2016 Fearless Gold Sector Forecast : Stay The Hell Away

Build Your Gold Watch List – but keep your portfolio in other sectors :

This past year was one of the worst ever for large mining companies, which suffered because of falling commodity prices and high leverage. They needed cash badly, and the streaming companies were more than happy to provide it. Mining giants such as Barrick Gold Corp., Glencore Plc, Teck Resources Ltd. and Vale SA all sold streams in 2015.

For junior or producing gold companies and their investors, the range of forecasts and continued volatility suggest it’s wiser to ignore the crystal balls for now and instead focus on what companies can control, like ensuring a sound business plan, keeping their balance sheets strong, monitoring costs, and building value for their shareholders.

Trends are against gold:

1) no inflation can be detected

2) rising interest rates offer a money making alternative while we watch and wait

3) global unrest in the middle East, Africa and Ukraine continue unabated but don’t move the panic button to ” buy”

4) Peter Schiff continues to see gold at $5,000  ( our best contrarian indicator )

This is the time of year when analysts roll out their economic forecasts for the New Year. For those who keep a close eye on gold prices, this can be a painful process.

It’s been another tough 12 months for the yellow metal, with prices falling for the third consecutive year — down about 10 per cent in 2015 alone. Prices touched a high in the neighbourhood of $1,300 and, as the year drew to close, they neared six-year lows around $1050.

That’s a big dive from the heady days of 2011, when gold hit over $1,900 an ounce.

What made things even more difficult for the sector in 2015 was the price volatility. Just when it appeared prices might be on a firm trajectory upward, they would then fall, creating more uncertainty among everyone from investors to gold companies.

That volatility is making it harder for prognosticators to estimate 2016 prices with any certainty. It’s the proverbial attempt to nail Jell-O to a wall.

That doesn’t prevent them from trying. But the resounding lack of consensus suggests it is a fraught exercise. Some are breathlessly proclaiming we’re on the brink of a new gold bull market. On the flip side, Goldman Sachs and JP Morgan predict it will fall to the psychologically important $1,000 US-per-ounce level — or lower — in 2016. Bank of America Merrill Lynch believes it will average $950 an ounce in early 2016 before recovering. Slightly more optimistic forecasters, like HSBC, predict gold will average $1,205 next year.

Gold is different from other metals in that its prices are not driven largely by typical supply and demand. While the prices of other metals, like copper or silver, tend to rise and fall as economies grow and shrink, a lot of different forces affect gold’s price. It’s used as a store of wealth, unlike most other metals (you don’t store copper to get rich), and it’s considered a “safe haven” — used as a hedge against political and economic uncertainty.

Inflation and the U.S. dollar are two major forces behind gold’s prices. In 2015, they didn’t work in gold’s favour. The collapse of the price of oil has kept inflation in check, which is bad for gold because of its role as a hedge against rising prices. The U.S. dollar has been strong — another blow for gold, which performs contrary to the greenback. Some say one of the reasons for the strong dollar was ongoing speculation that the U.S. Federal Reserve would raise rates for the first time in almost a decade. The Fed did that on Dec. 16, but there was minimal impact on gold due to the central bank’s dovish approach of a gradual tightening of future rates.

 

The dark side of metal streaming deals: Strapped mining companies trade future value for cash ( Financial Post )

 

In September, Robert Quartermain did something highly unusual for a mining executive — he signed a streaming deal with an early exit strategy.

Precious metal streaming companies looking to team up to tackle bigger deals

Valerian Mazataud/Bloomberg

Overwhelmed by the sheer volume of opportunities available in volatile commodity markets, precious-metal “streaming” companies are looking to team up to take on large acquisitions that they might not be able to readily afford on their own.

Continue reading.
Quartermain, the CEO of Vancouver-based Pretium Resources Inc., was alarmed at how much value miners are giving away in gold and silver stream sales, in which future output is sold at below-market prices in exchange for an instant cash infusion.

So when he sold a US$150-million stream on Pretium’s Brucejack project in British Columbia, he insisted that the deal include buyback options for Pretium in 2018 and 2019, and that it cap the number of gold and silver ounces that can be sold.

“When you start putting in higher levels of streaming, and the stream lasts forever, then the potential upside starts going to streaming holders and (away from) your existing shareholders,” Quartermain said in an interview.

This will go down as the biggest year ever for metal streaming deals, and it’s not even close. Miners have raised US$4.2 billion from 11 stream sales in 2015, according to Financial Post data. That is nearly double the US$2.2 billion raised in 2013, which is the second biggest year on record.

For the most part, mining analysts and investors have cheered these deals. But their sheer number has caused alarm for some observers, who worry that miners are giving away vast amounts of future upside once metal prices improve.

The metal streaming business was created back in 2004. In these transactions, a streaming company like Silver Wheaton Corp. gives a mining company an upfront cash payment. In return, it gets the right to buy a fixed amount of precious metals production from the miner at a fixed price that is far below the market price. The streamer can then sell the metal for a profit. The biggest players in this business are Silver Wheaton, Franco-Nevada Corp. and Royal Gold Inc.

This past year was one of the worst ever for large mining companies, which suffered because of falling commodity prices and high leverage. They needed cash badly, and the streaming companies were more than happy to provide it. Mining giants such as Barrick Gold Corp., Glencore Plc, Teck Resources Ltd. and Vale SA all sold streams in 2015.
On the surface, these deals made a lot of sense for mining companies. Their stock prices are so depressed that they do not want to even think about issuing equity. And the last thing this sector needs is to take on more debt. So they sold future metal production instead.

“When companies are between a rock and a hard place, they often sell what’s good because they can’t sell what’s bad,” said John Tumazos, an independent analyst.

The problem is that streams destroy much of the future “option value” for mining companies. Since the streaming metal is typically sold at fixed prices far below the market price, the streamers get all the benefit when market prices go up.

To take an extreme example, Silver Wheaton was buying silver from some mining companies at less than US$4 a pound in 2011, when silver prices rose to almost US$50. It was a massive transfer of wealth from mining companies to a streaming company.

Another concern is that streams can eliminate the exploration upside from a mine. If a miner has agreed to sell a fixed percentage of gold or silver production from a mine to a streamer, it will have to sell more metal if it makes a new discovery on the property and boosts production.

When companies are between a rock and a hard place, they often sell what’s good because they can’t sell what’s bad
John Ing, president and gold analyst at Maison Placements Canada, said streaming is reminiscent of hedging, in which metal is sold in fixed-price contracts. Hedging was all the rage in the gold industry in the 1990s, when prices were low. But it became a massive liability once prices rose far above the value in the contracts. Barrick had to spend more than $5 billion to unwind its hedge book in 2009.

Eventually, hedging became a toxic word in the industry. It is almost nonexistent today.

“It wasn’t until the price of gold went up that everybody realized what Barrick was leaving on the table,” Ing said.

“The same thing is going to happen (to streaming) when the price of gold goes up again. Not until then will people focus on the dark side of the streams.”

For investors that don’t like streaming, the good news is that miners are starting to preserve more upside for themselves in these transactions.

For example, Barrick struck a US$610-million stream sale with Royal Gold last August that guarantees higher sale prices down the road. For the first 550,000 gold ounces and 23.1 million silver ounces that Barrick delivers to Royal Gold, it receives 30 per cent of the prevailing spot prices. For every ounce after that, it receives 60 per cent of the spot prices. So if silver prices go up, Barrick stands to benefit.
Pretium Resources Inc.

Pretium’s Brucejack project in British Columbia.
Pretium went even further by negotiating optional buybacks of its stream and capping the total amount of gold and silver to be sold. If Pretium discovers more metal at the Brucejack project, it won’t go into the stream.

Traditional streaming companies like Silver Wheaton and Royal Gold are looking to buy streams that will last for decades, so Pretium’s deal is not for them. Instead, Pretium sold the stream to two private equity firms, Orion Resource Partners and Blackstone Group.

These companies are just looking for a good return and are not bothered by the idea of having their stream re-purchased in a few years. That is a relatively new concept in streaming, and it could be a game-changer if more private equity firms and other players decide to compete with traditional streamers.

Quartermain said his deal is proof that miners have alternatives to conventional streaming. He hopes other companies will follow Pretium’s lead and try to maintain some upside in these deals.

“We’ve shown you can, even in challenging markets, finance good projects and achieve that upside for shareholders,” he said.

 

 

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Silver Wheaton’s ‘train wreck : bought deal is getting snubbed

Silver Wheaton acquires silver and gold “streams” from mining companies to help them finance their projects. That has been a very active business during the mining downturn, and Silver Wheaton has kept bankers busy.

Nicky Loh/BloombergSilver Wheaton acquires silver and gold “streams” from mining companies to help them finance their projects. That has been a very active business during the mining downturn, and Silver Wheaton has kept bankers busy.

The stock traded below the offer price all day Tuesday, and sources said a very large portion remains unsold. One source described the entire deal as a “train wreck.”

The bought deal, which was announced Monday night, was priced at US$20.55 a share by lead underwriter Scotiabank. The pricing was very aggressive, as it represented a 3% discount to Silver Wheaton’s closing price that day. Typically, the discount on bought deals is larger, as a reflection of the risks taken on by the underwriters, one of which is that the stock price drops. On this deal, the underwriters are also charging agents’ fees of 3.75%. – or $0.77 a share.

Amid weaker precious metal prices Tuesday, Silver Wheaton shares did fall, by 5.5%, and closed at US$20.02. On heavy volume – trading in New York and Toronto at 11.4 million shares was about 1.5 times normal – the shares hit an intraday  low of US$19.83.

Silver Wheaton is a very liquid stock, so if investors want to build a large position, they can buy it on the open market and bypass the bought deal. Deal insiders are hopeful that metal prices will rise on Wednesday and they will be able to sell more of the offering.

Investment banks lined up to be part of this bought deal, because Vancouver-based Silver Wheaton has been one of their top mining clients in recent years. Indeed there are four lines of underwriters (all with varying degrees of liability), with BMO, CIBC and RBC on the second line, BofA Merrill Lynch and TD on the third line, and Scotiabank signed on for a 25% share.

Silver Wheaton acquires silver and gold “streams” from mining companies to help them finance their projects. That has been a very active business during the mining downturn, and Silver Wheaton has kept bankers busy.

A source said there has been no serious talk so far about trying to cut the price on the offering, or reduce the size. Scotiabank does not typically lead mining offerings this big.

This is the third time in recent months where banks had trouble selling a very large mining stock offering. It shows that investor appetite for these stocks is not endless amid rough market conditions.

In late 2013, Barrick Gold Corp. did a US$3 billion bought deal, which was priced at a 5.4% discount to the market price. And in the middle of last year, Franco-Nevada Corp.’s US$500 million share offering proved to be a tough sell.

The Franco-Nevada bought deal has similarities to the current Silver Wheaton deal. Both firms are in the mining-royalty business, and in both cases, the discount to the market price was very small. It was less than 2% in the Franco transaction.

Silver Wheaton plans to use cash from the bought deal to fund its acquisition of a gold stream from Vale SA’s Salobo mine in Brazil. It is the second gold stream that Silver Wheaton is buying from this mine.

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Silver Wheaton Corporation BUY Target Price $29

Metals and Mining — Precious Metals and Minerals
SLW : TSX : C$21.51
SLW : NYSE
BUY 
Target: C$29.00

COMPANY DESCRIPTION:
Silver Wheaton is uniquely positioned as the purest silver
producer. The company’s asset base consists of silver purchase
agreements with the San Dimas and Penasquito mines in Mexico,
Pascua-Lama project in Chile/Argentina, Zinkgruvan mine in
Sweden, Yauliyacu mine in Peru, Stratoni mine in Greece. Most
recent streaming deals with Hudbay minerals (silver and gold
streams at 777 and Constancia) and Vale (gold streams at
Salobo and Sudbury mines).
All amounts in C$ unless otherwise noted.

STRONG MOMENTUM INTO Q4
Investment recommendation
Silver Wheaton remains the preferred vehicle for exposure to silver
given the strong growth profile, margins, liquidity and diversification.
Further accretive streaming transactions are possible over the next 12
months, although new equity should be expected for larger transactions.
SLW is currently trading at 1.20x its forward-curve-derived NAV,
modestly above the silver producer group, but below SLW’s royalty
peers. Our NAV continues to assume a 25% permitting/development risk
discount for Pascua and Rosemont. We maintain our BUY rating.
Investment highlights
 SLW reported Q3/14 adjusted EPS of $0.20, in line with our
estimate and consensus. While attributable AgEq production was
below expectations (8.4 vs. 9.2Moz), a 1.3Moz inventory drawdown
resulted in sales beating our estimate (8.7 vs. 8.4Mozs).
 SLW wrote-down Mineral Park $37.1m following Mercator Minerals
Chapter 11 filing, and Campo Morado $31.1m given questionable
viability of the satellite resource base (metallurgy and low prices).
We have removed Mineral Park from our valuation and reduced our
Campo Morado’s valuation by 70%. Overall, these two small streams
are non-core and have limited impact on SLW’s overall profile.
SLW’s key streams remain well insulated to lower prices.
 SLW made a final $135m payment to Hudbay Minerals (HBM-T,
BUY, covered by Gary Lampard) relating to the Constancia gold
stream. While the payment was expected, SLW paid through the
issuance of 6.1m shares (dilution of 1.9%) rather than cash. The
preference for equity is understandable with the net debt to EBITDA
at 1.66x, which may not be high relative to SLW’s producing peers,
and is easily manageable, but remains high for a royalty company.
Both Franco-Nevada and Royal Gold have net cash positions.
Valuation
We have revised our target price to $29.00 from $30.00. Our target
remains predicated on a 1.55x multiple to our fwd. curve derived
5%/operating NAVPS estimate of C$20.02 (previously C$20.76) less net
debt and other corporate adjustments.

Silver Wheaton Corporation Update Target $30

SLW : TSX : C$21.59
SLW : NYSE
BUY 
Target: C$30.00

COMPANY DESCRIPTION:
Silver Wheaton is uniquely positioned as the purest silver
producer. The company’s asset base consists of silver
purchase agreements with the San Dimas and
Penasquito mines in Mexico, Pascua-Lama project in
Chile/Argentina, Zinkgruvan mine in Sweden, Yauliyacu
mine in Peru, Stratoni mine in Greece. Most recent
streaming deals with Hudbay minerals (silver and gold
streams at 777 and Constancia) and Vale (gold streams
at Salobo and Sudbury mines).
All amounts in C$ unless otherwise noted

Metals and Mining — Precious Metals and Minerals
MINERAL PARK FINDS A BUYER;
KENO HILL NOT EXPECTED UNTIL 2015; MAINTAIN BUY RATING AND C$30.00 TARGET


Investment recommendation


We maintain our BUY rating on Silver Wheaton. We believe the
perceived increased risk with respect to Pascua construction and
Rosemont permitting has been largely discounted in the company’s
shares. SLW boasts a robust growth profile and continues to generate
strong free cash flow at spot gold and silver prices.
Investment highlights
 We updated our model to reinstate the stream from Mercator’s
Mineral Park mine in Arizona following the proposed merger with
Intergeo MMC, which is expected to inject cash to sustain
operations. Based on Mercator’s previous mine plan, not assuming
any changes are made following the merger, we value the Mineral
Park stream at US$108 million or 1.4% of NAV.
 We also updated our model to incorporate the new PEA for Alexco’s
Keno Hill project in the Yukon. Production re-start is now expected
approximately one year later in Q1/15. Our valuation for Keno Hill
has declined from US$116 million to US$50 million. Given the
significant financing risk surrounding the re-start, we continue to
discount the stream by 50%. Alexco is in violation of the completion
agreement based on achieving throughput of 400tpd by YE14. We
assume SLW will extend the deadline given the option value.
 Overall, our 2014 production forecast of 39.4mozs remains largely
unchanged. Our 2013 EPS and CFPS estimates remain materially
unchanged at $1.06 and $1.50, respectively.
Valuation
We are maintaining our target price of C$30.00, which is predicated on
a 1.30x multiple to our forward curve derived operating NAV estimate of
C$25.29 (previously C$25.44) plus net debt and other assets.

Silver Wheaton Corporation BUY

SLW : TSX : C$22.50
SLW : NYSE
BUY 
Target: C$30.50

COMPANY DESCRIPTION:
Silver Wheaton is uniquely positioned as the purest silver producer. The company’s asset base consists of silver
purchase agreements with the San Dimas and Penasquito mines in Mexico, Pascua-Lama project in Chile/Argentina, Zinkgruvan mine in Sweden, Yauliyacu mine in Peru, Stratoni mine in Greece. Most recent streaming deals with Hudbay minerals (silver and gold streams at 777 and Constancia) and Vale (gold streams at Salobo and Sudbury mines).

Metals and Mining — Precious Metals and Minerals
Q3/13 RESULTS IN LINE; GOLDEN LINING GROWS WITH CONSTANCIA; REITERATE
BUY RATING
Investment recommendation
Silver Wheaton’s share price has declined almost 15% since Barrick’s unexpected announcement of the halt of construction at Pascua-Lama. With the Pascua risks now largely discounted in the share price, we reiterate our BUY rating on Silver Wheaton.
Investment highlights
 Silver Wheaton reported Q3/13 EPS of $0.22, which was in line with consensus and slightly ahead of our estimate of $0.21. The variance to our estimate was largely due to lower depreciation.
 Silver equivalent production was 8.9mozs, which was in line with our estimate, but sales were lower at 7.8mozs versus our 8.5mozs estimate. Sales from Yauliyacu and Penasquito lagged production in Q3/13 by ~874kozs. We anticipate inventory sales in Q4/13.
 SLW reiterated 2013 production guidance of 33.5mozs silver equivalent, including 145kozs of gold. The company also reiterated its recently revised 2017 production guidance of 42.5mozs silver equivalent, including 210kozs of gold.
 SLW recently announced the acquisition of 50% of the LOM gold production from Constancia for $135 million, which is expected to be paid in Q1/13. We view the transaction as accretive (NPV of the  stream ~$200 million). Risk has been reduced by utilizing a fixed recovery rate. Gold now represents ~30% of SLW’s medium term revenues. SLW continues to look for further accretive streaming opportunities.
 Our 2013 EPS and CFPS estimates have been revised to $1.05 (from $1.06) and $1.50 (from $1.59), respectively.
Valuation
We are maintaining our 12-month target price of C$30.50, which is predicated on a 1.30x multiple to our forward curve derived operating NAVPS estimate of C$25.41 (previously C$25.71) plus net debt and other assets.

Stonecap Securities Top Picks

TGR: How do investors make money in this space?

CD: By seeking out investment vehicles that limit exposure to input cost creep, but also deliver the benefits, assuming that the metal price continues to go up. Some of those investment vehicles may be royalty companies, which tend to pay a big lump sum upfront for a royalty stream and then receive a certain amount off the top of ounces produced every year after a mine begins production. They don’t pay an ongoing cost associated with the ounces that are delivered to them and therefore avoid the creep of input prices.

“We will see precious metals start to move upward in price again.”

One of the reasons that these royalties companies have tended to trade at a premium relative to mining companies on a net asset value (NAV) basis is that you do not pay for extended mine life. Even though mine planning can keep the margins constant and can reduce ounces produced from a deposit as the grade goes down, it also tends to lengthen the life of that deposit. It’s a question of would you rather have a 1% net smelter return (NSR) on 100,000 ounces for 10 years or a 1% NSR on 80,000 ounces for 15 years? At the end of the day, the total ounces you receive under that second scenario is larger, though in any one period the total ounces received is less than the first scenario. Royalty companies offer investors exposure to gold without a lot of the risks associated with owning mining companies.

TGR: While you haven’t covered many royalty companies in the past, you just launched on a company called Premier Royalty Inc. (NSR:TSX), which was spun out of Premier Gold Mines Ltd. (PG:TSX). Tell us about the company and your investment thesis.

CD: I’ve come out with a buy recommendation and a $1.80 target price. The stock is around $1.55/share. My valuation thesis and reason to own it are very simple. The comparable companies, Sandstorm Gold Ltd. (SSL:TSX) and Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) and Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), are trading on average around 1.2 times NAV and 16 times forward-looking cash flow. Based on my estimates, Premier Royalty is trading at around 0.9 times NAV right now and 12 times forward-looking cash flow. As the company gains more visibility in the public market and attracts more investors, it should trade more in line with its peers.

“When the precious metals complex starts to move up again I would not be surprised to see the gains in silver exceed the gains in gold on a percentage basis.”

I also like Premier Royalty because it’s got $30 million ($30M) in cash. It’s a very challenging market right now to raise money, so royalty companies have become a go-to source of capital for companies with good projects. Premier Royalty has the war chest to buy royalties on quality projects and the marketplace right now doesn’t provide mining companies with a lot of other options.

One of the things I really like about Premier Royalty is it only has around a $100M market cap. It has a bunch of operating royalties right now that are generating about 7,000 oz gold per year to its account, so it’s not as if it’s just a pile of cash waiting to do business. The company actually has royalties under its belt, but it’s also positioned to acquire new ones. It can also acquire royalties on a much smaller scale than its competitors because it just takes more to move the needle for a billion dollar company than it

does for a $100M company.

TGR: Can you give us a ballpark figure for what Premier is going to be looking for in royalties?

CD: Some of its existing royalties are generating less than 500 oz/year to its account. When you look at 50,000 or 60,000 oz/year operations with a 1% NSR, these generate some 500 oz gold per annum with a value (today) of around $800,000. That certainly doesn’t move the dial for a Franco-Nevada, but it can be meaningful to a company like Premier Royalty, especially if it can put a bunch of similarly sized deals together.

Premier Royalty is going to look at every opportunity in the royalty space that’s out there and might compete with some of the other players in trying to bid on the larger ones. But on the smaller ones, which are less material to a Franco-Nevada or a Sandstorm, the company can actually bid on them because it is only a $100M market-cap company and adding hundreds of ounces of annual royalty production can move the needle. The space it is going to be most successful in is the sub-1,000 oz/year stream. That’s 1% NSR on a 100,000 oz/year operation.

TGR: You follow a number of companies with operations in Mexico. Tell us about some of your favorites.

CD: One of the ones I cover is Argonaut Gold Inc. (AR:TSX), which operates a couple of mines in Mexico right now and is in the process of trying to build a third over the next year or so. It’s been a big success story. The company’s IPO was priced at around $3/share in 2009 or 2010 and it was up in the $10–11/share range for much of 2012. I had a Hold on it in early 2013 and it came down to the $8/share range, so I moved it back to a Buy. Argonaut is currently trading around $8.25-8.50/share. It’s a company I like. It’s got strong management and has really delivered into the expectations that it set.

While Argonaut has been experiencing margin pressure, it has done a very good job of keeping costs tight and has generated a very good return from operations. It’s a company I’ve recently gone bullish on again. My current target on it is $10.75.

TGR: Last fall, Argonaut bought Prodigy Gold Inc. A lot of analysts didn’t like that acquisition. We’ve seen the share price come off its highs since then. What’s your view?

CD: It is a very different beast for Argonaut compared with where it has normally played. Prodigy’s Magino asset is in Ontario, which is a different permitting and operating environment from Mexico. Although Argonaut paid a reasonable price for the asset on a per ounce basis, it is still a big change for the company jurisdiction-wise. It also will be the largest project from a capital expenditure (capex) and production standpoint. While many analysts may be negative, I’m taking a wait-and-see approach with a healthy dose of skepticism given that Argonaut has not been active in Ontario before.

TGR: But Argonaut is still very active in Mexico, right?

CD: The two assets the company has producing right now are in Mexico. The next asset to enter the production queue, San Antonio in Baja Sur California, is a Mexican asset as well. When I moved my rating to Buy at $8/share, one of the things I told clients was even if you strip out the Prodigy acquisition, the stock still is worth $8/share. You get what you pay for. If Prodigy works out, the stock should be worth more than $10/share.

TGR: Can you tell us about another Mexican play?

CD: I was the first to launch on Aurcana Corporation (AUN:TSX.V; AUNFF:OTCQX). The company is a silver producer that has two operating mines in Mexico including one called La Negra, which is a little cash flow machine. It’s also got the Shafter project in Texas, which unfortunately has been more challenging. As a result, the share price has suffered recently.

“Resource investors need to seek out investment vehicles that limit exposure to input cost creep.”

Shafter could be much bigger than La Negra: 3.5–4 million ounces (3.5–4 Moz) silver, compared with 1.5 Moz at Le Negra. Although the company has a plan to expand production at Shafter to 5 Moz, it still hasn’t quite gotten to the 3.5 Moz stage yet, so the jury is still out on this asset.

My take on it is La Negra alone is worth $0.75/share and the stock is currently trading around that level. If you buy it, you’re getting La Negra at the right price, and you’re effectively paying nothing for Shafter. If Shafter works out, I see lots of upside and if it doesn’t work out I don’t see a ton of downside.

The biggest challenge the company has is manpower. Hiring skilled workers for underground mining in Texas is not easy. Aurcana has been mining Mexico, which has a strong mining culture and history. Finding people there to drive machinery underground is not a challenge. It’s a different story in Texas. And bringing labor in from Mexico isn’t as simple as you’d think. You have to prove that there’s no American able to do the job. In my opinion, labor has been the single largest challenge for Aurcana at Shafter.

The company also had an issue with some filter presses. The presses should be installed by the end of the first half of the year. I have ramped down my assumptions on Shafter pretty aggressively. I only have it throwing off around 1 Moz silver this year as opposed to its potential 3.5 Moz annual production profile. Shafter probably won’t come fully on-line until halfway through the third quarter or the fourth quarter although Aurcana did declare commercial production there in December 2012.

TGR: So Aurcana could be positioned to have a good 2014?

CD: Absolutely. But with Aurcana, the shares are going to remain in the $0.70–0.80 range until we get positive news on Shafter. Given the struggles the company has had at Shafter and the current market conditions, investors are unwilling to ascribe any value for Shafter.

TGR: What are some companies you’re following outside of Mexico?

CD: One is Orvana Minerals Corp. (ORV:TSX), which is operating in Spain and Bolivia, and also has a development asset in the United States. This one has not had a great track record with its share performance since I initiated coverage. That unfortunately is tied to the fact that the El Valle-Boinás/Carlés (EVBC) mine in Spain was much more challenging than expected. It didn’t have a great 2012 from a share performance perspective, but I think operations at EVBC have turned around. The Don Mario operation in Bolivia has value too, though it’s a much smaller operation. Don Mario has turned around as well.

I’ve recently gone back to a Buy on it from a Hold. My only concern is the balance sheet needs some work. The company has a big debt facility with Credit Suisse coming due over the next four and a half years. As long as the operations continue to generate free cash flow it can pay that debt down, but it is going to be touch and go. Management doesn’t have a lot of wiggle room. A couple of bad quarters or even one bad quarter might require tapping new sources of capital.

TGR: The Orvana assets have bounced around from a few different companies. What makes you think that Orvana has figured it out?

CD: EVBC has been operated by Rio Narcea Gold Mines Ltd. and others. It was shut down primarily due to metals prices. It’s not as if Orvana has a magic formula here. The mine was acquired by Kinbauri Gold Corp. The company’s drilling showed that there were more resources there in addition to what was left behind. Orvana came in, bought it for cash and then put it back into production. It was not a very smooth startup. The company went through a couple of mine managers in the process. Ground conditions ended up being much more challenging than anticipated. That took time and money. That’s why the shares were moribund for quite some time. But on an operating basis, Orvana’s management seems to have hit its stride. In the last year, the company put in a new shaft, which has dramatically increased the number of tonnes that can ultimately be pulled out of it on a daily basis, and reduced the cost per tonne. It spent a lot of money sinking that shaft and putting in the hoist, but it is now paying off and you can see that in the last couple of quarters that the operations have really turned around after the shaft came on-line.

TGR: I understand you have a sell story. Tell us about it.

CD: San Gold Corp. (SGR:TSX.V) is the only Underperform in my universe right now. It has the Rice Lake mine in Manitoba. The operation has just struggled and absolutely failed to deliver on the expectations company management set for the project. The capex budget that came out back in February was for me the death of this story. It showed that there is no free cash flow for at least a couple of years to come. It’s just going to be a money pit. In fact that was the title of my note. Shares are trading around $0.25/share. I have an underperform rating on the stock. My $0.30 price target was set when the stock was at $0.50, so on paper it might not look to be a Sell right now, but I have a lot of fear here.

These guys just did a $50M convert, which will fund capital development. It’s a Hail Mary pass. If management is successful using this $50M, it might in three years start generating free cash flow again in significant amounts. The $50M convert was the last kick at the can.

TGR: Do you have any other companies you want to talk about?

CD: Why don’t I suggest the Canadian name that I think you should own instead of San Gold, which is St Andrew Goldfields Ltd. (SAS:TSX). The company is in the Timmins Camp. I had a Hold on it for quite some time and then I went to a Buy last fall. The company delivered three quarters in a row of free cash flow so it is adding to the treasury. St Andrew Goldfields also had some recent sexy exploration success beneath the Hislop pit. It’s only one hole so it doesn’t prove anything yet. But if it pulls a few more of those, it will start to define a high-grade ore zone. It’s run by Jacques Perron who is a great operator. As much as it struggled in 2011, St Andrew Goldfields turned itself around in 2012 and it’s very well positioned for 2013. I have an $0.80 target and the stock is currently trading at around $0.45/share.

TGR: Thank you, Christos, for your insights.

CD: Thank you.

Christos Doulis, before joining Stonecap Securities as a mining analyst in September 2010, spent 16 years in a wide variety of roles with a focus on the global mining sector. Most recently, Doulis was a partner at Gryphon Partners, a diversified global corporate advisory consultancy specializing in mining and resource company mandates. From 2006 to 2008, Doulis was a vice president in the Mining Investment Banking group at Blackmont Capital. Doulis began his professional career in 1994 with Scotia Capital as an equity research associate.

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Big Gold in Big Trouble?

Super Pit gold mine at Kalgoorlie in Western A...
Super Pit gold mine at Kalgoorlie in Western Australia is Australia’s largest open-pit mine (Photo credit: Wikipedia)

November 1

Big gold has done a poor job of keeping costs down: total costs per ounce are up almost 70% since 2008.”

Last week I saw a startling interview with Goldcorp‘s CEO.

To be honest, I don’t normally listen to the talking heads on TV. But if the fools at CNBC want to throw a few softball questions to the CEO of a top-10 gold producer, I’m all ears.

What I heard, though, was a little disconcerting. As you’ll see, it could signal another question mark above the heads of gold investors, especially when it comes to big gold…

The interview started out, right to the point…

When Goldcorp CEO, Chuck Jeannes was asked why there was a disconnect (in the past two years) between senior gold miners and the price of gold, he was quick to admit “it has been a quandary.”

You can see this “quandary” in the 2-year chart below…

isley gold

The three big gold producers that we follow here on a regular basis (for no other reason other than being a great litmus test for the sector) have failed to keep up with the price of gold over a two year period.

Jeannes was quick to ring this up to two factors:

1) He says it was “much easier to put some optionality value in the equities when gold was trading at three or four or five hundred dollars, than it is when gold is trading at $1,700.” So in essence, the market had more to look forward to with gold prices sitting at multi-decade lows, than it does in today’s gold market.

2) He also admits that “10-15 years ago you really had no choice but to buy physical gold or the [gold miners.]” Today with the advent of ETFs more investment cash is flowing away from miners.

Both of these responses shed some light on the situation. But like an election-campaign president, Jeannes failed to address the elephant in the room: skyrocketing costs for senior producers.

How much are costs rising? You may remember the chart that we shared a few months ago:

isley gold

There’s the rub. Big gold has done a poor job of keeping costs down – total costs per ounce are up almost 70% since 2008. Wow. And while some companies like Barrick Gold have come out with a more aggressive capital discipline plan (something that Byron King has covered in these pages), it was startling to notice that Goldcorp’s CEO failed to mention cost control upfront.

While commenting on the trend of gold ounces getting more expensive to pull from the ground – a great opening for at least one comment on capital discipline if you ask me – Jeannes didn’t have anything to say about cost-cutting.

Instead he made two last points:

First, he steered the conversation towards scarcity. Specifically saying increasing costs would create more scarcity for the metal and improve sales revenue.

Last, he quipped that with more expensive gold (due to higher costs), the senior miners will have “more leverage” going forward.

Yikes. Although this was a short snippet of an interview it really rings home a startling truth about the mindset of some big gold miners. Cost-cutting still isn’t a priority for some of these guys!

Frankly, there’s no reason why any CEO, let alone Goldcorp’s, would want to cover up any cost-cutting initiatives. That said, you can I can only assume that Jeannes doesn’t have any in mind, or isn’t worried about costs!

We’ll have to wait to see how this starts to play out. But I’m leery to say the least.

Meanwhile there is some good news. Since late July we’ve seen a nice run-up in all the big miners – Goldcorp (GG) up 28%, Newmont (NEM) up 16% and Barrick (ABX) up 16%.

 – for more portfolio ideas   click here  for  investment profits and much more detail on the ins and outs of investing in gold