Christos Doulis, mining analyst with PI Financial, hopes for the best but
plans for reality. The bear market in precious metals is well into its fourth
year and could persist into 2016. In this interview with The Gold Report,
Doulis says he remains hopeful that this is the year things take a positive
turn, but in case we see more of the same, he recommends a few low-cost
producers with saintly management teams that keep delivering on promises.
The Gold Report: In September 2014, you told us
that investors needed to own bulletproof, low-cost producers that can survive
lower gold prices. What is your investment thesis for this point in the bear
market?
Christos Doulis: Unfortunately, not much has changed. We certainly
do not appear to be in a bull market for gold. All of us would like to see
higher prices. They may come at some point in the future but no one knows
when that will be. So in the short and medium term, I would continue to recommend
owning the lower-cost producers in order to protect oneself from the chances
of insolvency.
TGR: What is your technical analysis of the recent performance of
gold telling you about what we're headed for?
CD: I am still negative. When I look at the trend over the last
year or so, there's been quite a bit of volatility, but in general, the highs
keep getting lower, and the lows are getting a bit lower as well. For
instance, in January 2014 we had a rally that went close to US$1,400 per
ounce (US$1,400/oz) before it petered out. Then we had another rally in
January of this year when gold got closer to US$1,300/oz, not to that
US$1,400/oz level, before it started to give back the gain. If you draw a
channel on the gold price, it certainly looks as if we have not reversed
course yet. The highs keep getting a bit lower on the volatility, and the
lows have been lower. Then again, gold popped US$20/oz in early April. If
gold could sustain a rally to US$1,250/oz, I would start feeling a little
more enthusiastic about the space.
TGR: What is your prognosis for this bear market?
CD: My personal view is that I'm hoping for higher gold prices in
the second half of 2015, and hope to see a return to an upward trend in the
metal's price. My view is that we are still in a long-term bull market for
gold but that after a 10-year bull run, we needed some pullback. This
pullback has been particularly vicious, but what else is one to expect after
gold went from US$300/oz to US$1,800/oz in a decade?
TGR: What price would gold have to sustain before you were willing
to declare the bear dead?
CD: If I saw gold trading north of US$1,350/oz, I would start to
think that even higher prices might be coming and the bear market was dead.
TGR: What are your price decks for gold and silver?
CD: We use US$1,250/oz gold and US$19/oz silver.
TGR: You have seen a few cycles in your 20 years in the space. What
are two or three things you have learned about this bear market that were
perhaps not evident in others?
CD: The one thing I've taken away from this bear market is the
longer the run-up, the more painful the correction. I thought that last year
would probably be the worst. When gold peaked in 2011, I was not surprised to
see a correction. I certainly thought that US$1,300/oz gold was in the cards,
but I did not see US$1,150/oz gold as likely. I have definitely concluded
that the market can be much more pessimistic than you can, and it certainly
isn't going to turn just because you want it to. As I said, I was thinking
2014 would be the year when we would see a reversal in gold prices. Now, I'm
hoping for the second half of 2015.
TGR: Miners have reduced their costs in order to boost margins at
US$1,200/oz gold, but some, not all, are doing that by mining the
higher-grade portions of their deposits. Were miners high grading to the same
degree in previous downturns?
CD: My take on it is some miners are definitely high grading, but
good miners aren't. They understand that if you high grade a mine, you not
only reduce its longevity by removing the high grade, but in effect you
reduce it even more because all that you have left is low grade, which might
never be economic. Imagine you have a deposit that has different zones
grading various grades. If you blend them all, you can deliver, call it, 8
grams per ton (8 g/t) to the mill, but if you high grade it, you can deliver
12 g/t. The problem is that means you deliver the high grade for a couple of
years, but then you're stuck with delivering 6 g/t or 4 g/t material to the
mill. It could mean that entire portion of the deposit is no longer economic.
Good CEOs are loath to high grade and, instead, they focus on cost reduction.
That is the bigger trend.
TGR: Do you learn more about a management team in a downturn?
CD: Absolutely. When gold is trending upward, it covers a lot of
mistakes, and the market is more forgiving. When gold is trending downward,
we see who the quality executives are because they're the ones who are able
to reduce costs without jeopardizing the longevity of their operations. It
goes back to the concept of high grading. Good CEOs in the last couple of
years have been the ones who have said, "We're going to reduce
costs," and have actually done so.
In bear trends like this, if you promise X and you deliver half of X, you
get penalized. This is a market where sins are not quickly forgiven.
Therefore, the people who don't sin, vis-à-vis the better CEOs who meet their
prognostications, are the ones that the market rewards. Also, as an analyst
it allows you to figure out what groups really know their asset(s) and
understand how to drive the business from a cost perspective.
TGR: Who are the saints? Who are the sinners?
CD: When I look at the saints in my universe, Rio Alto Mining
Ltd. (RIO:TSX; RIOM:NYSE; RIO:BVL) has just been stellar. Not only has
President and CEO Alex Black delivered at La Arena, but to do a deal on
Shahuindo and then to do a deal with Tahoe Resources
Inc. (TAHO:NYSE; THO:TSX) within a year is impressive. He is focused on
operations, but certainly hasn't left mergers and acquisitions (M&A) off
the table.
I like Endeavour
Silver Corp.'s (EDR:TSX; EXK:NYSE; EJD:FSE) management. The company has
reduced costs at its Mexican mines but the silver price has fallen harder and
faster than the cost savings Endeavour has delivered.
Another company I would like to talk about is Orvana Minerals
Corp. (ORV:TSX), which I just launched coverage on. It has the El
Valle-Boinás/Carlés mine in Spain that produces 65,000 ounces (65 Koz) a year
and the Don Mario mine in Bolivia that produces around 20 Koz/year.
Management has driven costs down at both operations.
Orvana was in a tough financial situation a couple of years ago with US$64
million (US$64M) in Credit Suisse debt looming. Falling metals prices brought
challenges at its operations but the company paid off the Credit Suisse debt,
so other than some minor (~US$5M) bank debt, Orvana is essentially debt free.
That shows you what good management can do. Orvana appointed Michael Winship,
a mining engineer by trade, as CEO a couple of years ago after a stint as
director. He was facing challenging times given Orvana's debt and falling
metals prices but he helped bring the company out of the wilderness and
establish it on much more sound footing. He recently announced his retirement
as CEO, although he remains a consultant to Orvana.
The biggest challenge with Orvana is that one shareholder owns around 52%
of the stock, which limits trading and appeal to institutional investors. I'm
hoping that Orvana will grow by acquisitions, which could dilute that holder
from 52% down to where that concentration of ownership no longer scares off
Canadian institutions. Plus, you get a bigger story by adding an asset or
two. I feel comfortable talking about mergers and acquisitions (M&A) with
Orvana because with the addition of Gordon Bodgen and Gordon Pridham to the
board—both of whom have extensive M&A experience—the company is clearly
looking at strategic alternatives.
TGR: And the sinners?
CD: When it comes to groups that have done poorly, the senior
producers are in the penalty box from the investors' perspective. Many of
those companies have made big acquisitions at the top of the market and
failed to deliver on either the cost savings or other promises made to the
market. Senior producers like Kinross Gold Corp. (K:TSX; KGC:NYSE) and
IAMGOLD Corp. (IMG:TSX; IAG:NYSE) have been considered out of favor for some
time due to large acquisitions at the top of the market.
TGR: What are some companies you're covering that are positioned to
weather another two years of stagnant or lower gold and silver prices?
CD: From my coverage universe, one company that is positioned to
really weather the storm is GoGold Resources Inc. (GGD:TSX), which is producing at
Parral at cash costs of around US$6/oz silver and all-in costs certainly
below US$10/oz. So it's well positioned to weather ongoing low silver prices.
TGR: When do you expect Parral to reach commercial production?
CD: I have been told that it is imminent. We should see that happen
in this month.
TGR: The Santa Gertrudis project in Sonora, Mexico, is at the
preliminary economic assessment stage. When do you expect a production
decision? Could GoGold fund development alone?
CD: The company recently received an environmental permit for Santa
Gertrudis and is waiting for a change of land use permit and final
engineering on some of the specifics relating to the project. I expect it to
begin construction fairly soon, sometime around Q2/15. I don't think GoGold
is in a situation to finance it out of existing resources, so it will likely
need to do an equity raise or some other form of capital raise. It has Parral
up and running, so one would think it could borrow a little more.
The jury is certainly out on Santa Gertrudis, but on paper, it looks as if
it's going to be a low-cost asset. Although I was skeptical initially of
Parral, GoGold management has done a great job. If you believe that they knew
what they were doing on Parral, hopefully, they'll know what they're doing on
Santa Gertrudis. GoGold is certainly one to watch over the next while, as is
Orvana.
TGR: What are some companies you cover with noteworthy news?
CD: I cover Premier Gold Mines Ltd. (PG:TSX), a development company
that has effectively no revenue. It just inked a deal with Centerra Gold
Inc. (CG:TSX; CADGF:OTCPK) for its Trans-Canada gold project in northern
Ontario. As part of the deal, Premier received an immediate CA$85M cash
payment, which goes a long way in this environment. While Premier, as a
development company, is subject to market availability for capital, right now
it is basically fully cashed up. Centerra will spend CA$185M on the project
before Premier has to spend another dime. So Premier's CA$85M from the deal
plus the cash that it had previously gives it a lot of flexibility to advance
its other projects even in a weak metals price environment.
TGR: What's the earliest Trans-Canada could enter production?
CD: It's pretty far out there. I'm hoping to see the first gold
pour in 2017 and commercial production in 2018.
TGR: Premier sold a 50% interest in Trans-Canada for CA$185M. Why
didn't Centerra just buy Premier outright?
CD: In order for it to be a friendly deal, Premier wanted to
maintain its independence. Premier wants to continue advancing its other
projects, like those in Nevada. I wouldn't be surprised if that discussion
happened but I don't think Centerra wanted to pay a big premium for the whole
enchilada, given that Hardrock is the focus.
TGR: Any others with news?
CD: Sierra
Metals Inc. (SMT:TSX) just significantly expanded the resource at
Yauricocha, its flagship mine in Peru. The previous resource was in the
neighborhood of 6 million tons (6 Mt). It's now 11 Mt, so huge growth. The
challenge is that the grade has gone down. My net take here is, yes, the mine
is going to run for a lot longer, but that doesn't necessarily add a lot of
value given that grades have gone down. The grade had been in the 70 g/t
silver range; it's now in the 50 g/t silver range. More marginal material is
getting included in the resource. Part of that is driven by lower per-tonne
costs that the company is experiencing. It's good to show the longevity of
the asset, and I don't think it changes the cash flow from the asset in the
short term. Its guidance for 2015 is already out, and I suspect 2016 will be
a similar year.
TGR: Could you give our investors a reason for optimism in this
space?
CD: One reason for optimism is the abounding pessimism in the
marketplace. An old adage is "buy when others are selling." Nothing
has changed in the grand perspective of post-financial crisis money creation.
The only thing that has not happened is visible inflation, and that's why
we've seen interest in this space decline. There has never been an economic
recovery that has been solely created by monetary expansion that doesn't come
with inflation.
While everyone is worried and nattering about deflation, if we ever see a
real economic pickup, which we haven't yet, I think that precious metals will
start moving up again. And I want to remind your audience that gold had a run
from US$300/oz to US$1,800/oz before it came back to US$1,200/oz. Even at
US$1,200/oz, that's four times where it was at the beginning of the 21st
century. One of the biggest cases for optimism is that nobody is telling you
to buy gold stocks today. When everybody and their uncle are telling you that
this is the asset you have to own, whether it's gold, Internet stocks
or whatever, it's likely that you already missed the market.
TGR: Thank you for your insights, Christos.