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How Low Can They Go?—Gold Breaking Points: Killian Charles

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Gold and GraphKillian Charles, an analyst with Industrial Alliance in Montreal, isn't too concerned if the gold price hits $1,300 an ounce or even $1,000. He's more concerned with the gold breaking point. How low can the gold price go without breaking a project? Investors will be surprised to know that a wealth of junior miners are lean and mean enough to survive a pint-sized gold price. Charles talks with The Gold Report about which companies have resized and redesigned their projects to make it in this unforgiving market.

The Gold Report: Killian, what are the main causes of the disconnect between commodity prices and the share prices of mining companies?

Killian Charles: It's the fundamental difference between the commodity itself and mining companies.

There's an unspoken belief that, when you invest in a junior mining company, you're essentially buying a portion of the deposit. Investors are looking to diversify by having gold as a commodity in their portfolios and they look to gold junior companies. Yet the exit strategy from those gold junior companies results in cash, so they're left tangibly playing the gold space, but not having what initially brought them in.

That is why a lot of companies are considering gold dividends. At least that way investors playing the gold space are actually being paid in the commodity that interested them at the start.

TGR: Do you think that's going to gain traction?

KC: The smaller producers are having a lot of difficulty getting good traction in this market. A lot of them are going to explore some of these alternative routes. Just as we've had alternative routes for financing, we're going to start seeing alternative routes to increase shareholder value.

TGR: The fall in precious metal values has shaken a lot of investors. What is Industrial Alliance's forecast for gold?

KC: We are less worried about noise surrounding the price of gold. We're focused on the breaking point of the projects we cover. Even if the gold price may be $1,300/ounce ($1,300/oz) at the end of the year, we are more concerned if the project may survive at $900/oz.

The gold price is important to companies that have producing assets, however. Into 2014 and out to 2020, we typically take a conservative approach and go well below $1,300/oz. Beyond 2020, we forecast roughly $1,100/oz because a lot of companies should not be getting excessive value for production that is too far down the pipeline.

TGR: What would you be doing to gain traction in this market if you were in the shoes of a junior precious metals company?

KC: Instead of showing how well a project works at $2,000/oz, I would show the market how well a project works in any environment. All gold projects have decent leverage to higher gold prices. What's more important is showing that there is a smaller sensitivity to the downside, showing how they can still stay relevant on a downturn. Quite a few companies out there would survive and make money in almost any scenario.

TGR: Many of the companies you cover are working on mining projects in the Canadian provinces of Ontario and Québec. Is the safety of those jurisdictions a considerable factor?

KC:. Yes, you can't split it any other way. When people here think about royalties, they're haggling at the details. By and large, there's never really going to be any threat of nationalization. There are no military coups happening in the U.S., Canada, U.K., Sweden or Norway, etc. I find that is very important because work will keep going and I do not have to be afraid that an election might change that suddenly. I can plan for royalties and taxes. I cannot plan for a government getting kicked out of a country and losing my property.

TGR: Some industry insiders are saying that only the better projects will get financed in the current tight market. How do you define "better" projects?

KC: For us, better projects are those that are difficult to kill off. We are big believers in finding the project's "gold internal rate of return." What gold price gives us a net present value (NPV) of zero? We try to find that gold price breaking point for different projects. The lower the gold price breaking point, the more interested we are in the project, and the stronger we feel a project could be.

"Just as we've had alternative routes for financing, we're going to start seeing alternative routes to increase shareholder value."

This allows us to have an agnostic approach to what a better project may be. We find that projects with slightly lower capital expenditures but offset by higher operating expenditures end up being stronger and that's not very surprising. It's much more important to get the mine into production through almost any means necessary. Even though it might be a little smaller and might not immediately benefit from economy of scale, expansion could come at a later point. Projects that may not be initially strong could, through a simple redesign, turn out much healthier in this market simply because they scale everything down to a scope that is manageable.

TGR: Some development-stage gold and silver projects are getting financing by forward selling a portion of their production to banks or royalty companies, while others have arranged credit facilities backed by board members. Some even manage equity financings despite record low share prices. What's your preference among those options?

KC: I'd rather see a company do a royalty or gold streaming when it is in a position of power, but that's rarely the case. At the end of the day, I find that most 3–5% royalties don't affect the final NPV greatly and still provide an injection of much-needed cash.

We've seen some companies manage to do equity financings. A lot of companies that our group previously approached to do a financing initially told us they were waiting for better times. As an example, company A's stock was trading at $1/share and went down to $0.50/share. Instead of thinking about the present, it is stuck looking in the rearview mirror at the $1/share. Sure enough, a few months go by and now the company is really hurting for cash. Its share price is possibly even lower and now it has no choice but to raise cash. Importantly, the market opportunity that presented itself previously may not be there anymore.

Convertible debt never really works out. These companies have no real way of servicing the debt so it almost always ends up being converted into shares down the road or renegotiated repeatedly to push back the payment schedule.

TGR: The great thing about royalty streaming is that royalty companies have such efficient and effective people vetting those projects. If a royalty company is willing to give a junior money up front, you know that it's going to go into production and generate cash flow.

KC: That is very true. A lot of streaming or royalty companies do more due diligence than large funds that might take a large position in an equity raise.

TGR: Some Québec-based mining companies can draw on Québec government-owned funds and the expertise of SOQUEM, the province's mining and exploration company. How much of an advantage is that in today's finance market for junior mining companies?

"Companies are going to die, but it's going to make a fair amount of companies much more robust."

KC: SOQUEM is more of an advantage in a bull market. It operates as a government-owned project-generating company that will flip or joint venture early-stage projects out to other companies. It does help.

What's much more interesting is the Québec government-owned funds. They move a lot slower, but what I find interesting with these funds is that there's no secret game being played; there are no backhanded maneuvers. Once they believe in your asset, they'll be stable. They're not going to try to short run your stock before an issue. That said, if your share price is stuck middling in the $0.10 range, they're not going to help you drive it up to $0.30/share either.

TGR: Have any of the companies that you cover taken advantage of those funds or do any of those funds own a position in any of the companies you cover?

KC: Nearly every company that runs through Québec will have some interaction with them. Metanor Resources Inc. (MTO:TSX.V) is a good example; it relied on Investissement Québec to provide some necessary financing.

TGR: Sandstorm Gold Ltd. (SSL:TSX) has agreed to purchase about 20% of gold produced from Metanor's Bachelor Lake mine, which is now up and running. Is everything going as planned at Bachelor Lake?

KC: I think so, but I'm still waiting to see last quarter's numbers. Metanor did have issues last year advancing the underground development as fast as it wanted to. It simply didn't have enough miners. Next quarter will be key to it demonstrating to the market that it's not just another company promising to produce thousands of ounces per year and is one that actually produces.

TGR: What is the production guidance for 2013?

KC: It hasn't put out any large guidance number yet. It should be able to hit anywhere from 30,000–40,000 oz (30–40 Koz) if everything moves along nicely.

TGR: What's your rating on Metanor?

KC: I have a Speculative Buy and a $1 target. It's at about $0.13/share. However, I'm waiting to see quarterly numbers so that I can revalue it.

TGR: I'd like to hear about some other interesting companies that you have under coverage.

KC: I'm a fan of Moneta Porcupine Mines Inc. (ME:TSX.V). The company's asset is about 100 kilometers east of the town of Timmins, Ontario. We're going to see some projects that are in a more agreeable location come in favor. Moneta Porcupine has, by and large, that potential. The project is right along the highway. It has power. There are mines nearby, including Brigus Gold Corp.'s (BRD:NYSE.MKT; BRD:TSX).

Moneta has a sizeable resource of about 4 million ounces (4 Moz) of Indicated and Inferred. It put out a very positive preliminary economic assessment (PEA) late last year.

The company's story is changing. It used to be a simple open-pit and now it wants to look into an underground component. There's a lot of work being done. Moneta recently hired some personnel from Detour Gold Corp. (DGC:TSX). It will be interesting to see if Moneta is able to leverage its experience to expand the bulk target tonnage and develop the asset.

TGR: Gold Canyon Resources Inc. (GCU:TSX.V) has a similarly sized resource.

KC: There's a difference between the companies, however. Gold Canyon is a little more remote. It's able to leverage a high-grade core that should allow it to be one of the richest open pits in Canada, considering the tonnage it wants to move.

Some of the grade has gone down slightly in subsequent resource estimates, but a high-grade core still accounts for almost 1.5 Moz of the resource. At 200–300 Koz production per year, for five to eight years of production, at anywhere from 1.5–2 gram/ton material—for Canada, that's stellar. There's really nothing that compares to it in Canada.

The problem with Gold Canyon's asset is that a lake overlaps part of the resource. It may delay permitting, but shouldn't choke or kill the project. Similarly, there are metallurgical issues that Gold Canyon is working through; management has alluded that there might be controlled lithological issues, but we're still waiting for confirmation.

TGR: Less than a year ago, this stock was trading at around $4/share. Now it's trading at about $0.33/share. Is it strictly the lake issue that's been the drag on the share price?

KC: I would be surprised if it were the lake because the lake issue has been known since the late 1980s. Investors moved into the story for that high grade. When the global resource grade decreased last year, a lot of people thought that it wasn't going to be able to leverage high-grade material.

What happened was that Gold Canyon added new regions that were lower grade, but the original portions with high-grade shoots and bulk tonnage material haven't disappeared. That's getting muddled and lost in this story.

TGR: Gold Canyon recently released its PEA. What did you take away from that?

KC: I was actually surprised that the capital costs were below what I had expected, especially on removing and dewatering part of this lake. I was pleased to see that. The PEA again highlights the advantage of the high-grade potential over the first few years. That's how this story should be repackaged: if the grades in the higher-grade portion remain constant, then it could be looking at a payback ratio that's substantially lower than its peers.

TGR: The management team has a number of people who have been with companies that have been taken over. Director Richard Hall was with Grayd Resource Corp. when Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) acquired it. CEO Troy Fierro was also with Grayd and FronteerGold Inc., which was acquired by Newmont Mining Corp. (NEM:NYSE). Chairman Conrad Pinette was with Northgate Minerals when it was acquired by AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE). Does that increase the likelihood of it happening again?

KC: It's a hard thing to predict. These executives have a good idea of what is attractive to larger gold companies out there. They definitely want to have their project acquired. However, whether they can do it is impossible to tell.

TGR: What other companies have captured your attention?

KC: I find Integra Gold Corp. (ICG:TSX.V) to be pretty interesting. Integra is at an earlier stage than the other two, but it's an interesting story. Its project used to be part of the Sigma and Lamaque mines, which essentially created Val-d'Or, Quebec. There's never been any real work done on the Integra property, which is just to the south of Val-d'Or. It's one of these interesting assets where you don't actually have to demonstrate a large resource to demonstrate that it works. It's continuous and geologically well understood.

Integra's situation comes back to talking about the gold breaking point. I feel an asset that's in a good location like that, with the grades that it has been putting out, would have a very low gold breaking point. Even though it wouldn't be mining 400 Koz per annum, costs would remain attractive in any gold mining scenario.

TGR: SOQUEM has a drill core database that certainly would have an immense amount of information available from previous operators on the Lamaque property. Do you know if Integra has tapped into that database to learn more about the deposit?

KC: Integra was able to access a wealth of information from various databases. In fact, most of the geological staff on this project has previously worked at Sigma or Lamaque. Not only does the staff have access to drill hole data, but on certain portions, there are drifts that intersect some of its targets at various depth. It's a question of going back and plugging in the holes between these drifts to demonstrate continuity. It's an easy way for the company to leverage this wealth of information and be able to pronounce rather sizeable results for a fraction of the cost of almost any other project out there.

TGR: Companies are not allowed to use any old drill core in NI 43-101 resource estimates, correct?

KC: They can't directly, but it gives them a lot of smoke to go chasing after.

Clifton Star Resources Inc. (CFO:TSX.V; C3T:FSE) ties right back in to that, too. The company has an old asset that's been looked at a number of times. The previous management team didn't do too much; it just kept it going. At a certain point, it may have overpromised and was halted by the British Securities Exchange Commission.

Now, there's a whole new team that is serious about the project. In a span of 12–18 months, the new team has been able to complete a new resource, put out a PEA and advance toward a prefeasibility study. This group can properly bring the project closer to fruition.

Clifton's project is very similar to Aurizon Mines Ltd.'s (ARZ:TSX; AZK:NYSE.MKT) Joanna project, except Clifton's project benefits from having a higher grade and lower strip ratio. Clifton's project is close to a community but the current mine plan doesn't require anyone to move.

TGR: Clifton will produce a gold concentrate at its Duparquet project in Québec. That could be a game changer for that project. But first we have to determine if there's a smelter that's willing to take the gold concentrate. Does that exist?

KC: That's my No. 1 question right now. It's not going to be easy. Clifton will have to market its final product around. A smelter might say, "You know? The gold content is very, very high, but the arsenic content—you're going to have to pay a penalty for it." Clifton Star is currently in the stages of taking a bulk sample and it's going to produce a product that it hopes to market to different smelters across the world.

TGR: Do you have any parting thoughts for us today, Killian?

KC: I think that investors are over-worried about the gold market. Projects are still coming true and companies are still working on interesting things. There is a lot of nervousness out there, but I'm still pleased to see that companies are rethinking and reimagining developing assets. It's going to make strong projects. To be sure, companies are going to die, but it's going to make a fair amount of projects and companies much more robust. If the market does turn, these projects are going to have a very good chance of being the next group of lower midtier gold producing companies.

TGR: Thanks, Killian.

Killian Charles joined Industrial Alliance Securities Inc. in February 2011 and covers small- and mid-cap exploration and producing companies. He graduated from McGill University with a Bachelor of Science degree in earth and planetary sciences. His technical training is an asset in the evaluation of companies in a sector that is changing rapidly. He previously worked with FNX Mining and QuadraFNX before joining the IAS team.

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1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He 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: Brigus Gold Corp., Detour Gold Corp., Gold Canyon Resources Inc., Clifton Star Resources Inc. and Aurizon Mines Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Killian Charles: I or my family own shares of the following companies mentioned in this interview: None. I personally or my family am paid by the following companies mentioned in this interview: None. In the previous 12 months, Industrial Alliance Securities has provided investment banking services to Clifton Star Resources Inc. and Integra Gold Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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