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Steven Butler: Equities Drop Opens Opportunities
Source: Sally Lowder of The Gold Report (10/3/11)
Steven Butler, senior precious metals analyst at Canaccord Genuity, didn't expect mining equities to fall as hard as they did after the gold price tumbled from a high of $1,900/oz. But the unexpected plunge has created some welcome bargains in the space. In this exclusive interview with The Gold Report, Butler talks about some equities unfairly bullied by the market that have promising projects underway.
Steven Butler: Yes, it is. We set a 12-month target at the end of July suggesting a peak of $1,750/oz. for gold and $45/oz. for silver. Gold shot up to $1,900/oz.—a little bit too far, too fast in August given the unchanged macro conditions. The world hasn't changed dramatically in terms of all the macro conditions affecting Europe and the U.S.
We predicted that there could be a chance for gold to pull back, but we didn't think that equities would pull back as much because they hadn't followed the gold price as high. Yet, in many cases the equity pullback was harsher than what we saw in the gold price.
TGR: There's certainly a whipsaw effect here.
SB: Today, the Global Gold Index is down about 5.3%. But some juniors are suffering even more. Keegan Resources Inc. (KGN:TSX; KGN:NYSE.A) shares suffered a double-digit decrease on its announcement of results of the prefeasibility study at its Esaase Gold Project in Ghana. Two names that I like, Premier Gold Mines Ltd. (PG:TSX) and Atacama Pacific Gold Corp. (ATM:TSX.V), are down 11%. There was some pretty harsh treatment of Silver Wheaton Corp. (SLW:TSX; SLW:NYSE), which is down 10%. Senior gold company Centerra Gold Inc. (CG:TSX) is down about 12% after having been one of the best performers year-to-date. In some cases, there is extra pressure on stocks that had done relatively well earlier in the year.
TGR: How could this impact M&A activity? Grayd Resource Corp. (GYD:TSX.V) recently agreed to be acquired by Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE).
SB: I do think that M&A will continue, although it's been a bit dry for several months. There are some names in the sector that have "potential M&A" stamped on their foreheads. There has been a disconnect between where spot gold has gone and equities. Companies that used to trade on a premium to net asset value, or at least a premium spread to their junior counterparts, can't easily afford to buy their junior counterparts because their share price multiple doesn't allow it. Normally, M&A is always about the expensive senior paper buying the inexpensive junior paper. Companies can show accretion that way.
Premier Gold, Atacama Pacific, Allied Nevada Gold Corp. (ANV:TSX; ANV:NYSE.A) and Detour Gold Corp. (DGC:TSX) have valid M&A arguments behind them. Allied and Detour, a larger-cap producer and non-producer, are a little less certain because some of the easier money has already been made.
Premier Gold's largest asset is the Hardrock Project in Geraldton, Ontario, a resource of 3.6 million ounces (Moz.) that is likely headed to 4 Moz. with the addition of the assets from the Goldstone acquisition. The greater project is going to be renamed the Trans-Canada Project. We believe that there is upside to the resource and our targeted valuation.
The reason why I say it is an M&A target, primarily for Goldcorp Inc. (G:TSX; GG:NYSE), is because of the Rahill-Bonanza joint venture in the heart of Red Lake. The Rahill-Bonanza joint venture is 49% Premier Gold and 51% Goldcorp.
The other asset in Premier's portfolio is the PQ North Project, north of Goldcorp's Musselwhite Mine. There is potential for Musselwhite to continue to strike to the north and eventually run up against a boundary with PQ North.
Premier's other asset, the Saddle Project in Nevada, is a non-compliant resource that the company is looking to drill by the end of this year, with a chance of a 1.5 Moz. or larger resource. That is in close proximity to Newmont Mining Corp. (NEM:NYSE).
TGR: What about Atacama?
SB: Atacama Pacific recently announced an initial NI 43-101 resource of 3.57 Moz. on its Cerro Maricunga project located in northern Chile. It's in the same neck of the woods as Kinross Gold Corp.'s (K:TSX; KGC:NYSE) La Coipa and Maricunga mines, and Barrick Gold Corp.'s (ABX:NYSE) Cerro Casale deposit (75%/25% JV with Kinross).
The unique and attractive thing about Cerro Maricunga is that the resource is completely oxide-hosted mineralization, which means it can be low grade. It is grading only about 0.53 grams per ton (g/t) in the current resource. However, since it is oxide that means it is more readily available by a heap-leaching technology. Heap leach deposits would rather be oxide than sulfide, with higher recoveries and lower operating costs.
The best example of low grade but low cost oxide heap leach mining is Argonaut Gold Inc. (AR:TSX), which operates the El Castillo mine in Mexico. El Castillo's reserve grade is only 0.36 g/t, but site costs are also low at $4–$4.20/tonne (cash costs were $578/oz. in Q211).
Atacama's upside potential could be a 6.7 Moz. resource, but our target price of $10 is based on a resource potential of 5.1 Moz., the mid-point of the current 3.57 Moz. resource and our upside scenario.
TGR: The stock is at $4.25 today, down 10%. This might present difficulty in terms of liquidity for investors, but it also could present an opportunity to buy.
SB: The stock is not the most liquid entity out there, so there is the potential for a bit more volatility in share price on sometimes fickle volumes. But we quite like the company's story.
TGR: What's your thinking on the M&A possibilities for larger companies like Detour Gold and Allied Nevada?
SB: Allied Nevada is operating its Hycroft Gold Mine, which is an oxide heap leach, under an accelerated expansion program that is a modest increase in production from its heap leach production. The bigger kick will come from the approximate $1.3B capital program to develop the sulfide deposit that sits beneath the oxide deposit. The company just completed the feasibility study and booked Hycroft's total reserve at 10.2 Moz. of gold and 389 Moz. of silver. Most of that is in the sulfide phase, which can be more expensive to process, given the refractory nature of the gold mineralization.
The reason we favor Allied Nevada is primarily for the re-rating potential for the shares under a go-alone approach to building the milling circuit at Hycroft and the optionality upside on its large exploration portfolio in Nevada, highlighted by its Hasbrouck project that is advancing toward a resource increase and preliminary economic assessment early next year. But there is M&A potential here as well. We view Hycroft's sulfide reserve/resource as a large and strategic resource in Nevada that could be of interest to either Barrick Gold or Newmont. We understand that Barrick needs to supplement its Goldstrike ore feed with the purchase of native sulfur or barren sulfides to maintain optimal sulfur and heat balances in its autoclave/roaster circuits.
TGR: The company has said it could triple production by 2013, which really gets my attention.
SB: Average production from the project could be more than 600 Koz. of gold and about 26 Moz. of silver annually once the milling project is up and running in 2015 and beyond.
TGR: Detour Gold is also a big operation. The whole project has been interesting to watch over the last several years.
SB: It's already booked a reserve of 13 Moz. and counting. It has raised all the required amount of capital that it needs to build the project. It is substantially advanced. The odds of M&A are not necessarily 100%, of course. For Detour, the attraction is that this deposit is already a large reserve at a conservative gold price and there is potential for Detour Lake to produce over 600 Koz./yr. when the mine starts up in less than two years.
TGR: It's off of its 52-week high by about 20%. Depending on what happens over the next several months, it might present itself as more of a bargain.
SB: The site construction is well underway. In a Jan. 11 update, the company said average annual production was 657 Koz./year. There is potential for it to be large enough to be of relevance to a number of other companies.
Detour is trading at about 0.5 times net asset value (NAV), while the senior and intermediate group is trading at about 0.9 times NAV. This could be enough of a value spread whereby valuation and production accretion would make sense.
TGR: In the meantime, the company will just keep working its plan and expanding the reserve and resource and moving forward.
SB: Yes, both Detour and Allied Nevada will continue to aggressively move forward on their plans. Both companies have the potential production on full rampup of over 600 Koz./yr., enough to move the dial for anybody.
TGR: Those would be large transactions.
SB: They would not be insignificant transactions! You are right. Detour and Allied Nevada are resources that are open to potential expansions, as well as additions. Both have scoped pretty big levels of throughput in their operations. You might not necessarily be able to get much more than 130,000 tons/day out of Allied Nevada's mill. That's a very robust level of milling matching that of Goldcorp's Peñasquito. Detour may very well look at an expansion beyond its mill throughput assumption of 55,000 tons/day. In fact, we model a modest expansion beyond that level because we believe that the reserve resources will continue to grow. There is some optimization that Detour and Allied Nevada will be able to do with both of their deposits.
TGR: You just attended the Denver Gold Forum. Did you discover some junior stories there that were compelling?
SB: There are a lot of projects out there. There always have been a lot of projects out there. And, at these gold prices, there are that many more, aren't there?
TGR: There are going to be more.
SB: There is certainly potential for very large resource growth. A lot of these companies are going to be booking over the next year or two. Some companies will push the dial up even further. If there continues to be a divergence between gold and gold equities, I think that value will surface in many of these names. They will drive resource reserve increases. They'll either be lucky enough to build their own projects, or the M&A will eventually kick into gear and many of these stories will be recognized with an increased level of corporate activity because it has been a little too quiet.
TGR: There are so many compelling, medium-size projects with proven reserves that are essentially, for lack of a better expression, rotting on the vine.
There is a vacuum of experienced management that knows how to put projects into production because no one was going into mining in the 1980s. We don't have a robust group of younger management that is experienced. Perhaps the lack of talent pool on some of these projects is why they aren't getting developed. I don't know if that is something you thought about or not.
SB: It's a very relevant comment. After I completed my undergraduate geology degree in 1988, the class sizes at the university that I attended kept getting smaller and smaller.
It's also proven to be a lot more difficult for the companies to raise capital, of course.
TGR: Permitting issues.
SB: Right, permitting and because they are going further and further abroad. I remember visiting a project in 1996 that didn't see production until about 2008. We thought it would be in production much more quickly. Sometimes it takes a couple of cycles for these things to get going. It's challenging, but the people element is a big deal. If you don't have experience, you have to train up a new pool of employees.
One of the most competitive locations for labor has proven to be Australia, because of the number of new projects and so few people with operating experience, developing experience, or experience as millwrights or metallurgists. It's not just lack of talent in the managerial positions, but back down at the operating level, too.
TGR: I have heard that some Australian companies are bringing in coal miners from Kentucky on three-week shifts.
TGR: That blows the mind. Steve, thank you so much. This has been great.
Steven Butler is managing director and senior precious metals analyst at Canaccord Genuity. He has spent over 17 years in mining research and has active coverage on 27 precious metals companies spanning the large cap and small cap space. Mr. Butler earned a BS in geology from Queen's University in 1988 and an MBA from Dalhousie University in 1991.
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1) Sally Lowder of The Gold Report conducted this interview. She personally and/or her 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: Premier Gold Mines, Allied Nevada Gold Corp., Detour Gold Corp., Argonaut Gold.
3) Steve Butler: 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. Premier Gold Mines Ltd., Atacama Pacific Gold Corp., Detour Gold Corp. and Allied Nevada Gold Corp. are investment banking clients of Canaccord Genuity.