The Gold Report: Canada's Globe and Mail reports that gold miners wrote off $17 billion in 2013. Does that encourage investors seeking greater exposure to precious metals to ignore the bigger names and look more closely at small-cap gold and silver equities?
Derek Macpherson: I think it makes investors a little more selective. During the last upturn in the gold market many of the big-cap companies purchased and built large, lower-grade projects; these projects have seen the majority of the write-downs over the last two years. This does not necessarily mean that there are no good big-cap mining equities; but it forces investors to be selective. However, many of the small-cap equities have undeservedly sold-off with their larger peers. We believe this creates an opportunity for investors to selectively add to their portfolios.
TGR: The junior mining sector is seeing some renewed interest from suitors, but is not yet the market darling. Do you believe this investor flirtation is likely to lead to a long-term love affair or is it more akin to a tryst?
DM: I think it's a little too early to tell. We're at the first or second date stage and we don't know whether this is the one or if it's a short-term fling. It is still too early to be investing in high-risk, high-leverage names. It fits well with our investment thesis and what we talked about the last time we spoke, which was that we like low-risk names even in the early stages of this rising gold price environment.
TGR: Low-risk names. Would you deem this a value sector right now?
DM: There are definitely some value plays in the sector, names that have been unjustly sold off, and there are some opportunities to catch them as they come back and their businesses recover.
"We like Klondex Metals Ltd. for its exceptionally high-grade resource, the strong management team and excellent jurisdiction."
TGR: In your last interview with The Gold Report you said, "In a rising gold price environment there was more room for error, and setbacks didn't have as large an impact on project economics." We're now in a modest rising gold price environment yet a number of companies have trimmed costs including some that you cover. Is this a sweet spot?
DM: If we are in a longer-term gold price rally, the best time to get in is at the very beginning. The thing that drives up or is perceived to drive up the gold price is inflation, which is also what drives up underlying costs, something we saw in the last cycle. Early on it was a great time to get in and it was a great time to build projects. That's when the most money was made. Then as the market got a little bit more frothy, we saw costs start to chase the gold price up and margins started to contract. Now is the time for investors to start taking a second look at the mining equities and start to invest.
TGR: Nonetheless, these equities present significant risk. Grade, jurisdiction and a simple mine plan/geology are common ways companies mitigate investor risk in this sector. In your coverage universe, how would you rank those?
DM: We view grade and simple mine plan/geology as 1A and 1B. With high grades there is more room for error, helping derisk a project. Similarly, a simple mine plan, like most heap-leach projects, also creates that lower risk environment. Companies don't necessarily need higher grades for that. Second would be jurisdiction. A company can take a little bit more jurisdiction risk with minimal impact, but if the grade or the mine plan doesn't work, the project doesn't work.
TGR: Are there some other risk mitigators that ought to be included in that list?
DM: There are two other things that investors sometimes overlook: management and the balance sheet. They will see a great project with great grade, but they will often overlook the management team. A company needs a strong management team to deliver on a project's potential. In this environment, there are good management teams out there that have done it before, which help derisk a project. The second thing that sometimes is overlooked is the balance sheet. Investors definitely want companies with balance sheet flexibility—low debt and a strong cash balance—which helps derisk projects, particularly as they are ramping up.
TGR: Some of these junior equities have seen dramatic price rises since the beginning of the year and even before that in some cases. There was a bit of a rally in late 2013. How should investors approach those names? With caution?
"Because Atico Mining Corp. has very high grade, it doesn't need a lot of throughput to generate meaningful free cash flow."
DM: Investors need to make sure a company has strong fundamentals and a valuation that should allow the rally to continue. Some of those names that have really moved in late December and early January were coming off tax-loss selling. We saw a number of equities rally on that alone, going down toward the end of 2013 with tax-loss selling and then rebounding in early 2014. From a trading perspective, after a strong rally investors want to wait for equities to take a pause, or even pull back a little, before stepping into names that continue to have attractive valuations.
TGR: What are some of what you would consider lower-risk gold names that you cover?
DM: The two low-risk gold names that we continue to like are Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB) and Lake Shore Gold Corp. (LSG:TSX). We like Klondex for its exceptionally high-grade resource, the strong management team and excellent jurisdiction. Klondex is based in Nevada and Paul Huet leads the management team. With its recent acquisition of the Midas mine and mill from Newmont Mining Corp. (NEM:NYSE), Klondex is well positioned to deliver on a promise of the high grade at Fire Creek.
TGR: How easily will Midas fit into the development plan at Fire Creek?
DM: Midas fits in very easily. Klondex has been toll milling its ore at the Midas mill prior to the acquisition. The Midas mill wasn't running at full capacity, so there's opportunity to increase throughput with ore from Fire Creek. There is also exploration upside at the Midas mine; Klondex may be able to extend the mine life there as well.
TGR: Investors watching Klondex are eagerly anticipating its preliminary economic assessment (PEA). What do you expect to see?
DR: I think the PEA is going to have strong economics not only because of the high grades at Fire Creek but also because a lot of the capital has already been spent. It's a straightforward mine and Klondex has the expertise and experience to develop it. Klondex has already acquired the milling infrastructure, reducing the initial capital commitment.
TGR: Lake Shore Gold has lowered costs and improved its grade in four straight quarters. Has Lake Shore Gold turned the corner?
DM: We think Lake Shore Gold is starting to show signs that it has. We are seeing the culmination of several years of work to get Lake Shore to where it is. The company finished the mill expansion in late 2013 and at the same it finished the development work it needed to do at Timmins West and at Bell Creek so that Lake Shore Gold could access its higher grades on a more consistent basis.
Our site visit in November 2013 demonstrated to us that Lake Shore Gold is focused on improving grade control at the Timmins West complex in order to keep head grades between 4.5 and 5 grams per tonne, where they need to be to keep the project economic over the medium term. Improving grade has directly resulted in its cost control efforts bearing fruit.
TGR: What are some other gold names you cover that could be poised for growth?
DM: On the growth side we continue to like Temex Resources Corp. (TME:TSX.V; TQ1:FSE). Temex has very high grades at Whitney and there are a couple of key catalysts coming in the near term. Besides drill results we probably will see an initial PEA later this year. We expect to see the drills start up again this summer, providing an opportunity to expand on a high-grade potential in a very strategic location.
The other gold name we just started covering that we think has an opportunity to grow is Marlin Gold Mining Ltd. (MLN:TSX.V). The company is at the final stages of building its La Trinidad mine in Mexico; we expect the first gold pour in the coming weeks. With that gold pour Marlin is going to make the transition from developer to producer. The valuation could easily reflect the developer multiples; there's an opportunity for the stock to rerate.
TGR: You're not scared off of Mexico based on the new royalty?
DM: I think the new royalty is priced into most stocks and companies have come to terms with the impact. The Mexican government realizes how important mining is for the long-term health of its economy, so I don't think this is a case where we are going to see a series of mining tax increases.
TGR: What should investors expect from La Trinidad once it's reached commercial production?
DM: We're expecting La Trinidad to produce around 50,000 ounces gold a year once it ramps up. This year it's going to be a little bit lower grade and then it's going to start delivering on its promise. Marlin is unique. For a heap leach it has relatively high grades with the head grade forecast around 1.5 grams per tonne in 2015 and beyond.
TGR: Will that generate free cash flow?
DM: We expect Marlin to generate material free cash flow in the $20–25 million a year range at current gold prices. Being a high-grade producer with significant free cash flow sets Marlin up to either grow via acquisition or through exploration. The area surrounding La Trinidad has great potential and has seen limited exploration in recent years as the company has focused on building La Trinidad.
TGR: What are some new names that are under coverage now that weren't when we talked to you in October?
DM: A couple of the names that we've added to our coverage list besides Marlin are Rambler Metals & Mining Plc (RAB:TSX.V; RMM:LSE) and Atico Mining Corp. (ATY:TSX.V; ATCMF:OTCBB). Rambler is a high-grade base metal mine in Newfoundland, a very safe jurisdiction.
Rambler is operating the Ming mine, which was a past producer. The company brought it back into production over the last couple of years and now has reached the point where it is generating free cash flow, as development spending has declined. We're going to see Rambler's balance sheet improve by the end of March as it pays off what's remaining of its Sprott loan. The other advantage that Rambler has is the Nugget Pond mill, which has the ability to process both copper-rich and gold-rich ores, putting it in a unique position in Newfoundland where there are a lot of interesting deposits, but many of them would not support their own milling infrastructure. Having a permitted mill puts Rambler in a position where it could be a strategic acquirer of assets.
TGR: You said the other company was Atico.
DM: Atico is a high-grade copper-gold mine in Colombia that's on the verge of seeing its first production results. We have followed the story for a while and launched coverage early in January. Atico was able to exercise an option and transition from being a developer/explorer to being a producer.
The company owns 90% of the El Roble mine, which has been in production for almost 20 years. The next key catalyst is the Q4/13 financial results, which are going to include about 30 days of production from the mine. Those 30 days will show the market that this company is shifting to being a producer. Again, similar to some of the other companies we have talked about in that transition stage, Atico is still being valued as a developer. It is trading at 1.1 times 2015 earnings before interest, taxes, depreciation and amortization (EBITDA), which puts it at a steep discount to producing peers.
TGR: Actually, 320 tons per day (320 tpd) is a pretty small operation. Is that ever going to get above the 1,000 tpd mark?
DM: The company plans to expand the mill to 650 tpd by the end of the year. Once you get to 650 tpd you have a fairly reasonable operation. Because Atico has very high grade, it doesn't need a lot of throughput to generate meaningful free cash flow.
TGR: Will they use that to expand its footprint in Colombia?
DM: I think the plan is to reinvest some of that free cash flow into the larger property. Exploration has been very limited on the property; it has really focused on the main ore body. As Atico generates free cash flow and gets the current operations to a steady state, it is going to start stepping out and looking wider on the property. The mill itself is permitted for 2,000 tpd, so exploration success is likely to lead to an expansion.
TGR: You cover some companies that are now mining base metals. What's a brief forecast for zinc and copper?
DM: We continue to prefer zinc to copper. With a number of large zinc mines coming offline and few ready to be built, we think that there's an opportunity for zinc to recover. While we are bullish on zinc in the medium term, near term we are only modestly bullish because of the amount of inventory that's in the LME warehouses that has to be worked off before the likely supply deficit starts to impact pricing.
For copper there are a number of large projects sitting out there. While some of them have been delayed and that takes the pressure off the oversupply in the near term, any kind of bullish move in copper could move those projects back into the construction pipeline. We're a little bit more neutral on copper and its pricing going forward.
If investors are going to be in that mid-cap base metals space they need to stay with companies that have material growth to support the current multiples. We continue to like Imperial Metals Corp. (III:TSX) and Trevali Mining Corp. (TV:TSX; TREVF:OTCQX; TV:BVL); both have material growth on the horizon. Trevali plans to have its New Brunswick assets come on-line in 2015.
Saving that, we suggest that investors look a little further down cap and look at the discounted valuations in the base metals space. Two companies that we cover there are Atico and Rambler.
TGR: Does Trevali have sufficient cash to act as a cushion in case of lower prices?
DM: Trevali's assets give it a pretty reasonable all-in cost based on a zinc net of byproducts basis. In 2015 we model Trevali being at US$0.47/pound of zinc net of byproducts, which gives it a reasonable margin to operate at current zinc prices. The investment opportunity with Trevali is unique because it's one of the only zinc producers listed on the Toronto Stock Exchange, so any kind of run in zinc price and it's going to catch a natural bid.
TGR: Trevali announced commercial production at Santander at the beginning of February. That's the first step in derisking that name as a whole. What's the next step?
DM: The next step for Trevali is the New Brunswick PEA. It will give investors a glimpse into what the economics look like for the restart of Caribou and what the company can look like in 2015 and beyond. I think that is the next key derisking step for investors.
TGR: Imperial Metals is an established company. Where does it fit into Canada's base metals producers?
DM: Imperial is going to end up being one of the larger mid-cap producers once Red Chris is ramped up to the 30,000 tpd level. We're looking for its production profile and free cash flow to more than double once Red Chris is in commercial production. That puts Imperial at the top end of the midtier space. While we only model a 30,000 tpd asset at Red Chris long term, we think that the opportunity exists for Imperial to materially expand production, but there are limited details on what that may look like.
Imperial is looking at May 2014 for commissioning. We model Q3/14, which is about a month later, but Imperial so far has been delivering on its critical timeline items. The key thing that we're watching for is the Iskut Extension of the power line. Imperial is completing that themselves and is scheduled to be finished in May 2014, the same time commissioning is supposed to start. We view that as probably the highest risk to both the project timeline and the budget.
TGR: Any parting thoughts to leave with us?
DM: We're starting to see some positive signs in the precious metals space. While we like what we're seeing currently, I think investors should still continue to be selective and focus on low-risk names in this early stage. If this is the early stage of a longer-term rally, we think that's where the money is going to flow first.
TGR: Thanks for your insights.
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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1) Brian Sylvester 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 company mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Klondex Mines Ltd. and Trevali Mining Corp. 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 or my family am 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., Atico Mining Corp.Temex Resources Corp. and Trevali Mining 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.
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