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Siddharth Rajeev: Recovery Signals Paler Shade for Gold
Source: Interviewed by Karen Roche, Publisher, The Gold Report (2/12/10)
As investment demand for gold—including its attraction as a preservation asset—diminishes in a recovering economy, Siddharth Rajeev, vice president of research for Fundamental Research Corp., suggests the price may dip back to the $750 neighborhood by 2012. But even at that level, he tells The Gold Report in this exclusive interview, "most projects can still make very good profits at very high margin," particularly those that manage to keep a lid on operating costs.
Siddharth Rajeev: We believe the economic recovery in the U.S. and increasing investor confidence will limit the upside potential of gold prices from current levels. This will result in a drop in investment demand as investors move from capital preservation assets—such as gold—into assets with higher expected returns. We saw that the U.S. GDP grew at 5.7% in Q4, which was the fastest in the last six years and in Q3 posted growth of 2.2%. Therefore, we are definitely seeing very positive signs in the U.S.
Yes, inflationary pressures are looming, but we expect the Fed to start increasing interest rates in the second half. We expect gold prices to converge to our long-term forecast of $750 by 2012. But remember that most gold projects will still make good profits even at $750 gold considering the historic average is only $360 per ounce.
TGR: So you're among those who see what people are calling "gold shoots of recovery" and are projecting sufficient positive growth within the U.S. in 2010 to prompt the Fed to start to increase rates.
SR: Yes, because once we see economic growth in the U.S., there's no reason the Fed should not increase rates, especially because of inflationary pressures. We believe the increase in interest rates would be able to limit the inflation rates in the next two years.
TGR: You're on the opposite side of what we've been hearing about a recovery in 2010. A lot of people are speculating that with the massive debt the U.S. government faces already—plus the potential for additional stimulus and radical healthcare changes—the U.S. will not go into recovery this year and possibly not even in 2011. Considering that projection is almost the exact opposite of yours, what are you seeing that they're missing?
SR: The main thing is that the U.S. dollar is still extremely weak compared to other currencies, which would benefit their exports. We believe the combination of a weak U.S. dollar and the stimulus package would result in an economic recovery in the U.S.
TGR: And you say with recovery, gold prices will decline as people move away from it as a preservation investment?
SR: Gold has always been perceived as a capital preservation asset, so when the economy recovers, when the investor confidence improves, there is no reason why they would hold on to gold. They would rather put their money into investments that give them higher returns. One of the primary drivers of the increases in gold prices we have seen has been investment demand. As that declines, we don't see gold prices increasing significantly from current levels.
TGR: What about other metals? Will there be enough recovery in the U.S. and/or in the BRIC (Brazil, Russia, India, China) countries to start seeing some increase in base metal prices?
SR: We've started seeing positive signs in the U.S. in terms of base metals, and do believe that the global economic recovery will have a positive effect on demand for most of the base metals. China recently raised interest rates and has much stricter lending policies now. Both indicate that China is confident in its economic growth and is taking steps to curb potential inflation.
TGR: If at least in the BRIC countries and North America are in recovery, are there other sectors besides base metals that you think will perform well?
SR: One of the sectors that we have a very positive outlook on right now is uranium. We've not really seen any increase in uranium prices, even though all the other metals performed really well in the past few months. It seems like investors have totally ignored this commodity versus all the other commodities, which have responded well to economic recovery. All the money that's being put into infrastructure growth has helped the base metals, but uranium prices have not really responded to the positive news in terms of demand that we've seen over the last six months to one year.
TGR: How do you see uranium demand as you look ahead?
SR: Basically, there have been no significant changes on the supply side with uranium, but we have seen very positive news on the demand side, especially long-term demand. Most governments worldwide are realizing the importance of cleaner energy. Uranium has the most potential on the clean energy side. Obama really stresses nuclear energy. In the long term, two years out, we believe the demand for uranium will be very strong.
I think we will see uranium companies probably doing well in the next 12 to 24 months, and uranium prices are something to watch.
TGR: Are you looking at any uranium companies in particular?
SR: We recently released a report on Fission Energy Corp. (TSX.V:FIS). We think that's one of our best uranium companies. When we initiated coverage in January 2010, they were at 18 cents. Now I think they are at close to 50 cents. Our target price on this is 80 cents.
TGR: What makes Fission Energy more appealing than other uranium companies you've evaluated?
SR: Their primary focus now is the Waterbury Lake joint venture project with a Korea Consortium led by Korea Electric Power Corporation (NYSE:KEP)—in the Athabasca Basin in Saskatchewan. We are seeing very good preliminary results from that project and if they continue to get more positive results, we expect the stock to move closer to our fair value. A related company to Fission that we do not currently cover but have on our radar screens is Strathmore Minerals (TSX.V:STM), which actually spun off Fission. Strathmore has advanced stage uranium projects in the Gas Hills Uranium District in Wyoming and the Grants Mineral District in New Mexico. What is interesting about Strathmore is their Roca Honda project is the largest proposed uranium mine in the United States in over 30 years. We think that given Obama's recognition of uranium, this U.S.-based project will be a fairly prominent project in the coming years.
TGR: One of the darlings of 2009 was all those rare earth metals. What's your view of that sector?
SR: We also have a positive outlook on rare earth metals, especially because more than 95% of the production comes from China. As you know, over the past year or two, China has increased restrictions on export quotas and raised export tax rates. So they are definitely trying to preserve their resources, and because the supply is concentrated in China, we believe global supply will be affected. On the demand side, rare earth metals are now being increasingly used in electronics and alternative energy. These factors will drive demand for rare earths.
TGR: What companies do you like in the rare earth area?
SR: One company that we have on our watch list though we do not cover it is Channel Resources (TSX.V:CHU). While technically not a rare earth, their Fox Creek Lithium/Potash Brine Project has a historical resource estimate of 2.7 million tones of Lithium Carbonate Equivalent (LCE). Spot prices for LCE are about US$6,500 per tonne.
TGR: You mentioned earlier on that you expect gold prices to actually begin to decrease as all this positive GDP information comes out. You also said that many gold miners can be profitable at $750 gold. But will capital resources flow to those companies that need it to bring projects into production with gold at $750?
SR: I think so, because even at $750, most projects can make very good profits at very high margin, so we expect capital to continue to flow towards exploration , development and production.
TGR: Part of the whole logic of the price coming down is demand coming down as well. So is there a change in the types of projects you're looking at—for example, closer to production versus more speculative?
SR: Especially because we don't expect gold prices to stay at current levels, we like projects with lower operating costs, and capital costs.
TGR: As you look at the landscape of hundreds if not thousands of companies, do you find that operating costs of gold juniors will force many of them out of business in the future? Or are most pretty well established that all of them will be sustainable if gold goes down?
SR: Although margins will drop from current levels if and when gold prices drop, we believe that most of the currently producing gold projects should be sustainable at $750 per oz. Having said that, projects with extremely high operating costs would be negatively impacted.
TGR: Would that negative impact go to the extent that you would see constriction in the gold junior miner sector?
SR: We could see a drop in exploration spending from current levels, but, as I mentioned, the gold sector should be strong at $750 per oz..
TGR: Which are some of the junior miners you like?
SR: Murgor Resources Inc. (TSX.V:MGR) is one of our top picks. They are focused on the Flin Flon greenstone belt of northern Manitoba and Saskatchewan. They have three deposits, Hudvam, Wim and Fon. Combined they have about 186 million pounds of copper, 444 million pounds of zinc, another 350,000 ounces of gold, and 3 million ounces of silver. Our fair value is 63 cents per share. They're currently trading in the range of 13 to 17 cents. One reason we like the company is that we believe it could be a potential takeover target, especially for HudBay Minerals Inc. (TSX:HBM), which is a key operator in the region and has all the infrastructure. HudBay is facing a declining reserve base in their properties, we believe that Murgor's deposits would be a good addition to HudBay's portfolio of assets.
TGR: If that takeover doesn't happen, will Murgor be able to get into production?
SR: It's still a small company, so they will try to keep increasing the size of their deposits. However, they are evaluating the option to ship their ore to HudBay's processing facilities, which would have excess capacity once HudBay's Trout Lake Mine is exhausted in 2011.
TGR: You said the Murgor deposits contain copper, zinc, gold and silver. Will they be shipping everything to HudBay's facility for processing?
TGR: Any others besides Murgor?
SR: Golden Goose Resources Inc. (TSX.V:GGR) is developing the Magino gold property in Ontario. The property is a former gold producer. It has about 1.6 million ounces measured, indicated and inferred. Very good grades of ore; 6.4 grams per ton. The deposit remains open to the northeast and southwest and also at depth, which means that there's significant room for additional resources. Golden Goose is planning to move the project into pre-feasibility stage, which we think might be underway in 2011. They have more than $2 million in cash in hand and they recently sold their nickel project, which brought in more than $3 million more in marketable securities. Our valuation is $1.40 . They're currently trading in the range of 30 to 35 cents.
TGR: The last time we spoke, you mentioned Gold Resource Corp. (OTCBB:GORO;FSE:GIH). Could you give us an update on Gold Resource?
SR: Gold Resource should be coming on line with commercial production very soon at its El Aguila project in Oaxaca, Mexico. They announced their first gold concentrate production earlier this month. Our price target was $6.83 as of our last report in August 2009. The current share price is well above those levels. We're currently revising our price target.
TGR: Since our last interview, have you added any interesting companies to those that you follow that you like in this economic environment?
SR: Canada Gold (TSX.V:CI;FSE:T9N; OTCBB:CNGZF) has a unique business model. They are also one of our top picks. Basically, they focus on establishing ore processing centers for artisanal and small scale mining (ASM) in developing countries. For those who don't know ASM, it's a very common practice in developing countries. One of the main problems is that small-scale miners rarely have modern processing facilities close by. Also, these small scale miners use mercury in amalgamation techniques, which is very bad for the health of the miners and also the community.
Canada Gold's first project is to establish an ore processing facility in northern Peru. Transportation cost is very high for the current miners, because ore from northern Peru is being shipped to processing facilities located 1,400 kilometers away in southern Peru. Canada Gold's plan is to build a 300-ton-per-day plant with minimal capex of $9 million. The best part is that they are already financed because one of their subsidiaries, in which Canada Gold has a 50% interest, holds more than $10 million of marketable assets. Those assets can be sold in the future to fund the capex for this project.
TGR: So this is a pure processing play in Peru?
SR: Yes, it is a pure processing play, but will not be confined to Peru. After establishing the first facility in northern Peru, Canada Gold plans to move to other countries where ASM is prevalent—countries such as Colombia and Ecuador.
TGR: With a $9 million cap ex cost to build the facility in northern Peru, will there be enough gold or processing demand to produce a sizable profit?
SR: The main risk in the model, of course, is consistent long-term supplies of ore. In the case of Northern Peru, we believe, the risk of long-term ore supplies is not high. ASM miners in northern Peru is currently producing 3,000 tons per day of high grade ore. At 300-600 tons per day, we believe Canada Gold should have sufficient access to ore, at least for the next five to ten years.
Although the ASM industry tends to depend on gold prices, Canada Gold's revenues are not directly correlated to gold prices, as the company generates its revenues from processing fees, and the spread between what is paid to the miners and what is recovered in the plant and sold.
TGR: But it sounds as if they have the built-in demand needed to make this first project profitable.
SR: Yes, we believe there is a demand for such a facility in northern Peru. Moreover, the low CAPEX makes the economics of such a project even more attractive.
TGR: Are there other new companies that you're following since our last conversation?
SR: Another company is Rio Alto Mining Limited (TSX.V:RIO), which is focusing on the La Arena Project in northern Peru. It's situated in a region with several significant deposits and producing mines. They have an indicated source of 900,000 ounces of gold in an oxide gold cap. They also have a copper-gold sulphide resource of 1.9 million ounces of gold and 1.74 billion pounds of copper. We feel it's a very straightforward project. There has been extensive drilling on the deposit, so geology and resources are well understood. The company is currently working on commencing oxide gold production in Q4 2010 at the rate of 50,000 ounces per year. Rio Alto has a very strong management team with extensive experience in the mining industry, including experience in Peru. We have a fair value of $1.69 per share. I think they're currently trading about 50 cents.
TGR: Is the property that's being developed as a two-stage process, with the oxide gold coming on line first?
SR: Right. Once they start with the oxide gold production in Q4, they expect to generate cash flows to partially fund capex for the sulphide deposit. We are expecting it to take at least three to four years for the sulphides to be in production.
TGR: Are there some other companies you'd like to share with us?
SR: One of our top picks is Abacus Mining & Exploration (TSX.V:AME). They're focusing on the copper-gold Ajax deposit project in the Afton Mining Camp in British Columbia. They have a very good resource with 2.9 billion pounds of copper and about 2.7 million ounces of gold measured and indicated. Last year they came out with a positive preliminary economic assessment (PEA). The company is currently working on a pre-feasibility study for a 60,000-ton-per-day operation. The company recently completed $7 million financing, so they're in a decent cash position. Our valuation is about $1 per share. Before the PEA, I think they were at 13 cents. They're currently trading at about 30 cents.
TGR: When do you expect results of pre-feasibility to come out?
SR: We expect sometime this year.
TGR: Turning to silver for a moment, you also talked with us about SilverCrest Mines Inc. (TSX.V:SVL). Any updates there?
SR: We have a price target of $1.98 on SilverCrest Mines. It's at about 90 cents now. They have made very good progress since we last spoke. Progress has been in line with our expectations. They are well financed; and we expect them to go into production this year.
TGR: We appreciate you sharing your news and information with us, Sid. It's always educational chatting with you. We love hearing about those very interesting projects you seem to find in the beginning of their uptrend.
Fundamental Research Corp. VP Siddharth Rajeev oversees FRC's research department as well as covering a broad array of companies, primarily in the mining, energy and technology sectors. Sid is ranked a 4-star analyst in the energy sector by Deutsche Asset Management, a division of Deutsche Bank, with 2009 picks in mining and energy sectors that outperformed their respective benchmarks after transaction costs. Prior to joining FRC in April 2006, he had a mix of engineering and finance experience including work in corporate finance at a leading investment bank in Kuwait. Sid holds a Bachelor of Technology degree in Electronics Engineering from India's Cochin University of Science & Technology, and an MBA in Finance) from the University of British Columbia. He is also a Level 3 candidate in the CFA (Chartered Financial Analyst) program, and has completed studies in exploration and prospecting at the British Columbia Institute of Technology.
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1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Strathmore Minerals, Rio Alto Mining Ltd. and SilverCrest Mines Inc.
3) FRC provides fee based coverage on some of the companies mentioned in this interview.