BMO’s Andrew Kaip: The Gold Majors Are Back
Andrew Kaip, managing director of mining equity research at BMO Capital Markets, does not expect near-term higher prices for gold or silver. However, due to continuing cost cutting and other efficiencies, he argues that the senior gold producers can now make profits above $1,100/oz gold. In this interview with The Gold Report, Kaip names two seniors as Sector Outperformers, and touts the virtues of a half-dozen undervalued near-term gold and silver producers.
The Gold Report: You recently became managing director of mining equity research at BMO Capital Markets. What kind of overview of the gold and silver sectors does this position entail?
Andrew Kaip: Taking one of the lead roles at BMO Research has given me the opportunity to step away from the day to day of covering stocks. Supervising a team of analysts allows me to spend more time thinking about where we are in the gold and silver cycles and the implications for investors. That’s precisely what we did when we launched coverage on the senior gold producers.
TGR: So where is gold in its current cycle?
“Asanko Gold Inc. is one of the opportunities in what we call predevelopment names.”
AK: At BMO, we’ve kind of stuck our neck out after some deliberate thought, and we’re suggesting a lot of similarities between 2001 and 2015. The price of gold was low then, just as it is now. Similarly, the gold producers of 2015 have come to resemble those of 2001, in that they have finally, after a long struggle, stabilized their operations such that they can contend with low prices. They have shut down unprofitable mines and lowered costs at those that they have kept.
I believe that gold producers are now in the early stage of a new cycle.
TGR: What are your 2015 and 2016 forecasts for the price of gold?
AK: Quite flat. We forecast a 2015 average price of $1,200 per ounce ($1,200/oz) and an average of $1,180/oz for 2016. Beyond that, we expect a slow and gradual rebound to about $1,250/oz long term.
TGR: And your forecasts for silver?
AK: Very much the same story. We forecast a year-end 2015 price of $16.43/oz, $16/oz for 2016 and $17/oz for 2017. We expect silver will then move toward $21/oz long term.
TGR: Despite the continuing massive expansion of global money supply and a host of geopolitical crises, most recently the possible exit or expulsion of Greece from the Eurozone, the gold price slid. Isn’t this counterintuitive?
AK: At first glance, it would seem counterintuitive. One might have expected that the Greek crisis would have supported a high gold price. I recently returned from a marketing tour throughout Europe and discussed this issue with investors. The reality is that the Greek contagion has been mostly isolated. To be honest, Greece is a very small component of the European economy, and so the crisis has a quite small global macroeconomic effect. It is not regarded as having any serious implications for the United States.
“Bear Creek Mining Corp. has one of the best-quality assets of any silver junior.”
More pertinent to the current price of gold is the discussion regarding whether the Federal Reserve will raise the prime rate in September.
TGR: We have heard talk of the Fed raising interest rates for years. U.S. gross domestic product fell 0.2% in Q1/15. Would the Fed really increase rates when the U.S. economy could be heading into a recession?
AK: No, it wouldn’t. But many economic data points must be released before it can be said that the U.S. economy is in recession. Right now, the data are mixed. We go through periods where the U.S. economy starts hitting good numbers, and investors get quite constructive about it. Then we see a couple of soft numbers, and the discussion changes to the unlikelihood of higher interest rates.
“MAG Silver Corp.’s Juanicipio project is high quality but early stage, with production forecast for 2018.”
I believe the U.S. economic trend continues to be more positive than negative. That is why, for instance, we’ve seen job numbers improve over the last few years, and quite frankly, why the U.S. dollar is as strong as it is. BMO is forecasting that by September the Fed will be in a position to raise the rate and will do so by that first quarter point.
TGR: A recent story in Al Jazeera suggests that China intends to move aggressively to make Shanghai the center of the gold world. What do you make of this?
AK: It’s a significant development. China has spoken often of its desire to increase its reserve holdings of gold. We don’t really know how much gold China holds, but we do know that China has become the world’s largest gold producer. China is certainly seeking to increase its control over the pricing of gold. This is a reality that not many investors are paying attention to.
TGR: As ownership of physical gold continues to shift from West to East, would Shanghai’s more powerful role lead to a higher gold price?
AK: A long-term trend has been established. Is it constructive for the price of gold? It has the potential to be, but ultimately, the price will serve as a barometer measuring the health of the larger economies in a global perspective.
In the meantime, this shift to Shanghai will increase the desire for investors to know more about the health of the Chinese economy and how that will impact the price of gold, just as today the price of gold is to a great extent determined by considerations of the health of the U.S. economy.
TGR: A June 15 BMO Research note states that you have “moved toward a more constructive view of the senior gold miners.” Have the senior miners slimmed down and become more efficient?
AK: They were forced to do so by the decline in the price of gold. They have been forced to move their companies to the point where they can operate profitably at a lower gold price.
They have achieved this in a number of ways. First, they have reduced their corporate overhead on an absolute or per-ounce basis quite substantially. Second, they began readjusting their capital programs. They scaled back new project development and reduced sustaining capital budgets dramatically.
TGR: Have the senior miners increased efficiency at the cost of compromising their reserves?
“Silver Wheaton Corp. has a great business model.”
AK: This is a matter that concerns investors. Reducing stripping in open-pit scenarios decreases sustaining costs but also results in fewer ounces mined. So, sustaining capital has declined because reserves have declined. It is our view, however, that producers have not cut as deeply as investors may think, that they have not rationalized sustaining capital levels to the point where they compromise mine lives.
TGR: You initiated coverage on six gold producers in June. Could you talk about the two that you have rated Outperform?
AK: They are Goldcorp Inc. (G:TSX; GG:NYSE), to which we have given a 52-week target price of $22 and Barrick Gold Corp. (ABX:TSX; ABX:NYSE), for which our target price is $16.
I’ll start with Goldcorp. Its shares began underperforming relative to its peers after weak Q1/15 results were announced. These surprised the market, which immediately began focusing on recent criticisms of the company: It missed guidance from 2014 and its balance sheet suffered through recent very large capital programs. This led to concerns about debt and worries that the company would neither meet its 2015 production guidance nor generate free cash flow. This is a market situation I like to call “maximum ugliness.”
The reality is that most of the issues Goldcorp was dealing with have been or are being resolved. We expect the company will meet its guidance. We expect it will show free cash flow sufficient to support its dividend, repair its balance sheet and invest in future opportunities. Goldcorp shares are lagging now, but we expect that investors will soon become cognizant of the new realities, and shares will outperform throughout the remainder of 2015.
TGR: Goldcorp has over the last 12 months brought on-stream three new mines: Éléonore in Quebec, Cochenour in Ontario and Cerro Negro in Argentina. That has to be a positive for its shares, right?
AK: Absolutely. Two of those new mines were declared commercial in Q1/15, and as this new suite of mines ramps up production, there’s a real opportunity for investors. These mines can be optimized at higher production rates. They’ll have healthy reserve grades for the next couple of years and the capacity to grow over time. Goldcorp shares are suffering now because there were a few hiccups along the path to production, and this wore thin the patience of investors.
TGR: Goldcorp dropped out of a bidding war over Osisko Mining. Is it now looking for another major acquisition?
AK: This is a company built on acquisition. You could say that this is in Goldcorp’s DNA. It does not invest much in greenfields exploration like some of its peers; it prefers to buy projects it can then develop. I think the Osisko bid hurt Goldcorp shares because investors believed it was too soon, that it should have resolved the problems I mentioned before it started buying. Once investors are persuaded, as we are, that the company has or soon will resolve these problems, they will be more than willing to support future Goldcorp acquisitions.
TGR: Tell me what you like about Barrick.
AK: This is a story about transformation. Barrick is the largest gold-producing company globally, but it was directionless until the beginning of this year, when it articulated its new plan. The company is now focused on quality, on its core assets and on reducing debt. In the execution of this plan, we are seeing a much healthier Barrick emerge. This is a company with the potential to look at good-quality growth opportunities and plan for the next generation.
Ours is not a universally accepted view. Some investors are quite critical of our thesis. But we maintain that a slimmer, smaller and much more profitable Barrick is one that can begin to rebuild in a manner very attractive to investors.
TGR: So you’re impressed with Barrick’s new management?
AK: We’re impressed with the direction it has taken. It still has a lot of work to do, and we know of the opportunities that are present. We’ve seen a number of operations divested by Barrick, and management teams of those new companies have shown that they can turn around those assets.
To give one example, Acacia Mining Plc (ACA:LSE), formerly African Barrick and two-thirds owned by Barrick Gold, has demonstrated that there was a lot of excess cost within the Barrick structure. It has further demonstrated how to remove that excess cost and revealed the opportunity this represents.
TGR: When you spoke to The Gold Report last year, you noted, “Over the last couple of years, valuations of royalty companies have come down significantly relative to precious metal producers.” Are royalty companies still undervalued?
AK: Since that interview, we have seen continued support for royalties and some of their valuations expand. But we still see some of the larger producers trading at comparable multiples. So I think there are opportunities within the royalties.
TGR: Which royalty companies do you follow?
AK: Only one: Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). The company has a great business model. Royalties are always the safe-haven trade with the precious metal world; they do best when metals prices are under pressure. At times like these, it is to royalty companies that investors move money.
TGR: Are the days of pure silver producers and pure silver royalty companies at an end?
AK: We have observed that trend and expect it to continue. For many of the silver producers we cover, there is a move toward increasing gold exposure. Silver Wheaton has also moved in that direction by spending $800 million ($800M) to increase its stream of Vale S.A.’s (VALE:NYSE) Salobo gold mine in Brazil to 50%.
TGR: Among the silver producers you follow, which are your favorites?
AK: Tahoe Resources Inc. (TAHO:NYSE; THO:TSX) and Fresnillo Plc (FRES:LSE).
TGR: In June, Goldcorp sold 58M Tahoe shares for $1 billion. That was 26% of Tahoe. Why did this happen, and what effect will it have on Tahoe?
AK: The divestiture of its Tahoe shares was an easy way for Goldcorp to strengthen its balance sheet and not draw on credit lines to complete construction of Cerro Negro and Éléonore. This selloff has had no effect on Tahoe other than to depress its shares. We see this as a real opportunity for investors. Tahoe is a solid company with a fine silver mine in Guatemala, Escobal, and two fine assets in Peru, its La Arena gold mine and its Shahuindo near-term gold project. We see it generating consistent free cash flow that will support not only its dividend but also grow its balance sheet over time.
TGR: How well has Tahoe integrated its Peruvian acquisitions?
AK: We will find out soon with the release of its Q2/15 production and earnings results.
TGR: What do you like about Fresnillo?
AK: Fresnillo has good quality assets in Mexico. It is expanding its Fresnillo mine, has completed a major expansion at its Saucito operations and is building a new mine called San Julián. Fresnillo is investing in its future and growing its business. Like Goldcorp, its balance sheet is being drawn down, a process we see being accomplished by Q1/16.
TGR: A while back, there was a lot of bearish talk about the new Mexican royalty-taxation regime. Was this overstated?
AK: No. It did impact the mining companies, and investors imputed this impact into their share prices.
TGR: Has it resulted in a decrease in mining investment?
AK: No, I don’t believe so.
TGR: Which junior and emerging silver producers do you want to talk about?
AK: I’ll mention two. The first is MAG Silver Corp. (MAG:TSX; MVG:NYSE). Its principal asset is the Juanicipio project, a 44%/56% joint venture with Fresnillo in the Fresnillo District. It’s high quality but early stage, with production forecast for 2018. In April, Fresnillo reported assays that included 405 grams per ton (405 g/t) silver, 2.7 g/t gold, 3.2% lead, 4.1% zinc and 0.37% copper over 35.4 meters. The market was quite excited about these results and for good reason.
TGR: And the other emerging silver producer is?
AK: Bear Creek Mining Corp. (BCM:TSX.V), which operates in Peru. Besides MAG silver, it has the best-quality assets of any silver junior. It has a very large silver reserve—over 500 million ounces (500 Moz)—relative to its market cap of $86M.
It has two projects. Santa Ana was frozen by the Peruvian government. This is now the subject of an international arbitration, one that I believe Bear Creek has a very good chance of winning. Its second project is Corani. This has Proven and Probable reserves of 228 Moz silver, 2.77 billion pounds (2.77 Blb) lead and 1.47 Blb zinc, at a grade of 51.6 g/t silver. According to its June feasibility study, it has a 20.9% after-tax internal rate of return and a $660M net present value. Mine life is forecast to be 18 years, and the sustaining capital expenditure is $667M. In this market, finding financing will be a challenge. I think Corani will need to wait for a more positive view of the future price of silver.
TGR: To what extent are companies operating in Peru deprecated because of the news of anti-mining riots coming out of that country?
AK: Bear Creek’s share price was a casualty of Peruvian politics. And the stories about anti-mining protests do affect the share prices of other companies there. However, Peru’s future prospects are very dependent on a healthy mining economy. Its current government is actually very supportive of mining, seeing it as a means to improve quality of life within rural Peru.
TGR: Are there any companies you could mention that are being ignored by the market now?
AK: We talk to investors about where to find value within the gold space without having to worry about the current gold price. One of those opportunities is in what we call predevelopment names. Some are Torex Gold Resources Inc. (TXG:TSX),which is building the 4.8 Moz El Limon-Guajes mine in Mexico, True Gold Mining Inc. (TGM:TSX.V), which is building the 5 Moz Karma mine in Burkina Faso and Asanko Gold Inc. (AKG:NYSE.MKT; AKG:TSX), which is building the 2.3 Moz Asanko mine in Ghana. All these companies have the balance sheets and the financing necessary to go into production, so long as they execute according to plan. And they’re trading at fairly significant discounts relative to intermediate or junior gold producers.
Another company in this group is Guyana Goldfields Inc. (GUY:TSX), which will declare commercial production at its 8.4 Moz Aurora mine this year. Its share price has done very well relative to its peers throughout its execution.
TGR: So you believe that West Africa remains a good mining region?
AK: A number of companies operating in Burkina Faso have suffered depressed share prices. Many investors remain concerned about the transition to a new government and the new mining regime. Even though we’re probably looking at increased taxation there, it’s a pretty supportive jurisdiction and has gone through a fairly orderly regime change. I expect that investors will over time become more comfortable with West Africa.
TGR: Summer is traditionally the weakest season for precious metals equities. Is it prudent for investors to buck the prevailing wisdom and take positions in gold and silver companies now?
AK: The history of the last 20 years has demonstrated the wisdom of summer buying. The seasonality analysis BMO did last year concluded that investors who bought in June and sold in September realized average returns of 9–10% 8 times out of 10. This is a real opportunity, and investors should pay attention.
Andrew Kaip is managing director of mining equity research at BMO Capital Markets. Previously, he worked as a mining analyst at Haywood Securities, most recently covering gold and silver junior exploration and mining companies. Prior to that, he served as a project and consulting geologist for more than 10 years. Kaip received his Bachelor of Science in geology from Carleton University and his Master of Science in economic geology from the University of British Columbia and is a professional geologist.