Select Gold, Silver Mid Caps for Near-Term Action: Bo Chew
Interview

The Gold Report: The CBOE VIX Volatility Index was all over the map in 2011. Your Magna Opportunity Fund is capped at only $20 million (M) with a goal of producing exceptional returns by trying to be nimble within the market. Can you explain how you plan to achieve this when a lot of the larger and more diversified funds try to just stay even?

Bo Chew: With this particular fund we expect to deliver very high returns by being concentrated in about 30 holdings where each position has a realistic potential to increase 100% within 12 to 24 months. The basic premise is buying companies that are undervalued, have great people, offer huge upside and have important catalysts in the next 6 to 12 months. Unlike large funds, we can take advantage of really beaten down companies or less liquid opportunities. One example is Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), which recently reached a three-year low at $33/share, down from a 52-week high of $78/share, due to closing Goldex and the challenges experienced at Meadowbank. With Agnico we bought $35 January 2014 call options for $6.90.

In 2012 Agnico-Eagle is expected to produce 1 million ounces (Moz) of gold at $750/oz cost, producing $950M of cash flow, and its market cap is only $6 billion (B). So, over the next two years we see a lot of potential catalysts, including possible resumption of operations at Goldex, lowering costs at Meadowbank, advances in Meliadine and La India, plus resumption of growth in 2013. If Agnico-Eagle gets back to $60/share, we've got a gain of 260%, not counting the value of the options.

TGR: So, you're playing that one through the options and not through the stock itself.

BC: That's right.

TGR: That certainly gives you plenty of upside leverage if you guess right. And, it limits your downside to the cost of your options.

BC: Exactly.

TGR: I'm assuming that in most cases you're probably going to be buying the stocks rather than playing options. Right?

BC: Yes. We have two options currently. The other one is Kinross Gold Corp. (K:TSX; KGC:NYSE). We try and buy them when we see them, in this case at multi-year lows, where we believe that the company is strong and its share price will recover.

TGR: How far out are the options?

BC: Two years.

TGR: Are you also buying physical metals or just equities and options?

BC: Generally we stick with equities and options. We do try to maintain about 10% cash and also we have the ability to leverage 25%. That gives us a lot of room to take advantage of opportunities. From time to time, we'll trade 10% in silver or gold exchange-traded funds.

TGR: Do you have a preference for how you weight your portfolio between the various sizes of companies?

BC: We tend to prefer the small caps and like the mid caps as well. The challenge with large caps is that in most cases I can't realistically see a stock increasing 100% within 12 to 24 months unless it's something that is really beaten down and misunderstood.

TGR: You can always play the options on the large caps if you can hit the right timing.

BC: Correct. For example, the other option that we're looking at is on Cameco Corp. (CCO:TSX; CCJ:NYSE), two years out as well.

TGR: You've also made an investment in the Commodity Capital Midas Letter Opportunity Fund. What do you like about it?

BC: We like the people: James West and Tobias Tretter, whom we had the opportunity to talk to a number of times and to meet. This particular fund is unique because approximately 80% of it is in placements, of which 30% is in seed and pre-IPO. We also get access to some of the placements for our fund. A huge advantage is we get warrants. On the pre-IPOs, we're getting in at significant discounts.

TGR: How long do you typically have to wait for a pre-IPO investment like that to turn liquid?

BC: Often on a pre-IPO you might have to wait two to six months. For example, there's one we're buying in at about $0.15/share and the discussion is that within three months the company will do the IPO at $0.35 to $0.40/share.

TGR: Turning to junior stocks, 2011 was a pretty dismal year. Are you expecting that 2012 will be a breakout year for them?

BC: That's a good question. The juniors are definitely quite undervalued. We do expect 2012 to be a good year as merger and acquisition activity picks up. However, it doesn't really need to be to help our performance because catalysts in the next 6 to 12 months with our stocks can push the prices up.

TGR: So, you're looking for specific catalysts that are independent of what the general market is going to do?

BC: Yes. I'm looking at companies that are advancing projects through to prefeasibility or feasibility or derisking as they ramp up toward production. We try to buy at the point in the resource company cycle where there's less risk. Often, that means buying early while the story is being formed and there isn't a lot of exposure. We also buy after a company has largely derisked the project and it's within one or two years of production. Sometimes we also buy when a company has disappointed but it's still a good company with an intact story.

TGR: How do you decide when you want to sell?

BC: The sell decision is based on one of the four buying criteria—value, catalysts, great management and upside potential—breaking down. Often we'll sell a stock when it's run up because there's no longer value, or when key people leave and we feel that materially impacts the ability for the company to move projects forward or when there's an absence of near-term catalysts.

TGR: Just looking at the price chart will give you a good indication of how much longer you might want to hang on.

BC: That's true. Often you have to give the markets time to tell you whether you're right or wrong.

TGR: Can you tell us about some of the companies you particularly like at this point and what you're expecting from them in the next couple of years?

BC: One of those would be Barkerville Gold Mines Ltd. (BGM:TSX.V). Barkerville is a $90M market-cap company with 117,000 hectares in the Cariboo Gold Belt in British Columbia that has produced 3.8 Moz of gold historically. It has seven past-producing mines; three gold deposits, including the QR Mine and a 900-ton-per-day (tpd) mill; and recently permitted the Bonanza Ledge Mine. I like this particular company because there's been a lot of gold produced in this area. It has really beefed up its advisory team and insiders own about 10%.

In 2012, Barkerville intends to process ore from Bonanza Ledge to produce about 20–30,000 ounces (20–30 Koz). At $800/oz cash cost and $1,700/oz gold, operating cash flow will be between $18M and $27M. There is potential to develop additional mineable reserves at the QR Mine to boost that production to 50 Koz in 2012. It's waiting for results on 33 more holes. One hole at Cow Mountain returned 52 meters of 14.2 grams/ton (g/t) gold. Within 24 months we would expect over 100 Koz of annual production. At a conservative $3,000/oz, we've got a $300M value to the company, which triples its $90M market cap.

TGR: Well, those are pretty substantial numbers.

BC: Scorpio Gold Corp. (SGN:TSX.V) is another one we like. Scorpio owns 70% of Mineral Ridge in Nevada, which has a history of gold mining dating back to the mid-1800s. There've been problems with this particular mine more recently. It sat dormant from 2005 to 2010 until Peter Hawley, founder of silver producer Scorpio Mining Corp. (SPM:TSX), took over in 2010. Insiders own 38%. Production started in May 2011 from the Drinkwater pit. Mining at the Mary Zone has just started increasing the production at Mineral Ridge to about 5 Koz per month. The ownership increases to 80% after four months of production above 3.5 Koz. The current resource is only 357 Koz, but it's only from two pits. There are another eight pits that are defined and another three pits outlined. Drilling between the pit areas should expand the resource and define a possible super pit that could be 3–5 Moz. If cash costs decline and production increases to 80 Koz, and if a super pit is defined, we expect Scorpio Gold to do very well.

TGR: Definitely has some big upside there too. So, what else do you like?

BC: MAG Silver Corp. (MAG:TSX; MVG:NYSE) is a company focused on two large-scale projects within the Mexican silver belt. MAG has a 44% joint venture with Fresnillo on a 221 Moz silver project called Juanicipio. It's one of the highest quality silver deposits in the world and borders the Fresnillo mine, which is the largest primary silver mine in the world. MAG has a significant land package in the area and we expect it to be taken over at some point.

TGR: That makes sense. Of course, all these companies that have something substantial going for them are potential takeover targets.

BC: For sure. We also like Pretium Resources Inc. (PVG:TSX; PVG:NYSE). Pretium is another one of our mid-cap takeover targets. It owns the advanced stage Brucejack and Snowfield projects in northern British Columbia with a combined 56 Moz of gold in all categories. Brucejack is one of the largest high-grade projects with 5 Moz at 16.9 g/t gold Measured and Indicated and 3.3 Moz at 25.6 g/t gold Inferred. So, the updated Brucejack preliminary economic assessment shows a net present value of $2.2B pretax.

TGR: On a per share basis what does that present value work out to?

BC: About $25. I like Pretium because that particular project has a lot of expansion potential with the large land package.

TGR: It's always nice to have big upside to expand resources.

BC: Another company we like is South American Silver Corp. (SAC:TSX; SOHAF:OTCBB), which has traded at a significant discount given its 230 Moz Malku Khota silver deposit. There are two reasons: it's low grade and it's in Bolivia. South American Silver is given very little value for the new 3.8 billion pound copper deposit in Chile, which is 35 kilometers (km) from El Teniente, the world's largest underground copper mine. The in-ground value of this deposit is roughly the same as the silver deposit. South American Silver is led by Greg Johnson, co-founder of NovaGold Resources Inc. (NG:TSX; NG:NYSE.A). Zamin Precious Minerals Ltd., a resource company with operations in South America, is 19% owner. It has a really strong relationship within the government of Bolivia, which has confirmed that private investments in mining, and South American Silver in particular, are welcome and will continue to be respected.

TGR: Apparently, the market hasn't recognized that and is focused on the political risk more than on the upside potential of the resource.

BC: Yes. Malku Khota makes up for the low grade with its high indium and gallium value. The preliminary economic assessment (PEA) shows that at $18/oz silver, there's $704M net present value (NPV) at 5%. And, the cost to produce net of byproduct is $2.94/oz. The catalysts for South American Silver are securing offtake agreements for the indium and gallium, completing prefeasibility and feasibility studies, and likely takeovers or joint ventures on both projects within 24 months.

TGR: So, that's relatively short-term visibility for upside movement.

BC: That's true. A little smaller company we like is called Metanor Resources Inc. (MTO:TSX.V; MEAOF:OTCPK). It is bringing its Bachelor Lake mine in Québec into production and has begun milling ore from a 5,000-ton bulk sample. Metanor is expected to produce 60 Koz of gold at a cash cost of $464/oz. Some 20% of the gold goes to Sandstorm Gold Ltd. (SSL:TSX.V) at $500/oz. Metanor has 1.6 Moz of resources with a fully permitted 1,200 tpd mill and the infrastructure replacement value is $150M. The huge upside comes from the 781 Koz Barry deposit, which has the potential to become a significant low-grade, high-tonnage deposit like Osisko Mining Corp.'s (OSK:TSX) Malartic mine. Osisko has a $4.5B market cap and will be producing about 610 Koz/year starting this year. Barry has only had 50km of drilling on a potential 13km strike, compared to the million meters of drilling at Malartic. If you multiply the drilling at Barry 20-fold, it could conceivably host a 14 Moz deposit.

TGR: That's a lot of expensive drilling.

BC: Perhaps, but it should have cash flow to help with the drilling. Industrial Alliance recently put out an estimate that the 300 Koz resource at Bachelor Lake is estimated to be about 700 Koz, which can extend the mine life to 10 years. So, if we take Bachelor Lake at 60 Koz/year, Metanor's 80% portion is 48 Koz. If we only assume $1,000 of operating cash flow per ounce, we've got $48M of cash flow. And, the company is trading at only about a $68M market cap.

TGR: Any others you'd like to talk about at this point?

BC: Avino Silver & Gold Mines Ltd. (ASM:TSX.V; ASM:NYSE.A; GV6:FSE), a re-emerging silver producer in Mexico, is expected to produce 1.1 Moz silver equivalent. Avino is in the process of stockpiling ore and will commence production once it has enough to operate at 250 tpd. It is targeting 3 Moz of silver production from three projects within three years. It does have a proven resource at San Gonzalo and the Avino vein as well as a tailings resource. Avino's market cap is only $61M.

Another company we really like is Gran Colombia Gold Corp. (GCM:TSX.V) because it's an extremely undervalued gold producer. It's taking production from 90 Koz to 540 Koz by 2016. It has total gold resources of 13 Moz with a market cap of $220M. Its main operating mine, Segovia, has planned expansion in 2013 to increase production to 200 Koz per year with cash costs of less than $900/oz by the end of 2013.

Gran Colombia's other project is Marmato, with 12.4 Moz gold and 75 Moz silver. A PEA done in 2011 shows a mine that's projected to produce 540 Koz gold and 1.3 Moz silver at $524/oz costs. As it ramps up production and gets closer to putting Marmato into production, we expect it to be taken out as well.

Another company that has really been beaten up due to delays is Gryphon Gold Corp. (GGN:TSX; GYPH:OTCBB). It was supposed to be in production at 43 Koz gold per year this March. It has about a 2.1 Moz combined resource in Nevada; $1,000/oz of operating cash flow times 43 Koz is $43M on a market cap of $30M. In addition, there are three new anomalies that have been identified, each significantly larger and shallower than the main sulfide resource, which is about 1.1–1.2 Moz. So, there is potential for Gryphon to get into the 3–5 Moz size.

TGR: Sounds good.

BC: We also see upside in Geologix Explorations Inc. (GIX:TSX), which has a $44M market cap. Geologix's Tepal project in Mexico shows a PEA with a $412M NPV at 5%. And, there's a potential for this to continue growing. There's a new resource estimate expected in March and a prefeasibility study in June. Depending on how the prefeasibility study goes, it could be in production in 2014.

TGR: Do you see any developing opportunities that are still in the early and more speculative stages that might be places for people to get into at this point?

BC: I think there are a couple of areas. One would be commodities that are less common or less mainstream, like graphite or tungsten. Also, companies that are less followed could be great opportunities, because with less news there's very little hype and very little trading, leading to potentially depressed levels. There are many great opportunities, but you have to do your research.

In the category of companies that are less followed, one is Xtierra Inc. (XAG:TSX.V), which is a $26M market-cap company with about $8M in cash. It has $100M silver equivalent in Mexico and is advancing the Bilbao project, which is likely to produce 2 Moz silver in Q414. But, it also has a tailings project that could produce 2 Moz silver, which is likely to come onstream earlier than that.

TGR: So, is there anything else you'd like to talk about?

BC: I have one more company in a less mainstream region. This is Minco Silver Corporation (MSV:TSX), which has a $168M market cap with $70M in cash. It has a 101 Moz silver deposit in China with significant resource expansion potential and is very close to getting into production at 5.5 Moz/year at a $5.65/oz cost. There's been very little news and it's just waiting for the environmental impact assessment to start construction. It is fully funded to production, which is expected in Q114.

TGR: What would you like to leave with our readers as far as how they can best profit in the current investment environment?

BC: We have a volatile investment environment so it's important to keep a certain amount of cash available to take advantage of opportunities. At the same time you have to take your profits when things do go up. Resource investing is inherently risky as only a small percentage of deposits ever become mines. But, you'll have greater success focusing on high-quality projects with a lot of blue sky run by excellent people who have financed, built, joint ventured and sold mining operations. These companies can reward shareholders in today's very difficult environment.

TGR: That's a good investment philosophy with useful guidelines to follow. Thanks for giving us a nice list of creditable companies with some great upside potential.

BC: Thank you.

Bo Chew is the manager of the Magna Opportunity Fund and has been associate portfolio manager with Chartwell Asset Management since 2010. He is the principal of Legacies Financial Group and was formerly the trading director for Chartwell Financial Inc, a mutual fund dealer, from 1994 to 2006. He is a Canadian Investment Manager (CIM). Chew has successfully managed a stock account since November 2003 using a similar investment approach as the Fund. He seeks the highest returns without excess risk and has a significant amount of money in the Fund.

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DISCLOSURE:
1) Zig Lambo 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: Barkerville Gold Mines Ltd., Scorpio Gold Corp., MAG Silver Corp., Pretium Resources Inc., South American Silver Corp., NovaGold Resources Inc., Avino Silver & Gold Mines Ltd., Geologix Explorations Inc. Streetwise Reports does not accept stock in exchange for services.
3) Bo Chew: I personally and/or my family own shares of the following companies mentioned in this interview: Agnico-Eagle Mines Ltd., Kinross Gold Corp., Barkerville Gold Mines Ltd., Scorpio Gold Corp., MAG Silver Corp., South American Silver Corp., Metanor Resources Inc., Avino Silver & Gold Mines Ltd., Gran Colombia Gold Corp., Gryphon Gold Corp., Geologix Explorations Inc., Xtierra Inc., Minco Silver Corporation. 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 story.