Forget the Majors

Forget the Majors, Buy the Midtiers

Michael Fowler Says Forget the Majors, Buy the Midtiers, The Gold Report, Streetwise Reports

According to Michael Fowler, senior mining analyst with Loewen, Ondaatje & McCutcheon, the major gold producers have gorged on debt and sold off their seed corn. In other words, they pursued exactly the wrong strategy in the past and are now paying the piper. The intermediates, on the other hand, have better balance sheets, positive cash flow and prospects for growth. In this interview with The Gold Report, Fowler highlights five producers prospering against the odds, and three companies with near-term projects likely to be taken out.

The Gold Report: What are your forecasts for gold and silver prices in 2015?

Michael Fowler: I think gold could go lower in U.S. dollars in the next three months. I stress U.S. dollars because the price of gold is rising in many currencies, such as in Canadian and Australian dollars. This will be a boon to producers in those countries, as will the significant declines in energy costs.

The average gold price should be slightly down: $1,150–1,200/oz. Negative factors for gold are the strong U.S. dollar and lower inflation. These, however, will be offset by strong physical demand from Asia, China in particular. Silver follows gold, so I expect a 2015 average of $16/oz.

TGR: The gold-silver price ratio, which for several years had been at a historic high of 65, has now reached 75. Will that ratio be maintained?

Pretium Resources Inc. has a very high-grade deposit, which suggests the ability to be financed.

MF: I think we will probably see a range of 65–70. Historically, silver has outperformed gold on the way up and underperformed gold on the way down.

TGR: Again, traditionally, geopolitical turmoil has been good for gold. We had a great deal of such turmoil in 2014, and it doesn’t seem as if 2015 will be any calmer. For instance, January brings the prospect of elections possibly leading to the exit of Greece from the euro. Could 2015 be the year gold’s value as a safe haven in a scary world is reaffirmed?

MF: I think the world has always been a scary place. Certainly, the Eurozone descending into crisis would be positive for gold. That said, the gold market in the longer term reacts more strongly to phenomena such as inflation, currency strength and monetary growth than to various political skirmishes.

TGR: Keeping in mind what you noted about the cost savings deriving from currency declines and lower energy costs, is gold production sustainable at $1,200/oz? Can we expect a significant drop in gold production?

MF: We should see a significant gold production fall from 2016 onward.I think the industry got it completely wrong. Producers should have been hoarding cash during the boom years so they could deploy it now. Instead, most of the big gold producers took on huge amounts of debt and are now selling off assets. Capital expenditures have been curtailed, and that will lead to a lower reserve and resource basis and, eventually, lower production.

TGR: Today, even projects with published all-in costs well below $1,000/oz are having difficulty raising capital. What does this tell us about the future health of the gold explorers?

MF: Essentially there’s no money going into the sector. At $1,200/oz, few junior deposits make sense.

TGR: The bear market in mining equities began in April 2011. Assuming that sentiment in the gold sector becomes positive again, how fast will financing come back? Are we talking months, or more than a year?

MF: Should my gold price forecast be wrong, and gold rises in price quickly, that would be a catalyst for many investors to get back into the gold market. Another catalyst would be major discovery, but that doesn’t seem to be on the horizon. For the juniors, there’s always a lag effect. Even assuming a big increase in the gold price, they would still be many months from a recovery.

MF: Three specific companies on my list would be Pretium Resources Inc. (PVG:TSX; PVG:NYSE), Torex Gold Resources Inc. (TXG:TSX) and Guyana Goldfields Inc. (GUY:TSX).

TGR: Despite rock-bottom asset prices, 2014 was not a brisk year for mergers and acquisitions (M&A) in the gold sectors. Will M&As pick up in 2015?

MF: I don’t expect much change. There are many impediments to an increase in M&A. Two that are especially important are soaring general and administrative expenses and golden parachutes for management.

TGR: What can be done about the latter?

MF: Well, most companies with oversized compensation contracts are probably not going to get taken over. They’re going to be put on the waste pile. Basically, shareholders should have a vote on these parachute clauses at annual general meetings, but that isn’t happening at the moment. That’s something regulators could focus on moving forward.

“What’s exciting about St Andrew Goldfields Ltd. is the Taylor deposit, its next development play.”

TGR: Doesn’t this suggest a significant structural advantage for intermediate or junior producers?

MF: Yes, even though some juniors do have outsized parachute clauses for management. So juniors with modest parachute clauses make themselves much more interesting for M&As.

TGR: What type of company is most likely to be taken out in 2015?

Takeover targets must be able to demonstrate good actual or potential returns on investment. The three companies I just named have that. Torex and Guyana Goldfields are both financed to production. Pretium isn’t but it has a very high-grade deposit, which suggests the ability to be financed.

TGR: In the current depressed environment, is mining jurisdiction more important than ever?

MF: I don’t really think timing matters. I’ve always preferred companies in countries with defined mining codes and overall stability. Canada, the U.S. and Australia are at the top of that list. Outside these areas, you’re always dealing with the potential for changes in tax regimes, royalty regimes or environmental regimes.

TGR: Let me ask you about Canada in this regard. The federal government has passed a Yukon environmental bill, which some observers believe to be calamitous. In British Columbia, the courts have given undefined rights over all Crown Land to Indian bands. And Ontario’s new mining regulations are controversial. In the light of these changes, does Canada remain one of the best jurisdictions?

MF: These changes cannot be considered in isolation. Worse changes have been made elsewhere. For example, Zambia just increased royalties up to about 20%, and Mexico has greatly increased royalties as well.

Canada should be considered on a province-by-province basis. What’s going on in British Columbia is quite difficult, but the First Nations situation is much more settled in Ontario, Québec and points east.

TGR: Which junior producers do you follow in Québec and Ontario?

MF: St Andrew Goldfields Ltd. (SAS:TSX) and Wesdome Gold Mines Ltd. (WDO:TSX). Wesdome has a property in Québec but also has major properties in Ontario. St Andrew Goldfields has properties right up to the Québec border on the Destor-Porcupine Fault line. These are two companies I really like. Wesdome is doing very well right now. It’s a small producer, but it has been finding parallel zones to its deposit in Wawa, Ontario, and the grade of the deposit is very high: 10 grams per ton (10 g/t). Wesdome has turned around its operation and is making good money.

TGR: Wesdome has effectively doubled its share price since October. How much of this is due to the recent rise in the price of gold, and how much is the market’s validation of what the company is doing?

MF: I don’t think that the upside is finished on Wesdome, to answer that question. Part of the reason for the share rise is the fall of the Canadian dollar, but more important than that is the company’s discovery of very high grade parallel zones to the Eagle River production facility.

TGR: Wesdome has had good assays results from Dubuisson North in Quebec, including 45 g/t over 5 meters (5m) and 3.4 g/t over 25m. Could this be a high-grade gold discovery?

MF: Dubuisson is really an exploration target at the moment. It could be a factor in two or three years. The real exciting thing for Wesdome is what’s going on in Ontario in Wawa, where it is producing about 45,000–50,000 ounces (45–50 Koz) gold per year. Wesdome found a parallel zone that can be accessed from the production shaft there. The company could actually increase its production at that mine at a lower cost.

TGR: St Andrew announced on Jan. 9 annual production of almost 91 Koz gold. Its stock rose $0.01 in response. Does that indicate a production figure pretty much in line with what was predicted?

MF: Yes, St Andrew revised its guidance upward about six months ago. What’s exciting about St Andrew is its Taylor deposit, the company’s next development play. That is a high-grade system as well. St Andrew is processing a bulk sample from the Taylor deposit as we speak. Bottom line on St Andrew is that it could increase its production, not this year, but in 2016. Its balance sheet is pretty good as well.

TGR: What do you think about St Andrew’s all-in sustaining costs?

MF: Well, they’re high, at $1,060/oz, but they’re coming down. St Andrew is doing a good job of efficiently mining what it has. St Andrew has a royalty issue with Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), which is not going to go away any time soon, but Taylor will lessen the royalty load after it goes into production.

TGR: Earlier you mentioned Torex Gold. What specifically do you like about the company?

MF: Torex has a very high-grade mine, El Limon-Guajes, in Mexico, which is fully financed. Torex has good management that has built mines before. And it has another good Mexico discovery. Torex has some good backing and good shareholders.

TGR: How prospective is the Guerrero Gold Belt?

MF: It’s a good belt and very prospective. There are little companies around Torex, and Newstrike Capital Inc. (NES:TSX.V), which looks very interesting as well. There are some difficulties in Mexico, as I have mentioned. There’s the royalty increase and the increase in drug cartel-related violence.

TGR: Going back to Pretium, when do you expect Brucejack to go into production?

MF: Something like 2018, if the company hasn’t been taken out by then.

TGR: Pretium’s share price has been rocketing, up 5.2% on Jan. 9 and 4.6% on Jan. 12 on no material news. Does this suggest rumors of an imminent takeout?

MF: There are always takeover rumors around companies like Pretium. And there’s the New Year bounce in share prices. Torex was up 5% Jan. 9, and so was Guyana Goldfields. The majors need to do something to increase production. Goldcorp Inc. (G:TSX; GG:NYSE) is a potential suitor for Pretium, and some of the midtiers could potentially get involved as well. The midtier producers now have significantly better balance sheets than the bigger producers, which is really strange.

TGR: Does Pretium intend to begin operations modestly at Brucejack?

MF: Pretium calls it modest, but my personal opinion is that it wants to mine this deposit at about 2,000 tons a day (2,000 tpd). If Pretium is taken out, the new owner will do its own feasibility, and will size its own mill, and so forth. It may be totally different from what Pretium is talking about right now.

Brucejack is exceptionally high grade. Who knows exactly how high? It’s difficult to determine reserves or resources from a deposit as nuggety as this.

TGR: How close is Guyana Goldfields’ Aurora gold project to production?

MF: A progressive start-up should begin in the middle of 2015. Guyana will initially mine the high-grade open-pit material. I was down in Guyana not long ago, and everything seems to be on time and on budget.

TGR: Have all of the details been worked out regarding Aurora’s financing?

MF: Yes, unless there’s a huge overrun in capital expenditure. I mean we’re talking about financing for the first two or three years. According to the feasibility plan, Aurora will be open-pit initially, and it will then go underground. I don’t know whether it will go underground, to be honest. My feeling is that Guyana Goldfields will keep Aurora as an open-pit deposit.

TGR: If Aurora is a success, will we see a gold rush in the country of Guyana?

MF: It’s part of the Guyana Shield. Many years ago, South America and Africa were joined at the hip. The shield area goes through Suriname, French Guiana, Brazil and into Africa and is very prospective for gold. Guyana does have a history of gold mining. The biggest issue for Guyana is infrastructure, which is not really that good. If the country had infrastructure similar to what we have in Canada, we’d have a lot of gold mines there already. But Guyana has worked out its mining code, and although the royalty rate is quite high, the country has a reasonably stable mining regime.

TGR: Which other gold companies would you like to mention?

MF: I like the midtier gold producers, three in particular: Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE), SEMAFO Inc. (SMF:TSX; SMF:OMX) and Centamin Plc (CEE:TSX; CNT:ASX, CEY:LSE). I don’t like the majors. They took on too much debt, have been selling off assets and, as a result, have little growth potential. The midtiers tend to have good balance sheets and good growth. They’ve got their costs under control and are cash flowing.

TGR: Randgold has been mentioned as a company that might be aggressive in M&A. Do you agree?

MF: I don’t think it’s going to be aggressive at all. Randgold is more interested in its organic growth profile. This is a company that is aggressive once every, say, five years or so.

TGR: SEMAFO suffered some very bad press a few years ago. Has it turned it around in Africa?

MF: Five years ago, SEMAFO didn’t have a very good mine. The company survived and found the Mana deposit in Burkina Faso. Then around that deposit SEMAFO found the Siou deposit, which is the big catalyst and source of increased production. Its production costs are fairly low. It’s efficient mining. Management has matured. I think it’s a pretty good situation still.

TGR: Centamin took a huge hit last week after it released its Q4/14 production and 2015 guidance. Was that an overreaction?

MF: Yes, I don’t know what some analysts were thinking. The company gave guidance, and with Q4/14 production of 128 Koz, Centamin basically came in with the guidance. Centamin is outperforming in the longer term. This year, with 420 Koz, it will show more production growth. The problem with the land title should go away. The regime in charge in Egypt is likely positive to Centamin.

TGR: After almost four years of dashed hopes for gold investors, why should they be optimistic in 2015?

MF: They should be optimistic because everybody is pessimistic. Already, Canadian dollar gold prices are actually in a bull market, and so are Australian dollar gold prices. Input costs are going down significantly. Despite my opinion that gold prices are going sideways to slightly down in 2015, the gold equity market will do reasonably well this year.

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

Michael Fowler, senior mining analyst with Loewen, Ondaatje, McCutcheon Ltd., has worked in the investment industry since 1987 as a base and precious metals mining analyst for numerous high-profile firms. His coverage list included the major North American gold mining companies, but is now focused on small- to mid-sized companies. Previously, Fowler worked as a geophysicist involved in mineral exploration for 10 years. He was involved in the discovery of the high-grade Cigar Lake uranium mine in Northern Saskatchewan in the early 1980s. Fowler holds a Master of Business Administration from Cranfield University, UK; a Master of Science in mineral exploration from Leicester University, UK; and a Bachelor of Science in geology with geophysics from Liverpool University, UK. He is a member of the Institution of Materials in the UK and a member of the Canadian Institute of Mining and Metallurgy.

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