade. The company has raised $65M to date, so it’s well capitalized for its 2013 drilling program. If the company can continue to increase its high-grade tonnage, it will certainly be a takeover candidate.
TGR: Do you have any wildcard plays anywhere that people might be interested in, either in precious metals or otherwise?
ML: We’ve been looking at a number of zinc plays and probably our favorite right now is Chieftain Metals Inc. (CFB.TSX), which has properties in northern British Columbia. We like this one because, first of all, it has a very experienced management team, which is critical to understanding the metallurgy and the mining in northwestern B.C. Second, with all the zinc mines that are going to close in the next few years, taking millions of pounds out of production, we believe there’s going to be an upward move in the price for zinc, certainly by 2014–2015. Chieftain has recently completed a financing and it should be publishing its feasibility study later this month.
Within a couple of years we think that the zinc price will increase up to $1.40 a pound. That makes a number of zinc plays attractive, especially Chieftain, given its potential to become a zinc producer.
TGR: Where do we go from here, and how should our readers be positioning themselves for what lies ahead in 2013?
ML: As I said, CHF has a number of clients in gold, some low-cost producers, too, but generally speaking, in the gold sector, we would concentrate primarily on jurisdictions we like. West Africa has a lot of advantages compared to some of the more traditional mining areas. One factor is that it is easier to get mining permits compared to some of the jurisdictions in North and South America. West Africa is also flat and dry, has water, power, transportation and a good labor force. In addition, we want experienced management teams that have experience in the jurisdictions where they are exploring.
TGR: Thanks for the ideas and updates, Mark, and we’ll stay tuned and hope for the best in 2013.
ML: Thanks for the opportunity.
Mark Lackey, executive vice president of CHF Investor Relations (Cavalcanti Hume Funfer Inc.), has 30 years of experience in energy, mining, banking and investment research sectors. At CHF, Lackey involves himself with business development, client positioning, staff team coaching and education, market analysis and special projects to benefit client companies. He has worked as chief investment strategist at Pope & Company Ltd. and at the Bank of Canada, where he was responsible for U.S. economic forecasting. He was a senior manager of commodities at the Bank of Montreal. He also spent 10 years in the oil industry with Gulf Canada, Chevron Canada and Petro Canada.
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The past year was a very tough one for the junior gold mining sector. In this interview with The Gold Report, Brien Lundin, CEO of Jefferson Financial, says that the past year has, in fact, put many gold mining companies on the bargain basement shelf. He shares some advice on end-of-year portfolio repositions and talks about some of his favorite stocks that he believes are poised for a rebound in 2013.
The Gold Report: Brien, in late October you and your company Jefferson Financial hosted the New Orleans Investment Conference. What were some of the commodity-related themes consistently making the rounds there?
Brien Lundin: The buzz was that the underlying fundamentals for precious metals would remain bullish regardless of who won the election. But if President Obama were re-elected, then all of the factors favoring gold and silver would become dramatically more bullish.
TGR: You wrote about that in the November edition of Gold Newsletter. Here’s a quote from that edition of your newsletter: “The bottom line is that President Obama’s re-election means that you need to buy gold and silver, and things that will retain their value as the dollar loses its value.” Why were things different on Nov. 7 than they were the day before?
BL: Even before the election, the economic and fiscal situation for the United States was pretty dire. In my view the only hope of recovery and reform, without a major ongoing crisis and very significant inflation, would be if the Paul Ryan plan were to be put into effect immediately.
“When the perceived risk is one of long-term currency debasement, gold is the preferred safe haven. “
Instead, we now have the same administration that took the emergency one-year spending levels enacted to keep the economy from crashing during the 2008 credit crisis, and has now made those massive spending levels the new baseline going forward. The difference is that the Obama administration is now unrestrained by the prospect of another election, so the trajectory of government spending is actually being steepened.
TGR: In another passage of the same edition of Gold Newsletter you wrote: “The coming inflation will be similar to what we’ve experienced in recent years. Huge pools of loose money will continue to flow into commodities and financial assets.” What makes you certain that we won’t see another round of risk-off sentiment if things go as badly as you suggest they will?
BL: The risk-off episodes that seized the investment markets over the past few years are in reaction to potential fiscal crises in the U.S. and Europe. This headline risk sent investors running to the safety of cash, specifically to the U.S. dollar. This seems counterintuitive, but investors are looking for short-term safety.
When the perceived risk is one of long-term currency debasement, then gold is the preferred safe haven. My whole bull market thesis for gold is based on a developing consensus that neither Europe nor the U.S. is going to face collapse anytime soon. Rather each will be kept afloat on a sea of new money printing by both the Federal Reserve and the European Central Bank. In such an environment, gold and silver are going to absolutely take off.
TGR: Do you think that lack of practicality of gold hampers its status as a safe haven?
BL: Not today. Gold is very liquid. A lot of speculators use the exchange-traded funds (ETFs), which I recommend for trading the metals. But I don’t recommend ETFs for core holdings.
In fact, one of the things that is keeping the market buoyed currently is the tremendous retail investor demand for the metals. That comes in the form of skyrocketing physical sales of coins and bullion, and in the ETFs. Metals holdings of the ETFs are at record levels. Coin demand is at near record levels. Yet we see the price moribund due to the whims of speculative demand.
TGR: It’s interesting that you’re pro ETFs, because most gold bulls aren’t. Is this a new tack for you?
BL: Not really. You know a lot of the hard-core goldbugs are somewhat doubtful of whether the EFT gold is actually there. I recognize those concerns, so I don’t recommend ETFs for core physical metals holdings, just for trading.
TGR: When should equities enter the mix for a retail investor?
BL: Simply put, right now. The junior resource stocks have been absolutely decimated over the past year. There are bargains galore right now if you have cash to buy them.
TGR: Are these bargains mostly market related or is this part of tax-loss selling season?
BL: I don’t really distinguish between the two. We’ve had a lousy year for the equities. When we have had risk-on environments, they have not lasted long enough to where it filtered down to the highly speculative junior resource equities.
We also have an unusual situation this year where we have not only tax-loss selling but also tax-gain selling as investors take profits to avoid higher capital gains taxes next year. When you combine that with the junior stock market that has been depressed all year, some incredible bargains emerge. I’m pinpointing a number of them in Gold Newsletter right now.
TGR: Let’s talk about some of the equities that you follow. You said in a recent edition of your newsletter that Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) has “opted to forego” the prospect-generator model in an effort to develop the promising Ixtaca gold-silver deposit in Mexico that’s part of the Tuligtic project. Is that your opinion?
BL: Yes. I have never been a big believer in the prospect-generator business model as an absolute. It should be a business model, not a religion. So when a junior explorer comes across a prospect that is particularly exciting and can provide rapid value advancement with relatively little risk, then I think the company should explore that project fully.
Almaden was the poster child for the prospector-generator model for years. But Morgan and Dwayne Poliquin had the vision and the foresight to see that Ixtaca could be different. Their decision has paid off in spades. Almaden right now is one of my top recommendations and I think that deposit is going to get much bigger than the company’s current market cap is indicating.
TGR: Almaden has about $36 million (M) to continue to develop Ixtaca. Do you think that it will sell that project, dividend the money out to shareholders, and then continue on its way? Or do you think it will sell the whole company? Or would it do something similar to what Virginia Mines Inc. (VGQ:TSX) did when it took all the other projects out of that company, put them in a new company, and sold that company to Goldcorp Inc. (G:TSX; GG:NYSE)?
BL: Typically in a case where a company has a number of earlier-stage projects, and it has one major project for which it is primarily being valued, then management will sell the company. Usually you’ll see a spin off of those other projects into a new vehicle so that shareholders can keep the benefit of that other property portfolio that really isn’t adding value to the transaction. That’s a process to fund that new company as well.
TGR: You’ve also written that Brigus Gold Corp. (BRD:NYSE.MKT; BRD:TSX) looked “undervalued” in early November after Brigus bought back much of its gold royalty stream from Sandstorm Gold Ltd. (SSL:TSX.V). Tell us about that deal and the market’s reaction to it.
BL: There are a few keys to Brigus Gold and the opportunity it presents. First, the company ran into operational problems when it was trying to ramp up production at its Black Fox Mine, prompting a decline in the share price.
“The junior resource stocks have been absolutely decimated over the past year. There are bargains galore right now if you have cash to buy them.”
Those production hiccups have been solved and production is now growing. Yet the company’s shares are on sale. In addition, there is the exploration drilling the company is doing on its Grey Fox property near the Black Fox Mine. In particular it is getting tremendous results from a high-grade zone called the 147 Zone. Those results are normally enough to absolutely catapult the value of a junior explorer. But the results are getting lost in the shuffle because Brigus is a production story. In fact, this Grey Fox property will become the company’s next mine.
TGR: Another company you follow is Comstock Metals Ltd. (CSL:TSX.V). You see more promise in the recent drill results from the company’s QV project in the Yukon than the market does. Give us your thoughts on that.
BL: Comstock is a case where expectations were really high before the first drill results came in. The results were actually quite good, but not quite up to the elevated expectations. So the share price sold off, which was unwarranted.
The first results showed the potential for a nice sized deposit at the VG Zone. Importantly, the company also outlined a number of other drill targets from soil sampling and trenching. The real key for Comstock will come with next year’s exploration program. The company’s geologists plan to mount a comprehensive attack on all those highly prospective targets.
“Once we get through these end of year trading games and that fiscal cliff fiasco, the markets should settle down into an environment where everyone recognizes that massive money printing will continue for years to come.”
I think Comstock is a longer-term story. It’s not going to be built on a few drill holes or even a couple of rounds of drilling. It’s a project that has a number of very exciting targets. It’s a cross between the Underworld Resources story, which had the Golden Saddle deposit just about 10 or 11 kilometers to the south, and the Kaminak Gold Corp. (KAM:TSX.V) story not far away. Kaminak had a number of anomalies that it had to drill off and is only now starting to connect those anomalies with mineralization.
There’s a lot of potential in Comstock. I see some very exciting analogs in the area and the mineralization that it has seen so far is very, very similar to that at the Golden Saddle discovery by Underworld. That discovery was a big winner for Gold Newsletter readers, when Kinross Gold Corp. (K:TSX; KGC:NYSE) took over Underworld at a big premium.
TGR: One hole cut 89.9 meters of 2.34 grams per tonne gold. Could this be a bulk tonnage starter?
BL: That wasn’t a very deep intersection, so it could be bulk tonnage. People tend to feel that the grades in the Yukon have to be very high even for a bulk-tonnage or an open-pit deposit for the economics to work. But this whole area is becoming ripe with new discoveries and infrastructure will follow, and, at some point, it’s also going to be ripe for consolidation. So I think that the current grades are very close to what a company would need to make a deposit work in the Yukon.
TGR: What did you make of the recent friendly merger between Keegan Resources Inc. (KGN:TSX; KGN:NYSE.MKT) and PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE)?
BL: It was a great deal for both companies. Everyone’s been waiting for one of the majors to come in and scoop up one or both of these juniors and consolidate the projects in this area of Ghana. But those takeovers never happened. So these two management teams essentially decided to do it on their own.
In the near term, this isn’t a big share-price catalyst. But considering that the combined companies can now fully find the development of the more advanced Obotan project of PMI and get into production, the financing risk is removed essentially for both projects.
Obotan should get into full production by 2015 at around 200,000 ounces (oz)/year. By 2017, Keegan’s Esaase project will get added to the mix and bring production up to around 385,000 ounces annually. The bottom line is that we now have either a must-have acquisition by a major or the emergence of a new midlevel producer with the potential to continue consolidating the region.
TGR: Do you see this as an investible theme? Companies with nearby development-stage projects that are suffering from markets that aren’t all that flush with cash getting together?
BL: In this case, both of these companies are fairly well funded. I see them as being potential aggressors in a new round of merger and acquisition activity. These companies also have additional exploration potential. Keegan just made a new, very important property acquisition. It was a property swap with the Ghana government that it’s been working on for years and where the company sees the potential for some sizable extensions to the Esaase mineralization. So the story could get bigger on every front.
TGR: You recently added some companies to the rather lengthy list of ones that you cover. One of them is Precipitate Gold Corp. (PRG:TSX.V), which is seeking gold in the Dominican Republic. Does it concern you that it has only $1.8M in exploration capital?
BL: Not really. That amount is actually a decent treasury compared to the peer group. There are hundreds of companies in the junior resource sector now that only have a few $100,000 in the treasury. The company, though, will have to raise more money to advance its projects in the Dominican Republic.
There is potential for further dilution, but the share structure is fairly tight. There’s only about 24–25M shares outstanding, no warrants overhanging the stock, and the company is well-held by a strong group of financiers. Bottom line is I don’t think they’ll have any problems raising additional funds if needed.
TGR: Another company that’s exploring the Dominican Republic is GoldQuest Mining Corp. (GQC:TSX.V). It recently had some less than ideal drill results and the market reacted negatively to those. Was Precipitate affected adversely by association?
BL: Absolutely. GoldQuest was another case where the expectations were raised really high. The first few drill holes from GoldQuest were just phenomenal and it would have been very difficult to continue that. GoldQuest really hit the honey holes right at the beginning.
But now the hype has definitely died down from the whole Dominican Republic play and Precipitate did suffer from that. The hype over the Dominican Republic helped obscure Precipitate’s outstanding property portfolio in the Yukon and British Columbia, where it has about 19 highly prospective properties that were acquired for really valid geological reasons. That’s the side of the company where I expect the next really important exploration news will come from.
TGR: What are some other companies that you follow that could see a rebound in 2013?
BL: The list is starting to grow a bit long. But there are really some remarkable bargains right now as the year draws to a close. Investors should concentrate on companies with either proven resources and/or the likelihood of big news on the near-term horizon.
Some of the prime examples that I would throw into this category are Cayden Resources Inc. (CYD:TSX.V), International Tower Hill Mines Ltd. (ITH:TSX; THM:NYSE.MKT), Gold Standard Ventures Corp. (GSV:TSX.V; GDVXF:OTCQX), Kaminak Gold, and Lion One Metals Ltd. (LIO:TSX.V; LOMLF:OTCQX; LY1:FSE).
TGR: Let’s start with Cayden. That’s a story that’s largely unfamiliar to our readers, with the La Magnetita target in Mexico.
BL: What’s important about Cayden is that there are a few aspects to the story. There’s the property position that it has at the Morelos Sur gold project. It actually partially surrounds and transects the largest producing gold mine in Mexico, Los Filos, which is owned by Goldcorp.
That mine has to expand, and in fact, it’s already encroaching on the surface onto Cayden’s property position. That means there’s going to have to be some kind of a financial accommodation done there and it could be significant for the company.
In addition, Cayden has the land between the two producing pits on Goldcorp’s mine and Cayden has drilled that. It has shown that there is mineralization trending from between those two pits at depth on its property. So Cayden has proven mineralization and an obvious natural buyer for whatever it can prove up.
Then you have the La Magnetita target. The key to that is that every mine and discovery in the Guerrero Gold Belt has been identified through geophysical means. Importantly, La Magnetita is the largest geophysical anomaly in the belt. To date Cayden has gotten some outstanding sampling and trenching results, and is now drilling, so I’m very excited about that potential.
TGR: International Tower Hill is a story that took off a few years ago and seems to have stumbled more recently. What’s happening with the company now?
BL: Its Livengood gold project is a case of a really large project with lower grades. The project is still economical, but you have to get the majors out there ready to buy up such a project. That will likely happen, but only when we have a sense of normalcy in the market that we haven’t had in the last 18 to 24 months.
TGR: How about Kaminak? We talked a little bit about the Yukon with Comstock and Kaminak’s right there too in the White Gold District.
BL: Yes, it is connecting all of these various anomalies on its property and building up a resource that, in its recently released maiden resource estimate, is already totaling over 3.2 million ounces of inferred resource.
Kaminak has come off a good bit and could be a prime takeover candidate. It’s being derisked with every drill hole. The company has had incredible success so far and it has just completed one of the most aggressive drill programs to be seen in the junior resource world in many years.
At the current price levels, it’s hard to get hurt in Kaminak.
TGR: Gold Standard Ventures, which owns the Railroad gold project in north central Nevada, is a made-in-America story. What’s the next catalyst for Gold Standard?
BL: This was a slow motion discovery. When the company first came public, I didn’t recommend it in my newsletter because I thought it was too expensive.
The company’s first results weren’t spectacular by any means, but they were technical successes—not market successes. However, once you understood the story and talked to the geologists, you understood that the company was vectoring in on something that could be big. We were able to get our readers in on the stock before the big run up, which was just wonderful timing, after it had declined a bit after it first came public.
The geologists kept vectoring in on the mineralization while proving up the geological concept, until they eventually found the higher-grade mineralization. At this point, it is still trying to fully understand the mineralization and get a much better handle on it. I think what you’ll see is that Gold Standard will be able to advance the resource to a much greater degree over the coming months. This is another example of those very hot stories that have come back a good bit, yet have a proven discovery, and the company will just keep drilling to prove up a resource.
TGR: What’s happening with Lion One?
BL: Lion One is progressing with permitting and development of its Tuvatu gold project in Fiji, a project with upside potential that I don’t believe is being valued by the market at all. Over $30M was spent on this project by Emperor Mines Ltd. in the late 1990s, including over 85,000m of drilling and 1,600m of underground infrastructure.
All Lion One has to do is dust off and update an existing feasibility study, and get the necessary permits to get into production. It is doing that right now, and will use proceeds from Tuvatu to fund exploration of the multimillion-ounce potential of the project.
Management, including legendary financier Walter Berukoff, owns about 40% of the company, so it has solid support going forward. It’s a great buy at these levels.
TGR: It’s the end of the year and some retail investors are wondering what to do with their portfolios and if they should make some changes. Is there a process that you go through at the end of the year?
BL: The end of the calendar year is a natural time to clean up a portfolio and rationalize things. But it is also the time of the year that you typically have tax-loss selling that creates a dampening effect on the markets and sometimes creates some pretty attractive bargains. This year, as I said, we’ve had some screaming bargains created.
I think what investors need to do, and we’re doing it with our Gold Newsletter portfolio as well, is to look at the number of companies that you can adequately follow. If you’re able to find some really attractive opportunities in this kind of an environment, you need to start switching into these faster horses in exchange for some of the slower horses in your stable. Just turn over the portfolio a bit, rearrange it and get prepared for the future.
It’s especially important if you can find companies that are better positioned going forward than the ones you have in your portfolio and you can realize some tax losses going forward. There’s no reason to play the psychological games of holding on to a loser just so you can get back what you paid for the stock. Be ready to break emotional ties, sell a company and put the money on a better bet going forward.
TGR: We’d be remiss if we didn’t ask a gold bull like yourself to tell us what you think the coming year has in store for gold. Please give us your thoughts on that.
BL: It’s going to be a very good year for precious metals and mining stock investors. Once we get through these end of year trading games and that fiscal cliff fiasco, the markets should settle down into an environment where everyone recognizes that massive money printing will continue for years to come. This is the fundamental story that’s going to drive metals prices higher and in this environment the equities will begin to benefit once again.
There’s also a very powerful technical picture developing. Both gold and silver are tracing out a cup-and-handle formation similar to the ones they formed during the 2008 credit crisis and the subsequent recovery from that crisis. After that, the metals rocketed higher out of those cup-and-handle bottoming formations. I fully expect a similar performance this time around, which would be a pretty exceptionally profitable situation for gold bulls.
TGR: Thanks, Brien, for your insights.
With a career spanning three decades, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events. Under the Jefferson Financial umbrella, Lundin edits and publishes Gold Newsletter, a cornerstone of precious metals advisories since 1971. He also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind.
Surveying reality from his perch on Vancouver Island, Leonard Melman is a veritable sage in the world of metal mining analysis. In an interview with The Gold Report, the economic philosopher is troubled about the direction of the global economy. However, there are a few bright spots for eagle-eyed junior metal investors, he reports, and names some of his favorite picks.
The Gold Report: Leonard, what are the most pressing issues facing investors today?
Leonard Melman: Let’s start with the fiscal cliff. If America falls into this abyss, the combination of tax increases and spending reductions will slow down economic growth. Interestingly, political leaders in Europe are calling for increasing taxes and decreasing spending in order to solve their problems. I find it amusing that the solution to economic problems being proposed by leaders on the European side of the Atlantic is thought to be the problem on the American side of the Atlantic.
TGR: How do you account for the disconnect?
LM: It is due to a philosophical inconsistency and a lack of economic understanding on the part of the world’s political leaders, most of whom are not well qualified as economic thinkers, nor as philosophers for that matter.
TGR: How important is a philosophical stance to making a cogent economic analysis?
LM: Adhering to a strong underlying philosophy can guide leaders through difficult times. Unfortunately, demands by the public for more and more government services are making politicians even more reluctant to come down on the side of austerity, particularly in America. The results are uncontrollable deficits and a massive national debt. The statutory debt limit of the U.S. government is $16.394 trillion. The national debt of the U.S. as of mid-December was $16.337 trillion. Therefore, a mere $52 billion remained before the ever-rising debt reaches the statutory limit.
TGR: What will happen if no measures are taken to change the debt limit?
LM: According to law, portions of the government must cease operations once the limit is reached. Nobody wants to see that happen, least of all politicians. So I believe they will likely agree to increase the debt limit by another couple trillion dollars.
TGR: What will happen if the two-party system fails to agree on tax and spending cuts? How will the market respond?
LM: The market operates in two different directions. The precious metals market historically has regarded instability as a plus. The financial markets have historically regarded instability or uncertainty as a minus. If the parties fail to resolve either the fiscal cliff or the debt limit problem, I believe the financial markets will react negatively, but the precious metals markets will most probably react positively.
TGR: Then why has the price of gold bullion during the last year been so out of sync with the deflated price of junior gold mining stocks?
LM: In late 2007 and early 2008, the price of gold hovered near $800/ounce (oz). It’s over $1,700/oz now—more than double the earlier price—and yet the three most popular mining share indexes, the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold BUGS Index (HUI) and the Market Vectors Gold Miners ETF (GDX), are all below their late 2007 and early 2008 levels. That is rather astonishing. The reason is that the nature of mining—especially for the juniors—has undergone dramatic changes in recent years, none of which are positive. Increasing energy, transportation, geological and licensing costs make it now more expensive to mine for metals, but the most pressing problem is that the time that it takes to put a newly discovered mine into operation has increased at a rapid rate.
“The precious metals market historically has regarded instability as a plus.”
I’ve been in this business for four decades. In the late 1970s, a mine could anticipate rapid progress from the time of discovery. A junior simply raised money, put the money into the ground, proved up the asset, got construction financing and went into production. Now a series of lengthy bureaucratic processes are making it difficult for mining companies to raise new funds in the financial markets because that causes share dilution.
Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing, which then makes it even more difficult to advance exploration and development and a most difficult spiral ensues that makes it very difficult for miners to generate revenue from production.
TGR: Are environmental regulations the only cause of slowing timelines for new mine development?
LM: There are other obstacles. In Canada, we have an aboriginal problem. The courts have literally given many aboriginal tribes the ability to interfere in the progress of a mining venture. Companies are required to “consult” with them at various stages of progress. Consultation is expensive, it’s time consuming, and it can be interrupted by legal procedures at almost any time.
TGR: Do you see any changes in the near term?
LM: The near term remains very difficult. In the long term, I’m fairly optimistic, because the world needs metals to survive, plain and simple. You can’t cook food, you can’t drive anywhere, you can’t process energy, you can’t run computers, you can’t have medical instruments and you can’t do almost anything that we do in modern life without metals. When genuine metal shortages begin to develop, we will see pressure build for a revision in these policies.
TGR: Are there any North American gold juniors that can weather these difficulties?
LM: There are some. I’ve developed an interest in Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX). A while back, I got to know Darin Wagner, and he struck me as a very competent individual. He successfully sold a company called West Timmins Mining Inc. (WTM:TSX), and now he’s the president of Balmoral. He understands the value of obtaining properties with a high likelihood of success. The old adage is that if you want to develop a new mine, acquire property in the vicinity of an old mine. Balmoral is working in the Detour Gold Trend along the Québec-Ontario border, which has four different multimillion-ounce projects. Wagner has a great chance of success there.
“Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing.”
Another company that I like is DNI Metals Inc. (DNI:TSX.V; DG7:FSE). It is working to develop black shale deposits in northern Alberta fairly close to the shale oil deposits and those black shales contain an enormous variety of metals. DNI has proven up very sizeable ore bodies at two locations on its properties, Buckton and Buckton South, and its current work involves resolving metallurgical problems. It’s obviously a high-risk investment. The shares are about $0.18/share right now, but there could be a very substantial return if the project works out.
TGR: DNI’s shares have fallen from a high of about $0.65 a year ago. Why is that?
LM: The same thing we’ve been talking about: the prolonged period of trying to prove up the resource during which time a firm has to keep raising funds to satisfy all operational and regulatory requirements. And the longer it has to keep looking for new funds, the more shares are outstanding, which tends to dilute the value per share.
TGR: So now would be a good time to buy DNI?
LM: From a risk/reward ratio, I believe it is a good time to acquire the shares—being fully cognizant of the risks and, of course, an investor should always do his own due diligence, but I think the potential gains outweigh the potential risks.
TGR: What about investing in bullion as opposed to investing in gold stocks?
LM: As noted earlier, during the last four years, investing directly in gold bullion would have provided a 112% gain. Investments in a variety of mining shares would have, on balance, stood still. But in the past, the opposite dynamic has applied. Looking forward, if the world monetary situation keeps declining, there could be a truly powerful gold bull market in front of us. That also applies to silver, platinum, palladium and some of the base metals. It is necessary for investors to clearly define their specific goals. If the general motive for investing in gold and silver is safety and preservation of purchasing power in case currencies break down, as they have done before, then one wants physical possession of the metals. But for trading gains, shares can be advantageous. Aside from shares, if a player desires to get in and out of the gold market quickly, exchange-traded funds work well. It depends on the investor’s objective.
TGR: What about silver?
LM: I like silver more than gold as a trading vehicle, because when precious metals are rising, silver tends to rise at twice the rate of gold. Of course, when the prices fall, silver falls farther; but if one anticipates a bull market in metals, then silver has real advantages.
“I like silver more than gold as a trading vehicle, because when precious metals are rising, silver tends to rise at twice the rate of gold.”
There are a couple of silver mines that I truly like in Mexico. Orko Silver Corp. (OK:TSX.V) has a very substantial deposit in Durango State of up to 200 million ounces of Indicated and Inferred reserves. Orko developed the property for about eight years before Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) bought into the project. It created a joint venture with Pan American, which provided expertise and at least $18 million (M) of capital for exploration. But then Pan American decided that the project did not fit its needs, so it abandoned it.
The net result is that Orko obtained, at no cost to itself, $18M worth of exploration, which enabled it to publish a resource estimate, and allowed for a substantial increase in holdings. There was a bit of a shock to the share price when Pan American pulled out, but the stock now seems to be moving in an upward trend. The project is huge. Orko can either sell it to a major, or develop it into a very important and productive mine.
NOTE: Immediately following this interview, on December 16 First Majestic Silver Corp. issued a Press Release that announced that it had just concluded a friendly takeover of Orko, which afforded Orko shareholders a 69% gain over the present market value of Orko shares.
SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) has a property in production in Sonora State, Mexico, called Santa Elena. It is throwing off a substantial amount of cash flow to further develop the Santa Elena resource, plus another property, La Joya, in Durango State. SilverCrest is expanding resources and increasing production, and doing it thanks to the cash from Santa Elena without suffering from the stock dilution that has been so harmful to other companies. It has managed to create a substantial cash reserve of about $20M.
TGR: Cash flow may be one of the most important things for investors to keep in mind.
LM: Cash flow improves the likelihood of a firm advancing its project by increasing production or discovering new resources without encountering potentially ruinous share dilution.
TGR: The share price of many specialty—or “rare earth”—metal mining corporations has disappointed investors during the past year. What will it take to reverse that trend?
LM: The world of rare earth elements is incredibly complex and potholed with variables. There are an enormous number of elements and each has its own attributes and its own uses. It takes full-time study to get a grip on how to identify demand, and how that demand can be met, given the network of variables. The rare earth miners definitely need to make a better effort to educate the public about the nature of their business.
And there is the same problem, as with all metals, of having to spend money without being on a clear path toward production. Some of the critical metals juniors went up very sharply a few years ago, after the Chinese announced they were suddenly limiting exports. Although the U.S. military establishment requires a stream of rare earth elements and other markets for rare earths are growing, many juniors have made little progress toward achieving production. The reputation of several of these companies has been hurt. The industry must more clearly identify to investors the positive attributes of rare earth elements and step up the pace toward production.
TGR: Are there any names worth watching in the critical metals space?
LM: Commerce Resources Corp. (CCE:TSX.V; D7H:FSE; CMRZF:OTCQX) is unique in that it has two specific projects with preliminary economic assessments. It has the Blue River tantalum-niobium project in British Columbia and a rare earth element project called Eldor in northern Québec. Each project appears to be capable of standing on its own merits; the company is attracting interest from potential end-users and possible joint venture partners. The price of the shares has come down recently, but I believe it’s reached the point where the potential rewards truly outweigh the risks.
TGR: Are there any holding companies in the metal mining space that investors should investigate?
LM: I enjoy Zimtu Capital Corp. (ZC:TSX.V) in Canada. Its game plan is to fund early-stage companies with developable projects. By funding and forming new companies, it is able to offer its own investors a chance to participate in early-stage share offerings at an advantageous price before the initial public offering (IPO). When Zimtu funds a project it normally receives a substantial block of shares. If the general market environment goes up, then the asset values of Zimtu go up, and that should lead to increases in its share price. It is a good game plan and if the market environment for the whole junior mining sector improves, then Zimtu stands to profit substantially.
TGR: Returning to the start of our conversation, how do your political and ideological preferences affect how you identify opportunities in the markets that you cover?
LM: I am a deep believer in limited government. There should be simple and easy to understand regulations only where they’re absolutely necessary. The current government interferences are a profound negative and worsening. If we can somehow turn the long-standing trend toward excessive regulations around, then profit opportunities within the mining industry should improve dramatically.
I’m normally an optimist, but I have serious concerns about the world’s financial stability going forward. Europe in many places is a basket case. Japan is facing enormous problems, particularly demographic problems. Nobody knows for sure what China is doing. America is facing colossal budgetary problems. There’s a mess out there and it’s hard to see a really clear path to valid solutions to the litany of ongoing serious problems.
It’s not that I’m a pessimist. I love life, I love nature and hiking in the woods and mountains, but when it comes to discussing economic matters, I do try to be a realist and look reality straight in the face. Frankly, there have been pleasanter times.
TGR: Thank you, Leonard.
LM: My pleasure, indeed, Peter.
Leonard Melman, publisher of The Melman Report, has been writing about precious and base metals for more than two decades as monthly columnist for California-based ICMJ’s Prospecting and Mining Journal and Vancouver’s Resource World Magazine. He focuses on how political and financial considerations impact the world of mining and the prices of the metals.