The Gold Report: Why haven't the recent Islamic State
attacks in Paris spurred a greater safe-haven gold trade? Does it mean the
concept of gold as a safe haven is, for the most part, dead?
Ryan Hanley: I don't believe so. Despite the recent attacks, this
is the first time in a long time we've seen the United Kingdom backing France,
and the U.S. and Russia on the same page. Gold continues to have an inverse
relationship with the U.S. dollar, and with the U.S. posting strong
employment numbers, we continue to believe that the focus is still on the
U.S. dollar and the implications of a rate hike in December.
TGR: What sort of interest rate hike are you modeling?
RH: Our expectation would be about 25 basis points. We believe
about 65–70% of that is already priced into the market.
TGR: Where do you peg the low end of the support range for gold in
the near term?
RH: With continued economic strength in the U.S., we expect some
near-term pressure to remain on the gold price. We could see it briefly
dropping below $1,000/ounce ($1,000/oz) in the near term, but in the long
term we're much more bullish, especially given the average all-in sustaining
cost of production among the companies we have under coverage is slightly
above $1,000/oz. Typically, we've seen seasonal strength in the second half
of the year. We could see gold rebound as early as H2/16.
TGR: Your investment thesis roughly consists of low all-in
sustaining cost production names in safe jurisdictions with near-term
catalysts. Did I miss anything?
RH: That's basically it. I might add that Canadian gold producers
continue to benefit from the depreciation of the Canadian dollar versus the
U.S. dollar, which has helped a lot. For example, the gold price has gone
down by about 10% over the previous year in U.S. dollar terms, but in
Canadian dollar terms, once you apply the exchange rate, it's actually up by
about 6%.
TGR: At a recent RBC Capital Markets conference in London, a number
of companies presenting said they had further room to cut costs. Are the CEOs
and management teams in your coverage universe echoing those statements?
RH: For most of the names we cover, there's not significant room
for much cost-cutting. We could see slightly lower input costs in terms of
mill re-agents, diesel prices, and drilling, so there is a bit of room to
boost margins, but not by any significant measure.
TGR: You cover some drilling companies. How much lower are drilling
costs now versus five years ago?
RH: I'd say they've come off about 50% on average, but in some
cases, it's significantly more. It depends on whether you are in a
well-developed camp like Red Lake, Ontario, or Val d'Or, Québec versus
northern British Columbia (B.C.), where helicopters are used to deliver
drills. In prime mining camps, drill costs are probably 50% lower, if not
more. You can get down to about $60 per meter ($60/m) on your base costs, but
in some cases that doesn't include geology or fuel. Forage Orbit Garant Inc.
(OGD:TSX), for example, drills primarily in Canada, and its average drilling
costs are about $90/m, which is toward the low end of the historical average.
On the positive side for the drillers, we have seen some signs of
stabilization, with the number of meters drilled and price per meter
continuing to increase slightly year-over-year for several consecutive
quarters.
TGR: AuRico Gold Inc. and Alamos Gold Inc.
(AGI:TSX; AGI:NYSE) merged earlier this year as equals. AuRico had
assets. Alamos had cash. These types of mergers tend to happen in small- and
micro-cap equity names. Are mining mergers and acquisitions (M&A) moving
up the food chain?
RH: I think so. These tend to be opportunistic events that have
recently focused more on companies generating cash flow. Alamos and AuRico
were a good fit because Alamos had permitting delays in its development
pipeline, specifically in Turkey, and AuRico had Young-Davidson, a gold asset
in northern Ontario that's ramping up on time and that will provide organic
growth.
TGR: Is Alamos going to have any long-term permitting issues with
either Kirazlı or Ağı Dağı in Turkey?
RH: We've never been overly optimistic on the timing of permitting
in Turkey. That being said, we think it will happen. Other gold
companies, like Eldorado Gold Corp. (ELD:TSX; EGO:NYSE), have proven they can
build and operate mines in Turkey.
TGR: Do you expect other companies under coverage to engage in
M&A in 2016?
RH: There may be a couple of other names in our coverage universe
where M&A could happen and we expect companies to explore those
opportunities throughout 2016. A lot of companies that have production assets
in riskier parts of the world could start to target companies with operations
in Canada to take advantage of the safer jurisdiction and Canadian gold
price.
But the focus is still going to be on cash flow. Investors are typically
looking at gold companies generating cash at the current gold price and are
not moving down the food chain to exploration projects just yet.
TGR: What are some names you cover that could be involved in
M&A?
RH: We see the most likely candidates as producers with good
balance sheets that probably want to further diversify. Klondex Mines
Ltd. (KDX:TSX; KLDX:NYSE.MKT) would be a good example. The company has
performed quite well. It has a strong balance sheet and it might be
interested in going after something that would fit its underground gold
mining expertise. Another one might be Lake Shore Gold
Corp. (LSG:TSX), which has successfully turned around its operations in
northern Ontario. The company is building up its balance sheet after several
consecutive good quarters. It might want to acquire something bigger than
Temex Resources Corp. (TME:TSX.V; TQ1:FSE) by using its slightly higher
valuation to its advantage.
TGR: AuRico
Metals Inc. (AUQ:TSX; AUQ:NYSE) was spun out of the AuRico-Alamos merger,
and you recently launched coverage on it—heady status for a new company. Why
did AuRico Metals make the cut?
RH: AuRico Metals caught our attention mostly because the company
has a cash flow-generating royalty portfolio. That includes a recently
created 1.5% net smelter royalty on Young-Davidson. We expect that to yield
about US$4 million (US$4M) in 2016. It's worth pointing out that the last
couple of times we've started following junior royalty companies with cash
flow-generating royalties, it didn't take long before they got taken out by
some bigger players. For example, Premier Royalty Inc., which was spun out of
Premier Gold Mines Ltd. (PG:TSX), was taken over by Sandstorm Gold
Ltd. (SSL:TSX; SAND:NYSE.MKT) not long after going public. Sandstorm acquired
Gold Royalties Corp. about 18 months later.
AuRico Metals also has the advanced-stage Kemess underground copper-gold
project in B.C., where there is a substantial amount of infrastructure in
place. And most of the management team that was at AuRico Gold is now with
AuRico Metals. We typically like to follow good management teams as they
transition from one company to another.
TGR: How long before Kemess reaches commercial production?
RH: It's going to take some time. We should see an updated
feasibility study in Q1/16. We don't anticipate a construction decision until
later in the year. You're probably looking at a late 2018/early 2019 start in
a best-case scenario for initial production, at which point Kemess is
expected to move through a five-year precommercial production period related
to initial underground development given that it will be a block caving
operation.
TGR: What are some gold companies you cover with near-term
catalysts?
RH: We like Teranga Gold Corp. (TGZ:TSX; TGZ:ASX). We think it has
underperformed lately due to a market focus on Canadian producers that
benefit from the Canadian dollar gold price. Teranga operates the Sabodala
gold mine in Senegal, and it started mining the Gora satellite pit in Q4/15.
The average reserve grade at Gora is north of 4.7 grams per ton (4.7 g/t),
and that high-grade material should help Teranga generate significantly
greater cash flow. The company is also looking at adding a heap-leach
component to its Sabodala gold production. We believe that this has the
potential to add about 32,000 ounces a year (32 Koz/year) by late 2018.
A little-followed name with near-term catalysts is Avnel Gold
Mining Ltd. (AVK:TSX), which has an 80% interest in the Kalana gold
project in southern Mali. The company should release a definitive feasibility
study in Q1/16 that will build upon a preliminary economic assessment (PEA)
that it released in early 2014. The resource is about 2.8 million ounces (2.8
Moz) in the Measured and Indicated category at an average diluted grade of
about 2.85 g/t, which is actually quite good for an open pit. Given the
high-grade nature of the deposit, it should have an internal rate of return
close to 50% at a gold price of $1,100/oz, which is quite impressive.
TGR: Turnaround stories have garnered the most attention this year.
What are those likely to be in 2016?
RH: In terms of turnaround stories, I'd probably go back to the
Canadian market and Primero Mining Corp. (P:TSX; PPP:NYSE). It is trading at
a steep discount—roughly 0.4 times net asset value (NAV) as it continues to
have underground throughput issues at Black Fox. Primero acquired Black Fox
through the purchase of Brigus Gold Corp. in March 2014. Since then its focus
has been transitioning the mine from an open pit to an underground operation,
with the goal of processing 1,000 tonnes per day (1 Ktpd). That's taken
longer than expected. In 2016 the company will be going after the Deep
Central zone, which should get it to a sustainable 1 Ktpd by Q2/16. The
deposit also tends to get better grades at depth, so grades should be moving
from about 5–6 g/t at the 560m level underground to about 8–9 g/t once it
reaches the Deep Central zone later in 2016.
Another one is St Andrew Goldfields Ltd. (SAS:TSX). We've taken a closer
look at it following the announcement of the Kirkland Lake
Gold Inc. (KGI:TSX) takeover bid. I've long believed St Andrew is
undervalued, although it is worth noting that the Abramson family owns 50%,
which limits liquidity.
St Andrew operates the Holt and Holloway mines and those assets continue
to perform well. It also started up the Taylor mine in Q4/15, on time and on
budget. Now that Kirkland Lake has effectively put St Andrew in play, it
might attract a rival bid from other companies in the camp, like Lake Shore
Gold, Primero or Richmont Mines Inc. (RIC:TSX; RIC:NYSE.MKT).
TGR: Please fill our readers in on the Kirkland Lake offer.
RH: It's a friendly, all-share deal consisting of 0.0906 Kirkland
Lake shares for each St Andrew share. Kirkland Lake is trying to combine
these assets to create an Ontario gold producer with production of about
260–310 Koz/year at cash costs of $600–690/oz. But again, the focus is on
taking advantage of that Canadian dollar gold price.
TGR: Holt and Holloway are older assets. Is there anything else in
the pipeline?
RH: St Andrew has a sizable exploration package. There are lots of
targets for it to explore on its own property. We thought St Andrew would
acquire other assets, not be acquired. Our belief is that the majority
shareholder is interested in the Kirkland Lake deal, but if somebody else
happened to make a sweeter bid, the company could be sold to another
acquirer.
TGR: What are your top picks for 2016?
RH: Avnel would be probably our top pick in the development space.
Primero would be our top in the intermediate space. Our two favorites in the
junior space are Wesdome Gold Mines Ltd. (WDO:TSX) and Klondex.
We've followed Wesdome for some time. It has the Eagle River underground
and the Mishi open-pit gold mines in northern Ontario. The company recently
discovered two new parallel zones at Eagle River, labeled the 300 and 7
zones. Those zones could significantly extend the Eagle River mine life. The
current reserve grade is about 10 g/t. Wesdome started mining the 300 zone in
Q3/15, so we'll see how those grades hold up. We expect good things in 2016.
Klondex has always been a favorite. We've visited Midas and Fire Creek in
Nevada several times over the last five years. Klondex has a good balance
sheet, and management continues to execute at its two high-grade assets,
which continue to generate free cash flow.
But the key for the Klondex story is what it's going to go after next. We
expect it to look at assets in North America, especially high-grade
underground gold projects because that's where the company can leverage its
expertise.
TGR: What would be some possible targets?
RH: Maybe Wesdome. With Wesdome you have a 10 g/t underground mine
that's working well, and the potential for a lot more. At this point, it's
just about getting a better handle on the grades. I think Klondex and Wesdome
would probably be the most logical fit.
TGR: Wesdome has fairly high operating costs. Do you have
sufficient confidence that management can bring those down?
RH: We do. Wesdome has a bit of a legacy issue in that previous
management did not spend money developing its assets. Eagle River has been in
production for over 25 years, but with two to three years mine life at a
time. CEO Rolly Uloth joined Wesdome a little over a year ago and started to
spend money on underground development, as well as expand the management
team. We're expecting that work to push cash costs down from about $900/oz to
sub-$800/oz next year. It is also looking at doing a mill expansion.
TGR: Klondex has about $40M in debt. Is that a problem?
RH: I don't think so. The balance sheet is still quite strong and
the company is generating free cash flow. Basically, it raised money to buy
the Midas mill by setting up a gold purchase agreement with Franco-Nevada
Corp. (FNV:TSX; FNV:NYSE). The only significant debt it has is the Franco
gold stream.
TGR: Will 2016 be the year when this sector finally begins its
climb out of the doldrums, or will investors have to wait until 2017 or
beyond?
RH: I'm hoping things start to turn around in 2016. We've seen a
lot of cost-cutting, especially among the senior producers. A few years ago,
Barrick Gold Corp. (ABX:TSX; ABX:NYSE), one of the world's largest gold
producers, was spending billions, and was billions more in debt. But with all
its asset divestitures and cost-cutting, it's now a totally different story.
Across the space everyone is looking through a magnifying glass at ways to
improve balance sheets. Now we need some cooperation from the gold price. Our
belief is that toward the end of 2016, we're going to see something of a
rebound. But it's really going to come down to the gold price, which is why
the companies we selected as our top picks are fit to weather the storm.
Should depressed commodity prices continue for a while, they will still be
the ones generating cash flow.
TGR: Thank you for your insights, Ryan.