How low can the price fall before producers stop making money...?
KILLIAN CHARLES, an analyst with Industrial Alliance in Montreal, isn't too concerned if the gold price hits $1,300 an ounce or even $1,000. He's more concerned with the gold breaking point. How low can the gold price go without breaking a project? Investors will be surprised to know that a wealth of junior miners are lean and mean enough to survive a pint-sized gold price. Charles talks with The Gold Report about the redesigns necessary to make it in this unforgiving market.
The Gold Report: Killian, what are the main causes of the disconnect between commodity prices and the share prices of mining companies?
Killian Charles: It's the fundamental difference between the commodity itself and mining companies.
There's an unspoken belief that, when you invest in a junior mining company, you're essentially buying a portion of the deposit. Investors are looking to diversify by having gold as a commodity in their portfolios and they look to gold junior companies. Yet the exit strategy from those gold junior companies results in cash, so they're left tangibly playing the gold space, but not having what initially brought them in.
That is why a lot of companies are considering gold dividends. At least that way investors playing the gold space are actually being paid in the commodity that interested them at the start.
TGR: Do you think that's going to gain traction?
Killian Charles: The smaller producers are having a lot of difficulty getting good traction in this market. A lot of them are going to explore some of these alternative routes. Just as we've had alternative routes for financing, we're going to start seeing alternative routes to increase shareholder value.
TGR: The fall in precious metal values has shaken a lot of investors. What is Industrial Alliance's forecast for gold?
Killian Charles: We are less worried about noise surrounding the price of gold. We're focused on the breaking point of the projects we cover. Even if the gold price may be $1,300/ounce ($1,300/oz) at the end of the year, we are more concerned if the project may survive at $900/oz.
The gold price is important to companies that have producing assets, however. Into 2014 and out to 2020, we typically take a conservative approach and go well below $1,300/oz. Beyond 2020, we forecast roughly $1,100/oz because a lot of companies should not be getting excessive value for production that is too far down the pipeline.
TGR: What would you be doing to gain traction in this market if you were in the shoes of a junior precious metals company?
Killian Charles: Instead of showing how well a project works at $2,000/oz, I would show the market how well a project works in any environment. All gold projects have decent leverage to higher gold prices. What's more important is showing that there is a smaller sensitivity to the downside, showing how they can still stay relevant on a downturn. Quite a few companies out there would survive and make money in almost any scenario.
TGR: Many of the companies you cover are working on mining projects in the Canadian provinces of Ontario and Québec. Is the safety of those jurisdictions a considerable factor?
Killian Charles: Yes, you can't split it any other way. When people here think about royalties, they're haggling at the details. By and large, there's never really going to be any threat of nationalization. There are no military coups happening in the US, Canada, UK, Sweden or Norway, etc. I find that is very important because work will keep going and I do not have to be afraid that an election might change that suddenly. I can plan for royalties and taxes. I cannot plan for a government getting kicked out of a country and losing my property.
TGR: Some industry insiders are saying that only the better projects will get financed in the current tight market. How do you define "better" projects?
Killian Charles: For us, better projects are those that are difficult to kill off. We are big believers in finding the project's "gold internal rate of return." What gold price gives us a net present value (NPV) of zero? We try to find that gold price breaking point for different projects. The lower the gold price breaking point, the more interested we are in the project, and the stronger we feel a project could be.
This allows us to have an agnostic approach to what a better project may be. We find that projects with slightly lower capital expenditures but offset by higher operating expenditures end up being stronger and that's not very surprising. It's much more important to get the mine into production through almost any means necessary. Even though it might be a little smaller and might not immediately benefit from economy of scale, expansion could come at a later point. Projects that may not be initially strong could, through a simple redesign, turn out much healthier in this market simply because they scale everything down to a scope that is manageable.
TGR: Some development-stage gold and silver projects are getting financing by forward selling a portion of their production to banks or royalty companies, while others have arranged credit facilities backed by board members. Some even manage equity financings despite record low share prices. What's your preference among those options?
Killian Charles: I'd rather see a company do a royalty or gold streaming when it is in a position of power, but that's rarely the case. At the end of the day, I find that most 3–5% royalties don't affect the final NPV greatly and still provide an injection of much-needed cash.
We've seen some companies manage to do equity financings. A lot of companies that our group previously approached to do a financing initially told us they were waiting for better times. As an example, company A's stock was trading at $1/share and went down to $0.50/share. Instead of thinking about the present, it is stuck looking in the rearview mirror at the $1/share. Sure enough, a few months go by and now the company is really hurting for cash. Its share price is possibly even lower and now it has no choice but to raise cash. Importantly, the market opportunity that presented itself previously may not be there anymore.
Convertible debt never really works out. These companies have no real way of servicing the debt so it almost always ends up being converted into shares down the road or renegotiated repeatedly to push back the payment schedule.
TGR: The great thing about royalty streaming is that royalty companies have such efficient and effective people vetting those projects. If a royalty company is willing to give a junior money up front, you know that it's going to go into production and generate cash flow.
Killian Charles: That is very true. A lot of streaming or royalty companies do more due diligence than large funds that might take a large position in an equity raise.
TGR: Some Québec-based mining companies can draw on Québec government-owned funds and the expertise of the province's mining and exploration company. How much of an advantage is that in today's finance market for junior mining companies?
Killian Charles: This is more of an advantage in a bull market. It operates as a government-owned project-generating company that will flip or joint venture early-stage projects out to other companies. It does help.
What's much more interesting is the Québec government-owned funds. They move a lot slower, but what I find interesting with these funds is that there's no secret game being played; there are no backhanded maneuvers. Once they believe in your asset, they'll be stable. They're not going to try to short run your stock before an issue. That said, if your share price is stuck middling in the $0.10 range, they're not going to help you drive it up to $0.30/share either.
TGR: Have any of the companies that you cover taken advantage of those funds or do any of those funds own a position in any of the companies you cover?
Killian Charles: Nearly every company that runs through Québec will have some interaction with them.
TGR: Do you have any parting thoughts for us today, Killian?
Killian Charles: I think that investors are over-worried about the gold market. Projects are still coming true and companies are still working on interesting things. There is a lot of nervousness out there, but I'm still pleased to see that companies are rethinking and reimagining developing assets. It's going to make strong projects. To be sure, companies are going to die, but it's going to make a fair amount of projects and companies much more robust. If the market does turn, these projects are going to have a very good chance of being the next group of lower midtier gold producing companies.
TGR: Thanks, Killian.