COMPANIES MENTIONED: BEAR CREEK MINING CORP. : FORTUNA SILVER MINES INC. : GOLDCORP INC. : GUYANA GOLDFIELDS INC. : PRIMERO MINING CORP. : SILVER STANDARD RESOURCES INC. :TAHOE RESOURCES INC.

RELATED COMPANIES

• : FREYJA RESOURCES INC.
• :INTEGRA GOLD CORP.
• : KLONDEX MINES LTD.
• :PERSHING GOLD CORP.
• : SANTACRUZ SILVER MINING LTD.
• : TIMMINS GOLD CORP.

 

The Gold Report: In a call with Sprott clients last week, you said that the junior resource market is at an intermediate-term top right now and there will be good summer entry points. Why is the market at a top now instead of May, which is more typical? Should investors wait until the summer entry points to get into good juniors?

Rick Rule: The top could continue through mid-May. If investors have positions in their portfolios that they aren’t thrilled with, they should use this market to sell. One of the things I’ve noticed is that if an investor paid $1 for a stock and the stock is at $0.35—even if the stock was valueless—they are unwilling to sell it for $0.35. In many cases, the stocks that fell from $1 to $0.25 or $0.35 are now selling at $0.50 or $0.60. My suggestion is that this is a great time to take advantage of it.

“Tahoe Resources Inc. has one of the finest silver deposits in the world.“

I want to draw people’s attention to the fact that the market is up 40% in some cases from its bottom. Amazingly, people are more attracted to that than a market that exhibited bargain basement prices.

Although I believe that the market has bottomed, we’re going to be in an upward channel with higher highs and higher lows, but we are certainly going to exhibit the volatility that the market is famous for. It’s my suspicion that the summer doldrums will see lows that, while higher than last summer, are substantially lower than the prices that we’re enjoying today.

TGR: Gold has been above $1,300/ounce ($1,300/oz) for several weeks. Is that influencing the market?

RR: Gold certainly is a bellwether commodity for the junior resource sector. For 25 years, people have referred to junior mining in many circumstances as junior gold. That’s misinformation because the junior resource sector encompasses a variety of commodities. My suspicion is that we have put in lows in the precious metals and they will trade higher, but not straight up. The gains will need to be consolidated. It will be volatile on the way up.

TGR: If it’s a misconception that gold is the bellwether commodity, what key commodities do you look at to support the claim that we bottomed out in the summer of last year?

RR: Virtually the entire complex, with the exception of copper, which has stayed pretty weak. Zinc has begun to cooperate. While uranium hasn’t cooperated, the sentiment for uranium juniors and the premium associated with Uranium Participation Corp. (U:TSX) has certainly done better. The energy complex has seen oil up $10/barrel and natural gas doubled. Platinum and palladium are up substantially, although that may be a consequence of fears about an embargo against Russian palladium supplies and a response to labor unrest in South Africa. However, generally, the whole commodities complex, including the soft commodities, even in the face of bumper grain crops, is doing well since last summer.

TGR: What do you attribute that to?

RR: There are a couple of reasons. The whole sector was oversold. We’ve participated in a bit of a dead cat bounce. The long-term thesis has a lot to do with the increasing ability of the bottom of the demographic pyramid to increase its standard of living, which involves more commodities. I’d say that the great unsung hero of a rebound in the fortune of commodity producers has been the increasingly constrained supply of resources. The demand side on resources has been very slow because this recovery in the West has been a false, paper recovery. It hasn’t been accompanied by capital spending or jobs. It’s an interest rate-led recovery with flat auto sales and home starts.

What has kept commodity prices stronger than what some investors thought they would be has been the constrained supply growth in the face of constrained demand. In sectors that were regarded as horrifically oversupplied, like natural gas, two things have happened: Cheap natural gas prices have led to more utilization of gas for power generation at the same time that Mother Nature threw the polar vortex at us.

This sort of supply response isn’t limited to natural gas. On the precious metals side, the industry has spent tens of billions of dollars during the past 15 years on exploration, construction and production. The production numbers for precious metals have been going sideways for gold and silver and going down for platinum and palladium. Supply constraints on a global basis led to the bottoming and then the recovery of commodity pricing.

TGR: If we don’t have enough supply to meet demand, even if demand stays flat, we would see commodity prices going up. But aren’t we still seeing some growth in developing countries as the poor become richer and invest in commodity-intensive products?

RR: That will be evident in future years. This year is simply a recovery from the oversold conditions of 2013. That’s normally the way bear markets become bull markets; they normally are a reaction to oversold situations.

TGR: Are the capital markets coming back to the commodity groups now to finance them? Will that financing ultimately result in increased supply?

RR: There is an increasing amount of equity available for the better companies in the junior resource space. This is precisely the set of circumstances that we talked about in our interview last summer, which we referred to as bifurcation. The best 20% of the issuers have begun to find bids, not just in the junior capital markets, which is where the share prices are up, but also in financing markets. An increasing number of bought financings are getting done. For the bulk of the juniors, of course, that capital isn’t available—and good riddance. They’ll go away.

Probably a bigger question is going to be where the project and development financing will come from. The large private sector banks that used to fund construction and permanent finance for major resource projects have been less willing to take those loans onto their balance sheets, choosing instead to become financial arrangers. A situation where everybody’s a financial arranger and nobody’s a funder means that projects haven’t been getting funded.

We believe that the likely lenders going forward will be sovereign wealth funds and superannuation or pension funds with a long-term horizon. But that hasn’t worked itself out yet. While there is a refreshing ability for the better juniors to get stop-gap equity financing, what is still missing from this market is the senior project financing. That’s something that Sprott is working very hard to address.

TGR: What will be the catalyst that will move sovereign wealth funds, pension funds or Sprott into doing those large capital financings?

RR: The time horizons of 10–20 years that are required in project finance correspond well to the needs of pension, superannuation and sovereign wealth funds. Because they are already equity investors, the balance sheet risk with being a senior secured lender will fit well with their needs. It’s just something that they haven’t done before. This is a natural progression that hasn’t occurred yet, and we hope to facilitate it.

TGR: Why is there a natural progression of moving these large project capital financings to a pension or sovereign wealth fund?

RR: Legislation in place now on a global basis for large banks forces them to be providers of capital to sovereign governments. If JPMorgan Chase has a loan to Greece on its books that is selling at 70% of par, European Union rules allow JPMorgan to carry that bond at 100% of par if it says it intends to hold it to maturity. In other words, the rules allow the bank to mark the loan to myth as opposed to the market. If the same sort of loan was made by JPMorgan to a private party, even a solvent private party, unlike an insolvent sovereign, the carrying value on that loan would have to be reduced, which would reduce the capital base of the bank.

As a response, the banks have become conduits that accept deposits on a global basis and borrow very short-term money from sovereign lenders and then relend the money to sovereign borrowers on a longer-term basis. They profit from the same type of arbitrage—borrowing short and lending long—which was the demise of the U.S. savings and loan business. This may or may not be a great business strategy. It’s one they’ve been, in effect, forced into as a consequence of banking regulations that came about after the 2008 liquidity crisis.

TGR: How might that play out over the next decade?

RR: That’s a many headed question. If we have a situation where short-term interest rates go up—where central banks are less able to manipulate short-term interest rates—it will have an extremely unpleasant outcome for the large banks.

TGR: You mentioned earlier that Sprott was looking at playing a role in that natural progression from the large banks to other types of fundees. What specifically is the role for Sprott there?

RR: Sprott has had discussions with many of the largest sovereign and pension investors in the world, including the National Pension Service of Korea, for which we manage some money. We have begun the process of educating these very large investors about the nature of project finance and how project finance might solve some of their investment needs. It’s an area that these very large investors hadn’t had much experience or interest in.

TGR: We’ve been talking about major debt project funding. Might these also come up in private placement opportunities, or do private placements fund other types of resource opportunities?

RR: Private placements have traditionally been on the exploration, development or preconstruction side of junior natural resource companies. This range of companies enjoyed unprecedented access to capital in 2003–2011. The consequence of that access to capital was a spectacular bull market that gave way to a spectacular bear market where the excesses of that period had to be exorcised. The issuers confused the optimal conditions with normalized conditions. The consequence has been that companies believe that the pricing circumstance that they enjoyed in 2003–2011 was normal as opposed to optimal. Issuers will be forced to be rational in 2014 simply as a consequence of their need for capital.

TGR: Are the latest financings discriminating or financing broadly across the sector?

RR: It’s been very discriminating, and it has to be. The junior resource business taken as a whole is valueless. Almost three-quarters of the issues on the exchange have no net-present value (NPV). The arithmetic consequence of that is any financing these poor quality companies do takes place at sub-$0 cost of capital. The better companies have found a bid. The better companies have been able to attract the financing. We need to take the bottom half of this industry and we need to flush it so that more money is focused on better projects and better companies.

TGR: Are you feeling a bit cautious about the potential continuing upmarket?

RR: I feel great about it. My experience has been that bear markets are always the authors of bull markets. While history doesn’t repeat, it certainly rhymes. The severity of the decline that we have experienced was at once the consequence of the extraordinary bull market that preceded it, but it’s also indicative of the type of response that we’re going to enjoy.

Make no mistake, the magnitude of this decline was as spectacular as anything I’ve seen since the mid-1980s. I feel the bull market that we are going to come into sometime in the next 18 months to 2 years will probably be as good a bull market as any I’ve ever experienced, and I’ve experienced some spectacular ones.

TGR: I was looking at the performance of the Sprott funds. The energy fund returned 23.4% in Q3/13 and Q4/13 while the gold and precious metals fund had a return of -4.2%. If the resource market bottomed in the summer of last year, how do you explain the difference between these two funds?

RR: The uptick in oil and gas equities happened faster because free cash flows recovered more quickly and because these energy issuers are generally better companies. It was easy to measure the impact of higher natural gas prices on the oil and gas juniors because they were producing. When the natural gas price went off its $1.90 million British thermal units ($1.9 MMBtu) low up to $4 MMBtu, the impact on producers’ income statements on a quarterly basis was immediate and dramatic.

An increase in the gold price from $1,100/oz to $1,300/oz for a company that is not yet producing gold is one that has to be factored in an NPV calculation to future cash flows. It took longer to work its way through the system.

TGR: There have been some really dramatic turnarounds so far this year in the gold and precious metals fund: Tahoe Resources Inc. (THO:TSX; TAHO:NYSE) was down 9% in Q4/12 and is up 48% year to date (YTD); Guyana Goldfields Inc. (GUY:TSX) was down 36% in Q4/13 and is up 67% YTD; and Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ) was up 25% last year, and is up 44% this year. What do you attribute this dramatic turnaround to over the last few months?

RR: It’s a turnabout in market sentiment. The middle part of last year, the stock charts went sideways on no volume—exhausted sellers, exhausted buyers. At the end of last year, those stocks began to catch some bids. The people who had to sell, sold. We began to notice small inflows of cash at Sprott into our resource-oriented mutual funds at the end of last summer. We were no longer forced sellers, and we became nominal buyers.

I think our experience mirrored the experience of the rest of the institutional investing community. The consequence was fairly dramatic moves up on small volumes in some ludicrously oversold equities. We’ve come into a period where there’s a better balance between buyers and sellers.

TGR: Are you expecting to see modulation in increases in the fund because it had a dramatic turnaround?

RR: That’s the theme of this call. My suspicion is that we’ve been through the worst of the bear market, that the bear market bottom will not be a “V,” it will be saucer shaped, and it will take 12–18 months from now before we’re truly in a bull market. The gains that we’ve just enjoyed will need to consolidate. They may go a little higher before they go lower, but the truth is that a recovery will see higher highs and higher lows, and will also feature the volatility that this sector is so famous for. The recovery is in its very early stages.

TGR: Can you comment on some of these companies in the fund that have had large YTD performances?

RR: I think we have a combination of circumstance here. Tahoe is, if not the finest, then one of the finest silver deposits in the world. It answered the question of “could it overcome its social license issues and mine construction issues by getting into production.” It delivered value. The naysayers were proven wrong. The small increase in the silver price certainly helped it, too.

Similarly, Primero Mining Corp. (PPP:NYSE; P:TSX) outperformed production expectations and then announced an acquisition of a development project that allowed the market some visibility as to how it might grow going forward.

Guyana Goldfields simply was a recovery from a ridiculously oversold level.

Silver Standard delivered improved performance in Argentina. It added some meat to the bones. The market liked the fact that it, in the last six months of last year, seemed to get its hands on the production difficulties that it was having at the Pirquitas mine.

More recently, the company enjoyed a tremendous share price spurt as a consequence of its acquisition of the Marigold mine in Nevada from Goldcorp Inc. (G:TSX; GG:NYSE) that shows the way for it to increase cash flow and profits on an accretive, per-share basis. It might allow Silver Standard to develop the rest of its portfolio internally without external funding.

Bear Creek Mining Corp. (BCM:TSX.V) got social license in Peru. There had been questions as to whether either of the company’s development projects would be able to be developed given local opposition in Peru. Bear Creek got the backing of every prominent local group and a landmark agreement between the central government of Peru and the local government that would allow for more equitable distribution to the region of tax, royalties and the social rents from mining. Historically, in Peru, the regions have borne all the costs of mining while the center has collected all the social rent.

Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE) continues to impress with its ability to operate midsize silver mines. Its two operations have consistently met its promises. That set it apart from an industry where probably 75% of the project news has been disappointing. Fortuna, as a consequence of meeting projections quarter after quarter, has begun to develop a loyal shareholder base among silver speculators.

TGR: With St. Patrick’s Day on the horizon, what company is really going to have the luck of the Irish and bring in the green?

RR: For your readers in the West and the Southwest, water will be a real important topic of discussion. We’ve had a situation in the West and the Southwest where water has been priced politically, which means it’s been delivered as a right irrespective of its supply and the cost of distributing it. The consequence of that has been gross misdistribution, which has worked as long as nature has cooperated. But nature this year has ceased to cooperate. We’re going to see tremendous distortions in water pricing across the West and the Southwest, and that will have spinoffs in areas like food cost. The very low cost of food that Americans have enjoyed in the last 40 years has had to do with the subsidies afforded to farmers for water supply.

Here in California, there are now several water districts whose allocation of water from the state and federal government is zero. Growing, as an example, almonds or pistachios or plums—pick a crop, really—in the summer in California with zero water allocation is very difficult. This is going to be a subject that is going to play very large among investors. It’s something that Sprott has been involved in through my own efforts for two decades. It’s something that we’re trying to get a lot more involved with in the next two or three years.

California had a pretty good drought in 1977 that caused us to do things like flush our toilets on alternative days and not wash our cars. It had much more profound economic consequences than that. The interesting thing for Californians to note is that since 1977, two important things have changed: There are 12 million more of us with our straws in the sponge, but the sponge hasn’t increased at all. At the same time, the safety valve Californians had from the Colorado River is gone. The consequences will be very dramatic.

Since 1977, people have moved to places like Phoenix, Tucson, Salt Lake City and Las Vegas. We don’t have the ability to overdraw our allotment anymore. The way that we got out of the predicament in 1977 is not a way out this time. It’s going to have profound consequences. I don’t know what they are, but it’s going to have profound consequences.

TGR: How do you play the water sector and this drought? You can’t get more rain. Are we looking at desalination? Are we looking at better water conservation?

RR: There is no play in the near term. The answer in the intermediate term is going to have to be more market pricing for water—and people are going to hate that. The way I’m playing it is to buy shares of companies that own water rights associated with their agricultural operations. My bet is that the California legislature does something that’s logical. I realize that’s a bet that plays against history. But my hope is that farmers are allowed to cease doing stupid things such as growing rice in the desert and are allowed to sell the water that they would have wasted growing rice in the desert to people who want to use it to flush toilets and brush teeth. If that takes place, there’s as much as a 90% arbitrage in the converting of agricultural water to urban and municipal use.

If we did that, by the way, we wouldn’t have a water crisis in California. We’d have a lot less agricultural production. But the truth is, if we had a market-clearing price for water in California, we wouldn’t be having this discussion at all.

TGR: But if we had a market-clearing price for water in California, what would happen to the agricultural component of the California economy? What would that mean overall for the state?

RR: Remember that California agriculture contributes less that 4% of state GDP and consumes 85% of the state’s water. I suspect that gross farm receipts would stay the same. We would have 25% or 30% of the farmland in California fallow, and we would have higher crop prices across lower production. That’s the inevitable consequence that we have to face. The idea that we take water and we irrigate a desert to cut eight crops of alfalfa and we export that alfalfa in bales to China for its dairy industry is the equivalent of us exporting water below our cost of production to subsidize the Chinese dairy industry. If you say to suburban homeowners, the Cadillac communists in West L.A. or Mill Valley, that they have to sacrifice $150,000 worth of landscaping at their houses, or be willing to pay 300% or 400% more for water so that they can subsidize the production of dairy in China, the political equation regarding water pricing in California could change. And that would confer enormous benefits on the people who understood the arbitrage of marking privately held agricultural water rights to market.

TGR: What’s to keep the California government from taking away those agricultural water rights or redefining them so that that arbitrage is minimized or eliminated?

RR: Zero. The People’s Republic of California will ultimately confiscate the product of intelligent savers but, mercifully, California is extremely inefficient, and it won’t get around to fashioning the political compromise necessary to steal that wealth for three or four years.

TGR: Can you share with us some of these companies that have water rights that can turn agricultural water into urban-use water to take advantage of this arbitrage situation?

RR: Sure, with a caveat that these are companies I own as opposed to companies that I recommend to your readership. I own J.G. Boswell Co. (BWEL:OTCPK), which is the largest of the California corporate farmers; Limoneira Co. (LMNR:NASDAQ), which is a grower and developer in Ventura, Calif.; and PICO Holdings Inc. (PICO:NASDAQ), which is the Physicians Insurance Company of Ohio, a water-rights owner in Nevada and Arizona.

TGR: That’s ironic. The Physicians Insurance Company of Ohio owns water rights in Arizona and Nevada?

RR: That’s a story for a different interview.

TGR: I appreciate your time, Rick.

RR: My pleasure. Thank you.

Rick Rule, CEO of Sprott US Holdings Inc., began his career in the securities business in 1974. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. His company has built a national reputation on taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forestry and water industries. Rule writes a free, thrice-weekly e-letter, Sprott’s Thoughts.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Karen Roche conducted this interview for The Gold Report and provides services to The Gold Reportas an employee. She or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Tahoe Resources Inc., Guyana Goldfields Inc., Primero Mining Corp. and Fortuna Silver Mines Inc. Goldcorp Inc. is not associated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Rick Rule: I or my family own shares of the following companies mentioned in this interview: Tahoe Resources Inc., J. G. Bozwell Co., Limoneira Co. and PICO Holdings Inc. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: B2GOLD CORP. :FRANCO-NEVADA CORP. : LYDIAN INTERNATIONAL LTD. : MOUNTAIN PROVINCE DIAMONDS INC. : NEW GOLD INC. : PILOT GOLD INC. : ROMARCO MINERALS INC. : ROYAL GOLD INC. : SEMAFO INC. : SOUTH AMERICAN SILVER CORP. : TRUE GOLD MINING INC. : YAMANA GOLD INC.

 

The Gold Report: Paolo, what three words would you choose to give our readers a sense of what to expect in the precious metals equity space in 2014?

Paolo Lostritto: Defense, defense and more defense.

TGR: The Vince Lombardi approach.

PL: Even though deflation risk is priced into most of the equities, it’s difficult to predict when inflation expectations will start to gain traction. While quantitative easing tapering efforts are being introduced with some signs of economic improvement in the U.S., we believe tapering could reignite deflation fears. The market was reassured after Janet Yellen’s nomination as Federal Reserve chair, but the bond yield-to-maturity suggests that deflation risk is still alive and well. There is more work to be done before inflation becomes a bigger concern, and as such, we believe the gold market will remain challenging. The challenge is centered on balance sheet risk in a market where margins are negative, thus resulting in many value traps that are out there right now.

TGR: Earlier this week, I spoke with a U.S.-based analyst who believes that rising wage pressure, higher rent and food prices in the U.S. will lead to a slow climb in inflation in 2014 and beyond. Yet, you are talking about the risk of deflation. Other than bond yield rates, what else tells you that deflation is the bigger risk?

PL: Across the board, commodity prices have been under pressure, suggesting that the risk of deflation is still real. Another data point is the inflation expectations data set compiled by the Cleveland Federal Reserve. Right now, it shows that inflation expectations are muted at best.

 

“Pilot Gold Inc. is an exploration/development company that offers tremendous value.” 

 

We believe we are in a similar environment to the 1974–1976 midcycle correction in gold before the onset of inflation. During that period, gold fell from ~US$200/ounce (~US$200/oz) to ~US$100/oz before higher money velocity generated inflation in the Western world that drove gold to more than US$700/oz. While gold has nearly decreased by a similar percentage since the highs set in 2011, we have yet to see definitive evidence of higher money velocity. This, combined with positive real rates, results in our cautious stance. It is worth noting that if higher inflation were to materialize, it is likely to be driven by emerging markets, which would then begin to export said inflation.

I believe gold could go much higher in the long term, but in the meantime, we’ve got to take a position that a lower price is quite possible and that balance sheet risk remains high.

TGR: An October 2013 research report from National Bank Financial (NBF) suggests that there is inflation risk when the money multiplier increases beyond a 1:1 ratio. What will keep that ratio below 1:1?

PL: The money multiplier is a crude measure of money velocity. While it demonstrates that both the monetary base and M1 are growing, there has been enough to translate into higher inflation expectations. The government is giving mixed signals. The Fed’s policies are reinflationary. Government policies, in contrast, have been emphasizing austerity.

We need to see that the liquidity being provided is actually getting traction and is producing real economic growth. While there are early signs that this is starting to happen, I would like to see how the bond market reprices inflation expectations. We still believe the deflation risk remains high—you need to be defensive.

There are signs that the U.S. economy is turning around. But, our NBF economists don’t see inflation in the system, and that’s bad for gold. That will change only when the velocity of money starts to improve, leading to better capacity utilization, which translates to higher inflation expectations. It will take time for those signals to align.

TGR: In the event of another collapse, what weapons does the Fed have left?

PL: More money is all we’ve got left. The Fed can purchase more bonds, which effectively introduces more liquidity, but we would probably see monetary policies that would coincide with fiscal policy to allow for some infrastructure projects. We would want the new liquidity to show up in the real economy, as opposed to the coffers of Tier 1 banks.

TGR: Physical holdings in exchange-traded funds (ETFs) have fallen in lockstep with the gold price. Are Chinese and Indian gold imports enough to sustain the gold price, or push it higher?

“I believe gold could go much higher in the long term, but in the meantime, we’ve got to take a position that a lower price is quite possible and that balance sheet risk remains high.”

PL: About 800 tonnes have sold out of the ETFs, and there have been a similar amount of purchases through Hong Kong into mainland China. Demand in India remains robust, despite elevated import taxes. There also are signs of more smuggling into India. However, we’re still dealing with a potential 1,800 tonnes of ETF supply.

The weak gold price is less a function of supply-and-demand and more a function of deflation risk. We see gold as another type of currency. If all the gold mines in the world shut down tomorrow, it would only equate to removing 0.1% of aboveground stocks.

TGR: What’s your projected trading range for gold in 2014?

PL: We’re using US$1,300/oz to value our stocks. If our worries are confirmed and the bond market starts to signal an increased risk of deflation, we could be dealing with a lower gold price deck.

The average all-in sustaining cost number may be the better number to use. That could drop to US$1,000–1,200/oz.

On the flip side, if we see velocity and inflation expectations start to go up and the real rates go negative again, that fair-value number is probably closer to US$1,600–1,800/oz. This is a very difficult time to predict the gold price.

TGR: When NBF calculates all-in cash costs for gold miners it uses a different definition than the World Gold Council. You omit non-cash remuneration and stockpiles/product inventory write-downs. On all-in sustaining costs, you also omit reclamation and remediation at operating and non-operating sites. Would investors be better served if these definitions were the same across the board?

PL: We, and the World Gold Council, are trying to define the true average cost of the industry. We are roughly in the same ballpark. You mentioned what we exclude, but we also include cash taxes. The World Gold Council excludes cash taxes and interest payments.

Remember, we’re tabulating this based on public data. Not every company breaks out its true sustaining capital in a given quarter versus growth capital. We approximate the sustaining capital number by using depreciation, depletion and amortization as a proxy. Of course, it won’t be accurate because it uses depreciated data dollars as a proxy, but it’s a good start.

TGR: Roughly what percentage of the producers you follow make money at today’s level of all-in cash costs or all-in sustaining costs?

PL: From an all-in sustaining cost perspective, the Q3/13 50th percentile is around US$1,050/oz. That means 50% of the industry is losing money, not from a growth perspective, but from a sustaining basis at US$1,050/oz and above. It was US$1,200/oz in Q2/13.

TGR: That’s shocking. Does that make you want to look for a different line of work?

PL: We’re in the midst of a once-in-a-century event. I believe there are two ways out of it. Scenario one: We have a deflationary recession, also called a depression. Scenario two: We repeat what happened in the 1970s and we inflate our way out. But this time it’s on a global scale.

Based on the behavior of the central banks of Japan, the U.K. and the U.S., they seem to be trying to inflate their way out. The question then becomes, when will inflation gain traction?

TGR: A recent NBF research report compared takeover transactions among senior producers, midtier producers, developers and explorers. Where are investors getting the best bang for their buck?

PL: Historic transactions have to be considered in the context of the market at the time. Today’s market resembles 2008. One could argue that this is a great time for free cash flow entities to acquire assets. In a market where cash is king, it’s all about doing bite-size, tuck-in type acquisitions that allow companies to take advantage of a challenging market.

Structurally, some large companies are set up to mine gold at a rate that Mother Nature cannot support. Deposit discoveries are not the size or frequency that can support them. There’s an opportunity for the smaller companies, like B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX), to acquire good assets that can be developed to create tremendous value when the market turns.

TGR: On net asset value (NAV) and enterprise value per ounce, which of those four spaces provides the best return to investors?

PL: There’s a lot of value out there, but investors want to avoid being caught in a value trap. For example, a company may be cheap on a price-to-NAV and price-to-cash flow basis, but it also could have lots of balance sheet risk. If it goes bankrupt before the market turns, investors are caught on the wrong side of the trade, despite the fact that it’s great value.

I would rather buy something that generates free cash flow, like a Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) or a Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). (Royal Gold is covered by Shane Nagle.) “Be defensive” has been our thesis since early 2013. Free cash flow companies will yield, even if this market lasts four more years; the NAV continues to grow. When the market rerates, investors are actually up.

TGR: NBF’s Oct. 13 report noted that producer transactions were completed at an average of 1.13 times NAV and $155/oz enterprise value. Senior gold producers were 1.2 times NAV and $125/oz enterprise value. Developers were 0.84 times NAV at $102/oz, and exploration transactions were 1.1 times NAV at $55/oz.

PL: No question, there’s tremendous value out there. The questions become: How long does this market last? How does an investor stay solvent? I would buy Franco or Royal Gold, knowing that I’m solvent.

TGR: What is your 2014 investment thesis in the precious metal space?

“There are value propositions out there. Solid management teams will be able to take advantage of this market to drive value in the longer term.”

PL: We remain defensive. Our top picks are Franco-Nevada and Royal Gold because they’re generating free cash flow yield even at lower gold prices and because we don’t know how long this deflation period may last.

For people interested in taking on a little bit more risk we start outlining companies like Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and New Gold Inc. (NGD:TSX; NGD:NYSE.MKT). (Yamana and New Gold are covered by Steve Parsons.) Both companies have strong balance sheets and a little bit more leverage to the gold price.

If you really want to look at names that offer some opportunity if gold goes to $1,500/oz, that group includes B2Gold, SEMAFO Inc. (SMF:TSX; SMF:OMX) and a myriad of names that give you that higher torque.

TGR: Let’s talk about the royalty plays for a moment. Does Franco-Nevada now transcend mining equities? Is it competing with yield-providing equities outside the mining space?

PL: It’s a bit of a hybrid. It’s not the same as owning physical gold. It provides some dividend exposure. It also gives investors torque to the actual underlying commodity, which is another good thing.

TGR: Is Franco-Nevada attracting investors that typically wouldn’t be in the gold mining space?

PL: People who are sprinkling a bit of exposure to gold in their portfolio feel more comfortable with larger companies. Franco-Nevada is a larger company and is more defensive than some of the pure torque names with exposure to the cost side of the equation.

TGR: What did you make of Franco’s deal with Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB) of $35 million over five years, or roughly 38,000 oz gold?

PL: That is the type of deal that you can do in this market where you’re tucking in an acquisition. There’s a discovery value to being in a camp and having exposure.

The real value proposition with owning a company like Franco-Nevada is getting the exploration opportunity without having to use your dollars.

TGR: Are there any milestones ahead for Yamana and New Gold?

PL: We expect New Gold to incorporate the recently acquired Rainy River deposit into its development plan.

Yamana recently made some tuck-in acquisitions. Management is focused on defense, keeping the company’s cash costs low and maintaining free cash flow yield.

TGR: In the past, B2Gold’s management has developed assets and sold them off. It’s currently a junior partner in a couple of Colombian projects. Where is B2Gold’s growth coming from?

PL: In the short term, there are two projects: Masbate in the Philippines and the Otjikoto mine in Namibia.

In addition to a great operating team, B2Gold is known for its great geological team. The geological team can find incremental ounces near existing infrastructure, thereby creating value through the drill bit.

TGR: Will B2Gold get to a point where it can compete in the next tier down from the biggest majors, say with Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) and Yamana?

PL: I don’t see why not. They’re all competing for the same growth profile. It becomes a matter of which projects are available, how much they cost and where the opportunity is for incremental value added through the drill bit or reengineering.

TGR: What is SEMAFO up to?

PL: SEMAFO has done a good job of retrenching. It’s focusing on higher-grade material—not ounces for ounces’ sake, but ounces that provide a better internal rate of return and better margins with the Siou and Fofina discoveries and recent anomalies identified in and around this trend.

SEMAFO has spun off or ceased production at some of its higher-cost mines to focus on locations where the company can get the best bang for the buck.

TGR: Let’s shift to silver. The fortunes of South American Silver Corp. (SAC:TSX; SOHAF:OTCBB) are well documented. Are there other small-cap companies with exceptional management teams developing world-class deposits that most investors probably aren’t aware of?

PL: We cover several exploration/development companies that offer tremendous value: Lydian International Ltd. (LYD:TSX), Pilot Gold Inc. (PLG:TSX), True Gold Mining Inc. (TGM:TSX.V), Romarco Minerals Inc. (R:TSX) and Mountain Province Diamonds Inc. (MPV:TSX).

 

“True Gold Mining Inc.’sfeasibility study for the Karma project supports a low capital intensive, relatively simple and scalable gold project.” 

 

These are phenomenal assets that deserve more attention than they’re getting. They will have their day; slow and steady wins the race. For example, True Gold announced the results of the feasibility study for the Karma project, which supports a low capital intensive, relatively simple and scalable gold project. The recent exploration results have also been encouraging and have the potential to add to current mine life. We believe the next catalyst for the company would be approval of exploitation permits and receipt of project financing for construction, which should further derisk the project and help in rerating of the stock.

TGR: Mountain Province is unlike the others in that it is a diamond play. Since when does NBF cover diamonds?

PL: We started covering Mountain Province in 2010. The company just finished permitting, and it has tremendous upside. It looks a lot like Aber Resources back in 2000–2003. Diamonds are a different animal. The commodity price beta is not as high as gold.

TGR: What is the tonnage? The carat grade?

PL: A new feasibility study is due in Q1/14, so all the data out there right now is a bit dated. Basically, Mountain Province is looking to produce approximately 4.5–4.8M carats/year.

TGR: What value are you using per carat?

PL: We’re using $130/carat, but it could be as high as $140–145/carat.

Two exceptionally large stones found in the drill core were not included in the valuation. That would suggest a population of special diamonds that could take the average value per carat much higher once in production.

The same thing happened at Aber, where the value of the stones was boosted 15–20% in a larger sample set. There’s no guarantee that will happen here, but the data are eerily similar in that regard.

TGR: Do you use a deeper discount rate with diamond equities than gold equities, given that the Ekati and Diavik diamond mines in northern Canada both have run close to 10% below feasibility projections to date?

PL: I used an 8% discount rate when I valued Mountain Province. We will reassess the risk/reward profile using the new feasibility study.

Based on what I know now, I like the name. There may be an opportunity for the company to rerate in the range of 10 to 12 times operating cash flow. That would suggest a stock price, when it’s built by 2017, in the range of $13 to $15 per share.

TGR: Do you have a parting thought for investors as we usher in 2014?

PL: It’s been a challenging market on multiple fronts. There are a lot of moving parts and it has been frustrating for everybody in the mining space. A lot of exuberance has been flushed out of the system.

Nonetheless, there are good people doing some good things. There are value propositions out there. Solid management teams will be able to take advantage of this market to drive value in the longer term.

TGR: But you’re still preaching defense?

PL: Correct.

TGR: Paolo, thanks for your time and insights.

At the time of this interview, Paolo Lostritto was director of mining equity research for National Bank Financial. He has also worked with Wellington West Mining, Scotia Capital and MGI Securities. He holds a Bachelor of Science degree in geological and mineral engineering from the University of Toronto.

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DISCLOSURE: 
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Reportas an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Klondex Mines Ltd., Pilot Gold Inc. and True Gold Mining Inc. Franco-Nevada Corp. is not affiliated with The Gold Report.Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Paolo Lostritto: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

 

 

The Gold Report: This year has been difficult for gold investors. The price went from a high of almost $1,800/ounce ($1,800/oz) to where it is now, in the mid-$1,200/oz range. You have written extensively about the supply and demand forces of precious metals. What is behind the drop in the gold price?

Jeffrey Christian: The single most important factor has been a massive decline in the investment demand for gold. In 2013 investors have bought about 30 million ounces (30 Moz) gold on a net basis globally. That’s down from about 39 Moz in 2012 and 31 Moz in 2011, but it is still at a very high level compared to historic investment demand. The net purchases are down 24% because some investors are selling gold.

TGR: Are they putting their money into other investment vehicles or are they sitting on their cash?

JC: There are people who buy gold and hold gold. One person recently told me, “I’m not a gold investor; I’m a gold stacker.” They buy gold as a long-term portfolio diversifier, a safe haven, a hedge against financial calamity and also an investment for other reasons. Those people have stepped back a little bit because they want to see how low the price goes before they buy and buy heavily again. That is also true among central bankers this year.

“The single most important factor in the gold price has been a massive decline in the investment demand for gold.”

But other investors who were big buyers in the period 2007–2011 have, in fact, left. They are momentum traders who were watching the price of gold rise, so they were buying. Now that the gold price has been falling for two years, they’ve either sold or they’ve gotten out of the market. There also are disenchanted investors. They were buying gold because they thought all of this monetary accommodation globally had to lead to hyperinflation. Or they thought that the euro, the European Central Bank, the dollar or the U.S. Treasury would collapse. None of that has happened and they are starting to doubt the thesis on which they were investing in gold, so they are going someplace else.

And then there are the general investors who probably represent 90% of the gold investment community, people who invest across assets and gold is just one asset in a diversified portfolio. Those people are refocusing on real estate in the U.S. to some extent and the stock market, which has been very strong.

TGR: You mentioned the theory that quantitative easing (QE) would impact the gold price, either by deflating the dollar or creating hyperinflation. Does QE impact gold? Would the end of QE impact it negatively?

JC: Yes, monetary accommodations can affect gold in several ways. What we saw in 2009–2011 was that investors assumed it would be inflationary and bought gold in anticipation of that. The inflationary consequences of all that monetary accommodation have not yet arrived and, frankly, may not arrive. Investors bought gold in anticipation of that inflation, based on false assumptions about the relationship between monetary policy and inflation that were not grounded in fact or good economic theories. Now they are selling, or at least not buying, in reaction to the lack of inflationary reactions to the increased money supply.

In addition, QE or monetary accommodation can have a direct effect on gold by being inflationary. If the money that the Federal Reserve is pumping into the banking system was being lent by the banks and being spent by the corporations and individual consumers borrowing that money, it would have a much more positive effect on the real economy. It also would have inflationary pressures. A combination of those factors would drive gold prices higher. That hasn’t been happening because the monetary accommodation we’ve seen the last five years has been going to shore up bank balance sheets. It hasn’t been lent and it hasn’t been spent. Therefore, it hasn’t had that inflationary consequence, and it hasn’t pushed gold prices up.

“Algorithmic trading is causing bunches of trades both on the upside and on the downside across markets.” 

Go back to late 1982–1983, the depth of the previous deepest recession in the post-war period, when Brazil, Mexico and Argentina were about to default. The gold price had fallen from $850/oz in January 1980 to $290/oz by mid-1982. It had given up three-quarters of its value over two years. Then-Federal Reserve Board Chairman Paul Volcker and the world central bankers opened the monetary sluices. The money was lent into the economy. The price of gold went from $290/oz to $500/oz in six months because investors saw all that monetary accommodation and assumed it had to be hyperinflationary. By Q1/83, we were out of the recession because that money was lent and spent.

Volcker started selling bonds, sopping up that excess liquidity, and we never had the inflationary consequence. Gold went from $500/oz in January 1983 back down to $285/oz by 1985 as a result. The reality is that monetary accommodation doesn’t have to be inflationary. A lot of people, I think, misunderstood that over the past few years. What you’re seeing now is a desire to understand the relationship between money supply, inflation and gold prices because it hasn’t been as simplistic as a lot of people believe.

TGR: A lot of the experts we talk to at The Gold Report say it’s really just a matter of time before the banks feel confident enough to start lending and that’s when the hyperinflation will become apparent. Do you disagree?

JC: Not necessarily. Some of those people have been saying this for 30 years. I know a guy who started writing a newsletter in 1981, and his first newsletter said all of this monetary accommodation is going to bring hyperinflation and the bond market is going to collapse. Someday he probably will be right, but in the last 32 years, he hasn’t been right.

If money starts getting lent and spent, that would strengthen the economy. Then we could start seeing inflationary pressures. But the Fed has this tremendous capacity to sell bonds to sop up that inflationary excess liquidity. It has $3 trillion in bonds sitting on its portfolio, and it can always go to the Treasury the way Volcker did in 1983 and ask the Treasury to print more bonds. Even when that money starts becoming mobilized, it may not have an inflationary consequence. We’ve seen it repeatedly, in 1982, 1987, 1991, 1997 and 2001. Money going into the economy may not have the inflationary effects that people who look at it in a less dynamic analysis are saying that it will have. It’s not necessarily going to happen that way.

TGR: Based on your description of the investment demand for gold right now, how do you explain the periods of heavy buying and selling in 2013 that led to gold prices declining as much as $40/oz in a short period of time?

JC: What you are seeing is algorithmic trading. We saw this on April 12. We saw a tremendous amount of selling coming into the over-the-counter forward market, the spot market and the COMEX within a very short period and that led to prices falling sharply. If we disaggregate that, what we see is it was actually more than 1,000 independent entities all trading on technical price chart points, many of them using computerized trading programs that all came in selling at the same time.

“Our expectation is that mining stocks probably are close to a cyclical low.”

We saw a similar situation in early October, when about 2.4 Moz of gold futures were sold in a 10-minute period on Oct. 1. The price, in fact, fell $24/oz in that 10-minute period, and it fell about $40/oz over the course of that day. A lot of people looked at it and said, OK, this is some large entity doing that selling. And some of the people, because they’re conspiracy theorists, said this is someone trying to suppress the gold price. Neither set of conclusions was right, however.

If we take several steps back and do a good analysis, we find several things. Over the course of October, there were seven 10-minute periods with abnormally high volumes of COMEX gold trading. Of those seven periods, four were buying events based on the expectation that prices were going to rise. And, in fact, prices rose. That proves this is not about trying to push the price of gold down.

It is also not a single entity. In each instance hundreds of entities are buying and selling. Most of them are algorithmic traders. A lot of them have computerized trading programs, so it’s not even an individual saying sell; it’s the computer just triggering sell orders. And they all are using the same or similar programs, and they’re all looking at the same price point as a buy or a sell signal.

It is also not isolated to gold. Gold people tend to be auro-centric. They look at the world through gold-tinted glasses. If we look at the overall commodities market, we see that this kind of algorithmic trading and this kind of concentrated sales and purchases at trigger points is occurring across commodities. It’s actually a bigger volatility issue in the grain markets than it is in gold and silver.

Then if we take another step back, we find out it’s not even limited to commodities. It’s happening in currencies, fixed incomes, bonds and stocks. Algorithmic trading is causing bunches of trades both on the upside and on the downside across markets. So it’s clearly not a single entity. It’s clearly not aimed at a one-way trade—let’s push the price of gold down. And it’s clearly not even related to gold. It is a number of people trying to make money by trading on a short-term basis across financial assets.

TGR: If algorithmic trading is magnifying the swings in an already volatile market, does it need to be regulated?

JC: That’s a tough philosophical and regulatory issue. I think that we should have a free market and it should be regulated. There may be some way that we can put brakes in there. We have had brakes in other markets. But who is going to be the arbiter to say, OK, you’re allowed to trade and this guy isn’t allowed to trade, or only limited size trades are allowed. As we speak, India is struggling with these definitions about what constitutes illegal speculation compared to legal investing. Ironically, many of the people who are demanding controls on algorithmic trading are the same people who don’t trust government officials, so the decisions about who will intervene, who will make the rules, who will be allowed to trade and who will be excluded are much more complex than whether or not algo trading should be banned.

TGR: Separate from the algorithmic traders, what about the role of gold exchange-traded products? Why was there a big selloff in those this year?

JC: From our analysis, we believe that gold exchange-traded funds (ETFs) attracted investors who were new to gold, which is a good thing. But these new gold buyers may not buy and hold the way traditional gold investors have done. And because there is a daily reckoning in the ETF market, people will take it as a mirror of the gold investment market sentiment even though they don’t necessarily represent the majority of gold investors. We’ve seen about a 25% reduction in gold holdings in the ETFs this year. So about a quarter of those investors have taken their chips and they’ve gone back to the stock market or wherever else they came from. I think that’s what you’re seeing in the ETF market.

TGR: So you think the dramatic selloff was caused by individuals new to the market who got scared?

JC: I don’t know that they got scared. In some cases, they just decided to take whatever profits they had left. In some cases, you clearly had people who were buying ETFs at a much higher level, and they were taking their losses and moving on to something else. But I don’t think that there was any particularly large participant. There were some hedge funds, and there were some companies that were using ETFs to hedge their short exposure to gold prices that had been liquidating those positions for a variety of reasons. But it was not any single entity that was liquidating 25 Moz gold. It was a lot of individuals who basically had said, OK, the gold bull market is over, at least on a cyclical basis.

TGR: So it wasn’t the John Paulsons of the world changing their mind about gold and in the process pushing down the price?

JC: We did see some large hedge funds that were using those positions. John Paulson’s position on the ETFs actually was not his core gold position. It was a hedge of Paulson & Co.’s exposure to gold prices from those investors in the Paulson hedge funds that had chosen to denominate their investments in those funds in gold. Paulson’s gold investments are apart from those ETF investments. Over the years, gold prices have risen sharply and then they came off. Paulson’s funds have done well and they’ve done poorly. The value of his position has fallen down in some of his funds. A lot of people have withdrawn money.

Paulson’s selling of gold ETFs has nothing to do with that company’s views about the gold market. It has to do with the fact that people either are withdrawing funds or they don’t want to index their positions in the fund in gold anymore because the dollar is doing well and gold is doing poorly. So those sales by those ETFs holders do not necessarily represent a vote pro or con of gold; it’s a hedge of his position with his investors, and as his investors make a choice, he’s just unwinding his hedge.

TGR: But it does impact the market.

JC: It definitely affects the market, but you have to understand, it’s not that there’s somebody out there saying, oh my God, I do not believe in gold anymore. At least it’s not Paulson & Co. saying that. It’s investors saying, we’ve had a very good run in 2010 and 2011 by denominating our investment in Paulson funds in gold because during that time, Paulson’s funds did very well and the gold price did very well. So we got a double whammy on the positive side. Now, Paulson’s funds haven’t done so well, and the gold price has plunged. So it makes sense to either take my money out or at least re-index it so it’s based on the dollar or some other currency.

TGR: You mentioned the role of central banks buying gold. What impacts have international central banks had on the gold price?

JC: Central banks shifted to being net buyers around 2008. They had been net sellers for several decades, basically since around 1967. In 2010–2012, central banks were buying about 9.5–11 Moz/year of gold. This year, they’re probably buying about 3.5–5 Moz of gold. It’s just a handful of central banks that have been significant gold buyers in the last few years—Venezuela, the Philippines, Kazakhstan, Russia, and China in 2009, which was a special case. Those central banks remain interested in buying gold, with the probable exception of the People’s Bank of China, but just like investors, they are price sensitive. They are waiting to see how low the price goes before they resume purchasing gold in significant volumes. We think the volumes will start rising again next year, once the gold price stops falling and starts stabilizing. We expect the gold price to rise over the next 10 years, so we expect those central banks to continue to buy gold over the next 10 years.

TGR: There is a lot of controversy around both supply and demand statistics from China and India. What statistics do you use for both investment and fabrication uses? What trends are you seeing in those numbers?

JC: CPM Group is in the business of developing its own estimates of supply and demand in commodities, including gold, silver and platinum group metals. We have been developing and maintaining our own supply and demand data since the 1970s, longer than anyone else in the market. We use our data.

In India, we are seeing a small increase in investment demand. The government has severely limited imports of gold except for manufacturing into jewelry that gets re-exported. It has raised taxes to try to discourage some of the investment demand in gold. But investors in India are still buying gold. The country has been a major gold investment market for centuries. In fact, for the last decade it was the largest market for gold, but China surpassed India last year as the largest market both for jewelry fabrication and electronics, as well as for investment products. We’re seeing an acceleration of that this year.

Our current estimate is that total demand for gold in China is about 35 Moz this year. A lot of that occurred in January, February and then April and May. Since that time, we’ve seen Chinese investors become more price sensitive along with everybody else, waiting for lower prices before they buy more.

Our estimate is in line with the estimates used by the China Gold Association, CPM Group’s strategic partner in China and the major Chinese gold industry organization. It also is in line with estimates from Chinese dealers and bullion banks that are moving gold into, around and out of China. There have been some outrageously unsupportable statements that gold demand in China is three times that, or more, but these numbers are totally unsupportable based on statistics and evidence that is available in the market, and are being pushed by gold marketing people desperate to convince Western investors that they should keep buying gold, and buy it from them.

TGR: Can you give me an example of some of the ways you figure out how much gold China is buying and mining?

JC: We collect import and export data. But that misses a lot of information. So we develop independent sources of information with major smelters, refineries, industrial users, investment wholesale and retail outlets, central banks, exchanges—around the world. For each major market, we create what we call a national metal account for each metal—gold, silver, platinum, palladium, rhodium, vanadium, aluminum, copper, all of the metals. We put it into a model, and that gives us a rough idea of what the size of the market is.

TGR: We’ve talked about a lot of things that could impact the gold price—the supply and demand in emerging markets, central bank buying, ETFs. Have the larger economic trends overshadowed traditional seasonal fluctuations in demand and price? There are the summer doldrums and the love trade buying season that Frank Holmes talks about, but the gold price doesn’t seem to be following the usual patterns anymore. Is that just being overshadowed?

JC: The seasonality patterns are averages. Like the weather report on television where they talk about how the normal temperature on a given day should be 50 degrees, it’s not the normal temperature; it is the average temperature over a period. The normal range in temperature that the average reflects might be 35 to 75 degrees. So seasonality is an average of a wide range of occurrences.

Seasonality is always trumped by macroeconomic and fundamental trends. If something is happening in the market, it regularly blows away the seasonal patterns. That is what we are seeing this year. Fundamental and macroeconomic factors are weighing gold prices down during a period where congestion usually drives the price temporarily higher.

TGR: In June, you issued a qualified Buy recommendation on gold as an intermediate- to long-term Buy. What trends are you anticipating for 2014, both in the developed and the emerging markets?

JC: As background, we issued a Sell recommendation on Jan. 2, 2012, for gold and silver. Gold was trading around $1,800/oz, and we said that we thought it would fall to $1,300/oz to $1,400/oz on an annual averaged basis in 2013–2015 before rising again. What we said in June of this year was that we are kind of there in terms of our downside price targets. There is some more weakness in the market, but long-term investors might want to buy gold if it spikes down to $1,200/oz.

Our expectation now is that the gold price will be relatively weak for the next two or three quarters, into Q2/14 or Q3/14. We think that this period of bearishness about gold still has a ways to go. We’re not convinced that we’ll see prices fall further on an intra-day basis, and that the $1,180/oz low that we saw in late June may well prove to be the low. It was tested earlier this month and we bounced off of it, at least for now. Arguably, that may well hold, but there is a tremendous amount of bearishness about gold, and there is a tremendous amount of bullishness about the global economy and the U.S. economy.

In that environment, gold could be relatively weak. Investors right now are turned off to gold and are refocused on stocks and bonds. We think that by H2/14 investors may start refocusing on the structural financial and economic problems facing the U.S., Europe, Japan, China and the world as a whole. That could lead to a downdraft in U.S. stock prices. Combined with nasty, uncooperative Washington politicians, and a nasty, uncooperative election, H2/14 could lead investors to start buying gold again in higher quantities.

TGR: The silver market is smaller and often more volatile than gold. Do you see the same fundamentals at work there? What are you expecting for 2014?

JC: Silver is pretty much in the same situation. We’re a little less optimistic about silver. Broadly speaking, we expect it to be the same, but because silver is a schizophrenic metal that acts as an investment product and an industrial commodity and both are negative at the moment. The silver price could bounce around $18–22/oz for the next three quarters. Then it could be a little weaker than gold in 2015. Depending on what happens in the global economy and whether investors remain keen to add to their silver holdings at these prices, silver could do well after 2015.

TGR: Do you think there is an ideal silver-gold ratio?

JC: No. In the history of free metal prices, since 1968, the ratio has ranged between 16:1 and 100:1. There are absolutely no physical or economic reasons why the ratio should be anything in particular. When people ask us where we think the ratio is going to go, we look at our 10-year projections for gold prices based on fundamentals in the gold market. We look at our 10-year projection in silver. We divide one by the other and come up with the ratio. There is no real reason for a ratio to be anything. There is very little substitutability except in the eyes of investors. Back in 1979 we said the ratio would go to 16:1 because Nelson Bunker Hunt thought the ratio should be 16:1. He was buying silver and selling gold accordingly. It did hit 16:1 the day he went bankrupt.

TGR: A lot of analysts are bullish on platinum and palladium because of country risk to supply and possible increases in demand as the global economy improves and people start buying cars with catalytic converters. Do you agree with that supply and demand picture?

JC: Yes. We have been more positive on platinum than on gold and silver, and we’ve been more positive on palladium than on platinum for a couple of years. We’ve been embarrassed to some extent because the prices haven’t been quite as strong as we thought. There are supply concerns in South Africa, and those supply concerns probably will be heightened in 2014 from what they were in 2013. So that should apply upward pressure on platinum prices and palladium prices. We’re actually already seeing relatively healthy markets for autos in China, India, the U.S. and Europe. We’re also seeing an increase in the sales of large diesel trucks and buses. That’s important because those vehicles use more platinum relative to palladium.

The problem with platinum and palladium is that there has been a buildup of millions of ounces in the hands of investors. Investors in gold, when they turn bearish on gold, tend not to sell gold. They tend to just stop buying as much because it’s a financial asset and it’s a quasi-currency in their minds. But platinum and palladium are industrial commodities. When investors turn bearish on them, they dump them.

One of the things we’ve seen since Q4/11 is that a lot of investors who had bought platinum and palladium earlier in the decade, in 2002 to 2008, were taking the opportunity of any rallies in the platinum and palladium markets in 2011 and 2012 to sell into the rallies. Now, in H2/13, they’re not even waiting for rallies. They’re just selling. There is a very positive balance between supply and fabrication demand, but a negative investor attitude. We think that will shift at some point over the course of 2014 and you’ll probably see platinum prices move sharply higher at some point. You’ll probably see palladium prices move steadily higher from early 2014.

TGR: What does all of this mean for the junior mining equities? They’ve been hit even harder than the commodities in a lot of cases.

JC: Mining equity values tend to be much more volatile than the metal prices. They are a less liquid market, so they have a high beta to gold prices. The juniors, in particular, are heavily exposed to that because of their small size and lack of cash and revenue stream to get through the bad times. They have been hit very hard over the last several years.

Investors have to be very careful and pick the good ones, but our expectation is that mining stocks probably are close to a cyclical low. They may go a little bit lower in H1/14 simply because investors are going to continue to be bearish on precious metals in general. There are some interesting opportunities to pick up stocks that were overvalued in 2009–2010. Then wait for that investor psychology to shift. We think it will happen over the course of 2014, but it may be the middle to late 2014.

TGR: Thank you for your time.

JC: Thank you.

Jeffrey M. Christian is managing partner of CPM Group. He has been a prominent analyst and advisor on precious metals and commodities markets since the 1970s, with work spanning precious metals, energy markets, base metals, agricultural markets and economic analysis in general. He is the author of “Commodities Rising: The Reality Behind the Hype and How to Really Profit in the Commodities Market,” published in 2006.

Christian founded CPM Group in 1986, spinning off the Commodities Research Group from Goldman, Sachs & Co and its commodities trading arm, J. Aron & Company. He has advised many of the world’s largest corporations and institutional investors on managing their commodities price and market exposures, as well as providing advisory services to the World Bank, United Nations, International Monetary Fund and numerous governments.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: COLORADO RESOURCES LTD. : GOLDCORP INC. : GOLDQUEST MINING CORP. : MIRASOL RESOURCES LTD. : MUNDORO CAPITAL INC. : RESERVOIR MINERALS INC. : ROXGOLD INC. : SAN MARCO RESOURCES INC. : SILVERCREST MINES INC. : TRUE GOLD MINING INC.

RELATED COMPANIES

• : ALMADEN MINERALS LTD.
• :KLONDEX MINES LTD.
• : SARAMA RESOURCES LTD.
• :SULLIDEN GOLD CORP.
• : TIMMINS GOLD CORP.

 

The Gold Report: Federal Reserve of Dallas President Richard Fisher gave a speech in Australia declaring that quantitative easing (QE) must end or it would “fuel the kind of reckless market behavior that started the global financial crisis.” If the Fed isn’t going to end QE until employment improves, how will this end?

Eric Coffin: Fisher gets to voice his opinion at Federal Open Market Committee (FOMC) meetings, but he won’t be a voting member until January. He hasn’t been comfortable with QE from the start and has said so repeatedly. There isn’t any news in that quote.

I don’t think you’ll see much change when the FOMC gets four different members next year. Janet Yellen, who will become chairman, is more dovish than Ben Bernanke. I think she was the right choice, not because she loves creating money from nothing but because she’s probably been the most accurate forecaster of the bunch.

TGR: What about the bubble that Fisher fears?

EC: If you want to be cynical, you can make the argument that a bubble is exactly what the Fed has been trying to create. It wanted to get equity markets to go up because that increases wealth and raises consumer confidence. About half of the Fed’s QE program is buying mortgage bonds. It is trying to keep mortgage rates down and resuscitate the housing sector.

At the end of this interview is a special offer from Eric Coffin for a free research report.

Fisher is right in a sense, but I don’t think we’re at the point where I’d be terribly concerned about things running out of control. I have to admit, though, that based on the growth of the economy, the U.S. equity markets are probably getting a little bit ahead of themselves. Most consumer inflation measures have been trending down, not up. Personally, I’m more worried about deflation, which is far harder for a central bank to fight than inflation.

TGR: The Q3/13 gross domestic product (GDP) report shows 2.8% growth.

EC: Right now, I’m kind of neutral on the economy. The data quality is going to be crappy for a month or two because of the government shutdown. The economy grew 2.8% because there was big growth in inventories, which is not the reason you want. Without that it came in at 2%, which was the expected number. You’re probably going to see production cut a little bit this quarter because more stuff was made than could be sold.

TGR: Karl Denninger pointed out that the gross change in GDP from Q2/13 to Q3/13 was $196.6 billion ($196.6B), but the Fed’s QE program injected $255B. So the economy actually shrank during Q3/13.

EC: I think he’s oversimplifying a little bit. QE is really swapping paper, creating money out of thin air and using that to buy bonds that inject money into the economy. But the velocity of money has been very low since the crash. It’s not as if the banks are taking that $85B/month and lending it all. That’s where the real multiplier effect is. Right now a lot of the money created through QE has ended up in bank’s excess reserves, not in the wider economy. Karl is a bit of a permabear, but I would agree with him that it wasn’t that great a report.

TGR: Let’s assume that QE continues at its present rate until June 2014. How will that affect gold and silver?

EC: When the Fed starts tapering, we have to assume gold and silver prices will get hit. Of course, if it doesn’t actually start tapering until well into next year, we could see gold and silver go up for two or three months before that. That doesn’t preclude later increases in the gold price based on physical demand, but the short term traders are completely fixated on QE (or lack thereof) and will be sellers once the taper starts, and the market will have to get past that before recovering.

TGR: What if it becomes clear we are going to get QE forever?

EC: Then I think gold goes to $2,000/ounce ($2,000/oz).

TGR: At the Subscriber Investment Summit in Vancouver last month, you compared the 10-year chart for gold to the 10-year chart for junior resources. The first chart looks good, but the second looks terrible. Why?

EC: For all the money thrown at exploration—and, of course, that number has been tumbling dramatically for the past two years—not many good discoveries resulted, especially in the last couple years. That’s one reason. The chart below shows the amount of gold discovered each year since 1990, counting only new gold discoveries above 2 million ounces (2 Moz). You can see how few discoveries there have been in the past couple years. Compared to the 1990s the numbers are tiny.

The other reason is that when the gold price was rising continuously many companies were looking for what I referred to in Vancouver as “crappy ounces.” Their intentions were good. They weren’t trying to hoodwink anybody. They made the reasonable assumption that with gold going up and up, economic cutoff grades would keep dropping. But you can’t produce gold at ever-lower grades with difficult metallurgy and infrastructure and make more money.

As it turned out, costs rose almost in lockstep with the gold price. A lot of the ounces that were marginal at $500 or $700 or $900/oz haven’t been salvaged by the gold price going to $1,300/oz. Many of those resources are still uneconomic and would require more capital expenditures with longer payback periods than larger producers are willing to accept.

TGR: You said that juniors have a major credibility issue, specifically, that preliminary economic assessments (PEAs) and feasibility studies do not match production realities.

EC: There are a couple reasons for that. I’ve already mentioned costs. And when the sector recovered after 2000, there was a real capacity issue. There weren’t enough geologists or engineers. There weren’t even enough people who make truck tires.

“For all the money thrown at exploration, not many good discoveries resulted, especially in the last couple years.” 

Many NI 43-101s, PEAs and feasibility studies have been written by people who lacked experience. To be fair to the engineering companies, miners can have cost overruns of 20% and still be within the stated margin of error, but people never read the fine print. They just look at the production cost, so when it comes in $100–200/oz higher, everybody freaks out.

TGR: Juniors chased lousy projects because gold was soaring, and money flooded into the market. Now that gold has fallen 30%, will this engender the return of old-fashioned values?

EC: I think it already has. The large mining companies, having spent huge amounts of money on capital expenses (capexes) that didn’t add to their bottom line, are now saying, “Show me margin.” Large and medium companies will now pick up deposits smaller than what they would have touched 10 years ago because they have the grades, the geometry and the metallurgy to enable low-cost production.

TGR: So is margin now more important than grade?

EC: Grade is king, but margin is the key. Majors are focused on margin per ounce produced. You can get high margins with a lower-grade deposit if everything goes right but, by and large, the higher grade the better the margin should be. It comes down to net present value (NPV) and internal rate of return (IRR). Companies now want gold projects that can be built for $100–150 million ($100–150M) with NPVs of $300M or $400M and all-in cash costs of $600-800/oz—assuming they’re big enough. They don’t want to go too small because they can spread themselves only so thin. I don’t see majors like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) picking up 50,000-ounce-per-year (50 Koz/year) deposits, but we might see them picking up 100–150 Koz/year projects, when a few years ago few majors would look at a deposit unless it was capable of generating 250 Koz/year or more.

In Sonora, Mexico, half a dozen mines that began production in the last five years don’t have grade. They’re 0.8, 0.7 or 0.6 grams per ton (0.6 g/t), but they have fantastic combinations of logistics, costs, workforces, metallurgy and geometry, and they produce at $500–700/oz cash costs.

TGR: Why are new discoveries so important to the junior sector?

EC: That’s what the juniors exist for. The market wants something new, with blue-sky potential. The companies with really big runs in the last year or two are, almost without exception, companies that made discoveries. They don’t always work out, but that’s the risk you take.

“Grade is king, but margin is the key.”

If you go back to the pretty spectacular bull market in the mid-1990s, it was driven by companies going international for the first time in a long time, juniors going to South America and Africa and finding 3, 5 and 10 Moz deposits. Gold prices rose in the mid-1990s, but discoveries drove the bull market.

TGR: You called Reservoir Minerals Inc. (RMC:TSX.V) a “classic discovery story.” Why?

EC: Most of its exciting concessions surround the Bor mine in Serbia. It’s a big camp. Reservoir has a joint venture with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), with Freeport holding 55% of the Timok project and Reservoir 45%. It’s a high-sulfidation epithermal system. One of the first holes was 5.13% copper and 3.4 g/t gold over 291 meters (291m).

A real back-of-the-envelope calculation (because the holes are still pretty widely spaced) is that Timok has 30–40 million tons (30–40 Mt) of quite strong-grade gold-copper material. Freeport is a great partner. It has lots of money, and it has direct experience operating bulk tonnage and also block-cave underground mines, which Timok would probably end up being.

TGR: Reservoir’s Sept. 9 Timok press release announced 260m of 3.93% copper equivalent. Is the early promise being fulfilled?

EC: It’s a fantastic discovery, definitely one of the best of the last few years. Assuming Freeport goes all the way to feasibility—and I’d be pretty shocked if it didn’t now—Reservoir essentially gets carried until then at 25%, which would still be significant value, considering the deposit.

TGR: What about other companies near Timok?

EC: The one that got my attention is Mundoro Capital Inc. (MUN:TSX.V). The company had originally gone into China and picked up a gold project that it expanded to 8 or 9 Moz with pretty good grades. Unfortunately, one of the state gold miners liked it even more, so Mundoro was shown the door and given $20M on the way out. It has lots of cash.

Teo Dechev is the president; her family comes from Eastern Europe and the VP of Exploration is based there. Mundoro picked up concessions there. Mundoro wasn’t chasing Reservoir; it just liked the geology. The initial drill program at its Borsko Jezero property didn’t come up with a Reservoir-style discovery, but its Savinac property has had some pretty interesting trench assays.

TGR: As high as 30 g/t gold and 171 g/t silver over 12m.

EC: I’m not assuming every trench is going to look like that, but it’s a good start. The other two trenches were pretty decent, too. Mundoro may actually have something there, probably an epithermal system. The company has another project in Bulgaria I’m expecting to see results from it soon and a lot of other ground near Bor that has targets at earlier stages. The story is by no means over.

It’s trading at only $0.24/share but has about $0.30/share in cash, enough for three years. So there’s lots of leverage, if it makes a discovery.

TGR: You mentioned in Vancouver other companies with discoveries that are not as “classic” as Reservoir’s but still have potential.

EC: I gave two examples. The first is GoldQuest Mining Corp. (GQC:TSX.V) in the Dominican Republic. It’s trading at $0.29/share. It had a high of $2/share, and I’d be much happier if it traded closer to that, but it was $0.07/share before it discovered Romero. GoldQuest just released an initial resource estimate: 2.38 Moz gold equivalent Indicated and 790 Koz Inferred.

Keep in mind that Bill Fisher, the chairman, and Julio Espaillat, the president—Julio is Dominican—have done this before. They put Cerro de Maimón into production. This is a small but very profitable mine that was taken out for $3.20/share in 2011. Having management with direct mine building experience in country is a huge advantage.

TGR: How does GoldQuest stand for cash?

EC: About $12M right now, enough to take it most of the way to feasibility. Romero needs some infill drilling and more metallurgical testing. Most of the maiden resource is Indicated already so it shouldn’t need to do a huge amount of additional drilling for the feasibility study. Metallurgical work should improve the economics. The old tests indicated 75% recovery, but those were simple bottle roll tests. Romero will be a sulfide plant and recoveries in the 90% range for both copper and gold are more common for that sort of operation.

TGR: What was the other company?

EC: Colorado Resources Ltd. (CXO:TSX.V), which has the North ROK porphyry discovery in northern British Columbia. This is one of those situations where the best hole is the first hole: 0.63% copper and 0.85 g/t gold over 242m. Colorado has since drilled decent intercepts, but none like the first, and the market has punished it.

We won’t know for certain until the company puts out the remainder of its pending drill holes, but hole 9 looks as if it has hit a structure. If the zone doesn’t continue SE of Hole 9 North ROK could still contain 100–300 Mt, and 300 Mt happens to be the size of Imperial Metals Corp.’s (III:TSX) Red Chris mine, which is going into production down the road. Colorado’s president, Adam Travis, told me in Vancouver that the company is still figuring out the controls on the mineralization. But its logistics are really good, the best in the area, so this is a legitimate discovery, which may well be economic.

TGR: How much cash does Colorado have?

EC: It should have $5–7M after drilling. The company will probably get the rest of the holes and an initial resource estimate out before worrying about raising more money. Porphyries take a lot of drilling. If North ROK turns out to be a moderate-size, moderate-grade resource, Colorado may look for a partner.

TGR: Which discovery stories do you like in Africa?

EC: I like a couple. Actually, the first, True Gold Mining Inc. (TGM:TSX.V) in Burkina Faso, is now long past being a discovery story. It also has quite good logistics. The deposit is probably about 3 or 4 Moz, but right now the company is focusing on the oxides. The idea is to get a heap-leach operation into production, because that’s a much lower capex, and leverage that to build a sulfide plant later. I expect to see a feasibility study early next year.

True Gold has very strong management. Mark O’Dea ran Fronteer Gold before it was taken out by Newmont Mining Corp. (NEM:NYSE). He’s done something I hope we see more of—he brought in a completely unrelated company, an insurance company, which put a large placement into True Gold. O’Dea has done a good job of funding, admittedly with more dilution than I would have liked, but that’s just the market we’re in. The company certainly has enough to get through feasibility. We’re probably looking at a $100–120M capex for a mine that should be able to do, say, 100+ Koz/year for 10 years. A feasibility study should be out within a couple months.

TGR: And the second African discovery?

EC: Roxgold Inc. (ROG:TSX.V), also in Burkina Faso. The 55 Zone of its Yaramoko project is a high-grade, steep-vein setting. It put out a PEA and mineral resource in September: 850 Koz gold at 13.88 g/t. This will be a small but very high-margin operation.

TGR: What other companies with new discoveries do you think have potential?

EC: Mirasol Resources Ltd. (MRZ:TSX.V) is a very successful explorer and project developer. It sold a high-grade silver discovery in Argentina to Coeur Mining Inc. (CDM:TSX; CDE:NYSE). Thanks to that, Mirasol has about $40M in cash and Coeur shares, which, coincidentally, is the same as its market cap. For political reasons, no one is a fan of Argentina these days, but the company also has large projects in northern Chile that look pretty interesting—early stage but big.

“When the Fed starts tapering, we have to assume gold and silver prices will get hit.”

San Marco Resources Inc. (SMN:TSX.V) is focused on northwest Mexico, an area I’ve always liked and still do. The company is not cash rich but has strong joint-venture agreements with Exeter Resource Corp. (XRC:TSX; XRA:NYSE.MKT; EXB:FSE) on its Angeles and La Buena projects. Exeter has to spend $10M on Angeles and $15M on La Buena to get 60% of each. La Buena is just north of Goldcorp Inc.’s (G:TSX; GG:NYSE) Peñasquito mine and a lot of the geochemistry and geophysics are similar. San Marco has started drilling the Julia zone, and I hope we’ll see drill results sometime this month. It is a riskier play but has a $3M market cap, so if it makes a discovery, there’s a lot of upside.

TGR: What other companies do you want to talk about?

EC: SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) announced a silver resource of 199 Moz at La Joya. It’s a low-grade, polymetallic skarn: silver, copper, gold, lead and zinc. The company followed that up with a pretty good PEA: an after-tax NPV% of $93M and a 22% IRR for a “starter pit” operation that is focused on the highest grade portion of the resource.

TGR: How do you rate its management?

EC: That’s the main reason I like it. Chairman Scott Drever, President Eric Fier and CFO Barney Magnusson have been a team since day one. They are all well experienced in both exploration and putting mines into production.

That experience really showed with Santa Elena, SilverCrest’s Sonora mine. It has good grades and pretty much an even mix between gold and silver in value. The team has managed to get it financed at the bottom of the market in 2009, which was no easy feat, and built it for a little more than $20M, which is pretty amazing. It’s producing silver equivalent at $8.50/oz. That’s quite a bit better than most.

TGR: What are the prospects for Santa Elena expansion?

EC: It’s most of the way through one now. Santa Elena started out as a heap leach, but SilverCrest is building a mill, which should start production early next year. That should bring the company up from, say, 2.5 Moz silver equivalent to close to 3.5 Moz next year. As the mine gets into deeper, higher grade material, it should surpass 4 Moz silver equivalent in 2015. La Joya will be more difficult, but I definitely wouldn’t bet against management building it on time and on budget and making sure it makes money.

TGR: SilverCrest is in Mexico, and the new mining regime proposed by the Mexican government has been met with threats by mining companies to close operations and cease investment. Is this premature?

EC: I think some of this is politics and not just on the part of the Mexicans. If someone raises your taxes, you jump up and down. I don’t want to underestimate the seriousness of this, but it gets called a royalty when it really isn’t. It actually comes off the net. I think it will reduce after-tax profits by 10%, which isn’t wonderful but I don’t think it will suddenly make economic mining projects uneconomic. What it will do is raise the bar a bit on projects still in development. Some operations that already looked a bit marginal might not get built now.

That said, Mexico, especially the northwest where SilverCrest operates, is one of the few areas in the world where companies can put mines into production fairly painlessly, with a well-understood permitting regime and low capexes. Miners that produce gold at $500 or $600/oz cash costs are not going to become unprofitable because of a tax increase from 30% to 37%.

TGR: Eric, thank you for your time and your insights.

EC: You’re welcome. I have a new report available for your readers that is free to download—it is actually an interview with one of the companies I have discussed above, which I think is a very worthwhile read. We also have a special subscription offer included in this report.

Eric Coffin is the editor of the HRA (Hard Rock Analyst) family of publications. Coffin has a degree in corporate and investment finance and has extensive experience in merger and acquisitions and small-company financing and promotion. For many years, he tracked the financial performance and funding of all exchange-listed Canadian mining companies and has helped with the formation of several successful exploration ventures. Coffin was one of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997. He also predicted the start of the current secular bull market in commodities based on the movement of the U.S. dollar in 2001 and the acceleration of growth in Asia and India. Coffin can be reached at info@hraadvisory.com or the website www.hraadvisory.com.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Kevin Michael Grace conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Colorado Resources Ltd., Mundoro Capital Inc., Roxgold Inc., SilverCrest Mines Inc. and True Gold Mining Inc. Goldcorp Inc. is not affiliated with The Gold Report. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Eric Coffin: I or my family own shares of the following companies mentioned in this interview: Colorado Resources Ltd., GoldQuest Mining Corp., Mundoro Capital Inc., Reservoir Minerals Inc., Roxgold Inc., San Marco Resources Inc., SilverCrest Mines Inc. and True Gold Mining Inc. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: B2GOLD CORP. :COMSTOCK MINING INC. : CORVUS GOLD INC. :KLONDEX MINES LTD. : MIDWAY GOLD CORP. :PRIMERO MINING CORP. : SILVERCREST MINES INC. : YAMANA GOLD INC.

RELATED COMPANIES

• : IMPACT SILVER CORP.
• :PERUVIAN PRECIOUS METALS CORP.
• : PRIMERO MINING CORP.
• : RICHMONT MINES INC.
• : ST ANDREW GOLDFIELDS LTD.

 

The Gold Report: Sean, over the next two months, you’ll be launching two different newsletters. The first one will be called Gold and Resource Trader. Why is now the right time to debut?

Sean Brodrick: It is a good idea because gold is generally hated right now. I like to look smart. One way to look smart is to buy things near a bottom and then hold onto them as they increase in value.

There is real value in the gold mining area. I ran a screen recently showing 25 miners trading on U.S. exchanges below book value. Some of them I wouldn’t buy, but some I would. This shows that real value is there. We are closer to the bottom than we were to the top, so now is a good time to get in.

TGR: Tell us about the second newsletter you’re going to launch in January?

SB: Oxford Resource Explorer is about energy, metals and other resources. It’s more energy focused because there are tremendous opportunities right now. If you told people 10 years ago that the U.S. would be producing at this level, you would have gotten some head shaking. They just wouldn’t have believed that.

“In gold mininig, we are closer to the bottom than we were to the top, so now is a good time to get in.”

The amazing stuff is what’s coming down the pike. The Gulf of Mexico is just kicking into high gear again. This shows how the natural resource market can turn on its head. People think they have the story figured out, and something comes along and changes the whole thing around. That’s why people are so bearish on gold. They think, well, that’s it, gold’s done; gold has had its day in the sun. No, it hasn’t. There are many good fundamental reasons for gold to go higher.

TGR: In some recent posts on your blog, King One Eye, you note that China is the driving force behind physical demand for gold, yet the central banks are on pace to buy almost half the gold they did in 2012. Does that trend concern you?

SB: Sure, it concerns me and it bears watching. But what the world’s central banks will buy is a guess. The proof is that Chinese demand for gold just keeps rising year over year. There’s extraordinary growth in China as millions join the middle class. And it’s not just China. There is lot of uplift in the whole economic atmosphere across Asia.

“Chinese demand for gold just keeps rising year over year.”

The central banks are important and I am absolutely keeping an eye on what they’re doing. But you have to understand why the central banks buy gold. They buy gold because they want to have something real and tangible, in case there’s ever a run on their currency or some other kind of financial crisis, to keep people from freaking out.

But there are some good reasons to freak out. We have quantitative easing, not just in the U.S. where it’s $85 billion/month, but around the world. The balance sheet of the whole of central banks system is now estimated to be more than $20 trillion by Bloomberg. Central banks keep buying gold because they are worried that some of those pigeons will come home to roost eventually.

TGR: Are higher gold prices necessary to make money in mining equities?

SB: Many companies do need the price of gold to go higher. Mining costs have been going up. Some companies that could make it on $400–500/ounce ($400–500/oz) during the last decade can’t anymore. There are low-cost miners out there. In fact, I love finding low-cost miners. Those are the companies I’ll be recommending to my subscribers in my new publication. But unless we see the price of gold go higher, we’re probably going to see even more large projects shut down.

Also, declining ore grades are putting pressure on companies. There used to be nice, rich gold ore that could be dug up cheaply. Now, companies are mining the gold ore that they used to drive over to get to the easy gold ore that they mined up. That’s the problem with gold. It’s a non-renewable resource. Ore grades are declining and costs are going up. That’s a one-two punch that means the price of gold needs to trend higher for companies to make money.

TGR: You recently told MarketWatch that you examine earnings to see if they’re telling you the story on the individual company or if they’re indicative of a larger trend. Please explain that idea.

SB: Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) recently came out with pleasantly surprising earnings. For one thing, it is using an expected price of around $950/oz to build its models. That shows a company that is thinking in realistic terms. If there is a pullback in gold price, Yamana will be prepared and actually survive.

“The miners you want to buy are the ones that are smart enough to buy something now, when things are so darn cheap and there are projects that are going for a song.”

The earnings of other companies have really taken a slide year over year as the price of gold has gone down. However, there are companies that can make it at the current price. Primero Mining Corp. (PPP:NYSE; P:TSX) has a great low-cost gold structure. It also continues to do exploration, when some companies have pulled back because they don’t have the money for it.

That’s what I look for in an earnings report. If a company can’t make it at $1,400/oz gold, it definitely won’t make it at $1,100/oz gold.

TGR: You’ve noted in your blog that you’re buying on the dips and pullbacks. What are you buying?

SB: What I’m seeking isn’t right for everyone. It depends on individual appetite for risk. Investors need to know their appetite for pain in an unforgiving market like this. If you don’t have an appetite for that, then you might just want to stick to exchange-traded funds (ETFs), like the Market Vectors Gold Miners ETF (GDX:NYSE.ARCA), which is the large gold miners, and the Market Vectors Juniors Gold Miners ETF (GDXJ:NYSE.ARCA), which is the juniors. In fact, I bought both of those, not because I don’t have an appetite for risk but because I need something to benchmark my holdings against.

That said, I also like to buy individual companies because that’s where you’re really going to see the outperformance.

Primero is a great gold miner. Management knows what it is doing. The company has a really bright future. It also produces silver, though it sells most of that to Silver Wheaton Corp. (SLW:TSX; SLW:NYSE).

I also like SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT). It is raising production and seems to be doing all the right things. It only has one big project, but it is working on more. That’s a company that should have a great future. It has a low cost of mining.

I also like some large-cap names, such as Yamana. Larger cap works for some people. Some people should not be playing in the juniors anyway.

TGR: To that end then, Sean, you’re going to build a portfolio in Gold and Resource Trader. How are you going to structure it?

SB: I actually plan to include some of the larger caps. There are not that many large caps anymore. There are only about four mining companies that are still valued at more than $10B. I’ll also include the mid-cap range. But small caps are where I think the real value is.

Take Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB), which is an excellent project. I visited its Fire Creek mine; the company is doing all the right things there. Klondex had a rough patch when I was worried about its funding, but it knew what it was doing and was able to bridge the gap. Things seem to be working out quite well.

I also recently visited Comstock Mining Inc. (LODE:NYSE.MKT), which is trading near the low end of its range. However, it is ramping up its production and will be able to do incredibly well.

I also like B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX). The company is doing great stuff in Nicaragua, where it has multiple mines. It spends its money wisely and is in the process of making another purchase. B2Gold has a great team.

I’m always looking for companies that have smart management so they can make it through hard times and reposition themselves for the next upswing.

TGR: Comstock’s project in Nevada is in an area that was mined before, but a lot of mineralized ore was left behind. You visited the project. Does that premise stand up?

SB: Yes. There are some smart geologists on Comstock’s team who have been doing excellent modeling. The drill results seem to be bearing this out. The company is going to be finding a lot more ore. It is already getting nice results—every time it drills, it comes up with something good. I expect we’ll see more and better news. Comstock has the right geologists, knows that it’s in the right place, has a plan for how it should unfold and is following that plan. It should work out great.

TGR: B2Gold issued guidance of 360,000–380,000 oz (360–380 Koz) this year. It plans to produce about 400 Koz in 2014. Why isn’t that share price performing better?

SB: Optimism has been beaten out of the market. Investors don’t believe good news at this point. Natural resource investors are like Boston Red Sox fans. They have been getting bad news for so long, they have a hard time believing that something good has happened.

TGR: What were some other stories in that part of the world that caught your interest?

SB: I went to see Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.MKT), which was interesting. I think it is being too optimistic about what it can accomplish in a short amount of time because it wanted to be in production so quickly. There aren’t always delays on mining projects, but there often are. Midway is not planning for anything bad to happen. If something bad does happen, then that stock will get hammered.

I also went to visit Corvus Gold Inc. (KOR:TSX), which I’ve been to a few times. It is early stage, but it has a handle on a high-grade zone. Things seem to be working out the way it wants them to. It is moving ahead with the development of the project and recently came out with a new resource estimate. Corvus had to readjust some things because its plan had shifted.

There are such incredible values in producing miners that have exploration upside and will be likely adding to their resources and their production that I’m not picking up the developers at this point. I know some people are saying, “You should see how cheap the explorers are right now!” Yes, I know that. The explorers are super, super cheap. There are probably some that will do extraordinarily well, but I don’t need to raise my level of risk at this point. The producers are also so darn cheap, so why not just buy them?

TGR: But what about their all-in production costs?

SB: That’s a great point to bring up. I still see miners using cash costs of production. It makes me roll my eyes. I then have to go in and see what their all-in costs are. Investors know enough not to just go with the cash costs of production. They have to figure out what it is actually costing the miners by crunching the numbers.

Moreover, costs can fluctuate. For example, Mexico is going to move ahead with a 7.5% tax on miners. Now those companies will have to adjust their cost basis higher.

In this environment, some larger miners that had been planning on putting new projects into production when they thought the cost of gold was going to get to $2,000/oz very quickly are going to have to reassess. Many of them are also sitting on big, ol’ fat cash piles. They are going to buy these smaller producing miners that have resource upside and just move them right into their production pipelines. That’s one of the trends I hope to be playing because we will see some great mergers and acquisitions in that area.

TGR: That’s noteworthy because we certainly haven’t seen much of that to date.

SB: No, we haven’t. You can look at it two ways. No one is going to start doing mergers until the price goes higher. But the companies that wait that long aren’t really the ones you want to own. The miners you want to buy are the ones that are smart enough to buy something now, when things are so darn cheap and there are projects that are going for a song. They could be really mercenary and wait for another company to go out of business and then try to buy the project at a super-discount. But there’s no guarantee that they’ll actually get control of it because everybody is trying to do the same thing.

TGR: You’ll have more bidders.

SB: We’ll see some smart deals made at these prices because people will have their eye on the longer term. Smarter miners think about the longer term.

TGR: Are you still enthusiastic about Mexico as a jurisdiction given the impending tax situation?

SB: I was really keen on Mexico. We’ll have to see how that shakes out, though I think the bad news is priced in already.

Nicaragua is great. Parts of Canada are wonderful. You can get some real benefits for working in a place like Quebec that you can’t get somewhere else. I like parts of Africa as well. There are some opportunities in Turkey, Greece and Spain. They had historical mining and now they’re starting to examine those projects again.

Some places are heating up and you don’t want to go there—at least not at the present time. Nobody wanted to go to Peru when it had a really nasty political situation. Now it is becoming much more amenable to foreign investment. It’s actually looking like a good place to put money to work. On the other hand, Ecuador was pushed as the next place to be for a while. Now its government is getting kind of grabby. I wouldn’t want to be working in Ecuador right now.

The more politically upset the world gets and the more frothy with all this violence, new taxes, etc., the better North America looks. I think we have some great opportunities right around here.

TGR: What’s one helpful thought you can leave with our readers, Sean?

SB: The overall pessimism is overwhelming. I was speaking to a mining analyst recently—a sharp guy who has been at this for years. He was so pessimistic. He was talking about going off and doing something else because he just can’t take it anymore. When we see that kind of pessimism in anything, that’s a real contrary indicator that things might be about to move the other way.

There are three bullish forces for gold. First is global stimulus. We’re seeing the world’s central banks start to increase stimulus because they’re worried about economic growth as estimates have slowly lowered. Now, the banks are starting to pile in more stimulus. That generally tends to pump up the price of gold.

Second is selling by gold ETFs, which is starting to taper off. If that does taper off and end, then a major bearish force in the market will be lifted. That could really lift a weight off the price of gold rather quickly.

Third is the emerging middle class in Asia. It’s enormous. They want all the things we have, all the cars, the air conditioners, you name it, but they have a cultural affinity for gold. They don’t trust banks. That’s one thing they are going to buy.

You put those three things together and we could have a good year for gold in 2014.

TGR: Thanks for your time.

Sean Brodrick, a natural resources strategist for the Baltimore-based Oxford Club, travels far and wide seeking out investment values in the sector. A graduate of the University of Maine, Brodrick has more than 25 years of experience as a professional journalist and financial analyst. He is a regular contributor to InvestmentU.com and occasionally contributes to Dow Jones’ MarketWatch. Brodrick’s expertise has led to many financial talk show appearances. His book, “The Ultimate Suburban Survivalist Guide,” was published in 2010.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Reportas an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Primero Mining Corp., SilverCrest Mines Inc., Klondex Mines Ltd. and Comstock Mining Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Sean Brodrick: I or my family own shares of the following companies mentioned in this interview: Primero Mining Corp. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: ARGONAUT GOLD INC. :BALMORAL RESOURCES LTD. : BEAR CREEK MINING CORP. : CORVUS GOLD INC. : FIRST MAJESTIC SILVER CORP. : KLONDEX MINES LTD.

RELATED COMPANIES

• : ALLIED NEVADA GOLD CORP.
• : CAYDEN RESOURCES INC.
• : GREAT PANTHER SILVER LTD.
• : PERSHING GOLD CORP.
• :RYE PATCH GOLD CORP.
• : SILVERCREST MINES INC.

 

The Gold Report: The managing director of the International Monetary Fund, Christine Lagarde, worries about the world sliding back into recession. What are the chances of that?

Jordan Roy-Byrne: We tend to have recessions every four or five years, on average. In the last 30 or 40 years, however, recessions have been less frequent than the average, due to extremely expansionary monetary policy. But another recession is almost a certainty in the next couple of years. I expect it will be milder than the 2008 recession. Typically, after such a severe recession or financial crisis the next recession is quite mild in comparison.

TGR: We seem to have permanent quantitative easing in the U.S. Do you think there’s a point when the country will hit a debt wall?

JRB: I don’t know if the U.S. will ever hit a debt wall. We have the world’s reserve currency, and that’s not going to change any time soon. We have the ability to print a lot of money, and there’s always going to be demand for our bonds. If that demand wanes, I think we will see central banks increase their buying. They will buy every bond if they have to in order to prevent interest rates from rising.

“Historically, gold stocks have performed fantastically at times when equities are in a bear market.”

Looking out over the next five years, I see similarities to the 1940s after World War II when there was essentially huge quantitative easing and interest rate price fixing. This was done to lower the debt-to-GDP ratio. There were a couple of recessions, but when the economy grew, it grew very strongly. There was quite a bit of inflation, that was the negative consequence, but the debt-to-GDP ratio did begin to decline.

The problem with debt is not the nominal amount. The problem is when the economy doesn’t grow fast enough to service the debt. One way to deal with that problem is to keep interest rates extremely low so there is very high nominal growth. The drawback to this is inflation. Commodity prices in the mid-to-late 1940s escalated substantially. I think we could see similarities in the next five years.

TGR: We’ve seen for some time an inverse relationship between precious metal stocks and equities in general. Do you think this will continue? Must equities fall before gold and silver stocks rise?

JRB: I do think this relationship will continue. Historically, gold stocks have performed fantastically at times when equities are in a bear market. The two best examples are 1972–1974 and 2000–2003. Because the gold bugs have lost a lot of money and don’t have the firepower to drive the market higher right now, outside money is going to have to come in. I think once conventional investments weaken, which I expect to happen in the next three to six months, asset managers will look to precious metals. For example, there were quite a few generalists and international fund managers at the recent Denver Gold Forum.

TGR: How long will this bear market in precious metal stocks last?

JRB: It could already be over. Gold and gold stocks have been in a bear market for two years and two months but silver, silver stocks and juniors peaked in April 2011 and have been in a bear market for 2.5 years. History shows that bear markets in the gold stocks tend to average 65%, while the two worst were 72%. At the June low the NYSE Arca Gold BUGS Index (HUI) was down 67%. That tells us the market is likely very close to a low or has already bottomed.

The market is retesting its summer low. Some stocks have already bottomed. Some will make double bottoms, and the worst will make new lows. That’s just how a bottom is—disjointed. The major bottoms in 2000 and 2008 occurred in October–November, so we are right on schedule.

TGR: How strong will the recovery be?

JRB: The recovery will be fantastic because that’s what always happens in this sector. Looking at recoveries from major bottoms starting from 1960, the average recovery for large gold stocks was 58% over the first four months and 75% over the first seven months. My guess is that the next recovery will be stronger than average, but the problem is we don’t know when it will start. It could be late November or even January. It could have started already. In the summer rally, Market Vectors Junior Gold Miners ETF (GDXJ) rebounded 59% from its low in only two months. Odds are, many stocks could be up 40–50% before most realize a bottom is in.

TGR: Could you talk about relative strength analysis and its importance to the valuation of precious metal stocks?

JRB: Relative strength analysis is a type of technical analysis that compares one security or market to another. We use this analysis to spot market leaders and market laggards. We want to own the leaders and avoid the laggards, obviously. You don’t necessarily want to chase the strongest stocks. There’s an art to it. My view is you want to identify what the strongest stocks are when the sector is correcting, and you want to buy them when they are correcting.

For example, the market has been correcting for the last several weeks, and this may continue for another week or two. So, if you happen to like a stock that has performed really well and you haven’t bought it yet, maybe in the next week or two that stock will come down another 5%, 10% or 15%, and that gives you the opportunity to buy it.

“This bear market in precious metal stocks could already be over.”

TGR: You’ve written that buying a weak stock on the dip is not a good idea. In a time of bottoming stocks, however, there is a great temptation to go bottom fishing. How do investors distinguish between stocks that are truly undervalued and those that have fallen for good reason?

JRB: Mining companies—95% of them, anyway—are not like blue chip stocks. A lot of these companies that have declined 80% can end up declining 99%. Relative strength analysis should be used in conjunction with fundamental analysis. For example, you may really like a company, but if it’s badly underperforming the sector, that is a warning sign.

A recent example is Pretium Resources Inc. (PVG:TSX; PVG:NYSE). It was very strong during the summer rebound, but at the end of August some huge and consistent selling came in and it continued into September. It was one of the weakest stocks in September, ahead of its major decline. The warning signs were there.

TGR: Let’s look at the four big mining locations in North America: Nevada, Mexico, Ontario and Quebec. We’ll begin with Mexico. Which companies do you like there and why?

JRB: Some of the absolutely best companies are located in Mexico, and that should tell you something about Mexico as a jurisdiction. Two of the best are First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) and Argonaut Gold Inc. (AR:TSX). First Majestic put its Del Toro mine into production this year. It is ramping up steadily and will be the company’s largest mine. First Majestic continues to have a stronger growth outlook than all of its smaller former peers, which is quite amazing considering how strongly the company has grown already. One might expect its size to limit its growth. That’s not the case.

As far as relative strength goes, First Majestic has held up very well during this downturn compared to the majority of silver stocks. Typically, when silver rallies, First Majestic shares perform well. In the recent summer rally, shares went from $9 to $16. Again, this is quite amazing, considering that First Majestic is a billion-dollar company, not some tiny junior.

TGR: And Argonaut?

JRB: Argonaut has two growing mines in Mexico, La Colorada and El Castillo, and two strong development projects, San Antonio in Mexico and the recently acquired Magino project in Ontario. There could be permitting issues with San Antonio. It’s not going to be a slam dunk, but if Argonaut can get that mine into production before the end of 2014, it will have a growth profile basically unmatched by anyone in the industry. In addition, Argonaut has ongoing cash flow, a very strong cash position of around $140 million ($140M) and one of the best management teams in the industry.

TGR: Do you consider Argonaut to be an undervalued stock that’s likely to show a significant gain with the end of the bear market?

JRB: Yes. Argonaut’s relative strength has been very strong for the most part over the last year or two. In early July, its shares went from about $5 to more than $8, and I think we’re going to see a similar move when the bear market ends in the next few months.

Argonaut has the management, the capital and the projects to be a serious growth-oriented producer over the next three or four years. That’s why I call it a long-term gift.

TGR: What do you like in Nevada?

JRB: Nevada’s a great jurisdiction, both politically and geologically. Drill costs tend to be lower and deposits are easier to work with because so many projects are open pittable and heap leachable. There are two Nevada companies I like. The first is Corvus Gold Inc. (KOR:TSX). This is one of my absolute favorites right now. The company has a large gold deposit called North Bullfrog very close to Barrick Gold Corp.’s (ABX:TSX; ABX:NYSE) old Bullfrog mine.

Corvus’ main resource at North Bullfrog is moderately economic at current prices, but the real kicker is that it has been getting higher-grade intercepts at Sierra Blanca and especially Yellowjacket, and the metallurgy on the latter is very good. Corvus will be coming out with a new resource estimate by the end of 2013 or early 2014 and a preliminary economic assessment will follow. Yellowjacket is going to be part of a starter pit, and I believe the economics at these gold prices are going to be very favorable.

TGR: What is Corvus’ relative strength?

JRB: Its relative strength could be indicating that it has something very significant on its hands and that Yellowjacket is going to be worth quite a bit. Corvus is one of only three stocks in this sector trading above a rising 400-day moving average. It’s difficult to buy a stock that’s already gone up so much, but I think Corvus is going to perform very well in 2014. I think it has a good shot to be acquired.

TGR: What is your second Nevada pick?

JRB: As far as production stories go, Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB) is one I’ve started following recently. With regard to relative strength, it has been one of the strongest stocks over the last six to nine months. If you like the fundamentals, you want to try to buy it on weakness. Klondex’s Fire Creek project looks to have outstanding potential. Grades have been spectacular; the company has a sizeable resource and it has been doing some bulk sampling, which I believe has gone pretty well.

“Looking at recoveries from major bottoms starting from 1960, the average recovery for large gold stocks was 58% over the first four months and 75% over the first seven months.”

When Klondex goes into commercial production, it is going to be able to produce a sizeable amount of gold at a low cost with very low capital expenses. It’s going to be highly economic, but it won’t be easy, and there will have to be some financings along the way. This is an underground, narrow-vein mine, but the new CEO, Paul Huet, is experienced with these types of deposits and is the man for the job. It’s a perfect fit.

TGR: What do you like in Ontario and Quebec?

JRB: Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX), which just announced a financing that will take its cash position to $11M. The company has made a high-grade discovery at its Martiniere project, which is located about 40 kilometers away from Detour Gold Corp.’s (DGC:TSX) mine. Balmoral should have a maiden resource estimate out in early 2014. This is going to be a high-grade property, and, like Corvus, it’s another potential acquisition.

The stock has been beaten down, but it did rally 100% during the summer. That tells me that there is a lot of leverage if you buy shares near a low. CEO Darin Wagner has done it before—built up an exploration company and sold it for nearly $0.5 billion. It looks as if he’s going to be able to do it again. The question comes down to what price will Balmoral sell out. Obviously it wants to wait for a market recovery, so it can prove up more value and get a better price. At the same time, potential acquirers (of not just Balmoral) want to wait for improved market sentiment. No one is taking any risks right now, though those that do could be rewarded.

TGR: Any other companies anywhere you’d like to mention?

JRB: Bear Creek Mining Corp. (BCM:TSX.V) in Peru. The company’s Corani deposit has gotten environmental approval, and it’s going to be a mine. The economics are tremendous. It can make money at $20/ounce ($20/oz) silver, and it can make a ton of money at $25/oz. This is a stock that has shown very good relative strength over the last 12 months. That says that long-term selling has dried up.

The only issue for Bear Creek is financing. The company can’t escape doing an equity component if it intends to finance the entire project, and that would be just too dilutive at these prices. So it is going to look at starting with a smaller operation, getting that going and then working its way up because this will eventually become a huge mine.

TGR: What about Bear Creek’s Santa Ana project?

JRB: That was taken away by the previous administration in Peru. Bear Creek has been going through the courts to try to get it back. There was a story in Reuters that quoted the mining minister of Peru saying he was looking for an amicable solution. The market is essentially giving Bear Creek zero for this project, but it looks as if the company could get some value out of it in the coming months. I think investors should keep their eyes on the Santa Ana situation. Who knows? This could be a reason why Bear Creek shares are showing good relative strength.

TGR: Bear Creek’s share price has yo-yoed from $1.60 to more than $2.50 twice since August.

JRB: It’s a very volatile stock. There’s not a huge amount of liquidity in it because something in the vicinity of 50–60% is held by a small number of hands. Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) and Tocqueville are big holders. It’s a stock you want to buy on weakness rather than on strength.

TGR: We’ve discussed companies in Mexico and Peru. A couple of people I’ve interviewed in the last month have said that they are not happy with the talk of a new Mexican royalty regime. What do you make of this?

JRB: First, nothing has gone through. Second, the mining lobby in Mexico is very powerful, so I would be surprised if it does go through at that level. We’re talking about a 7% tax. If we get back into a bull market for precious metals, I don’t think 7% is really going to matter. I’m not an expert on this issue, but maybe we’ll see a 3% or 4% tax go through. It’s just a random guess.

Based on the charts of how companies operating in Mexico are performing, this potential tax is not an issue. However, if these companies in Mexico start to underperform the sector it could be because of the new tax regime.

TGR: Peru was regarded as toxic just a few years ago, but its reputation has improved a fair bit. I’m told that each company operating in Peru has to be considered individually based on its ability to come to a modus vivendi with the government and local communities. Do you agree?

JRB: I think that’s accurate. Let’s step back and remember that Peru is one of the world’s leading producers of commodities. Peru is economically dependent on the mining industry. Bear Creek is a wonderful example of what you said. At Corani, Bear Creek has done fabulous work with the local community, which will see lots of jobs when it goes into production. But Santa Ana was taken away from the company because of local strife. The two projects are in completely different areas. It’s a case-by-case situation. Investors have to look at where the project is located and the attitudes of the local community. Bear Creek’s situation underscores this perfectly.

TGR: Maynard Keynes said famously that the market can remain irrational longer than an investor can remain solvent. Many investors in gold and silver companies are close to their limits in this regard. What advice do you have for them?

JRB: Well, everyone’s personal financial situation is different. Everyone has different goals and tolerance of risk and time objectives. Therefore, it’s difficult to give blanket advice, but if investors are in companies that have been market laggards, companies that don’t have much potential, they have got to sell them. They should do research and get into companies with the potential to be market leaders, companies that will not just survive but thrive when we do get a recovery.

TGR: Jordan, thank you for your time and your insights.

Jordan Roy-Byrne is a Chartered Market Technician, a member of the Market Technicians Association and a former official contributor to the CME Group, the largest futures exchange in the world. He is the editor of The Daily Gold Premium, and his work has been featured in CNBC, Barron’s, the Financial Times, Alphaville, Yahoo Finance, Business Insider, 321Gold, Gold-Eagle, FinancialSense, GoldSeekand Kitco.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Kevin Michael Grace conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Argonaut Gold Inc., Pretium Resources Inc., Klondex Mines Ltd. and Balmoral Resources Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Jordan Roy-Byrne: I or my family own shares of the following companies mentioned in this interview: Argonaut Gold Inc., Bear Creek Mining Corp. and Corvus Gold Inc. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Argonaut Gold Inc., Corvus Gold Inc., Bear Creek Mining Corp., First Majestic Silver Corp. and Balmoral Resources Ltd. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: ATICO MINING CORP. :COLORADO RESOURCES LTD. : GOLD REACH RESOURCES LTD. : KLONDEX MINES LTD. : MEGA PRECIOUS METALS INC. : TEMEX RESOURCES CORP. : TIMMINS GOLD CORP. : TREVALI MINING CORP.

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• : CLIFTON STAR RESOURCES INC.
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The Gold Report: Derek, when it comes to junior mining equities you’re something like a shark cruising for prey, seeking an opportunity to strike. What common buying opportunities do you look for that other investors might overlook?

Derek Macpherson: We seek out assets that have been underappreciated or unjustly tossed aside, companies whose stories are starting to change. That change might be an operations turnaround, a turnover in the management team or a revision to the capital structure.

TGR: One of your recent research flashes reported on the Mexican government’s consideration of imposing a royalty on Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) on companies that mine commodities in Mexico. Tell us about that.

DM: Whenever that topic comes up, it puts pressure on Mexican producers and developers. We are seeing the potential of a royalty getting priced in to those companies, and priced in as a worst case scenario.

Initial discussions centered on a 5% EBITDA royalty, which could affect company valuations significantly. However, Mexican mining companies are working with the government to find a more reasonable solution. If the proposal gets ratcheted down to a 2.5% EBITDA royalty or perhaps a 2% net smelter return, then company valuations could recover.

In Mexico, you want to look for companies that have low all-in cash costs. They will be somewhat insulated from the royalty because their margins won’t be as compressed as higher cost operations.

For example, we like Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT), which sold off on the royalty news. We think the selloff was unjustified, because the company has generally low all-in cash costs and higher margins than many of its peers.

TGR: Timmins is expected to announce that the mine life at San Francisco could be extended 10 years. Would that attract a buyer?

DM: It could, but I don’t think Timmins is in the sweet spot for acquisition. The company is too small for a big company to acquire and too big for some of the midtier companies.

Once Timmins’ resource report comes out, the stock should move up as investor confidence improves. There has always been concern about Timmins’ long-term grade profile and the mine life at San Francisco. The pending resource update will answer those questions.

TGR: Your share target on Timmins is $3.20, correct?

DM: Yes, and we have a buy rating on Timmins. Considering its cash cost profile, Timmins is trading below three times 2014 EBITDA. If you look at the company’s low cash cost peers in Mexico, similar open-pit, heap-leach operations trade at six to eight times EBITDA. I think the resource update will improve investor confidence and we could see an upward rerating.

TGR: What other common events lead you to undervalued equities?

DM: One of the most obvious is when management teams disappoint; the mining space is littered with those.

In those instances, we look at the underlying value and whether the management team can turn the operation around. We ask ourselves if the selloff was excessive, potentially creating a buying opportunity if the damage is recoverable.

TGR: Do you think management teams are being punished too harshly for performance shortcomings?

DM: I think it’s partly a function of the commodity price environment. In a rising gold price environment, there was more room for error and setback didn’t have as large an impact on project economics.

In a volatile price environment, investors have shown very little patience. If production results or a resource update aren’t in line with projections or better, the market pushes the stock down.

TGR: Do you watch for seasonal opportunities, or has seasonality become less predictable?

DM: Seasonality has been a bit less predictable. It has been dampened, first, by gold being driven by macro events and, second, by it being technically traded.

This year, in particular, investors should be looking at the season for tax-loss selling. I expect to see an accelerated selloff near the end of 2013, as investors try to capitalize on their tax losses. This should create a buying opportunity for a lot of good stocks. This is the time for investors to do their homework and find the stocks they want to pick up as they sell off later in the year.

TGR: What types of stocks do you think will sell off more than others?

DM: I think it will be a function of the company’s year-to-date performance. Companies that had a tough time from January to October will be the most affected. That doesn’t speak to the quality of their projects, which could create buying opportunities.

“In Mexico, you want to look for companies that have low all-in cash costs. They will be somewhat insulated from the EBITDA royalty because their margins won’t be as compressed as higher cost operations.”

TGR: News flow used to dry up in the summer and start to flow again in September with the publication of summer drill results. Does news flow still matter?

DM: To a certain extent, yes. Drill results became a bit of a selling opportunity or a liquidity event this summer. However, we are seeing that abate, particularly in September.

TGR: Haywood Securities produces a quarterly report on the junior exploration companies that looks out three months to forecast how the companies listed will perform quarter to quarter. Do you look for quarter-to-quarter performance or do you look more long term?

DM: In the junior exploration space, you have to look a little bit longer term. It often takes time and money to determine the value of a deposit. We try to look through flashy drill results that might move the stock over the short term but don’t necessarily indicate anything about a company’s long-term economic viability.

We try to hitch our wagon to companies that take a long-term approach to how they do their work and a long-term approach to driving value.

TGR: Can you give us an example of drill results that have moved a stock?

DM: Two base metals names are good examples: Colorado Resources Ltd. (CXO:TSX.V) and Gold Reach Resources Ltd. (GRV:TSX.V). Both have been hitting good results in northwest British Columbia. Both are near two of Imperial Metals Corp’s. (III:TSX) assets, a company we cover. Their results, even through this summer’s tough market, moved the stocks up. However, the market is very selective when rewarding good drill results. At the very least, it has to be a good project in a good location.

TGR: It also helps if your neighbor has a world-class asset.

DM: Yes, Colorado Resources benefits from being next to Red Chris. That provides an obvious synergistic solution for the company.

Imperial is building a 30,000 ton per day (30,000 tpd) mill at Red Chris, and there is likely more to come on its own property. I wouldn’t be in a rush to say that Colorado Resources is on its way to becoming part of Imperial. Imperial has its hands full maximizing the value of Red Chris over the medium term.

TGR: Speaking to those of our readers who are new to the junior mining space, what are some effective approaches for novice investors?

DM: You certainly need to account for commodity volatility. Pick companies that have lower risk and can withstand volatility.

When it comes to projects, we look for one of two things: a project needs to have very high grade, for example, Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB), or it needs to be technically simple, such as Timmins Gold’s open-pit, heap-leach project. Having one of those two features can reduce the risk of your investment.

The next thing to be aware of is jurisdiction. In the current market, there is an increased discount for political or permitting risk, and for the additional capital expense (capex) needed to put infrastructure in a remote location. Consequently, we tend to focus on North America, Mexico and some South American jurisdictions. In South America we look for jurisdictions with an existing mining culture, which can mean focusing on a specific region or even town in a given country. Peru is a good example; mining is welcome in some areas and is more challenging in others.

TGR: What about playing the volatility itself in metals prices?

DM: That’s very difficult to do because investors have to guess right on which way metal prices go that day. If investors want to play that volatility through equities, they have to get into more leveraged names, which tend to have a higher risk balance sheet. Playing the volatility can be very difficult and very expensive if you guess wrong.

TGR: Your thesis seems to prefer companies with cash and those that can raise cash with low-cash projects. Is that accurate?

DM: Yes. That is, in part, a function of the current market environment. Klondex and Timmins are two examples of low-cash costs and clean balance sheets: Klondex, thanks to its recent equity raise and ability to self-fund development going forward and Timmins, which should see its balance sheet strengthen over the next several quarters as it starts to generate free cash flow.

Temex Resources Corp. (TME:TSX.V; TQ1:FSE) fits into that category as well as an exploration-stage company with an attractive project that should be able to finance in the current market environment. Its project has the potential to be a high-grade, low all-in cash cost producer. It has low capex to start and $6 million ($6M) in cash on May 31 of this year. This is the type of company likely to get funded in the current market environment.

TGR: Temex is trading at $3/ounce ($3/oz), when some of its peers are as high as $20/oz. What accounts for that discount?

DM: As you know, exploration-stage companies are not as popular as they once were. Temex is still at an early stage, and investors might not fully understand the low-capex and shortened path to production that the Whitney project represents.

I think Temex is an excellent investment in the current environment for two reasons. First, it is in a joint venture with Goldcorp Inc. (G:TSX; GG:NYSE) on the Whitney project near Timmins, Ontario. That’s shaping up to be a higher grade, low-tonnage underground project.

The project is within sight of Lake Shore Gold Corp’s. (LSG:TSX) Bell Creek mill and about 12 kilometers (12km) from Goldcorp Inc.’s Dome mill. However, the Whitney ore is likely to be higher grade than either of those mills currently run, and consequently could displace ore at one of those mills. The market is still unsure of how real that opportunity is. The updated resource due out from Temex should increase market confidence in its potential.

Second, the Juby project makes Temex a good investment for the next gold price environment. Juby is the kind of lower grade, high-tonnage project that’s been popular target for majors. It resembles Prodigy Gold Inc., Rainy River Resources Ltd. and Trelawney Resources Ltd.—all of which have been taken out. Already at 3.2 million ounces (3.2 Moz) gold, there is a lot of upside at Juby, as it is still early days.

TGR: How long would its $6M cash in hand keep Temex running?

DM: Probably into mid-2014.

TGR: Does the board have access to funds?

DM: The board is strong. Ian Campbell is the CEO and the board includes René Marion and Gregory Gibson, both of whom have good track records.

TGR: In September you published a research flash on Trevali Mining Corp. (TV:TSX; TREVF:OTCQX; TV:BVL) that said, “Trevali is currently trading at 3.5 times consensus 2015 EBITDA whereas other base metal producers trade closer to 5.4 times EBITDA.” Is that discount strictly zinc related?

“Even though markets are challenging for mining equities, some high-quality names have sold off, creating an opportunity for investors to get involved at a reasonable price.”

DM: No, the flash was issued when concentrate production had just started at Santander, something the market had been waiting for. Trevali has now been operating for less than two months. The discount is related to the risk of being at such an early stage.

When it comes to zinc, Trevali is one of the few pure-play zinc producers in the midtier base metal space. The macro environment for zinc is looking very positive. With so few vehicles to play in that positive macro environment, Trevali could trade at a premium to its peers.

TGR: You recently visited the Santander mine in Peru.

DM: It was a good trip, and the operation appears to be ramping up smoothly now that the mill has started. The silver lining to the delays in getting the mill commissioned was that Trevali was able to ramp up the underground operations and get approximately 140,000 tonnes ahead of the mill. That is about two months of mill feed and gives the company lots of flexibility as it brings underground operations to a steady state. In our view, the mill is very close to its operating capacity already, after just over a month of operation.

TGR: What is the mill’s capacity?

DM: Full throughput is 2,000 tpd, although Trevali has talked about the potential to expand to 4,000 tpd. Based on what we saw—the mill and crushing capacity, the underground mining width and the amount of development—we think 4,000 tpd is achievable, but not for a couple of years. Before an expansion at Santander, Trevali will be working to restart the Caribou mine in New Brunswick.

TGR: Is it realistic to think that Trevali will be generating cash flow by the end of October?

DM: Based on what we saw, yes. While we were on-site, we saw concentrate shipments leaving the mill. Because Trevali gets paid within a couple weeks of the shipments being delivered to the port, it should be generating cash very soon.

TGR: Trevali has discovered some high-grade mineralization at Magistral Norte, which is part of the Santander complex. What do you know about that?

DM: Trevali was aware of the Rosa Vein but had done little exploration on it from surface because the deposit’s orientation made it difficult. Once underground, it became easier to explore this new zone. Initial results point to the potential for higher than resource grades.

The high-grade potential led to Trevali completing some initial development in the zone and we actually stood in that zone when we were on-site. This zone further increases Santander’s tonnes per vertical meter and supports our view that an expansion to 4,000 tpd is likely.

TGR: Where else have you visited lately?

DM: We went to Klondex Mines, where we were also impressed with the ramp up. Klondex has exceptionally high grade; Measured and Indicated grade is 44 grams/tonne (44 g/t) gold.

TGR: But it’s a very small resource. Could it be expanded?

DM: The resource is 720,000 oz; however, the grade has gone up substantially. While the previous resource was larger, the earlier resource methodology wasn’t suited for this type of deposit. The new management team reworked the resource with a more applicable methodology and consequently now has a higher quality resource. We believe there is opportunity to grow the resource.

Resource growth is likely to come from two areas. The first is additional exploration; generally speaking the property is underexplored, providing the opportunity to expand the resource along the existing veins, and add new ones. The second opportunity for growth is the mineralized halo. Unlike most narrow-vein deposits, the host rock is also mineralized; however, it’s not included in the existing resource. The halo could be included in future updates, as Klondex’s understanding of it increases. The other benefit of a mineralized halo is an effective reduction in mining dilution, which should also benefit project economics.

TGR: What can you tell us about Klondex’s toll milling arrangements?

DM: Klondex doesn’t have its own mill. Klondex has toll milling agreements with both Newmont Mining Corp. (NEM:NYSE) and Veris Gold Corp. (VG:TSX; YNGFF:OTCBB).

In the current environment, saving capex is important. It allows Klondex to get cash flow very quickly. In fact, it has already started receiving payments from its toll milling agreements.

This ability to generate cash in the near term should allow Klondex to continue exploring while doing the necessary development for steady-state operations. We model it reaching 500 tpd and producing over 80,000 oz gold in 2015; Klondex is able to fund the underground exploration drilling needed to meet these targets.

TGR: What other stories would you like to share with our readers today?

DM: Atico Mining Corp. (ATY:TSX.V; ATCMF:OTCBB) is making the rapid transition from being a base metal developer to a producer. The company recently exercised the option on the El Roble property in Colombia. Because El Roble was a producing asset, Atico will go from being a developer to a producer once it completes that agreement later this quarter.

El Roble historically has generated positive cash flow even though there is significant opportunity for the operations to improve. Applying new engineering and a modern approach should allow Atico to surface additional value. As Atico improves El Roble, the stock should move higher.

TGR: It sounds a little like Klondex.

DM: It is, as it’s also a high-grade, low-tonnage operation. The recent resource update for this Cu-Au-Ag deposit had copper equivalent grades above 6%.

As a result of exercising the option a few weeks ago, Atico should be generating positive operating cash flow by year-end.

TGR: In March, the share price was more than $1/share. Now it’s about $0.50/share. What happened?

DM: Early on, Atico had some pretty flashy drill results at El Roble, which drove the share price higher. However, Atico had to raise money to exercise the option—the last option payment was $14M. That probably put an overhang on the stock. It is also worth noting that the move down in the stock price coincided with the drop in commodity prices.

TGR: Atico just completed a number of financings as well.

DM: Yes, that money went toward two things. First was $14M to exercise the option on El Roble, which gives Atico 90% ownership of the asset. Additional funds were raised to reinvest in El Roble’s operations, allowing Atico to optimize the asset.

TGR: And the final name that you want to talk about today?

DM: That is Mega Precious Metals Inc. (MGP:TSX.V), an exploration-stage company in northeast Manitoba—a good jurisdiction.

Mega Precious is sitting on 3.6 Moz of 1.25 g/t gold and has defined resources over a 4km trend with a total potential strike length of 8km. And, it has yet to test three parallel structures. Obviously, this could be a real district play.

The really interesting thing about this story is the presence of a tungsten kicker. Management is re-assaying old core to determine how much tungsten is present. Based on results released to date, there could be as much as a 25–30% improvement in gold-equivalent grade from the inclusion of tungsten. This could significantly improve project economics with limited additional investment.

TGR: Do you have any parting thought for our readers?

DM: Even though markets are challenging for mining equities, some high-quality names have sold off, creating an opportunity for investors to get involved at a reasonable price. Despite the overhang that equity markets have put on the space, it will get better; it’s just a matter of when.

TGR: Derek, thanks for your time and insights.

Derek Macpherson Derek Macpherson is a mining analyst at M Partners; before joining M Partners he worked in mining research for a bank-owned investment dealer. Prior to entering capital markets, MacPherson spent six years working as a metallurgist. Macpherson has a Bachelor of Engineering and Management in materials science and a finance-focused MBA.

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DISCLOSURE: 
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Reportas an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Timmins Gold Corp, Colorado Resources Ltd., Klondex Mines Ltd., Trevali Mining Corp. and Atico Mining Corp. Goldcorp Inc. is not affiliated with The Gold Report. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Derek Macpherson: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Klondex Mines Ltd, Timmins Gold Corp. and Temex Resources Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: BEAR CREEK MINING CORP. : CAYDEN RESOURCES INC. : COLORADO RESOURCES LTD. : EASTMAIN RESOURCES INC. : ENDEAVOUR MINING CORP. : FORTUNA SILVER MINES INC. : GOLDCORP INC. : MAG SILVER CORP. :PROBE MINES LIMITED : SILVERCREST MINES INC.

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• : EXCELLON RESOURCES INC.
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• : IMPACT SILVER CORP.
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• :SANTACRUZ SILVER MINING LTD.
• : SILVER BULL RESOURCES INC.

 

The Gold Report: In a July research report, you wrote that the ongoing decline from the all-time high in the gold price may represent a correction of the last large up leg, which some say began in 2009 or mid-2008. Or it may represent a correction of the entire 1999–2011 advance in the gold price. Which is it? And has that correction run its course?

Tom Szabo: We are in a correction of the 2008–2011 rally and it is ongoing. Big picture, the gold price needs to drop below $1,155/ounce ($1,155/oz) and then subsequently below $1,067/oz before this would represent a correction of the entire gold cycle that goes back to 1999. We haven’t seen such a decline at this point so we can’t conclude that it’s a larger correction.

TGR: We’ve seen modest upward momentum in the gold price since the lows of April. Is there enough momentum to invest in gold equities?

TS: There are smaller cycles within a correction. So long as investors select the right gold equities they can do well. A lot of projects are viable at this gold price. A lot of discoveries are going to become mines at this gold price.

TGR: What’s your near- and midterm forecast for gold and silver?

TS: I suspect we will see a secondary low for gold, perhaps near the low that we reached this past summer, before this entire corrective wave is over. Potential lows are $1,155/oz and $1,067/oz. Longer term, about three years or less, I suspect that gold will again challenge its 2011 high.

TGR: Is silver going to follow suit?

TS: Silver will follow gold, especially during the initial phase of a rally. As a rally progresses, silver has the distinct ability to overshoot expectations. I easily see it exceeding $50/oz and spiking to a $70–80/oz level before settling to a low in the $30–40/oz range.

TGR: What is the sweet spot right now: explorers, developers or producers?

TS: In this market, it has to be about growth, which is a concept that can be applied to all of those categories. Explorers make discoveries and grow the resource. Developers grow by taking a project into operation. Producers grow by adding capacity, upgrading or bringing additional projects into development.

TGR: MetalAugmentor.com uses the Peerless system to rank the quality of companies. How does that system work?

TS: The Peerless system is a subjective determination that is based on quality. We consider the factors that point to the success of an enterprise. Success can be measured in different ways and means different things depending on the development stage of a company and its projects. We use different criteria for an explorer versus a producer versus a developer.

It is also a binary rating where a company is either peerless or not. We don’t rank a level of peerlessness, although we do keep track of potential peerless candidates that don’t quite have all of the pieces together yet.

TGR: What companies are considered peerless by MetalAugmentor.com?

TS: A company like Cayden Resources Inc. (CYD:TSX.V; CDKNF:NASDAQ). The company’s strategy worked out really well in acquiring its two main projects in Mexico.

TGR: Cayden was approached by some companies seeking a stake in the Las Calles project. Could you tell us more about that?

TS: I don’t think it’s a secret that there is interest from other companies about potentially monetizing that opportunity.

The Morelos Sur project is next to Goldcorp Inc.’s (G:TSX; GG:NYSE) Los Filos project, one of the more profitable gold mines. Cayden sold a portion of that land position, which Goldcorp needs for infrastructure, heap leach, roads and other things, for about $16 million. Cayden still holds a very strategic piece of land called Las Calles, which separates the Los Filos and El Bermejal pits. Expansion plans are essentially going to join them together. The problem for Goldcorp is that there’s a strip of land that Cayden owns in between—Las Calles. It will have to acquire rights to that.

Companies have latched on to this and I’m presuming they now may want to offer Cayden an early monetization in exchange for any upside from the eventual conclusion of the negotiations with Goldcorp. From Cayden’s perspective, it could be attractive if it needs money for exploration or to build a mine at El Barqueño.

TGR: What other companies are considered peerless?

TS: One is SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) in Mexico. The company has a project that is expanding and going underground, as well as a project going into the development stage. Its capital constraints and size should allow SilverCrest to develop such a project into a producing asset.

TGR: You’ve called SilverCrest a growth story. Can you explain that further?

TS: SilverCrest is interesting because it started with a project that was not an existing mine. Many current operations in Mexico are old silver mines that have been revived during this latest mining cycle. SilverCrest’s Santa Elena was a new project. Now it’s going underground.

While other companies went dormant after the 2008 crisis because money wasn’t available, SilverCrest pushed ahead. It sold a portion of its gold as a stream to Sandstorm Gold Ltd. (SSL:TSX), which allowed it to get into production and get ahead of the curve for being a producer. Meanwhile, the operations have been profitable almost from the very beginning and that has now allowed SilverCrest to use internal cash flow to expand production as well as to develop its second project.

But just to show that it’s not just one kind of company we’re looking for, take Eastmain Resources Inc. (ER:TSX), a small, gold explorer in Québec. It has been exploring the Eau Claire project for years. Every time it steps out from the initial discovery, it is finding more gold. Eastmain’s strategy is to attract a midtier or a major to take that project out. It is not quite there, but all the elements are moving in that direction.

TGR: What’s the next catalyst for Eastmain?

TS: It needs to get the resource size and confidence to a level where potential suitors would start looking at acquiring the project—say 200,000 oz annual gold production over a 10-year mine life.

TGR: Is there a reason to believe that the size is there and it just hasn’t been delineated yet?

TS: Yes, that is why we consider Eastmain peerless. It keeps expanding. I would probably target 5 million ounces as its eventual size with most of that resource being at depth, but it is spread out and will take a while longer to fully delineate.

TGR: Any other peerless companies?

TS: Colorado Resources Ltd. (CXO:TSX.V)—this one is pure exploration with more risk. It recently discovered a copper-gold porphyry system in northern British Columbia near the Red Chris project of Imperial Metals Corp. (III:TSX). We like its relatively simple strategy of looking for obvious targets that no one has bothered to properly explore. In the case of copper-gold porphyry systems, this could mean something as simple as looking for rust-colored hills that haven’t been adequately tested.

TGR: The geology in British Columbia is conducive to hosting copper-gold porphyries and many have been discovered, but very few have been developed because critical mass is needed for that to happen. What makes this different?

TS: I would own Colorado Resources because it has made a copper-gold porphyry discovery. The grades in the first drill hole line up with world-class potential. It remains to be seen if that is just anomalous and it has one high-grade core and everything else is too low grade. That’s certainly a risk. The potential is there for multiple higher grade core zones or for the original core zone having dimensionality to support the type of large tonnage operation that could be successful in northern British Columbia.

It’s a peerless explorer. If it gets to the development stage we’ll have to use other factors to determine if it’s a peerless developer.

TGR: What are some prospective peerless companies?

TS: We keep our eyes on prospective peerless companies as they develop because we think they could have it in them to be successful. These are generally more risky, have some blemish or perhaps a past history that doesn’t scream quality or the highest level of investor confidence. Nonetheless, we think they could be on a path to becoming peerless.

An example would be Bear Creek Mining Corp. (BCM:TSX.V), a silver play in Peru. Its Santa Ana project wasn’t popular with the local population. It ended up getting taken back. It’s still trying to figure out the endgame on that one. But it has another project, Corani, a large, low-grade bulk silver project, that’s on the cusp of potential. The market hasn’t fully given Bear Creek credit for it. Of course, bulk low-grade silver projects don’t have a history of becoming fantastic profit-making machines. But the metallurgy, resource size, lead-zinc co-products and other factors seem to suggest that Corani can make it.

Endeavour Mining Corp. (EDV:TSX; EVR:ASX) is a project amalgamator focused on West Africa. It has some hardnosed, smart people behind it. A company like this will be judged on its operational success. Will it acquire projects where it can lower costs and generate outstanding profits? It seems to be on that path; we have to give it time.

Probe Mines Limited (PRB:TSX.V) in Ontario previously focused on chromite in the “Ring of Fire” area before switching its focus. I guess you could say that the company saw the writing on the wall, unlike some other unnamed parties.

Probe’s Borden Lake gold project is an example of potentially peerless. It is encountering higher grades and very distinct structures as it steps out drilling to the southeast. There’s an opportunity to look at this project as several different phases. It already has a several-million-ounce resource potentially open pittable that’s decent grade and now also has the potential for underground bulk mining that could make initial development easier because the project is next to a lake.

Projects near lakes have inherent risks. There’s a bigger focus on local stakeholders having a say, as witnessed by recent legislative developments in Québec. And of course across Canada over the last several decades, the First Nations have had increased input throughout the exploration and mine development process. It’s important to have a flexible strategy or options when a project is near something sensitive. However, the Borden Lake project is still in a stage where we don’t need to fully consider that.

I wouldn’t be buying Probe Mines because I think it’s going to be a great mine. I would buy it for the optionality and potential. It can still reach the next stage without having to solve issues that are important to local stakeholders. At the current stage, there’s just so much prospective upside from the discovery itself. As an explorer, I consider it a potentially peerless company.

TGR: Are there other interesting silver names?

TS: MAG Silver Corp. (MAG:TSX; MVG:NYSE) shares an excellent, high-grade polymetallic silver deposit in Mexico called Juanicipio with Fresnillo Plc (FRES:LSE). Unfortunately, the companies’ interests have not always been aligned historically. Fresnillo made a low-ball opportunistic offer to take out MAG Silver in 2008 that was rightfully rejected. This created some bad blood between the two companies.

Juanicipio is an attractive development prospect. But if each party has a different idea and they can’t somehow come to an agreement, then the project isn’t moving forward at a satisfactory pace for MAG Silver shareholders. If development progress suggests these issues are being left behind then MAG Silver would be on a path to being peerless.

And then there is Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), a gold-silver producer in Mexico that we already consider to be peerless. It’s a well-run operation, a growth story that continues to be pretty hungry, and is possibly on the cusp of acquiring its next project with the intent of turning it into Fortuna’s third profitable mine.

TGR: Fortuna recently completed the first stage of expansion at San Jose. Is that going to dramatically change its cash flow?

TS: It’s going to improve the cash flow. The persistence of the gold-silver ore shoots continues at depth and along strike. The company has only been able to take the resource so far given that San Jose is a new mine, but the edges keep expanding as the drilling progresses. This creates a confidence boost for management. So sure, the expansion improves cash flow, but it also says management is confident enough in the deposit to go forward with such an aggressive expansion. I would argue that when management is confident and competent, shareholders can be confident as well.

TGR: People are quite interested in Trinidad North. What’s happening there?

TS: This is really interesting. This zone is a northern extension of San Jose. It was not explored historically because it was owned by another company. The known mineralization backed up right against the property boundary. Not only is the mineralization continuing, but it seems to be strengthening. Fortuna picked up the additional land and the subsequent drilling has demonstrated that.

TGR: Some companies begin prospecting with a program of community engagement to let the locals know their intentions and potential outcomes. Other companies prefer to avoid this and just get down to business. Is there any evidence that suggests investors are better served by one approach versus the other?

TS: We’ve looked at why companies fail to develop or continue on to development and one of the things that comes up is local stakeholder resistance. There are some cases where a company simply will not be able to mine in a particular area. There’s so much resistance to mining that it’s not going to happen. But in most areas, if a company faces a lot of resistance or has really strong opponents, it’s often because the company has not properly addressed the opposition.

TGR: What do you make of companies that are “high-grading,” which is mining the highest grade zones early on to pay back debt or get early profits?

TS: High-grading is just a way to pick the low-hanging fruit. Historically, where mining was very labor intensive, it was usually the only way to mine profitably. In modern mining, to attempt to recover the initial cost of the mine or pay off the project loan quickly, it’s almost necessary. I don’t find it very controversial.

What’s controversial is high-grading based on the metal price, which I actually think has some merit. Companies should high-grade when prices are near historic lows and highs. When prices are stable, they should mine the design grade.

The reasoning is pretty obvious and simple. When prices are high, deliver as much metal through the plant as possible in order to build up your cash position. When prices are really low there’s usually no other option. If a company doesn’t go after the highest grades or the most prospective portion of the mine, it may have to shut down.

An extension to that, for example, would also be locking in a price spike via short-term hedging. When silver prices momentarily reached $50/oz, it would have served the silver producers very well to lock in the price on a quarter or two of production yet none of them did that. They could have generated millions in additional cash flow with minimal risk.

TGR: Could you leave our readers with a tidbit of insight that could serve them well this autumn?

TS: I would caution your readers to be aware of where we are in the market cycle and what type of companies they want to own and why. In a situation where not all boats are rising, only a select few are going to succeed. In this environment, investors need to have some growth stories. I don’t think investors are going to be well served for the time being by simply investing in companies that are sitting on huge low-grade deposits but aren’t doing anything to expand their potential, increase production or acquire projects to grow. There may be times when the companies with the biggest resource are the ones to own, but not now. Investors have to match strategy with the market reality.

Investors should also be aware of what stage the company is in. Unless investors are going to own an explorer from the first drill hole to production, there are factors investors probably don’t need to worry much about early on. An investor should care about the factors that the market cares about while the investor owns the stock. This is pretty controversial and I suspect many investment professionals would have a problem with such a cynical approach.

Conversely, I think most retail investors will probably say, “No, this is too hard to do. You should really just look at the big picture.” From my perspective, that shuts investors off from a lot of great opportunities (and exposes them to a few lousy ones). If investors are able to segment the holding period of their portfolios and match positions to a specific investment thesis, they can increase their odds of success.

TGR: Thanks for your time today, Tom.

TS: My pleasure.

Tom Szabo is co-chief analyst of Metal Augmentor, an investment research service focused on metals and mining. Szabo has co-founded several precious metal related businesses and investment funds.

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DISCLOSURE:
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Reportas an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Cayden Resources Inc., SilverCrest Mines Inc., Colorado Resources Ltd., Probe Mines Limited, MAG Silver Corp. and Fortuna Silver Mines Inc. Goldcorp Inc. is not affiliated to Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Tom Szabo: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Cayden Resources Inc. and Eastmain Resources Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

 

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COMPANIES MENTIONED: CAYDEN RESOURCES INC. : DALRADIAN RESOURCES INC. : GOLDCORP INC. : GOLDROCK MINES CORP. : KAMINAK GOLD CORP. : NEWMONT MINING CORP. : NEWSTRIKE CAPITAL INC. : PREMIER GOLD MINES LTD. : TOREX GOLD RESOURCES INC.

RELATED COMPANIES

• : GREAT PANTHER SILVER LTD.
• : SILVER BULL RESOURCES INC.
• : ST ANDREW GOLDFIELDS LTD.
• : TIMMINS GOLD CORP.
• :VIRGINIA MINES INC.

 

The Gold Report: The Federal Reserve decided last week against tapering its quantitative easing. Gold rose $55/ounce ($55/oz)—over 4%—as a result, and silver was up 6.5%. Were you surprised by how robust this one-day rally was?

Michael Curran: Not really. We had already been out with our call in early July for a potential 25% recovery in the gold price in H2/13, which is the average fall recovery seen over the past four years. As such, we saw potential for gold to reclaim $1,450–$1,500/oz over the next few months, so we viewed the Fed tapering news as just another “quiver in the bow” to see our recovery scenario come to fruition.

TGR: Now that tapering is off the table, can we expect an end to the downward pressure on gold and silver?

MC: Our view is that with tapering off the table, short-term prospects for gold and silver are materially improved.

TGR: To what would you attribute gold’s spectacular fall earlier this year?

MC: I think it was a stock market malaise leading investors to liquidate gold to cover other losses.

TGR: We’ve been hearing about liquidation bringing down the price of gold for some time. Is there a point at which investors have done all the liquidating they need to do?

MC: That would be our view. In prior pullbacks in the gold price, we didn’t really see much liquidation in gold exchange-traded funds (ETFs). But this year, for the first time, we saw meaningful selloffs, and these investors redeployed their assets elsewhere. I think we’ve seen the bulk of that. August was the first net positive month for gold ETFs since the spring.

TGR: Small- and micro-cap explorers have suffered terribly in the last 18 months. Can we now expect a resurgence of these stocks?

MC: I think we’ve seen the bottom, but it’s the quality juniors that are going to be the beneficiaries. Not all boats will rise. Investors need to be more selective than in past recoveries.

“With tapering off the table, short-term prospects for gold and silver are materially improved.”

Our recommendation is to focus on early exploration or discovery plays. We’re also looking beyond gold. We like select base metals and uranium, and we have a few favorites there as well. Diversification is our focus for investors right now.

TGR: There are a great many low-price metal stocks today, but how do we find the real bargains?

MC: We concentrate on assets, location, management and balance sheets. We’re looking for assets with potential for high-grade discovery. We’re looking for low political risk in the location of these assets. We’re looking for strong management with backgrounds in exploration and discovery or people who have demonstrated past involvement in success stories. And we’re looking for companies that have enough cash to do exploration in the short term or a combination of assets and management expertise sufficient to raise money, which is not the easiest thing to do in this market.

TGR: Which speculative gold play do you find most attractive?

MC: Cayden Resources Inc. (CYD:TSX.V; CDKNF:NASDAQ) is currently our favorite speculative drill play. It has two main projects in Mexico, Morelos Sur in the Guerrero Gold Belt, which many investors will be familiar with, and the El Barqueño property in Jalisco.

TGR: Cayden is up about 50% in the last month to about $1.50 a share. Your 12-month price target is $3, which would be a 100% increase. On what do you base that projection?

MC: We’ve visited Cayden’s properties earlier this year. Morelos Sur is more of a long-term play. This is a blind, buried deposit several hundred meters below surface. It could take some time to discover a new skarn-hosted gold deposit, but certainly the market interest in the Guerrero Gold Belt is so strong that one good drill hole could generate a lot of interest.

“Investors need to be more selective than in past recoveries.” 

Cayden’s neighbors in the area, Goldcorp Inc. (G:TSX; GG:NYSE), Torex Gold Resources Inc. (TXG:TSX) andNewstrike Capital Inc. (NES:TSX.V), have all had very good success on these kinds of targets and found multimillion-ounce deposits.

TGR: Goldcorp has found over 13 million ounces (13 Moz), Torex over 5 Moz and Newstrike over 2 Moz.

MC: That’s right. So Morelos Sur is the big potential discovery. El Barqueño has the lower short-term risk; as recent results have confirmed near-surface mineralization. Drilling will begin shortly and we expect the initial drill program can be successful and delineate resources. We see initial potential of 1–2 Moz at El Barqueño.

TGR: Hasn’t Cayden’s management had success in the past?

MC: A lot of the management team was with Keegan Resources, which was recently renamed Asanko Gold Inc. (AKG:TSX; AKG:NYSE.MKT). Your readers will know about Asanko’s 6 Moz Esaase gold deposit in Ghana.

TGR: What other companies would you like to mention?

MC: One company we like in the gold patch is Premier Gold Mines Ltd. (PG:TSX). The company has a very strong portfolio of assets with high-grade components in both Ontario and Nevada. It has made several additions in the last 18 months from former Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) management. This is a junior with the technical expertise of a mid-tier producer.

TGR: Premier Gold Mines shares rose 19% last Wednesday on results from two holes at its Cove Project in Nevada, including 6.74 grams per ton (6.74 g/t) gold over 9.1 meters and 26.3 g/t gold and 39.8 g/t silver over 2.3 meters. How significant are these results, in your opinion?

MC: We believe Premier Gold’s 19% rise was a result of two positive developments that day—the Cove project drill results reported before the open and the announcement by the Fed regarding tapering in the afternoon. We viewed the drill results as positive as the latter higher-grade intercept you mentioned successfully extended the Helen zone gold mineralization to the east of previous drilling. The other intercept you noted opens up the potential for the Helen zone mineralization to extend several hundred meters to the east, to below the previously mined Cove open pit. Of course, follow-up drilling will be required to confirm this.

TGR: Under a joint-venture agreement, Newmont Mining Corp. (NEM:NYSE) can buy 51% of Cove. How likely do you think that is, and do you think Premier is a possible takeover target?

MC: We believe that it is highly likely that Newmont will be involved with any mine development at Cove, either through the exercise of its right of first refusal or as the preferred partner to process Cove ores, thus holding either a direct interest or via a toll-processing agreement.

TGR: Goldrock Mines Corp. (GRM:TSX.V) was another winner last Wednesday, up 11% after announcing a $9.25 million ($9.25M) strategic alliance with Austral Gold Ltd. Goldrock’s stated objective is to develop its Lindero project in Argentina by 2015 so as to “become a mid-tier gold producer with annual gold production of 250,000 oz.” Does it now have the means to accomplish this?

MC: While we view the news of attracting a new strategic partner as positive for Goldrock, the company still has a long way to go to complete full financing for the development of its Lindero gold project in Salta, Argentina. Even with successful fundraising, the Lindero mine would only represent the first step toward achieving the company’s production target of 250,000 oz/year (250 Koz/year), as the open-pit, heap-leach mine is only forecast to be a 125 Koz/year mine. Thus we assume Goldrock’s target of becoming a 250 Koz/yr gold producer would require a second producing asset, likely via acquisition.

TGR: At its Coffee gold project in the Yukon, Kaminak Gold Corp. (KAM:TSX.V) has already drilled more than 35,000 meters this year and has announced a $2.5M bought-deal private placement so it can drill more. Is Kaminak looking to increase the size of its resource or its reliability or both?

MC: One of the main objectives of this summer’s $11M exploration budget was to delineate additional gold resources in proximity of the main mineralized zones at Coffee. We expect the expanded drill program will continue these efforts, as well as provide some infill drilling to increase the reliability (confidence) of gold resources in the main zones, presumably focusing on areas of higher-grade mineralization.

TGR: How many ounces could we see at Coffee?

MC: We believe drill results this summer could increase total resources at Coffee from the previous 3.2 Moz level to 3.7–4 Moz. Longer-term, we maintain our view that gold resources are likely to exceed 5 Moz.

TGR: Shares of Dalradian Resources Inc. (DNA:TSX) are up almost 50% over the last month. Its flagship project, Curraghinalt in Northern Ireland, has exceedingly high-grade gold, although most of its measured ounces (2.23 Moz out of 2.79 Moz) are Inferred. How close is Dalradian to derisking Curraghinalt?

“Our recommendation is to focus on early exploration or discovery plays.”

MC: We are awaiting a major milestone for Dalradian later this fall, when the company is expected to receive environmental permits that will allow the next phase of exploration at Curraghinalt to begin. This phase centers on 2 kilometers of underground development that will allow Dalradian to perform detailed infill drilling to confirm and upgrade the Inferred resources, as well as test mining methods and provide a bulk sample for metallurgical testwork, as part of feasibility-level economic studies. We expect this phase to begin early in 2014 and take 15–18 months to complete.

TGR: If the price of gold makes a substantial and sustained move toward $2,000/oz, will we see an end to the doom and the gloom and a return to excitement in the junior sphere?

MC: I think so. For some existing companies, it’s probably too late, but if we approach $1,800/oz, $1,900/oz and $2,000/oz, we’ll have a new wave of names coming up. We’d see new money going into new stories, as opposed to propping up existing exploration stories that haven’t worked.

TGR: Mike, thank you for your insights.

Michael Curran, CFA, is a managing director and a mining research analyst with Beacon Securities Ltd. in Toronto. He was previously a managing director and a mining research analyst with RBC Capital Markets. Curran received the #1 Ranking for Mining and Metals research coverage in The Wall Street Journal’s Annual Best on the Street Survey in May 2013. He holds a Master of Science degree in mineral exploration, a Master of Business Administration and is a CFA charterholder.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Kevin Michael Grace conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Cayden Resources Inc., Goldcorp Inc. and Premier Gold Mines Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Michael Curran: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. A principal of Beacon Securities is on the Board of Directors for Cayden Resources Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

COMPANIES MENTIONED: ALMADEN MINERALS LTD.: ENDEAVOUR SILVER CORP. : GREAT PANTHER SILVER LTD. : KIMBER RESOURCES INC. : PRETIUM RESOURCES INC. : RED EAGLE MINING CORP. :SILVER STANDARD RESOURCES INC. : SILVERCORP METALS INC.

RELATED COMPANIES

• : IMPACT SILVER CORP.
• :MANDALAY RESOURCES CORP.
• : SANTACRUZ SILVER MINING LTD.
• : SILVER BULL RESOURCES INC.
• : TINKA RESOURCES LTD.

 

TGR: The traditional market advice is sell in May and go away. This period of market restraint typically lasts until November. Why should investors in precious metals come back then?

Ash Guglani: What we’re seeing now is companies adapting to a new environment. The big theme this past quarter was cost containment. Many companies have followed through on that and reported good operating numbers. Going into the fall, investors will have the opportunity to pick companies that have shown improvement.

TGR: We’ve had a recovery in bullion, with silver over $23/ounce ($23/oz) and gold over $1,350/oz. Do you expect silver and gold equities to increase to match the increases in bullion?

AG: Yes. We’re seeing it now. The main thing is that we need some sort of price stability so that companies can adapt to this new price-point environment. If you go through the quarterly earnings, a lot of companies are cutting headcounts, capital expenditures (capexes) and exploration budgets. They are focusing on operating efficiency. I’m finding that miners are very quick to react.

TGR: I’ve been looking at your coverage list and see Pretium Resources Inc. (PVG:TSX; PVG:NYSE). Its Brucejack project in British Columbia has been an investors’ darling for years. The company put out a feasibility study in June, and you visited the site that month. In your opinion, is the promise justified?

“What we’re seeing now is companies adapting to a new environment.”

AG: Pretium’s flagship asset is its high-grade Brucejack project. In the Brucejack feasibility study, the capex was $663.5 million ($663.5M). For that amount of money it would produce 7.1 million ounces of gold over a 22-year mine life. This bodes well for the project. There are not a lot of high-grade discoveries like this out there right now. The feasibility study showed the numbers are very strong. In our visit, Pretium outlined a little bit more of what it is doing with underground development. The bulk sampling remains the major catalyst for the story and we’re hoping to see that by the end of 2013.

TGR: Why is the bulk sample so important?

AG: When you get a high-grade asset like Brucejack, there’s always the question of what kind of grades we are actually going to see consistently. The main reason for the bulk sample is to verify the strength of the economics of this project.

TGR: How is Pretium’s cash position?

AG: At the end of June it had $33M in cash. The company is in a position now where it doesn’t need a lot of cash at this moment. The feasibility is done and most of the exploration work is finished. Pretium has excavated most of the bulk sample now. Cash-wise, the company is okay for now, but at some point, if it decides to go ahead and develop Brucejack, it will need more cash. But given what we’ve seen with this project, I don’t expect it will have any problem getting the capital it needs.

TGR: British Columbia is not known as the easiest place to open a mine in Canada. What suggests to you that Pretium will succeed where others (for environmental and First Nations reasons) have failed?

AG: I don’t foresee any environmental problems because Brucejack Lake is not a fish habitat. I believe the company is talking to three different First Nations groups in that area, and the talks have been going well. The company hopes to have agreements in place by the end of the year. Seabridge Gold Inc. (SEA:TSX; SA:NYSE.MKT), which is nearby, also reports positive talks with First Nations. I don’t see any real permitting issues here; the area has been permitted before. The Tahltan tribe worked with Barrick Gold Corp. (ABX:TSX; ABX:NYSE) during the Eskay Creek days.

TGR: You rate Pretium a Buy. What’s your target price?

AG: $17.50.

TGR: Turning to Mexico, you rate Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) a Speculative Buy. This is a company that has about $24M in working capital and owns its drills. Does that put it in pretty good shape?

AG: Definitely. Almaden has a history of raising money in challenging times. It was able to raise another $5.5M in July. It has a strong cash position, and, as you said, it owns its own drills, so the drilling cost per meter is a lot cheaper than its peers. Almaden is in a great position.

TGR: Almaden has pursued a policy of drill, drill, drill at the Ixtaca gold-silver zone of its Tuligtic property. How close is this to bearing fruit?

“The big theme this past quarter was cost containment.”

AG: Almaden has drilled about 80,000 meters so far and has done a great job at filling in the blanks. It is a project generator, so I’m pretty sure Almaden’s management is out there generating interest in this story. It will be interesting to see what people think. Ixtaca is a decent gold story with a nice silver byproduct credit.

TGR: The Poliquin family, which runs Almaden, finds properties, develops them and then sells them. Do any companies come to mind as possible acquirers?

AG: Recently we’ve seen Alamos Gold Inc. (AGI:TSX) make a bid for Esperanza Resources Corp. (EPZ:TSX.V). Mexico being what it is, there would be a lot of producers there that would be looking at a project with this kind of scope. It’s just that we need a little bit of consolidation to start happening in the market first.

TGR: What is your target price for Almaden?

AG: $3.75.

TGR: What other companies have you rated Speculative Buy?

AG: Red Eagle Mining Corp. (RD:TSX.V) has pushed for near-term production at its Santa Rosa gold project in Colombia. That’s what I like about this story. It’s not a massive deposit, but it is something that could be producing within a couple of years. It is an open-pit scenario, so Red Eagle could look at different alternatives to get Santa Rosa into production. The company is deciding now whether to go underground first. Red Eagle’s market cap is about $12M. I think it has about $10M in cash. It has some great strategic investors, including Liberty Metals & Mining Holdings and Appian Capital Advisory out of London. Both groups have pretty good technical backgrounds. I don’t expect to see a massive capex for Santa Rosa, and that’s another reason I like it.

TGR: What’s your target price for Red Eagle?

AG: $0.55.

TGR: These days, is small beautiful with regard to capex?

AG: Yes, it is. Small is beautiful now. Until we have stabilization in gold and silver prices, the days of looking at multibillion-dollar capexes are over. There are a lot of them out there already, and I don’t think we’re going to see a lot being developed any time soon.

TGR: What other companies do you rate as Buys?

AG: Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ) and Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT) are both Buys. My target prices are $16.50 for Silver Standard and $1.30 for Great Panther.

TGR: Has Silver Standard met the challenge of the lower silver price?

AG: It just reported a good operational quarter. The theme for all these producers is to take the right steps in containing costs. We need to see that continuing over the next few quarters as we figure out where gold and silver prices are going.

TGR: What do you think of Silver Standard’s projects?

AG: Silver Standard has one operating mine, Pirquitas in Argentina. The company has the big Pitarilla silver-lead-zinc project in Mexico and it has a whole bunch of little projects in its portfolio that it could potentially develop. I think Silver Standard’s main focus right now is increasing efficiency at Pirquitas. I believe it is looking for a partner for Pitarilla.

“We need some sort of price stability so that companies can adapt to this new price-point environment.”

The beauty of Silver Standard is that it has a pretty sizeable cash position that allows it control over its production profile. The company also has projects that it could divest, if it needed more cash, including a sizeable position in Pretium. I think Silver Standard is actually in a great position right now.

TGR: And Great Panther?

AG: It is a higher cost producer, but it showed some promise this past quarter. The company needs to demonstrate consistent operating efficiency.

TGR: You have a Buy recommendation for Silvercorp Metals Inc. (SVM:TSX; SVM:NYSE), correct?

AG: Yes, and a $4.60 target price. Silvercorp has done a good job at scaling back costs wherever it can and shutting down some of its high-cost mines in the Ying mining district.

TGR: Has Silvercorp triumphed over those who claimed it had exaggerated its resources in China?

AG: I think the company did a good job fighting those allegations and in getting back to what it does best: operating mines in China. So now there is more focus on the actual numbers coming out of the company.

TGR: What other companies are in your coverage universe?

AG: Kimber Resources Inc. (KBR:TSX; KBX:NYSE.MKT) is a Speculative Buy with a price target of $1.25. The company’s Monterde gold-silver project in Mexico is interesting, but it has been the victim of funding. Its cash position limits what it can do. Kimber needs the market to improve so that investors can open up their wallets to get Monterde back on track. The company needs to do a lot more work to delineate its underground resource. But it does have both open-pit and underground mining scenarios.

TGR: Is there one more company you would like to discuss?

AG: Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE) is a Buy recommendation at $5.50. The company has two mines in Mexico, Guanaceví and Bolañitos, that are profitable and cash-flow positive even with $20/oz silver. Its El Cubo acquisition has hampered the company a little bit, but it has taken the right steps to control grade there, and it will be interesting to see how that plays out.

TGR: What will it take for investors in gold and silver equities to become excited about the market again?

AG: I’ll say again that we need price stability. Also, we need producers continuing to show that they’ve adapted to the new commodity price environment. That’s when investors will begin to see that valuations are ridiculously cheap. That’s when people will start getting excited again.

TGR: Many of these companies have been ridiculously cheap for quite some time, but investors have been waiting for a bottom. Have we gotten to the point where investors can’t resist these bargains any longer?

AG: I think we’re seeing it now.

TGR: Ash, thank you for your time and insights.

Ash Guglani is a research analyst with Salman Partners, covering precious metals companies in the mining sector. He has been with Salman Partners since 2004. Guglani holds a Bachelor of Business Administration degree with a focus in finance from BCIT.

Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Kevin Michael Grace conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Pretium Resources Inc., Almaden Minerals Ltd., Red Eagle Mining Corp., Silver Standard Resources Inc. and Great Panther Silver Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Ash Guglani: I own or my family owns shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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