The Gold Report: I recently read a 63-page report Industrial Alliance published in December titled, "Gold Idol: Finding the Next Profitable Producers." What prompted that theme?
Killian Charles: We were getting tired of seeing press releases and technical reports that focused largely on upward sensitivity analysis with elevated gold prices. Of course, projects look very good at elevated gold prices. We wanted to tone down the rhetoric a little bit and put them on even footing.
Investors think, "Oh my God, gold is $1,200/ounce ($1,200/oz)—everything is going to die out there!" That statement does not apply to all projects, just as it does not apply to all mining companies or producers. Some producers will struggle at $1,200/oz, but some can continue making money. We hoped to find projects that could eventually fall in the latter category.
TGR: American Idol found talents like Carrie Underwood and Clay Aiken. What did you discover when you crunched the numbers in Gold Idol?
KC: There's still a predisposition in this market for large projects with middling grades. We wanted to see if lower grades could be balanced with higher production rates. We also wanted to see if this also resulted in a higher net present value (NPV). The connection was there, but we were surprised by the link's weakness. We had expected a solid correlation between the two.
We tried including strip ratio in the mix, which improved the correlation, but not dramatically. Investors shouldn't just be focused on grade. There are so many different risks at a mine. I believe the impact of strip ratio can be underestimated. If the rock happens to be a little bit harder and a company is moving a lot of tonnage, the mining operating expense (opex) can quickly get out of control since it's largely leveraged to the strip ratio.
TGR: Could you explain strip ratio?
KC: The strip ratio describes how many tons of barren material have to be mined to access a single ton of ore.
TGR: Let's talk about your thesis for the market.
KC: Honestly, our thesis shouldn't be market dependent. Otherwise, you could overvalue projects. Investors still need to do due diligence and get a good idea if the project can work in a bull or a bear market. Investors need to focus on a longer investment horizon. I can't help but feel that a lot of investors are weak hands. They move in and out too fast. Following momentum is a bad way to invest and doubly so in the mining industry. If a project works in a variety of commodity scenarios, it will eventually be recognized. At the very least, it will survive to the next bull environment.
TGR: You had some criteria that companies needed to have before they got included in your analysis: an economic study, no other assets in production, capital expenditures (capex) to develop the asset below $1.5 billion ($1.5B) and a value of less than 15 times capex divided by market cap. Why are those important?
KC: I think the mining industry is moving on from large projects—projects with capex over $1.5B. Large projects are just too hard to manage and cost overruns become problematic rapidly. Right now there's no appetite from producers and there's definitely no appetite from the equity market to finance large projects.
We wanted to make sure that the companies had an economic study of some sort because overestimation ends up being a large problem. Too many "back of the envelope" calculations are simply ridiculous and set unrealistic expectations. I don't have the time or the team to develop a perfect mine plan for all the projects at the resource stage and, honestly, neither do most people out there, so we have to rely somewhat on these third-party engineering firms to produce something that we can judge. I know many people will disagree with my statement but, at the very least, it's a more accurate starting point.
As for capex divided by market cap, we wanted to avoid projects that had an execution risk. If the market cap is $10 million ($10M) and the project's going to cost $600M to build, odds are the company will have a hard time raising the money.
TGR: The market effectively did some filtering for you there.
"I can't help but feel that a lot of investors are weak hands. They move in and out too fast. Following momentum is a bad way to invest and doubly so in the mining industry."
KC: It doesn't mean that these projects won't come back. We feel that the 15x capex to market-cap ratio is elevated enough that most companies can meet this criterion. If the market cap comes back into an acceptable range, we could definitely take another look at them and include them in our compilation.
TGR: In one scenario, you used $1,200/oz gold, $20/oz silver and a 7% discount rate. In scenario two, you used $1,000/oz gold, $15/oz silver and a 10% discount rate. What were the companies that ultimately survived your scrutiny?
KC: We divided them into three groups based on how their projects perform in our more stringent second scenario. Our first group consists of projects with a positive NPV at $1,000/oz gold. Those companies are Dalradian Resources Inc. (DNA:TSX); Golden Queen Mining Co. Ltd. (GQM:TSX); Guyana Goldfields Inc. (GUY:TSX); Lydian International Ltd. (LYD:TSX); Midas Gold Corp. (MAX:TSX); Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.MKT); PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE), which is now the focus of an acquisition by Asanko Gold Inc. (AKG:TSX; AKG:NYSE.MKT); Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX; SUE:BVL); and Torex Gold Resources Inc. (TXG:TSX).
Then we had a second group that was more marginal. Their respective NPVs varied between $50M and negative $50M. These projects were on the inflection point and could go either way.
TGR: What are some likely candidates to move away from the cusp and into the first group?
KC: There are a couple of projects that with revaluation have a good chance to move up: Gold Canyon Resources Inc. (GCU:TSX.V), Romarco Minerals Inc. (R:TSX) and Sabina Gold & Silver Corp. (SBB:TSX.V; RXC:FSE; SGSVF:OTCPK).
TGR: What are the most interesting names among the survivors?
"Even if the gold price keeps going down there are still projects out there that could work. It's not all doom and gloom."
KC: The interesting ones are currently entering construction, which can limit financing risk. Guyana Goldfields stands out. It has almost all it needs to enter into construction and has a pretty simple mine.
PMI Gold is the focus of an acquisition by Asanko Gold. Fingers crossed that it's going to work because Asanko's and PMI's projects are so close to one another it make sense to merge them.
Torex came out with very good numbers and is moving along nicely. Similarly, Lydian International's project may have some political issues in the short term, but then it has clear development opportunities.
TGR: Lydian has a big gold mine in Armenia, which isn't a well-known mining jurisdiction. What are your thoughts on that country?
KC: Mining in any country that doesn't have a Western mentality toward investment can mean there may be misunderstandings, but that doesn't mean that there's going to be problems. Countries can say they're against mining, but every single nation in the world has a mine of some sort in it. One hopes that there's no corruption and the person a company is dealing with actually can make a decision and doesn't expect a bribe at the end of the day. Luckily, most nations avoid that. Then again, I live in Quebec and even we seem to have problems with corruption! Mining companies can avoid a lot of unfortunate accidents as long as management is of decent caliber and the company is transparent.
TGR: What's next for Lydian and its Amulsar project?
KC: There should be more information available about the permitting process and obtaining the mining license and the license to operate in the country. Lydian is also updating the feasibility report and moving onto financing.
TGR: Could you update us on some companies you have discussed with us in the past?
KC: There is Integra Gold Corp. (ICG:TSX.V), which was a single property with lots of potential but a lot of the ounces can feel separate even if they are close to one another. We're finally seeing the story come together. The company updated its resource estimate. Integra is expecting to put out a preliminary economic assessment (PEA) in the coming weeks that will continue tying it into a single front. The location is still excellent and it's still fairly high grade. Once the story comes together, investors are going to start paying attention to this simple project in a safe jurisdiction with what could be a textbook mine.
Another company is Clifton Star Resources Inc. (CFO:TSX.V; C3T:FSE), which is hoping to put out its prefeasibility report in the first half of the year. The company's PEA only used a small portion of the entire resource because the project is proximal to the town of Duparquet, Quebec. Clifton Star wanted to avoid unnecessary complication with the municipality until it properly opened up a dialogue. It wanted to make sure that there wasn't any misunderstanding that arose from a PEA that made an assumption that a portion of the town had to be moved. By avoiding that, it left 2 million ounces in the Measured and Indicated category that are starting right at surface and are easily mineable, so there's great upside there if negotiations do work with the city. The PEA underestimates the potential of that project, but I like seeing a management team that does a top-notch job and doesn't overpromise.
TGR: Do you think that eventually Clifton Star will produce concentrate or doré?
KC: Concentrate excludes some opportunities because smelters are only willing to pay for a certain amount of gold. If there are any penalties through elevated elements in the concentrate, the company could also lose out a little bit. However, it definitely saves on capex. The plant would be much smaller and less equipment is needed. The prefeasibility study will give us a good idea of which plant is better. The key is that the project can work both ways. If Clifton Star wants to get into production faster, it can start producing a concentrate, sell the concentrate, then down the road build a full plant with pressure oxidation, and process and smelt gold ore on site.
TGR: Any other companies you would like to mention?
KC: Fortune Minerals Ltd. (FT:TSX) continues to be in an interesting position. Management has built a strong team to support and advance permitting at NICO in Canada's Northwest Territories. Right from the start, it identified key participants in the permitting process and the receipt of this permit is further proof of its due diligence. There's still more work to complete before all necessary permits are granted but it's a clear indication that the company should be successful. As discussions with foreign partners continue to advance, a fully derisked NICO project will ensure investors receive full value from any future partnerships.
TGR: Any parting thoughts?
KC: Investors need to remember that even if the gold price keeps going down there are still projects out there that could work. It's not all doom and gloom. There are projects out there that show potential to provide a return—even at $1,000/oz.
Companies are rightfully stressed. Will they be able to finance? There are some perfectly reasonable questions being asked, but our report disproves that they aren't going to work just because the gold price decreased. There are some projects out there that may struggle, but there are definitely projects that—short of capex increasing 50% or grade decreasing 50%—should do well in nearly all gold environments.
TGR: Thanks for giving us your insights.
KC: It's always my pleasure.
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: Guyana Goldfields Inc., Sulliden Gold Corp., Integra Gold Corp. and Clifton Star Resources Inc. 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 am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Torex Gold 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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