David Coffin: Pick Away at Bargains Until Prices Pick Up
Source: The Gold Report (9/5/08)
In this exclusive interview with The Gold Report, David Coffin, co-editor of the HRA (Hard Rock Analyst) Journal, advises investors to take a cautious, medium-term outlook until the metals sector regains its strength. With one of the best track records in the business, Coffin applies his encyclopedic knowledge of geology and mineral deposits to the selection of the best-looking prospects—and names his current favorites.
The Gold Report: Would you say gold is still in a correction or do you think it's over? And what's going on with the juniors? Why do they seem to be so unloved?
David Coffin: The juniors are unloved because we’re in a very risk-adverse market. There’s no reason to leave gold after this correction. Does that mean the price is going back up? There’s no guarantee. Volatility will prevail until we get financial stability both here and in Europe. We take a medium-term outlook with our subscribers and have a preference for gold and things like zinc and nickel that are selling below current costs. We're also looking at economies that are doing very well. We're not seriously concerned that China or India will roll over. So, we continue to like commodities in general, and gold is the hedge against calamity in the North American markets, which I’m afraid is coming.
TGR: You mentioned India and China. Does that mean you think copper has a lot of growth potential?
DC: We’re definitely still in copper, but at the moment it's in a consolidation phase. We look at these markets in terms of supply first and demand second. From a supply perspective, new mines are just barely keeping pace with Asian demand. Once the U.S. housing problems started back in mid-2006, there was a pull back in copper. The copper price—then trading at around $4 a pound—dropped to $2.90 or $2.85. Chinese demand drove the price back up again. Now we're watching for the consolidation that will propel the Chinese to buy with greater strength. Once that happens we will be taking a longer-term perspective.
TGR: What companies in the copper area are you recommending, assuming demand picks up?
DC: Sherwood Copper Corp. (SWC:TSX.V) is one that's in new production with a mine in the Yukon. It’s a deposit that everybody who's worked in the exploration sector in Western Canada knows—now it's finally in production. Given where copper prices have been for the past nine months, it's taken Sherwood exactly 2.5 quarters to pay down half of their capital debt. Going forward, they will have a copper price that will continue to make the mine look good. They also have a small gold component, which may help if the gold price runs up.
We think that the only reason it’s not trading higher is that the market’s waiting for them to work through their debt payment schedule, which they’re actually ahead of, and then will start to give them some more price.
TGR: Are they on schedule with their debt payment or ahead?
DC: They're on track. In the last quarter they made their payment and then put $12 million aside for the next payment. So when I talk about them having earned enough to pay down half the capital costs, that does include the $12 million they set aside from the earnings from last quarter.
TGR: What is the mine's life expectancy?
DC: It has an eight-year life with the potential for expansion. They are working on that. The story is that ASARCO LLC was one of three senior companies that got a piece of this deposit when it was discovered. They reworked their holdings such that a Canadian junior public company got the lion’s share of the deposit. That failed because the mine didn’t get into production before copper prices dropped. Sherwood bought out ASARCO’s interest and went at it full tilt. There was already a plant about 70% complete. They have expanded the deposit and will be increasing the plant size as well. It’s quite a good situation. I knew about it because I worked up in the area. The chairman, whom I know, asked me to take a look at it. I did and liked it quite a bit. The gold was a quite a surprise. It was better than I’d recalled. We are happy to recommend it. They've moved into production quickly and they'll be able to expand quickly as well.
TGR: When did you first recommend it?
DC: Late 2005 or early 2006.
TGR: I’m looking at a long-term chart. Mine only goes back to 2007 and the stock was $7.00.
DC: It ran up with copper. Juniors and development level stocks have a tendency to run a bit ahead. We actually are comfortable that it’ll make that price again.
TGR: The $7 price?
DC: It’s not trading a whole lot right now. We believe the price is at a base.
TGR: Do you have any juniors you'd recommend in the gold sector?
DC: We're telling people to buy Minera Andes Inc. (TSX.V: MAI;OTCBB:MNEAF). It has cash flow and deposit expansion. It’s similar to Sherwood except it’s a gold-silver project in Argentina. We like it quite a lot. We think they will be able to double their output. They are trading at around a 5 P/E ratio, which is typical for this market. This stock could easily double over the next 12 months.
TGR: In September 2007, that stock was $2 and it got below $1.
DC: It did go below $1 and this is an instance where, if you look a little farther back on the chart, people made money by selling it all the way down to $1.00. I don’t think it’ll see $1.00 again, but it takes time to wind back up.
TGR: You indicated that Minera Andes had the potential to pay for their expansion from cash flow and has the potential to double in 12 months. Will that depend on what’s happening with the price of gold and silver?
DC: It’s not wholly independent of the price of gold and silver, but you’d have to see a significant drop in the price of gold and silver for that mine to falter. Minera owns 49% of the deposit. Their partner is Hochschild, a Peruvian-based miner. Hochschild would be able to ensure the expansion continued. That would increase Minera Andes’ debt load, so there’d be a longer repayment period if that happened. But we consider that unlikely. The cash flow is strong. It’s a very good deposit. They do have to turn some of their resources into reserves to improve forward projections for people like myself and analysts who are watching the situation. Otherwise it's quite straightforward and Minera is in an area that’s in favor. Southernmost Argentina has had a number of profitable mines open up and gold-silver output there is likely expand, so that helps as well.
In terms of asset-rich companies, I have a long list, but for now we are focused on cash flow. The value of asset-rich juniors – in other words, juniors that have deposits that look viable and have been partially defined – has come down, along with the value of other assets. We expect that to turn at some point, but we can't put a date on it.
TGR: What would cause that turn?
DC: Two things. One is the continued growth of Asia. The other is the acceleration of buyouts and mergers. As that process gathers momentum, people will start looking around for undervalued assets and buy them. How long will it be before people are comfortable enough to start buying their favorites? Again, it's hard to say.
TGR: Are you still following Terraco Gold Corp. (TSX.V:TEN)?
DC: Terraco is a speculative story. They've done a few drill holes. To get the market excited again, they need drill results indicating upside potential.
TGR: Weren’t they trying to figure out if there was a connection with the Midway Gold Corp. (AMEX, TSX.V:MDW;MDWGF.PK) deposits?
DC: It wouldn’t be a direct connection, but I do think their systems are related. They’re drilling to see whether they do have an extension. The morphology indicates that there has been a gold deposit within Terraco’s ground. There’s a placer deposit and one known high-grade silver vein that comes to surface, so the potential definitely exists. But it can take time to determine the exact extent of it. They need financing at a good price to move that process along. So, we’re still watching Terraco but, as with most specs, we’re not telling people to accumulate more. It's a wait-and-see period.
TGR: A good drill result could make a difference.
DC: If you put out a big drill result, the market will respond. Some companies have done quite well over the summer, but only a handful. Two or three years ago, companies were doing well based on the expectation of good results. That’s how much the market’s changed.
TGR: You're saying gold doesn't have to go to $2,000. You find projects that are going to be developed, go into production, become profitable and generate cash flow at today’s prices — not necessarily the fantasy prices people want.
DC: We’re not big on saying “these guys have seven million ounces of gold… If the gold price goes to $1,500, it’ll be a great project.” We'll consider them after the price goes that high. We do have a mix. First Quantum Minerals Ltd. (FM.TSX), a copper producer in Zambia, is the largest company we follow. We just told people to nibble away at it in the $50-60 range after having started with it closer to $2.00. So, again in a risk-adverse market, their price has pulled back further than they should have, purely on a cash flow basis. We look for companies that can grow that way. In this market we want companies that are going to grow as part of a merger or acquisition, at least until we see a turnaround in the sector.
First Quantum was trading at a P/E ratio of 5 when they put out their last quarterly. Again, that's the market we're in. People are understandably discouraged. The fundamentals are saying look at it, but we say wait. It’s not about the resource sector. It’s a different set of problems.
TGR: Do you have another company in the junior sector that would meet your criteria?
DC: We track Teck Cominco Ltd. (NYSE:TCK; TSX:TCK.A; TSX:TCK.B), a senior company with a mix of coal, zinc, and Alberta oil sands. It's recently increased its exposure to copper. The company has had a nice price run this year because of its coal holdings. Zinc is the one thing pushing its earnings down a little and, for that reason, we'd be picking up more of it on days when it’s weak.
TGR: How long do you think this commodity boom will last and which commodities do you think will excel over the next three to five years?
DC: The boom is likely to last another 10 to 15 years. That's how long it will take China and India to build their infrastructures. That could change very quickly if their economies were to take serious nosedives. Copper can just barely satisfy demand now. That's also true for zinc and nickel. Xstrata (XTA.L; XTA.S), a large producer in the nickel subsector after taking over Falconbridge, is taking its Falcondo operation in the Dominican Republic offline. The Falcondo operation is a swing producer, and its coming off-line tells you the nickel price is too low. The price of oil is killing the operation since Xstrata generates power with its own diesel generators, and the production halt is in part to deal with that.
The price of oil has a huge impact on the metals market. Once oil settles back into the $80 to $100 range, we can calculate what the new base price in each of the sub-sectors should be. Companies are now very quick to shut down their losing producers. That is what's different about this downturn. In the past, companies continued to mine because they had to pay the banks regardless of whether they were making money or not. This time around, there are a lot of very cash-rich metal producers. When prices drop below their cost of production, they shut the mine down.
TGR: I would assume that once the swing producer goes offline, that’s going to add some pressure.
DC: Exactly. Falcondo is about 2% of the nickel supply. Today the message is that if the nickel price comes back up – by say $2 or $3 a pound – then we’ll think about putting the mine back into production. We’re seeing curtailment in a number of areas in nickel. This price is too low—it's at a base. A number of zinc mines have shut down too, so if this is not a price base, there’s not going to be enough zinc.
TGR: That makes sense.
DC: The problem the mining sector has had historically is borrowing to put deposits in production and then being forced to operate at a loss in order to make interest payments. We’ve had a strong five-year cycle and producing companies are very healthy, so they aren’t so beholden to the banks. We’re telling subscribers to be patient, but we’re still picking away at a few things until the prices move back up.
I would advise caution about the broader economy. There are still serious banking sector issues that need resolution. And keep an eye on China and India. We’re not seeing evidence of a serious slowdown in either, but if that happens, we would adjust our outlook. Other than that, pick away, focus on companies that are new to cash flow like the ones I’ve mentioned, and, as the number of takeovers and mergers increase, start looking at them a little more closely.
David Coffin and his brother Eric are the co-editors of the HRA (Hard Rock Analyst) family of publications. David is the “rocks side” of HRA, and has been active in mining exploration for over 30 years in roles spanning prospecting through feasibility studies, and now markets commentary.
Dave went against the crowd in the late 1990s, urging companies to return to high grade underground mining, which turned out to be salvation for many of them during the bear market that followed. He was also one of the first (along with Eric) to call the current cycle as the secular trend others have only recently recognized. Although the HRA publications keep him too busy to do much else he is still regularly asked to review and give opinions on new exploration projects.
David logs, literally, hundreds of thousands of miles every year, visiting exploration sites on six continents in order to bring back the real goods for HRA subscribers. Eric and David can be reached at [email protected] or through their website at www.hraadvisory.com . At publication date of this article, David Coffin had positions in Sherwood Copper, Minera Andes, Terraco, and Teck Cominco Ltd. He also owns Golden Predator (GP-T) that is currently in a friendly merger with Midway Gold.