The Gold Report: A number of thought leaders in the larger
investing community have come out lately in favor of gold. How do you know it
is time to move into the resource?
Frank Holmes: You have to consider the source. If it is a Goldman
Sachs or a J.P. Morgan, ask whether they are talking their book. Do some
homework and find out if they are long or short. The secret is to find people
who are delivering great outcomes and ask what their processes are and what
is their passion.
TGR: What is your process for finding the best time to move in the
resource sector?
FH: We look at the two pillars of demand, the love trade and the
fear trade. This is the beginning of the wedding and holiday season in Asia
so the love trade is just ramping up right now. The fear trade is based on
the machinations taking place in China and at the Federal Reserve right now.
Just before the big United Nations meeting in New York, China devalued its
currency. This was a signal to the U.S. that it will be going in a different
direction from where the Federal Reserve is taking the dollar. What most
people don't know is that real interest rates have already increased from
negative 3% in 2011 to positive 2% compared to the rates in Japan. That means
the Fed will be looking at easing them, which is bad for the dollar, but good
for gold.
TGR: China's markets are not very transparent. What do we really
know about how much gold that country is buying?
Ralph Aldis: The Shanghai Gold Inventory tells us how much gold is
delivered to that exchange, although there is much controversy regarding the
possibility of double counting there. I also examine the earnings reports of
some of the Chinese retail jewelry shops. The data indicate an increase in
retail gold buying after the Chinese stock market crash.
Worldwide, we could be seeing an increase in gold purchases due to
concerns about growing geopolitical risk, most recently Russia's decision to
intervene militarily in Syria.
TGR: When we interviewed you in March, you explained the five
principles of capital allocation and named several management teams
prospering by the application of these principles. Despite 2015's relentless
bear market, many of these companies have continued to prosper. Can you bring
us up to date on your favorites?
RA: The company we like best based on its continuing potential is Klondex Mines
Ltd. (KDX:TSX; KLDX:NYSE.MKT) and its Midas and Fire Creek gold-silver
projects in Nevada. Shares trade at $3.32 today, up almost a dollar from
March, but our price target is almost twice that.
Klondex has been exceedingly busy. It raised $26.3 million ($26.3M) to pay
off debt and expand its drill program. It published a revised resource
estimate in September, which not only replaced all depletion due to mining,
but also added ounces. The company will publish another resource update by
year-end with likely similar results. Ultimately, the company will add
50,000–100,000 ounces (50–100 Koz) to the resource statement in the near
term, an excellent way to increase share price.
The company just got its NYSE.MKT listing, KLDX. That should mean greater
exposure, liquidity and index accumulation. Klondex could soon be included in
the Market Vectors Junior Gold Miners ETF (GDXJ:NYSE.Arca).
TGR: What about some of the other companies you praised in March?
RA: Claude
Resources Inc.'s (CRJ:TSX) share price has gone from ~$0.40 to around
$0.72. We calculate that its fair value is closer to $1.80. The Street
doesn't necessarily see it that way, but this is due to a problem with the
net asset value (NAV) model. Typically, NAVs systematically overvalue
low-grade deposits and undervalue high-grade deposits such as Claude's Seabee
gold mines in Saskatchewan. This is because the NAV model assumes that a
dollar of revenue from a low-grade deposit has the same probability that a
high-grade deposit has in dropping a dollar of revenue to the bottom line.
And that is simply not true, thus the price targets advertised for low grade
are too high and those for high grade are too cheap.
Claude announced this month that gold production was up 13% year-to-date
and that it was increasing its 2015 guidance to 70–75 Koz. This is a
vindication of CEO Brian Skanderbeg. He knows the geology and he has a great
plan. He continues to deliver value to shareholders.
TGR: How about another management success story?
RA: Richmont
Mines Inc. (RIC:NYSE.MKT; RIC:TSX) has a new president/CEO in Renaud
Adams, and is entering some high-grade zones at its mines in Ontario and
Quebec. Earlier this month, it announced a cash balance of $76.5M and
confirmed that it would meet the high end of its 2015 guidance of 87–95 Koz
gold.
Richmont shares have oscillated up and down since summer, but there was an
analysts' tour this month, and they seemed fairly impressed. I think we
should still see some value creation on this one. Our fair-value
determination is ~$5.85.
TGR: Is that a 12-month target?
RA: I don't know if it will take six months, three months or
whatever, but I do believe that Richmont is a deep-value proposition that
will increase in value.
TGR: You had earlier mentioned two other Canadian gold miners as
turnaround stories.
RA: The first would be Kirkland Lake
Gold Inc. (KGI:TSX) and its new CEO George Ogilvie. That stock is up
about $1.50 from March. Ogilvie has reduced his company's debt
opportunistically. Kirkland needs to continue to execute its plan and build
cash reserves.
The second would be Lake Shore Gold Corp. (LSG:TSX). There is the possibility
that Goldcorp
Inc. (G:TSX; GG:NYSE) could move and consolidate there in northern
Ontario, control the whole camp and extend the mine life. Of course, Lake
Shore has itself consolidated with its takeover of Temex Resources Corp. The
share price hasn't reacted too much yet, but that's not unusual. We'll have
to wait and see what Lake Shore intends to do with the properties Temex
brought to the table.
In the meantime, Lake Shore published in September some very promising
intercepts from the 144 Gap Zone of its Timmins West mine, including 6.29
grams per ton gold (6.29 g/t) over 36.8 meters (36.8m), 7.83 g/t over 18.8m,
10.97 g/t over 14.4m and 8.16 g/t over 10.3m.
TGR: Beside Klondex, which other companies are you following in
Nevada?
RA: There are two. The first is Rye Patch Gold
Corp. (RPM:TSX.V; RPMGF:OTCQX). It lifted off in the spring but then came
back down. The company is concentrating now on derisking its Lincoln Hill
gold-silver project. It is doing metallurgical studies on a 10-ton bulk
sample with a view to optimizing a mining plan. Lincoln Hill is right next to
Coeur Mining Inc.'s (CDM:TSX; CDE:NYSE) Rochester property, so Coeur might
decide to take it out in order to extend Rochester's mine life.
The second is Comstock Mining Inc. (LODE:NYSE.MKT), which has assembled
an extremely interesting land package in the historic Comstock district. It
is looking at a potential pit at its Dayton project, where it's had some good
drill results from its quartzite-type PQ target.
The company will probably go back and do some additional infill drilling
and then put together its mine plan for higher-grade ores underground. I
think that the production profile will probably stay much the same in the
next six months. Nonetheless, I expect positive things because this area
remains largely underexplored by modern methods.
TGR: What are the companies investors want in their portfolios
regardless of what happens to the resource market in the short term?
RA: I want to own companies where management can increase the value
proposition. Going back to many of the companies we've already discussed,
their share prices have risen even in the midst of arguably one of the worst
gold markets on record.
One such company would be Integra Gold Corp. (ICG:TSX.V; ICGQF:OTCQX), which has
the near-term, high-grade Lamaque South gold project in Quebec. Eldorado Gold
Corp. (ELD:TSX; EGO:NYSE) recently invested $14M in Integra. There may be
potential tax write-offs for Eldorado in this, but I would also imagine that
it has given Integra guidance with regard to the future of Lamaque South. I
expect that Integra will get taken out by Eldorado or someone else. Agnico
Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) could certainly have an interest in that
region, too.
TGR: Integra released drill results from Lamaque South on Oct. 8,
including 22.6 g/t over 2.6m and 11.95 g/t over 4.8m. Is the market taking
notice?
RA: To some extent. There's also been a block of shares out there,
originally about 16M shares and now about 8M shares, that some investors been
looking to place. The share price may not have immediately reacted to this,
but once this is cleared, the picture should become more positive.
TGR: Can you mention another big value creator?
RA: Orex
Minerals Inc. (REX:TSX.V). Last year it negotiated a joint venture (JV)
with Agnico Eagle on its Barsele gold property in Sweden. Orex has a couple
of properties in Mexico, including a JV with Fresnillo Plc (FRES:LSE) and a
property in Canada. Orex has now spun out Barsele 1:1 for each share that it
had. After the spinout, the combined pieces were almost twice as much as what
the company was worth the day before. It was a nice lift for us.
Orex wanted Barsele separated out as a clean vehicle, so if Agnico Eagle
wants to take out Barsele as it continues to do additional drilling on it
this year, then it's basically separated from Orex's properties in Mexico.
Agnico Eagle likes Mexico but, again, Orex has a joint venture already with
Fresnillo on one of its properties. Orex has used networking to create value
for shareholders. Management is a big holder of stock, which is very much
part of our philosophy.
TGR: Do you see mergers and acquisitions (M&A) as a possible
upside for investors on a number of these stories?
RA: The M&A part always comes, but it tends to come not so much
at the beginning of the cycle. We've seen some M&A stuff here, and most
of it has been asset rationalization where companies have peeled off assets
to pay down debt. But we haven't seen too many people go in there and do just
a strategic deal to try to create some value. Typically, we see that a little
bit later in the cycle, when valuations start to go up.
What normally happens right now is that the senior stocks' prices get
lifted up first because there are money flows. Then that puts a company in a
position where it can sometimes take out some of the junior miners, but
that's why you see these bigger premiums on them, whether it's 40%, 50%. I've
even seen 100% premiums on some of these stocks here. Yes, there is certainly
opportunity. I'm not expecting it to be extremely intense yet, but it's
something that probably will come later.
TGR: Would you tell us about one company you got out of but then
got back into?
RA: That's Tahoe Resources Inc. (TAHO:NYSE; THO:TSX). We were out of
it because of the political risk in Guatemala and the likelihood that it
would do a transaction to try to diversify that. We were very fortunate that
we owned Rio Alto Mining, so we kind of got our shares back when Tahoe took
over Rio. But then, as I mentioned earlier, there was the transitional period
where the stock is in nowhere land. Another problem was that Goldcorp sold
its large block of Tahoe shares, which further depressed its share price. So,
yes, it's the valuation that's gotten us back into Tahoe.
TGR: Is there a catalyst you're looking for in the rest of 2015 or
the beginning of 2016?
RA: One would be its advancement of Shahuindo in Peru, showing the
Street what kind of progress it's making there. That's what I'll be looking for.
TGR: You have a number of companies listed on the Australian
Securities Exchange (ASX) or operating in Australia in your portfolio. Does
exposure to African and Asian markets and a favorable exchange rate make
those more attractive to you?
RA: Yes. Just as the Canadian dollar has weakened, so has the
Australian dollar. In Africa, the euro has weakened, which is very positive
for some companies operating there.
I almost feel guilty that it's been so easy to make money in Australia. Northern Star
Resources Ltd. (NST:ASX) has been one of our bigger positions. Barrick
Gold Corp. (ABX:TSX; ABX:NYSE) wanted to get out of Australia desperately, so
it transferred almost a billion dollars' worth of assets to Northern Star for
less than $100M. Northern Star has done a great job rationalizing this
property and buying additional assets. It didn't step into the last rounds of
auctions where I think properties went for prices that were too high.
Another one of our large Australian positions is St. Barbara
Ltd. (SBM:ASX). This is another company that has benefitted greatly by
new management. The prior operators at its Gwalia mine were sending trucks
down and bringing trucks up to the same drift with two different access
points. Bob Vassie, the new CEO, rationalized this process. He connected the
routes at the bottom and eliminated the congestion. The productivity gains
have resulted in St. Barbara shares being up almost 300% this year. It's been
a great winner for us.
Cardinal
Resources Ltd. (CDV:ASX) has a new discovery, the Namdini project in
Ghana, which is a great jurisdiction. The company has found gold of 2-3 g/t
from surface to 100 meters, so I think it is definitely on to something.
Simon Jackson, ex-Red Back Mining and Mark Thomas, ex-Macquarie Bank, have
joined the board and I think put money into the most recent placement. After
that, Macquarie came in for a $1M private placement. What will happen next is
it will go back and try to infill drill and extend the strike of this ore
body to see how big it is. There could be some very positive things happening
on that one.
TGR: How soon might we have the results from that drilling?
RA: By year-end.
TGR: Another of your holdings has itself become a consolidator.
RA: Yes, Newmarket Gold Inc. (NMI:TSX; NMKTF:OTCQX), which has
taken some of the assets that AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) and
Crocodile Gold Corp. (CRK:TSX; CROCF:OTCQX) had previously. I don't think
anybody really paid that much attention to Newmarket in terms of what it
could do. The company had been private for some time.
Management was actually able to buckle down and turn these operations
around. It is trading at something like only two times cash flow, as opposed
to the industry average of four or five. Newmarket needs to get out and tell
its story and let investors know what it is doing. I think the stock was $1 a
month or so ago. It's moved up to maybe the $1.45 area. But it's probably
more like a $4 stock.
TGR: Are you optimistic about higher gold prices?
RA: We may see a turn in the gold market soon. Some of the brokers
who have been so bearish on gold are now saying that it could begin to
perform better because it appears that the Federal Reserve will not raise
rates as high and as fast as some thought. The U.S. dollar has started to
weaken a little bit, and that is good for gold. I'm hoping for a gold rally
in Q4/15.
TGR: Thank you for your time and your insights.
