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PI Financial's Goguen Has Latin Fever

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David Goguen David Goguen, PI Financial's vice president of Institutional Mining Sales, tracks advanced explorers, emerging producers and junior producers in Latin America as they move through the development cycle. In this exclusive interview with The Gold Report, David discusses PI Financial's recent institutional sales desk report titled Select Golds: Latin Focus, which is flush with gold juniors ready to tango.

The Gold Report: David, you recently published a report titled Select Golds: Latin Focus. Tell us about your report.

David Goguen: With the Select Golds piece we're tracking advanced explorers, emerging producers and junior producers in Latin America as they move through the development cycle.

One objective of our report is to look for ounces in the ground that are being undervalued by the marketplace. For example, I can look at an advanced explorer like Grayd Resource Corporation (TSX.V:GYD) and see that Grayd is valued at $75/oz. in the ground. That's probably a fairly appropriate representation at this stage of that company's development. As Grayd de-risks those ounces and makes them more clearly economically viable, through the required engineering and development work, we expect that the market will afford Grayd a higher valuation on a per-ounce basis.

But among the junior producers, the market focuses less on enterprise value per total ounces and more on the basis of their ability to generate cash flow and earnings.

TGR: Can you define advanced explorer?

DG: Typically, advanced explorers have published a National Instrument 43-101 resource estimate that to some extent outlines the quantity and quality of the resource that is under consideration in the report. They generally have a sufficient number of drill holes into the resource that we're able to adequately define what it is and what its potential could be. As these projects become better defined, they move up the curve to become emerging producers and eventually junior producers.

TGR: How can an investor differentiate an explorer with good chances of success from an explorer that's unlikely to succeed?

DG: There are a number of factors that define a quality project. One should look at explorers seeking deposits in world-class districts. They should have a strategic land position with district scale potential and the possibility to host multiple deposits. Perhaps most important is whether or not these newly defined resources are on productive faults and large structures. Without these structures you're limiting your potential to find world-class deposits. The structures are very, very important.

TGR: You rank all of the companies in each category by dividing each company's "enterprise value" by each company's total ounces. How do you determine enterprise value?

DG: We calculate enterprise value by taking the company's market cap plus debt and minority interest, less its cash and cash equivalents. Enterprise value provides a more accurate reflection of the total value of the company. By then dividing the enterprise value by its gold ounces we are able to get a measure of what the market is currently paying for gold in the ground

TGR: That's a fairly simple calculation.

DG: It is. In situations where a company has a market cap that is significantly comprised of cash, our method tries to take the cash out of the equation so that we can look at what the market is currently valuing it at for its gold ounces.

The enterprise-value-per-ounce calculation is really a preliminary filter that gets us to ask additional questions and conduct additional due diligence. In the case of junior producers, it's going to lead to further analysis, including absolute and relative cash flow multiples and net asset values. With emerging producers, it's going to lead to greater definition in the various resource categories.

TGR: You manage to quantify quite a few things, but how do you quantify management, exploration upside, jurisdiction and things like that?

DG: Again, this report represents a screening process that leads us to ask additional questions and get into some of the qualitative elements. There a long list of factors we consider in our analysis. For example, we would evaluate the quality, diversity, geological background and experience of the management team. We would also research their track record in finding deposits and successfully raising equity. Of course, we would evaluate the corporate and financial structure of the company and where its properties are located to ascertain country and mining development risks.

TGR: In terms of the enterprise value divided by total ounces, some incredible numbers jump out. More than doubling the next largest number is Andean Resources, which was just bought by Goldcorp Inc. (NYSE:GG; TSX:G) for about $3.6 billion. Are you seeing some trends among the companies that are being taken over?

DG: Yes, there are some. In the case of Andean and some other companies that have been acquired, the basic premise is grade. High grade can mean a tremendous margin once in production. In this instance, Andean's deposit models are difficult to define in their entirety in the early stages, but are situated in large structural features that are permissive for additional discoveries. The acquiring company must make a certain leap of faith, if you will, that the geology will provide for additional discoveries and thereby ultimately lower the cost of purchase on a per-ounce basis.

TGR: In your report there are junior producers, emerging producers and advanced explorers. Are there other companies on this list that share similar characteristics with Andean?

DG: Certainly Primero Mining Corp.'s (TSX:P) San Dimas mine in Durango, Mexico, is a high-grade resource that's in production and that's undergoing some new thinking with respect to exploration potential, particularly in the Sinaloa Graben where there is tremendous upside.

The Sinaloa Graben is a structural feature immediately adjacent to its existing mine. Primero is currently doing both above-ground and underground exploration there.

TGR: What sort of grades is it averaging per ton there in terms of production?

DG: The grade there is approximately 4 to 5 grams gold with almost 10 oz. of silver.

TGR: What sort of production numbers are we looking at in 2011?

DG: Management is expecting 2011 numbers of about 140,000 gold-equivalent ounces.

TGR: What are its cash costs?

DG: Cash costs are expected at roughly $345/oz.

TGR: Other than grade, are there other factors that these companies being taken over have in common?

DG: Certainly there's a theme within Mexico and elsewhere in Latin America at the moment, and what's being consolidated is the 70 to 100 thousand ounces-per-annum (Kozpa) producer.

We're coming out of an era where a company that was looking to grow through acquisitions was really not looking at companies producing less than 100 Kozpa. Now, with the gold price moving from $800 to $1,300, we're seeing that 70 to 100 Kozpa producer generating some $40 to $60 million in operating cash flow, depending on cash costs. These companies have now become much more attractive to anybody looking to consolidate through acquisitions.

TGR: From the other side, which companies are typically seeking these takeover targets? Is it the majors? Is it mid tiers? Is it both?

DG: No, it's the 100 to 150 Kozpa producer today that is recognizing the challenge of discovering another 150 Kozpa ore body and seeing the relative value in existing companies that have either just finished building or are in the process of building a 100 Kozpa mine.

One recent example is Gammon Gold Inc. (NYSE:GRS; TSX:GAM) making a friendly merger proposal to Capital Gold Corp. (TSX:CGC; NYSE.A:CGC; Fkft:CGU). Both are producers based in Mexico. Capital Gold was producing about 65 Kozpa and is moving toward being a 90 Kozpa producer, but it needs cash for further development. So Capital was faced with either raising money or being subject to overtures from other public companies looking to grow. And now Timmins Gold Corp. (TSX.V:TMM) has made public its interest in acquiring Capital Gold.

TGR: Could we have a bidding war?

DG: We effectively have a bidding war.

TGR: Of those two companies, Gammon is the more well heeled.

DG: Gammon is certainly more established, but we would argue that the best value for Capital Gold shareholders is to merge themselves with Timmins Gold to form a $500 to $600 million market-cap company.

Through the additional size and strength and the synergies from the proximity of the two operations, we see a significant re-rating in the market for the combined company.

Timmins is in production, generating substantial cash, trading at five times cash flow and trading at the low end of its peer group on an enterprise value per ounce of production. Capital Gold is also trading at five times cash flow. If these two companies were to combine, then we would have a junior producer with approximately 170 to 185 Kozpa of gold production. We could see its valuation start to migrate closer to its peer group of 8 to 10 times cash flow multiple and attract a broader range of institutional investor.

The sizing up and the operational diversity that come from combining producing assets can produce substantial economies of scale, lower costs and greater efficiencies. Size begets an additional premium in the marketplace.

TGR: Timmins and Capital are both near the top of your list of junior gold producers when it comes to enterprise value divided by ounces. Obviously you seem to like Timmins and Capital, but the company that ranks second on that list behind Timmins is B2Gold Corp. (TSX:BTO; OTCQX:BGLPF). Tell us about that one.

DG: B2Gold is a company with two producing mines in Nicaragua. They produce a combined 125 Kozpa.

B2Gold is looking to make acquisitions and they have a track record of doing so. The company recently took over Central Sun Mining. And B2Gold has projects in Colombia, including the Gramalote property, which is a joint venture with AngloGold Ashanti Ltd. (NYSE:AU; JSE:ANG; ASX:AGG; LSE:AGD). Between $15 and $20 million will be spent over the next 12 to 24 months on Gramalote to grow the gold resource and begin some preliminary economic assessments (PEA).

TGR: What's the catalyst for B2Gold? Is it growing production, or could it be a takeover target?

DG: I believe it would be on the basis of growing its production profile. It's into its first year of production at La Libertad, its new gold mine in Nicaragua. B2Gold has been successfully commissioned, and we see the market is in a position to give B2Gold full credit for that production.

B2Gold has a proven management and exploration team to develop additional assets in the pipeline or grow the business through other opportunities that may surface.

TGR: Let's talk about the advanced explorers in Latin America. What companies among those are likely takeover targets?

DG: One advanced explorer that we believe will very likely become a junior producer is Sulliden Gold Corp. (TSX:SUE; OTCQX:SDDDF). Sulliden's primary project is the Shahuindo Gold Project in Peru.

It would be a heap-leach operation with an anticipated 105 Kozpa of production at cash costs of about $400 per ounce.

TGR: What's the resource there?

DG: At the moment the resource is expected to be about 1.8 million ounces (Moz.). But there is a 35,000-meter drill program underway that has already gone some distance toward defining a resource that, according to management may be double that.

The catalyst for Sulliden will include the delivery of a revised resource estimate in December, followed by a revised feasibility study by the end of Q111. That feasibility study may outline a production profile closer to 150 Kozpa given that the company has made significant strides in expanding the resource.

TGR: Does Sulliden have the people on board who will be able to pull the financing together to reach production, or is it a takeover target?

DG: I think it could be both. The president of the company is Peter Tagliamonte. Peter is a highly driven engineer with project-development oriented experience and a proven record. He worked in Latin America previously with Eldorado Gold Corp. (TSX:ELD; NYSE:EGO) at its Săo Bento mine in Brazil. After that he was with Desert Sun Mining and that got taken over by Yamana Gold Inc. (TSX:YRI; NYSE:AUY; LSE:YAU). And then he was with Central Sun in Nicaragua, which was taken over by B2Gold. He's now spearheading development and exploration efforts with Sulliden in Peru. He's definitely a key man in that situation.

TGR: What about some other advanced explorers that have caught your attention?

DG: Pediment Gold Corp. (TSX:PEZ; OTCBB:PEZGF; FSE:P5E) is certainly one. Pediment has a gold project in Baja, Mexico, that recently delivered a PEA, which is basically a first-pass engineering report that looks at all of the elements required to advance projects to production. Within 40 days of producing this report, Pediment found itself the subject of a takeover bid by Argonaut Gold Ltd. (TSX:AR). Here's an example of a company that has been advancing a resource, while delivering some of the first-pass engineering work that is an effective means of de-risking a project and answering the questions that any possible acquirer would have.

TGR: Are there other advanced explorers with a similar profile?

DG: Grayd is somewhat similar to Pediment in that it has a project in the Sierra Madres in Mexico. It just delivered a PEA outlining a production profile that would see Grayd produce 92,000 oz. of gold over a nine-year mine life at cash costs of about $500/oz. It would be a heap-leach operation with modest capital expenditures (CAPEX) and high internal rate of return.

Here's a project that will produce roughly 100 Kozpa that would represent the solution for any junior or intermediate company looking to grow its business through acquisition. Through acquisition, another junior producer could bolt on one of these development projects to its existing production

TGR: Perhaps a next-door neighbor like Alamos Gold Inc. (TSX:AGI)?

DG: Given the proximity of both companies to one another, Alamos could certainly be a consideration. As are others operating in Mexico with heap-leach experience.

TGR: Among these various groups—junior explorers, advanced explorers and junior producers—which group has the greatest potential for share price appreciation?

DG: I think as a group we've seen that the advanced explorers have probably the lowest valuation on a per-ounce basis. But the continued expansion of the existing resource by 50%, 100% or even 200% through drilling generally brings a lot of additional value to shareholders. By expanding a resource into something in the 1–3 Moz. range, these companies are going to become potential acquisition targets.

A number of these companies with a dynamic enough resource may not make it to a junior producer but may get taken over in the advanced explorer stage.

TGR: You talked already about Timmins, B2Gold, Capital and Primero among the junior producers. Are there some other names in that list that you like?

DG: We like Argonaut Gold. We think that it has made a smart decision in its proposed acquisition of Pediment. It has an established management team formerly from Meridian Gold with a stated ambition to build an intermediate-sized gold producer through acquisition and development.

TGR: Are there some companies that offer really good value at their current share prices?

DG: In the producing category I think Timmins Gold represents the best value. Timmins is growing production from its existing San Francisco Mine. Its valuations probably don't reflect that yet but likely will with consistent production numbers from San Francisco.

Timmins has a strong management team and an operating team that is capable of being a consolidator in northern Mexico, specifically in terms of heap-leach operations.

TGR: What do you think of the remaining emerging producers? Which one offers the best value?

DG: I think Guyana Goldfields, Inc. (TSX:GUY) has gone a good distance in de-risking its Aurora Gold Project, and the company has raised a lot of the necessary capital to advance it toward production. Aurora is an asset for which there's been a lot of unknowns answered and it represents a fairly sizeable acquisition, probably for an intermediate-sized gold producer.

TGR: You list Sandspring Resources Ltd. (TSX.V:SSP) among the advanced explorers. Sandspring recently published a new resource estimate. It has had some share price appreciation but is only being valued at $30/oz. on your chart. What's going on with that company?

DG: We like Sandspring. Sandspring's Toroparu Project resource is growing dynamically along a large, favorable structure. The company is really still trying to get its hands around all of the mineralization. And I think the resource will continue to grow.

Sandspring is starting to reach the point where it needs to bring in more engineering expertise and start thinking about the economic viability of the ounces that it has in order to add value to those ounces. Going from 6.5 Moz. to 8.5 Moz. may not necessarily do a lot to add value to the company in the near term. But what would add value is the ability to outline what the production profile might look like four or five years down the road.

TGR: How about some parting thoughts on this particular report and these kinds of companies?

DG: The Metals Economic Group recently published a report that said $11.5 billion will be spent on exploration in 2010—that's a 44% increase from 2009. That work, coupled with the work that's taken place since 2005 when we had a large number of junior company financings, and even more financings in '06 and '07, is starting to bear fruit five years later—after we've had second, third, fourth passes at understanding these new discoveries. That money has allowed junior companies to have their “Eureka” moments in terms of doubling and even tripling the size of their resources through a better understanding of the geological controls on those resources.

That's a powerful theme that's taking place and that is going to feed Select Golds' advanced explorer category. A lot of those discoveries are happening in Latin America. They're happening in countries like Argentina. They're happening in Peru. They're happening in Colombia. They're happening in Ecuador. They're certainly happening in Mexico. Those are the areas where we're going to see a new breed of advanced explorers come in and continue to populate our Select Golds list.

TGR: David, sounds like some exciting opportunities ahead. Thanks for your time.

David Goguen, CFA, vice president, Institutional Mining Sales, has been focused on the mining sector at PI Financial for 17 years. David has 20 years of investment experience servicing institutional and private client portfolios.

David's focus includes
Select Golds— advanced, exploration, emerging producers and junior producers. David earned a BA in economics from Carleton University and holds the Chartered Financial Analyst designation. David services Canadian, U.S. and international institutional clients.

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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: Sandspring Resources.
2) The following companies mentioned in the interview are sponsors of The Gold Report: B2Gold, Capital, Goldcorp, Grayd, Guyana, Pediment, Sandspring, Sulliden and Timmins.
3) David Goguen: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family are paid by the following companies mentioned in this interview: None.

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