The Gold Report: Some market experts believe central banks
have no more bullets left in their attempts to stimulate global economic
growth and that could lead to a worldwide economic downturn. What is Dundee
Capital Markets' outlook over the next 18–24 months?
Matthew O'Keefe: The strength of the U.S. dollar is still a
headwind against a rising gold price. With the expectation of U.S. interest
rates rising and U.S. economic data pointing to a stronger dollar, there is
not much conviction that we're going to get a major uptick in the gold price
in the short term. Interest rates have been held down longer than anyone
expected. The next kick will likely be in December when the U.S. Federal
Reserve is expected to raise rates. What could strengthen the gold price are
geopolitical concerns such as increased tension between China and the U.S. as
the U.S. puts more patrols in the South China Sea or on heightened concerns
over Russia's involvement in Syria.
TGR: Can investors make gains in the gold space without the broad
market turning bearish?
MO: There are several different investment theses to look at in gold.
The majority of investors who go into precious metals are there because they
want gold exposure as a natural hedge against a U.S. dollar crash or
geopolitical risk. Investors don't generally get into gold stocks or any
metal stock unless they believe that the commodity price is going to go up.
Having said that, there are other ways that companies can drive value. Growth
is one way, so we look for companies with an increasing production profile.
Another good strategy is to look for companies that can lower costs, increase
margins and produce free cash flow.
On the developer side—an area that we quite like—a company can add value
by derisking its projects and moving from explorer status, which tends to
trade at a discount, to producer status and getting a rerating. In those
scenarios, companies don't need the metal price to go up or down. They just
need to maintain investor confidence and go through their natural development
cycle.
TGR: Can investors make 50% or greater gains in the absence of a
bear market?
MO: Again, it has to do with getting a rerating. Fifty percent is
tough in any market, but if there's an exploration component and/or you're
graduating into a whole new category of gold company—going from an explorer
to a producer, for example—you can expect some significant gains. Right now,
developers are trading at a half net asset value (NAV) basis, and junior
producers are trading at almost double. So, yes, you could expect 50% or so
gains on crossing that threshold, and those companies' stocks will typically
start to run up as they get within six months of cash flow. That's when
stocks tend to get rerated, over that one-year period from preproduction to
established production. Sometimes it takes a little longer. Of course
exploration is the highest-risk gain, but if a company makes a big discovery
or dramatically increases its resource, it should get a fairly large bump in
its share price.
Because this is such a volatile market and there is still a lot of
uncertainty, most investors would be better off not swinging for the fences
so much as picking solid gold or silver companies with strong balance sheets
and that are producing metal well below the spot price, giving exposure to
any upside in metals prices but also providing some downside protection. Our
preference would be for companies with a growth profile or other catalysts
that add value in the absence of a gold price move.
Investors who want to trade actively can play the leverage game. Companies
that have fully loaded costs of production right around that of the metal
price sell off faster when the metal price drops. But when gold and silver
prices move up, and these companies move back into cash flow positive
territory, you can get a major stock price swing and you can trade around
those.
TGR: Does your gut tell you precious metals investors should be
long?
MO: Investors should be long in this market. We're getting the sense
that gold has found a bottom here. We're starting to see more interest in
gold across the landscape, maybe not buying interest just yet, but interest
in reaffirming what names are out there and who's where on the valuation
side.
TGR: Tell us about some gold developers that you're following and
that perhaps you've visited recently.
MO: I will start with two development-stage gold names— Dalradian
Resources Inc. (DNA:TSX), which has a project in Northern Ireland, and Sabina Gold
& Silver Corp. (SBB:TSX; RXC:FSE; SGSVF:OTCPK), which has a project
in Nunavut. We have a Buy rating on Dalradian Resources, with a CA$1.40/share
target price. We have a Buy rating on Sabina Gold & Silver Corp., with a
CA$1.25/share target. Both companies are advancing high-grade gold deposits
and, in our view, have the right mix of management, asset, jurisdiction and
the ability to finance, which should allow them to continue to move these
projects forward.
I recently visited Dalradian's advanced Curraghinalt project in Northern
Ireland. It has a resource of 1 million ounces (1 Moz) averaging 10.4 grams
per ton (10.4 g/t) in the Measured and Indicated (M&I) category, plus
another 2.5 Moz Inferred. The company is upgrading the resource and
determining the mining method that will drive the economics; it is on track
to deliver a strong full feasibility study by the end of next year. When
you're dealing with high-grade deposits with a swarm of narrow veins like
this one, you want to understand the best mining method and potential
dilution so that you can have a solid handle on costs. Technically, we think
Dalradian is on track to meet those goals. We're expecting Curraghinalt to
produce about 150,000 ounces (150 Koz) gold annually at cash costs in the
$600–700/ounce range. We're excited about it, but Dalradian still has some
work to do.
TGR: Dalradian just completed a $40 million ($40M) financing to
upgrade its resource. Once the new resource calculation is done, does
Dalradian move to the top of your list of takeover candidates or does
Curraghinalt become a mine?
MO: Dalradian's management is not afraid to build mines. Chairman
and CEO Patrick Anderson has not yet built a mine but he's an ambitious
person. The next step in his career, in a sense, would be to build a mine.
And he has roots in Northern Ireland, which could be an additional driver.
Director Sean Roosen has built Osisko and Chief Operating Officer Eric
Tremblay has lots of experience operating similar-type high-grade mines.
Dalradian could get a takeover bid but I think Dalradian management is
approaching this with the intention to build the mine.
TGR: Tell us about Sabina and its asset.
MO: Sabina had a dramatic selloff when the gold price started to tank
in 2011 and it's had a tough time getting back but it has recently started a
recovery. Its main asset is the Back River project, a high-grade gold project
in Nunavut, Canada. What makes this one stand out aside from the grade, which
is about 6 g/t, is that it has 7.2 Moz outlined in M&I and Inferred,
which is big. The company completed a feasibility study in May 2015, which
looked at a 6,000-ton-per-day (6 Ktpd) operation over several areas in this gold
belt. The capital cost was $700M, which was a pretty big ask in this market.
Bruce McLeod was recently put in place as the new CEO. We have confidence in
Bruce as he built Sherwood Copper Corp.'s Minto mine in the Yukon and sold it
to Capstone Mining Corp. (CS:TSX) in 2009, so he knows how to develop
projects in the north.
TGR: A new feasibility study suggests a much smaller operation at
Back River.
MO: In September, Sabina delivered a new feasibility study for an
initial project that outlines a 3 Ktpd operation that is expected to produce
200 Koz/year over 12 years largely from high-grade open pits, and that makes
for a very robust project, even though it's in the north. The company should
get its main environmental permit in Q1 or Q2/16. That will be probably the
key catalyst after the feasibility study. Once Sabina has its permit, it will
cost CA$400M to build. Sabina should be able to get 60% or 70% of Back River
debt financed. Once it gets that, I think the equity would be available for a
high-quality project like this.
TGR: Let's move to some of your favorite producers.
MO: One producer that we've been pretty excited about is Tahoe Resources
Inc. (TAHO:NYSE; THO:TSX). We have a Buy rating on Tahoe Resources and a
CA$19.00/share target. Tahoe has a very high grade resource, long mine life,
low costs and a very solid balance sheet—all the things I was talking about
as an investment thesis. Tahoe has two mines currently in production. The
first is the Escobal mine in Guatemala that produces about 20 Moz/year
silver, and it's one of the best silver mines in the world.
This year, Tahoe acquired Rio Alto Mining for its La Arena mine, which is
a producing gold asset in Peru, and the Shahuindo project, a development
asset in Peru that is on track for first production in January. That adds a
growth component and a gold component to the story. From that perspective, we
think this is a key company in the space. It still trades at a bit of a discount
due to its Guatemala exposure—Guatemala increased its royalty on Tahoe last
year—but a new government was recently elected on an anti-corruption platform
and it seems mine friendly. Tahoe has top management and a sustainable
monthly dividend as well.
TGR: Is this as close to a blue chip stock in this space as it
gets?
MO: This is the one we point to if you want a "safe" way
to play the metals space (which is inherently high risk). Tahoe is as good as
it gets because it has top management, a long-life resource at Escobal and
growth. It has a dividend, so you get paid while you wait, if you will, for
metal prices to take off. And there's internal growth, which should add value
with time. Management still wants to do mergers and acquisitions so we would
expect in the next 12 months that Tahoe would bring something else into the
fold, possibly a development-stage asset, so it wouldn't cost it a lot. The
company would be able to build it out of current cash flow. Tahoe has
virtually no debt, so it could lever on the production of the new asset, if
it wanted to.
TGR: What are some other producer names that you have a fondness
for?
MO: There are four other names that I am currently focused on. In the
same space as Tahoe is B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX) where we have a
Buy rating and a CA$2.80/share target. Similar to Tahoe, it has a solid
management team and a relatively large and growing production profile. B2Gold
has key assets in a variety of places including — Nicaragua, the Philippines,
Namibia, Mali. It may be a little higher risk given the jurisdictions, but
it's also diversified across a number of jurisdictions with five mines (one
under construction).
Its cash costs are on the lower side for gold producers, and the company
is growing. The Otjikoto gold mine in Namibia came into production this year
and continues to ramp up. That will bring B2Gold's annual gold production
into the 500 Koz range, which puts it squarely in the midtier bracket. That
alone should see a tick up in its valuation. Then it's financed for the
Fekola project in Mali as its next big growth project. Fekola should produce
300 Koz/year on top of the 500 Koz/year level that B2Gold will reach this
year. Fekola should start production at the end of 2017. As far as its
balance sheet, the company is leveraged more than Tahoe, so it has a fair bit
of debt, but based on our model, it's quite manageable. That's one that we've
liked and should continue to like.
TGR: Tell us about the others.
MO: We cover Kirkland Lake Gold Inc. (KGI:TSX) with a Buy rating and
$7.50/share target, Claude Resources Inc. (CRJ:TSX) with a Buy rating and
$1.25/share target and Wesdome Gold Mines Ltd. (WDO:TSX) with a Buy rating and
$1.50/share target. These three companies all have high-grade mines that they
have successfully turned around. They're also benefitting from a lower
Canadian dollar versus the U.S. dollar.
TGR: Which one of those three companies is most likely to have the
most successful encore?
MO: The one that's farthest down the path is Kirkland Lake. It has
changed management, improved its operations and has lots of near-mine
exploration potential. I think it's come a long way.
I'm very excited about Claude because it is really benefitting from its
recently opened up Santoy Gap, a new zone at its Seabee mine. It is getting
some higher grades from that zone, which has improved its operations and
given it a much-needed bump and incredible rerating, which we think is not
yet done. Claude has some of the lowest costs in the space and should be able
to sustain production of 70 Koz per year. Also, the company recently opened
up a new drill platform to test the down-plunge extension of the Santoy zone,
so we should see some near-term exploration results from there, which could
be good.
Wesdome, which had been an awful performer over the past few years, has
also had a good run this year after restructuring its operation and changing
management. The new management team has come up with a four-year plan that
provides more growth on a relative basis than either Claude or Kirkland.
However, it's also the smallest producer in the group, producing 50 Koz
annually, but by 2018, it plans to get to 80 Koz, while keeping costs low.
Most of the increased production will come from new discoveries at the deeper
parts of the mine—an area that hasn't really been well evaluated. So Wesdome
probably has the most potential to outperform the others, but again, it's the
smallest of the group. That may limit its appeal.
TGR: What are some differences in this bear market versus others
you have witnessed?
MO: Too much leverage can get you into real trouble. That's been
the biggest problem with the gold space and the biggest difference. In the
early 2000s, the last time the market was really down on gold, companies were
struggling, but they weren't levered so much that they would run the risk of
breaching their covenants, whereas now a lot of companies have loaded up on
debt that they've had to deal with. Debt has to be managed very carefully.
Valuations and investment theses also have to be rethought. You have to think
about what is the best story over the longer term and what is the best story
to trade around, rather than just what is the best story.
TGR: Is there anything else you'd like to add?
MO: There's still opportunity in metals and mining, I would say
particularly now because valuations are a lot lower than before. Sticking to
the principles of a strong balance sheet, strong management and good assets
with growth remains central to our investment thesis. We do our best to
identify names that fit those criteria. Be careful and be patient.
TGR: Thank you for your insights, Matt.
Wall Street Journal. He holds a Bachelor of Science in geology from the
University of Toronto, a Master of Science in geology from Queens University
and an MBA from the Ivey Business School at the University of Western
Ontario.
