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Chris Thompson: Investors Not Quite Ready to Embrace 'Ugly Sister' Silver
Source: Brian Sylvester of The Gold Report (11/21/11)
Volatility in the markets overall, and particularly in the silver price, continues to deter investors, even the major producers, from stepping in on silver juniors. However, Chris Thompson, equity research analyst with Haywood Securities, names some attractive opportunities in South and Central America in this exclusive Gold Report interview.
Chris Thompson: Silver is often called gold's ugly sister because historically it presents itself as a very volatile metal, price-wise. Silver demand is typically determined by two main influences. First, silver as a store of value, much like gold. Second, silver is valued as an industrial metal. Right now, there's a lot of concern about demand for silver as an industrial metal, about the lack of demand for silver for industrial fabrication. The interplay between these two demand uses contribute to its price volatility.
TGR: And you expect that volatility to continue for a while yet?
CT: I think so. We've seen a lot of volatility in gold. Earlier this year, many argued that gold could easily move up to $2,000/ounce (oz), over the long term. When gold ran up rapidly a couple of months ago, it did more damage than good to the precious metal sector because it caused a lot of people to wonder whether those high prices were sustainable. It discouraged them from playing the precious metal game in anticipation of a correction of sky-high gold prices.
The same is true for silver. Earlier this year silver approached $50/oz, and then fell back severely. My sense is the move forward will be volatile for a lot of metals, copper included.
TGR: You suggest the near-term price for silver will be around $38/oz. But, your long-term price drops to $20/oz. Is the lack of industrial demand behind that or are you just taking a very conservative approach?
CT: We are taking a conservative approach. We are looking for a weakening in the silver price into the medium to longer term. Anyone who suggested a long-term silver price of $20/oz a couple of years ago would have been called very, very aggressive. Now, a lot of commentators are predicting $20/oz in the long term. My sense is that $38/oz is a healthy price for silver in the near term, as is $20/oz as a long-term price. These prices will, in time, contribute to new mine production, which will contribute to new mined supply. Increased supply will depress the price of the metal.
Also, we have to recognize that 80% of the mined silver supply comes as a byproduct credit. In that sense silver production is linked to the economics of gold, lead and zinc. All things being equal, we are looking at good prices for gold and reasonable prices for base metals, all supportive of additional silver mined supply and a lower silver price in the long term.
TGR: For most of 2011, share prices of most major precious metals producers lagged the price appreciation of gold and silver. Lately that gap has started to close. Will this trend continue?
CT: I believe so, yes. I think the lag relates to the volatility of gold and silver prices, and arguably copper as well. That price uncertainty has caused a lot of companies to stay on the sidelines, to wait and see whether metals prices in the broader context are sustainable before engaging in merger and acquisition (M&A) activity. Now, I think there is a growing appetite for M&A in the precious metals space, being driven by the need to sustain production growth.
TGR: So, in effect, investors need precious metals prices to stabilize before they will invest in the companies that produce them?
CT: I think so, yes. This is the case for many individual investors, particularly those looking at takeout candidates. For certain producers, equity prices have caught up to metal prices.
A couple of the companies we have under coverage in the silver space, companies that have cash flow, are trading at relatively high multiples to cash flow for next year. That suggests that there is a lot of appetite for cash-flowing companies focused on silver, especially companies that have demonstrated their ability to grow their business.
But that's not the case with companies oriented more toward longer term growth or development. If an investor is looking at a development opportunity, he has to be fairly confident about where the underlying price of the metal is going before making an investment decision. There has been a lot of doubt in the marketplace about whether metal prices are sustainable at current levels.
TGR: In addition to some of the silver majors trading at healthy multiples, some of the gold majors are putting their free cash flow into higher yields. Yet, prices for juniors, even juniors with significant resources, continue to languish. Do you expect any of the majors—gold or silver—to wade into the takeover game?
CT: I do anticipate that. But you have to understand that a potential acquirer of a mining or exploration company is just as much an investor as Joe Blow on the street. Potential buyers have to be confident in the sustainability of metal prices before making any significant merger and acquisition decisions. A lot of companies or potential buyers remember that a couple of years ago the marketplace was very different from where it is now. We all are acutely aware that things can change.
TGR: Another factor in the mix right now is increasing risk. Some Latin American countries, including Peru and Argentina, are enacting policies that will increase royalties or taxes on mining profits. Could that be a deterrent for foreign direct investment and ultimately, for the average precious metals investor?
CT: There is a broad-based acceptance, especially regarding Peru, that taxes and royalty rates will increase in line with other South American jurisdictions. My sense is that as long as that is handled in a predictable and transparent way, it should not be an impediment for foreign direct investment.
What upsets the marketplace and upsets investors is the knee-jerk reaction we've seen from many jurisdictions with regard to adopting or even suggesting radical changes in the taxation and royalty regimes. That type of reaction causes a lot of concern with regards to the investment of significant funds in those countries and jurisdictions.
TGR: You have a Sector Outperform rating on Kimber Resources Inc. (KBR:TSX; KBX:NYSE.A), which is developing the Monterde silver mine in Mexico. Your target is $3/share and Kimber is now trading around $1.40/share. Why will the share price effectively double in the next 12 months?
CT: Kimber is a good example of a potential acquisition target. The Monterde deposit is primarily a gold-rich deposit that carries a substantial silver credit. This project would be attractive for a mid-tier silver or even gold producer looking to expand its production profile.
Kimber is a turnaround story. Recently the company has refocused its attention on repositioning itself by developing an open-pit underground opportunity at Monterde. Kimber is releasing some very interesting results from deep drilling at Monterde that suggest good grades at depth. Monterde offers exploration potential, underpinned by prefeasibility-stage economic analysis that calls for an open-pit underground mine that can deliver gold production at a low cash cost. It is an opportunity that also offers a lot of resource growth potential and, in that sense, is an attractive acquisition target.
TGR: Kimber is expected to put out a new resource estimate incorporating recent drilling results by the end of April 2012. Do you think takeover offers will wait until that happens?
CT: Yes, I think anything that plays into derisking the asset is worth waiting for. That could be the confirmation of a larger resource, a revised and improved resource estimate or the delivery of a prefeasibility study. Any of these developments would add a level of comfort and make the project more attractive for a potential acquirer. The timing of the resource estimate may be early 2012.
TGR: Let's move on to Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BLV), which you also give a Sector Outperform rating, with a target price of $7.25/share. When you made that call, Fortuna was trading around $5.50/share. Now it is around $6.80/share. What is responsible for that price spike?
CT: We initiated coverage on Fortuna about six months ago when it was trading at $4.60/share. At that point, the company was commissioning a new mine, the San Jose mine, in Mexico. It was also generating cash flow from its Caylloma mine in Peru. We felt comfortable that the company offers an attractive and a growing production growth profile with Caylloma and San Jose. Everything is running according to plan.
I visited the San Jose site about two weeks ago. The company is on budget and on time. The mill is operating very well; it's at nameplate capacity right now. The development of the mine is proceeding according to plan. Basically, the market has recognized that success, which has caused the share price to react positively, on the back, I might add, of an increase in the silver price.
TGR: Fortuna recently published production numbers for Q311; silver production at Caylloma was up 42%. Is that in line with what your expectations?
CT: Yes, pretty much. We see both projects presenting potential for growing production profiles. Caylloma is not just a silver producer. It's a silver producer that offers byproduct credits by way of lead and zinc and a little bit of gold. I think there is a lot of untapped exploration potential at Caylloma. The company is really looking at how it can deliver value by expanding the mine's reserve base, as well as potential for increased production.
TGR: In Metals & Mining Weekly, you estimate total cash costs for Fortuna in 2011 at negative $0.62/oz produced. That jumps to positive $0.42/oz in 2012. Obviously the byproduct credits you mentioned are responsible for the negative cash costs this year. Why would they jump almost a dollar per ounce by 2012?
CT: It's a complicated picture. Effectively, Fortuna is integrating a new operation into its corporate structure. It also has more silver ounces than byproduct credit, including lead and zinc credits from Caylloma. With all that in the mix, we see Fortuna delivering very attractive cash costs into the near term.
TGR: Let's move on to Mirasol Resources Ltd. (MRZ:TSX.V), which also garners a Sector Outperform rating. Mirasol owns the Joaquin silver project in Argentina. Silver miner Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE) is earning a 51% stake in Joaquin by funding current exploration. Joaquin is located about 80 kilometers north of Coeur d'Alene's Martha silver mine. Do you see Coeur eventually just buying Joaquin outright?
CT: Coeur d'Alene is probably the most logical acquirer for Mirasol. Coeur d'Alene already has an operation, the Martha mine, in relatively close proximity to the Joaquin Project. It is also Mirasol's joint-venture partner at Joaquin.
TGR: What measures do you see the Argentine government enacting in terms of royalties?
CT: Argentina is an important provider of precious metals in the global context. Mining is important for the economy in Argentina. As a consequence, I would like to think that any adjustments by way of taxation or royalties will not penalize the investment or the mining industry.
TGR: Would you like to share other silver or gold stories in Latin America with our readers?
CT: Bear Creek Mining Corp. (BCM:TSX.V) is relatively well known in the sector. About six months ago, the company garnered a fair bit of negative press in the run-up to the Peruvian presidential election. Bear Creek was in the final stages of permitting one of its projects, the Santa Ana project, which accounted for about 15% of my valuation of the company.
Santa Ana became a lightning rod for many who were opposed to anything and everything to do with mining in Peru. As a consequence, investors panicked and we saw a significant selloff in Bear Creek shares, all for an asset that delivered relatively little value in our valuation of Bear Creek.
The reality is that much of the company's current valuation is underpinned by another project called the Corani project. That asset can arguably deliver more than 10 million ounces in annual silver production, accompanied by significant lead and zinc credits. With a target price of $7.30/share, the stock is trading above $4/share right now, a very attractive valuation.
Bear Creek is definitely undervalued based on its development-stage Corani project in Peru, which is attractive from an acquisition/takeover perspective.
TGR: What should investors playing the precious metals market—be it in actual metals or equities—be aware of now that wasn't in play a few months ago?
CT: That's a good question. As far as precious metals or the mining sector as a whole is concerned, investors have to be aware that we are approaching the tax loss selling season. This might be an impediment for some mining and exploration stories through to early 2012.
Moving into Q112, I think a lot of attention will again be focused on the mining sector on the back of mining shows like the Mineral Exploration Roundup in Vancouver and the PDAC show in Toronto. Over the next six months, I expect we will see the mining sector as being a volatile space, but one that will garner a lot of attention.
TGR: Chris, thank you for your time and your insights.
Chris Thompson was trained in South Africa and has over 20 years of industry experience working as a geologist for major through to junior mining/exploration companies, in addition to a stint working as a mineral economist for the South African State. He has a bachelor's degree from the University of the Witwatersrand, a graduate degree in Engineering, a master s in mineral economics, and a PGeo designation. Thompson has been with Haywood for over seven years and specializes in junior exploration and the silver and PGM sectors. Thompson was recently awarded the 2011 Starmine No. 1 Stock Picker award for the Canadian Metals and Mining Sector.
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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: Kimber Resources Inc., Fortuna Silver Mines Inc.
3) Chris Thompson: 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.
4) As of the end of the month immediately preceding this publication either Haywood Securities, Inc., its officers or directors beneficially owned 1% or more of Bear Creek Mining Corp. and Mirasol Resources Ltd.
5) Haywood Securities Inc. or an Affiliate has managed or co-managed or participated as selling group in a public offering of securities for Bear Creek Mining Corp., Fortuna Silver Mines Inc., Kimber Resources Inc. and Mirasol Resources Ltd. in the past 12 months and may have received compensation for investment banking services from this company in the past 12 months.