Is It Time to Get into Gold Junior Mining Plays?: Philip Ker
Interview

The Gold Report: Philip, welcome. In a recent Union Securities research report, you wrote, "Despite global market volatility and foreign debt issues, we believe market valuations for mining companies, particularly in the precious metals sector, appear to be at incredibly low prices, on level with values seen prior to Q310's commodity bull run. This is regardless of gold and silver being approximately 30% and 50% higher, respectively." I agree that current share prices in the junior precious metals space are comparative to that timeframe, but we have been in a risk-off sector investing environment since last July, and you are operating in a high-risk sector. Share prices are low but without investors bidding up prices, how are we going to see a rebound in junior precious metals equities?

Philip Ker: We are seeing current market conditions affect the junior mining space, but also educating investors and helping them identify lower-risk opportunities in projects that are backed by strong management, and ones that can provide value growth in the future. We will need to see continuous positive news, particularly from the senior and midtier producers, at which point it should give more traction toward junior equities. I also expect mergers and acquisitions (M&A) activity to be a key factor for the juniors as a result of the strong balance sheets senior producers continue to build; as they look to replenish diminishing production portfolios they will target junior developers coming online.

TGR: Are you saying to stay on the sidelines at your peril?

PK: Not necessarily. It is more or less identifying the correct opportunity and the projects that are most targeted for growth that would be a good fit for a senior producer in its portfolio.

TGR: One thing, though, with regard to M&A activity, we recently watched Kinross Gold Corp.'s (K:TSX; KGC:NYSE) shares fall about 20% after it announced there were problems with its Tasiast gold mine in Mauritania, which it acquired through the takeover of Red Back Mining Inc. (RBI:TSX) early last year or the year before. Do you think something like that might make the majors think twice about dipping into the sector with some juniors with prospects that look promising?

PK: What was skeptical about that original takeover was that Kinross was stepping outside of the gold space and more into a copper play. Getting that project into development has been a task for Kinross and, as seen recently with the write-down along with the higher-than-anticipated costs, affected them considerably.

TGR: Will that have any trickle-down effect on the sector at large in terms of potential takeovers?

PK: No. There is always going to be M&A. The seniors need to do their due diligence in order to identify the best-fit projects and ones that they can develop or take over at a stage where they can restructure or integrate the management and more efficiently operate the new project.

TGR: You recently made some changes to your outlook for metals within foreign exchange numbers.

PK: For my gold forecast, my long-term price remains the same at $1,000/ounce (oz). The main change has been in the short term where we see average prices being sustained slightly higher over the next one to five years. With respect to gold, we just slightly increased it over the next few years, as we see a higher average price to come. For silver, we were previously using a gold:silver ratio of 42:1. I felt that was a little high, so we are now using a 50:1 ratio going forward. For copper, our long-term price didn't change. The slight decrease for 2012 was to reflect a pretty strong pullback in prices, but we remain quite bullish, as India and China continue to grow and develop their rapidly expanding economies.

TGR: Can we also have a specific 2012 price for gold, silver and the U.S. dollar?

PK: Sure. 2012 gold: $1,725/oz, silver: $34.50/oz, copper: around $4/pound (lb). Keep in mind that these are average prices over the year. For the U.S. dollar, over most of 2011 it was at par with, or subpar to, the Canadian dollar. What we have seen in the last quarter was the strengthening of the U.S. dollar, so we made adjustments to compensate for these changes within our models and in our target prices.

TGR: Please tell us briefly about your coverage universe.

PK: I am about 50–60% precious metals as well as some bulk materials, including iron ore, potash and coal. I also have a great story on Northern Graphite Corporation (NGC:TSX; NGPHF:OTCQX), which we brought public in April 2011.

TGR: Another company you cover is Geologix Explorations Inc. (GIX:TSX), whose primary project is the Tepal copper-gold porphyry project in Mexico. Despite a downgrade in your outlook for copper prices, your 12-month target price on Geologix did not change. Tell us why you remain bullish on that junior.

PK: The downgrade in the copper price was only affecting models in the short term, whereas Geologix's target is based on a discounted cash flow for its production scenario. This did not affect the production model using the long-term price for its Tepal project. I'm still quite bullish on Geologix as the economics only become more attractive should copper prices remain above our long-term outlook. The company's Tepal project in Mexico is an attractive play that has become more appealing on top of its already robust economics. Recent drilling has demonstrated a higher-grade zone below the current pit shell, which is showing two to three times the grades used within the existing resource. It is currently at a valuation suggesting approximately $5/oz gold equivalent (Au eq).

TGR: Recent drill results seem to indicate that the copper-gold mineralization continues at depth. What is the earliest the company could test that theory?

PK: Geologix is testing it now. It has completed a substantial drill program to define the outer limits of the deposit. There are still 96 holes of assays to come from this drill program.

TGR: If you believe that copper and gold prices are going to continue to rise over the medium to long term, this looks like a good bet.

PK: The economics are robust for Tepal and I am astonished at such a low valuation that the market is giving it at this point. My 12-month target is $1.25, and it is currently trading at about $0.25.

TGR: There are certainly some gains to be had there. Another company where changes to your outlook for metal prices did affect the target price was Timmins Gold Corp. (TMM:TSX.V; TMM:NYSE.A). You cut your target price on Timmins to $3.90, which you said reflects "the leverage to the decreased gold price and stronger U.S. dollar outlook in the short term." You are expecting Timmins to go from earnings per share of $0.02 in Q212 to $0.8 in Q312. What is going to bring about that kind of jump?

PK: I toured this property last August and initiated coverage shortly after. What happened in the previous quarters is the company was struggling with lower-than-expected recoveries, which ultimately resulted in lower-than-expected gold production. The good thing, however, is that it was not a geological or depositional issue, but more of an operating efficiency problem. The company brought in some specialists who recommended adjustments to the leaching cycle at the San Francisco mine. Timmins has now adjusted the flow rates and the irrigation setup and has now shown that it has recovered 30% more gold this quarter than the previous, and increased recoveries from 50% to 65%. As well, it demonstrated recoveries of 76%, ultimately achieving a record 8,500 oz gold production in December.

TGR: What sort of production are you expecting this year?

PK: I'm quite optimistic for Timmins this year and expect around 115,000 oz of production. With the increased recoveries as well as an increase to its throughput expected later this year from the addition of a mobile crusher, Timmins should be able to achieve this target.

TGR: Could a company like Timmins be looking to acquire another mine or project in the vicinity in order to leverage its current cash flow?

PK: It is quite possible because Mexico has great gold and silver deposits. At this point, Timmins is focused on extending the mine life at San Francisco, as well as identifying additional mineralization from La Chicharra to increase reserve life to San Francisco.

TGR: You wrote that you determined the companies on Union Securities' 2012 Watch List by "strategically selecting precious metals exploration companies in various stages of project development. The general focus is on properties located in prominent regions of hosted gold and silver mineralization." One company that fits that bill is Kiska Metals Corp. (KSK:TSX.V), whose Whistler gold-silver-copper project is in the same region as Alaska's Northern Dynasty Minerals Ltd. (NDM:TSX; NAK:NYSE.A) Pebble copper-gold porphyry deposit. Tell us about how Kiska's ongoing drill efforts at Whistler are growing the project's gold-equivalent ounces?

PK: Whistler is a huge land package with an abundance of targets. With a limited field season in Alaska to test these targets, Kiska needed to be more efficient with prioritizing the targets, which were generated from geophysics. It has utilized a scout drilling program that allowed it to drill shallow holes around 100 meters (m) deep and allowed it to test multiple targets in the shorter timeframe. This was a successful exercise and demonstrated at its Rainmaker target that the scout drilling extended mineralization 110m along strike. This program also helped show that non-anomalous magnetic signatures do contain mineralization, as scout drilling identified gold-copper mineralization at its Dagwood target and quartz stockwork veining over 138m. These targets will be followed up this year.

TGR: There was also a high-grade intercept on its Island Mountain deposit.

PK: Island Mountain has now been expanded to more than 300m by 300m, and it is particularly open to the north. The high-grade zone that you are speaking of was about 2.2 grams/ton over 100m within the brecchia zone at that porphyry target. What needs to be done now is infill between the north zone and the southern zone to test the continuity between them.

TGR: Those results will not be included in the resource estimate that is due in the second half of 2012, right?

PK: They should be. Toward Q212, I am expecting close to 7 million ounces (Moz) Au eq. Its past resource was 5.4 Moz Au eq.

TGR: That is a significant increase. Will that be a significant catalyst in the share price to get it back up to that $1.50/share level?

PK: It definitely will start to get more traction for Kiska. Its ultimate goal is to get close to 10 Moz. I think this scouting drill program was a good step in the right direction to target certain proprietary targets in order to achieve this goal. Our target is $1.40 and is currently trading around $0.29.

TGR: What are some other junior precious metals companies that could rebound significantly in 2012?

PK: I like Kootenay Gold Inc. (KTN:TSX.V). It has the Promontorio silver deposit down in Mexico and is currently engaged in a 25,000m drill program. It has been successful with extending mineralization outside of the current resource pit, particularly in the northeast and southwest zones. It is aiming for almost five times its current resource, targeting 100 Moz Ag eq.

TGR: What does that tell you about the project and the deposit?

PK: This northeast zone at Promontorio is not a one-hole wonder. It is continuing to intersect this zone along strike as well as along different fence lines within the zone. There definitely seems to be a high-grade area that can add significant resources in the upcoming NI 43-101.

TGR: What are you expecting from that?

PK: It is targeting 100–105 Moz Ag eq. In terms of silver prospects, it is mid to small size, but it is definitely in a good district. Mexico is one of the largest silver producers on the planet.

TGR: If it keeps hitting intercepts like that, it will not be long before that resource doubles. What is your 12-month target price for Kootenay?

PK: $2.50.

TGR: What about some other juniors?

PK: One copper story I cover is Excelsior Mining Corp. (MIN:TSX.V). Its North Star deposit has an in situ resource of close to 5 billion tons copper at about 0.3%. This project in Arizona is targeting an in situ recovery method that would produce 80 million pounds/year. Arizona is a mining friendly state, and copper mining is one of the leading producers toward the state's gross domestic product. This is more of a permitting and development story that is ultimately going to come into production down the road. Right now, the company is engaged in a feasibility study to better define the metallurgy and engineering needed to increase its overall expected recoveries.

TGR: The key thing with in situ recovery is that it really lowers the cost of mining copper. In this case, you would be able to produce 1 lb copper for under $1, and that's really good.

PK: That's right. Excelsior is looking at costs of approximately $0.94/lb and would become significantly lower should it add an onsite acid generation plant. It would bring down its operating costs to about $0.68/lb.

TGR: The preliminary economic assessment done on the North Star project calculated a net present value (NPV) of $480M with an internal rate of return (IRR) of 34%. How does that compare with its peers in the space?

PK: It is quite comparable, particularly to Curis Resources Ltd. (CUV:TSX.V; PCCRF:OTCPK). I do not cover Curis, but Excelsior does have a higher NPV and relatively similar IRR with a shorter payback period. Excelsior is also looking at an annual production rate that is higher than that of Curis. My 12-month target on Excelsior is $1.75, and it is currently trading around $0.57.

TGR: I would like to talk about one more and then move onto Northern Graphite.

PK: One that I do not cover is Riverstone Resources Inc. (RVS:TSX.V) in Burkina Faso. I have this featured on my 2012 Watch List. It has recently expanded its Karma deposit to 2.7 Moz of gold resources across five main targets. This company is moving the project in the right direction as well as within a good jurisdiction for mining. The initiative right now in Burkina Faso is to electrify the country, and the International Finance Corp. is funding two major power lines that will be within close proximity to Riverstone's Karma asset.

TGR: Right, part of the World Bank.

PK: The big overhang on this right now is the final transaction needed from Golden Star Resources Ltd. (GSC:TSX; GSS:NYSE), for the option agreement to take over 90% of the project. Once that is cleared up, we will be able to see the full direction and the continued growth of the asset.

TGR: Is that 2.7 Moz open-pittable gold?

PK: Yes, and a majority of it is contained within the Indicated category. That material will be easily accessible within an open-pit mine.

TGR: What do you think the upside is on Riverstone in terms of ounces?

PK: The Kao zone is open along strike and down dip particularly to the northeast. Riverstone also has other targets that have yet to be tested on the property that could be other mini-pits to add future throughout in a production scenario. I think a 4 Moz global resource for Karma isn't out of the question.

TGR: Finally, some graphite. This may be saving the best for last. It is a graphite play, and probably not a four- or five-hour drive from your office in Toronto. The company is named Northern Graphite. A year ago, virtually no one knew about this company, and now it is about to publish a feasibility study on the Bissett Creek graphite project in central Ontario. Tell us why you believe the share price will double this year.

PK: The graphite space is something that we are really bullish on. We brought Northern Graphite public in April 2011 through an IPO. The Bissett Creek graphite project is a large-flake, high-quality, carbon graphite deposit where the large flakes within the deposit are abundant—greater than 50%. Large-flake graphite currently sells for around $2,500/ton (t). The upside for Northern Graphite is that its jumbo-flake graphite will be sold on the market for a substantial premium to $2,500/t. It is on the fast track to production and already has a mine permit plan in place with the Ontario government and can begin construction with permit approval. There should be a feasibility study by the end of Q112, and I expect it to have a strategic offtake partner in place that could emerge right around the time of that feasibility study.

TGR: Is that likely to be a Chinese partner?

PK: It is quite possible as China is the world's leading producer and consumer of graphite, and has dwindling resources available to meet its growing demands.

TGR: The project is not far from Algonquin Park. Do you expect any issues with regard to bringing a mine into production in a relatively well-traveled part of the province?

PK: No, I don't. The water drains in the opposite direction of the park from the project site and the tailings are not acid generating so this is a definite positive for Bissett Creek to become a mine.

TGR: As far as an NPV goes, what sort of numbers are we looking at with Northern Graphite?

PK: It depends on which discount rate you use for Bissett Creek; using 10%, I have it at about $125M. The upcoming feasibility study should provide further insight into what to expect from Bissett Creek.

TGR: For how long would that mine be in production?

PK: It could easily expand the existing resources and increase its production scenario, but our model uses a 35-year mine life.

TGR: Any parting thoughts?

PK: I am pretty optimistic that we will see a strong market for 2012 and, particularly, I favor junior advanced exploration and development stories that can either be developed by the existing management groups or ones that would be targeted by a senior midtier company to fit its project portfolio for future production.

Philip Ker is a mining analyst for Union Securities Ltd., a company formed in 1963 that is now one of the largest independent brokerage firms in Canada. The company has offices all across Canada as well as one in London, England. He has field experience as an exploration geologist working across Canada on gold, diamond and base metal projects. He joined Union Securities in June 2011 after completing his Master of Business Administration degree in finance at the University of Alberta. He holds a Bachelor of Science degree in geology.

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DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his 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: Northern Graphite Corp., Geologix Explorations Inc., Timmins Gold Corp., Kiska Metals Corp. Streetwise Reports does not accept stock in exchange for services.
3) Philip Ker: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise for participating in this story.