By The Energy Report, on May 9th, 2012
 Investors may still be holding their breath, but larger mining companies aren’t waiting around for the price of uranium to go up. No, indeed, they are buying smaller companies on the cheap. In this exclusive interview with The Energy Report, Equity Research Analyst Rob Chang of Versant Partners makes his case for deep value and discusses his favorite plays. With or without Germany and Japan, life goes on for uranium producers.
The Energy Report: Fourteen months after the fact, the biggest story in uranium is still the tsunami that struck Japan and destroyed four nuclear reactors at the Fukushima Daiichi nuclear power station. Japan is attempting to eradicate its dependency on nuclear energy. Are any plants still operating? Will all reactors be shut down in the near future?
Rob Chang: My numbers indicate that there are 50 reactors in Japan in total with only one still operating, and that last one is scheduled for a regular maintenance shutdown in early May. Since the Fukushima disaster occurred, every reactor that has been turned off for routine maintenance has not been permitted to restart. By mid-May, Japan will no longer run on nuclear power at all.
TER: There is a huge rise in carbon emissions in Japan, where fuel oil consumption for power production has doubled. Are drastically increased emissions likely to affect policy decisions in Japan, Germany or elsewhere?
RC: The carbon emissions are certainly growing. For Japan and Germany, an incredible rise is expected. There was an estimate that over the next few years, the increase in CO2 for Germany alone will be between 170–400 million tons (Mt) of additional CO2, which completely contradicts the country’s previous goals. The populations and governments of these two countries are currently putting carbon emission concerns behind their fears of nuclear power. Germany is aggressively following its anti-nuclear power path while moving toward renewables and using other sources of power, such as natural gas, which unfortunately does generate a lot of CO2. Whether the country decides to go back to its original commitment of reducing CO2 emissions or to stay the path of avoiding nuclear at all costs will certainly be an issue, considering that alternative energy sources can’t yet meet their energy demands.
TER: It sounds like there could be some very interesting alternative plays emerging from Germany and Japan’s planned energy shifts, as both countries have large economic bases.
RC: That’s the goal for both countries, to move toward alternative energy, which includes solar, wind power, hydro and geothermal. The problem with that is none of these can really provide a consistent form of baseload power. With solar, if you get a sustained period of darkness, you’re going to have problems. You could also have a lack of wind, or a lack of suitable locations to build dams to generate hydro-electric power. As for geothermal, Japan has some capacity, but studies show that it’s not enough to fully replace nuclear.
TER: What are the predominant, global sources of baseload energy?
RC: Baseload sources of power, those that are available at all times, include natural gas, coal and nuclear. Of the three, only one is zero-carbon emitting after being built, and that would be nuclear power. That’s the big argument in favor of nuclear power. It is pretty much the only source of baseload power that solves all of the problems in terms of carbon emissions, low-cost power production and being relatively safe outside of the potential of nuclear meltdowns. Even when we look at Fukushima, it’s really more about fear than reality. Nuclear power is still quite safe.
TER: Rob, you said nuclear is low-cost compared to other forms of energy. Tell me more.
RC: The costs of operating a nuclear power plant after it’s already been built are probably the lowest among all energy sources. If you look at it in terms of alternative energy, which are heavily government-subsidized forms of power, it’s actually very expensive to run those projects. On top of that, you still have the additional not-in-my-backyard problems for wind farms, which many people dislike. Although alternative forms of energy sound like a great option, nuclear power makes a lot more sense.
TER: Looking at a chart, uranium seems to have some support at about $50/pound (lb), and it seems to be in a trading range now with resistance at around $55/lb. That looks like a consolidation pattern to me.
RC: I’m more of a fundamentals analyst than a technical analyst, but I do observe the same patterns that you’re seeing. It seems like it’s trading in that range primarily because of near-term supply and demand fundamentals. Two, three or five years from now, if mine production schedules go the way they’re supposed to, we should be in balance, with maybe even a slight surplus.
TER: Where is new supply coming from?
RC: The three primary mines that are coming online that are expected to meet upcoming demand are Cigar Lake in the Athabasca, run by Cameco Corp. (CCO:TSX; CCJ:NYSE), the expansion of Olympic Dam by BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) in Australia and the Imouraren mine that’s run by AREVA (AREVA:EPA) in Niger. Together, these make up the bulk of the upcoming supply that’s theoretically supposed to balance the increase in demand. That’s assuming the World Nuclear Association’s best-case scenario, as presented last year, unfolds. Demand may be lower or higher, but it does take into account the shutdowns in Japan and Germany.
TER: Does this consolidation pattern have anything to do with the acquisitions we’ve been seeing in the industry?
RC: I can’t really say it is definitely a consolidation pattern. But when you are seeing consolidation in the industry, you generally see it in the low parts of the market when larger firms can see value in other firms and believe that their prices are going to go up and markets are going to be better. They might as well buy now when it’s cheap and get bigger. We are certainly seeing that now, and we have been seeing that for the last two years. In my opinion, we’re going to see more of it going forward.
We’ve seen some pretty nice ones—the Chinese buying Extract Resources Ltd. (EXT:TSX; EXT:ASX), Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) getting Pitchstone Exploration Ltd. (PXP:TSX.V) and now Energy Fuels Inc. (EFR:TSX) acquiring the U.S. assets of Denison Mines Corp. (DML:TSX; DNN:NYSE.A). These represent a lot of very positive signs for the industry because usually when you see consolidation, it signals the bottom in most industries. It looks as though we may be seeing that as well here.
TER: What about uranium price? Will it remain weak, as it is now at $50–55/lb.?
RC: It could, unless we have a catalyst. Right now, it seems like a very comfortable range for uranium. The main catalysts that many are waiting for is Japan’s possible decision to restart its nuclear reactors. Once that happens, I would bet that we would see a run-up in the spot price. How far up it goes will be tough to say. It will entirely depend on how aggressive the nuclear roll-out or re-ignition occurs in Japan. For most of us, we believe that it’s not a matter of if, but when the reactors are restarted. The government has already decided that it needs to. It’s more a matter of getting the locals and the mayors in the areas to sign off on it. But once that happens, we should see the price go up.
TER: What is your price forecast?
RC: I believe uranium prices will rise a little bit, from here at least. For 2012, we’re expecting an average price of $55/lb.
TER: If it rose above $55/lb, would that create a secular bull trend in uranium equities?
RC: I believe so. The uranium equities have been moving higher over the last six to eight months, primarily based on the fundamentals despite the fact that the uranium price hasn’t moved. I fully recognize that they’ve come off highs from January and February, but overall they’re still up relative to the Fukushima event. I believe that as the uranium spot price moves higher, there will certainly be more interest in the uranium equities.
TER: What names are you recommending to investors?
RC: The three names that we cover are Energy Fuels, Fission Energy and Kivalliq Energy Corp. (KIV:TSX.V). We still are very bullish on all three.
TER: Ok, let’s take Energy Fuels first.
RC: As you know, Energy Fuels acquired the U.S. assets of Denison Mines, but Denison has been getting most of the publicity because it is basically cleaning itself up to be acquired by Rio Tinto (RIO:NYSE; RIO:ASX) for its Athabasca assets. However, people should be recognizing Energy Fuels as a big winner given that it has established itself as the premier producer in the U.S. That’s pretty significant, because the U.S. is the largest consumer of uranium. The U.S. consumes over 50 million pounds (50 Mlb), but it only produces 4 Mlb/year. So there’s a massive shortfall between U.S. demand and supply. Security of supply is always going to be important for power generation.
Another thing is that Energy Fuels acquired the White Mesa mill from Denison, which allows it to put its Energy Queen and Whirlwind mines into production. Those are two turn-key mines that could be turned on within a year of the production decision. Those two mines are basically on pause while Energy Fuels clears all of the permitting and rebuilding hurdles for the Piñon Ridge mill, but now that it has acquired the White Mesa mill, it no longer needs to wait for Piñon Ridge. It can just go and process everything through there. So, unlocking those two mines will allow it to produce over 1 Mlb/year in the U.S. and provide immediate upside. There aren’t that many producers out there, and Energy Fuels is a new producer on the block. I can see the company commanding a premium once the dust settles.
TER: Your target price on Energy Fuels is $1.10, which is an implied 300% return from here. Do you believe that startup of these two turn-key mines is going to be the catalyst for that kind of move?
RC: It’s one of many catalysts. It’s a near-term producer now, so that is also factoring the net asset value (NAV) of the production coming from those mines. It factors in all revenue streams coming into the company. The reason why, in my opinion, Energy Fuels has been trading this low is that uranium has been out of favor and Energy Fuels has been viewed previously as a developer that was not producing and still needed a permit. These hurdles have been addressed, improved upon or eliminated. I think once people give Energy Fuels a good hard look, they will realize it’s significantly undervalued.
The overall market has been pretty negative, so investors are pretty reluctant to deploy capital. And they generally prefer producing companies that are large and subsequently safer. Energy Fuels has historically been a developer, but will be a producer after the deal closes. For this combination of reasons, it is not moving up as much as it should be. I believe that this is temporary and when sanity returns to the market, Energy Fuels will rise.
TER: What about Kivalliq?
RC: Kivalliq has the highest grades of any uranium company outside of the Athabasca Basin, 0.69% U3O8. The global median for U3O8 grades is 0.07%. So at 0.69%, Kivalliq is actually one decimal spot to the left of the global median. Kivalliq is located in Nunavut, which does present some challenges given there is little infrastructure in the area. However, the company already has 27 Mlb of this high-grade uranium near the surface. It has the potential of getting a lot more. There is the possibility that it could grow this to a +100 Mlb resource with the proper time and drilling. This makes Kivalliq a very interesting company. Another reason to like this company is that to the northeast of it, AREVA is developing the Kiggavik uranium deposit, which is a +100 Mlb uranium deposit. AREVA is way ahead of Kivalliq in terms of exploration/development, and there may be some synergies involved there in terms of Kivalliq being able to use AREVA’s infrastructure builds. So I’m very positive on Kivalliq.
TER: Kivalliq has been weak for the past month. Does that make it even more interesting to you? Do you see it as a deep value currently?
RC: Absolutely. I have $1.10 target price for Kivalliq as well. That’s about 150% of upside from here. So I believe there is lots of upside.
TER: Your third pick was Fission.
RC: I really like Fission Energy. This is in the Athabasca Basin, located right next door to Hathor Exploration, which is now Rio Tinto’s Roughrider deposit. In fact, the western extension of the Roughrider deposit actually goes over the border into Fission’s territory. If Rio Tinto was to ever develop this, it would make a lot of sense to develop that little nub that goes over the border. There’s no reason for Rio Tinto to stop right at the property line. A few meters to the west of that is Fission Energy’s J Zone deposit, which has an initial NI 43-101-compliant resource of 9 Mlb that it announced earlier this year. It would make a lot of sense for anyone, like Rio Tinto, wanting to consolidate the region, to buy Fission Energy next door as well as Denison’s and AREVA’s assets. Within a 5 kilometer (km) area, there is already more than 110 Mlb of uranium. So it would make a lot of sense for one company just to consolidate the whole region.
TER: An acquisition certainly does not look to be baked into Fission’s stock price.
RC: It was previously. Fission traded over $1 at one point in November, when Hathor was being acquired. It’s the classic situation where investors buy on the potential and when it doesn’t happen immediately, they give up and sell. It is further exacerbated by the fact that we have a negative market in general.
Even though you’ve seen Fission drift lower, the story hasn’t fundamentally changed. If anything, it is closer to actually happening now than it was right after Rio Tinto bought Hathor. I haven’t seen many scenarios where an acquiring company buys Company A and immediately turns around and buys Company B. They generally take some time in between to digest the acquisition or do more work. So, if anything, now would probably be a better time to buy Fission.
Another reason Fission has drifted down is that many expect Rio Tinto to acquire Denison first given that it’s larger, and then turn its attention to Fission last, or after AREVA. So maybe it’s more of a timing issue and people would get back into Fission when they see more activity in the basin and because they could see a bid for Denison.
TER: What are some other names you like?
RC: Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.A) is a near-term producer. It is scheduled to produce by the end of this year, which would make it the next uranium producer in the world. It is located in the Powder River Basin in Wyoming. It has pretty high grades as far as in situ recovery (ISR) mining goes. It’s an ISR miner, which means it uses injection wells and pumps the solution out of the ground. It is a low-cost operation similar to that of Uranium One Inc. (UUU:TSX) in Kazakhstan and some of the assets that Cameco has in the U.S. Uranerz is also run by one of the best management teams that I’ve come across in the uranium space. Given that it’s a near-term producer, I am very positive on Uranerz for the same reason I feel that Energy Fuels is a bigger deal than what the market is giving it credit for.
Another name that I’ve very positive on is U3O8 Corp. (UWE:TSX.V). It is basically a South American consolidator of uranium assets, with assets in Colombia, Argentina and Guyana. I had the opportunity to visit all three. The flagship property is in Colombia, where it has decent grades. It looks like it there will be a suite of metals that the company can extract. In fact, it believes it can economically extract other metals such as molybdenum, vanadium, some rare earths and phosphate. Its asset in Guyana could be another Athabasca Basin.
TER: Many thanks to you, Rob.
RC: I’ve enjoyed it. Thank you for having me back.
Versant Partners Analyst Rob Chang has extensive financial markets experience dating back to 1995. He helped run a multistrategy hedge fund, worked in base metals research at BMO Capital Markets, managed resource funds at a boutique investment management firm and was a global mining equity analyst at an independent investment bank.
By The Gold Report, on May 7th, 2012
 A “paralyzed” Federal Reserve Bank, in its “final days,” held hostage by Wall Street “robots” trading in markets that are “artificially medicated” are just a few of the bleak observations shared by David Stockman, former Republican U.S. Congressman and director of the Office of Management and Budget. He is also a founding partner of Heartland Industrial Partners and the author of The Triumph of Politics: Why Reagan’s Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy. The Gold Report caught up with Stockman for this exclusive interview at the recent Recovery Reality Check conference.
The Gold Report: David, you have talked and written about the effect of government-funded, debt-fueled spending on the stock market. What will be the real impact of quantitative easing?
David Stockman: We are in the last innings of a very bad ball game. We are coping with the crash of a 30-year–long debt super-cycle and the aftermath of an unsustainable bubble.
Quantitative easing is making it worse by facilitating more public-sector borrowing and preventing debt liquidation in the private sector—both erroneous steps in my view. The federal government is not getting its financial house in order. We are on the edge of a crisis in the bond markets. It has already happened in Europe and will be coming to our neighborhood soon.
TGR: What should the role of the Federal Reserve be?
DS: To get out of the way and not act like it is the central monetary planner of a $15 trillion economy. It cannot and should not be done.
The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of “Operation Twist” is an abomination.
Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed’s monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street.
TGR: If we are in the final innings of a debt super-cycle, what is the catalyst that will end the game?
DS: I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world’s financial market.
Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors—none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move.
As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades.
On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out.
If that happens, the massive repo structures—that is, debt owned by still more debt—will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked.
TGR: Is that what happened in 2008?
DS: In 2008 it was the repo market for mortgage-back securities, credit default obligations and such. In 2008 we had a dry run of what happens when a class of assets owned on overnight money goes into a tailspin. There is a thunderous collapse.
Since then, the repo trade has remained in the Treasury and other high-grade markets because subprime and low-quality mortgage-backed securities are dead.
TGR: Walk us through a hypothetical. What happens when the fast-money traders lose confidence in the Fed’s ability to keep the spread?
DS: They are forced to start selling in order to liquidate their carry trades because repo lenders get nervous and want their cash back. However, when the crisis comes, there will be insufficient private bids—the market will gap down hard unless the central banks buy on an emergency basis: the Fed, the European Central Bank (ECB), the people’s printing press of China and all the rest of them.
The question is: Will the central banks be able to do that now, given that they have already expanded their balance sheets? The Fed balance sheet was $900 billion (B) when Lehman crashed in September 2008. It took 93 years to build it to that level from when the Fed opened for business in November 1914. Bernanke then added another $900B in seven weeks and then he took it to $2.4 trillion in an orgy of money printing during the initial 13 weeks after Lehman. Today it is nearly $3 trillion. Can it triple again? I do not think so. Worldwide it’s the same story: the top eight central banks had $5 trillion of footings shortly before the crisis; they have $15 trillion today. Overwhelmingly, this fantastic expansion of central bank footings has been used to buy or discount sovereign debt. This was the mother of all monetizations.
TGR: Following that path, what happens if there are no buyers? Do the governments go into default?
DS: The U.S. Treasury needs to be in the market for $20B in new issuances every week. When the day comes when there are all offers and no bids, the music will stop. Instead of being able to easily pawn off more borrowing on the markets—say 90 basis points for a 5-year note as at present—they may have to pay hundreds of basis points more. All of a sudden the politicians will run around with their hair on fire, asking, what happened to all the free money?
TGR: What do the politicians have to do next?
DS: They are going to have to eat 30 years worth of lies and by the time they are done eating, there will be a lot of mayhem.
TGR: Will the mayhem stretch into the private sector?
DS: It will be everywhere. Once the bond market starts unraveling, all the other risk assets will start selling off like mad, too.
TGR: Does every sector collapse?
DS: If the bond market goes into a dislocation, it will spread like a contagion to all of the other asset markets. There will be a massive selloff.
I think everything in the world is overvalued—stocks, bonds, commodities, currencies. Too much money printing and debt expansion drove the prices of all asset classes to artificial, non-economic levels. The danger to the world is not classic inflation or deflation of goods and services; it’s a drastic downward re-pricing of inflated financial assets.
TGR: Is there any way to unravel this without this massive dislocation?
DS: I do not think so. When you are so far out on the end of a limb, how do you walk it back?
The Fed is now at the end of a $3 trillion limb. It has been taken hostage by the markets the Federal Open Market Committee was trying to placate. People in the trading desks and hedge funds have been trained to front run the Fed. If they think the Fed’s next buy will be in the belly of the curve, they buy the belly of the curve. But how does the Fed ever unwind its current lunatic balance sheet? If the smart traders conclude the Fed’s next move will be to sell mortgage-backed securities, they will sell like mad in advance; soon there would be mayhem as all the boys and girls on Wall Street piled on. So the Fed is frozen; it is petrified by fear that if it begins contracting its balance sheet it will unleash the demons.
TGR: Was there some type of tipping that allowed certain banks to front run the Fed?
DS: There are two kinds of front-running. First is market-based front-running. You try to figure out what the Fed is doing by reading its smoke signals and looking at how it slices and dices its meeting statements. People invest or speculate against the Fed’s next incremental move.
Second, there is illicit front-running, where you have a friend who works for the Federal Reserve Board who tells you what happened in its meetings. This is obviously illegal.
But frankly, there is also just plain crony capitalism that is not that different in character and it’s what Wall Street does every day. Bill Dudley, who runs the New York Fed, was formerly chief economist for Goldman Sachs and he pretends to solicit an opinion about financial conditions from the current Goldman economist, who then pretends to opine as to what the economy and Fed might do next for the benefit of Goldman’s traders, and possibly its clients. So then it links in the ECB, Bank of Canada, etc. Is there any monetary post in the world not run by Goldman Sachs?
The point is, this is not the free market at work. This is central bank money printers and their Wall Street cronies perverting what used to be a capitalist market.
TGR: Does this unwinding of the Fed and the bond markets put the banking system back in peril, like in 2008?
DS: Not necessarily. That is one of the great myths that I address in my book. The banking system, especially the mainstream banking system, was not in peril at all. The toxic securitized mortgage assets were not in the Main Street banks and savings and loans; these institutions owned mostly prime quality whole loans and could have bled down the modest bad debt they did have over time from enhanced loan loss reserves. So the run on money was not at the retail teller window; it was in the canyons of Wall Street. The run was on wholesale money—that is, on repo and on unsecured commercial paper that had been issued in the hundreds of billions by financial institutions loaded down with securitized toxic garbage, including a lot of in-process inventory, on the asset side of their balance sheets.
The run was on investment banks that were really hedge funds in financial drag. The Goldmans and Morgan Stanleys did not really need trillion-dollar balance sheets to do mergers and acquisitions. Mergers and acquisitions do not require capital; they require a good Rolodex. They also did not need all that capital for the other part of investment banking—the underwriting business. Regulated stocks and bonds get underwritten through rigged cartels—they almost never under-price and really don’t need much capital. Their trillion dollar balance sheets, therefore, were just massive trading operations—whether they called it customer accommodation or proprietary is a distinction without a difference—which were funded on 30 to 1 leverage. Much of the debt was unstable hot money from the wholesale and repo market and that was the rub—the source of the panic.
Bernanke thought this was a retail run à la the 1930s. It was not; it was a wholesale money run in the canyons of Wall Street and it should have been allowed to burn out.
TGR: Let’s get back to our ballgame. What is to keep the U.S. population from saying, please Fed save us again?
DS: This time, I think the people will blame the Fed for lying. When the next crisis comes, I can see torches and pitch forks moving in the direction of the Eccles building where the Fed has its offices.
TGR: Let’s talk about timing. On Dec. 31, the tax cuts expire, defense cuts go into place and we hit the debt ceiling.
DS: That will be a clarifying moment; never before have three such powerful vectors come together at the same time— fiscal triple witching.
First, the debt ceiling will expire around election time, so the government will face another shutdown and it will be politically brutal to assemble a majority in a lame duck session to raise it by the trillions that will be needed. Second, the whole set of tax cuts and credits that have been enacted over the last 10 years total up to $400–500B annually will expire on Dec. 31, so they will hit the economy like a ton of bricks if not extended. Third, you have the sequester on defense spending that was put in last summer as a fallback, which cannot be changed without a majority vote in Congress.
It is a push-pull situation: If you defer the sequester, you need more debt ceiling. If you extend the tax expirations, you need a debt ceiling increase of $100B a month.
TGR: What will Congress do?
DS: Congress will extend the whole thing for 60 or 90 days to give the new president, if he hasn’t demanded a recount yet, an opportunity to come up with a plan.
To get the votes to extend the debt ceiling, the Democrats will insist on keeping the income and payroll tax cuts for the 99% and the Republicans will want to keep the capital gains rate at 15% so the Wall Street speculators will not be inconvenienced. It is utter madness.
TGR: It is like chasing your tail. How does it stop?
DS: I do not know how a functioning democracy in the ordinary course can deal with this. Maybe someone from Goldman Sachs can come and put in a fix, just like in Greece and Italy. The situation is really that pathetic.
TGR: Greece has come up with some creative ways to bring down its sovereign debt without actually defaulting.
DS: The Greek debt restructuring was a farce. More than $100B was held by the European bailout fund, the ECB or the International Monetary Fund. They got 100 cents on the dollar simply by issuing more debt to Greece. For private debt, I believe the net write-down was $30B after all the gimmicks, including the front-end payment. The rest was simply refinanced. The Greeks are still debt slaves, and will be until they tell Brussels to take a hike.
TGR: Going back to the triple-witching hour at year-end, if the debt ceiling is raised again, when do we start to see government layoffs and limitations on services?
DS: Defense purchases and non-defense purchases will be hit with brutal force by the sequester. As we go into 2013, there will be a shocking hit to the reported GDP numbers as discretionary government spending shrinks. People keep forgetting that most government spending is transfer payments, but it is only purchases of labor and goods that go directly into the GDP calculations, and it is these accounts that will get smacked by the sequester of discretionary defense and non-defense budgets.
TGR: I would think to unemployment numbers as well.
DS: They will go up.
Just take one example. According to the Bureau of Labor Statistics monthly report, there are 650,000 or so jobs in the U.S. Postal Service alone. That is 650,000 people who pretend to work at jobs that have more or less been made obsolete and redundant by the Internet and who are paid through borrowings from Uncle Sam because the post office is broke. Yet, the courageous ladies and gentlemen on Capitol Hill cannot even bring themselves to vote to discontinue Saturday mail delivery; they voted to study it! That is a measure of the loss of capacity to rationally cognate about our fiscal circumstance.
TGR: In the midst of this volatility, how can normal people preserve, much less expand their wealth?
DS: The only thing you can do is to stay out of harm’s way and try to preserve what you can in cash. All of the markets are rigged or impaired. A 4% yield on blue chip stocks is not worth it, because when the thing falls apart, your 4% will be gone in an hour.
TGR: But if the government keeps printing money, cash will not be worth as much, either, right?
DS: No, I do not think we will have hyperinflation. I think the financial system will break down before it can even get started. Then the economy will go into paralysis until we find the courage, focus and resolution to do something about it. Instead of hyperinflation or deflation there will be a major financial dislocation, which means painful re-pricing of financial assets.
How painful will the re-pricing be? I think the public already knows that it will be really terrible. A poll I saw the other day indicated that 25% of people on the verge of retirement think they are in such bad financial shape that they will have to work until age 80. Now, the average life expectancy is 78. People’s financial circumstances are so bad that they think they will be working two years after they are dead!
TGR: Finally, what is your investment model?
DS: My investing model is ABCD: Anything Bernanke Cannot Destroy: flashlight batteries, canned beans, bottled water, gold, a cabin in the mountains.
TGR: Thank you very much.
David Stockman is a former U.S. politician and businessman, serving as a Republican U.S. Representative from the state of Michigan 1977–1981 and as the director of the Office of Management and Budget under President Ronald Reagan 1981–1985. He is the author of The Triumph of Politics: Why Reagan’s Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy.
Stockman was the keynote speaker at last weekend’s Casey Research Recovery Reality Check Summit. This event featured legendary contrarian investor Doug Casey, high-end natural resource broker Rick Rule, New York Times bestselling author John Mauldin and 28 other financial luminaries. Over the three-day summit, they provided investors with asset-protection action plans and actionable investment advice. And even if you were unable to attend, you can still hear every recorded presentation in the Summit Audio Collection. Learn more here.
By The Energy Report, on May 4th, 2012
 Chen Lin isn’t one for doom-and-gloom prophecies, nor is he particularly interested in energy-related political squabbles. As the title suggests, the publisher of What Is Chen Buying/Selling? is first and foremost a trader, and he’s booked the profits to prove it. In this exclusive interview with The Energy Report, the ever practical Lin discusses where to look, when to buy and which names will have him coming back for more later this year.
The Energy Report: Chen, we last spoke in February. What’s new in energy markets since then?
Chen Lin: The oil price has mildly declined since then, despite the war between Sudan and newly independent South Sudan that interrupted the oil supplies. In general, oil prices tend to go up during the spring and summer. This year, however, the price is telling a different story. A lot of traders are trying to front-run the trend, and recent problems from the E.U. are creating volatility. Personally, I believe $70–80/barrel (bbl) oil is fair. At this price, most producers are very profitable and gasoline prices would be acceptable to most consumers. The high volatility of the oil price created a lot of booms and busts in the industry. As a trader, however, this created excellent opportunities to buy low and sell high.
TER: What about natural gas?
CL: Natural gas in North America took a big dive; it dropped below $2/thousand cubic feet (Mcf). Many North American natural gas producers are leveraged plays, and that can create some unfortunate situations. At the current price, they may have trouble paying back bank loans. Banks may even start to pull credit lines. This could create chaos in the next 6–12 months. As an investor, I am waiting for market forces to take out some weaker players. That could create good buying opportunities down the road.
TER: In other words, a market that punishes companies can reward traders. What is your investment style in this landscape?
CL: I focus on different sectors and I’ll overweight an undervalued sector at a given time. For example, in Q4/11 I saw that the energy sector was greatly undervalued, and I was buying energy stocks aggressively when we last spoke. Since then, I have been busy booking profits in energy. Now I’m starting to look into the precious metal space, which has been hit very hard in the past few months. I sold New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX), TransGlobe Energy Corp. (TGL:TSX; TGA:NASDAQ) and Ithaca Energy Inc. (IAE:TSX) and I reduced my position in PetroBakken Energy Ltd. (PBN:TSX) and sold my shares in its sister company, Petrobank Energy & Resources Ltd. (PBG:TSX), for nice profits.
TER: What energy positions are you still holding? Who is the mainstay?
CL: My personal largest position is still Mart Resources Inc. (MMT:TSX.V). I just went to the HiAlpha conference, where its CEO, Wade Cherwayko, was presenting. He told investors that Mart has over $60 million ($60M) in the bank and each month it is generating $15M in after-tax income (about CA$50/share in annual income). The company is about to pay dividends and is discussing dividend vs. share buyback. In the meantime, it is very close to announcing a deal with Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) to build a pipeline and triple its current production in a year. The investors I met at the conference were very excited about Mart’s future, both near term and long term.
Mart just filed its annual report. It earned $71.8M for 2011, or CA$21.4/share. Its cashflow was $144.1M for 2011, or CA$42.9/share. Field was pumping at about 7 thousand barrels per day (7 Mbpd); Mart got 71% or 4,941 bpd because of cost recovery. This year, Brent was over $120/bbl for most of the time, and Mart is getting a premium to Brent, at least $125/bbl. It’s pumping at about 15 Mbpd, according to its recent presentation. Using these factors, it is easy to see that Mart is earning about CA$50/share on an annual basis, with cashflow at about CA$1/share. Next year, when Mart increases production to 30 Mbbl, 45 Mbbl and even higher, you can expect the earnings to double and triple again. Mart’s market valuation will be higher than the current stock price.
TER: What are some other long-haul names?
CL: My next largest position is still Pan Orient Energy Corp. (POE:TSX.V). The stock was hit hard recently on the mixed test results from its L53D well. Most analyst reports mentioned both positives and negatives in the announcement, but investors tend to sell first and ask questions later. This tells us how nervous investors were. Also, most funds exited the company at the end of last year and investors are generally not very risk-tolerant. Last year, I was telling everyone to load up on the stock. The company made a nice discovery, but the stock didn’t show much appreciation. The company is drilling very high-impact wells in Indonesia after four or five years of preparations, but the market is completely ignoring it. It has no debt and trades at less than two times its cashflow, with blue sky opportunities in Indonesia. Currently, the stock offers a very good entry point for those who are willing to take limited risks.
I am still holding Porto Energy Corp. (PEC:TSX.V). It is about to start drilling the high-impact presalt well around the mid year. Considering the stock is trading at a huge discount in light of its recently announced deals, I like the risk-reward ratio here.
I am also holding Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:FSE) and Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE). Both stocks have been down sharply lately, like most junior mining stocks. Insiders participated in the recent private placement at much higher rates than the current stock price. I believe both stocks offer good values.
TER: Thanks for the company rundown. What’s your reading on current market movements, and how should investors play it?
CL: In general, we have recently seen sharp pullbacks in resource stocks. The market is suffering greatly from lack of liquidity. That offers good opportunities for long-term, value-oriented investors. I am mostly holding companies with good balance sheets and cashflow. I intend to buy stocks on the cheap later this year.
TER: Thanks for catching up with us today, Chen.
CL: My pleasure.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc. Lin is a value investor who focuses on deeply undervalued stocks or sectors that are ignored by the market. He also demonstrates excellent market timing due to his technical analysis.
By The Energy Report, on May 3rd, 2012
 China and India have returned to the potash markets, stabilizing current prices as long-term demand continues to grow. In this exclusive interview with The Energy Report, Corey Dias, who covers the industry for MGI Securities, brings us up to date on industry developments and shares why Brazil-based companies offer huge potential for prudent investors.
The Energy Report: Have there been any significant developments in the potash industry since you last spoke with us in January?
Corey Dias: The biggest change has been that China has actually come back to the market and is buying potash. Earlier this year, neither China nor India were buying, hoping to see a price decline. China has since agreed to purchase about 550,000 tons (t) at $470/t from Israeli potash company ICL Fertilizers (ICL:TASE). Canpotex Ltd. (private) signed a similar-sized agreement with China’s Sinofert Holdings Ltd. (297:SEHK) for Q2/12 delivery priced at $470/t. Finally, the Belarusian Potash Company (BPC), the other major potash consortium in the business, signed an agreement with Sinochem International Ltd. (600500:SSE) and CNAMPGC Shanghai Corp. (private) for a price of $470/t. Those buys are underpinning the price as it stands today, slightly below the $500/t spot. It seemed China wanted to hold out for better pricing, but it was inevitable that it would have to come back to the market. India will likely have to do the same soon.
TER: Have your views of the industry’s potential changed as a result?
CD: No, nothing has fundamentally changed. This just reinforces my view that fertilizers remain essential to the global agriculture market in order to facilitate growth, improve yields and provide food for burgeoning middle classes throughout the world.
TER: Do you see anything on the horizon that might have a major effect on the market or the prices, either positively or negatively?
CD: I expect some short-term impacts. Both the U.S. and Europe are obviously still facing economic headwinds, which can impact the fertilizer-buying patterns of those regions. That said, I am still bullish on the industry’s longer-term prospects. At the end of the day, populations will continue to grow, as will the middle class. Diets will continue to change, and therefore increased fertilizer use is inevitable. I expect the market opportunity for fertilizers such as potash to remain attractive going forward. There still seems to be a lot of positive sentiment out there.
TER: Do you expect any major changes in the number of companies entering into the business in the next 5–10 years?
CD: There will probably be a number of new entrants into the marketplace, especially given how topical potash is at the moment. However, as these projects attempt to advance towards production, many will fall by the wayside due to the difficulty of securing financing for these multibillion-dollar projects. I would assume that the first step of financing a major potash project would involve signing a long-term offtake agreement with a third party looking to secure supply in exchange for an upfront equity investment in a project. This offtake agreement, in turn, could be used as a form of collateral for project debt. Furthermore, not all of the output from these potash projects is going to be necessary from a demand point of view. A number of potash producers have new Brownfield projects that could help meet a significant portion of the expected increased demand for potash. That may not leave a lot of room for new entrants.
TER: Do you expect bigger companies to take over smaller projects that can’t finance themselves?
CD: I would think so, assuming that the smaller projects provide some kind of strategic value to the acquirer. That said, many large producers already have an inventory of deposits or projects they can use to expand production without seeking other acquisitions.
TER: Is location the primary factor in determining which projects are “strategic?”
CD: Yes. If one is operating a potash mine in Brazil, one has an internal market that could absorb one’s entire potash output. A company that wants to enter the potash market in a cost-effective manner would certainly aim to buy an asset in Brazil in order to benefit from the significant transportation price advantage expected to be enjoyed by the local potash producers. Moreover, Brazil imports over 90% of its current potash needs and, therefore, the Brazilian government is encouraging local projects to be built in order for the country to reach fertilizer independence by 2020.
TER: How have the major players performed during the first quarter of this year?
CD: Mosaic reported significantly lower sales numbers year over year, as did Potash Corp. This is unsurprising, given that China and India were not participating. Unsurprisingly, both Potash Corp. (POT:TSX; POT:NYSE) and The Mosaic Company (MOS:NYSE) have reduced production twice recently. In Eastern Europe, Uralkali (URKA:RTS; URKA:MCX; URKA:LSE) also reduced its production forecast. These companies are likely reducing production to preserve the current $500/t spot price and will probably continue to do so in order to avoid another price collapse similar to what took place a few years ago. Remember that Potash Corp., Uralkali and Mosaic are each tied to regional consortiums—Canpotex and BPC—and probably represent between 60% and 70% of the supply side of the market, so their actions are quite influential with regard to the rest of the market.
TER: What’s been going on with the smaller companies you cover in the last three months?
CD: The only junior potash company I was covering when we first spoke was Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX). Since then I’ve added five other names. Passport released an NI 43-101 resource estimate for its Holbrook Basin potash deposit, which officially confirmed the existence of potash on its property. While the deposit is relatively low-grade when compared to Saskatchewan deposits, it is also quite shallow, which lends itself to conventional mining methods. This is the first of many milestones that will move the Passport story forward. I expect more and more positive news to come from the company in the next few months, including the release of a Preliminary Economic Assessment (PEA) by the end of 2012 that should provide a boost to the stock price.
Karnalyte Resources Inc. (KRN:TSX) had to provide clarification to the Alberta Securities Commission over a filing it made related to its updated technical report before Christmas. There was supposed to be an equity financing around the time of the report release, which subsequently didn’t take place due to delays related to the technical report. In the absence of clear information with regard to the delay, the market assumed the worst, so the stock price started to slide. Fortunately, the updated technical report was finally released at the end of March and, in fact, some of the numbers were an improvement over the previous technical report.
We still really like Karnalyte. The fact that it is planning to go into production in 2014 – ahead of a number of its peers – puts it in a great position to attract strategic investors interested in an offtake agreement which, in turn, could facilitate debt financing for plant construction.
CD: I also cover Western Potash Corp. (WPX:TSX.V). Western has one of the largest recoverable potash resources in the junior potash developer universe, and three other companies with deposits of similar size in Saskatchewan have been bought by larger entities such as BHP Billiton and K+S Aktiengesellschaft. This could make Western an acquisition target. The Company is currently in discussions with overseas potash buyers with regard to securing an offtake agreement. If Western is successful, the effect on the stock price would be extremely positive.
TER: How about Rio Verde Minerals Development Corp. (RVD:TSX)?
CD: I visited the Company’s assets in Brazil a couple of weeks ago. It’s a very interesting company aiming to produce both phosphate and potash. In the short term, the Company’s first phosphate project is expected to commence production in Q113, thereby providing some cash flow to somewhat mitigate share dilution as it moves its first potash project forward. The important thing about Rio Verde is that it’s operating in a market that has significant potash demand with very little domestic supply. The only potash mine currently operating in Brazil is run by Vale S.A. (VALE:NYSE) and produces less than one million tons a year (Mt/y). Demand for potash in Brazil in 2011 was over 7 Mt/y. So there’s a significant gap that needs to be filled. In addition, shipping from North America to the Brazilian fertilizer markets adds another $150–200/t in costs. A domestic producer could clearly save buyers a lot of money and improve its own the bottom line.
TER: Could Brazil be the next China or India in terms of potash demand?
CD: Brazil is already bigger than India when it comes to potash demand, and not far behind China. Its combination of fertilizer-intensive crops, low fertilizer application rates and little domestic potash supply makes it an ideal market for potash suppliers. Moreover, Brazil probably has the highest amount of available arable land in the world and the water necessary to irrigate it, which means that it has an opportunity to become an even greater agricultural powerhouse.
TER: What about Encanto Potash Corp. (EPO:TSX.V)?
CD: Encanto is another appealing company. It’s an interesting potash play because it involves a First Nations group called the Muskowekwan. Encanto has increased the size of its land package by more than threefold recently, which resulted in an increased potash resource estimate announced in an updated report released in March. The Company has two memorandums of understanding (MOUs) signed with other First Nations groups within Saskatchewan, which means that it could potentially replicate its Muskowekwan junior venture (JV) with these other two groups. That could make the company significantly larger than it is today. Encanto’s PEA states that it is aiming to produce 2.5 Mt/y and has alluded to the potential of doubling that output, based solely on its Muskowekwan JV. Output could be significantly higher should either or both of Encanto’s MOUs be successful.
TER: Looking at the projected price-to-earnings ratios on smaller companies that are planning to be in production in the next two to five years, it seems the markets are not giving them enough credit at this point. Are investors just waiting to see whether things turn out as expected?
CD: As we discussed earlier, not all of these potash projects will reach the production stage. So the market is taking a wait-and-see approach until project financing is secured and construction and production actually starts. Right now the companies basically trade based on the milestones that they’ve reached. A company will start with an NI 43-101 resource estimate and then it will perform an economic analysis on the project in order to determine the project’s viability, whether it’s a PEA or a prefeasibility study (PFS). Even when an economic assessment is completed, the project will still have to be constructed. At that point, the ability to finance the cost of building a production plant becomes a big question.
TER: You just initiated coverage on March 2nd on Verde Potash (NPK:TSX.V). What’s going on with that one?
CD: Verde is another junior potash developer with assets in Brazil. The company plans to produce conventional potash using glauconite, which is a green rock that can be found on the surface of Verde’s property. The company is planning to use a method called the Cambridge process, which was developed as a collaboration between Verde and a professor at the University of Cambridge in the U.K. The company recently released a positive PEA and expects to begin production in 2015, which is still ahead of many other junior developers. Obviously, that should provide Verde with an early-mover advantage in a country that is a major producer of fertilizer-intensive crops and that has very little domestic potash production. Verde seems to have a great opportunity to become one of the major players in the potash space.
TER: Do you expect Verde to have little difficulty financing its project?
CD: I think that would be the case, because the Brazilian government is very interested in becoming fertilizer-independent by 2020. This goal is even more poignant given that, in 2011, Brazil imported 92% of its potash requirements. To this end, the government has lined up lenders or partners who would be willing to help fund the production of these projects.
TER: What kind of market performance do you expect from these stocks as we head into the summer doldrums?
CD: A lot of the junior and small-cap stocks have been negatively affected in the current market environment and the stocks in the junior potash developer sector are no exception. Those are the ones that investors usually abandon first whenever market sentiment turns negative. It might take until the fall for these stocks to start rebounding. However, falling prices present opportunities for accumulation before the summer doldrums really do kick in and volumes completely dry up. I expect to see an uptick, certainly towards the end of the summer and into the early fall.
TER: We appreciate your updates and insights.
CD: You’re very welcome.
Corey Dias has worked in the capital markets industry since 2003 and has spent eight years in institutional equity research and institutional equity sales. In addition, he has worked for a U.S. hedge fund, where he shared responsibility for the running of a $400M portfolio and sought out assets for private equity investment on behalf of the fund. Mr. Dias holds a Master of Business Administration from the Richard Ivey School of Business at the University of Western Ontario.
By The Gold Report, on May 3rd, 2012
 Sagient Research Systems is known for its investor research in the drug and medical device field, but the firm has also tailored its scientific approach to market-moving catalysts in the precious metals industry. In this exclusive interview with The Gold Report, Senior Analyst Jocelyn August discusses looming events in a select group of natural resource stocks that are expected to move as information flows out.
The Gold Report: Jocelyn, you are following catalysts that affect resource stocks. Tell me about that.
Jocelyn August: We have started looking at catalysts in the natural resource sector. Originally, our CatalystTracker was designed to look at just medical devices and diagnostics as well as drugs and the catalysts involved in their development. But we did another impact study for the natural resource sector and identified some large-impact events in the minerals sector. Similar to drug and device development, you can follow a timeline for the development of a natural resource from the planning stages to exploration, and you can see similar catalysts in terms of the testing of the natural resources and results that might be announced. We think those types of events have large impacts for these companies.
TGR: And you publish on these events, right?
JA: We recently completed a Q212 Outlook Report for natural resources, and we discussed four upcoming gold catalysts for the second quarter.
TGR: Speaking generally for a moment to the differences between drug and resource development, I’m thinking that you have much shorter development times with mines than you do with drugs. Don’t you?
JA: It depends. I think there definitely are companies that have been developing a mine for a long time and have run into a lot of regulatory and permitting hurdles.
TGR: Can we talk about some of the impending events and companies?
JA: One that we highlighted in our report for gold was the General Metals Corp. (GNMT:OTCBB; GMQ:FSE). This is a very small company with a $5.8 million (M) market cap. It is working on the Independence mine project in Nevada. We expect it is going to announce a preliminary economic assessment (PEA), which is an important step in moving the mine toward production. It’s going to tell us if this mine is going to be economically viable in terms of development. So it’s a necessary step for moving on in the feasibility stage. It will be an important event for the company considering that that market cap is so small.
TGR: How important will this PEA be as a catalyst for General Metals?
JA: The company has announced that it does not have the additional funds to proceed with the plan of operation. So if the PEA is negative, then it’s going to be hard for it to come up with additional development funds. Because this is its only project in development right now, it might be forced to cut back or even cease operations if the PEA is negative. On the other hand, if it is a positive announcement, then this could be a major step for the company with pretty significant upside for that specific event. We think that that’s going to be happening in Q212 as well.
TGR: What else have you written about in your Q2 Outlook Report?
JA: We are looking at several different gold companies that have some updated resource estimates. There is a project in the Marban block in Quebec for Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A). It has an option agreement with NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK) for this project. NioGold is currently the 100% operator of the project, but through its option agreement Aurizon can earn an additional 50% and then potentially up to 65% if it completes certain developmental milestones. So this updated mineral resource estimate for Marban would mean further fulfillment of the requirement for the option. It would mean that Aurizon would be at least a 50% operator here. That should work for both of them. That is also supposed to occur in Q212.
We also have an updated resource estimate projected for mid-2012 for Coeur d’Alene Mines Corp. (CDM:TSX; CDE:NYSE) for the Joaquin project, which is the gold and silver project in Argentina. It has already released some information on the estimate, and it is expecting to announce another update. That should give us a better indication of how much is actually present in that resource.
TGR: Coeur has a market cap of about $1.9 billion (B). How much can these catalysts mean?
JA: Coeur is a larger company with some other projects, but it should help give investors a better idea of where the company is going, how it’s continuing to develop its resources and continuing to make money. Obviously, all mines have a certain lifespan, and all these mining companies have to continue to find new areas to develop so they can make up for other mines’ production going down. It’s like a pipeline in drug development.
TGR: Is there one more you might mention?
JA: The only other one we have is North American Palladium Ltd. (PDL:TSX; PAL:NYSE). It’s a palladium company, obviously, but it is developing the Vezza mine, a gold mine in the Abitibi region of Quebec. The gold project is functioning as a diversification vehicle for the company, and we think that’s appealing. It is expecting to announce the start of commercial production in Q212.
TGR: Thank you very much.
JA: Thank you.
Jocelyn August is currently the senior analyst and product manager for CatalystTracker, a proprietary research product focused on identifying and analyzing the future events that will materially impact publicly traded companies. In her five years at Sagient, she has developed expertise in the highly event-driven medical device and diagnostic sector. In addition, she spearheaded the development of a new Natural Resource Industry product within the CatalystTracker product line with the publication of the Catalyst Impact Study: Natural Resources Sector. Outside of Sagient, August was named the director of communications for the San Diego Professional Chapter of MBA Women International. August received a Master of Business Administration from the Rady School of Management at the University of California, San Diego and graduated cum laude from the University of California, San Diego with a Bachelor of Arts degree in sociology.
By The Gold Report, on May 2nd, 2012
 Scott Jobin-Bevans, immediate past-president of the Prospectors and Developers Association (PDAC), candidly assesses the political, environmental and technical challenges facing foreign companies exploring for gold and other minerals on the Caribbean island of Hispaniola. In this exclusive interview with The Gold Report, we learn that the majors are paving the way for junior mining firms on the island, which holds much buried treasure, despite environmental and political challenges.
The Gold Report: Scott, you live and work on Hispaniola, which is divided into two countries, Haiti and the Dominican Republic (DR). The island is bisected by a mountainous spine of precious metal deposits, with part of the resource in Haiti and part in the DR. Majescor Resources Inc. (MJX:TSX.V) and Newmont Mining Corp. (NEM:NYSE) are players in the Haitian space. The biggest player in the DR is a joint venture between majority partner Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Goldcorp Inc. (G:TSX; GG:NYSE). Since 2009, Barrick has been developing the Pueblo Viejo mine, estimated to hold gold reserves of 23.7 million ounces.
What is the history and significance of Pueblo Viejo?
Scott Jobin-Bevans: In 1975, a private company called Rosario Dominicana opened up the Pueblo Viejo mine. It was the largest open-pit gold mine in the Western Hemisphere. A few years later, the Dominican government bought out Rosario and ran the mine. The operation went through the oxide cap in the early 1990s. When it hit the sulfide ore, costs became prohibitive. Engineers didn’t have the technology to efficiently process this type of ore. The government shut down the mine, leaving behind an environmental and political mess.
Even though Pueblo Viejo went dark, there were small operations around the island, including a number of alluvial miners panning for gold in rivers. There was also ferronickel. Falconbridge, which is now Xstrata Plc (XTA:LSE), was involved in nickel laterite production on the island. Alcoa Inc. (AA:NYSE) was working bauxite in the southwest part of the island. There was not much hard rock gold mining going on, but there was a fair amount of exploration.
In the early 2000s, things began to take off for the junior gold mining firms.
TGR: What drove the renaissance? Technology?
SJ-B: Geophysics or geochemical soil and rock sampling technologies are very useful. But the main thing is the amount of virgin ground with great targets that nobody had systematically explored. I believe it’s a highly prospective and wide-open field for the juniors.
TGR: Why wasn’t the space explored systematically before the millennium?
SJ-B: I think a lot had to do with the issues around government stability on the island. In Haiti, there are problems with permitting. The Haitian government is in disarray; it is difficult to move mining ventures forward. The DR may be on island time, but it is more advanced than Haiti. Permitting can be slow, but it gets done. Securing land tenure has been an issue. Now that land tenure in the DR is clear, systematic exploration using Canadian experience and know-how can be applied with confidence.
TGR: What is the political climate for mine operators in the DR?
SJ-B: Ask me after May 20th. That’s the election date. Pueblo Viejo is a political card, but overall the desire for mining and exploration in the DR is positive. I’ve met with the director of mines and with local political people whose communities are affected by exploration and mining. They are all very positive. I think it all comes down to jobs and opportunities for the communities from a socio-economic point of view. When calculating the potential royalties from Pueblo Viejo, it’s pretty tough for the government to say that it’s against mining.
TGR: How do you win over the locals?
SJ-B: First and foremost is good communication with the affected communities. By holding community meetings to educate people on what we’re doing we can demystify the exploration and mining processes before negative perceptions are created. Specific examples might include going into a community with a drinking water problem and helping it upgrade the drinking water system or by helping with hospital supplies or schools. Local philanthropy builds good relationships.
TGR: There have been international press reports of protests about Barrick’s proposed use of cyanide refining methods at Pueblo Viejo. Can you talk about that?
SJ-B: Barrick is not hiding the fact it is going to be using cyanide. Cyanide is a natural part of most refractory gold recovery processes. It’s very well managed. We’ve obviously had problems when things went wrong but it’s not to be treated lightly. It’s cyanide. It’s poisonous. Cyanide breaks down very quickly under UV light like sunlight and dissipates within hours. An interesting analogy can be drawn between the presence of metallurgical cyanide as used in gold extraction and how cyanide occurs naturally in the environment.
This story comes from a colleague, Hugo Dominguez. Have you heard of cassava bread?
TGR: Sure.
SJ-B: It’s made from the yuca plant, which has cyanide in it. When the Dominicans process the yuca to make cassava, they remove the cyanide with a water treatment. Where does that toxified water go? It goes into the drain. Arguably, cassava bread processing pumps more cyanide-laced water into village streets than any mining operation. But the cassava-cyanide water is ultimately not poisonous, because sunlight breaks down the cyanide. Same with mine wastes.
TGR: You’re the immediate past president of a leading mining industry group, Prospectors and Developers Association of Canada, or PDAC. As president, you consistently supported socially responsible mining practices. Can you talk about some of the safety and environmental precautions that are in place in mines that you have seen on Hispaniola?
SJ-B: Barrick had a problem in the construction of its tailings ponds, which it has now corrected. It had to do with high volumes of rain during a freak storm. Luckily, the breach of one of its dams occurred when there was no production going on. But the engineers build things to survive failure. It’s like NASA; there’s redundancy built into the system.
Most hurricanes do not penetrate the inland region where Pueblo Viejo is located. But up in the hills, there is another problem: lightning. In addition to traditional safety systems on the mine, Barrick has designed and implemented a lightning warning system that alerts workers if there is danger of lightning in the area. I have never seen this before on a mine site and it is a credit to the conscientious effort Barrick is making toward providing a safe work-place.
TGR: How do utility and transportation infrastructures on the island affect mining costs?
SJ-B: Electricity is expensive. In my home, for instance, we are penalized for over usage. We start off at approximately $0.08/kilowatt and very quickly jump up to $0.33/kilowatt. In addition, the electrical distribution system really needs a lot of work. There are areas on the island with only 18 hours a day of power so really these are rolling blackouts. But the government is working very hard to take the whole island to 24/7 electricity. Although there is hydroelectrical power generation, there is a lot of power generation based on diesel fuel. That’s expensive. I have noticed that the government is seriously looking at solar power and wind projects.
Barrick’s processing facility is power intensive. Barrick bought a power generating station in Santo Domingo from the government after agreeing to feed a portion of the electricity back into the grid.
As for transportation, some of the roads are great but some are atrocious. You can get around most of the country because there is a large network of toll highways and secondary roads. I have a two-wheel-drive Jeep that gets me most places. But when I go into the field, I grab a four-wheel drive because with flash flooding a road can quickly become an off-road situation.
TGR: What about telecommunications?
SJ-B: It seems that everyone’s got a cell; landlines are rare. I’ve had good cell service at about 95% of the places I’ve been on the island, including jungle trekking.
TGR: Barrick is the world’s largest gold producer. How do other firms on the island stack up against Barrick?
SJ-B: In Haiti, the major gold producer is Newmont, which has optioned projects in the border region from Eurasian Minerals Inc. (EMX:TSX.V). Majescor is not a major company, but it is working in the same neck of the woods as Newmont, in the northeast region of Haiti. Jumping over the border into the Dominican Republic, we find Unigold Inc. (UGD:TSX.V) immediately east of Newmont. Further southeast are GoldQuest Mining Corp. (GQC:TSX.V) and Everton Resources (EVR:TSX.V; ERV:FSE; EVRRF:OTCQX). I should also mention that located near Everton is another producer, Perilya Ltd. (PEM:ASX), which operates the Cerro de Maimón copper-gold mine; it is a very successful operation.
TGR: Did the 2010 earthquake affect mining operations on the island?
SJ-B: The earthquake was centered around Port-au-Prince. As far as I know, further northeast, Majescor and Newmont weren’t affected. But there are active fault lines everywhere on the island and mining and exploration companies are quite aware of that. New buildings are designed with earthquakes in mind and in many cases even core racks are cemented into the ground, so that they do not topple.
TGR: How does Majescor’s SOMINE property in Haiti compare geologically to the Pueblo Viejo operation in the Dominican Republic?
SJ-B: There is a mineralized belt that runs through the Cordillera Central, the big mountains in the middle of the island. In Haiti, it looks as though Majescor and Newmont are dealing with copper-gold porphyry systems. But as we move southeast into the Dominican Republic, we find epithermal systems that appear to be more related to volcanogenic massive sulfide or VMS systems, although there is the chance for porphyry discovery. Either way the region is highly prospective for gold and copper mineralization.
TGR: Do these geological differences require different mining techniques?
SJ-B: If the deposits are narrow vein, it’s usually not economic to do an open pit. In Haiti, Majescor has broad intercepts of very nice grade mineralization. It is working its way toward a porphyry open-pit scenario, maybe underground long term. Mining sulfide ore at Pueblo Viejo requires a very large open pit.
TGR: What work is your geological consulting firm, Caracle Creek International Consulting, doing for Everton in the DR?
SJ-B: André Audet, who is the head of Everton Resources, also started Majescor in Haiti years ago, but he has been working on the DR side for 10 years. Everton has a nice property package, including a concession named Ampliacion Pueblo Viejo, which is immediately west and northwest of Pueblo Viejo. The Ampliacion team is headed by Hugo Dominguez, a past president of the Geological Society of the Dominican Republic. He knows the geology; he’s well connected. We are working with him on 3-D modeling, database management and targeting. We are also hoping to utilize Caracle Creek’s proprietary geophysical system, EarthProbe. It’s exciting because all of the fundamentals have been done and we believe we are at the stage where discoveries are just around the corner.
TGR: Let’s talk about recovery of gold from tailings.
SJ-B: PanTerra Gold Ltd. (PGI:ASX) [previously EnviroGold] is recycling tailings and extracting gold and silver as part of cleaning up the environment around Pueblo Viejo. The company is applying the Xstrata-owned Albion process, which is a brand name for a metallurgical and processing recovery system that basically re-grinds the tailings and then uses cyanide to produce gold from tailings. PanTerra has about half a million ounces of gold and some silver outlined, which will carry it for six or seven years of production.
TGR: Do you have any stock picks for investors interested in exploring opportunities in Haiti and the Dominican Republic?
SJ-B: There are three junior explorers that I really like and all three have the potential to define gold and/or copper resources in the near term and make multiple new discoveries. Unigold, which was languishing around $0.09 less than six months ago, is now upward of $0.29 with intraday high of some $0.47 in mid-January on the back of some impressive drill results that included 73 meters at 2.36 grams per ton gold from the Lomita Piña project next door to its Candelones deposit. Unigold then raised $11 million (M) on a bought deal, a lot of which will be spent on its projects in the northwest.
Everton Resources also has numerous highly prospective projects in epithermal gold-copper and also in volcanogenic massive sulfide ore deposits (Cu-Au-Zn). GoldQuest could be on the verge of defining a million-ounce gold resource in the next few months. It announced the start of a drilling program in late February aimed at upgrading and updating its resources at the La Escandalosa property. All three of these companies are bargains but especially Everton and GoldQuest.
The Chinese-Australian company Perilya has a base metal mine called Cerro de Maimón near Pueblo Viejo. It bought this property for next to nothing from GlobeStar Mining Corp. (GMI:TSX) and paid it back within the first year of production. It’s not huge, but it’s got a number of productive years left. On the island, a capital expenditure of $50–75M can develop a small mine with a 10- to 15-year production life. This presents a great opportunity for a company like Everton Resources that has a number of projects similar to the Cerro de Maimón mine.
TGR: If Barrick is successful at Pueblo Viejo, will the island’s mining infrastructure evolve to make it easier for the juniors?
SJ-B: Infrastructure is already building up from the service/supply side. Chemicals and other mining products, like drill rods, drill bits, muds, vehicles and portable shelters, are being imported into the country. That is good for exploration. The bottom line is that once Barrick starts producing a million ounces a year, the DR will get the notice it deserves and the whole island will be a hot bed for exploration and discovery.
TGR: Thanks for your time.
SJ-B: Thank you.
Dr. Scott Jobin-Bevans has more than 22 years in mineral exploration with public company experience as a director, officer and technical advisor. He has expertise in project evaluation and in leading multi-million dollar projects from generative stage through advanced exploration and into development. Jobin-Bevans is a member of the board of directors for a number of public and private companies and is the past president and director of the Prospectors and Developers Association of Canada. He is a co-founder of Caracle Creek International Consulting and was managing director from 2001 to 2008. In 2008, Jobin-Bevans stepped down as managing director and became part of the founding management team of TSX-listed Treasury Metals Inc., where he served as president, CEO and a director until April 2011. He returned to Caracle Creek in May 2011 as director of corporate development and is currently leading the Dominican Republic operations for Caracle Creek Dominican Republic.
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By The Gold Report, on May 1st, 2012
 Paolo Lostritto, mining equity research analyst with National Bank Financial, attributes development companies’ current struggles to both the recent trend for capital and operating cost increases and to the European sovereign debt crisis. But there are opportunities as long as investors look for companies with free-cash-flow growth and solid balance sheets. In this exclusive Gold Report interview, Lostritto shares some names of companies that have these attributes.
The Gold Report: Paolo, a lot has changed since we talked in January 2011. Specifically, National Bank Financial purchased your former employer, Wellington West Mining. More generally, the once-rebounding world of precious metals equities is now decidedly bearish. What is your take on precious metals equities?
Paolo Lostritto: We are seeing two things. One is ongoing cost creep and eroding margins. The second is a dampening of valuations as the market tries to assess the resurgence of sovereign debt risk and the potential of an unorganized breakup in Europe, as signaled by bond yields.
TGR: How have those factors changed your thesis for gold equities?
PL: This situation is ultimately a positive for gold as there are only two ways out. One, you can try to devalue your currency, which a lot of are countries are trying to do and should lead to an inflationary recession. The second is having the multiple layers of debt collapse onto itself, leading to a deflationary recession.
The gold market is struggling to figure out which scenario will play out. Gold bullion protects you in both scenarios. In an inflationary recession the metal outperforms. In a deflationary recession, gold equities would eventually do better.
TGR: Perhaps, but that was not the case for gold equities in the fall of 2008 and early 2009.
PL: In 2008, the market was pricing in the risk of a depression. As a result, gold behaved as the last source of liquidity. Yes, gold came off a bit, but it worked as the go-to source of liquidity, the insurance policy that worked.
Equities also behaved the way they were supposed to—the multiples contracted initially. But on the back of reduced costs, margins expanded and project internal rates of return improved. Once the initial depression scare passed, the precious metal equities outperformed.
TGR: What are you looking for in gold equities?
PL: We are looking for companies that can fund their growth organically on their own, companies with strong balance sheets that do not have to go to the equity markets to survive.
Development companies are struggling right now because the equity markets are not open to funding exploration or development.
TGR: First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) just did a friendly merger with Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC). Are we likely to see more deals like that?
PL: You will probably see two types of transactions. First, development mining companies that have run out of options will be looking to do a deal out of necessity. Second, we believe there are more opportunities for activity involving royalty and streaming companies.
This is a perfect environment for companies like Franco-Nevada Corp. (FNV:TSX), Sandstorm Gold Ltd. (SSL:TSX.V) and Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). It opens the door for them to get involved with development projects that may otherwise have been supported by the equity markets.
TGR: You and your team use a number of metrics to compare apples to apples among precious metals companies. Please tell our readers about a couple of your favorite metrics and how you calculate them.
PL: We are big believers in both net asset valuation and price-to-cash-flow growth valuation.
Over the last 12 months, we believe the market has applied a higher discount rate to future cash flows that have been trimmed to account for higher costs.
We are seeing a transition from a historic premium applied to precious metal companies to one with a more traditional valuation methodology. Precious metal companies are being modeled similar to base metal companies. We no longer see the premium we used to see in gold companies, in part due to cannibalization from exchange-traded funds. Many gold companies are trading at 12–15% discount rates using the forward curve.
Using the price-to-cash flow metric, these stocks typically trade anywhere from 10 to 12 times cash flow. Right now, some of them are trading as low as three to five times cash flow 2013 estimates.
TGR: So there are bargains to be had?
PL: Right now, our view is that investors should take a conservative stance. Focus on companies that have cash, cash-flow growth and solid balance sheets. The old saying is that the markets can stay irrational a lot longer than you can stay solvent. You want to have a defensive portfolio in this market, until we get a clear signal that deflation risk has been reduced. The recent Long-Term Refinancing Operations (LTRO) program from Europe only managed to give us two months of reprieve before the second LTRO program at the end of February disappointed relative to the sovereign debt risk.
TGR: Let’s talk a bit about the companies you cover that have gold projects in Burkina Faso, a small country located between Ghana and Mali. It is home to about 30% of the Birimian greenstone belts of West Africa. What are the main characteristics of gold deposits native to these greenstone belts?
PL: We are in the early stages of defining what Burkina Faso has to offer in terms of exploration.
A lot of exploration dollars have gone into West Africa on the back of efforts from companies like SEMAFO (SMF:TSX), Orezone Gold Corporation (ORE:TSX), AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE), Gold Fields Ltd. (GFI:NYSE), Newmont Mining Corp. (NEM:NYSE), Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE), Perseus Mining Ltd. (PRU:TSX; PRU:ASX), Keegan Resources Inc. (KGN:TSX; KGN:NYSE.A), Volta Resources Inc. (VTR:TSX), IAMGOLD Corp. (IMG:TSX; IAG:NYSE), Red Back Mining [now Kinross Gold (K:TSX)] and Avion Gold Corp. (AVR:TSX; AVGCF:OTCQX). It will be up to these companies to drive the next leg of exploration growth.
TGR: Why would companies look for gold deposits in the greenstone belts of West Africa instead of Ontario or Québec, for example?
PL: The influx of money into West Africa was fueled by the large deposit discoveries and a favorable tax environment.
However, labor costs, royalties and taxes in West Africa have been increasing. The recent increase in royalties and taxes has caused some deviation in this flow of funds.
TGR: Did the recent coup in Mali cause you to rerate any of the companies you cover?
PL: We are watching that situation very closely in light of the ties to al-Qaeda in parts of Northern Mali. If this trend continues, it could have implications for surrounding countries and how we value them.
TGR: Does jurisdiction risk outweigh the exploration potential in West Africa?
PL: We believe there are still elephants to be found in that part of the world. But the discount rate that one uses to value these assets will have to change from country to country, and jurisdiction to jurisdiction, relative to the associated risk.
For example, we use a higher discount for a company in Bolivia versus a development story in West Africa, versus a development story in Ontario.
TGR: Have you already beefed up your discount rates for companies operating in Burkina Faso, Ghana or Mali?
PL: We have not. In our current view, projects in Burkina are politically safe. We are keeping a close eye on Mali. If things start to spread to surrounding countries, we may have to reassess the discount rate we apply.
TGR: As far as operating mines go in Burkina Faso, it is hard to beat IAMGOLD’s Essakane mine, which produced 340,000 ounces (oz) in 2011, at a cash cost of roughly $488/oz. Do you believe IAMGOLD will expand the resource through the drill bit or is a takeover more likely?
PL: IAMGOLD has said it is trying to expand resources around Essakane through the drill bit. It is spending a fair amount of exploration dollars there.
The company wants to repeat what it did at Rosebel: expand in and around existing infrastructure to leverage its initial investment and improve internal rates of return.
IAMGOLD has a billion dollars in capital. Its after-tax hurdle rates, if I recall correctly, are something in the order of 10% to 12% in North America, 12% to 15% in South America and 15% to 17% for West Africa.
TGR: Despite the pullback in some of the exploration plays in West Africa, do you see more value in companies operating there than a couple of months ago?
PL: I would say there is a lot more value here in North America when you adjust for the risk profile. A number of these stocks have been hit in tandem when it comes to development stories.
Rainy River Resources Ltd. (RR:TSX.V) and Romarco Minerals Inc. (R:TSX) in North America have been hit just as hard as development stories in West Africa.
TGR: Can you give us the names of some companies in the development stage in West Africa on which you have buy recommendations?
PL: In the development stage, I cover Orezone, IAMGOLD and Volta Resources.
TGR: Orezone expects to issue a feasibility study on Bomboré in Q412. What does the market want to see in that study?
PL: Although the market is shying away from low-grade deposits in this current environment of increasing capital and operating costs, Orezone has the advantage of having a soft rock development component, which should result in a lower capital cost and operating intensity. We expect the feasibility study to focus on these advantages and yet still produce a soft rock reserve close to 2 million ounces.
TGR: Right now, Bomboré is valued at an enterprise value of $38/oz, just about average for the companies you cover. What does that say to you?
PL: That metric tells me the market is applying a higher discount rate for the sulfide ounces that Orezone is finding.
But that is just one of many metrics. In my mind’s eye, the real value-added opportunity is demonstrating soft-rock versus hard-rock ounces. The company should be able to add value through its soft-rock development.
Our target for Orezone is $4.60. It is now trading at $1.69.
TGR: What can you tell us about Volta?
PL: We expect a prefeasibility study from Volta this quarter. This is another bulk-tonnage, low-grade project, with less soft-rock material than Orezone’s but a more compact deposit, which should allow the company to capture economies of scale. We expect the prefeasibility study to highlight bigger trucks to drive down unit operating costs.
Our target on Volta is $2.75 a share; it is currently trading at $0.83.
TGR: So, an outperform rating?
PL: Yes, for both Orezone and Volta, but we apply a speculative risk rating for both companies because they are development stories.
TGR: Volta’s project isn’t that far from Essakane. Could it become a target?
PL: I would say that they are too far apart. There might be synergies between Orezone’s Bomboré and Volta’s Kiaka project, along with Channel Resources Ltd. (CHU:TSX.V)—probably related to electrical grid power.
TGR: Channel Resources is in the same neighborhood. What can you tell us about it?
PL: Channel is a smaller, earlier-stage exploration play along the Markoye Fault.
Channel does not yet have a resource, although one is expected shortly. The company has some interesting drill holes along the Markoye Fault, but more work is necessary to develop it. It is worth keeping an eye on.
TGR: Channel recently completed 15,000 meters of drilling. Is that above average for a company of its size in that area?
PL: Yes, I would say so. The company had some interesting targets. However, the market is not paying for drill holes at the moment. It is paying for free-cash flow. A substantial discount is being applied to all exploration and development companies right now.
TGR: What three things should our readers know before taking a position in a West African gold play?
PL: First, there are still elephants to be found there. Second, focus on names that have good infrastructure. Those companies will be better insulated against the cost inflation we’re seeing in West Africa. Third, grade is king. Better grades also provide insulation against cost inflation.
TGR: What constitutes good grade there?
PL: It is a function of the dimension and characteristics of the deposit, the metallurgy and the strip ratio. For example, a project with soft rock characteristics and low strip ratio can process lower grade material than one with harder rock characteristics and a high strip ratio.
TGR: Thanks for your time.
Paolo Lostritto currently serves as a mining equity research analyst for National Bank Financial. He has formerly worked with Wellington West Mining, Scotia Capital and TD Securities. He holds a Bachelor of Applied Science degree in geological and mineral engineering from the University of Toronto.
By The Gold Report, on April 27th, 2012
 Last year, Africa was the region that witnessed the strongest growth in gold-mining operations. In an exclusive interview with The Gold Report, Nana Sangmuah, managing director of research with Toronto-based Clarus Securities, expects that trend to continue and suggests some immediate smart investments in Ghana, Mali, Liberia and the Democratic Republic of the Congo.
The Gold Report: Gold consultancy GFMS, which is now owned by Thomson Reuters, recently published its 2012 Gold Survey. GFMS predicts that before the end of 2012, the yellow metal will likely reach above its all-time nominal high of $1,920/ounce (oz) in September 2011. The catalysts include inflation concerns and sovereign debt problems in Europe, especially Spain. What are your thoughts on these predictions and conclusions?
Nana Sangmuah: I agree with those predictions and the drivers. One thing that has been missing from the gold rally is inflation hedge demand. With the significant monetary easing that has occurred to drive a global recovery, inflation is definitely going to be an issue at some point. We haven’t seen inflation trade come into gold throughout these 10+ years. That’s the strong headwind that is going to move gold to another level.
TGR: The survey reported that mine production hit a record high in 2011, rising 2.8% year over year to reach 2,818 metric tons (mt). That marks the second straight year that gold production reached a new all-time high. Does that mean the theory of peak gold is dead?
NS: Not exactly. If you peel back the data over the past two years, the greater part of this growth has come from mines digging into their stockpiles and people revisiting old resources that previously were thought not to be economic but at these price levels look economic. There have been very few discoveries despite the fact that there’s been quite a lot of money spent on the exploration front. That rate of increase is not sustainable going forward. And the bigger picture still looks grim because the last big discovery of 5+ million ounces (Moz) is the Aurelian discovery—the Fruta del Norte deposit in Ecuador, which now belongs to Kinross Gold Corp. (K:TSX; KGC:NYSE)—from early in the 2000s. It takes on average at least five years to move from discovery into production, so we’re looking at a situation where the supply is not going to grow that much. If the investment demand is sustainable going forward, basically there won’t be enough ounces to feed that demand.
TGR: The GFMS survey also reported that new gold-mining operations contributed 47 mt of new gold supply, while Africa was the region that witnessed the strongest growth, increasing production by 51 tons (t) despite a 5 t drop in output from South Africa. Do you believe Africa will continue to lead the way in worldwide gold production?
NS: Certainly. The ground is very favorable, and there are a lot of projects that have only scratched the surface. Even in the more prolific zones, which have seen a lot of dollars thrown at them, the concentration has just been on open-pit, near-surface mining. In some of these greenstone belts, you can trace mineralization down to more than 2.5 kilometers (km) at depth. As people get more comfortable with the region’s politics, more dollars are going to move in, and certain grounds will be tested. The key is political stability. As commodity prices go up, countries move their fiscal regimes around.
But I think a lot of countries will smarten up and realize they can attract more investments, which will ultimately generate more revenues to the government if their current regimes are seen to be stable. The Asankrangwa Belt in Ghana is one example. This belt is as old as the Ashanti Belt, but we have just recently seen action on it. So far, within a period of less than three years, 10 Moz have been delineated. Some people would think that certain districts are mature and cannot be coming up with even more discoveries, but that is not true.
TGR: Mali’s interim president said that he wouldn’t hesitate to wage “total relentless war” against the Tuareg rebels who have seized much of northern Mali. Do his words make you less bullish on all West African gold producers?
NS: He’s trying to send a strong signal that he’s all for maintaining stability in the region. And the regional force, ECOWAS—Economic Community of West African States—acted quickly to prevent this from blowing up. A stabilizing force has made its dominance known in West Africa, which I think is going to foster more stability and get people to be more comfortable investing more dollars in the region. Access in general has not really been impaired. The borders are open. People can focus on the day-to-day running of businesses and mines. There’s the potential for a few situations here and there as they try to push the Tuaregs away. But the Tuaregs’ links with al-Qaeda are definitely going to unify the international community against any issues. That means that this is not going to drag on for long, and very soon we should see this issue behind us. We’ve seen similar events before and people have hit the panic button and sold off, but as the situations stabilize, valuations come back strongly. So, I see this as a buying opportunity, and I’ll be focusing on assets. If these assets have not been impaired in any way fundamentally, they should be bought at these levels.
TGR: Ghana is second only to South Africa in African gold production. What are some of the companies operating in Ghana that are well positioned to grow their gold production and see it translate to their share price?
NS: In this current environment, we should be watching the balance sheets of companies to see whether they have enough capital to maintain their growth strategies. One company that I think has a very strong balance sheet is Perseus Mining Ltd. (PRU:TSX; PRU:ASX), which has finished up building a mine in Ghana and announced very strong Q112 results showing good cost containment. Commissioning has gone well and it’s in a ramp-up phase. I think most of the risk is behind it. Perseus is on the cusp of generating a lot of cash flow. That is going to help it bring its second asset, which is not in Ghana, into production. Cast your eyes two years out and Perseus will be producing around 450,000 oz, generating a lot of cash flow that could be channeled into further growth opportunities or shareholder dividends. Currently the resource is 9 Moz and Perseus is spending quite a lot on exploration; about 200,000 meters (m) are being drilled in West Africa. The likelihood of growing 9 Moz into 12 Moz is high. And Perseus has had a very good success rate converting these ounces into reserves, so we should see the production profiles also tip up along the way. At these levels, with no finance hurdles ahead of it, being in a fully funded position and just on the cusp of generating strong cash flows, Perseus is one that investors should be watching.
TGR: Perseus boosted the resource at the Edikan by 1.03 Moz in December 2011. Is it reasonable to think that it could do that again by December 2012?
NS: It’s doing about 200,000m of drilling this year; last year it drilled about 250,000m split between both assets. The rate of resource growth should be more significant because now it’s switching focus from infill drilling to regional targeted. That’s where you see a lot more growth in the resource. I’m quite optimistic that we should be seeing a lot of wider swings in the resource growth going forward. And the company’s picking up new targets in and around the existing mine.
TGR: Ghana also has a number of smaller companies exploring for gold deposits, some of which have had early success. Could you introduce our readers to some of those companies?
NS: There are a lot of junior companies prospecting for gold in Ghana. One of the more successful ones in recent times has been PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE). It is advancing a brownfield operation previously operated by Resolute Mining Ltd. (RSG:ASX), which mined about a million ounces at 2.2 grams per ton (g/t). PMI came in and has been able to delineate about 5 Moz on the flagship asset. What is most exciting about the company is it has more ground toward the south on the Asankrangwa Belt, on the Asanko project and the Obotan project. This is the first time that ground has been developed by one single company. This points to the potential to grow the ounces profile well north of the current 5 Moz. PMI also has ground—the Kubi project—next to one of the world’s most prolific mines, the Obuasi mine, which has produced and delineated about 60 Moz. And it actively drills Kubi, which is just 15km south of Obuasi. For the first half of the year, it’s drilling about 100,000m on all these targets. And we just saw eight new anomalies discovered last week, signaling the potential to add to the current resource envelope.
TGR: The Obuasi gold mine is operated by AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE), which is a major gold producer. Would that make PMI a potential takeover target?
NS: Most of these junior companies that have solid resource growth potential are likely targets.
TGR: Any others in Ghana?
NS: There are quite a few, but we can talk about some other early-stage companies, like Abzu Gold Ltd. (ABS:TSX.V; ABZUF:OTCQX). It’s about to come out with a maiden resource on the ground in northern Ghana in a district that is known for gold-bearing structures.
TGR: On Jan. 19, 2012, you wrote, “Abzu’s vast tenement package with a plethora of targets diversifies exploration risk well for shareholders and its proven management team reduces execution risk.” Tell us more about the management team there.
NS: Abzu’s CEO Allan Serwa is a Canadian who’s been in Ghana for quite some time and has built up a lot of relationships there. He brings to the table the ability to manage community relationships very well—better than seamless. You find a lot of companies with good projects but a lot of problems dealing with communities. So Serwa really gives Abzu a solid platform from which to take off. Paul Klipfel has been a geologist with some of the more senior mines, including Placer Dome Inc. [now Barrick Gold Corp. (ABX:TSX; ABX:NYSE)], and has had some decent experience in Ghana as well. Quite a few other accomplished geologists and company CEOs who will provide necessary direction are on Abzu’s board of directors.
TGR: Abzu’s sizeable land package stretches across four different gold belts in Ghana. What sort of exploration success has Abzu had to date?
NS: Abzu has delineated a mineralization trend of 1.5km in one. I have visited that structure and have seen that it extends well to the north and to the south. On the Asafo Belt right on the Kibi Belt in the south, Abzu has been coming up with some very decent grade intersections of 4+ g/t material. It’s still early but indications point to, with additional drilling, sizeable results.
The concessions are in close proximity to prolific mines. Abzu has properties near Newmont Mining Corp.’s (NEM:NYSE) Ahafo and Akyem projects. It’s got property that is close to Keegan Resources Inc.’s (KGN:TSX; KGN:NYSE.A) Esaase mine. So, these are spanning all the belts coming through to the south. And Abzu is on the Kibi Belt as well—that is also close to a past-producing mine. There is the adage that the best place to find gold is within the shadows of a headframe. I think that is the strategy that guided Abzu in staking all these concessions.
TGR: You also cover companies with gold projects or mines in Burkina Faso, Liberia and even the Democratic Republic of the Congo (DRC). Please tell us about some of those companies.
NS: In Burkina Faso one of my top picks is SEMAFO (SMF:TSX). It’s seen quite a significant pullback in recent times. It has a very solid balance sheet, $170 million (M) in cash, no debt, and it’s generating an operating cash flow of about $130M per year. This company is in a position to fund all its organic growth without coming back to the market. Any value from additional expansions flow to the shareholder. SEMAFO has been able to demonstrate the ability to bring that production on for the past three years. There are a few catalysts coming down the pipeline, including a resource update. And as management continues to show to the market that its large Mana project has resource growth potential with several exploration updates expected, not only in June but after, we should begin to see that attention back into the stock. We will probably see it recover earlier than most of its peers because there’s nothing fundamentally wrong with the company.
TGR: You’ve got a $12 target price on that and a Buy rating. SEMAFO has a promising project in Niger called Samira Hill. What are your thoughts on that?
NS: It is a mine that sits on a mineralized trend that stretches for a good distance. Only about 15% has been tested and developed as pits. So there’s a lot of potential along the strike. In the past, very little capital was reinvested in the mine because ownership was split between Etruscan Resources Inc. (EET:TSX) and SEMAFO, and Etruscan never had enough money to put into expansion activity. The mine has not been performing at its optimum level for some time. That’s changing with SEMAFO now taking full control of the mine and investing a lot more into exploration and capital projects. It’s smaller and we need to see a much, much larger expansion to get more stability in the operation. But I think it’s still a worthy asset to have in the company.
TGR: Tell us about Liberia.
NS: Often people shy away from countries that have had issues. But Aureus Mining Inc. (AUE:TSX; AUE:LSE), which will likely be the first company to commence production in Liberia, is making good strides. Infrastructure-wise Aureus’ New Liberty project is very close to the port, and most of the access to the ground is via a paved highway. That makes it relatively easy to access, compared to other projects in the country. The capital required to kick-start the mine is around $120M—that’s not so huge that it will make this project’s financing risk insurmountable. I see Aureus coming up with its first production sometime in 2014. At this level, it’s one of the highest grade projects in the whole of West Africa near surface. And that’s just the beginning. About 40km north is its main asset, New Liberty, which in itself has a lot of potential to grow in surrounding anomalies that have been delineated. Northwest of the structure is a new 13km anomaly that has been picked up. The grades that Aureus has been picking up from initial intersections on this system are quite encouraging. So, there’s definitely a gold district there and the grades are quite compelling. That would definitely have a good impact on cost.
And we like the DRC. That country has had its issues in the past, but as with any other such situation, there’s always a time when it stabilizes. The fact that the election was conducted is a good thing. There were a lot of irregularities, but post-election issues have not been too severe, and that’s a good sign that the DRC is maturing and stabilizing. You see a huge discount in companies operating in the DRC, which in my opinion is not warranted, because it has one of the most prospective mineral belts in the world.
We just saw the first commercial gold production coming with Banro Corporation (BAA:TSX; BAA:NYSE) picking up the march. And we’re going to be seeing Kibali from Randgold Resources Ltd. (GOLD:NASDAQ) come through. I just visited the Kibali project and was very impressed by the progress made for relocation, which is probably the most challenging part of construction. With a solid technical and mine-building team in place Randgold expects to bring Kibali into production by 2014 without a lot of challenges. As these two continue to do well, people will change their perception of gold mining in the country.
Another that I would highlight as very cheap at these levels is Kilo Goldmines Ltd. (KGL:TSX.V), which is on the Ngayu greenstone belt and will be commencing drilling very shortly. David Netherway and Alex van Hoeken have taken over, and they are seasoned mining personnel who focus on the exploration growth potential of their large land package. One similar ground to the Kilo ground is Geita, which in the 1990s started as a small resource from old mine workings and has grown to north of 10 Moz. It’s a similar story for Kilo. It has an old mine at Adumbi, which is currently around 1.8 Moz, and there are a whole slew of prospects around it. This is one of the few times that a company has enough drill rigs to chase some of these targets. It’s very early, but there’s a lot of growth ahead of Kilo—including the fact that Kilo also has an iron ore exposure that the market is not paying anything for. So, you rarely get something for free, but Kilo could be an example of where that really works.
TGR: An iron-ore sweetener, as you’ve called it. In a March 30, 2012, report, you said you expected a rerating of the stock. When?
NS: Rigs are on-site and drilling has commenced. It has its own sample prep lot, so turnaround times are not going to be that long. As news starts to flow, which could be as early as midyear right through the end of the year, and people begin to appreciate the size potential of this asset land package and also the grade profiles, that’s when everyone will start waking up to the opportunity and drive the re-rating.
TGR: Do you have some parting thoughts on African gold plays?
NS: People should continue to focus on the fundamentals. Take advantage of the situation, which will turn around and stabilize, to pick up on names that you missed out on and wait for the disconnect between the commodities and the equities to correct. I see very little downside risk at these levels.
TGR: Thanks for your insights today.
Nana Sangmuah is managing director of research at Toronto-based Clarus Securities. His previous industry experience includes the Prestea underground mine, AngloGold Ashanti’s Obuasi and Iduapriem mines, and Gold Fields’ Damang gold mine. He has over eight years of global mining equity research experience that covers more than 60 mining companies worldwide in the gold, base metals and diamond sectors and has in-depth knowledge of mining projects in West Africa. Sangmuah completed a Master of Business Administration in finance at the University of Toronto’s Rotman School of Management in 2004 and obtained his Bachelor of Science in engineering from the University of Mines and Technology, Ghana, in 1999.
By The Energy Report, on April 27th, 2012
 Most investors may not have Australian resource companies on their radar screens, but that doesn’t mean that there aren’t some great opportunities worth pursuing Down Under. In this exclusive interview with The Energy Report, Ivor Ries, utilities and energy analyst at E.L. & C. Baillieu Stockbroking Ltd., one of Australia’s oldest securities firms, describes the challenges faced by energy-related companies in his country and how they are taking advantage of the opportunities available both at home and in the U.S., Canada and South America.
The Energy Report: Your firm has been in the investment business for over 120 years. Can you give us an overview of the energy markets and the challenges and opportunities that energy companies in Australia face?
Ivor Ries: Australia has historically been the quarry and energy source to emerging Asian economies. As a result, our economy is inextricably linked with the progress of China, Korea, Japan, India and the other Southeast Asian economies. Initially, we were mostly a supplier of minerals, but in recent years, the liquefied natural gas (LNG) markets have become a very large part of our economy. We have two very large LNG projects in production and a third smaller one in Darwin. Another five LNG projects are now under construction, which will more than triple Australia’s LNG output over the next five or six years.
The LNG boom has its pros and cons. The investment spending is a huge boost to our economy, but it also has caused a huge shortage of contractors and manpower. The price of labor has gone through the roof in any business related to oil and gas. An unskilled laborer working on an LNG project in Australia is probably paid somewhere between two and four times as much as he or she would be elsewhere. Australia has very tight restrictions on labor coming in. At the moment, the industry is forcing the government to change that. The government recently announced it is going to reduce the visa requirements for American and Canadian oil and gas workers, so they can help plug that gap. That would be a huge relief for the industry. We have a very heavy-handed set of regulations here, and there has been a lot of media hysteria surrounding fracking, particularly in the coal-seam gas areas and a very strong campaign to have fracking stopped. Anyone running coal-seam gas or unconventional gas here has to run through a very stringent and time-consuming environmental approvals process, which probably adds two to three years to getting a project off the ground. When it comes to the cost of getting things done, everything takes longer and is more expensive than expected. That’s frustrating.
TER: What’s the breakdown of Australia’s energy production versus its consumption of oil, gas, coal and other energy sources?
IR: The domestic market in Australia is overwhelmingly coal driven. Australia is the world’s largest seaborne coal exporter, and our domestic power industry runs about 80–85% off coal and to a smaller extent off hydroelectric power and gas. Cheap coal gives us very low-cost baseload power across the entire economy. A population of only 23 million (M) people is just not enough to create a significant market for gas, and that has resulted in a terrible oversupply. Until we started shipping LNG, gas prices were incredibly low. We’re just now starting to see the connection between the domestic gas price and export prices. Typically, for the last five years, the price for gas on the east coast of Australia was about $3.50 per million British thermal units (MMBtu). Now we’re starting to see some longer contracts being signed at about $7–8/MMBtu.
TER: Do LNG exports offer a big potential opportunity?
IR: Yes. In Australia, unlike the U.S., the mineral resources belong to the government. So the people who own the land do not own the minerals underneath. In the States you have the overriding royalty system where the landowner typically gets a percentage of the production. Here in Australia, the state government gets a royalty that is typically about 10%. The net cost of producing coal-seam and conventional gas is very low. There is a good network of pipelines on the east coast for moving the gas around where cash production costs, particularly from the better coal-seam gas fields, are typically less than $1/MMBtu. That’s very cheap. With an LNG plant, the price is now around $12–13/MMBtu. Even after the pipeline charges and the LNG plant operating costs, that is quite a big margin. In the recent years, we’ve had quite a lot of consolidation with global names buying up the smaller coal-seam gas players to increase their reserves and have a bigger stake in LNG.
TER: Are most Australian energy companies geographically diversified with operations in other countries?
IR: Our bigger companies here tend to be multinationals, like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto (RIO:NYSE; RIO:ASX) and Woodside Petroleum Ltd. (WPL:ASX). The Australian market is so small that to grow beyond a certain size, you have to become multinational in some way. The next tier down is a huge drop in terms of size. Our biggest pure domestic gas play is probably Origin Energy Ltd. (ORG:ASX). It has about a $16 billion (B) market cap.
TER: About how many energy-related public companies are there in Australia?
IR: There are a lot. Our market is a bit like Calgary in that we have a lot of really small exploration companies here. There are probably more than 250 listed energy companies on the Australian Stock Exchange (ASX).
TER: You have a fairly broad range of companies in your coverage list in terms of stage of development, type of business and the price of the stock. How do you decide what companies you want to cover?
IR: Many companies are working on a lot of small things. Our chief criteria is the company has to be involved in pursuing one or more core projects where the central resource is at least 100 million barrels oil equivalent (Mboe). Otherwise, there’s no point. Companies chasing smaller projects tend to burn through shareholders’ capital and then ask for more. We figure if you chase a 100MMbbl target and you derisk it, you may not actually produce it, but someone will come and pay you some real money for it. So that’s the first criterion. The other criterion is the quality of the management. Once we feel comfortable in that area as well, the company goes onto our coverage list. But as you can see, there are not many.
TER: What are your favorite companies right now?
IR: The ones that stand out to me at the moment are companies like Karoon Gas Australia Ltd. (KAR:ASX), which is a midsize explorer/developer with an LNG project in Australia and a huge exploration project ahead in Brazil. Molopo Energy Ltd. (MPO:ASX) and Red Fork Enegry Ltd. (RFE:ASX) are essentially American companies that happen to be listed on the ASX. Molopo has acreage in the Bakken in Saskatchewan, Canada and a project in the Wolfcamp play in the Permian Basin in Texas. It has about 25,000 net acres in Texas. We’re very excited about that. Red Fork has about 75,000 net acres in the Mississippi limestone play in Oklahoma. It has been getting some good results from its early wells there. We think these stocks are all very undervalued relative to the size and quality of the land positions they have. The next 12–18 months for all three will be exciting because they have a lot of wells going in and production will be ramping up. If they get a reasonable run of drilling success, their share prices will be significantly higher than they are now.
Molopo’s Wolfcamp drilling areas are surrounded by a lot of very big players getting some really good results. These include EOG Resources Inc. (EOG:NYSE), El Paso Pipeline Partners L.P. (EPB:NYSE), Approach Resources Inc. (AREX:NASDAQ), ConocoPhillips (COP:NYSE), Pioneer Southwest Energy Partners L.P. (PSE:NYSE) and Devon Energy Corp. (DVN:NYSE). On some of their better wells, those guys are getting over 1.8 Mbpd from long laterals. Molopo has drilled three short lateral wells so far, and all have flowed oil. It is about to crank up production and put in somewhere between 8 and 10 wells there by year-end. Long, lateral wells will target much higher flow rates than achieved to date. As the company derisks the project, the market will really appreciate that asset.
TER: What about Red Fork?
IR: Red Fork is up in the Mississippi limestone area in Oklahoma. That’s a real hotspot, and the last time I looked, there were 240 drill rigs running in the area. Red Fork is run by some very experienced oil guys out of Tulsa. It’s had a couple wells on pump so far and has been getting some nice oil flows, and is about to crank that up. Red Fork has a very big land position. It will be getting a big following from the States as its production cranks up, going to somewhere between 10–12 wells this year. Toward the end of the year, I wouldn’t be surprised if its production was getting close to 2 Mbpd.
TER: Does that hold up or does it taper off relatively quickly?
IR: Because it has so much acreage, it will just keep drilling. I think it will eventually have more than 300 well locations that it can drill there. It will certainly be able to grow its production by just steadily increasing the footprint there. Its neighbors are getting 30-day initial production rates around 350–550 bpd on pretty low-risk wells. If it can string together a whole bunch of those, we think it will then be seen as a serious company. At the moment, Australians see Red Fork as purely speculative and they haven’t really bought the story yet.
I should talk about Karoon Gas Australia Ltd. for American investors. Over the years, it has looked long and hard at whether it should actually be listed in America simply because the Australian market is probably struggling to value it. It has three projects, including a huge gas condensate field discovery in a joint venture with ConocoPhillips in the Browse basin off the northern coast of West Australia. That’s the Poseidon fields, which have estimates ranging anywhere between 3 trillion cubic feet (Tcf) and 15 Tcf gas, with a P50 estimate of around 7 Tcf gas, and a reasonably high condensate cut in that. It’s drilling another five wells there with Conoco this year to get it to the point where it can have bankable reserves and then start going out and looking for customers. It’s not really an exploration project anymore, but more of an appraisal development-type thing. It will require very big capital and a contract offtake for at least 4 million tons (Mt) LNG before that project will stand up. We’re talking an $18–20B capex to get that project up and going. Karoon is the junior partner in that. It originally scoped it, found it and then took it to the market, and Conoco farmed into it. Since then, it’s just working it up to the point where it can start signing up customers. That’s its number-one project.
The other two projects are in Brazil and Peru. In Brazil, it won five blocks in a government tender two years ago. It has spent a huge amount of money and time on 3D seismic and developed a large number of 200–300 MMbbl targets there, which it will start drilling in the second half of this year. This is a very high-impact exploration program. Before it does that, Karoon is almost certainly going to farm it out to a larger player because it lacks the people and manpower to carry out a project of that size alone. Degolyer & McNaughton have done some work on this and estimate around about 900 MMbbl potential in those five Karoon blocks. So we’re expecting a strong interest in it.
TER: So that amounts to about $90B in the ground, correct?
IR: Yes. These are huge targets in not terribly deep, but not shallow water, either. These are $80–100M wells, and Karoon will be looking for someone to make a commitment to at least three wells and fund its back costs. Anyone coming through probably has to have a check in their pocket for $500M. That farm-out process is now almost complete with the partner announcement expected around mid-May, and drilling starting in the second half of the year. It already has a drill ship contracted so whoever buys into it is getting a fully worked-up project and it’s going to get instant excitement as soon as it buys.
In Peru, Karoon has some onshore and offshore leases with potential for up to 700 Mboe. Again, it’s looking for farm-in partners for that. The approval will probably come out toward the end of the year. This is a company that is chasing really big, high-impact projects. The stock is generally not held by Australian institutions. Most of the non-aligned shareholders are American pension and hedge funds and high net worth individuals.
TER: So it is definitely working in elephant country.
IR: That’s right. With these sorts of companies, the only way you can value them is by applying a probability or a risk factor to the chance of success. Poseidon is definitely a project. We just don’t know how big or how valuable it is. You have to apply some probability to the rest of the stuff. We end up with a valuation range of between $7.04 and $17.35/share. It is about $6 at the moment. Our midpoint value is $12.20. These are risked valuations with pretty heavy risk factors so if one of these things in Brazil, in particular, turns into a discovery, then obviously that valuation would increase very dramatically. It’s a high-risk, high-reward kind of stock, not for the faint-hearted.
TER: Are there any other companies you’d like to talk about or mention?
IR: In big-cap land, Origin Energy has been a great performer over the years. Its share price is really suffering at the moment because the market is so concerned about cost blowouts on LNG projects. It’s building a $20B LNG project with Conoco up in Queensland. Because other project costs are blowing out, the market is very wary, and its stock has really been sold off over the last 12 months. We think it’s really an excellent company, with about $2.5B/year cash flow from its domestic operations. It’s a really great business that’s been one of the best performers in the Australian market for as long as it’s been listed. If anyone wanted to play the big and liquid way, certainly Origin would be the standout.
TER: How would you summarize the big picture on energy investment opportunities in Australia?
IR: We think there is certainly a lot of value in Australia. Our market is somewhat thin and illiquid, so we don’t have the depth of analysis. We have a lot of companies often holding U.S. assets, which actually trade at a huge discount to what they would do in their home market. If you’re selective, you can find some real bargains here.
TER: Thanks again for joining us today
IR: Thank you.
Ivor Ries is a senior analyst and director of industrial research at E.L. & C. Baillieu Ltd., a long established stockbroking firm with offices in Melbourne, Sydney, Perth, Bendigo and Newcastle. Ries joined the world of stockbroking in 2001 after a 22-year career in media, included reporting and commentary roles with The Age, Business Review Weekly and The Australian Financial Review. Ries joined E.L. & C. Baillieu in July 2001. The firm specializes in research and corporate advice for medium-sized industrial and resource companies and counts many of the country’s major institutional investors as clients. Ries’ areas of specialization are utilities, oil and gas and online media and e-commerce. A native of Queensland, Australia, Ries lives in Melbourne with his wife and daughters. He is a Brisbane Lions supporter.
By The Gold Report, on April 26th, 2012
 Ongoing inflation pressures and China’s investments in the African gold supply chain point to a higher gold price, according to Matt Badiali of Stansberry & Associates. Bullion in all its forms belongs in every portfolio and when it comes to equities, investors have their choice of business models—dividend payers, prospect generators and royalty companies. In this exclusive Gold Report interview, Badiali outlines companies whose equities should catch up to the higher gold price.
The Gold Report: Matt, in the February 2012 edition of Stansberry’s Investment Advisory, Porter Stansberry predicted gold would hit $9,600 an ounce (oz) someday. How should investors protect themselves from this coming crisis?
Matt Badiali: In general, I agree with Porter’s thesis. Bullion—gold, silver coins or bars—should be part of everyone’s portfolio. It is one of the best anchors against inflation. Gold and gold stocks also are important holdings because as the value of paper money falls, the value of gold rises.
TGR: Stock prices have not gone up as much as the gold price. Will that trend continue?
MB: We have been in an odd scenario. If gold miners were T-shirt makers and the price of T-shirts went up, the market would buy the company to match the earnings. That has not happened for gold stocks.
Last year, the Market Vectors Gold Miners ETF (GDX:NYSE.A) was down 25% while the price of gold was up 15%. Looking at just the last three years, stocks were up 40% while the gold price rose 90%. So, in the short term, the Gold Miners ETF has underperformed gold.
Gold miners’ earnings have climbed dramatically, but their share prices have not followed suit. I believe gold miners will outperform the metal just because they have to rebalance.
TGR: What does the volatility in gold tell us?
MB: Generally speaking, the market wants a stable U.S. dollar. It rallies to dollars for all sorts of reasons. I think that is false faith.
So many new dollars have been printed that the value of all tangible things has to increase in response. For example, we all think $110/barrel oil is crazy expensive. But, relative to gold, oil has been less expensive over the last couple of years. The price of oil is falling in terms of real money, but going up in terms of dollars. That is a good indicator of how much new paper money has been printed.
TGR: What effect would higher interest rates have on junior miners? Can the increase in the gold price offset the greater cost of raising capital?
MB: Raising interest rates immediately strengthen the dollar, and a strong dollar is hard on all real assets. They rein in inflation, and inflation is why the price of real things like gold and oil go up. Therefore, if rates increase, the price of gold will probably fall.
Many companies have already adapted their plans to a higher gold price. Recently, I have seen development plans based on $1,000/oz and $1,200/oz gold. If the dollar were to strengthen and the gold price fall, it would negatively affect the gold mining industry.
TGR: How does the price of oil affect the operating expenses of gold mining companies?
MB: A gold mine is essentially a commodity swap. A company uses fuel, diesel, gasoline, electricity, concrete and steel to build out a mine and recover gold. As long as the commodities you put in cost less than the commodity you take out, the mine is in business.
Over the last 10 years, the commodity cost to build mines has increased. In any business, when your costs rise as quickly as your revenue, your earnings stay pretty much the same.
TGR: On the earnings side, some large precious metals producers are offering dividends. Is that working?
MB: Newmont Mining Corp. (NEM:NYSE) pays a 2.9% dividend, tied to the price of gold. That is a spectacular idea if your operating costs are well enough in hand to support it.
The thesis is that the Federal Reserve will continue to stimulate the economy by adding money to the system, thereby driving up the gold price. If you trust that thesis, buying a dividend-issuing gold company now when they are relatively inexpensive will lock in your yield at a lower price.
Newmont’s profit went from $4.7 billion (B) in 2009 to almost $6.5B in 2011. The rising price of gold contributes heavily to its bottom line. Investors who get in now stand to see a 5–7% yield in a couple of years.
TGR: Can that same business model work for smaller companies?
MB: It depends. There are some opportunities out there, but there have also been some spectacular failures. For example, I thought the silver miner Hecla Mining Co. (HL:NYSE) would be a great company over the long term, but it had a problem with its Lucky Friday mine and the company tanked.
TGR: But that was a resource problem, not the business model.
MB: Sure, but the point is the dividend model works for the big miners like Newmont, Barrick Gold Corp. (ABX:TSX; ABX:NYSE) or Goldcorp Inc. (G:TSX; GG:NYSE). Companies that can diversify their revenue stream over many mines on many continents mitigate risk. They can absorb more hits and continue to pay dividends. If a company generates most of its revenue and income from one mine and that mine takes a hit, that company is done.
Our first rule is never take a big loss. I typically use a 30% trailing stop on mining companies, which means that if it falls 30% from the highest point reached during my investment period, I sell.
If a mining company falls 30%, there is a fundamental flaw. Either the market has changed or the company has a problem. We limit ourselves to 30% losses because we can recover that. A loss of 50% or 80% is hard to recover.
TGR: What about dividends for royalty equity companies?
MB: I love them. Royalty companies are my favorite. The really big, safe ones are the best: Silver Wheaton Corp. (SLW:TSX; SLW:NYSE), Franco-Nevada Corp. (FNV:TSX) and Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). These companies have 50 to 80 royalty streams. If their royalty stream on one mine ends, it is just a dimple in their revenue stream. Most of these royalty companies could survive 10 losses with only a modest hit to their revenue.
The other great thing about these royalty companies is they have none of the carrying costs of mines. Because they take such a small piece of a lot of mines—typically 2–5% of production—they have very diluted political and mine-specific risk.
TGR: Does the dividend model work there?
MB: Typically, they pay a very modest or no dividend because they reinvest their capital.
Right now, mining companies are coming to these royalty companies for cash to develop their mines. In return for $5 million (M) of its cash, the royalty company gets 2% of the gold produced over a mine’s 15- or 20-year lifespan. I would rather see the company reinvest because mining is so cyclical and there are so many opportunities now.
TGR: In February, you produced a report, “How to be an Investor in China’s Fort Knox.” What is its investment thesis?
MB: We have been watching China’s investments in Africa for a while now. China is spending billions of dollars in Africa in very specific ways: financing power plants, building railroads and developing other infrastructure plays.
Why? If you want to build a mine, you need electric power. You need to be able to get ore from the mine to a port. China is laying the groundwork for mine development all over Africa.
Look also at what China is buying: one of the world’s largest undeveloped uranium deposits, bullion and shares in African gold miners, from major mining companies to partnerships with juniors and exploration projects.
At the Mines and Money Conference in Hong Kong, I asked representatives of major Chinese investment banks and funds if gold is a major target for Chinese investment in Africa. Across the board, they all said yes.
TGR: How can people outside of China get involved in that?
MB: That was my next question. The best approach is to find companies where the Chinese government or government entities have already invested. I think serious investors who want to participate in mining—especially in Australia, Africa and China—need to understand the Chinese philosophy of resource investing.
When a company gets money from a Chinese bank, it gets far more than funds. It gets exposure to the entire Chinese system. The banker will help the company find a market for its goods or find a Chinese engineering firm to provide technical expertise.
Chinese banks protect their investments. Once a Chinese bank is involved in a mining program, the company typically can get more cash without problems.
TGR: You often emphasize the importance of diversity within the mining company and within portfolios. Where do precious metals fit into a good portfolio mix?
MB: There is a spectrum of risk in precious metals. Bullion is fairly low risk; it is limited to the commodity risk.
With major mining companies, your risk of a 50% loss is pretty low. For investors with low tolerance for risk, a senior mining company is the best place to be.
Mid-cap growth gold miners all have risk. For older investors looking toward retirement, I do not recommend putting a large portion of your portfolio at risk. If 5% of your portfolio is higher risk, some percentage of that can be in mining.
Junior miners are just little bundles of risk. They are not safe; 90% of them bomb. When I write about junior mining companies, I advise investing only if you can afford to lose 50%.
TGR: What do you look for to downplay risk?
MB: The first thing I look for is management. Imagine two junior mining companies, both listed on the Canadian TSX Venture Exchange. Company A is run by a lawyer and a serial stock promoter. Company B is run by a mine executive who worked 25 years for one of the majors. To reduce risk, I would choose B.
Company A is most likely what I call a “lifestyle company.” Its high-rise offices have a spectacular view; management wines and dines you, all on the company’s dime.
Company B, my ideal investment, has offices in a building where the elevator barely works. There are rocks stacked in the lobby and geologic maps on the walls. These guys are working; this company offers opportunity.
TGR: What are some examples of Company B?
MB: ATAC Resources Ltd. (ATC:TSX.V) is a great example. I know the CEO and the principals. I knew the area and spent a lot of time there. In 2008, after the company put out a press release on a discovery, we wrote it up and made 597% on the trade.
Another is Riverside Resources Inc. (RRI:TSX), led by Dr. John-Mark Staude, who has years of experience as an exploration geologist. This company uses the prospect generation business model, which means it uses other people’s money to find projects. Cliffs Natural Resources Inc. (CLF:NYSE) funds Riverside’s exploration and gets a first look at whether its projects are worth anything. Choice Gold Corp. (CHF:CNSX) is Riverside’s partner on the Sugarloaf Peak project, a low-grade gold resource.
Typically, only 1 in 3,000 exploration projects becomes a mine down the road. John-Mark and his crew have generated more than 11 projects, most of them with partners.
TGR: Riverside seems to have lots of technical knowledge, a great database and great partners, including Antofagasta Plc (ANTO:LSE). But its stock is at $0.86. What catalyst could take it higher?
MB: With a prospect generator like Riverside, you have multiple shots on goal. Even though Riverside does not own 100% of Sugarloaf, 30% of a major gold discovery will take an $0.86 stock to the moon.
TGR: We talked about investing in Africa earlier. What are some exploration and development companies there that interest you?
MB: My favorite African play right now, which is ridiculously cheap, is Keegan Resources Inc. (KGN:TSX; KGN:NYSE.A) in West Africa. Its Esaase project will be a mine, the other, Asumura, is just starting to find gold in its drill results.
Keegan is in a bad place in terms of the mining cycle. It is spending money on permitting and environmental reports. The only news that could come out would be bad news, like a permit delay. Add to that its location in Africa, a jurisdiction that scares people. Everybody expects it to be bought by a major mining company. While that drags out and the company continues to spend money, the share price continues to erode.
I think Keegan will be taken out. My concern is that its share price has sunk so low, it may get taken out at a modest premium and wind up not being anywhere near the value I anticipated.
TGR: If it is not taken over, could Keegan be a successful mine developer?
MB: If it gets the right partner, it can be very successful. Many small mining companies have come in as junior partners and have done quite well. MAG Silver Corp. (MAG:TSX; MVG:NYSE), through its partnership with giant silver miner Fresnillo Plc (FRES:LSE), for one.
TGR: How about safer jurisdictions like Canada?
MB: Canada has its own risks. There are a lot of taxes and some of the projects, even in British Columbia, are remote.
Seabridge Gold Inc. (SEA:TSX; SA:NYSE.A) owns the Kerr-Sulphurets-Mitchell (KSM) project. I love this company and KSM, which is a big, low-grade project. The most recent development estimate was somewhere north of $4B. Seabridge is a great company to play arbitrage on the gold price. When the market does not like gold, Seabridge shares fall to nothing; when the market likes gold, Seabridge trades much higher.
However, there’s another deposit up near KSM that’s exciting. Brucejack, owned by Pretium Resources Inc. (PVG:TSX; PVG:NYSE), is a high-grade gold and silver deposit. It’s just a few miles from KSM and is likely related. In Brucejack, the gold and silver are concentrated. Brucejack’s resource is 4.9 million ounces (Moz) of Indicated gold ounces at 17.3 grams per ton (g/t). That’s over half an ounce of gold per ton of rock. There is another 10.4 Moz of Inferred resources at 25.5 g/t. Those are spectacular grades. In November 2011, one of its drill holes ran 17.75 kilograms (kg) gold per ton. It was beautiful, striped with gold in places. Pretium’s shares went from $8.50 to $12.30. The stock is at $15/share now. Unless Pretium brings in a development partner, it will probably get bought for this project.
TGR: Will more strikes be announced?
MB: There is more exploration drilling to come. I don’t have it as a Buy, but this might be a good time to add a position. With such a great deposit at high grades, Pretium will have a lot of leverage to the gold price if it starts to climb. At $2,000/oz, this project is a cash machine.
I see this whole Valley of the Kings area as a catalyst for the entire region. Over the next 25–30 years, this part of British Columbia. could become a major, major gold and copper mining center.
TGR: Let’s go south to Mexico. Do you have a name or two there?
MB: Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC) was recently acquired.
I like Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE) and have for a long time. Again, it’s a great example of a company run by industry experts with 30 years in the business. It has two operating mines, Guanacevi in Durango State and Guanajuato in Guanajuato State in Mexico. Its Q112 results were spectacular: 20% increase on silver production and 26% increase on gold production. We’re looking at a very healthy silver producer. That should increase further, as the company expands both mines in 2012.
If the Fed does more quantitative easing, silver prices are likely to touch $50/oz in the near future. Endeavour is a good company now; when silver gets to $50/oz, it will be a spectacular company. It offers fairly low downside risk with the potential of a big gain.
TGR: Any parting advice?
MB: One of the best pieces of advice I was given is: The best time to make an investment is probably when you are most terrified about making it. When an investment is easy, it is probably near the top. I love to hear people say they will never invest in gold or silver again because they got burned before. If people like that flee the sector, I have less competition.
For folks who despair over the gold and silver market, I say, hold your nose, figure out how much money you can afford to invest and do it. The risk is fairly low and the potential rewards are pretty high.
TGR: Matt, thank you for taking the time to talk to us.
Matt Badiali is the editor of the S&A Resource Report, a monthly investment advisory that focuses on natural resources—from small exploration outfits to equipment companies, to the biggest commodity companies in the world. He also writes S&A Junior Resource Trader, which focuses on the “bloodhounds” of the mining and energy industries—small gold, copper, oil, diamond and uranium miners—and how to earn thousands of percent in the coming years. Badiali has real-world experience as a field geologist, lecturer, researcher and a consultant. He holds a master’s degree in geology from Florida Atlantic University.
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