The Gold Report: A recent Raymond James research report refers to silver as the "devil's metal." What is the story there?
Chris Thompson: Silver is much more volatile than gold. Typically when we see a weak day for the gold price, silver has a terrible day. Likewise, if we see a strong day for gold, typically silver delivers exceptional performance. Because it's so volatile, we term it the devil's metal.
TGR: If the selloff in precious metal equities is over and this is the bottom, how long do you expect the flat-lining to persist?
CT: At Raymond James, in the near term we see gold trading rangebound between $1,200 per ounce ($1,200/oz) and $1,300/oz and silver trading rangebound between $16.50/oz and $18.50/oz. We are not seeing fundamentals that would prompt a price outside of those respective ranges. We expect current price strength to continue to the end of Q1/15, followed by some weakness into the summer and then more strength toward the end of the year.
TGR: In a recent research report you warned investors about 2015 possibly being the "Year of the Dodo" for certain precious metal producers. Please explain.
CT: Over the last three years or so, the silver price has dropped to a level that calls into question the economics of a lot of the primary silver-producing companies that I follow. It's now about survival. We all know that the dodo could not fly. What I'm looking for—regardless of metal prices—are companies that can continue to deliver real growth and shareholder upside; companies that can "fly," not just survive. That is why we cautioned investors toward the end of last year that the majority of the silver names are in survival mode at these metal prices. We want to direct investors toward those few stories we cover where we see significant upside opportunity, even at these metal prices.
TGR: That report noted four differentiators that influenced equity performance in 2014. Those were: valuation relative to peers, success in managing/reducing costs, ability to meet expectations, and ability to advance near-term organic growth. Please briefly take our readers through those.
CT: Valuation is at the core of what we do. My current research and analysis shows that precious metal companies are not cheap; many companies in my universe are trading at over 1X net asset value (NAV). My view is that if companies are trading at over 1X NAV, there's got to be extra on the table. Arguably, certain companies qualify to trade at over 1X NAV based on good management, strong free cash flow at current metal prices and organic growth potential. We look for companies that are undervalued relative to their peers that offer all those attributes.
On cost management, we're in a situation where no one can do much about metal prices and most of these companies don't have a lot of opportunity to grow organically, so the only alternative is to reduce costs. That's something we're watching, especially as these companies deliver their Q4/14 and Q1/15 financial results.
Meeting expectations is critical. The market is already a little nervous about the long-term outlook for precious metal companies and is relying on management to meet—and preferably exceed—expectations. Transparency here is fundamental and that's a key element that I need to see as an analyst.
"MAG Silver Corp.'s Juanicipio probably has the second highest grade, undeveloped primary silver project in the world."
We've spoken a lot about the need for organic growth. There must be more on the table than just survival to really excite and attract investors. We are seeking the few companies that can generate free cash flow at current metal prices, deliver on expectations and grow organically.
TGR: By organic growth, do you mean by the drill bit on existing properties?
CT: A company is growing organically because it's bringing a development-stage project to production, or reducing the costs of an operating mine, or extracting higher-grade ore. Those are all examples of growth without acquiring other assets or merging with other companies.
TGR: Concerning meeting expectations, doesn't that lead to CEOs under promising so that they can over deliver?
CT: That is just as dangerous. As an analyst, I look at a company's guidance and ask: Is it achievable? Second, is the company sandbagging it? The important thing is predictability. I don't like to see a company overshoot in a significant way or miss on guidance; I'm looking for some confidence that the company understands its mines by way of grade, tonnage and recovery.
TGR: What are your top picks among silver producers?
CT: As I've said, the silver sector has been decimated. I cover 10 silver companies and would really only recommend two or three to our clients. One company that our clients should be looking at is Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE). This is one of the few companies that is delivering on all of those criteria that we discussed earlier. It's a good management team. It's delivering on expectations. It's advancing its San Jose mine in Mexico by way of expanding capacity and has enjoyed exploration success by delivering high-grade potential at depth. All of this really is reflected in Fortuna's potential to grow organically. We're watching Fortuna closely.
TGR: Will the San Jose mine expansion lead to the kind of performance that management expects?
CT: Management's near-term objective is delivering on that expansion and by doing so we're going to see the significantly improved economics with a mine that's already profitable. Moreover, management believes that even after the mine is expanded to 3,000 tons per day (3,000/tpd) the company will have further success expanding the high-grade depth extension at the current operation. In the years to come this mine will probably be a lot larger than 3,000/tpd.
TGR: What are some other silver producers under coverage?
CT: Another company we recommend to investors is SilverCrest Mines Inc. (SVL:TSX; SVLC:NYSE.MKT). It's a small, one-mine company that is delivering on expectations by generating free cash flow and completing a ramp up at its Santa Elena project in Mexico. There is a little technical uncertainty as to whether it can complete the job at Santa Elena, but so far so good.
Another company that we recommend that investors watch is Silvercorp Metals Inc. (SVM:TSX; SVM:NYSE), a company with its core operations in China. That company comes with a little bit of geopolitical uncertainty, but relative to its peers Silvercorp is cheap and can generate healthy free cash flow at current metal prices. A year ago it was all about getting the operations right and it succeeded. Now it's a matter of just building the cash flow. Based on its performance over the last two quarters, that is what the company is achieving.
TGR: Let's move to the developers. What are some companies you're covering there?
CT: Raymond James only covers two silver-focused, development-stage companies: MAG Silver Corp. (MAG:TSX; MVG:NYSE) and Bear Creek Mining Corp. (BCM:TSX.V). My colleague David Sadowski covers MAG Silver. The management team has succeeded over the last six months in fostering good relationships with its joint-venture partner, Fresnillo Plc (FRES:LSE), on its Juanicipio project in Mexico. After Escobal, Juanicipio is probably the highest-grade undeveloped primary silver project in the world.
Bear Creek has a well-respected management team. It is well financed with two assets, both in Peru: Corani, a polymetallic deposit, and Santa Ana, a development-stage silver project. Bear Creek is currently negotiating with the Peruvian government to restore its ownership of Santa Ana.
TGR: Corani is a massive silver project. How does it compare with Escobal and Juanicipio?
CT: Corani is a totally different asset. Corani is a very large low-grade polymetallic deposit. It would be an open-pit mine, whereas Juanicipio and Escobal are high-grade underground mines. Corani is attractive from an operating cost perspective but in these restricted markets for project funding it is challenging to come up with the capital required to build Corani at the moment. The company is currently rescoping the project, and we anticipate a revised feasibility study published in H1/15. Hopefully, it will show a project with lower capital costs, while maintaining strong economics.
TGR: What are some of your picks among gold-focused producers?
CT: It's easier in the gold space because the opportunities are more numerous. I like B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX). B2Gold just started production at its Otjikoto mine in Namibia. This is important because it is the first mine it has built from the ground up under the B2Gold umbrella. We look forward to seeing Otjikoto grow. We also expect a development plan for a second project, Fekola, in Mali. B2Gold presents well as far as its organic growth potential.
TGR: Are there others?
CT: Another African producer that we're watching in the gold space is SEMAFO Inc. (SMF:TSX; SMF:OMX). We see the current economics of its Mana mine in Burkina Faso as giving the company an ability to generate significant free cash flow in the near term.
TGR: Should investors wait for a dip given that it's making some modifications to its SAG mill at Mana in the first quarter?
CT: The company is attractively valued relative to its peers. I would be acquiring at these levels.
Another gold producer that we follow is Mandalay Resources Corp. (MND:TSX), a company that I like a lot based on its management team.
TGR: Last year Mandalay acquired Elgin Mining, a small company that owned the Björkdal gold mine in Sweden. Björkdal is a puzzle that multiple companies have had trouble solving. What makes you think Mandalay can solve it?
CT: The simple reason is that Mandalay has big company expertise in a small company. It has acquired over the course of the last five or so years two distressed mines, Cerro Bayo and Costerfield, both of which are now producing cash flow. That is the sort of opportunity that the company has with Björkdal and Mandalay has the know-how to do the job. Björkdal is currently breaking even or making a bit of cash flow but it comes with a large resource base that needs to be refined. That is what Mandalay is good at. It is focused on economics and shareholder return. It wants to build a balance sheet and grow the company like a business.
TGR: Do you have some general wisdom for investors in this market?
CT: When we see these sharp selloffs, in most instances there's an overreaction in the market, especially in terms of equity pricing. We see those as good opportunities to acquire good quality companies with good quality assets. The second side of it is that you don't want to own shares in a mining company that presents marginal economics in the current metals price environment. For investors who have to be invested in precious metal stocks, quality is paramount both in management's capability and asset value.
TGR: When 2015 is over, people in the precious metal space will call it the year of the what?
CT: I would say the year of the rebuild. I'm looking at 2015 as being the differentiator; we're going to begin to see the emergence of companies that present well via their ability to deliver on expectations, grow organically and really generate the sort of return that investors require from mining companies.
TGR: Thank you for talking with us today, Chris.
Chris Thompson, PGeo, is an analyst for Raymond James specializing in precious metals and small- to mid-cap developers and producers. He worked previously for Haywood Securities. He holds a Bachelor of Science in mining and exploration geology, a Master of Science in mineral economics and a graduate diploma in mining engineering from the University of the Witwatersrand in South Africa. He was awarded the 2011 StarMine Top Analyst Award for Stock Picker in the Metals and Mining sector.
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1) Brian Sylvester 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 independent contractor. He owns, or his 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: Bear Creek Mining Corp., MAG Silver Corp. and Mandalay Resources Corp. 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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