The Gold Report: When we talked in November,
you warned that there would be downward pressure on gold this year. What are
you anticipating for the balance of 2015 and into next year?
Florian Siegfried: We were being cautious in November when we
published guidance that indicated gold could trade as low as $1,070 per ounce
($1,070/oz) as a support zone. And that is pretty close to where it is
trading right now. But I think that we have to distinguish between the paper
price of gold and the physical price, which trades at a premium. For example,
the U.S. Mint currently sells gold at around $1,400/oz.
This suggests that there is some tendency toward increasing premiums in the
market for physical metal. Where we go by the end of the year is a difficult
question because it's always hard to catch the bottom of the market. But a
look at the last three or four years gives us some clues. Hedge funds were
maximum net long in gold at the peak of 2011, and now they're maximum net
short, which could be a good contrarian indicator (see chart above).
It looks as if $1,080/oz could be the bottom. It's not defined yet, but
the sentiment is definitely at extremes.
The turn in gold will come from short covering, and the short covering
will come when the bearishness really reaches a climax event. Probably we are
there, but we will have to wait and see. It is difficult to make a call for
year-end because there are so many factors influencing the gold price, and
sentiment is extremely negative. The trigger for moving up could come from
the bond market, which is in a difficult spot right now. Liquidity is down.
Yields and credit spreads are rising. When something goes wrong there, where
will the conservative money go to? I don't think it is going to go back into
government funds. As investors lose confidence, that could be the trigger for
gold. We are probably going to see this in the fall, by September or October.
I think the bond market is about to turn around.
TGR: What are some of the other triggers you're watching? Are you
monitoring the U.S. Federal Reserve and whether that rate hike happens in the
fall?
FS: I think the Fed is testing the market because it knows we are
in a massive bubble and is talking to see what happens. I have four simple
reasons why I would not expect a rate hike in September:
1. The Fed sits on a US$4 trillion balance sheet. Raising rates would mean
bonds go down in value, and this could wipe out the Fed's capital. That's the
last thing it wants.
2. The impact to the carry trades, which the banks always need, would be
drastic. The banks get free Fed money now that they can invest in treasuries
and multiply it tenfold, making a profit basically at no risk. An increase in
rates would put pressure on the banks, something the Fed doesn't want either.
3. U.S. exports are already suffering with a strong dollar, and a rate
hike would make the dollar even stronger.
4. This fragile economic situation is also something that the Fed doesn't
want. That is why quantitative easing is somewhat like the Hotel California.
You can check out, but you can never leave.
I would expect more market dislocations because I think the Fed is between
a rock and a hard place. Generally my advice is to play it safe and not to
put all your capital at work at this time.
TGR: You're in Switzerland. Are you more worried about what's
happening in Europe or what's happening in the U.S.? Do you think the Greek
crisis is now behind us and we've solved that problem or will that continue
to haunt us the rest of the year?
FS: I would be more concerned about Europe right now because Greece
is not fixed. It's an exercise to save the banks because everybody knows that
if Greece defaults, it will trigger a chain of events that becomes
uncontrollable.
The market seems to like the short-term fix and the U.S. dollar is
benefitting. If you are looking to park your money, probably the U.S. is the
only place you want to go. I don't know how long it will last because the markets
in the U.S. are shaky. I think we are lurking on a major top in the equity
markets. But people still like the dollar, and it's probably the best
currency right now.
TGR: The last time we talked, you also anticipated that mergers and
acquisitions (M&A) would be a major theme for this year, and that
definitely seems to have played out. Let's talk about some of the deals that
have happened recently in the resource sector. What can investors learn from
that?
FS: There were a few interesting acquisitions/mergers in the last
month. The transaction between OceanaGold
Corp. (OGC:TSX; OGC:ASX) and Romarco Minerals
Inc. (R:TSX) is interesting because OceanaGold is an Australian gold
producer with assets in the Philippines and New Zealand. The company is
buying, for almost CA$900 million (CA$900M) in an all-equity transaction,
Romarco, which has the 4 million ounce (4 Moz) high-grade Haile deposit in
South Carolina. I think the transaction shows that good quality deposits are
very rare. Otherwise, an Australian company wouldn't enter new territory in
the U.S. Also, I think this shows investors that good projects, despite dire
market conditions, come at a premium. OceanaGold paid almost a 70% premium on
the Romarco shares.
TGR: Are similar premiums being paid for rare high-quality silver
projects?
FS: Yes. First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE)
recently bought SilverCrest Mines Inc. (SVL:TSX; SVLC:NYSE.MKT). Both are
silver producers in Mexico. This was a friendly all-share deal for the Santa
Elena high-grade mine. It is probably strategically important for a company
like First Majestic to add to its footprint to realize the vision of becoming
the leading silver producer in Mexico. The deal also adds net cash to its
balance sheet on the order of CA$25M. That means the company is improving its
balance sheet and it has another high-grade deposit to add to its portfolio.
In this market, there aren't too many companies that can offer a $120M
transaction, so it's a buyer's market. In a rising silver price environment
investors will revalue the whole company and see the wisdom in the timing.
TGR: Will these deals set a precedent for pricing going forward?
FS: It really depends on quality.
Temex
Resources Corp. (TME:TSX.V; TQ1:FSE) recently received a superior
proposal from Lake
Shore Gold Corp. (LSG:TSX) following the initial takeover bid from Oban Mining
Corp. (OBM:TSX). Lake Shore is paying 50% more than Oban offered on the
Temex share price and the weighted average price is roughly a 100% premium,
but it's a small transaction, $24M, compared to Lake Shore's $500M market
cap. That transaction makes sense strategically because the Whitney project
is so close to Lake Shore's Bell Creek mill in Ontario, Canada.
I would be cautious when transactions don't make sense operationally, for
example, a company with a good asset base and poor balance sheet buying
another company with a bad asset base but a good treasury. That might just be
a transaction to fix the company financially without creating any long-term
value or creating any benefit for the shareholders.
TGR: As you mentioned, a lot of these are paper deals. Do you think
that's going to be the standard?
FS: The companies buying now can dictate the terms. No one wants to
pay a premium in cash because cash is rare, and companies need the cash for
their mines, as we probably won't come out of the downturn any time soon. So
they use their share price as currencies, and that's exactly the right thing
to do. But it's going to change when the market gets more buoyant, companies
make cash and accumulate a treasury, and banks prove more willing to lend.
It's all cyclical.
TGR: Based on those deals, what are some companies that look
attractive today, either as M&A targets or as projects that could be well
positioned once the gold price does turn?
FS: The big mining companies, AngloGold Ashanti Ltd. (AU:NYSE;
ANG:JSE; AGG:ASX; AGD:LSE), Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and
Newmont Mining Corp. (NEM:NYSE) are currently disposing of nonstrategic
assets. They have to shrink their portfolios and fix their balance sheets.
Sooner or later, these companies have to refill their production pipeline,
and they will have to do this by acquiring.
When you are betting on M&A, one way is to evaluate smaller
exploration companies that are in a good position financially because they're
backed by major shareholders who can fund their exploration programs through
the downturn. Even better are companies with solid brownfield assets, which
make it rather easy to prove up a substantial gold resource.
One of two companies I would suggest that are in this position would be Falco Resources
Ltd. (FPC:TSX.V), which has a past-producing portfolio in Quebec called
the Horne project. The strategy is pretty clear—drill this deposit out, prove
up the preliminary economic assessment (PEA), prove up the metallurgy, move
the project to bankable feasibility level and then sell it to a major. One
way of getting exposure to M&A upside is through Falco Resources.
The other one in a similar position is TerraX Minerals
Inc. (TXR:TSX.V), which has a huge district in the Northwest Territories,
the Yellowknife City project, just north of the historic Con and Giant mines,
which collectively produced about 10 Moz gold in the past. TerraX controls
the whole district and is targeting a 5 Moz gold resource. Management knows
what a high-grade deposit should look like to make it attractive as a
takeover target. TerraX is never going to be a producer. I think it is
heading for an exit strategy. Management holds 15% of the company. When the
majors need to buy something, this project will be available with great
recent work. But it needs time. This is not a stock you only need to hold for
a couple months. You have to be patient. That requires a three- to five-year
time horizon.
TGR: What are a couple of other companies that might be good
acquisition targets?
FS: Torex
Gold Resources Inc. (TXG:TSX) was an acquisition target over the last few
years. With a market cap close to CA$1 billion and a new PEA for its second
project called Media Luna in Mexico, which has an after tax net present value
of almost US$500M, it might be too big when you consider that a potential
buyer would have to pay a substantial premium. The company is building its
first mine, El Limón, right now. It's permitted and financed and adjacent to
the Media Luna deposit. Both deposits are world class. Torex is poised to
build the mine and go into production on its own.
Three names that still circle around as acquisition targets are Lake Shore
Gold, Detour
Gold Corp. (DGC:TSX) and Pretium Resources Inc. (PVG:TSX; PVG:NYSE).
TGR: What makes Lake Shore an interesting company as a takeover
prospect?
FS: I think it is in the right jurisdiction. It is benefitting from
the weak Canadian dollar and has a decent operation, plenty of in-the-ground
potential and is fixing its balance sheet over time. Gold in Canadian dollars
is almost $1,500/oz right now, so it is protected. It's like a hedge.
TGR: What are the steps Lake Shore still needs to take to derisk it
to the point that it would start turning heads?
FS: It was turned around two years ago. It has a relatively long
mine life and generates cash flow. Although the valuation discount of the
past has largely been removed over the last few quarters, I don't think the
market has really factored in an M&A premium. This could change once the
company demonstrates its ability to repay its CA$103.5M convertible debenture
by operating cash flow in the next two years in order to reduce the balance
sheet risk.
TGR: Is Detour in the same position?
FS: In terms of mine life and annual gold production Detour is the
only major Canadian deposit that is still in the hands of a single asset
producer now that Osisko Mining Corp. is gone. Detour is highly leveraged to
the gold price, but it has been volatile. Sometimes it makes money, sometimes
it doesn't, based on mining and milling rates. I think there is still some
financing risk in a persisting low gold price environment as Detour currently
has some CA$500M in outstanding convertible debt. What Detour really needs is
an elevated, high gold price environment. Then it would make sense for an
acquirer to buy. Right now, I don't see that. It's just a name circling
around.
TGR: Pretium is busy moving the Brucejack deposit ahead in British
Columbia. It recently announced new permitting and infill drilling in Valley
of the Kings. Are there any key catalysts we should be looking for there?
FS: The great thing about Pretium is the sheer size of the deposit,
as well as the grade. It's one of those mines that brings a long mine life
and high grade in a safe jurisdiction. Pretium is probably clicking the box
there as well, but it's also hard to say if an M&A premium is factored
in. It recently received an Environmental Assessment Decision Statement from
the Federal Minister of the Environment that also includes agreement with the
Nisga'a Nation treaty. CA$80M in new Chinese money has been invested in the
company. Pretium is a third name that I hear regularly in M&A
discussions.
TGR: What about companies that might just be good investments right
now?
FS: St
Andrew Goldfields Ltd. (SAS:TSX) is attractive for me because it is
priced right. The company has growth potential and no debt. It's trading at
around $0.28/share for a market cap of less than US$100M. The market has not
taken note of St Andrew because of the tight shareholder structure. A single
shareholder owns around 50% of the company so brokers have not really covered
the stock, and it is not very liquid as a result. But when you look into the
company a little bit deeper, it is currently producing around 100,000 ounces
(100 Koz) of gold per year in the Timmins mining district on Ontario, Canada,
but in Q4/15, it will bring the Taylor mine into production. That could add
another 20–30 Koz of high-grade and low-cost production to its portfolio.
TGR: Do you think that is what investors are waiting for?
FS: In the last bulk sample, St Andrew put out a very good results
from Taylor demonstrating the grades were 20% higher at almost 9 grams per
ton (9 g/t) than its forecast. The stock price didn't really react on the
news, but I think that's just a function of the market. There is no interest
in the sector. This is an opportunity because if it can grow production by 25–30%,
it doesn't need to dilute shareholders, and it has another high-grade mine,
which is open at depth, gives free cash flow and has no major royalty. That
is something investors will really have to pay attention to. Taylor is going
to change the whole production profile and financial situation of the
company.
TGR: What is another company worth watching?
FS: When you look for value, where do you turn? Companies that
suffered dramatically in the current downturn, but generate cash flow at
current metal prices, have cash in the bank and no debt. I think one of them
is Gold
Resource Corp. (GORO:NYSE.MKT). It just put out Q2/15 financials. Despite
an illegal mine protest and work stoppage in May, the company earned US$9.4M
in operating cash flow and is paying around a 4% dividend yield, which should
be sustainable given the strong balance sheet. It has cash in the bank. It's
debt free. It has a nice, high-grade silver-gold project in Mexico and plenty
of exploration potential; nevertheless, the stock is down to US$2.50/share
after the company announced a decrease in metal production for the second
quarter. I think the selling is overdone. I remember in 2009 it moved from $1
or so to close to US$30/share in 2011 and it wasn't even in commercial
production. Now, Gold Resource is in production and the market cap is down to
$120M, and it is still paying a dividend. The good news is it didn't dilute
all the way down. I think the sentiment there is very negative and consider
the stock undervalued.
The same is true for Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT), which just
made two acquisitions in Mexico over the last eight months. I think the
market is overly concerned over whether the company has the capability to
bring the two gold projects into production in the foreseeable future. But
Timmins, with its existing San Francisco mine in Mexico, financed and put
this mine into production in the last down cycle in 2008 and 2009, so
management has proven it knows how to execute. The company has US$40M in net
working capital and can sequence the development of the two new projects to
manage the capital requirements. It is producing around 120 Koz annually. It
reduced guidance a little bit, but the underlying asset portfolio has the
potential to become a 300 Koz producer. The market cap in U.S. dollars is
down to $100M, which I think is ridiculously cheap. Timmins looks very
undervalued, in my opinion.
TGR: You also follow Australian companies. What will the precious
metals mining landscape look like there once the dust settles on the
OceanaGold deal?
FS: I think the Australian producers with West African operations
get virtually no attention in this market regardless of the quality of the
assets. The Australian dollar is so weak that gold there is at a two- to
three-year high. That makes the local producers with mines in Australia look
attractive.
One to watch is Perseus Mining Ltd. (PRU:TSX; PRU:ASX). The market cap is
around AU$150M, and it has AU$127M in cash and bullion with no debt. This is
an opportunity to buy a producer almost at cash value. Its Edikan gold mine
in Ghana is targeting 200 Koz of annual production. It has a 5.4 Moz gold
resource. The company added AU$40M cash and bullion in Q2/15. What is really
attractive to me is that the resource base is so big. The mine life is eight
years. Management has now proven that it has effectively brought costs under
control. In the June quarter the company's all-in site costs are below
$700/ounce, so it has a good cash margin. It's a low-grade deposit, 1.2 g/t
according to the mine plan and, typically for such deposits, any reduction in
mining costs can improve the operating cash flows significantly. At Edikan,
there are seven pits to mine over the mine's life, so it's not so easy to
work these deposits, but if you're a value investor and you're thinking gold
is going to turn around one day, here is a company that trades almost at cash
and you get the gold virtually for free.
TGR: Is there one last story that you want to mention?
FS: Probably the last one that also touches on this whole M&A
story would be Great
Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT). The stock has suffered
lately after some exchange-traded funds sold their positions. But it made two
acquisitions over the last few months that are interesting. It bought an
option on the Coricancha polymetallic gold-silver-zinc deposit in Peru from
Nyrstar (NYR:BSE). If it wants to execute its option to buy the whole
project, including the infrastructure, mill, everything on site, the price
would be around US$18M. It has a 124 Moz silver equivalent Inferred resource
and 22 Moz silver equivalent Measured and Indicated resource. So it's a big
resource. Great Panther is reviewing the mine plan to see if it can find cost
efficiencies. Then it will decide if it wants to execute on the option. I
think that's smart. Great Panther is a stock to watch.
TGR: Do you have any final words of wisdom for readers looking to
survive 2015?
FS: Every bear market eventually turns into a bull market again.
Things are cyclical. So don't get depressed. You can never pick the bottom,
but you can prepare for the next upturn. Be patient. Don't get frustrated.
The cycle will turn. I think it's probably coming in late 2015 or early 2016.
When we see the best teams in the mining industry buying assets, that gives
you some confidence that the bottom can't be far away.
TGR: Thank you for taking the time to talk with us, Florian.
