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How to Find the Next Tenbagger in Peru: Maria Belen Vega and Ricardo Carrion

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María Belén Vega Ricardo Carrión In a tough market for junior gold shares over the past three years, Peruvian mining stocks have outperformed the mining indexes. Peru is a booming economy with well-defined mining laws and a vocal mining protest movement that could be playing a constructive role in future development. In this exclusive interview with The Gold Report, Maria Belen Vega and Ricardo Carrión of Kallpa Securities in Lima, Peru, analyze the protest situation and clarify the role of mining as one of the leading sectors of the economy. Junior companies they follow include mine developers, producers and a "pure Peru play" explorer; some of these companies could repeat the outsized performance of the last few years and become tenbaggers.

The Gold Report: Before we talk about specific companies, let's talk about mining in Peru. Mining is big business in Peru, but recently there have been a lot of protests. Newmont Mining Corp. (NEM:NYSE) Conga project gets the most attention from the U.S. media. Can you give us an update?

Maria Belen Vega: Regarding the importance of mining in our economy, it's important to highlight that mining is in the interest of government, society and Peru as a whole. Peru is a mining country. To give you some numbers, approximately 5.5% of gross domestic product comes from the mining industry without accounting for the supporting industry. Approximately 30% and 60% of total income tax collection and exports, respectively, come from mining. Also, mining accounts for around 60% of the Lima Stock Exchange's (LSE) main indexes.

Lima Stock Exchange Composition By Sector

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The protests started because activists understand that mining is a lucrative industry in Peru. Protestors feel that the communities are not getting their fair share of the profits. To give you an idea, the canon minero regulation establishes that 50% of the funds from income tax collection derived from the mining industry is required to return to the region in which the mine operates. If you take a look, most protests originated in the regions that should have received funds from the canon minero. While some local administrators live very well off these incomes, the investment made from these funds was either not yet executed or not profitable. So it makes sense that the communities want to receive some benefit from mining.

Gold Production in Peru

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Another important issue regarding mining in Peru is water. This is one of the main issues at Conga as well as Southern Copper Corp.'s (SCCO:NYSE) Tia Maria project.

TGR: So that's freshwater supply?

MBV: Yes, water supply is an important issue. Most mining projects in Peru are located in the upper part of the Cordillera de Los Andes, which has a shortage of water. Mines can consume large amounts of water, which often comes from rivers or underground aquifers. The communities are concerned that mining could use too much of a scarce resource because their main activities are livestock and agriculture.

It is interesting to note that the mining protestors don't discuss pollution. Big mines in Peru are strongly regulated and some of them are listed on at least one international exchange. Companies like Southern Copper, Barrick Gold Corp. (ABX:NYSE) or Compañía de Minas Buenaventura (BVN:NYSE; BUE:BVL) have strong corporate governance policies. Artisanal miners are mine polluters. There is even a contagion effect where big projects become surrounded by informal miners who create serious pollution problems.

TGR: It sounds as if the opposition to mining is more about political issues and wealth sharing and not so much because of environmental issues.

MBV: Exactly. In Peru, the mining industry has done some of the work in infrastructure and healthcare that should have been done by the government (roads, hospitals, bridges, etc.) in the first place. Therefore, communities are not against the mining industry as a whole, they just want to have a bigger piece of the pie.

Ricardo Carrión: A good example of Peruvian mining politics is what just happened to Xstrata Plc's (XTA:AIM) Antapaccay project in southern Peru. Communities have a long list of requirements in order to reach mining agreements. The most important change to the Xstrata agreement was in the project ownership. The negotiated share was 3%, but the community wanted its share upped to 50%. That gives you an example of the political environment the miners face.

Geographic Distribution of Main Mining Projects in Peru

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TGR: It sounds as if the central government is pro-mining. So are the local citizens, but they want more of the benefits. Where do the foreign investors fit into the picture? Investors need to get a fair return for the risk of investing in a mining project.

RC: Taxes paid by mining companies are one of the largest sources of income for the government. As stated before, 30% of income tax collection derives from mining. The government can't afford to lose that income and it's fully committed to supporting investment in mining. Peru has approximately $50 billion (B) of investments in the mining sector, which is one of the drivers for the country's growth. The $4.8B Conga project is an example. The government has supported Newmont while working to improve the project from a social point of view. That is a win-win situation. The result is a better project overall. The government is mediating between companies and communities in a way that supports investment, growth and sustainability.

TGR: That was an example of a large company. Does the government also support smaller mining companies?

RC: Yes, the government understands that without junior explorers, there won't be big mines. It's not that they are pushing exploration companies to make a discovery. We have clear exploration regulations that are friendly for foreign investors. Last year, Peru implemented new regulations aimed at junior companies. The new regulation is called "Prior Consultation." The regulation requires having an agreement with the community before starting exploration. This is not a big change because that is the way most companies have been doing business for the last decade, but now it is formally part of the Peruvian regulation. As before, without a "Prior Consultation" you can't do anything on the ground.

TGR: Let's discuss some specific companies that you cover. Candente Copper Corp. (DNT:TSX; DNT:BVL) has a potentially large project with approximately $1.5B in capital expenditures (capex). How is a junior going to finance a project that big?

MBV: Candente's main goal is to develop a world-class deposit in order to be saleable while evaluating going into production. Currently, the Cañariaco project is in the prefeasibility stage and Candente has just received approval by the government and communities (surface rights agreements) to start drilling. It has been working on those permits since 2010 and has $20 million (M) in cash to start the next drilling campaign to get the project into feasibility.

Copper Production in Peru

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One of the main questions is how a $70M market-cap company can finance a $1.5B capex. If the feasibility study is positive and Candente proceeds to IAS approval, I believe that the share price will likely go up. That scenario should increase the market cap to at least $100M. From there, financing options include a joint venture with a major copper company or offtake agreements because the resource is approximately 70% copper, 20% gold and 10% silver. The company is evaluating corporate sources of financing that might include banks.

TGR: Candente faces several challenges including infrastructure. What does it look like onsite?

MBV: I visited the project late last year. Most projects in Peru are at high altitude, but at 3,000 meters (m), Candente is relatively low. The project is literally a greenfield—there is a lot of vegetation there. It takes six hours to get to the project from Chiclayo, which is the capital of the Lambayeque region. Half the distance is on paved roads.

Besides access, metallurgy may be a challenge. The ore at Cañariaco has a moderate arsenic content, which may result in smelting penalties. The prefeasibility study included a roasting processing unit to reduce the arsenic content yet achieve high recoveries of the metal. Based on what is known today, the problem has been solved and investors are not punishing the stock price for that reason but mainly for the delay in getting the permits to start drilling.

Currently, Candente is valued at less than $0.01/lb copper; it has 10 billion pounds (Blb) copper in equivalent resources. This valuation is much less than other companies like Panoro Minerals Ltd. (PML:TSX.V: PZN:FSE; PML:BVL), which has a 4 Blb copper project valued at $0.03/lb, which is still less than latest copper acquisitions in Peru in the range of $0.05-0.07/lb. Based on that metric, it is one of the most undervalued companies listed on the LSE's Venture Exchange.

TGR: Another small miner you cover is Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL). Compared to Candente, Rio Alto has a different and much smaller deposit. It is a gold oxide deposit, which lends itself to much lower capex and quicker startup. Since you have covered it, it has done really well. It is more than a tenbagger from your first research report. Do you have an update and where you think it's going?

MBV: Rio Alto is one of the biggest success stories on the Lima Stock Exchange. It listed in November 2009 at $0.33/share and now, quotes at $4.20/share. Rio Alto has a two-stage project. The first is the gold oxide deposit, which is now in production. The second one is the copper-gold sulphide project, which is moving toward development. Originally, management bought a deposit that was undervalued (in prefeasibility) but that was able to start production rapidly. It took the company less than two years—very fast. Now Rio Alto ranks 8th among Peruvian gold producers. It is a success story in both Peru and Canada.

Production started in May of last year and met management's target of 50,000 ounces (500 Koz)/year. The target for 2012 is producing between 150–160 Koz gold @ $550–600/ounce cash cost. As of H1/12, they have produced more than 100 Koz. Currently, mine capacity is being increased from 24,000 tons (24Kt)/day to 36 Kt/day, financed by a prepayment facility with Red Kite Explorer Trust. One of the management's goals is to finance all expansion without shareholder dilution. This expansion will allow it to produce above 200 Koz/year by 2014.

Rio Alto's next step will be the completion of the feasibility study for the sulfide project. The size of the resource is over 4 Blb copper plus 5.6 million ounces (Moz) gold and there is ongoing drilling. The target is to begin production by 2016.

TGR: How can an investor find the next company like Rio Alto? Which companies on the Lima Stock Exchange resemble the Rio Alto of three years ago?

MBV: There are many companies on the Lima Stock Exchange with potential. One of the more advanced juniors is Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX; SUE:BVL). Sulliden is a Canadian company whose main project is Shahuindo, a gold project located in the Cajamarca region. Shahuindo could become a world-class gold deposit because of its medium-to-high grade and potential to build a low-cost deposit with a potential increasing resource. Currently, it has 2 Moz in Indicated resource and an additional 2 Moz Inferred. In 2011, Sulliden developed a 70,000m drilling campaign to increase the resource size and improve its classification in order to achieve feasibility.

TGR: That 4 Moz was from the June resource that was just released?

MBV: Yes. The 4 Moz is information from 2011's resource estimation prepared according to Canadian NI 43-101 requirements. Because all of the companies listed at LSE's Venture are dual listed in Toronto, everything reported must meet Canadian standards. Pending is the new resource estimation from the latest 70,000m campaign that should increase the actual resource significantly.

TGR: Sulliden's Shahuindo project is located in Cajamarca. Isn't that home to Peru's mining protest movement?

MBV: Yes. Cajamarca is a region located in northern Peru. But besides being known for mining protests, the region is home to many world-class mines including Newmont's Yanacocha & Conga, Barrrick Gold's Lagunas Norte and Rio Alto's La Arena (the last two are located 30km south from Shahuindo).

TGR: So there should be lots of good mining infrastructure and good technical support.

MBV: I visited Shahuindo three months ago and it has some of the best infrastructure in Peru. It is not located at high altitude: 2,800–3,000m above sea level. It's a three-hour drive from Cajamarca city with half on a paved road. It has a 3km power line on the project. Additional infrastructure for the transmission line is being built up to supply energy to the community.

One important consideration is that Sulliden deals directly with landowners at the property. Currently, Sulliden owns 85% of the surface rights for constructing the open-pit mine. This situation is different from many juniors that still need to negotiate and purchase surface rights. Besides, dealing with landowners tends to be much easier than with communities.

The most interesting feature of Shahuindo is the deposit. Sulliden has identified three main mineralized zones; only one has been strongly drilled and included in the current resource estimation. And that's from the oxides only. The sulphides are another potential deposit that has not yet been drilled. As mentioned before, a resource estimate is planned for this month. Another catalyst for share price growth would be the IAS approval after achieving feasibility. Located in Cajamarca, the same region of Newmont's Conga project, there is some risk attached such as delay in the environmental impact study approval/startup of the project. Despite Shahuindo being located 80km from Conga in Cajamarca and subject to the same regional authorities as Conga, Sulliden is following the process and will submit the IAS study to the ministry this year to advance and construct the mine.

TGR: What other challenges will Sulliden need to address?

MBV: The management is confident that it will have no problems developing a mine, but the project has risks due to the social and political situation in Cajamarca. I believe that's one of the main reasons why the company is undervalued right now. Even though there are high expectations with the new resource estimation, the stock is undervalued because of the junior mining market and the social risk tied to Shahuindo being located in Cajamarca.

TGR: Maybe it can benefit from Newmont investing in social capital there.

MBV: Yes. One of the other advantages of Sulliden compared to other juniors is that Sulliden has $50M in cash. It doesn't have a cash requirement for at least one and a half years. That is a big plus.

TGR: What other companies do you follow that the readers might not know about?

MBV: Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL) is one of them. Minera IRL has three main assets. It owns the producing Corihuarmi gold mine near Lima and the soon-to-start-up project Don Nicolas in Patagonia in Argentina. The third asset is the Ollachea gold project located in the Puno region of southern Peru.

Minera IRL was a company listed first on the Alternative Investment Market (AIM) in London. Initially, it was listed on the Venture segment in Peru and after Corihuarmi started production, it migrated to the main board. It was a success case for the Lima Stock Exchange. Corihuarmi is a small mine with a remaining three-year life of mine at approximately 30 Koz gold/year. After closure, in 2015, Don Nicolas will start production. As of today, Don Nicolas is a small project of about a 360 Koz gold resource that now is subject to higher costs due to Argentina's economic outlook and risks, mainly exchange rate policies. Start up at Don Nicolas will give Minera IRL continuity in the gold production. Don Nicolas will run for three years, in time for Ollachea to start production.

The Ollachea gold deposit is Minera IRL's main project with 2.6 Moz in resources. Ollachea accounts for more than half of Minera IRL's value. The Ollachea project is in the feasibility stage and is planned to be an underground mine with a nine-year life of mine producing approximately 120 Koz/year. Compared to its first projects, Ollachea is big. The strategy of Minera IRL is continuity in production and demonstration of growth.

TGR: Panoro Minerals is another one that you cover. Could you briefly give us an overview?

MBV: Panoro Minerals is a copper pure play. Panoro's portfolio is composed of 14 projects located in the well-known Andahuaylas-Yauri copper district, home of Xtrata's Las Bambas, Hudbay Minerals Inc.'s (HBM:TSX; HBM:NYSE) Constancia and First Quantum Minerals Ltd.'s (FM:TSX) Haquira. Bottom line, it's a well-known copper district in Peru.

Within its portfolio, Panoro has two development properties, one of which is the Cotabambas project with 2.4 Blb copper. The project has a lot of geological potential having defined a resource with copper grades above 0.7% and gold content above 1 gram/ton. Also, the deposit has no major contaminants.

In 2011, Panoro drilled 30,000 additional meters to increase the resource; the estimate is expected by mid-August. HudBay Minerals has a 6% stake on Panoro and there is a lot of speculation in what HudBay's interest is in Panoro's project. Panoro's strategy is to use its expertise in Peruvian regional copper exploration and development to find saleable deposits that can be bought by major copper players.

TGR: Are most or all of those projects in Peru?

MBV: Panoro's assets are all in Peru.

TGR: So that's an exploration pure-play in Peru?

MBV: Exactly. Panoro is a strategically located copper exploration and development company. It has a quality and well-known board and a lot of potential to bring its assets into world-class copper deposits. Panoro and the other companies mentioned should be on an investor's watch list.

TGR: To wrap things up, can you summarize the mining investment situation in Peru? There are protests, but also positive developments that aren't widely reported in the North American investment markets. Maybe investors need to look past the sensational news, as there may be opportunities.

MBV: Mining is an important industry for Peru—the government and the people understand this. However, of the $53B in mining investments in Peru, only 3% is local. The other 97% comes mainly from China, U.S., Canada, Australia and Switzerland. Peru has a capital deficit for mining investment. That's why the Peruvian government is committed to mining and foreign investment. In time, the protests will be resolved between the companies, government and communities so that everybody will benefit from the industry. Everyone is aware that we need this capital, investment, jobs and development. Of course, foreign investors will also benefit from playing a part in the mining industry in Peru.

TGR: Thank you for your time.

Maria Belen Vega currently serves as an investment analyst of corporate finance for Kallpa Securities in Lima, Peru. Through pre-professional training, she developed expertise in the area of Peruvian securitization, its structure and risks. She later served as an analyst of transfer pricing at KPMG and provided support to the investment risk unit of AFP Profuturo. She has a Bachelor of Economics degree from Universidad del Pacifico.

Ricardo Carrión is the managing director for capital markets and corporate finance for Kallpa Securities in Lima, Peru. He served as a senior analyst of Banco de Credito in the areas of corporate banking, corporate finance and capital markets and was an adviser to Lima's Stock Exchange. Carrion holds a bachelor's degree in business administration from Universidad de Lima with specialization in finance and capital markets.

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1) Alec Gimurtu of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: Southern Copper Corp.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Sulliden Gold Corp. and Minera IRL Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Maria Belen Vega: I personally and/or my family own shares of the following companies mentioned in this interview: Rio Alto Mining Ltd. and Sulliden Gold Corp. I personally and/or my family am paid by the following companies mentioned in this interview: Rio Alto Mining Ltd., Candente Copper Corp. and Panoro Minerals Ltd. I was not paid by Streetwise Reports for participating in this story.
4) Ricardo Carrión: I personally and/or my family own shares of the following companies mentioned in this interview: Rio Alto Mining Ltd. and Panoro Minerals Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: Rio Alto Mining Ltd., Candente Copper Corp. and Panoro Minerals Ltd. I was not paid by Streetwise Reports for participating in this interview.

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