The gold sector has always had a boom-and-bust mentality. Ron Stewart of
Macquarie Equity Research says the flip side to the bear market is that the
next bull market will produce phenomenal gains, and the companies leading the
pack will be those that can still flourish at $1,000/ounce. In this interview
with The Gold Report
Stewart identifies low-cost, high-grade miners, several of which are likely
to excite interest from cashed-up suitors.
The Gold Report: There was a widespread assumption in 2011
that the price of gold could only go higher. As we have seen, this assumption
was very much mistaken. Today the mood is much more pessimistic. Could this
pessimism be just as mistaken as the optimism was?
Ron Stewart: Yes, it could, but it's my experience that markets
tend to overshoot on the upside and downside alike.
TGR: Why has gold lost so much value?
RS: Several reasons. Gold tends to rise in times of high inflation,
and inflation is pretty low right now. The U.S. economy is doing well
compared to other countries, and gold has a negative correlation with the
U.S. dollar. Money is flowing into the U.S. economy and to the U.S. dollar
and exiting other instruments such as gold.
TGR: What do you make of the argument that financial institutions
such as Goldman Sachs are using shorts to beat down the gold price?
RS: It's really hard to point a finger at any one institution or
entity that could drive the gold price one way or another. There are so many
factors in play. For example, Russia now has the fifth-largest central bank
holding of gold and continues to accumulate it. Should Russia become
sufficiently distressed economically and need to acquire foreign currencies,
it might become a gold seller.
It's important to remember that the gold sector is a relatively small one
in the global economy, and so its volatility is exacerbated as a consequence.
TGR: How long will the price of gold remain depressed?
RS: The last time the gold and gold mining sectors were so out of
favor lasted from roughly 1998 to 2002. We're now two to three years into the
current bear market. How long will it last? That's the $64,000 question.
TGR: In 2008, economic shocks led to rapid gold appreciation. Do
similar conditions exist today?
RS: The situation today is considerably different than in 2008.
Back then, several major banks were on the brink of collapse, and the markets
were basically frozen almost overnight. Today, we have a weak European
economy and a slowdown in China. But I don't consider another almost
catastrophic failure in the financial system to be imminent.
TGR: What are your near- and longer-term predictions for the price
of gold?
RS: In the near term, we're looking at a range of $1,150 to $1,300
per ounce ($1,150–1,300/oz). Could it go lower? Yes. Over the next three to
five years, we see the opportunity for a constructive price increase.
TGR: The Gold Report interviewed Oliver Gross in October, and he told us that all-in
sustaining costs for gold producers are now above $1,150/oz and that
increased production will require a gold price of at least $1,400/oz. That
being the case, doesn't it suggest that absent a significant rise in the gold
price many mines will become marginal or will be shuttered?
RS: We are seeing some margin squeeze at the top end, but the
recent fall in the oil price helps miners by reducing operating costs. More
important, any analysis based on the U.S. dollar price of gold fails to
consider the local impact of different currencies. For instance, if one
considers the Canadian or Australian dollar, the gold price fall in these
currencies hasn't been as dramatic, and so Canadian and Australian operations
haven't been squeezed quite as badly as operations priced purely in U.S.
dollar terms.
Mines don't shut simply because they are losing money in the short term.
Mines are long-term investments, and their owners have taken and will take
steps to further reduce costs.
TGR: Toward the end of last year, hundreds of precious metals
stocks reached 52-week lows. Will investors consider this a buying
opportunity?
RS: Buying and selling are individual decisions, so it's hard to
make sweeping predictions. Investors who take the long view should consider
Warren Buffett's advice: Be fearful when other investors are greedy and
greedy when other investors are fearful.
TGR: Investors in gold companies are fearful, so what are the
critical factors they should consider before buying shares?
RS: We look for good management teams, good balance sheets and
projects that are not highly leveraged. Investors should also take care to
choose stocks that have sufficient liquidity to allow them to get out, should
circumstances change or they change their minds.
TGR: Which junior gold producers today are your favorites and why?
RS: We like smaller Canadian producers because of the currency
advantage I mentioned above.
TGR: Could you give some examples?
RS: AuRico
Gold Inc. (AUQ:TSX; AUQ:NYSE) and Richmont Mines
Inc. (RIC:TSX; RIC:NYSE.MKT) are two. Both are well managed and have
bright futures. In the case of AuRico, it is currently gearing up its
Young-Davidson mine in Ontario. We expect this to be a long-life, low-cost
asset.
Richmont is developing a deep, high-grade zone at its Island gold mine. At
around 9.5 grams per tonne (9.5 g/t), this zone is almost double the 5.5 g/t
of the upper zone that it has been mining. We expect this high-grade will
drive strong cash flow and earnings for some time.
Alamos
Gold Inc. (AGI:TSX) has $350 million ($350M) cash, no debt and is
producing at a profit. Rio Alto Mining Ltd. (RIO:TSX; RIOM:NYSE; RIO:BVL) is
also profitable and can weather the storm. SEMAFO Inc.
(SMF:TSX; SMF:OMX) has no debt and is generating cash. These are
companies that could still do relatively well with gold at $1,000/oz.
Teranga
Gold Corp. (TGZ:TSX; TGZ:ASX) is producing over 200,000 ounces (200 Koz)
annually at about $1,000/oz all-in costs at Sabodala in Senegal. Its balance
sheet is somewhat weaker than the companies I've just mentioned, but Teranga
is working through that problem. I can see a really good opportunity for
returns should it execute its plan, but it might take a little bit longer for
this company to get its value reflected in the market.
TGR: Are mining operations in Senegal affected by the Ebola
epidemic?
RS: There was only one case of Ebola in Senegal, and now the
country has been declared Ebola free. Teranga is on guard against the disease
and has secured its supply lines. So Ebola has had no material effect on the
operation, but it might have had an effect on market sentiment.
TGR: What are the prospects for production expansion at Sabodala?
RS: Teranga's mine plan is 225–250 Koz annually for 8–10 years. The
opportunity to make another discovery, even a game-changing discovery is
there, but that depends on the success of the aggressive exploration campaign
it is pursuing.
Teranga is a good, solid company with competitive costs. We have an
Outperform rating for it, with a 52-week target price of $1.40/share, close
to three times its current valuation.
TGR: Which near-term U.S. gold producer are you keen on?
RS: Romarco
Minerals Inc.'s (R:TSX) Haile mine in South Carolina is now fully
permitted, and its debt is secured. The company still needs to complete its
financing, but Haile is shovel-ready. Haile should produce 150–175 Koz per
year for 10–12 years. Its reserve is about 2.6 g/t, which means an all-in
sustaining production cost of less than $700/oz.
TGR: Until the company suspended exploration in 2013, Romarco was
regularly getting outstanding assay results. Now that mine construction is
close, will exploration recommence?
RS: Haile has a current gold reserve of 2 million ounces (2 Moz),
with a Measured and Indicated resource of 4 Moz. So the possibility of
expansion is already contained in the mining plan. Romarco's priority is
money. It was successful in organizing a bank syndicate to give it a $200
million ($200M) term sheet, but it still needs to secure an additional $250M
or so needed to build the mine. I would expect to see news on that front
ahead of exploration news.
We believe that Haile will be built and that it will be a success. We've
given Romarco an Outperform rating, with a target price of $1.15/share, which
is over an 80% premium over its current share price.
TGR: Which U.S. gold exploration company are you keen on?
RS: We like Castle Mountain Mining Co. Ltd. (CMM:TSX.V; CTMQF:OTCQX)
and its Castle Mountain mine in San Bernardino County in California, just
over the Nevada border. This is a past-producing mine, in production as
recently as 2001, and is still permitted. It has an NI 43-101 resource (at a
0.34 g/t cutoff) of 2.56 Moz gold Indicated and 828 Koz Inferred.
The company is currently working through a feasibility study to decide
what scale of operation could be built and at what cost. Castle Mountain has
a very capable group of people shepherding this.
TGR: The new chairman, Mark Wayne, was formerly chairman of Alamos
Gold. What does he bring to Castle Mountain?
RS: As well as a new perspective, Wayne brings the experience of
advancing companies through feasibility and construction to production. He
complements what is already a strong team. I know these people quite well,
and there is depth across the board.
We rate Castle Mountain Outperform with a $1.75/share target price. This
stock currently trades at $0.32/share.
TGR: Which African near-term producer is your favorite?
RS: We've recently resumed coverage of Roxgold Inc.
(ROG:TSX.V). Its Yaramoko project in Burkina Faso is fully financed. This
is an extraordinarily high-grade deposit with an Indicated resource of 1.6
million tons at 15.8 g/t for 810 Koz gold.
Roxgold is developing a small underground mine, probably 750 tonnes per
day, capable of producing 100 Koz per year, with outstanding exploration
upside. All-in cash costs are in the $700/oz range. The internal rate of
return we have on its $100M capital expenditure (capex) is 48.4%, a
spectacular return on investment.
TGR: How is the political turmoil in Burkina Faso affecting
Roxgold?
RS: A popular uprising forced the resignation of President Blaise
Compaoré on Oct. 31. The country is currently under martial law. Roxgold just
got its exploitation agreement in place with the administration of the
interim government. It still needs to have that signed by a sitting president,
and is waiting for a president to be appointed from the civilian ranks. This
should be imminent. Following that, construction will begin, with production
expected toward the end of 2015.
We've given Roxgold an Outperform rating and a 12-month target of
$1.35/share, more than double the current share price.
TGR: There's a gold mine currently under construction in Mexico you
rate highly, correct?
RS: That's Torex Gold Resources Inc.'s (TXG:TSX) El Limon in
Guerrero State. It's a 2.5 g/t open pit with a $700M capex. It's fully
financed. Torex has already started the pilot mine, and it is stockpiling
ore. Pre-commercial production will begin August 2015, with a nine-month ramp
up to full commercial production. That will be over 300 Koz per year at about
$700–800/oz all-in cost.
This is a compelling story made even more so because the company has a 5.8
Moz gold equivalent discovery to the south of El Limon, Media Luna. Torex is
considering development options that would allow it to bring that forward and
combine it with El Limon to enable yearly production of 500 Koz. This is a
very well-managed company.
TGR: Guerrero State has been racked by turmoil since 43 students
were abducted by police in September. Has this had any effect on Torex?
RS: There is a national and international outcry about this. And it
happened only 60 kilometers from the Torex site, so there's heightened
security there. We spoke to CEO Fred Stanford. He's mindful of the situation,
but it has not affected the company at this stage.
We rate Torex Outperform, with a target price of $2.25/share, a 64%
appreciation over the current share price.
TGR: Are any of the companies we've discussed likely takeover
targets?
RS: Torex, Roxgold and Romarco all have one asset, and single-asset
mining companies rarely remain independent for long. The industry covets
low-cost commercial mines, and so the opportunity for acquisitions over the
lives of these mines is quite high.
TGR: Given the state of the industry, juniors with deep-pockets
joint venture (JV) partners are sitting pretty. Which such junior are you
particularly interested in?
RS: Reservoir
Minerals Inc. (RMC:TSX.V), which has a JV on its Timok copper-gold
project in Serbia with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE).
Reservoir has come up with what is shaping up to be a world-class system with
fantastic opportunity to the upside.
Freeport has the right to buy 75% of Timok, and in return Reservoir is
fully funded to feasibility. I know Simon Ingram, Reservoir's CEO, quite
well. He's working with and negotiating with Freeport on an operating JV
agreement right now. This is a process that's been ongoing for the better
part of a year because Ingram is determined to establish the best possible
working arrangement.
TGR: Will Freeport buy out Reservoir?
RS: Well, Freeport certainly has a lot on its plate, but Freeport's
CEO Richard Adkerson has recently made it clear just how bullish he is on
Timok. So a takeover is possible. That said, I believe Simon and his team
will do everything they can to unlock maximum value for Reservoir's
shareholders. We think Reservoir brings some welcome excitement to a sluggish
market.
We've given Reservoir an Outperform rating with a $9/share target price.
As you know, the stock was recently up around $5/share, but now it's back
down to $4.15/share. This is an example of the volatility I've spoken of. We
see a considerable opportunity for value in Reservoir with continued
exploration success.
TGR: What reasons do precious metals investors have to be cheerful?
RS: Investors really have to look at their timelines and determine
what's motivating them to put money into any sector and when. Certainly
anyone who's been invested in precious metals over the last three years is
feeling a lot of pain right now. I understand that, but going back to the
famous Warren Buffett quote, fear has become dominant across the entire
materials spectrum: gold, silver, copper, iron ore, etc. But the world is not
going to stop needing metals.
There are good places to invest, if you have the patience and fortitude to
ride out the downturn. When the next bull market begins, returns will be
phenomenal. When that's going to happen I leave to a higher authority.
TGR: Ron, thank for your time and your insights.