The Gold Report interviews Derek Macpherson, mining analyst at M Partners.
The Mining Report: Even at today’s very low gold prices, many—including Goldman Sachs (GS)—have warned gold could go lower still. What is keeping the gold price down? What could turn it around?
Derek Macpherson: Over the last several weeks, the gold price has been affected by the strong U.S. dollar. The U.S. economy is the least bad out there, given Europe’s marginal recovery trajectory and the sanctions levied against Russia, its key trading partner. This isn’t a flight to safety, it’s a flight to the least-bad economy. Consequently, the dollar has rallied, putting pressure on gold and all other commodities.
“Castle Mountain Mining Co. Ltd. is currently optimizing its mine plan so it can complete a feasibility study.”
We typically see this correlation return when we have big moves in the dollar relative to other currencies. Once the U.S. dollar stabilizes, gold returns to the underlying fundamentals, which are more driven by macroeconomics. Our view remains that an inflation-driven gold trade is coming. Like everyone else, we’re still not sure just when that will happen.
TMR: Could gold go down further or have we hit bottom?
DM: I think we could flirt below $1,200/ounce, but I don’t think we’ll see an extended period of significantly lower gold prices. We’re getting very close to the marginal cost of production for most producers. If that situation lasts for an extended period, mines are likely to start shutting down, and it could swing back to being a supply-and-demand story.
TMR: In your March interview with The Gold Report, you said it was too soon to invest in high-risk names and suggested low-risk companies that could handle even lower gold prices. History seems to have proven you right. Do you still recommend a defensive posture, or is it time to snap up higher-risk stocks?
“Integra Gold Corp. is one of our favorite development stories right now.”
DM: We still have a defensive view. There are bargains out there; with the commodity price pulling off, almost all companies have seen material share price declines, both the good and the bad. That’s probably not fair, but it provides investors an attractive entry point on some higher-margin producers.
TMR: Can you give us a few examples?
DM: The first name that stands out is Klondex Mines (KLNDF). The company has a very high-grade asset, which allows it to have high margins. Even though the risk is a little bit higher because the company is ramping up production, its grades should allow it to retain very reasonable cash costs over the long term and tolerate much lower gold prices.
TMR: Klondex just found a new mineralized zone at the Fire Creek project. How much of an impact does that have on your view of the company?
DM: Klondex has exploration upside on both projects. At Fire Creek, the company has identified three veins that are outside the current resource, which bodes well for the pending resource update. Meanwhile, at Midas, the company recently announced an expanded resource based on some exploration results and by applying different mining methods than previous operators. Importantly, the Midas update highlights that the company has two mines with reasonable lives and exploration upside.
“Klondex Mines Ltd. has a very high-grade asset, which allows it to have high margins.”
Before we leave the topic of commodity prices being negatively impacted by the strong dollar, I want to talk about zinc. It has not been affected because it is supported by underlying supply/demand fundamentals. One of the only ways to play the impending zinc deficit is Trevali Mining (TREVF). It remains one of the only pure-play names in that commodity. Holding Trevali is a good position to have in the mining space.
TMR: Are you excited by the commodity or by the potential of Trevali’s Santander and Caribou mines?
DM: Both. Trevali has strong commodity fundamentals and it has a strong organic growth profile. It brought Santander into commercial production earlier this year. Caribou will come online next year. Following that, Trevali’s next likely leg of growth is the potential doubling of the throughput at Santander. Then, it has two more assets in New Brunswick—Halfmile and Stratmat—to develop. Trevali is uniquely leveraged to a strong macro-environment for zinc and it has a strong organic growth pipeline.
TMR: You mentioned the importance of having defensive stocks in safe jurisdictions. What are some companies in the U.S. that would be worth looking into just for that reason?
DM: With both projects in Nevada, Klondex is certainly located in a safe jurisdiction. We also like California as a mining jurisdiction, once the company has permits, as the process can take longer than normal in California.
“Marlin Gold Mining Ltd. has relatively high grades, so the cash costs should be on the lower side longer term.”
Two companies with permitted projects that we like are Golden Queen Mining (GQMNF) and Castle Mountain Mining. Both have heap-leach projects. Golden Queen is slightly more advanced with construction at an early stage. Castle Mountain is currently optimizing its mine plan so it can complete a feasibility study.
TMR: When do you expect to see Castle Mountain’s feasibility study and what are you looking for in it?
DM: We are expecting the feasibility early in 2015 and there are a couple of key pieces to that feasibility study. The first is the metallurgy, which will have an impact on the mine’s capital expenditures (capex) and operating expenditures, as the company is examining the trade-off of increasing the crush size. Increased crush size potentially allows for lower initial capex by installing less crushing capacity and lower ongoing operating costs; however, the trade-off is the potential for reduced recoveries.
Second, and probably most important, we expect to see additional drilling get rolled into the resource. Infill drilling is ongoing and with some success, the strip ratio could be reduced likely benefitting the near-term economics.
TMR: Any other names in reliable jurisdictions?
Marlin Gold Mining (MLNGF) is another interesting company. It owns and operates La Trinidad in Mexico, which could be a pretty solid, cash-flowing, small-scale, heap-leach project. It has relatively high grades, so the cash costs should be on the lower side longer term.
“Trevali Mining Corp. has strong commodity fundamentals and it has a strong organic growth profile.”
The company has a unique structure. The company recently bought a royalty on the San Albino gold deposit in Nicaragua. Part of Marlin’s plan is to create a royalty company within the operating company and eventually spin it out once it reaches critical mass.
At the current valuation, when you buy Marlin, you’re not even paying for the underlying producing asset, providing investors a free option on the potential value created by spinning out a royalty company.
TMR: So Marlin’s El Compass project is just a kind of bonus?
DM: We consider El Compass a noncore asset. The company has updated the resource and has the permits. Management is now working to maximize its value.
TMR: Do you have another Nevada name?
DM: We recently added NuLegacy Gold (NULGF) to our watch list. We visited the company’s Iceberg project and believe it’s an interesting exploration target. NuLegacy has another $2 million ($2M) to spend to earn 70% of the Iceberg project from Barrick Gold (ABX).
The Iceberg project is in the Cortez Trend, and within sight of Barrick’s Goldrush project, and recent exploration results suggest the project has potential. A key inflection point for the project is likely to be when NuLegacy completes the earn-in, and Barrick decides whether to re-earn a 70% interest by spending $15M and carrying NuLegacy to production or simply take out NuLegacy. Alternatively, Barrick can remain a 30% joint venture partner.
TMR: What about companies in Canada?
DM: Integra Gold (ICGQF) is one of our favorite development stories right now. The company purchased a neighboring mill on very good terms. Management did an exceptional job adding value to the company that has yet to be reflected in the share price. Its updated Preliminary Economic Assessment (PEA) should be a catalyst because it should provide investors a better understanding of the impact of not having to toll mill the ore, as was envisioned in the first PEA.
In the current environment, we also like Lake Shore Gold (LSG). We would consider it low-risk as the ramp-up is complete, in a good jurisdiction. Our estimates suggest that the company can generate free cash flow below the current gold price and should be able to fund its modest, organic growth opportunities.
Kirkland Lake Gold (KGILF) is more leveraged, but is on the turnaround path and on its way to lowering risk. With recent management changes, Kirkland has shifted its focus from tons to grade. Its Q1 FY/15 results had grades 20% higher than guidance. We see that trend continuing and the company coming in above guidance for FY/15.
Kirkland has a very interesting asset that is high grade in an exceptional camp. However, investors are unlikely to recognize this potential until the company is able to get the current operations to generate positive to free cash flow.
The advantage for Canadian producers is that they have a bit of a natural hedge. When a strong U.S. dollar drives down the commodity price, it also drives down the underlying costs. Even though gold is off 5% or 6%, the Canadian dollar is off about that same amount. Companies like Kirkland Lake and Lake Shore haven’t seen their margins erode as much as producers in other jurisdictions.
TMR: M Partners is releasing its quarterly preview report. What can we expect to see in that?
DM: Along the same lines as our discussion today, we remain focused on more defensive names, which we consider to be companies with higher margins. As well, we have updated our commodity price assumptions to reflect the recent declines in spot prices. The key takeaway will be that we continue to prefer lower risk, high margin names like Klondex, Lake Shore, Atico Mining (ATCMF) and Timmins Gold (TGD).
As well, we continue to like Trevali, as the underlying supply/demand fundamentals for zinc remain strong, and the company’s margins are likely to benefit from weakening currencies in its operating districts.
TMR: Derek, thank you again for taking the time to talk with The Mining Report. Our readers value your insights.
Derek Macpherson is a mining analyst at M Partners; before joining M Partners he worked in mining research for a bank-owned investment dealer. Prior to entering capital markets, Macpherson spent six years working as a metallurgist. Macpherson has a Bachelor of Engineering and Management in materials science and a finance-focused Master of Business Administration degree.
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