The Gold Report: We have a scenario where the price of gold has held up and is trading at about $1,775/ounce (oz), but the share prices of large caps aren't comparable. What is the reason behind that?
Charles Gibson: Typically, large companies are valued in relation to their margin, the difference between the price they sell gold and the cost at which they mine it. There was a period of margin expansion from about 2009 to 2011 where, by and large, the share prices of big producers did very well. The gold price was rising and costs were under control.
In late 2011, however, this dynamic reversed and the gold price started to tail off at the same time as costs began to pick up. Then there was a period of margin contraction. That's what's caused the share prices of the majors to fall.
TGR: Would you factor in the general malaise in the stock market?
CG: Commodities can dance to a very different tune than the broader economy as a whole and the broader stock market. There's been margin expansion and margin contraction. It won't go on forever. There is a very close correlation between revenue per ton and costs per ton for mining companies and there are lots of different ways to explain that. But if the commodity price moves, the likelihood is that the cost base will move at some point. That works both downward as well as upward. Commodity price and cost base don't work exactly in time with each other, but by and large the broad direction is similar. That tends to temper the upside, but it also saves a little bit on the downside as well.
TGR: Given the unremarkable performance in some of the large caps, should investors be looking at small to mid caps for value and growth?
CG: It's not a question of being small, mid or large cap necessarily. The key question for investors at the moment is: Which companies have costs under control? Perhaps that is due to the jurisdiction they're in or because of a particular cost basis. If companies have access to hydroelectric power, for example, that often acts as a buffer against rising prices. When costs are under control, margins are under control and companies can benefit from rising commodity prices.
TGR: What's your view on precious metals prices going forward?
CG: There's a very strong correlation since 1959 between the U.S. monetary base and the price of gold for fundamental reasons. After the first two rounds of quantitative easing (QE), the implied gold price from that correlation was $1,350/oz. That's where we were until about a fortnight ago when Ben Bernanke announced QE3, which at the moment is open-ended. Our long-term gold price of $1,657/oz goes through 2013. If QE3 continues to 2014, you're looking at $1,887/oz and by 2015 it's more than $2,000/oz.
I stress that this is not a day-to-day trading price. It is the fundamental long-term price. To paraphrase John Maynard Keynes, "Markets can stay irrational longer than you can stay solvent."
TGR: It'll be interesting to see what happens in November with relation to QE3. Let's talk about some names that you're following in Africa.
CG: Pan African Resources Plc (PAF:AIM; PAN:JSE) is a stock worth looking at with an asset in Barberton, South Africa. However, this is greenstone gold—not conventional South African Witwatersrand gold—in this case, with a 10-year life. It has had a 10-year life for the last 100 years, roughly speaking. It's a very tight little management structure. It produces about 100,000 oz (100 Koz) every year and has done that for as long as anyone can remember.
Pan African announced its full-year results last week showing earnings nearly doubling compared to the prior year and more than doubling compared to the half-year stage. That is strongly suggestive of a cost base that is well under control.
It also just made a major acquisition of Evander Gold Mines Ltd., which it is buying from Harmony Gold Mining Co. (HMY:NYSE), this time in the Witwatersrand Basin. Pan African's management has good prior knowledge of operations of Evander. A lot of the board has worked there. Pan African has been able to buy it at a low price. It will be very accretive. The mining plan indicates that it could double Pan African's earnings in the short term.
TGR: I'm looking at Pan African's stock chart right now. It's trading near its 52-week high. There aren't many North American-based gold producers that could say that.
CG: Pan African's share price is a testament to the tightness of the management structure and the fact that the company has been able to deliver on its promises half year in, half year out. It has supportive shareholders. There are few substitutes for a good track record in mining circles and Pan African has a very good track record.
I'd like to talk about Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT), too.
Casa Berardi on the Casa Berardi Fault in Québec is the major asset. Its management has an exceptional track record of delivery. It has roughly 160 Koz/year of production and, with very few exceptions, it hits that. It usually hits its quarterly guidance as well.
There are also relatively few shocks on the cost side. Costs have suffered recently as the mine has moved to lower levels. The costs per ton are moving up, but that's really a one-off effect. Even after that, it's still producing gold at about $640/oz. At the moment Casa Berardi has a mine life to 2020, but it's looking to expand that.
In particular, there have been some remarkable intersections made by underground exploration drilling at Zone 123. If confirmed and continuous, it may be that not only will Casa Berardi's underground mine life be extended, but it may turn out to be one of those Canadian mines where the grade gets higher as you get deeper. Also, because this zone is off the main Casa Berardi break, it will require less ground support and therefore the additional costs of being further from the shaft will be offset both by higher grades and lower costs.
TGR: The gift that keeps on giving. It also has exploration potential beyond Berardi with Joanna and other assets.
CG: Joanna is split into the Hosco and Heva sectors. Hosco has a prefeasibility study that came out all right. It is refractory ore, which means there were a lot of additional capital expenditures related to autoclaves etc. Management stuck it on the backburner. The area is very prospective, but it's clear that the mineralization changes to non-refractory moving west, which means that it should be much less costly to develop.
It pleases me the way that management tackled this. Rather than chasing that very obvious goal of getting Joanna into production, the company said, "Let's just wait a minute. Let's see if we can improve this." It went from a feasibility study back to exploration. But now there is the potential for a much bigger dividend at the end than might otherwise have been the case.
TGR: David Hall is not the chief executive officer (CEO) anymore, but he's probably the man behind a lot of those decisions.
CG: The new CEO is George Paspalas, who is an Australian with a very long pedigree in underground mining. He managed the South Deep extension of the Western Areas gold mine in South Africa for Placer Dome [now Barrick Gold Corp. (ABX:TSX; ABX:NYSE)]. He's also a chemical engineer with extremely good experience with refractory ore so, in short, he knows about the two things that he really needs to know about at Aurizon.
TGR: I'm interested in hearing a little bit about Cluff Gold Plc (CFG:TSX; CFG:LSE). I just met the management group of this company at the Denver Gold Forum. They seem very keen to introduce this company in a more proactive way to the market.
CG: Cluff Gold has also literally just changed its name to Amara Mining! That aside, its assets, which are in Sierra Leone, Burkina Faso, and Côte d’Ivoire, run the gamut from exploration to production.
The Burkina Faso asset is Kalsaka, which is a nice, relatively small-scale mining operation that produces about 70 Koz/year at about $900/oz. It is providing the cash flow and the profitability to fund the rest of the company's operations.
The flagship asset is Baomahun in Sierra Leone. I'm expecting a resource upgrade to be announced this quarter followed by a full feasibility study. It will have 130 Koz or more of production from 2015 onward.
Its exploration asset is Yaoure in Côte d’Ivoire. Now, this is an interesting asset in that it has been mined in the past. It has been known to be very prospective. Cluff has done a lot of drilling there. Our best estimate of the resource is roughly 2 Moz. It could turn out to a very significant asset indeed.
Kalsaka generates the money and some of that is used in exploration in Baomahun and Yaoure. Cluff assumed until recently that it would need an equity raising to fund the capital expenditures of Baomahun. However, management has recently said that, given where its equity price is, it's not happy with the level of dilution. The company is looking at non-traditional forms of finance. Reading between the lines, what we're probably looking at is some sort of debt instrument with a coupon that's connected to the gold price. That route is a much more efficient way of funding as far as existing equity shareholders are concerned.
I think that's part of the reason that the share price has performed very well over the last couple of months. Nonetheless, it is not valued at much more than the implied value of Baomahun. Investors are getting Kalsaka and Yaoure for free. And the company is already generating profits and cash flow.
TGR: It's interesting. Its small producing mine is funding the exploration. Sega, Cluff's add-on acquisition to Kalsaka, should have a preliminary economic assessment soon and then there is the blue sky of Yaoure. Cluff announced a strategic alliance with Samsung. Tell me about that.
CG: It is part of its non-traditional funding. Samsung made a $20M credit facility available to Cluff. That is more than enough for the company in the short to medium term. It is looking in the longer term toward a cornerstone funding arrangement to bring the Baomahun project into production.
TGR: I have not seen any mining company entering into an agreement with Samsung. Are we talking about the same Samsung that is the electronics manufacturer?
CG: It is. This is an example of the increasing scenario where dollars are held in Asia and they're looking for a home. One of the very obvious places to invest, if you're long dollars, is in gold. In this particular instance, you're merely looking at the first derivative of that investment strategy, i.e., gold equities. It's not wholly unknown though for Asian industrial companies to get involved in mining. The one that leaps to my mind is Mitsubishi.
TGR: We're also seeing a lot of that in the minor metals and specialty metals space right now, too.
CG: I think that, in general, those investments are aimed toward a guaranteed offtake—they have an industrial logic—whereas I suspect that the Cluff deal is more of a pure investment.
TGR: Cluff seems like a very ripe cherry for a company that would want an African asset.
CG: It's difficult to comment about where mergers and acquisition activity will fall. I think it's true to say that there is a keen focus on West Africa and there is an assumption in the market that there are more mergers and acquisitions to come in that particular part of the world.
TGR: What can you tell me about Mwana Africa Plc (MWA:LSE)?
CG: Mwana is an interesting company to talk about because its assets are located in such an interesting part of the world—Zimbabwe and the Democratic Republic of the Congo (DRC). It has a very nice little gold mining operation, Freda Rebecca, which produces about 70 Koz/year for about $850/oz. People hear Zimbabwe and think it sounds like a difficult place to operate. Historically, it has been. But I visited the mine recently and it is operating in good order. The plant is pretty rugged. There are no concessions made to luxury at all but in its own way it does work very well.
It's an amazing ore body. The mine has been open-pitted in the past, but now it's moving underground. If you go underground, the size of the voids, because of the competence of the rock, is absolutely unbelievable. The voids are easily the size of a church. It is the perfect engineer's mine.
Freda Rebecca is funding Mwana. It has a majority interest in another complex, Bindura Nickel Corp. (BNC:ZSE), a bulk massive nickel sulfide ore body. It has been on care and maintenance for several years. Mwana just got an agreement with creditors to raise money via a rights issue in order to restart the operation.
Bindura Nickel is underground. Various assets actually have been open-pitted in the past and could be open-pitted again in the future. There are not many assets like this in the world when the rest of the world is shifting from nickel sulfides to nickel laterites. And the entire infrastructure is sitting there in very good order.
The first part of the restart is to get the Trojan underground mine into operation and to produce a concentrate. In due course, with material from other assets and potentially third-party material as well, the idea will be to smelt and refine the concentrate to a pure nickel product.
Bindura Nickel has a history going back to the 1950s when it was developed by Anglo American Plc (AAL:LON). It ran very solidly and profitably for most of its existence. It's an exciting time for Mwana.
TGR: I noticed that it had a fairly dramatic jump in its share price this month. What was that about?
CG: That was the closure of the Bindura rights issue. When the announcement came out that an agreement had been reached, the money had been raised and that it was closed, it moved Bindura from an asset that is on care and maintenance and costing the best part of $1M a month currently, to one that should instead be cash-flow positive situation within the space of a couple of years.
TGR: Mwana is a multi-commodity company. What else is it mining?
CG: It has two other major assets in the DRC—one copper and one gold.
The first is Zani-Kodo in northeast DRC. It is an exploration asset with about 2 million ounces (Moz) gold proved up. It's located between AngloGold Ashanti Ltd.'s (AU:NYSE) Mongbwalu and Randgold Resources Ltd.'s (GOLD:NASDAQ) Kibali prospects. It's probably some of the easiest exploration that I've ever seen. The company expects to be able to increase its resource by 50% a year for the next couple of years. At that point, it will be a very significant resource on a global scale.
The other asset is SEMHKAT in the DRC's copper belt. It is a vast area that has shown indications of copper mineralization. However, it is almost an asset too far for Mwana. It gets the least attention. At any other company, it would have probably been a lead asset, but in Mwana it has had to queue up behind Freda Rebecca, Bindura Nickel and Zani-Kodo for attention.
The company has done a couple of joint ventures at SEMHKAT. It has an original joint venture with Anglo American and a joint venture with Chinese company Zhejiang Hailiang Co. Ltd., which it announced in August. Hailiang will put about $25–40M into the ground and take a majority interest. Mwana will be left with a non-dilutable 38% interest. As a result, SEMHKAT has moved from an asset that was very difficult to value because it was just prospectivity in the ground, to suddenly an asset that can be valued in pounds, shillings and pence.
TGR: It certainly has a lot for only having a $100M market cap. I'm blown away at the possibilities there.
CG: This management team has a track record of working in these sorts of jurisdictions. Look at Freda Rebecca in Zimbabwe, where the company got a mine it rehabilitated back into profitable production with 70 Koz/year.
TGR: Now they're doing it again.
CG: That's the idea. A track record like that is worth a lot.
TGR: Let's leave Africa and talk about Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL).
CG: While developing and operating a mine in Argentina does currently present some challenges, the Don Nicolas project is in a very mine-friendly province and Minera is halfway through the permitting process. The company also appears to have the support of local communities by recently signing a 10-year surface rights agreement.
I don't believe there will be nationalization of junior mining companies in Argentina. The government needs foreign investment and is probably not interested in owning and operating mines. More likely, they will do what governments do best and simply take its cut in the form of taxes and royalties.
As for Minera as an investment vehicle, the company has an excellent management team with a proven track record and some fantastic assets within mine-friendly locations.
TGR: Do you have any wisdom for investors on how to navigate the precious metal equity space?
CG: With commodities, you always have a choice in which commodity you're going to invest. It's worth being aware of the macroeconomic qualities and profile that those commodities have. There is a spectrum. If you looked in the '90s, someone would probably think that all commodities dance to the same tune. We're not in that macroeconomic environment at the moment. The environment we're in at the moment is one of stagflation, where the economy is struggling to grow and where there are question marks over the value of paper currency. I would strongly recommend that investors be weighted toward the precious end of that spectrum at the current time. The other thing is to spread risk, particularly with the juniors. Be aware of the risk profile of companies; there's no substitute for research and don't buy just two or three stocks. That's fine if you're investing in the majors, but you need to diversify more than that if you're speculating in the junior space.
TGR: Well, Charlie, thank you so much. We certainly gleaned a lot of intelligence.
Charles Gibson is the head of mining for Edison Investment Research in London. A chemist by academic training, Gibson spent a decade in the City as a mining analyst at Cazenove and a specialist mining salesman at T Hoare Canaccord, before joining Edison. He has extensive media experience, having written for MoneyWeek and The Business magazines and The Evening Standard. Gibson is a leading authority on mining and guest presents from time to time for LBC radio on financial and business matters.
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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: Aurizon Mines Ltd. and Minera IRL Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Charles Gibson: 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. I was not paid by Streetwise Reports for participating in this interview.
4) The following companies mentioned in the interview are clients of Edison: Pan African Resources Plc, Aurizon Mines Ltd., Cluff Gold Plc, Mwana Africa Plc and Minera IRL Ltd. Edison does not accept stock in exchange for services.