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Senior producers seeking
to replenish depleted gold reserves will be looking to promising juniors to
provide needed ounces, suggests Dave Goguen,
director of institutional sales for PI Financial Corp. In this exclusive
interview with The Gold
Report, Goguen provides his views
on where senior gold producers will be hunting and which companies will meet
newly stringent criteria in the risk-averse but increasingly gold-hungry
world marketplace of today—and tomorrow.
The Gold Report: Dave, tell us a little
bit about PI Financial.
David Goguen: PI Financial Corp. (PI) is one of Canada's
largest, independent, employee-owned full service investment dealers. PI has
been advising and financing the mining sector for the past 30 years and I
have been providing resource sales coverage to institutional clients for over
15 years.
TGR: It's been a tumultuous
year in the mining space. Maybe gold prices haven't hit the highs that we saw
in 2011, but with prices hovering around $1,700/oz,
most gold producers can make a profit. On the other hand,
equities—particularly the mid caps, small
caps and micro caps—have been decimated by summer doldrums or investor
disinterest. PI Financial obviously sees opportunity in the mining sector.
DG: A very good proxy for
the senior gold companies is the Van Eck Market Vectors Gold Miners ETF
(GDX). Going back 12 months from today, this ETF is down 23%. Over the same
period, the Market Vectors Junior Miners ETF (GDXJ) is down considerably
more, by 39%.
I think a key reason for
the underperformance is due to the recent challenges that juniors have had to
face in raising capital to fund continuing exploration and development.
Historically, smaller and less liquid mining companies are hardest hit in a
risk-averse, "risk-off" market. The junior mining sector is
delivering a lot of technical studies that have been underway for the last
year. These studies will provide the insights by which investors will choose
certain development projects over others as they assess capital cost of
construction and project rates of return. This process will see investors
supporting companies that they expect will lead the way in the next cycle.
TGR: You've predicted that
some of these junior miners will have a recovery in the fall. Could senior
producers that need to replace reserves be shopping for mid-size junior
companies with promising projects to acquire? Do you see merger and
acquisition (M&A) activity in the fall and going into 2013?
DG: I agree that there will
be mergers and acquisitions, driven by poor returns on some senior gold
producers' larger capital development projects. Looking back on the second
quarter reporting season, which just ended, commentary reflects management
and shareholder displeasure with the rate of return on some of the larger
capital development projects.
"The majors will
likely look at smaller projects, instead of the larger ones previously
targeted."
Unanticipated project
cost escalation due to increased capital expenditures (capex),
schedule extensions and geopolitical risk has meant that the cost of
executing on these construction programs exceeded what was originally
factored into budgets by a very wide margin. Barrick
Gold Corp.'s (ABX:TSX; ABX:NYSE) statement that
"returns drive production instead of production driving returns"
has become a new mantra echoing among senior gold companies. Projects are
going to be assessed with a more critical evaluation of risk-adjusted
returns, and capital allocation discipline is really going to be stressed.
We would expect greater
scrutiny of some of the more marginal projects in the development pipeline,
some of which may be put on hold or even canceled. A prime example from the
base metal space is BHP Billiton Ltd. (BHP:NYSE;
BHPLF:OTCPK) putting $63 billion of capital programs on hold. Barrick Gold has suspended projects as well.
TGR: If senior companies use
more fiscal discipline and scrutinize potential acquisitions more carefully,
won't margins improve and financials look correspondingly better? Couldn't
this be a positive thing for shareholders?
DG: Fewer projects will
satisfy the decision criteria for development and construction. With fewer
projects launched and fewer marginal ounces coming onstream,
there is going to be reduced supply in the global gold market. As development
projects idle and the effects are felt in future production and global supply
numbers, there will be a resulting reduction in gold supply or at minimum a
reduction in future supply growth. This, in turn, should mean higher gold prices
in the intermediate and longer term and should be positive for the junior
gold companies.
TGR: What else will that
mean?
DG: In the past, the
capital requirements and capital risk of developing larger
projects—especially larger projects in remote locations—has been
underestimated. As a result, the majors will likely look at smaller projects,
instead of the larger ones previously targeted. These projects are potential
producers of, perhaps, 200,000 to 400,000 ounces (oz)/year,
instead of 500,000+ oz/year.
Their development cycle is shorter and their ultimate capital costs can be
contained. These are the smaller projects held by some of the junior
companies that we follow. Investors should focus on companies with projects
that are amenable to phased development and can be scaled up offering smaller
initial capital outlays and future expansions funded out of project level
cash flows.
TGR: So the majors are going
to be looking at smaller projects with lower capex
requirements and higher margins, as opposed to pursuing larger development
programs in more remote places with smaller margins?
DG: Exactly.
TGR: Given that backdrop, in
what parts of the world are majors going to be sniffing around?
DG: We would focus on Latin
American-based projects. Latin America has historically had one the highest
allocations of exploration capital. PI Financial produces a quantitative
research piece called "Select Golds" that
focuses on Latin American precious metal companies. We examine advanced
explorers, emerging producers and junior producers. We track their evolution
and progression through each of those categories and into production.
TGR: In what countries?
DG: We specifically like
Mexico. The geology is excellent and continues to yield new discoveries both
in precious metals and in base metals. Mining has a long history in Mexico.
There is an ample skilled labor force and a strong network of technical
suppliers and technical services. Permitting and mining laws are transparent,
with a record of fair treatment. Technical submissions and permit
applications are responded to and processed by the various ministries in a
timely manner.
"Latin America has
historically had one the highest allocations of exploration capital."
Mining is socially
accepted in Mexico. A good example of a locale that provides technical
services to mines and to development projects within the Sierra Madre is
Hermosillo. Mexico has proven its ability to cater to companies that are
developing assets there.
Brazil is also well
regarded for supporting mining exploration and development. Processes for
getting approvals are both well laid out and well understood. Brazil also has
the bureaucratic infrastructure to approve permits. So, the path from
development to production in Brazil is a relatively straightforward one.
TGR: What are some
particularly promising companies and projects in Brazil?
DG: In Brazil, the Volta
Grande project is being developed and advanced by Belo Sun Mining Corp. (BSX:TSX.V). This project has a lot
going for it. It has attractive size, with over 5 million ounces (Moz) Measured and Indicated and Inferred. It has
attractive grade, at 1.7 grams per ton (g/t) gold. The resource should
support a meaningful production profile, likely 250,000 to 350,000 oz/year. And, the deposit sits in a prospective
greenstone belt that is 100% controlled by Belo Sun. So, if a major were to
come in and acquire Belo Sun for the Volta Grande project, that major would
also expect the benefit of an entire greenstone belt package on which to fund
continued exploration, while maximizing purchase value through additional
discovery within the prospective belt.
TGR: What other Latin
American companies that might be not as well developed as Belo Sun offer
potential for M&A?
DG: Considering the new
criteria for M&A interest that we've discussed, in Mexico, Torex Gold Resources Inc. (TXG:TSX) would certainly be a
company the majors could be looking at. Torex has
4.8 Moz in the Measured and Indicated category with
a grade of 2.79 g/t. This open-pit development is expected to be ready to
begin construction in mid-2013, with production by early 2015. And, Torex is due to deliver a feasibility study shortly. It
is my belief that this study will further validate the project and show that
it has sufficient resource to merit interest from intermediates and majors.
TGR: Is this in the
Hermosillo area you mentioned? It looks as if it's actually relatively close
to Mexico City.
DG: Torex
is in the state of Guerrero, within the Guerrero Gold Belt. Torex has features that make it an attractive acquisition
candidate, with a project located in a productive gold belt that has
geological exploration upside potential and future optionality on discovery.
Any prospective buyer of Torex is ultimately going
to enjoy the benefits of any subsequent discoveries in the belt.
TGR: Torex
is also an unusual company because it has a sizeable treasury at this point.
DG: Yes. Torex has $69 million (M) in cash as of July 31, 2012.
But, with delivery of a feasibility study expected soon, this capital will be
needed for long lead-time expenditures. The capex
on this project is going to be somewhere in the $500–700M range, and
that means equity and debt financing will be needed.
TGR: What other names are
there in Mexico?
DG: Timmins Gold Corp. (TMM:TSX.V; TGD:NYSE.A) is in Sonora, Mexico.
Timmins started production approximately two years ago and is on track to
produce 100,000 oz in 2012.
The company has made
good progress in its revitalization of the San Francisco mine. Expansion
plans currently underway target a production level of 130,000 oz/year.
"We specifically
like Mexico. The geology is excellent and continues to yield new discoveries
both in precious metals and in base metals."
Improvements in
throughput rates have raised monthly gold production. After a period of
spending cash flow on capital development and mine optimization, Timmins is
turning the corner and is expected to generate coveted free cash flow.
For intermediate gold
companies looking to grow and for investors looking to position themselves in
real value, Timmins is also especially attractive. When we look at other
junior developers that are attempting to build mines of the same scale as
Timmins' San Francisco, it becomes very clear that Timmins is trading well
below replacement value.
TGR: What other companies do
you like in Mexico?
DG: On the development side
I would be looking at Esperanza Resources Corp. (EPZ:TSX.V). Esperanza looks like a
good value in the junior gold space.
Esperanza has the Cerro Jumil project. This time last year, Esperanza delivered a
preliminary economic assessment (PEA) that called for just over 100,000 oz/year of production, for an initial capex
of approximately $114M to construct a heap-leach operation mining 35 million
tons (Mt.) of material grading 0.83 g/t gold. They've achieved surface land
and made submissions for water permits. At present gold prices, the Cerro Jumil project has an internal rate of return in excess of
50%. Esperanza is expected to deliver a prefeasibility study shortly, along
with a revision in resource expectations. I think that resource could see the
project mine life expand from six years to upward of 10 years,
and further define the ability to scale up the size of the annual production
profile.
Importantly, Esperanza
also benefits from a new management team. The development, construction and
operation team comes from Minefinders Corporation
Ltd., which was recently taken over by Pan American Silver Corp.
(PAAS:NASDAQ; PAA:TSX).
I'm quite confident that
Esperanza is going to be able to move the Cerro Jumil
project from prefeasability to production. The
Esperanza team is experienced in Mexico and is very experienced with this
particular kind of ore body and with this type of process flow sheet.
TGR: It also looks as if
Esperanza has other projects in the pipeline.
DG: Esperanza is doing
regional exploration. When the time comes, there are both local and regional
exploration targets that will be of interest.
TGR: We've spoken about four
companies in Mexico on the development side and four on the production side.
Which explorers or project generators in Mexico do you like?
DG: Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) is a very
well-disciplined, well-managed project generator with a very good track
record of making discoveries, and from either joint-venturing or advancing them
further. Its present flagship asset is the 100%-owned Ixtaca
property, which is a discovery Almaden made in
August 2010. The original discovery hole was 300 meters of 1 g/t gold and 48
g/t silver.
Almaden has four drills
operating and has now drilled over 200 holes on the project. Mineralization
has been traced for over a kilometer, and a parallel zone has been
discovered, which has also been yielding some good results. Almaden is expected to publish its maiden resource in
December.
TGR: Almaden's
Duane Poliquin invented the whole model of the
resource generator, didn't he?
DG: Almaden
is a classic example of the project generation model. After 26 years in the
exploration business, Almaden still has only 59.2M
shares outstanding. Almaden has shown that it can
fund the company through joint ventures and by monetizing assets and projects
that have been developed and sold to other companies.
TGR: Other than Mexico, what
other countries do you particularly like in Latin America?
DG: Nicaragua fits that
description perfectly, although those taking a cursory glance might conclude
otherwise. The operating experience of B2Gold Corp. (BTO:TSX; BGLPF:OTCQX) in Nicaragua has been
exceptionally good. It has no doubt benefited from the quality management
team it brought to Nicaragua.
But the country, through
its government and permitting processes, has been refreshingly responsive to
this junior gold company's needs. As a result, B2Gold has been successfully
operating the Limon mine, a 40,000 oz/year
producer. The La Libertad mine was developed and is now a 100,000 oz/year producer.
Cash costs for B2Gold
were $583/oz in the last quarter. The company has
recently raised its production forecast, anticipating the development of
what's called the Jabali zone. This zone exists in
a 15+ kilometer-long corridor of prolific rocks that are host to some
higher-grade mineralization that will be put through the La Libertad Mill.
TGR: Based on its success,
is B2Gold more of an acquisitor or an acquisitee?
DG: I think B2Gold is more
of an acquisitor. It has exhibited the bench
strength and the management capacity to operate a company three times its
size.
TGR: B2Gold has successfully
negotiated and navigated the Latin American political waters. The fact that
it can have such a successful project in Nicaragua suggests that it can also
be successful in Peru. And perhaps it can be successful in other areas, like
Argentina or maybe even Chile.
DG: B2Gold's management has
a long history in Chile, having formerly been with Bema Gold Corp. [acquired
by Kinross Gold Corp. (K:TSX; KGC:NYSE)] on the
Cerro Casale project and others.
TGR: Moving to a more macro
discussion, do you see a general and continuing recovery in the precious metals
equities? What other macro indicators, in your view, portend continued
recovery of the space?
DG: High levels of global,
unsustainable debt continue to support the upward trend in gold prices.
Unfunded debt impairs the ability of countries to grow and erodes confidence
in currency, whether that currency is the euro or the U.S. dollar or
something else. All the moves by the various central banks to effectively
print money through bond purchase programs to keep the yields and the
interest rates low just further debase currency. Many smart observers in the
marketplace have recognized that gold offers protection from those
activities. As it becomes increasingly evident that central banks have no
intention of stopping the printing of currency, gold should continue to rise
again.
This is a process that
is not going to sort itself out in weeks or even in months. It's going to
take years. While some of this pain is discounted in present valuations
already, volatility will continue as the global central banks work their way
out of this mess.
TGR: What a great summary by
which to end our conversation. What else would you like to add?
DG: Perhaps more than any
other time in the recent past, the Q2/12 reporting season has cleaned the
slate with respect to disclosures among senior mining companies,
intermediates and even junior companies. This fundamental reconciliation of
the challenges gold companies have had with their associated assets paves the
way for better news going forward as these challenges are overcome. The
prospect of better news is what we're starting to see get discounted in share
prices, hence the sector is in the early stages of moving higher.
TGR: What new interest is
there in the junior gold space from institutional investors? Considering that
we have a cleanly set table, what different people are at the table than
you've seen before?
DG: The past six months
have brought a kind of cleansing process to institutional portfolios. The
shares of companies that did not meet expectations and projects that did not
evolve as hoped are being sold. And the resulting proceeds are being
reinvested in some of the better companies that remain. It is those better
companies that we see now leading the market higher in junior golds.
TGR: Excellent. We and our
readers value your comments.
David Goguen is PI Financial's director of institutional mining sales, where
he focuses on the mining sector. Goguen's focus
includes Select Golds—advanced, exploration,
emerging producers and junior producers. Goguen
earned a Bachelor of Arts degree in economics from Carleton University and
holds the Chartered Financial Analyst designation.
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DISCLOSURE:
1) Sally Lowder of The Gold Report conducted
this interview. She personally and/or her family own shares of the following
companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Gold Report: Timmins Gold Corp., Almaden
Minerals Ltd. and B2Gold Corp. Streetwise Reports does
not accept stock in exchange for services. Interviews are edited for clarity.
3) David Goguen: I personally and/or my family own
shares of the following companies mentioned in this interview: Esperenza Resource Corp. 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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