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Gold bugs say the global economy could collapse any day now. But what
about investors who see continued growth in emerging economies and a steady,
if slow, U.S. recovery? Look to base metals, recommends Haywood Analyst
Stefan Ioannou. He expects price runs for
2013–2015, especially for zinc, which is facing a serious supply
squeeze. Do your homework now to get positioned as soon as the uptick begins.
Ioannou shares
his favorites in this Gold
Report interview.
The Gold Report: Stefan, what is your
2013 outlook for copper?
Stefan Ioannou: Strong fundamentals underpin the copper price
going into 2013. Despite a tough copper equity market in 2012, the metal
price itself has been pretty solid, averaging around $3.60 per pound ($3.60/lb). Improving automobile numbers out of the U.S. and
stronger manufacturing numbers out of China will both have a positive
near-term impact on the copper price. We expect copper prices to move a bit
higher in 2013.
"Strong
fundamentals underpin the copper price going into 2013."
TGR: How far off is a return
to $4/lb copper?
SI: I think 2013 is too
soon for a sustained $4/lb price, but it will
likely test that mark a few times in the coming year. There is a stronger
argument for a long-term $4/lb copper price.
TGR: Many of the copper
companies you cover also have a zinc component. Zinc started 2012 near $2,200
per metric ton ($2,200/mt), dipped to $1,750/mt at midyear and now hovers around $2,000/mt. What is behind the volatility?
SI: Primarily negative
sentiment. London Metal Exchange inventories remain near an all-time high of
~1.2 mt and there is continued concern that China
could flood the market at any time. Hence, the near-term outlook on zinc has
been weak. However, there is an interesting dynamic taking place: As we move
toward 2014, the market will be faced with a potential longer-term supply
deficit.
A number of large zinc
mines, which combined account for ~10% of global zinc supply, are scheduled
to shut down within the next two to three years when their reserves become
depleted. There are very few large, advance-stage zinc projects available to
fill in the supply gap. When the big mines close down, the squeeze on the
supply side will move the zinc price higher.
"A number of large
zinc mines are scheduled to shut down within the next two to three years.
There are very few zinc projects to fill in the supply gap."
The first big project
slated to shut down is Xstrata Plc's (XTA:LSE) Brunswick
mine, which alone accounts for almost 2% of global supply. The company has
talked about shutting the mine down for the last several years, but every
year Xstrata seemed to squeeze a little more zinc out. However, in March
2012, the company formally notified Brunswick's union of a planned shutdown,
as per a legally required one-year notice period. Hence, the writing is on
the wall.
The key is that there
are very few ways to play the zinc space—arguably only five or six
quality development projects. Even the majors are scrambling to find new zinc
assets. Given the limited number of publicly traded zinc-focused companies,
all are poised to do well in the event of a zinc price run.
TGR: In light of the
impending supply squeeze, what is your predicted zinc price average for 2013?
SI: We expect 2013 to be a
transitional year, so near-term pricing will likely remain in the
$0.90–$1/lb range. As for stock prices, we
anticipate people will start paying attention to the zinc space as the
supply/demand dynamic becomes more apparent, probably in the latter half of
2013. Looking further down the road into 2014–2015, we could easily see
prices jump up to $1.25/lb pretty quickly. From
there, the sky is the limit.
TGR: What is the industry
average in terms of cash costs of per payable pound of zinc?
SI: That is another
important consideration. With a copper price at $3.50/lb,
hypothetically almost every copper project on the planet could or should make
money, even the very low-grade ones. Even high-cost copper producers have
costs on the order of $2.00–2.50/lb, which
generates a solid margin at today's prices.
Margins are a lot
tighter in the zinc space. Most zinc projects carry total cash costs north of
$0.50/lb net of byproduct credits,
and a number are even higher at $0.70–0.80/lb. If zinc were to drop
below $0.75–0.80/lb, we would likely see a
number of higher-cost mines shut down because they would not be economic.
"There is one wild
card at play in the zinc space: China."
There is one wild card
at play in the zinc space: China. The country is able to bring a lot of new
supply into the market quickly. However, exact numbers are difficult to
forecast. That said, a lot of the Chinese production
comes from smaller, "mom-and-pop" mines, which carry higher costs.
Thus, even though there is potential Chinese production out there, it will
likely take a zinc price north of $1.00/lb to get
it out of the ground profitably. At a $0.90/lb
price, most of this Chinese production is arguably marginally economic at
best.
TGR: Should investors avoid
zinc plays until the latter half of 2013, when they can start to position
themselves for the shutdowns in 2014, or are there opportunities in the near
term?
SI: This is the time to do
your homework and figure out where you want to be when the zinc price starts
gaining momentum. I am telling clients to be aware of the zinc stories out
there; know now where you might want to put your money. You do not
have to buy them today or tomorrow, but be prepared to invest when the market
turns, because in the case of zinc it could turn quickly.
TGR: You mentioned earlier
the high margins on copper. What are the cash costs per payable pound of
copper?
SI: There is definitely a
range. The low-cost producers—especially those with a big gold or other
byproduct credits—are under $1/lb, net of
credits. My guess is that the average is closer to $1.25–1.75/lb.
High-cost producers would be on the order of $2–2.50/lb.
TGR: If a company's
management, jurisdiction and net asset value are for the most part equal, why
should an investor choose a base metals play rather than a precious metals
play trading at similar prices?
"This is the time
to do your homework and figure out where you want to be when the zinc price
starts gaining momentum."
SI: The answer to that question
depends on your outlook on the global economy. Growth in Asia, namely China,
and recovery in the U.S. will require a lot of materials. If you believe that
will happen, a portfolio slanted toward base metals stands to gain a lot.
But if you are more
worried about the economic situation in the U.S. and Europe, then there is an
argument to be more focused on gold, primarily as a hedge against inflation.
Investors need to ask themselves which story they are positioning themselves
for and tailor their portfolios appropriately.
Of course, historically,
precious metals—namely gold stocks—do trade at higher multiples
relative to base metals. Over the last 10 years, established base metal
producers have, on average, typically traded around 5 times cash flow,
whereas gold stocks have traded at over 12 times cash flow. That said, gold multiples have contracted more than those of base
metal over the last year or so.
TGR: What is Haywood's
prediction for gold's trading range in the first half of 2013?
SI: We expect levels will
stay stable in the $1,700–1,800 per ounce ($1,700–1,800/oz) range. Taking a longer-term perspective, we see costs
creeping up across the board for base metal and gold projects. Five years ago
if you talked about a gold mine that had a cash cost
on the order of $800-900/oz, people would have been
shocked. Today, that is not uncommon. Higher costs will only drive the gold
price higher over the long term.
TGR: How are companies
coping with the cost problem?
SI: Majors are focusing
efforts on cutting costs at existing operations, which has prompted them to
shelve large, longer-term development projects that have been plagued by
capital cost overruns and, in some cases, political challenges. There's a
greater focus on what is in production today. However, if anything,
this type of action will only lead to a supply issue in the
future—which bodes well for higher long-term metal prices.
TGR: Can you give our
readers the essentials of your thesis for the base metals plays you cover?
SI: In the short-term, the
most relevant base metal to watch is copper. It is the most widely used metal
and is the best indicator of the overall sector. With stronger auto sales in
the U.S. and stronger manufacturing in China, I see no reason why copper
would not trade north of $3.50/lb in early 2013. At
that price, copper producers will make a lot of money.
Of course, if a company
is in production and is generating good cash flow, investors will start to
ask what management is going to do with that money. I think the stage is set
for a significant amount of merger and acquisition (M&A) activity in the
base metals space, especially copper. Producing copper companies will
establish strong balance sheets pretty quickly. People do not invest in
mining companies so management can sit on cash. Investors want to see cash
redeployed for growth or delivered to shareholders as a dividend.
TGR: Let's move on to the
companies you cover. You have a Sector Perform rating on Nevsun Resources Ltd. (NSU:TSX;
NSU:NYSE.MKT), despite the fact that it is expected to halt
production for perhaps as long as six months at its 60%-owned Bisha gold, copper and zinc mine in Eritrea. Why did you
revise your target upward after this news?
SI: The recent target price
revision was fairly modest, from $4.75 to $5. It was little more than some
model tweaking based on the company's Q3/12 financial and operating results.
The overall thesis remains intact. Bisha is a
world-class volcanogenic mass of sulfide deposit (VMS). It is quite
high-grade, open-pittable and has been in
production since 2011. The initial focus was on a very rich oxide gold cap.
That is scheduled to be completely mined out in Q1/13 or Q2/13.
From there, Nevsun will move to processing supergene copper and,
eventually, primary copper and zinc sulfide material. During the transition,
there will likely be a production hiatus of at least three months. There are
several moving parts, including construction of a port facility to ship concentrate.
The key thing to be aware of is that, on paper, 2013 will be a lackluster
year for Nevsun. The company will likely have at
least one quarter without any significant positive cash flow from Bisha.
TGR: Does Nevsun have the cash to withstand the hiatus?
SI: Yes. The company's
strong balance sheet included almost $380M in cash and no long-term debt at
the end of September. As we get into 2014, Nevsun
will have a pretty rich base metals mine. Our $5 target will require patience
next year, and is more a reflection of the company's anticipated position
going into 2014, namely as an established base metals producer.
TGR: Why do we hear so
little about the geological and mining potential in Eritrea?
"The Eritrean
government recognized early on that it had to work with foreign investment to
make a mining industry a reality."
SI: People are not familiar
with Eritrea, and red flags typically go up when anything related to
Northeast Africa is mentioned. Nevsun was basically
the first publicly traded company to get into Eritrea. It made the Bisha discovery and over 10 years, took it through
exploration, permitting, development, construction and into production. Along
the way skeptics pointed to the risk of the government taking more than its
fair share of the project.
I give the Eritrean
government a lot of credit. It has been very pragmatic. The government
recognized early on that it had to work with foreign investment to make a
mining industry a reality, and not just with Nevsun.
The last time I checked there were about 15 exploration companies active in
Eritrea. I have been to Eritrea twice now and had very good experiences both
times. The common sentiment among visitors is that it was safer than they
expected.
Sunridge Gold Corp. (SGC:TSX.V) is also active in
Eritrea, as is Chalice Gold
Mines Ltd. (CXN:TSX; CHN:ASX). The latter is
exploring for VMS deposits along the same belt that hosts Bisha,
and recently announced a discovery.
TGR: Sunridge
just published a resource estimate for its Adi Rassi discovery. Given the size and scope of the deposit
and Sunridge's lack of cash, could this be a
takeover target?
SI: I think the Eritrean
government would like to see more than one foreign player developing the
mining industry in Eritrea.
With respect to takeover
potential, I think the completion of a feasibility study, expected in Q2/13,
on the company's Asmara project will be key. The
feasibility study will not include Adi Rassi. It is based on four other projects, the Emba Derho, Debarwa
and Adi Nefas
copper-zinc-gold and silver deposits and the Gupo
gold deposit. That said, Adi
Rassi is located near Debarwa
and could ultimately develop into the Asmara project's fifth deposit.
Also important for Sunridge is the Eritrean government's intention to buy
upwards of a 30% interest in the project, similar to what it did with Nevsun at Bisha. The price
still needs to be determined. That may happen before the feasibility comes
out or the government may use the feasibility study as the basis of the
valuation.
The government paid fair
value to Nevsun and we expect the same to happen
with Sunridge. Once the government does that, it
will signal a vote of confidence to the investment community that things are
moving in the right direction.
The feasibility study,
of course, will give us a better handle on the project's economics and what
it should be worth. The big questions include what it will cost to build it,
how much money Sunridge will have to raise, and
what that means from a dilution point of view.
TGR: What other companies
would you like to share with our readers today?
SI: The whole base metals
space was beaten up this year, so it's a good time to move higher up the food
chain. Producers are typically safer than exploration companies.
Copper Mountain
Mining Corp. (CUM:TSX) has a mine of the same
name in British Columbia. It restarted production at the brown fields project in mid-2011 and ramp-up has been slow.
Issues getting the mill up to capacity caused some market frustration. But
those issues seem to have been addressed through the latter half of Q3/12.
Once we see the
company's Q4/12 numbers, we should have a much better idea of what Copper
Mountain will look like in terms of steady-state metrics. We hope to see the
stock rerated on the back of that news. Right now, it is not trading like an
established base metal producer, even though it effectively is.
Copper Mountain owns 75%
of the mine. Mitsubishi Materials Corp. (MMC:FSE) purchased the other 25%
interest from Copper Mountain in 2009 for $29M and concentrate offtake, and arranged debt financing to cover a
significant portion of the project's $438M capital cost.
TGR: How about some names in
the zinc space?
SI: As we discussed, zinc
will be lot more attractive in late 2013. Now is the time to identify stories
with potential. I would suggest investors look at companies like Trevali Mining Corp. (TV:TSX; TREVF:OTCQX) and Donner Metals Ltd. (DON:TSX.V). Both are near-term
producers that will be well-positioned to benefit from a zinc price run in
2014 or 2015.
Moving a little bit down
the food chain to the developers, Foran Mining Corp.
(FOM:TSX.V) has a VMS project, McIlvenna Bay, with a significant zinc component. The
deposit is in the Flin Flon
mining belt, the stomping ground of HudBay Minerals
Inc. (HBM:TSX; HBM:NYSE). This area is home to the
777 and Trout Lake mines, and the $700M Lalor
project, which is under construction. McIlvenna Bay
is located in east central Saskatchewan, but it is the same geology that
hosts the Manitoba-based Flin Flon
deposits.
What distinguishes Foran is that the company owns 100% of McIlvenna Bay. Most of the other juniors in the area are
underpinned by joint ventures with Hudbay. If they
discover anything of significance, Hudbay has the
option to back into the lion's share of those projects. It is not
unfathomable to think that one day Hudbay may be
interested in McIlvenna Bay, but the mid-tier won't
have the luxury of low costs right now.
The current resource at McIlvenna Bay in all categories totals over 20 Mt. That
puts it in the top five largest deposits ever found in the world-class camp.
Given that it is within 60 kilometers of the town of Flin
Flon, Hudbay's home base,
there is plenty of established infrastructure in
place, and most importantly, a hungry smelter.
TGR: Would Hudbay have to make any changes to its process circuit at
Triple 7 to process that ore?
SI: It is a bit too soon to
say. Foran completed some initial metallurgical
test work earlier this year and the results were promising. Because it is a
typical VMS deposit, in theory it would be a standard froth floatation flow
sheet: crush, grind, float and thicken to produced
copper and zinc concentrates. There might be some tweaking needed to
fine-tune recoveries, but it will not require a completely different process.
TGR: To finish, what should
our readers look forward to in 2013?
"With a bit of
improved sentiment, I think you will see the prices move higher."
SI: Improved sentiment.
This was a tough year, underpinned by a presidential election and economic
uncertainty in the U.S., the European debt crisis and mixed economic signals
coming out of China. At least now the direction is a little clearer and the
numbers coming out of China are improving.
That said, look at what copper did even in a tough year. It managed
to average around $3.60/lb—a pretty robust
price in the grand scheme of things. With a bit of improved sentiment, I
think you will see the prices move higher. With any luck, that will take the
equities along for a ride as well.
TGR: Stefan,
thanks for your time and your insights.
Stefan Ioannou has spent the last
seven years as a mining analyst covering mid-cap base metal companies at
Haywood Securities. Prior to joining Haywood, he worked with a number of
exploration and mining companies, as well as government agencies as a field
geologist in Nevada and throughout the Canadian Shield in both the gold and
base metal sectors.
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DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He
personally and/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: Foran Mining Corp and Sunridge Gold Corp. Streetwise Reports does
not accept stock in exchange for services. Interviews are edited for clarity.
3) Stefan Ioannou: I personally and/or my family
own shares of the following companies mentioned in this interview: None. I
personally and/or my family am paid by the following
companies mentioned in this interview: None. I was not paid by Streetwise
Reports for participating in this interview.
4) As of the end of the month immediately preceding this publication either
Haywood Securities, Inc., one of its subsidiaries, its officers or directors
beneficially owned 1% or more of Donner Metals Ltd. and Sunridge
Gold Corp.
5) Haywood Securities, Inc. has reviewed lead projects of Copper Mountain
Mining Corp., Donner Metals Ltd., Nevsun Resources
Ltd., Sunridge Gold Corp. and a portion of the
expenses for this travel have been reimbursed by the issuer.
6) Haywood Securities Inc. or one of its subsidiaries has managed or
co-managed or participated as selling group in a public offering of
securities for Donner Metals Ltd. in the past 12 months.
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