The Metals Report: Kevin, base metals analysts from London to Sydney to Toronto are increasing their price outlook for copper. Do you agree with their bullish outlook for 2013?
Kevin Puil: Yes, I absolutely agree with their bullish outlook. In fact, I've been bullish on copper for quite some time. Although there have been many analysts purporting that the commodities cycle has run its course, I disagree. The fundamentals for copper remain highly favorable and I continue to see secular demand for most commodities, copper in particular. Industrialization and urbanization, especially in the BRIC (Brazil, Russia, India, China) countries, is not about to stop, and this continues to put pressure on copper miners, who struggle to keep up with demand. Supply growth has slowed due to lower grades, higher costs and political unrest. In addition, the new projects and mine expansions that were scheduled to come on-line haven't materialized, and if they do, it will not be in a timely fashion.
Quite frankly, I think you could see copper peak above $4 a pound ($4/lb) this year, and $3.75 is reasonable for an average. It's interesting to look back at the five-year average for copper. Even though a lot of analysts are using ~$2.75/lb as their long-term outlook, copper has only broken below $3/lb for that brief amount of time during the financial crisis. The rest of the time, it's been well above $3/lb. I think it's about time they brought the price up to a more realistic level.
TMR: What particular jurisdictions do you see as having advantages in moving projects forward to alleviate some of the supply tightness?
KP: A lot of the traditional copper-producing countries and jurisdictions are becoming less mining friendly, be it from governments wanting a larger stake, such as Mongolia, or scalability not being achievable because of inadequate power supply, such as in Chile. Many producers are looking toward more mining-friendly, politically stable places. In the U.S., Arizona comes to mind. It's a politically stable place to mine with extensive infrastructure close to many of the deposits. In fact, it's an excellent operating jurisdiction, with great infrastructure, labor and neighboring operations including smelters with excess capacity. I think you're going to see a lot more activity out of Arizona.
TMR: What are some names that you're following in Arizona?
KP: A number of operating companies are based there, but I tend to look upstream to the advanced development companies. My top junior pick is probably Redhawk Resources Inc. (RDK:TSX; QF7:FSE; RHWKF:OTCQX), a very underfollowed company. Redhawk controls the Copper Creek deposit, which is just north of Tucson. It couldn't be located in a better jurisdiction with better infrastructure all around it. The deposit currently contains close to 8 billion pounds of copper, including Measured, Indicated and Inferred, although ultimately I think it's going to end up being quite a bit larger. It's largely overlooked by most sell-side analysts because I don't think they understand the geology. I won't go into detail, but it's not your ordinary porphyry system. It's an early halo-type porphyry deposit with the dominant copper-bearing veins being of the early dark micaceous or EDM veins, rather than the quartz stockwork veins, which are more common in porphyries. A good example of this type of deposit is also found in Butte, Montana. I believe this system is a lot bigger than is currently being modeled, and I'd be surprised if the company remains independent much longer. I'm looking forward to its preliminary economic assessment(PEA) later this quarter, and would expect a little pin-action on the heels of it.
TMR: Redhawk recently chose to develop Copper Creek, which is its flagship project, as an underground mine. Can you help investors understand that decision?
KP: I believe the company went with the underground scenario because it's a lower-cost method in terms of the initial capex�cheaper than implementing an open-pit operation. In the current climate of multibillion-dollar projects, I would think this makes the project look a more attractive as a takeover target to an intermediate miner. As I said, I'm looking forward to its PEA, which should be out sometime this quarter. In the mining world, there are a lot of eyes on this project. My model suggests some pretty robust economics even with an underground situation, and I'm looking forward to the economic assessment to confirm this.
TMR: Who would be the potential suitors?
KP: Well, with the available number of good projects in good jurisdictions shrinking, I think there are a number of potential suitors. Larger companies such as Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), which used to operate a mine directly across the highway from Redhawk, might have their eyes on this. However, I wouldn't be surprised to see the likes of, say, Teck Resources Ltd. (TCK:NYSE; TCK.A:TSX), KGHM Polish Copper Ltd. (KGHPF:OTCPK), Anglo American Plc (AAUK:NASDAQ), Imperial Metals Corp. (III:TSX) or Grupo Mexico (GMEXICOB:MXN) make a move. It's really wide open; I think the potential project size will also be a factor.
TMR: Any other Arizona players on your radar?
KP: Another Arizona player is Augusta Resource Corp. (AZC:TSX; AZC:NYSE.MKT).
TMR: The Arizona Department of Environmental Quality just awarded an Air Quality Permit for Augusta's Rosemont Copper project. What does that mean for investors?
KP: Well, first off, Augusta's had a difficult run in Pima County. It experienced a lot of opposition to the project and permitting has been an issue, so this permit is a major step. It's not the final go-ahead permit, but it's a major hurdle that it has now overcome. I believe it still needs the final Environmental Impact Statement (EIS) as well as the water quality permit, but this news just represents another signal that the Rosemont project should be fully permitted in due course. It's a big copper-molybdenum porphyry deposit. It should have very robust numbers, and it is construction ready. I could see this in production in perhaps H2/15. It has good infrastructure, good economics and with this permit in hand, I could see it beginning construction as early as later this year.
TMR: Augusta recently expanded a loan. Tell us about the cash and debt situation there.
KP: I'm not that concerned about the additional debt. It's an extension of the Red Kite facility, and a project this large is ultimately going to require a lot of financing regardless�I'd rather see some offtake agreements and debt rather than additional equity raises. It doesn't need to expand the resource anymore, so I'm okay with its cash situation. Not to mention, it also has KORES as a partner, which by the way, might present a bit of a wrinkle for potential suitors, although I could still see a company like Grupo Mexico taking a hard look at Rosemont.
TMR: What are some other copper-focused names you're following and that you like?
KP: Panoro Minerals Ltd. (PML:TSX.V: PZN:FSE; PML:BVL) is an exploration and development company operating in Peru. It's got a great portfolio of about a dozen properties that include copper, gold and polymetallic deposits. Its two flagships, Cotabambas, a high-grade, gold-rich copper porphyry-style deposit, and Antilla, a copper-molybdenum porphyry, both have the potential to become large mines. They're located in a prolific copper- and gold-producing area, with majors such as Xstrata Plc (XTA:LSE), HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) and First Quantum Minerals Ltd. (FM:TSX; FQM:LSE) operating in the neighborhood. Panoro has experienced management and a well-funded operation. PEAs on both those properties are expected this year, so I'm watching those closely. In addition, the local population is supportive of mining, and with operations nearby, I don't expect any problems with permitting. Both these projects also have good infrastructure nearby, something that is becoming more important these days. This is one that I would absolutely keep my eye on.
I love seeing these porphyry systems for a number of reasons. First, the byproduct helps keep cash costs under control, but these large copper-gold porphyries are also definitely in vogue as acquisitions. They're attracting other types of companies, more diversified miners or even gold miners, that wouldn't normally look at a pure copper play.
TMR: What is another copper name the Encompass Fund is following?
KP: In terms of producers, we've got a position in Teck Resources. It's the largest diversified miner in Canada with a focus on copper, met coal and zinc. It has great exposure to high-quality, large-scale, low-cost production. That's what we love to see. In addition, it's got a fantastic pipeline of low-risk projects, not to mention a strong balance sheet. It was touch and go at the end of '08, when equities were plummeting across the board, and there was concern that Teck had bitten off more than it could chew, but it has since come back and management has proven that it has the goods. That remains a core holding of ours.
TMR: The World Economic Forum in Davos, Switzerland just named Teck one of the 100 Most Sustainable Corporations in the world. How do you view this development?
KP: I think that's great. More eyes are now on a lot of these mining companies and some of the practices they've had in the past. And we look for that kind of responsibility in a company. We certainly don't want to get involved with a company that may be, for example, exploiting the indigenous people or destroying the environment beyond what is necessary to extract the minerals. Teck has really done well in terms of responsible resource development and considering the community and the environment. From my travels and my site visits, I've definitely seen an improvement over the last 10 years and I think a lot of that has to do with investors pressuring companies, which is good to see.
TMR: What are some other copper-focused names you're watching?
KP: I also like Lundin Mining Corp. (LUN:TSX). It's an intermediate producer with operations in Portugal, Spain, Ireland and Sweden, as well as an interest in the Democratic Republic of Congo. It's a very good copper and zinc name. Although Lundin's copper production looks relatively flat over the next year or so, I could see an expansion at the Tenke Fungurume mine increasing production quite significantly. I expect its zinc production to increase by as much as 50% year over year as well. It has a strong balance sheet, and I could see it as a potential takeover target�again.
TMR: There was a deal with HudBay at one point, right?
KP: Yes. That was back when Lundin's balance sheet wasn't quite as strong as it is now, but ultimately I think it was the HudBay shareholders who felt it wasn't a good deal.
TMR: What's your outlook for zinc, considering that some analysts think that the percentage growth in price would be even larger than copper's percentage growth this year?
KP: Zinc looks good for the next couple of years. There are a lot of mine shutdowns and structural issues in the mining industry that are supporting an upward shift in zinc's price. I believe there's something in the order of 2 million tons of zinc production that will be lost over the next few years as a result of shutdowns; that's about 15% of the global supply. Added pressure from capital cost escalation, resource nationalization and deposit depletion also suggests some pretty strong fundamentals ahead for zinc.
TMR: So what are some of the zinc juniors you're following?
KP: There aren't many, but Trevali Mining Corp. (TV:TSX; TREVF:OTCQX) comes to mind. It has operations in both Canada and in Peru. It is in a good situation and is fully funded to bring two mines into production later this year. It also has offtake agreements with both Xstrata and Glencore International Plc (GLEN:LSE) that don't require hedging. This is a good deal for Trevali and gives it flexibility and potential access to additional capital, should the company need it. With about half of its revenues coming from byproducts, it's not a pure zinc play, but it's just about as good as you'd get.
TMR: Does Trevali have its costs under control at the Santander and Caribou projects?
KP: Not many mining companies these days have their costs under control. What I like about Trevali though, is that it owns the power station that will be supplying the Santander mine. This will impact the economics significantly. There's also the possibility that Trevali could sell some of the power back into the Peruvian grid.
One more zinc junior, Rathdowney Resources Ltd. (RTH:TSX.V) is worth mentioning. It's an interesting company with projects in Ireland and Poland. Its advanced Olza project is just outside of Krakow and right next to an operating mine in a town that's been producing zinc for years. It's interesting because the current the mine is shutting down and Rathdowney's project is right next door, with a resource of around 20 million tons of pretty high grades. Infrastructure couldn't be better and includes power, rail, water and paved roads, and there's no shortage of experienced labor. As I mentioned, the current Pomorzany mine, the only feed source for the ZGH Boleslaw smelter, is scheduled to shut down in 2014, so I think the Olza project will be the next mine in production over there. It is in a great position to be acquired. I've walked the property and it's definitely one of our holdings. Rathdowney's Irish properties are also highly prospective, and Teck Resources has invested in the company through a non-brokered private placement.
TMR: What were your takeaways from the site visit?
KP: How easy it was. I travel to a lot of faraway places that are hard to reach, and once you're there it's difficult to move around. This, on the other hand, is 10 minutes from town. You couldn't ask for a better situation.
TMR: In summary, what are your parting thoughts on copper and zinc?
KP: To sum things up, the commodities super cycle is still intact. There's just a scarcity of supply as capital cost inflation and declining grades persist. Mines are underperforming, and that will continue. In addition, there just aren't that many large projects like Oyu Tolgoi or Olympic Dam on the horizon. The low-hanging fruit has already been found and it's getting more expensive and more difficult to find the new projects. Governments are impacting development with more stringent permitting and increased tax burdens. This is affecting cost and delaying supply growth out there. At the same time, industrialization in emerging markets is running at a very high rate, leading to more demand for these commodities. In a sense, everything we touch in this world came from the ground, be it from agriculture, mining or energy, and as the world progresses, we're going to need more and more of these commodities and they're not that easy to find. But all of these factors bode well for investors, and there's definitely an opportunity here for investors if they pick the right companies.
TMR: Thank you for joining us today, Kevin.
KP: My pleasure.
Kevin Puil has more than 15 years' experience in the investment management business. He is a portfolio manager at Malcolm Gissen & Associates and the senior analyst at the Encompass Fund in San Francisco. He spent the majority of his career working in Canada, before relocating to California. He studied economics at the University of Victoria and the University of British Columbia, and is a Chartered Financial Analyst.
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DISCLOSURE:
1) Brian Sylvester of The Metals 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 Metals Report: Trevali Mining Corp. Interviews are edited for clarity.
3) Kevin Puil: I personally and/or my family own shares of the following companies mentioned in this interview: Redhawk Resources Inc. and Teck Resources Ltd. 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.
