The Gold Report: When we talked in October, you compared the resource sector to a swamp. Is that still a good analogy?
John Kaiser: The resource sector is analogous to a swamp in that companies in this space are having a very difficult time making any headway. Valuations are extremely low. All the big narratives are either going south or stuck in a rut. There is no capital flowing in to make this swamp a little bit more liquid, so it is really a morass that all the companies are bogged down in.
TGR: One of the narratives we discussed last time was discovery exploration. Exploration Insights author Brent Cook believes gold supply will start suffering as early as next year due to a lack of investment in exploration. Do you see the same challenge for companies looking to replace high-graded mined ounces, and will that lead to higher gold prices?
JK: In principle the all-in cost of producing new ounces suggests that if overall demand for gold goes beyond the existing 5.4 billion ounce stock, then gold prices have to go up. Miners simply can't keep mining projects in a loss position, and they really can't push into production deposits that will lose money at the current price. However, it could take a number of years before we see the higher gold price emerge.
One of the potential surprises for 2015 is not from the usual suspects of fiat currency debasement or hyperinflation or deficit expansion, but from an old standby called geopolitics. What we're seeing with this decline in the oil price, down to below $60 per barrel and possibly lower, is an extraordinarily destabilizing effect on the global power balance. Even the recent North Korean cyber attack on Sony and the subsequent outage of the North Korean Internet could have a destabilizing effect. I think 2015 will be the year that gold may put on several hundred dollars an ounce for geopolitical reasons. Those would be real price gains. They would instantly flow to the bottom line.
TGR: Could low prices also lead to more mergers and acquisitions?
JK: Yes. Something on the order of $140 billion ($140B) worth of Canadian juniors were taken over in the past decade. A good chunk of those involved copper-related deposits. What's left are copper deposits that need a somewhat better copper price to justify being taken over. A lot of the deposits that were taken over are still in the pipeline waiting for a final go signal.
In the gold space, a number of high profile takeover bids have been written down, but there are still a significant number of advanced deposits owned by juniors that are not very appetizing to the majors at the current gold price. If we start seeing an increase in the price of gold, we would see a scramble to clean out the remaining batch of advanced gold deposits. For investors, it's not going to be much of a consolation to get a 200–300% premium off current levels, which are down 90% from their peak prices in the past four years. However, this could provide a wave of capital into the sector.
Very few existing gold deposits that work below $1,400 an ounce ($1,400/oz) remain in private hands awaiting acquisition by a public junior, and when the current inventory held by juniors gets cleaned out through takeover bids, it is possible that the resulting capital could go into discovery exploration for new deposits that work below $1,400/oz. Of course, if gold were to go to $2,000/oz, a lot of projects would look good again and capital aimed at feasibility demonstration would flow into gold projects that are hopeless below $1,400/oz.
TGR: Do you still see the collapse in the resource sector as a good thing because it killed off the dead wood, making it easier to find good values?
JK: Unfortunately the problem is that the sector is dropping through an extinction threshold that threatens good and bad juniors. Some 700 companies have negative working capital that is never going to be repaid by real money. Another 400 companies have under $500,000 in the bank. These are the ones that are hanging in there, but because it's become so difficult to refinance, their willingness to spend dollars on discovery exploration is very muted. This has created a kind of trap where the high-risk type of exploration programs that deliver the surprise discoveries are not happening with the degree of abundance needed to get investors excited again. That is why we need to put some money into projects where management has been burning the midnight oil to determine the best targets for the few bullets they have left.
TGR: What are some of the companies that are making or advancing discoveries that could give investors hope for a future in natural resources?
JK: We recently saw Avrupa Minerals Ltd. (AVU:TSX.V), a prospect generator focused in Europe, produce an interesting volcanic massive suphide (VMS) intersection of copper and zinc in the Iberian Pyrite Belt project called Alvalade, with Antofagasta Minerals (ANTO:LSE) as the partner. That stirred hopes that maybe it was on to the edge of a Neves-Corvo type deposit, which is the second largest VMS deposit in the world. Follow-up drilling so far has hit additional mineralization, but hasn't really tied it together to make Antofagasta confident that it is a major system. Then, last week in Kosovo, another partner of Avrupa's intersected 126 meters of 6 grams per ton (6 g/t) gold, which is an extremely impressive intersection. Although the geological context is such that one cannot very easily at this point assign multimillion-ounce gold growth potential to this hole, it was a grassroots play in an area that had never been drilled. It was generated in the old-fashioned manner of going into a region that's been underexplored and assessing the geology.
I think the nature of the mineralization is such that this has to be related to a very big system. It is a jigsaw puzzle because there's been local faulting that has moved the pieces around, but with this type of intersection, there is room for a significant discovery. That is an example of something that was off everybody's radar coming through with a surprise discovery hole.
TGR: It looks as if the market indeed got excited. The price went from $0.20/share to almost $0.35, which is amazing in this environment.
JK: Yes. The market seemed to recognize it as a selling opportunity just as much as others recognized it as a buying opportunity. The largest shareholder managed to sell 400,000 shares on the day the news came out at an average price of $0.26, which helped snuff out some of the momentum. Because Avrupa is a prospect generator, it farms out with a net interest of anywhere from 30% to 15%—in this case 15% of the project. Some 60 million shares fully diluted at $0.30/share gives the project an implied valuation of $130 million ($130M).
Of course, we need to see more results to show that there's some running room for this intersection. The project could ultimately be worth $1–2B, in which case we could see a valuation of $300–400M eventually emerging, which would mean maybe a doubling or tripling of the stock price.
Because of the fractional ownership, Avrupa would not go to the moon, but could inspire the market to exercise all those warrants between $0.25 and $0.50 and give the company the money and the green light to drill some projects 100% rather than farm them out on punitive terms. This is the drawback of the prospect generator farm-out model in a bear market where the junior gets very poor terms, so that even if it delivers a major discovery, the impact on the share price is relatively muted.
TGR: What are some other companies that are giving investors hope?
JK: One of my favorites from the past year has been Probe Mines Limited (PRB:TSX.V). This is a hybrid-type company with an existing resource of low-grade disseminated gold at about 4–6 million ounces (4–6 Moz) at 1 g/t. At the current gold price, those resources are not very interesting. But in 2013 the company discovered a much higher grade zone that can be mined underground, and produced a resource estimate of 2 Moz at a good underground mineable grade. The story stalled during 2014 because the ability to chase the extensions of the zone was constrained by the land position.
For two years the company has been negotiating with the lumber company surrounding the property to acquire that land. A combination cash-and-stock deal finally came through in early December. Probe now has lots of running room to chase the deposit, and this system has the potential to blossom. If we do get a pop in the price of gold, the company benefits because it starts bringing the lower-grade ounces back into the equation, but primarily it is an exploration play where one can hope to see the resource estimate double or triple with similar high-grade mineralization pursued down plunge, and perhaps even in parallel zones on the ground just acquired.
TGR: When might we start seeing test results from some of that new property?
JK: At the moment Probe is doing infill drilling. The main drilling is under Borden Lake, which has to wait until the end of January when it is frozen. We will see an intensive lake drilling program from February until late March as long as the ice holds. The goal is to track the zone across the entire lake, see if it makes landfall, and then carry on drilling from solid ground in the summer. Any meaningful assays will not come out until May or June of next year. However, news about where the zone is going and what the nature of the mineralization looks like could get the market excited in the meantime.
TGR: What's another explorer that's exciting?
JK: The Hunter Dickinson Group has a company in its stable focused on British Columbia exploration: Amarc Resources Ltd. (AHR:TSX.V; AXREF.OB:OTCBB). It appears to have made a significant copper-moly-silver porphyry discovery on its IKE project. The news received very little response from the market when it was published in November. However, it is probably the beginning of a major new copper porphyry play in British Columbia. Delineation should start in June. That gives the company time to raise money and wait for market conditions to improve.
TGR: Does being part of the Hunter Dickinson Group mean Amarc has more resources to move forward?
JK: Historically, Hunter Dickinson has been able to raise money from a wide range of institutional sources. The flagship is Northern Dynasty Minerals (NDM:TSX; NAK:NYSE.MKT) with the Pebble project, which is bogged down in the environmental opposition to developing a copper mine in the watershed of the salmon fishery. Plus, copper prices are a little bit weak at the moment, with a debate evolving as to whether the projected surplus will indeed be a surplus in the next couple of years, and keep pressure on the metal price. On the other hand, there's some suggestion that a lot of the copper mines that were supposed to come onstream will not happen because of various geopolitical and social license issues and that, in fact, copper may surprise us on the upside in 2015. But until that happens Amarc may have a hard time tapping institutional capital for IKE. How Hunter Dickinson goes about funding an aggressive program in 2015 without hideous dilution bears watching very closely.
TGR: Is there another company worth watching for discovery movement in 2015?
JK: Clifton Star Resources Inc. (CFO:TSX.V; C3T:FSE) has been one of my picks as a bet on higher real gold prices that has not worked out well.
TGR: There is a debate about the direction of the company going on at the board level that has resulted in a flurry of press releases recently. What is going on there?
JK: A number of years ago Clifton Star acquired an expensive option on the Duparquet gold project in the Abitibi Belt on the Québec side. The company published a prefeasibility study earlier this year suggesting that a gold price above $1,400/oz is required for this to have any opportunity to be advanced. The deal included heavy underlying payments totaling $50M over four years, with $10M coming due on Dec. 1. Clifton Star attempted to renegotiate the terms with no luck and defaulted, leaving only a 10% net interest in the Duparquet project.
Fortunately, Clifton Star received a significant refund from the Québec government for all the money sunk into this project so far. It now has a treasury of about $3.5M, shares issued of only about 38M, a very competent management team, and a disgruntled shareholder group that was involved with the original promotion and would like to push aside the management and take charge of this treasury.
Given how difficult it is to get advanced projects that can work at the current metal price, and how much money it costs to do feasibility demonstration, it would be a much better value for shareholders if management looked at investing the money in interesting exploration projects. Of all those juniors out there, perhaps 700 are pretend exploration companies, but another 500–600 companies are serious companies suffering weak treasuries. That represents an opportunity for companies such as Clifton Star to do farm-in deals with significant upside potential that don't take many drill holes to prove out. If a junior pulls a major hole in today's market, then it's off to the races. We have see what direction management takes Clifton Star in 2015.
TGR: Talking about timing, often stocks go through a yearly cycle, with tax-loss selling in December and investors returning to the market for the January Effect, positioning themselves for spring advances. Are you planning for a January Effect?
JK: Last year we saw a selective turnaround in the first quarter, with better juniors starting to trend up. A fair amount of money was raised during this time and we saw some takeover bids, such as Osisko Mining Corp. acquired by Agnico Eagle Mines Ltd. (AEM:TSX; NYSE) and Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE), which put some money into the system. That rebound was tracking gold's run toward $1,400/oz gold. But by the third week of March, gold started to retreat and we have been in a downtrend ever since. If we do not get a sustained uptrend in gold this year, I question whether we will get any sort of meaningful January Effect in 2015.
I think there is reason to start accumulating companies that can afford to be patient. Those companies may develop modest uptrends heading into 2015. In the absence of a meaningful gold price spike, it's going to be tough to get any broad-based uptrend going. As far as macroeconomic trends, even if copper prices start to improve, the United States economy continues to grow and starts giving heart to the emerging market economy again, it could be another year before any of that washes over into optimism that the commodity cycle narrative is back in an uptrend.
TGR: You are speaking at the Cambridge House Canadian Investment Conference in January. What message are you going to be giving?
JK: I'm going to argue that in this type of environment the only way investors can get any significant action is through exploration discoveries. That is why we need to look at companies that are doing exploration, perhaps finance those companies and then monitor to see who is coming up with a significant discovery. These types of discovery plays have always bailed out the Canadian junior sector after some pretty bad bear markets. After a long discovery dry spell, I think the idea that a junior could still make a meaningful hit could inspire investors to take a look at the serious companies with proper exploration teams and with a story that gives reason to be optimistic.
TGR: John, thanks for your insights.
John Kaiser, a mining analyst with 25-plus years of experience, produces Kaiser Research Online. After graduating from the University of British Columbia in 1982, he joined Continental Carlisle Douglas as a research assistant. Six years later, he moved to Pacific International Securities as research director, and also became a registered investment adviser. He moved to the U.S. with his family in 1994.
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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Clifton Star Resources Inc. and Probe Mines Limited. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
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