The Gold Report: Gold spiked to about $1,800/ounce (oz) after the latest round of quantitative easing was announced. It was at about $1,700/oz recently. What's responsible for gold's recent price weakness?
Cosmos Chiu: If you look back, the month of October is usually the weakest month of the year. Because investors look at it as a seasonably weaker month, there's less demand. That has held true this year as well.
TGR: Could gold finish the year higher than where it is now?
CC: Different factors that could drive bullion higher in November and December, including the restocking of jewelry for the winter holidays in the West and in India, the rethinking of the role for gold following traditionally weaker markets in October, and continued bailout concerns for Spain and Greece. It has also been a favorable monsoon season in India as well. That should also help increase demand coming from the Indian population.
TGR: Do you forecast strengthening investment demand, too?
CC: Investment demand was lower for the first half, but there's been strong central bank buying, which certainly helps. Demand isn't just composed of exchange-traded funds.
TGR: What's your investment thesis for midtier producers predicated on higher gold prices?
CC: They're in the industry of producing gold so higher gold prices don't hurt. Even though they're in production, they're small enough to have meaningful growth ahead. It's not that hard to grow a company by 20–30% during the next year if a company has a starting base of 200,000 oz (200 Koz). Some of the midtier companies benefit from dealing more with pure gold instead of base metal byproduct credits, base metal contracts and smelter contracts. There's sometimes less complexity in running these companies as well.
"While mining in South Africa is well developed, a lot of opportunities are still currently available to investors in other parts of the continent."
I just got back from traveling to a road show in Europe—I go about twice a year. Investors are still very bullish on the gold and silver prices. One key question that's been unanswered in North America and across the pond is why have equities underperformed the commodity and will that continue?
Costs, more or less, are not stable—they're not going down, but they're not increasing at the same rate they did before. Earlier, they were increasing at a faster rate than the increase in the gold price. There has been some margin deterioration. We don't have any concrete evidence that this has reversed, but we certainly have seen some of the input costs moderate a little. That's going to be a key driver for some share price catch-up to the underlying commodity.
Companies' multiples will start to move more consistently as investor confidence continues to come back.
TGR: What about jurisdiction?
CC: People always like to bring up political risk. But what is political risk? Is it higher taxes? The risk of expropriation? The risk of war? To understand political risk, investors have to understand all these different types of risks. And don't ever forget about permitting challenges and issues like that. Investors need to understand that there's a wider scope to political issues than what's highlighted in newspapers.
TGR: What's the first thing you would tell an investor interested in African gold plays?
CC: Africa is one of the fastest growing areas in the world. While mining in South Africa is well developed, a lot of opportunities are still currently available to investors in other parts of the continent. I quite like Burkina Faso, Ghana, Sierra Leone. They provide good value for investors.
I'd also say it's a mistake to lump together all countries in the entire region. There might be issues in Mali, for example, but that doesn't mean all the other countries are impacted.
TGR: Which countries in West Africa are you most bullish on?
CC: I look for stability in the government and exploration upside. The three that I like the most are Burkina Faso, Côte d'Ivoire and Ghana.
I currently have an outperform rating on Perseus Mining Ltd. (PRU:TSX; PRU:ASX), which is one of the best startups in the past year. Its operations at the Edikan mine in Ghana are running really well. It met its targets and has a second project, Sissingue, that's being built in Côte d'Ivoire.
TGR: It's an interesting project, but at the same time it's not into full-scale development because it's awaiting the government's decision on something called a super-profits tax. What do you know about that?
CC: The government is planning to impose a super-profits tax on the gold industry, but in the end I believe the goal of any tax rate changes in Côte d'Ivoire will be to make it more comparable to other West African countries. The end result, I believe, will be more of a catch-up to the norm rather than the government trying to take all the economics away from that project.
For my modeling purposes, I've already put in the higher tax assumptions and the project continues to be profitable with a very good return on investment.
TGR: Is Perseus on target to meet its production estimates?
CC: It is. It reaffirmed last week its targets once again for fiscal 2013, which is the year ending in June. Based on my numbers, I agree that it will meet those targets.
TGR: How much gold is Sissingue going to produce per year?
CC: It's going to be producing close to >100 Koz life-of-mine, on top of what it's producing at Edikan. My 12-to-18-month target price for Perseus is $4/share and it's currently around $2.60/share.
TGR: SEMAFO Inc. (SMF:TSX; SMF:OMX) recently made the transition from one "Benoit" to another. Benoit La Salle, the long-time president and chief executive officer of the company, handed the reins to Benoit Desormeaux. Is that a positive change?
CC: Benoit Desormeaux has brought something different to the table even though he's been with the company for quite a while now as the chief financial officer. His focus will continue to be generating value at Mana. He's only been at the job for a few months, but he has the desire to generate value for investors by developing Mana, Samira Hill and Kiniero.
TGR: The cash costs from operations at SEMAFO were higher than expected in the second quarter. Is that something shareholders should get used to?
CC: Cash costs have increased in the third quarter mostly due to mining lower-grades, closer to 2 grams per ton (g/t), when it had been mining 2.5 g/t in previous quarters. It happens. Any deposit has lower-grade portions and higher-grade portions. I don't think it's a long-term issue.
"I favor companies that are more pure gold than the ones with a significant base metals component."
Also, power isn't as abundant as it would be in Canada or Mexico. A lot of costs are dependent on fuel prices. There's a lot more power being generated by fuel.
SEMAFO was definitely impacted by higher fuel prices early this year and last year. The reverse is also true. As fuel prices moderate, SEMAFO and similar companies will have more favorable cash costs.
TGR: You have a 12-to-18-month target price of $6/share. Its shares are currently trading above $3. Where is that growth going to come from?
CC: Mana is the flagship asset and I expect that to continue. It's had some exploration results from different areas within its mining concession. There should continue to be upside in terms of resources coming from Mana this year and into 2013.
TGR: Where will the next wave of producers come from? What are some development-stage projects in West Africa that you're keeping an eye on?
CC: West Africa is the most favorable jurisdiction. There's a greenstone belt that goes through all these different countries. It's quite simple. The more greenstone belt, the more exploration potential for a country.
Mali has been a historic producer of gold, but given the recent instability in the country, exploration and production have been more muted of late.
One up and comer, although it doesn't hold as much of the greenstone belt, is Sierra Leone. It has several projects under development. Given the civil war that devastated the country more than 10 years ago, it is looking forward to and very supportive of foreign investment.
TGR: Are there some other junior narratives that are compelling?
CC: Pilot Gold Inc. (PLG:TSX). I covered Fronteer Gold, which was eventually acquired by Newmont Mining Corp. (NEM:NYSE) almost two years ago; Fronteer's management went on to create Pilot. The entire management team stayed intact. When you invest in junior exploration companies, you want to be investing with a good management team. I would say that Pilot has a very good management team. It has some pretty interesting assets in Turkey and Nevada, too.
TGR: Pilot Gold has a preliminary economic assessment on Halilaga in Turkey that said it has a net present value of $474 million and a 20% internal rate of return, taking a little more than 2.5 years to pay that back at $1,200/oz gold and $2.90/pound copper. Are those numbers sufficient for development or does Pilot Gold need to make the economics even more robust to reach a production decision?
CC: I was on-site last year. The good thing about Halilaga is that there continues to be upside potential. We don't have to sit back and say, "This is all we have and is this good enough?" It has more potential than what is being shown today. That certainly makes it more attractive as a development decision. It also has a joint-venture partnership with a very strong company, Teck Resources Ltd. (TCK:NYSE; TCK.A:TSX), that would help to fund some of the development needs.
TGR: Does Newmont still own a piece of that as well?
CC: It does. Newmont subscribed to the latest round of financing that Pilot Gold had. It topped off and made sure that its percentage stayed the same.
TGR: How would you compare Turkey to West Africa in terms of gold exploration potential?
CC: They are very different. I was actually in Turkey two weeks ago on a mine tour. The mineralization is different in Turkey because there is a larger silver component. The mining is somewhat different in that there is more heap leaching. The infrastructure is better.
However, gold mining is not yet a huge component of Turkey's economy. There's a culture behind gold production, of course, given the history of the country. That said, at this time, it's not as well developed yet as Canada, Australia or other jurisdictions with a longer, modern mining history.
TGR: Royalty companies have been the sector's star performers over the last few years. How do you decide which royalty companies to cover?
CC: To analyze royalty companies well, you need to understand the underlying contracts and the underlying mines. We have an advantage because we cover most of these underlying mines that actually pay a royalty to companies like Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) and Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). At this time, I have Sector Outperformer ratings on Franco-Nevada and Silver Wheaton.
You need to look at the composition of these royalty streams. Where are they coming from? Is gold a byproduct of these streams, are the economics driven by gold or is it driven by silver or some other precious metals? How big of a component is each stream of the total net asset value (NAV)? You never want a single stream to dominate the NAV of a royalty company because part of the royalty attraction is the diversification of risk.
I always say they're one of the easier types of companies to cover—they tend to meet my earnings and cash-flow targets quarter over quarter.
TGR: Do you expect royalty companies to perform as well over the next three years as they did over the last three years?
CC: It's certainly been a good environment for royalty acquisitions. We've seen all three do accretive deals within the last two months. For example, Silver Wheaton did a deal with HudBay Minerals Inc. (HBM:TSX; HBM:NYSE), Franco-Nevada purchased a royalty from Inmet Mining Corp. (IMN:TSX) and Royal Gold topped up its royalty at the Thompson Creek Metals Company Inc.'s (TCM:TSX; TC:NYSE) Mt. Milligan project.
The favorable conditions for royalty acquisitions should continue for the next two to three years.
TGR: What are some of the favorable royalty contracts that Royal Gold has with producers?
CC: The royalty that served as the first cornerstone for Royal Gold was the Cortez contract in Nevada. The asset, operated by Barrick, paid Royal Gold quite handsomely for a long time, up until about two years ago when it switched to mining Cortez Hills. The Cortez royalty created a very important cash-flow generator for Royal Gold for a long time so it could leverage cash flow into purchasing other interests.
Looking ahead, some of the bigger ones that Royal Gold has would be Peñasquito, which is a key Mexican mine for Goldcorp Inc. (G:TSX; GG:NYSE), and the Andacollo, a key mine for Teck, which is looking into further expansions.
TGR: When is Peñasquito slated to go into production?
CC: It's already in production. It's a staged approach to development, but it's already been in production for quite a while now. It has a mine life of more than 20 years.
The royalty company doesn't have to pay anything, so an expansion is the best thing that can happen to it. There's more gold upfront, more production and more payment to the royalty, but there's no additional capital expenditures needed.
TGR: Will royalty companies pay larger dividends?
CC: It's a double-edged sword. They want to return investment to investors, but, at the same time, why would they if they have opportunities out there where they can continue to generate positive alpha for the company itself?
We've seen over and over again how these royalty acquisitions have increased the NAV of the company. I believe companies will keep it at a certain point, say more than a 1% yield, to make sure that there is some return to investors, but they will want to make sure that they also are able to capitalize on opportunities.
TGR: There aren't a lot of royalty companies, but do you see further consolidation among them?
CC: I wouldn't be surprised. I've covered them for a long time. I've seen International Royalty Corp. get taken out by Royal Gold and Gold Wheaton taken out by Franco-Nevada. It's much easier for a larger royalty company—some of these companies have been around for a long time and it takes a long time to build up a good portfolio. The diversification benefits are not as clear for some of the smaller companies. I wouldn't be surprised if there's more consolidation knowing that it's actually quite a small space in the end.
Royalty company financing has become more mainstream. Many of these mining companies are looking at it from the perspective that they want to have a royalty financing component as part of a more integrated financing package. They want to do some type of equity financing, a portion debt financing, a portion project financing and also a portion of the royalty financing.
TGR: What are some investable themes that our readers should watch for in the precious metals space throughout the remainder of this year and into 2013?
CC: I've been telling clients to look for the companies that will deliver on their promises. Look for companies that have the ability to capitalize on some of this cost abatement that we might see in some parts of the industry. From my perspective, I favor companies that are more pure gold than the ones with a significant base metals component.
TGR: I've appreciated speaking with you today. Thanks, Cosmos.
Cosmos Chiu, director, Precious Metals Equity Research, CIBC World Markets, joined CIBC in June 2006 to provide coverage of development and production-stage companies in the gold sector, as well as royalty companies. Chiu has a specific focus on mining assets in North America, Europe and Africa, covering companies with market capitalizations ranging from $200 million to $10 billion. He was ranked fifth overall best stock picker by Starmine in 2010. He is consistently ranked in the top 10 in the Brendon Wood International survey for the Precious Metals—Small/Mid-Cap sector.
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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 this article are sponsors of The Gold Report: Franco-Nevada Corp., Royal Gold Inc., Pilot Gold Inc. and Goldcorp Inc. Interviews are edited for clarity.
3) Cosmos Chiu: 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.
