'Lean and Mean' Is the Secret to Junior Mining Equity Success: Thibaut Lepouttre

The Gold Report: In January, you told The Gold Report that the price of gold is driven by market panic and inflation, neither of which looks imminent. If investors can't expect higher gold prices in the near term, why should they be in this space?

Thibaut Lepouttre: I've never been a goldbug but I see gold as a form of asset diversification. There's nothing wrong with having some exposure to precious metals in a portfolio, both in the physical form and in the form of precious metals mining equities. Mining companies are much like any other company. You should find the ones that have free cash flow or have set their sights on positive cash flow, even when the gold price is range bound. It's up to investors to make sure that they know what they own and understand the financial situation of those companies.

TGR: How are you playing this space?

TL: I want reliable, low-cost precious metals producers and some companies with development-ready projects. I try to identify companies with projects that are viable at the current gold price and that should be able to get financing because their projects' internal rates of return (IRR) are still acceptable at $1,200/ounce ($1,200/oz) gold or lower. I avoid companies with projects with high capital costs because the markets want companies that are small, lean and mean. I'm not investing in companies that need gold at $1,500/oz or $2,000/oz to make a project work.

TGR: You're based in Belgium. Greece recently made a $224 million ($224M) payment to the International Monetary Fund (IMF). Essentially, that's an interest payment on its European "credit card," but the country is still negotiating with the IMF, the European Central Bank and the European Commission on its next bailout. How do you expect these negotiations to unfold?

TL: It was really the European Union's (EU) credit card that was used to make the payment because Greece asked all its public services to wire cash to Athens as an emergency measure. The big question is where will Greece get the money for its next payment? The treasury in Athens is running on fumes. Greece has to repay about €6–7 billion (€6–7B) over the next two months. It's a tricky situation, but Greece is probably in the driver's seat because the EU clearly does not want Greece to leave the Eurozone (for now).

But would Greece be willing to leave the euro and go back to the drachma? It would in a heartbeat. That would once again give Athens a sovereign currency. The drachma would be weak but that would boost exports and attract more tourists, especially from Russia. European leaders are trying to make it sound as if Greece has to stay, but Greece doesn't have to do anything. If Greece leaves the Eurozone, it would be an important catalyst for gold because that would increase uncertainty in the markets.

TGR: Which countries in the Eurozone are closely watching these negotiations with Greece?

TL: The southern countries are really following the negotiations closely because if Greece exits, there's no reason for these countries to stay in the Eurozone; it's much easier for them to go their own way. It's the idea of a unified European Union that is causing the governments in the western and northern countries in the Eurozone to make sure that a solution is found because they would lose face if the EU failed.

TGR: There is a critical IMF meeting in about a month. Could that be pivotal for gold?

TL: You're alluding to the IMF meeting that will decide the compilation of the Special Drawing Rights (SDR) basket. The Chinese have requested that its currency be included in the SDR basket, which currently consists of the Japanese yen, U.S. dollar, euro and British pound. Gold could also potentially be included in the basket but I don't think the yuan nor gold will be included, at least not yet. It will be interesting to hear the Chinese arguments. China has not updated its gold reserves in a long time. It wouldn't surprise me to see China update its official gold reserves just before that meeting. If China chooses to disclose its gold reserves, it will show that China is serious about getting the yuan included in the SDR basket. It might be the main factor that the IMF considers.

TGR: What range do you expect gold to trade in through the end of this year?

TL: It depends whether Greece collapses or not. We're still in the same range where we saw strong support at $1,175–1,180/oz, but we also saw strong resistance at $1,220–1,225/oz. The range is definitely narrowing. Once we break out of that range, either in a positive or negative way, we will see a big move in the gold price.

TGR: Which elements of junior developers are you most focused on with gold around $1,200/oz and financing still at a premium?

TL: Investors should try to focus on high-margin projects with low capital and operating costs because the financing environment remains difficult. Mining projects with high IRR numbers will attract the necessary financing to move ahead and will always command a premium over other assets. The second priority is low geopolitical risk. I'm avoiding high-risk countries like the Democratic Republic of the Congo and South Africa.

TGR: Do the essentials change for the smaller companies like the explorers?

TL: It's a good time to be an exploration company with cash because diamond-drilling costs are the cheapest they have been in almost a decade. The all-in cost for diamond drilling is less than $100/meter ($100/m) in North America. The cost was $250–270/m four years ago. On the negative side, the explorers operating in remote areas will have a tougher time because it will cost them three or four times as much to drill the same hole.

TGR: What are some companies you are following among the developers?

TL: The first one is Integra Gold Corp. (ICG:TSX.V; ICGQF:OTCQX), which is advancing the Lamaque gold project in Quebec. You can't get any safer than Quebec. It's a high-grade gold deposit with 1.1 million ounces (1.1 Moz) gold at about 10 grams per ton (10 g/t), but there is potential for much more. Recent drill results indicate that the Triangle zone could be much larger than originally thought. Drilling intersected about several meters in excess of 0.5 oz/t gold, which is much better than the average grade at Lamaque. That prompted Integra to increase this year's drill program to 50,000–75,000m. The after-tax IRR in its updated preliminary economic assessment (PEA), which includes the new mill, is 59% based on a gold price of $1,175/oz. Those are numbers that get any mid-tier or senior producer drooling.

TGR: Do you think Integra is going to have any trouble raising the capital it needs to continue development?

TL: In the past 11 months the company has raised about $30M, including an oversubscribed $13M financing a few weeks ago. It shows that good companies with good projects can still get their hands on cash. This will continue as Integra builds value at Lamaque.

TGR: What are some other companies you're following?

TL: I recently visited Red Eagle Mining Corp.'s (RD:TSX.V) Santa Rosa project in Colombia and I liked what I saw. There were paved roads from Medellin to close to Red Eagle's camp, about 8 kilometers (8km) away, with a decent dirt road connecting the base camp with the paved road. The team at Santa Rosa has worked hard to gain approval from the local community. About half of the capital requirements and 90% of the operating expenditures for Santa Rosa are in Colombian pesos, which have lost about 20% of their value versus the U.S. dollar since the feasibility study was published. That should allow Red Eagle to shave off about $5M from its initial capital requirements, and its all-in sustaining costs at Santa Rosa could be less than $700/oz. Orion Mine Finance put $65M into the project on the condition that Red Eagle raises another $15M. I expect that to happen in the next few weeks. The company is eager to start building its processing plant.

TGR: You have noted the importance of jurisdiction. What are your thoughts on Colombia?

TL: Red Eagle has all the community support it needs and is fully permitted. It's going to be an underground mine. That means there won't be any scars on the landscape because this is not your typical low-grade, open-pit copper-gold project in Colombia. The impact will be minimal. It's also a case study for the Colombian government because it wants to show its foreign investors that mining works in Colombia. The country was a net oil exporter before the oil price collapsed, so it needs to find another revenue stream to compensate for the lower oil revenues.

TGR: What are some other developers that you are following?

TL: I'm keen on Columbus Gold Corp. (CGT:TSX.V; CBGDF:OTCQX). It will release a PEA on its Paul Isnard project in the next few weeks. The outcome should be quite positive because in a recently updated resource estimate Columbus announced that it had almost 5 Moz gold at an average grade of 1.5 g/t, which is good for an open pit. And the euro has depreciated against the U.S. dollar, so it has become cheaper for Columbus Gold to mine in French Guiana, which uses the euro as its currency. It will cost $350–400M to build and I expect it to have a net present value (NPV) north of $500M. That's based on the 5 Moz in-pit resource, but that's based on about half the strike length of the mineralization. I am confident that several million ounces ultimately will be added into the mine plan.

TGR: It has a big partner there in NordGold N.V. (NORD:LSE). What is French Guiana like as a mining jurisdiction?

TL: Mining has been going on in French Guiana for several hundred years. A few years ago, the French government issued a new map of the area that states where underground mining is allowed and where open-pit mining is allowed. France is trying to create a framework to attract modern mining companies to French Guiana. Columbus Gold's Paul Isnard project is located in the zone where open-pit mining is permitted, and about a month ago the company hosted officials from French Guiana and Paris to make sure that they really understand its project.

TGR: What are some companies that you are following among the explorers?

TL: I recently spent two days with Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX) CEO Bill Howald in Nevada. I was most surprised by the Lincoln Hill project, which is located just 3km from Coeur Mining Inc.'s (CDM:TSX; CDE:NYSE) Rochester gold-silver mine. The Lincoln Hill economics look good on paper but there is potential to improve those numbers. Metal recoveries are much higher at the nearby Rochester mine, which is processing essentially the same ore. Rye Patch believes that by adding crushers to the processing circuit it could boost gold recovery rates to 90% and to 60–65% for silver. That would immediately add $25–30M to the Lincoln Hill NPV. That's something that the market hasn't realized yet.

The company also has a heap-leach project in Nevada called Wilco that's next to Interstate 80. It has an NI-43-101-compliant resource of 1.3 Moz gold in the Measured and Indicated category, and an additional 0.5 Moz in the Inferred category. Newmont Mining Corp. (NEM:NYSE) has a back-in right on Wilco once Rye Patch completes a feasibility study. But instead of spending $10–15M to finish the study, Rye Patch will probably go back to Newmont and try to negotiate a better deal to make sure that it's a win-win for everyone. If Rye Patch is successful, it could change the company overnight.

TGR: Some people believe Coeur Mining will eventually buy out Rye Patch to extend the life of its Rochester mine. Is that your view?

TL: It's a possibility, but I think Coeur would prefer to first see a more advanced study on Lincoln Hill. I think it would make sense for Coeur to buy Lincoln Hill but not the entire company.

TGR: What about other companies in Nevada?

TL: Pilot Gold Inc. (PLG:TSX) is a favorite in Nevada. What I like most about Pilot is that it has about $17M, or about CA$0.20/share, in working capital. It's a well-financed group that seems to be hitting the right targets. It owns 79% of the Kinsley Mountain gold project in Nevada. This year Pilot will explore the northern part of Kinsley Mountain in order to find more high-grade, Carlin-style mineralization. It has budgeted $2–2.5M for about 11km of drilling. We should see a maiden resource estimate early next year and my calculations suggest there should be about 1.1–1.3 Moz gold there.

TGR: In a better gold market, would we have seen some more interest in Pilot Gold's assets in Turkey?

TL: Absolutely. Pilot Gold's assets in Turkey are great but they are in a joint venture with Teck Resources Ltd. (TCK:TSX; TCK:NYSE), which limits some possibilities. Even though Pilot Gold has made a major silver discovery and has a lot of copper and gold there, it could prevent a potential suitor from acquiring Pilot Gold because it could not own the project outright. Perhaps a third party will buy both Pilot Gold and Teck's interests or maybe Teck will consolidate the area.

TGR: What other explorers have your attention?

TL: Farther up north is TerraX Minerals Inc. (TXR:TSX.V), which is operating the Yellowknife City gold project, about 4km outside Yellowknife in Canada's Northwest Territories. It's one of the last undeveloped high-grade gold camps and TerraX has a 100-square-km land package there. The summer drill program will start in June and we should see more results from the winter drilling program soon. The company was drilling the Barney Shear zone where one intercept yielded 22m of 6 g/t gold, which is phenomenal. I like that management owns about 20% of the company.

TGR: TerraX is working on a gold system that once hosted two significant mines. How did it get these assets?

TL: TerraX picked them out of a bankruptcy procedure for next to nothing. Now TerraX CEO Joe Campbell has the right people to advance the Yellowknife City project. TerraX could have the next high-grade gold deposit in Canada. I hope to see a resource estimate by the end of 2015.

TGR: You recently started following some gold toll-milling companies. Why do you like that model?

TL: These businesses work because it does not make sense for small-scale and artisanal miners to build mills; they only produce 20 or 30 oz/month. Moreover, toll-milling businesses are semi-independent from the gold price because revenue per ton is more or less fixed, depending on the tonnage versus the gold price. Compared with gold miners, these service providers are less subject to market sentiment.

TGR: What are some companies you're following in that space?

TL: The first one is Dynacor Gold Mines Inc. (DNG:TSX). It operates a 250 ton per day (250 tpd) mill in Huanca, Peru. It recently announced that it has the permits to increase capacity to 300 tpd. It also received a permit to build a new plant in Chala, Peru. Dynacor also has an exploration project called Tumipampa. I hope that Dynacor monetizes that asset in the next 18–24 months because Dynacor should not develop Tumipampa alone.

The other one is Inca One Gold Corp. (IO:TSX.V), which operates a 100 tpd mill in Chala, almost next door to where Dynacor will build its new mill. I visited Inca One's mill in December. The company is ramping up to 100 tpd from about 70–75 tpd right now. At the current throughput rate, Inca One should already be cash flow positive. Inca One has started to increase ore deliveries to the mill in order to continue to incrementally ramp up throughput. The company is now sourcing high-grade ore from Bolivia, which is not far away. The ore from Bolivia runs about 1 oz/t, probably with a substantial silver credit. Once the mill ramps up to 100 tpd sometime this summer it can start looking to either expand again or buy another mill somewhere else. There is a lot of demand from small-scale and artisanal miners for toll milling.

TGR: If Dynacor and Inca One have mills next to each other, wouldn't that competition for mill feed drive down margins?

TL: The average grade of the ore that the toll millers are processing is high enough that it makes sense to truck ore from up to 1,000km away. It's common to see trucks traveling up to 12 hours from all parts of Peru to deliver ore to the mill. There's sufficient ore available in a 1,000km radius around both mills to ensure that both companies can successfully coexist.

TGR: Finally, what are some junior mining stories that you're following outside of the precious metals space?

TL: Let's start with copper. I recently visited Nevada Copper Corp.'s (NCU:TSX) Pumpkin Hollow copper project in Nevada, where the company has completed its production shaft for the underground portion of the deposit. It is now working toward an integrated feasibility study, which would see the company combine its open-pit and underground mine plans into one big plan. The results should be published by the end of May. Pumpkin Hollow is one of the last huge copper resources in North America. It contains about 5 billion pounds (5 Blb) copper, and more copper is found every day. Nevada is mining friendly. The nearby Anaconda copper mine produced almost 2 Blb copper over 30 years beginning in 1952. Nevada Copper is going to attract some senior producers.

TGR: Nevada Copper was courting suitors five years ago. What is the stumbling block?

TL: It finished the initial feasibility study three years ago and decided to start construction on its own and keep the underground deposit for itself, while potentially seeking a partner to develop the open pit. The plan changed when some potential partners demanded an integrated feasibility study. We could see a completely new mine plan where both zones are mined simultaneously but it will cost more than $1B to get the open pit into production. These aren't decisions you make overnight.

TGR: What are some other non-gold names?

TL: I also follow two tungsten companies. The first is Blackheath Resources Inc. (BHR:TSX.V). It recently released a maiden NI 43-101 resource estimate at the Covas project in Portugal, which contains about 1.2 million metric ton units (1.2 Mmtu) at almost 0.4% tungsten. That's a capped grade and a capped resource. If you go through the data and ignore the capping, I see at least 1.5 Mmtu of tungsten at an even higher grade. The 0.4% grade sounds low, but the Hemerdon tungsten project in the U.K. will have a production cost of about $160/mtu at a grade of just 0.19%. Blackheath has four other tungsten projects, one of which is Borralha, where a drill intercepted almost 120m of 0.29% tungsten. Blackheath is in the right place with the right people and is advancing its projects.

The second tungsten company is Carbine Tungsten Ltd. (CNQ:ASX) in Australia. It recently signed a deal with Mitsubishi Corp. (MSBSHY:OTCPK) whereby Mitsubishi would arrange financing and sign an offtake agreement for tungsten from Carbine's flagship Mount Carbine tungsten project in North Queensland. Mount Carbine should be in production by Q2/16. It's going to be a fairly small operation producing 70,000–75,000 metric ton units (70–75 Kmtu) annually. That's about $20M in revenue. It doesn't sound like much, but operating costs will be extremely low as it's a stockpile project. Carbine should generate at least $6–7M in cash flow—not bad for a company with a $40M market cap. It's probably going to be the world's next best tungsten producer, along with Wolf Minerals (WLF:ASX).

TGR: Perhaps one more?

TL: I was recently introduced to Cancana Resources Corp. (CNY:TSX.V), which is producing manganese in Rondonia, Brazil. It has the highest-grade manganese ore in the world at 54%, whereas most competitors are producing at grades of 40–46%. Because it is such high grade, the manganese will be used as fertilizer. Brazil has a huge agricultural sector and these farmlands need additional nutrition. The company is backed by the Sentient Group, which owns about 50% of Cancana and a stake in the project. The project produced less than 5,000 tons (5 Kt) agricultural grade manganese last year. The total capacity is 20 Kt/year. Cancana should increase output this year, and next month it will launch the first ever drill program on the property. Once Cancana puts out an NI 43-101-compliant resource estimate, the market should start to appreciate Cancana. Cancana's target is to produce between 1 and 2 million tons/year of manganese.

TGR: What is agricultural manganese?

TL: Basically, it's used to correct a manganese-deficient situation in the topsoil. Over time, the manganese layer gets eroded and especially soybean plants have a hard time growing on manganese-deficient farmland. By adding manganese to the soil, this problem gets corrected. Cancana Resources is also quite lucky to have its mine relatively close to some soybean plantations. I would expect those plantations to be the most important potential customers of Cancana.

TGR: How do you maintain your optimism in this space?

TL: You always need to make sure that you understand the markets. I strongly believe that should gold go back to $1,000/oz, it will not stay there. It is going to be one of those V-shaped corrections as we saw in 2007–2008, and then it will move back up again. China and Russia are still buying gold and they will buy even more if the gold price goes as low as $900/oz. But I wouldn't be unhappy if gold were to stay at near current prices.

TGR: Thank you for your insights, Thibaut.

Caesars Report, a newsletter and mining portal based in Belgium that covers several junior mining companies with a special focus on precious metals and base metals. Lepouttre has a Bachelor of Law degree and two economics masters degrees that have forged his analytical approach to the mining sector. Considered a number cruncher, Lepouttre focuses on the valuations of companies and is consistently on the lookout for the next undervalued mining company.