The Gold Report:
When we talked in October, you compared the resource sector to a swamp. Is
that still a good analogy?
John Kaiser: The resource sector is
analogous to a swamp in that companies in this space are having a very
difficult time making any headway. Valuations are extremely low. All the big
narratives are either going south or stuck in a rut. There is no capital
flowing in to make this swamp a little bit more liquid, so it is really a
morass that all the companies are bogged down in.
JK: In principle the all-in cost of
producing new ounces suggests that if overall demand for gold goes beyond the
existing 5.4 billion ounce stock, then gold prices have to go up. Miners
simply can't keep mining projects in a loss position, and they really can't
push into production deposits that will lose money at the current price.
However, it could take a number of years before we see the higher gold price
emerge.
One of
the potential surprises for 2015 is not from the usual suspects of fiat
currency debasement or hyperinflation or deficit expansion, but from an old
standby called geopolitics. What we're seeing with this decline in the oil
price, down to below $60 per barrel and possibly lower, is an extraordinarily
destabilizing effect on the global power balance. Even the recent North
Korean cyber attack on Sony and the subsequent outage of the North Korean
Internet could have a destabilizing effect. I think 2015 will be the year
that gold may put on several hundred dollars an ounce for geopolitical
reasons. Those would be real price gains. They would instantly flow to the
bottom line.
TGR: Could low prices also lead to more
mergers and acquisitions?
JK: Yes. Something on the order of $140
billion ($140B) worth of Canadian juniors were taken over in the past decade.
A good chunk of those involved copper-related deposits. What's left are
copper deposits that need a somewhat better copper price to justify being
taken over. A lot of the deposits that were taken over are still in the
pipeline waiting for a final go signal.
In the
gold space, a number of high profile takeover bids have been written down,
but there are still a significant number of advanced deposits owned by
juniors that are not very appetizing to the majors at the current gold price.
If we start seeing an increase in the price of gold, we would see a scramble
to clean out the remaining batch of advanced gold deposits. For investors,
it's not going to be much of a consolation to get a 200–300% premium off
current levels, which are down 90% from their peak prices in the past four
years. However, this could provide a wave of capital into the sector.
Very
few existing gold deposits that work below $1,400 an ounce ($1,400/oz) remain
in private hands awaiting acquisition by a public junior, and when the
current inventory held by juniors gets cleaned out through takeover bids, it
is possible that the resulting capital could go into discovery exploration
for new deposits that work below $1,400/oz. Of course, if gold were to go to
$2,000/oz, a lot of projects would look good again and capital aimed at
feasibility demonstration would flow into gold projects that are hopeless
below $1,400/oz.
TGR: Do you still see the collapse in the
resource sector as a good thing because it killed off the dead wood, making
it easier to find good values?
JK: Unfortunately the problem is that the
sector is dropping through an extinction threshold that threatens good and
bad juniors. Some 700 companies have negative working capital that is never
going to be repaid by real money. Another 400 companies have under $500,000
in the bank. These are the ones that are hanging in there, but because it's
become so difficult to refinance, their willingness to spend dollars on
discovery exploration is very muted. This has created a kind of trap where
the high-risk type of exploration programs that deliver the surprise
discoveries are not happening with the degree of abundance needed to get investors
excited again. That is why we need to put some money into projects where
management has been burning the midnight oil to determine the best targets
for the few bullets they have left.
TGR: What are some of the companies that
are making or advancing discoveries that could give investors hope for a
future in natural resources?
JK: We recently saw Avrupa Minerals
Ltd. (AVU:TSX.V), a prospect generator focused in Europe, produce an interesting
volcanic massive suphide (VMS) intersection of copper and zinc in the Iberian
Pyrite Belt project called Alvalade, with Antofagasta Minerals (ANTO:LSE) as
the partner. That stirred hopes that maybe it was on to the edge of a
Neves-Corvo type deposit, which is the second largest VMS deposit in the
world. Follow-up drilling so far has hit additional mineralization, but
hasn't really tied it together to make Antofagasta confident that it is a
major system. Then, last week in Kosovo, another partner of Avrupa's
intersected 126 meters of 6 grams per ton (6 g/t) gold, which is an extremely
impressive intersection. Although the geological context is such that one
cannot very easily at this point assign multimillion-ounce gold growth
potential to this hole, it was a grassroots play in an area that had never
been drilled. It was generated in the old-fashioned manner of going into a
region that's been underexplored and assessing the geology.
I think
the nature of the mineralization is such that this has to be related to a
very big system. It is a jigsaw puzzle because there's been local faulting
that has moved the pieces around, but with this type of intersection, there
is room for a significant discovery. That is an example of something that was
off everybody's radar coming through with a surprise discovery hole.
TGR: It looks as if the market indeed got
excited. The price went from $0.20/share to almost $0.35, which is amazing in
this environment.
JK: Yes. The market seemed to recognize
it as a selling opportunity just as much as others recognized it as a buying
opportunity. The largest shareholder managed to sell 400,000 shares on the
day the news came out at an average price of $0.26, which helped snuff out
some of the momentum. Because Avrupa is a prospect generator, it farms out
with a net interest of anywhere from 30% to 15%—in this case 15% of the
project. Some 60 million shares fully diluted at $0.30/share gives the
project an implied valuation of $130 million ($130M).
Of
course, we need to see more results to show that there's some running room
for this intersection. The project could ultimately be worth $1–2B, in which
case we could see a valuation of $300–400M eventually emerging, which would mean
maybe a doubling or tripling of the stock price.
Because
of the fractional ownership, Avrupa would not go to the moon, but could
inspire the market to exercise all those warrants between $0.25 and $0.50 and
give the company the money and the green light to drill some projects 100%
rather than farm them out on punitive terms. This is the drawback of the
prospect generator farm-out model in a bear market where the junior gets very
poor terms, so that even if it delivers a major discovery, the impact on the
share price is relatively muted.
TGR: What are some other companies that
are giving investors hope?
JK: One of my favorites from the past
year has been Probe
Mines Limited (PRB:TSX.V). This is a hybrid-type company with an existing
resource of low-grade disseminated gold at about 4–6 million ounces (4–6 Moz)
at 1 g/t. At the current gold price, those resources are not very
interesting. But in 2013 the company discovered a much higher grade zone that
can be mined underground, and produced a resource estimate of 2 Moz at a good
underground mineable grade. The story stalled during 2014 because the ability
to chase the extensions of the zone was constrained by the land position.
For two
years the company has been negotiating with the lumber company surrounding
the property to acquire that land. A combination cash-and-stock deal finally
came through in early December. Probe now has lots of running room to chase
the deposit, and this system has the potential to blossom. If we do get a pop
in the price of gold, the company benefits because it starts bringing the
lower-grade ounces back into the equation, but primarily it is an exploration
play where one can hope to see the resource estimate double or triple with
similar high-grade mineralization pursued down plunge, and perhaps even in
parallel zones on the ground just acquired.
TGR: When might we start seeing test
results from some of that new property?
JK: At the moment Probe is doing infill
drilling. The main drilling is under Borden Lake, which has to wait until the
end of January when it is frozen. We will see an intensive lake drilling
program from February until late March as long as the ice holds. The goal is
to track the zone across the entire lake, see if it makes landfall, and then
carry on drilling from solid ground in the summer. Any meaningful assays will
not come out until May or June of next year. However, news about where the
zone is going and what the nature of the mineralization looks like could get
the market excited in the meantime.
TGR: What's another explorer that's
exciting?
JK: The Hunter Dickinson Group has a
company in its stable focused on British Columbia exploration: Amarc Resources
Ltd. (AHR:TSX.V; AXREF.OB:OTCBB). It appears to have made a significant
copper-moly-silver porphyry discovery on its IKE project. The news received
very little response from the market when it was published in November. However,
it is probably the beginning of a major new copper porphyry play in British
Columbia. Delineation should start in June. That gives the company time to
raise money and wait for market conditions to improve.
TGR: Does being part of the Hunter
Dickinson Group mean Amarc has more resources to move forward?
JK: Historically, Hunter Dickinson has
been able to raise money from a wide range of institutional sources. The
flagship is Northern Dynasty Minerals (NDM:TSX; NAK:NYSE.MKT) with the Pebble
project, which is bogged down in the environmental opposition to developing a
copper mine in the watershed of the salmon fishery. Plus, copper prices are a
little bit weak at the moment, with a debate evolving as to whether the
projected surplus will indeed be a surplus in the next couple of years, and
keep pressure on the metal price. On the other hand, there's some suggestion
that a lot of the copper mines that were supposed to come onstream will not
happen because of various geopolitical and social license issues and that, in
fact, copper may surprise us on the upside in 2015. But until that happens
Amarc may have a hard time tapping institutional capital for IKE. How Hunter
Dickinson goes about funding an aggressive program in 2015 without hideous
dilution bears watching very closely.
TGR: Is there another company worth watching
for discovery movement in 2015?
JK: Clifton Star
Resources Inc. (CFO:TSX.V; C3T:FSE) has been one of my picks as a bet on
higher real gold prices that has not worked out well.
TGR: There is a debate about the
direction of the company going on at the board level that has resulted in a
flurry of press releases recently. What is going on there?
JK: A number of years ago Clifton Star
acquired an expensive option on the Duparquet gold project in the Abitibi
Belt on the Québec side. The company published a prefeasibility study earlier
this year suggesting that a gold price above $1,400/oz is required for this
to have any opportunity to be advanced. The deal included heavy underlying
payments totaling $50M over four years, with $10M coming due on Dec. 1.
Clifton Star attempted to renegotiate the terms with no luck and defaulted,
leaving only a 10% net interest in the Duparquet project.
Fortunately,
Clifton Star received a significant refund from the Québec government for all
the money sunk into this project so far. It now has a treasury of about
$3.5M, shares issued of only about 38M, a very competent management team, and
a disgruntled shareholder group that was involved with the original promotion
and would like to push aside the management and take charge of this treasury.
Given
how difficult it is to get advanced projects that can work at the current
metal price, and how much money it costs to do feasibility demonstration, it
would be a much better value for shareholders if management looked at
investing the money in interesting exploration projects. Of all those juniors
out there, perhaps 700 are pretend exploration companies, but another 500–600
companies are serious companies suffering weak treasuries. That represents an
opportunity for companies such as Clifton Star to do farm-in deals with
significant upside potential that don't take many drill holes to prove out.
If a junior pulls a major hole in today's market, then it's off to the races.
We have see what direction management takes Clifton Star in 2015.
TGR: Talking about timing, often stocks
go through a yearly cycle, with tax-loss selling in December and investors
returning to the market for the January Effect, positioning themselves for
spring advances. Are you planning for a January Effect?
JK: Last year we saw a selective
turnaround in the first quarter, with better juniors starting to trend up. A
fair amount of money was raised during this time and we saw some takeover
bids, such as Osisko Mining Corp. acquired by Agnico Eagle Mines Ltd.
(AEM:TSX; NYSE) and Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE), which put
some money into the system. That rebound was tracking gold's run toward
$1,400/oz gold. But by the third week of March, gold started to retreat and
we have been in a downtrend ever since. If we do not get a sustained uptrend
in gold this year, I question whether we will get any sort of meaningful
January Effect in 2015.
I think
there is reason to start accumulating companies that can afford to be
patient. Those companies may develop modest uptrends heading into 2015. In
the absence of a meaningful gold price spike, it's going to be tough to get
any broad-based uptrend going. As far as macroeconomic trends, even if copper
prices start to improve, the United States economy continues to grow and
starts giving heart to the emerging market economy again, it could be another
year before any of that washes over into optimism that the commodity cycle
narrative is back in an uptrend.
TGR: You are speaking at the Cambridge House Canadian Investment Conference in
January. What message are you going to be giving?
JK: I'm going to argue that in this type
of environment the only way investors can get any significant action is
through exploration discoveries. That is why we need to look at companies
that are doing exploration, perhaps finance those companies and then monitor
to see who is coming up with a significant discovery. These types of
discovery plays have always bailed out the Canadian junior sector after some
pretty bad bear markets. After a long discovery dry spell, I think the idea
that a junior could still make a meaningful hit could inspire investors to
take a look at the serious companies with proper exploration teams and with a
story that gives reason to be optimistic.
TGR: John, thanks for your insights.
