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Cosmos Chiu, a director and
research analyst with CIBC in Toronto, focuses on midtier
gold producers, but his coverage gives him a leg up on truly understanding
royalty companies' assets. In this interview with The Gold Report, Chiu talks about how much longer royalty companies
could continue to outperform the rest of the market, while also discussing
companies he follows in some of his favorite jurisdictions.
The Gold Report: Gold spiked to about
$1,800/ounce (oz) after the latest round of
quantitative easing was announced. It was at about $1,700/oz
recently. What's responsible for gold's recent price weakness?
Cosmos Chiu: If you look back, the
month of October is usually the weakest month of the year. Because investors
look at it as a seasonably weaker month, there's less demand. That has held
true this year as well.
TGR: Could gold finish the
year higher than where it is now?
CC: Different factors that
could drive bullion higher in November and December, including the restocking
of jewelry for the winter holidays in the West and in India, the rethinking
of the role for gold following traditionally weaker markets in October, and
continued bailout concerns for Spain and Greece. It has also been a favorable
monsoon season in India as well. That should also help increase demand coming
from the Indian population.
TGR: Do you forecast
strengthening investment demand, too?
CC: Investment demand was
lower for the first half, but there's been strong central bank buying, which
certainly helps. Demand isn't just composed of exchange-traded funds.
TGR: What's your investment
thesis for midtier producers predicated on higher
gold prices?
CC: They're in the industry
of producing gold so higher gold prices don't hurt. Even though they're in
production, they're small enough to have meaningful growth ahead. It's not
that hard to grow a company by 20–30% during the next year if a company
has a starting base of 200,000 oz (200 Koz). Some of the midtier
companies benefit from dealing more with pure gold instead of base metal
byproduct credits, base metal contracts and smelter contracts. There's
sometimes less complexity in running these companies as well.
"While mining in
South Africa is well developed, a lot of opportunities are still currently
available to investors in other parts of the continent."
I just got back from
traveling to a road show in Europe—I go about twice a year. Investors
are still very bullish on the gold and silver prices. One key question that's
been unanswered in North America and across the pond is why have equities
underperformed the commodity and will that continue?
Costs, more or less, are
not stable—they're not going down, but they're not increasing at the
same rate they did before. Earlier, they were increasing at a faster rate
than the increase in the gold price. There has been some margin
deterioration. We don't have any concrete evidence that this has reversed,
but we certainly have seen some of the input costs moderate a little. That's
going to be a key driver for some share price catch-up to the underlying
commodity.
Companies' multiples
will start to move more consistently as investor confidence continues to come
back.
TGR: What about jurisdiction?
CC: People always like to
bring up political risk. But what is political risk? Is it higher taxes? The
risk of expropriation? The risk of war? To understand political risk,
investors have to understand all these different types of risks. And don't
ever forget about permitting challenges and issues like that. Investors need
to understand that there's a wider scope to political issues than what's
highlighted in newspapers.
TGR: What's the first thing
you would tell an investor interested in African gold plays?
CC: Africa is one of the
fastest growing areas in the world. While mining in South Africa is well
developed, a lot of opportunities are still currently available to investors
in other parts of the continent. I quite like Burkina Faso, Ghana, Sierra Leone. They provide good value for investors.
I'd also say it's a
mistake to lump together all countries in the entire region. There might be
issues in Mali, for example, but that doesn't mean all the other countries
are impacted.
TGR: Which countries in West
Africa are you most bullish on?
CC: I look for stability in
the government and exploration upside. The three that I like the most are
Burkina Faso, Côte d'Ivoire and Ghana.
I currently have an
outperform rating on Perseus
Mining Ltd. (PRU:TSX; PRU:ASX), which is one of the best
startups in the past year. Its operations at the Edikan
mine in Ghana are running really well. It met its targets and has a second
project, Sissingue, that's being built in
Côte d'Ivoire.
TGR: It's an interesting
project, but at the same time it's not into full-scale development because it's
awaiting the government's decision on something called a super-profits tax.
What do you know about that?
CC: The government is
planning to impose a super-profits tax on the gold industry, but in the end I
believe the goal of any tax rate changes in Côte d'Ivoire will be to
make it more comparable to other West African countries. The end result, I
believe, will be more of a catch-up to the norm rather than the government
trying to take all the economics away from that project.
For my modeling
purposes, I've already put in the higher tax assumptions and the project
continues to be profitable with a very good return on investment.
TGR: Is Perseus on target to
meet its production estimates?
CC: It is. It reaffirmed
last week its targets once again for fiscal 2013, which is the year ending in
June. Based on my numbers, I agree that it will meet those targets.
TGR: How much gold is Sissingue going to produce per year?
CC: It's going to be
producing close to >100 Koz life-of-mine, on top
of what it's producing at Edikan. My 12-to-18-month
target price for Perseus is $4/share and it's currently around $2.60/share.
TGR: SEMAFO Inc. (SMF:TSX;
SMF:OMX) recently made the
transition from one "Benoit" to another. Benoit La Salle, the
long-time president and chief executive officer of the company, handed the
reins to Benoit Desormeaux. Is that a positive
change?
CC: Benoit Desormeaux has brought something different to the table
even though he's been with the company for quite a while now as the chief
financial officer. His focus will continue to be generating value at Mana. He's only been at the job for a few months, but he
has the desire to generate value for investors by developing Mana, Samira Hill and Kiniero.
TGR: The cash costs from
operations at SEMAFO were higher than expected in the second quarter. Is that
something shareholders should get used to?
CC: Cash costs have
increased in the third quarter mostly due to mining lower-grades, closer to 2
grams per ton (g/t), when it had been mining 2.5 g/t in previous quarters. It
happens. Any deposit has lower-grade portions and higher-grade portions. I
don't think it's a long-term issue.
"I favor companies
that are more pure gold than the ones with a significant base metals
component."
Also, power isn't as
abundant as it would be in Canada or Mexico. A lot of costs are dependent on
fuel prices. There's a lot more power being generated by fuel.
SEMAFO was definitely
impacted by higher fuel prices early this year and last year. The reverse is
also true. As fuel prices moderate, SEMAFO and similar companies will have
more favorable cash costs.
TGR: You have a
12-to-18-month target price of $6/share. Its shares are currently trading
above $3. Where is that growth going to come from?
CC: Mana is the flagship asset and I expect that to
continue. It's had some exploration results from different areas within its
mining concession. There should continue to be upside in terms of resources
coming from Mana this year and into 2013.
TGR: Where will the next wave
of producers come from? What are some development-stage projects in West
Africa that you're keeping an eye on?
CC: West Africa is the most
favorable jurisdiction. There's a greenstone belt that goes through all these
different countries. It's quite simple. The more greenstone belt, the more
exploration potential for a country.
Mali has been a historic
producer of gold, but given the recent instability in the country,
exploration and production have been more muted of late.
One up and comer,
although it doesn't hold as much of the greenstone belt, is Sierra Leone. It
has several projects under development. Given the civil war that devastated
the country more than 10 years ago, it is looking forward to and very
supportive of foreign investment.
TGR: Are there some other
junior narratives that are compelling?
CC: Pilot Gold Inc. (PLG:TSX). I covered Fronteer Gold, which was eventually acquired by Newmont
Mining Corp. (NEM:NYSE) almost two years ago; Fronteer's management went on to create Pilot. The entire
management team stayed intact. When you invest in junior exploration
companies, you want to be investing with a good management team. I would say
that Pilot has a very good management team. It has some pretty interesting
assets in Turkey and Nevada, too.
TGR: Pilot Gold has a
preliminary economic assessment on Halilaga in
Turkey that said it has a net present value of $474 million and a 20%
internal rate of return, taking a little more than 2.5 years to pay that back
at $1,200/oz gold and $2.90/pound copper. Are those
numbers sufficient for development or does Pilot Gold need to make the economics
even more robust to reach a production decision?
CC: I was on-site last year.
The good thing about Halilaga is that there
continues to be upside potential. We don't have to sit back and say,
"This is all we have and is this good enough?" It has more
potential than what is being shown today. That certainly makes it more
attractive as a development decision. It also has a joint-venture partnership
with a very strong company, Teck Resources Ltd.
(TCK:NYSE; TCK.A:TSX), that would help to fund some
of the development needs.
TGR: Does Newmont still own a
piece of that as well?
CC: It does. Newmont
subscribed to the latest round of financing that Pilot Gold had. It topped
off and made sure that its percentage stayed the same.
TGR: How would you compare
Turkey to West Africa in terms of gold exploration potential?
CC: They are very different.
I was actually in Turkey two weeks ago on a mine tour. The mineralization is
different in Turkey because there is a larger silver component. The mining is
somewhat different in that there is more heap leaching. The infrastructure is
better.
However, gold mining is
not yet a huge component of Turkey's economy. There's a culture behind gold
production, of course, given the history of the country. That said, at this
time, it's not as well developed yet as Canada, Australia or other
jurisdictions with a longer, modern mining history.
TGR: Royalty companies have
been the sector's star performers over the last few years. How do you decide
which royalty companies to cover?
CC: To analyze royalty
companies well, you need to understand the underlying contracts and the
underlying mines. We have an advantage because we cover most of these
underlying mines that actually pay a royalty to companies like Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) and Silver Wheaton Corp. (SLW:TSX;
SLW:NYSE). At this time, I have
Sector Outperformer ratings on Franco-Nevada and Silver Wheaton.
You need to look at the
composition of these royalty streams. Where are they coming from? Is gold a
byproduct of these streams, are the economics driven by gold or is it driven
by silver or some other precious metals? How big of a component is each
stream of the total net asset value (NAV)? You never want a single stream to
dominate the NAV of a royalty company because part of the royalty attraction
is the diversification of risk.
I always say they're one
of the easier types of companies to cover—they tend to meet my earnings
and cash-flow targets quarter over quarter.
TGR: Do you expect royalty
companies to perform as well over the next three years as they did over the
last three years?
CC: It's certainly been a
good environment for royalty acquisitions. We've seen all three do accretive
deals within the last two months. For example, Silver Wheaton did a deal with
HudBay Minerals Inc. (HBM:TSX;
HBM:NYSE), Franco-Nevada purchased a royalty from Inmet
Mining Corp. (IMN:TSX) and Royal Gold topped up its royalty at the Thompson
Creek Metals Company Inc.'s (TCM:TSX; TC:NYSE) Mt. Milligan project.
The favorable conditions
for royalty acquisitions should continue for the next two to three years.
TGR: What are some of the
favorable royalty contracts that Royal Gold has with producers?
CC: The royalty that served
as the first cornerstone for Royal Gold was the Cortez contract in Nevada.
The asset, operated by Barrick, paid Royal Gold
quite handsomely for a long time, up until about two years ago when it
switched to mining Cortez Hills. The Cortez royalty created a very important
cash-flow generator for Royal Gold for a long time so it could leverage cash
flow into purchasing other interests.
Looking ahead, some of
the bigger ones that Royal Gold has would be Peñasquito,
which is a key Mexican mine for Goldcorp Inc. (G:TSX; GG:NYSE), and the Andacollo, a key mine for Teck,
which is looking into further expansions.
TGR: When is Peñasquito slated to go into production?
CC: It's already in
production. It's a staged approach to development, but it's already been in
production for quite a while now. It has a mine life of more than 20 years.
The royalty company
doesn't have to pay anything, so an expansion is the best thing that can
happen to it. There's more gold upfront, more production and more payment to
the royalty, but there's no additional capital expenditures needed.
TGR: Will royalty companies
pay larger dividends?
CC: It's a double-edged
sword. They want to return investment to investors, but, at the same time,
why would they if they have opportunities out there where they can continue
to generate positive alpha for the company itself?
We've seen over and over
again how these royalty acquisitions have increased the NAV of the company. I
believe companies will keep it at a certain point, say more than a 1% yield,
to make sure that there is some return to investors, but they will want to
make sure that they also are able to capitalize on opportunities.
TGR: There aren't a lot of
royalty companies, but do you see further consolidation among them?
CC: I wouldn't be surprised.
I've covered them for a long time. I've seen International Royalty Corp. get
taken out by Royal Gold and Gold Wheaton taken out by Franco-Nevada. It's
much easier for a larger royalty company—some of these companies have
been around for a long time and it takes a long time to build up a good
portfolio. The diversification benefits are not as clear for some of the
smaller companies. I wouldn't be surprised if there's more consolidation
knowing that it's actually quite a small space in the end.
Royalty company
financing has become more mainstream. Many of these mining companies are
looking at it from the perspective that they want to have a royalty financing
component as part of a more integrated financing package. They want to do
some type of equity financing, a portion debt financing, a portion project
financing and also a portion of the royalty financing.
TGR: What are some
investable themes that our readers should watch for in the precious metals
space throughout the remainder of this year and into 2013?
CC: I've been telling
clients to look for the companies that will deliver on their promises. Look
for companies that have the ability to capitalize on some of this cost
abatement that we might see in some parts of the industry. From my
perspective, I favor companies that are more pure gold than the ones with a
significant base metals component.
TGR: I've appreciated
speaking with you today. Thanks, Cosmos.
Cosmos Chiu, director, Precious Metals Equity
Research, CIBC World Markets, joined CIBC in June 2006 to provide coverage of
development and production-stage companies in the gold sector, as well as
royalty companies. Chiu has a specific focus on mining assets in North America,
Europe and Africa, covering companies with market capitalizations ranging
from $200 million to $10 billion. He was ranked fifth overall best stock
picker by Starmine in 2010. He is consistently
ranked in the top 10 in the Brendon Wood International survey for the
Precious Metals—Small/Mid-Cap sector.
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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 this article are sponsors of The
Gold Report: Franco-Nevada Corp., Royal Gold Inc., Pilot Gold Inc. and
Goldcorp Inc. Interviews are edited for clarity.
3) Cosmos Chiu: 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
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