The Gold Report: Kitco reports that gold-specific exchange-traded products (ETPs) attracted $570 million (M) in net new funds, and holdings of gold ETPs hit an all-time high of around 77 million ounces (Moz) during the second quarter. There were also inflows into silver ETPs of $269M. Will this impact mining equities?
Philip Ker: We're in a period of extremely tight liquidity within capital markets. Any capital that's not being deployed into equities and transformed into ETPs will definitely impact equity valuations going forward. Keep in mind that exchange-traded funds do offer variable perks, such as diversification and lower management fees versus other managed investment options, which is why a lot of investors are beginning to favor them.
TGR: On a macro level, the problems of the euro continue to plague the U.S. dollar-denominated gold price. The International Monetary Fund recently said that there was "a sizeable risk" of deflation in the Eurozone. What is Union Securities' view of what's happening in Europe and the possible effect on the gold price?
PK: We believe that this is just a temporary shift out of the Eurozone, which is ultimately strengthening the U.S. dollar while consequently weakening the gold price. In the longer term, we see the gold price going much, much higher. The substantial leverage created by the U.S.' escalating debt will cause investors to shift away from these temporary investment vehicles and back into the safety of gold.
TGR: When we talked to you in February you were predicting an average 2012 gold price of $1,725/ounce (oz) and $34.50/oz for silver. Have those numbers been revised since?
PK: We're maintaining those targets until some macroeconomic things evolve and answers begin to be known, particularly concerning the skepticism within the market about the Eurozone and U.S. debt issues. There are also several significant elections globally, including the U.S. presidential election in November.
TGR: You must think that gold's going to have a strong finish this year then?
PK: That's correct. We are pretty optimistic for a strong run later this year and view the current lull in precious metals and relative equities as only a temporary phase of market sentiment.
TGR: Small-cap resource equities are down an average of roughly 40% since September 2011. Why should investors continue to hold these companies?
PK: The overall perspective of the investment community is that we are in a fairly bearish cycle. Fortunately for investors, markets are never static and there's always an upside. I prefer the view to buy and accumulate when no one else believes there is money to be made. Buying at opportune times such as now positions one ahead of the herd and can churn much more profitable investments. If investors are well positioned and ready to take advantage of the market, they can be very prosperous in the long run.
TGR: You like sizeable and growing mining-friendly jurisdictions. What are some of the companies you're following that fit those terms?
PK: Geologix Explorations Inc. (GIX:TSX; GIXEF:OTCQX) has a great gold-copper resource base in Mexico. In addition to its huge 187 million ton resource containing 4.5 Moz of gold equivalent, the company recently identified additional targets about 1.5 kilometers north of its resource boundary. Several of these anomalies are looking quite interesting from their geophysical signatures and preliminary sample results. The exploration team is currently taking additional prospecting and chip samples on the targets and will continue sampling and delineating them through an upcoming 5,000-meter (m) program.
"Buying at opportune times such as now positions one ahead of the herd."
TGR: When should we know how much this new mineralized zone could add to its Tepal project's resource?
PK: The company is aiming to start its shallow drill hole program later in August. I expect to see assay results in late September or October and that will give us a good indication of grades and potential. A secondary program would follow up on successful results.
TGR: Geologix has a prefeasibility study due in the third quarter. What does that study need to show in order to move the needle at the company?
PK: The study should confirm that the economics of Tepal are robust. The project has a strong net present value, a long mine life and good production numbers at low operating costs. Unfortunately, Geologix has a lower market cap of about $30M at this time and capital expenditure (capex) requirements pushing $400M. It could be a severe challenge to get project financing. However, it should be able to use the prefeasibility study to its advantage in negotiating its financing options.
TGR: Do you believe that it will have to fully delineate that new mineralized zone before this project gets green-lighted?
PK: I don't think so, but it definitely adds upside. What's been indicated in the chip samples thus far is that grades are 2–3 times higher than what is in the current resource. It only gets better from here if there are additional grades and economic tonnage to be added.
TGR: What are some other companies you're following?
PK: Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) recently put out a bankable feasibility study and the market had mixed reactions. This was due to slightly higher than anticipated capex requirements and any potential dilution that may come into play as it raises capital to start the groundwork at Bissett Creek in Northern Ontario.
TGR: Northern Graphite is looking at possibly selling battery-grade graphite at a substantial premium to concentrate. The economics of that idea were not included in the recent feasibility study. Have you developed any models on how that could change the economics of Bissett Creek?
PK: My target actually includes the production of battery-grade graphite. I changed my model and increased my target substantially when Northern Graphite confirmed that spherical high purity graphite could be made from its large flake deposit. Currently, the company is investigating what parameters and infrastructure would be needed for upgrading a recovered flake concentrate to high-purity battery-grade material. Management is indicating that it would need approximately $10M in addition to the current capex requirements for the required processing facilities. An engineering study into the upgrading scenario is under way and we can expect the results of that later this year. Adding this circuit provides a substantial premium for spherical graphite of approximately $5,000/ton.
TGR: Right now, the company has about 60M shares outstanding. Considering those new capex requirements, how high do you think that float could go?
PK: It all comes down to an offtake agreement. I know management is keen on having some skin in the game from an offtake suitor. I believe the company will be working diligently on this over the next few months to solidify its financing options.
TGR: You regularly conduct site visits. Tell us about some of your recent trips.
PK: A few months back I toured Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX) in Nevada. The company is in an interesting scenario because of its current litigation with Coeur d'Alene Mines Corp. (CDE:NYSE; CDM:TSX) over some lapsed property claims that Rye Patch picked up. If Coeur d'Alene is continuing to mine the Rochester pit and is damaging Rye Patch's claims, under current mining laws in Nevada, damages done to another's claims requires three times the gross metal value taken out of the ground to be paid to the injured party. I believe Rye Patch is in a situation where it will either be taken out or awarded a substantial settlement.
TGR: You think the companies are likely to settle out of court for cash?
PK: To avoid the court battle and have the litigation result in favor of Rye Patch, I believe it's in Coeur d'Alene's best interest to settle out of court through a lump sum or just purchase the company outright. If the latter occurs, Coeur would add over 2.5 Moz gold and 32 Moz silver to its asset base plus upside from its exploration prospects in the Cortez Trend.
TGR: Rye Patch has the Wilco deposit in Nevada that it's proving up. After seeing some of the core first hand, what were your thoughts?
PK: The site visit was a great learning tool to see the size potential of not only Wilco, but the entire Oreana Trend. It's definitely in a good jurisdiction to be in for developing gold and silver projects. Wilco is a small past-producing pit, but there still remains a lot of upside and recent drilling targeted mineralized zones down dip along structurally controlled contacts. The recently updated resource proved the beauty of the beast and although low grade, an abundance of these deposits in Nevada get mined because of the simple fundamentals, infrastructure and quality personnel located in Nevada. I can see this is going to a mine someday with continued work on the property.
TGR: You recently launched coverage of Atna Resources Ltd. (ATN:TSX), which increased its gold production by 30% in 2011 and almost doubled its total Measured and Indicated gold resources, which are spread over several projects in the western U.S. What catalysts lie ahead for Atna?
PK: This is a great story and my current top pick. Last year, Atna picked up 100% ownership of the previously producing Pinson Mine just 30 miles north of Winnemucca, Nevada. The company is currently working underground with plans of commencing full production in Q4/12. Management plans on going from a small miner's permit, which allows only 36,500 tons per year, to a full production permit of 400,000 tons per year in 2013. It should more than double its production in 2013 and beyond based on the addition of Pinson production alone.
" It's an ugly time in the market but it's a great time to be a value shopper for cheap mining stocks."
The company is also poised for internal growth by using internal cash flows from its Briggs and Pinson mines to fund development at the Reward Mine. The Reward mine is also in Nevada, has easy access to infrastructure and will provide low operating costs under a heap-leach mining method. I believe Atna will have this project pouring gold in 2014 and would be the third producing mine under Atna's asset portfolio.
TGR: Atna is developing quite the following. Joe Mazumdar, an analyst at Haywood Securities, follows the company, as does Rahul Paul at Canaccord. Pinetree Capital CEO Sheldon Inwentash and his holding company own almost 10% of Atna. Why does this junior have such a strong institutional following?
PK: Atna has a great pipeline of projects and an experienced management team to bring them into production. Acquiring the Pinson Mine at such a near-term production phase definitely gives the Street something to consider. The scale and ramp-up of its production from Briggs, and with the addition of Pinson, and shortly thereafter Reward, Atna has created a substantial growth trajectory for the company and for investors to look forward to.
TGR: Are there other companies under coverage that you'd like to tell us about today?
PK: I toured Kootenay Silver Inc.'s (KTN:TSX.V) Promontorio deposit in Sonora, Mexico, earlier this year. I came away quite impressed with the core and the layout of the land there. Management is extremely knowledgeable in hydrothermal-type deposits. I am currently anticipating a resource estimate to come out sometime in August and am targeting approximately 100 Moz silver equivalent, which is five times its historical resource. Management now thinks a substantial gold credit may be worked into the resource and would add additional value to the project valuation.
The stock has performed quite well during this market turmoil. I believe a lot of investors are keeping a close eye on it and it will be a good growth story moving forward.
TGR: You had a $2.50 target price on Kootenay around Christmas 2011. What's your target now?
PK: It's $1.75. It was cut based on lower comparable in-situ valuations for other silver explorers and developers.
TGR: The Promontorio deposit is quite promising and reasonably high grade. What about its mineability? Is the geological structure set in a way that's going to make this easy to mine?
PK: The deposit is a hydrothermal breccia and the structure could be easily mined with a combination of open-pit and underground mining to target the various zonations and concentrations of higher-grade mineralization. The deposit has only undergone one good round of drilling and management is planning additional exploration within the center of the zone in order to further prove continuity between the northeast and the southwest zones where the historic pit is located.
"The substantial leverage created by the U.S.' escalating debt will cause investors to shift away from these temporary investment vehicles and back into the safety of gold."
TGR: Then we don't really know yet if there's no pit wall drilling. Can you tell us about some recent results that keep you optimistic about Kootenay?
PK: It's definitely had some bonanza-grade intercepts, especially up in the northeast zone. It's had exceptional numbers of about 18m of 873 grams/ton (g/t) silver equivalent within an intercept of 71m of 297 g/t silver equivalent. The strong metal credits from lead and zinc (and now possibly gold) lead to a good indication of metal credits should the project become a mine one day.
TGR: Of the companies you cover, which one is best positioned for a takeover?
PK: I'd say Timmins Gold Corp. (TMM:TSX.V; TGD:NYSE.A) is positioning itself nicely for M&A activity. Its San Francisco mine is located in a mining-friendly jurisdiction of Sonora, Mexico, and it has the infrastructure in place with considerable mine life remaining. Last year the company added over 1 Moz to the deposit through drilling and is currently expanding its throughput at the mine in order to achieve 32,000 tonnes per day, which will help the company exceed 130,000 ounces of production annually. A complete takeover or a merger of equals could be a likely outcome in the future.
TGR: When adding positions to a portfolio would you suggest dollar-cost averaging or looking for value in this market?
PK: At this time I would first look at companies with strong balance sheets and growth profiles. You know these companies won't have to go to the market and end up with any equity dilution, especially at depressed prices. Then, if investors already hold those equities, I'd definitely take a look at the dollar-cost average if their portfolios are down. It could make the timing of the break-even point come faster and they could dissolve the position and look at other investment opportunities.
TGR: Could you please provide our readers with a bit of a pep talk to raise their spirits before you go?
PK: It's an ugly time in the market but it's a great time to be a value shopper for cheap mining stocks. I suggest taking advantage of this market to perform due diligence in order to pick the next winners, because there is always an upside to the market and there will always be more profits to be made. We've seen several good spikes out there, with parabolic-looking charts for some explorers, even in these tough markets. Investors should prepare and not be last on the train when the next upward ride in the market comes.
TGR: Thanks, Phil.
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. 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 a 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: Geologix Explorations Inc., Northern Graphite Corp., Rye Patch Gold Corp. and Timmins Gold Corp. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
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 Reports for participating in this interview.
