John Kaiser: I would say mining companies have one more year of tough going, not three. We are in a transition zone.
China and the U.S. are weaning their economies off the interventionist stimulation that followed the 2008 crash. China has curtailed its infrastructure stimulus program and is pulling in its shadow banking system. Its real estate market is cooling off; a real estate bubble implosion would significantly hurt the Chinese economy. The U.S. continues to taper quantitative easing. The drip feed solution to the Great Recession and the inevitable uncertainty associated with it has discouraged businesses from making the significant capital investments that stimulate employment, and discouraged banks from lending to consumers.
Uncertainty will persist through the transition. Metal prices will languish. Right now, we're working through the stockpiles generated in the last five years as a result of new mine supply mobilized in response to the higher metal prices of the past decade and weaker-than-expected demand. It will take about a year to know if the weaning process is over, and the economy is growing organically again. If we are growing, metals prices will creep up, along with the valuations of mining stocks. After one more year of misery, a gradual upward trend for the mining sector will culminate with the supercycle being back on track in 2017.
TMR: What about growth in Europe?
JK: Europe is the problem child. It listened to the austerity siren call of the semi-libertarian ideologues, and put the Eurozone into a very slow recovery mode. Now, it is grappling with deflation and the conflict between Russia and Ukraine. The Eurozone is very dependent on raw material supplies from Russia. Russia depends on the cash from its sales of oil, gas and other materials to Europe. If the problem does not get resolved, both sides will be hurt. Overall, I do not see any great help for the global economy coming from the Eurozone.
TMR: Do the recent Toronto Stock Exchange (TSX) company filings confirm your thesis from last year about the likely disappearance of as many as 500 companies from the Venture exchange (TSX.V)? Are the healthy companies the only ones left?
JK: The statistics are grim. Of the 1,700 companies we cover, 40% have negative working capital. These are zombie companies, still listed and trading, but in no position to create new wealth. Another 20% have between $0–500,000 ($0–500K) working capital. To me these represent good bottom-fishing territory because the market has already written them off as future zombie companies. Unfortunately, these statistics do not yet include the Dec. 31, 2013 annual filings for about 600 TSX.V-listed companies. Once we process those filings, we will know what the numbers are. I expect them to be worse because monthly financing activity among the resource juniors is back to what it was in 2003 and during the six-month trough straddling 2008-2009.
To date, about 600 junior companies remain in reasonable financial shape. But even they hesitate to spend money, because they don't see any easy way to replace it except in the case of outstanding results. The whole idea of a venture capital market as a funding mechanism is stalled. In the absence of upward trends in metals prices, this makes it hard for investors to be optimistic about the sector. And with little money going into discovery exploration, the chances of a world-class discovery that brings investors running back are low.
TMR: How do you determine if a company might be one of the survivors?
JK: Ideally, it will have sufficient capital to continue to advance its prospect in the next year, be that an exploration play or a mine development play. It might have plenty of working capital or it might have farmed the project out to another company with deep pockets to advance the project, without worrying about what the market in general is doing.
TMR: What are the most important factors someone reading your company profiles should look for?
JK: It's the standard triad of people, capital and story. Is there a well-rounded team of people involved? For this to be the case, the company needs sufficient working capital to pay salaries that will keep the technical and executive teams intact and at work. You also need capital to advance the project. And of course, there has to be something compelling about the story.
On the exploration side, that story would be a strategy or an idea that makes investors believe that the company can increase the stock price 10, 20 or even 30 times—a discovery play. The story behind an existing deposit would be the grades and cost structure that could allow the deposit to be developed at current prices. However, at current prices, most of the projects in the hands of juniors are not very exciting. Their projects have become options on higher metal prices.
The strategy for investors now would be to buy juniors, stash them away and hope they do not get bought up cheap by bigger companies planning to inventory them until the metal price cycle turns positive.
TMR: Which companies listed in Spec Value Hunter do you consider to be good values?
JK: Among companies with advanced deposits, Clifton Star Resources Inc. (CFO:TSX.V; C3T:FSE) just completed a prefeasibility study on its Duparquet project in Québec, which concluded that pressure oxidation is the best way to process the ore. However, with a $1,300 per ounce ($1,300/oz) base case gold price, its after-tax net present value (NPV) of $135 million ($135M) and internal rate of return (IRR) of 12.1% aren't high enough to get excited about. This is an example of a company treading water, waiting for a higher gold price. I recommend it to people who believe that gold is going back to $1,500+/oz. At that price Clifton Star's NPV and IRR increase substantially and the current $15M market valuation will grow by multiples as the junior becomes a buyout target.
TMR: If that's a gold-going-to-a-higher-price story, what about a story on another metal?
JK: Zinc could develop a sustainable uptrend in the next few years. Zinc never really rallied like nickel and copper did during the last decade. The mining industry responded to both copper and nickel. Only China responded to zinc, which helped put zinc into the doghouse as far as price is concerned.
Several major Western zinc deposits are depleting. China's ability to ramp up its zinc supply has stalled and will likely go into reverse as China addresses its pollution problem.
In the rest of the world, it will take time to develop the large zinc deposits because they are in remote locations and will require infrastructure development.
I have pinned my hopes on InZinc Mining Ltd. (IZN:TSX.V) and its West Desert zinc deposit in Utah, one of the more development-friendly states. It just completed a preliminary economic assessment (PEA) for a scenario that includes magnetite as a payable byproduct. That substantially changed the economics of this project. Its mining plan now includes zinc, copper and an important magnetite credit. Indium remains a potentially payable critical metal byproduct. The company is getting ready to raise money for more expansion drilling, which will set the stage for a prefeasibility study next year. Because it's a smaller-scale project, it could be developed by 2017-2018, by which time we expect zinc to be in a significant supply deficit, priced above $1.20 per pound.
TMR: Interesting. What else is developing in the U.S.?
JK: I have been following Adamera Minerals Corp. (ADZ:TSX.V). Formerly in the uranium and diamond exploration sector, a couple years ago Adamera began to focus on eastern Washington. Several good-grade gold deposits were exploited there in the past, but there has not been significant regional exploration for quite a few decades. Adamera has a strong technical team and a number of the shallower targets teed up for drilling this season. It has a good chance of pulling the kind of initial intersections that will attract retail investors. The stock has a low market cap and substantial upside. It needs to get out of the trap of being stuck with financing at very low prices and diluting away the upside taken on by the early-stage investors. While the very low valuations of exploration juniors offer very big upside in the event of a discovery hole, the downside is that the upside may get diluted away by the high cost of delivering that discovery hole.
TMR: Its stock price is up from January. Does being in an historic mining area appeal to investors?
JK: Yes. You can make discoveries three ways. One is regional exploration that looks at surface anomalies in the form of mineralized outcrop or soil geochemical anomalies. You generate targets by prospecting the old-fashioned way, conducting soil sampling surveys, and even examining satellite images for evidence of alteration halos, which signal that potentially ore forming fluid flow took place.
The second way is to use sophisticated geochemical or geophysical methods and conceptual thinking to generate targets that are hidden under barren cover. That is difficult, expensive and outside the capacity of many juniors because it requires sophisticated geology and drilling. A hammer or backhoe are useless for blind targets.
The third is to look at old districts where smaller-scale mineralization such as gold veins were found and exploited long ago by mom-and-pop-scale operations until the easy pickings were depleted. When you return with modern geological models and drill for lower grade in the context of a higher metal price, you can come up with a bigger zone within what had been dismissed as a small potatoes system. Adamera belongs in this third category of discovery exploration strategy.
TMR: Is there an example in Europe of a company using one of those strategies successfully?
JK: Avrupa Minerals Ltd. (AVU:TSX.V) is using the second strategy: looking under cover rocks. It picked up a piece of the Iberian Pyrite Belt in Portugal, a 240-by-35 kilometer belt that runs from southern Portugal into southern Spain. It hosts some of the world's biggest polymetallic volcanogenic massive sulfide (VMS) deposits. One of these is Neves Corvo; the second biggest VMS deposit in the world after Kidd Creek, found only 40 years ago.
In this part of Portugal, younger cover rocks obscure the prospective host rocks. The Alvarade prospect has been explored a fair bit in the last 20 years, without success. Avrupa's Paul Kuhn developed a theory about why previous exploration strategies failed to find anything meaningful, and he attracted Antofagasta Plc (ANTO:LSE) as a farm-in partner. Avrupa spent the last few years and more than $4M of Antofogasta's money testing his theories. In February 2014, it reported the first new VMS intersection found in the last 20 years in the Iberian Pyrite Belt.
Avrupa discovered the new VMS zone under 90 meters (90m) of barren rock cover and is using Antofagasta's capital helping to prove the discovery. It is drilling around this initial intersection to see how the geology and the geometry work. It is not a major deposit yet, but the game of focused exploration is now on. I expect that, within 12 months, Avrupa will have a 20% net interest in a world-class VMS discovery.
TMR: What is the catalyst on that project?
JK: You want to see signs that management understands the geometry of the discovery zone within the local geology, which in the Iberian Pyrite Belt can get very messed up with faulting and folding. Neves Corvo consists of eight separate bodies, which likely were all part of one body that got ripped apart by tectonic forces. The last part was found only a few years ago. Watch for a sign that Antofagasta is following up the recent six-hole program with a major program. Then, it will be just a matter of time before a big intersection clinches the discovery as a major one.
TMR: Avrupa also works in Kosovo. Do you watch its projects there as well?
JK: Yes. Avrupa picked up a number of geologically promising areas in Kosovo, a couple of which have been farmed out to other parties. It did the same in the Erzgebirge of southeastern Germany, formerly East Germany, which had been explored primarily for tungsten. These sheeted intrusive tungsten systems often have a significant gold component. This is an example of strategy number three: looking at old districts from a new perspective.
TMR: Let's move to Canada. Which companies there use these strategies?
JK: Probe Mines Limited (PRB:TSX.V) has been one of my Top Picks. It is a hybrid story. On the one hand, it has more than 4 million ounces (4 Moz) of 1 gram per ton (1 g/t) gold, which can be open-pit mined, but not very profitably, at $1,300/oz gold. One bet here is that gold goes back over $1,500/oz and the market then assigns value to these ounces.
But in the last year, the story has been the discovery of a high-grade zone extending southeast of the low-grade zone. The company tracked that through drilling from the edge of the lake last summer. Its winter drilling program extended the zone for another 600m and recently released results. The market responded negatively to the results due to the lack of high-grade intervals that were seen where it stopped drilling during the summer. The speculative hope had been that the zone would blossom in grade and width as it plunged deeper. Instead, the zone continued with a lower grade, similar to other parts of the zone. That reduced the hope for a 5-10 Moz high-grade system back to the 1–2 Moz potential demonstrated by drilling last year.
The stock's recent retreat reflects the market's disappointment over this outcome, but the jury is still out on the blue sky potential. Probe planned its winter drilling program according to the apparent plunge of the high-grade zone. This involves thickening the ice for optimal drill pad locations. Partway through the program, management realized that the zone's plunge leveled off. The drills were intersecting the lower grade down-dip envelope of the zone, rather than the high-grade core that dazzled the market last year. But it was too late to prepare new drill pads because winter in Canada came to an end.
The speculative upside has been stripped out of the stock for now, but Probe plans to drill several angled holes from the lake shore to intersect up-dip where management now thinks the high-grade mineralization is still present. Confirmation would restore optimism that the extension will add many mineable high-grade ounces. Meanwhile, we are waiting for an NI 43-101 resource estimate for the high-grade zone. We hope it comes in at 1–2 Moz with a grade of 4–6 g/t. A PEA expected at the end of Q3/14, will show what underground mining would cost. In three to five years, the time to permit and build a modest 2,000 tons per day (2,000 tpd) underground mine, gold is likely to be higher than $1,300/oz. At that point, the mine could be fed with additional ore from the low-grade zone.
TMR: With the stock price down right now, is this a bottom-fisher opportunity?
JK: The resource estimate is expected in early June, at the latest. There is controversy right now about the proper cutoff grade needed to create a mineable resource. Some analysts use a 4–6 g/t cutoff. It they go that high, the deposit shrivels and does not look very valuable. Management wants to use a lower cutoff grade, around 2.5 g/t, which would create a larger resource. It will be a function of costs. So Probe's Borden gold project has shifted to a feasibility demonstration story.
For the moment, I regard Probe as a Buy at the current price, though I will have to revisit this recommendation after the NI 43-101 resource estimate is released to see how significant the upside is.
TMR: Let's switch to scandium. What's the supply and demand picture going forward?
JK: Scandium is fairly abundant in the earth's crust but it does not concentrate well in the manner of less abundant metals such as lead. When it's alloyed at very low percentages, 0.5%, with aluminum, it makes the resulting alloy much stronger. It has an anti-corrosion characteristic, good conductivity and is much more heat resistant. If the $100 billion ($100B) aluminum industry had a reliable annual supply of hundreds of tonnes of scandium oxide, there would be no shortage of applications using aluminum scandium alloy, which end-users would rush to commercialize.
Unfortunately, the world only produces about 10 tonnes of scandium oxide annually from a hodgepodge of byproduct sources that are not scalable. Emerging byproduct sources include certain titanium dioxide processing operations in China. Another source is in situ leaching of uranium deposits in Russia and Kazahkstan, as well as nickel-cobalt operations in the Philippines. Tests are underway to see if scandium can be recovered through the remediation of red mud, the toxic waste created when bauxite is converted into alumina. The only primary scandium mine was the Zhovti Vody deposit in Ukraine, which was part of an iron mine in which the Soviets discovered 100 g/t scandium that they exploited to make aluminum scandium alloy for their MiG fighter jets. The supply situation of 10 ton per annum (10 tpa), even at a $2,000/kilogram ($2,000/kg) price, has an inconsequential value of $20–40M/year. But over the last six years scandium-enriched laterite deposits were discovered in Queensland and New South Wales, Australia at or near surface with grades of 200-500 g/t.
I have high hopes for EMC Metals Corp. (EMC:TSX). It is $3M away from owning the Nyngan deposit in New South Wales, which has a resource at $2,000/kg, $9B in situ value and a rock value of $800/ton on a 100% recovery basis. According to my speculative cash flow model of this system, a mine producing only 50 tonnes annually could be worth $200M. But there is a chicken-and-the-egg problem: If there is no supply, there is no demand, and nobody wants to put up capital for something that does not have an offtake agreement. The aluminum alloy industry isn't willing to help EMC. It wants to see the scandium first.
But Bloom Energy, based in Silicon Valley, has developed a solid oxide fuel cell that relies on scandium to reduce the temperature of its Bloom Boxes. This would reduce the high maintenance cost that prevented solid oxide fuel cells from commercialization as a way to convert natural gas into electricity much more efficiently than ordinary combustion.
Bloom reached an installed capacity of 100 megawatts (100 MW) last year. That would only have consumed about 7 tons of scandium oxide, but if its annual sales doubling trend continues, annual demand could be 20–40 tons scandium oxide by 2017. This could result in a marriage of necessity between EMC Metals and Bloom. If Nyngan can be in production by 2016-2017, it solves Bloom Energy's supply problem. I would also expect the aluminum industry to be interested.
Until very recently, EMC Metals has been an extremely risky pick because it had a market cap of only $5M but needed to raise $3M by June 24 to secure the Nyngan asset, on which it has done feasibility work since 2010. What changed during the past week was news from EMC Metals that it has made a new scandium oxide discovery not far from Nyngan in Australia with similar grades and a tonnage footprint sufficient to meet Bloom's needs for the next decade. The Honeybugle discovery can be fast-tracked in place of Nyngan, though it is still important for EMC Metals to acquire Nyngan. But with a market cap of about $15M reflecting both the value of Honeybugle and the option it has on 100% of Nyngan, it should be much easier for EMC to raise the $3M acquisition cost and another $3-4M needed to deliver a feasibility study by the end of 2015.
TMR: Is Bloom talking with EMC Metals about that funding?
JK: Bloom Energy has been in discussions with EMC Metals since 2010. The talks derailed in 2012 when a title dispute arose over EMC's acquisition of a stake in Nyngan, at which point, Bloom Energy did an offtake agreement with Metallica Minerals Ltd. (MLM:ASX) for Metallica's lower-grade Lucknow deposit in the amount of 20–30 tons scandium oxide and an option for another 30 tons. But Metallica could not scale down to just produce 20–30 tons. It tried to find another offtake partner for the surplus, but could not.
Bloom has done deals with Chinese titanium oxide producers, but the byproduct supplies are incremental and cannot be scaled up. If Bloom Energy is going to succeed, it needs a primary supply that can guarantee it 30–50 tpa scandium oxide.
I like the Bloom story because it's about making things more efficient and utilizing an energy source of which America has a growing supply, natural gas. Solid oxide fuel cells have a smaller carbon dioxide footprint than conventional combustion of natural gas. As Japan looks at ways to avoid nuclear energy, including the import of liquefied natural gas, it becomes an obvious and big market for Bloom's technology.
TMR: Could the other Australian scandium project be a partner for Bloom?
JK: Yes, indeed. In 2011, Platina Resources Ltd. (PGM:ASX), discovered the Owendale scandium deposit along with a platinum system. The platinum grades aren't high enough yet to justify development, but Platina raised money to extract a bulk sample for metallurgical studies on the Owendale scandium deposit, which is separate from the platinum zone. In about a year, we'll know more about the metallurgy.
As with rare earths, metallurgy and mineralogy are key factors. Owendale will have a grade close to 400 g/t. The question is whether the difference between 300 grams (300g) and 400g is wiped out because the ore has a higher content of magnesium and other acid-consuming elements. The companies have to assess the grade and whatever else scandium-enriched ore contains. The cost of getting rid of the other stuff may balance out the grade difference.
Nonetheless, this is a substantial resource. Now that Metallica has returned to the drawing board with Lucknow, EMC's Nyngan deposit has the first-mover advantage, which I doubt Platina's Owendale will overtake. Owendale will arrive to serve the alumnimum-scandium alloy market. The end users want to see multiple sources of ore-grade, primary scandium deposits so they are not reliant on a single source. The situation is different from rare earths in that no meaningful scandium supply currently exists, but there is a latent potential consumption of 500-1,000 tonnes scandium oxide annually by 2025. There is a race underway now to be the party that supplies Bloom's needs, but the very completion of this race will coax demand from the aluminum-scandium alloy sector, so that the runner-ups collect the same prize.
Those juniors with scandium deposits grading 300 g/t or better do not need to stab each other in the back, as rare earth juniors felt compelled to do because their goal was to each supply the world's incremental demand growth. It will be a while before a lot more deposits are found, even if New South Wales undergoes a scandium rush.
TMR: You consider investing in scandium an investment in changing the world. How will scandium make the world a better place?
JK: If airlines converted the skins of the planes and all the brackets into aluminum-scandium alloy, it would reduce the weight by 15–20%. That would greatly reduce fuel consumption. It might even persuade the airlines to shelve their very unwelcome plan to add a fifth seat to the middle row of their overseas aircraft.
Ford is producing aluminum-based pickup trucks to help it reach the 2025 target of 54-mile-per-gallon fuel efficiency. Apart from fiddling with the engine and aerodynamics, the only way you can do that is reducing the weight of the vehicle. Even electric cars would benefit from a lighter weight that does not sacrifice safety. Unlike other metals such as beryllium, which bestow remarkable properties to alloys, scandium is not toxic. It is not often that resource juniors can positively change the world by finding and developing a mine. Scandium is that opportunity.
TMR: What's your message for the Cambridge House Vancouver Resource Investment Conference in June?
JK: It's the unfortunate message that we appear to be in the fourth year of a resource sector bear market. Without significantly higher gold prices, it will be difficult for companies to raise capital for feasibility demonstration or discovery exploration without the cost of hideous dilution.
Investors need to look for stories that can attract capital, even if it involves a rollback and dilutionary financing.
We're in the trough of a turning point. Stock prices are likely to weaken again in the summer doldrums. It will be an excellent bottom-fishing opportunity, especially with so many companies clearly sidelined. But there will be competition from high-net-worth groups looking to scoop the better stories. Minority shareholders will see their stake reduced, as their companies get rolled back and refinanced by new money.
Going forward, there will be opportunity to make significant money, but 700 companies will be left in the dust. They have no story. They will be shells waiting for whatever the momentum traders are willing to pile into next.
TMR: John, thanks for your time and 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 company mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Clifton Star Resources and Probe Mines Limited. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) John Kaiser: I own or my family owns shares of the following companies mentioned in this interview: InZinc Mining Ltd., Adamera Minerals Corp., Avrupa Minerals Ltd., and EMC Metals Corp. 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: None. 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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