No Easy Answers in Gold Mining
Monday, 10/28/2013 18:54
Tough times now, tougher times ahead. But that doesn't mean you can't profit...
KERRY SMITH, research analyst at Haywood Securities, has been a mining analyst since 1992. He was a mining engineer with 10 years of mine experience, and holds a Master of Business Administration degree.
Here Kerry Smith talks to
The Gold Report about why there are no easy answers in the gold mining market right now. Companies and investors alike have to hunker down and make tough calls. But that doesn't mean companies and investors can't make money, even in the short term...
The Gold Report:
Haywood Securities recently published its
Q3/13 Junior Exploration Report, which tells prospective investors about 17 exploration companies across a range of mine commodities. There were 20 companies covered in the Q2/13 report. Six of those have since been removed, while three new companies were added. Why does the report have such a short-term investment horizon?
Kerry Smith: Our focus is to identify companies that will have meaningful news in the next three months that could impact the share price. We're looking for companies with projects that we like from an exploration perspective and we have a PhD. geologist who is charged with making sure the names in the report offer geologic potential.
TGR: Investors typically take a longer-term view of
gold mining equities, but do you believe you can make money with a short-term horizon?
Kerry Smith: If a company has meaningful catalysts coming in the next three months, money can be made by investing in it. I would agree that, ultimately, the way investors make real money in the space is by investing in an exploration play that makes a discovery and staying invested until it has been drilled off to a resource stage. Typically, investors would want to sell before the company starts talking about permitting, construction and project finance because that's when a company goes into a huge vacuum – there is no news and the stock rolls over.
We're trying to find companies that can deliver decent catalysts in the short term. It's a constantly evolving list. We roll names off, and we roll names on.
TGR: There are hundreds of exploration plays. At a time when investors are eschewing risk in gold mining, what do those three new companies in the report have in common?
Kerry Smith: We like the projects that they are working on. There is the potential for a discovery or they already have a discovery with the potential to grow. The corollary is that the valuations are relatively modest.
Our primary criterion is the potential to deliver an economic discovery with compelling margin potential and high project returns.
TGR: Did any new investment themes come to light while assembling the report?
Kerry Smith: The market is looking for projects with high grades, low political risk and lower capital expenses (capex). It's impossible to finance a 1 billion ton ore deposit with $2-4 billion in capex. The market is looking for bite-size projects, like a heap-leach project with a $100 million capex.
Investors are also interested in open-pit milling operations where the mill is a straightforward, cyanide-leach circuit. It's not complicated metallurgy and companies can get good recoveries.
It all comes down to margin. You can have a good-grade, open-pit deposit, but if the strip ratio is 20:1, it's not going to be very interesting economically. In my opinion no junior company should be focused on a project that delivers less than a 30% return after tax at a gold price of about $1200 per ounce). A project that needs $1300 per ounce gold to get a 15% or 20% return is destined to fail in the near term.
There are way too many projects that are being pursued and promoted that aren't high-return projects.
TGR: The commodity price charts in your report look fairly stable, perhaps with the exception of uranium. Which commodities are you most bullish on?
Kerry Smith: We are the most bullish on the commodities that are most out of favor: zinc, uranium, iron ore and gold. The longer these metals stay out of favor and the less new supply comes into the market, the better the fundamentals will be going forward.
TGR: Most of the companies in the report are working on projects in North America, which is a safe jurisdiction. What are some of those companies?
Kerry Smith: One of our themes is to pick stable jurisdictions. That tends to be the US, Canada, Mexico, Australia and Chile, to a certain extent.
TGR: Do you expect a lot of significant news from mining companies in Q4/13?
Kerry Smith: There are about 3,000 exploration companies. Probably three-quarters aren't spending any money at all. There are companies that have some money, but they're doing nothing. In some cases, it's actually the right strategy because the risk an explorer runs in a market like this is that it depletes its treasury and the news it gets has no meaningful impact on valuation. If that's the case, a company is better off just sitting on the project.
Probably 85% of those 3,000 companies don't have projects that make much sense in this market, either because the grade is a bit skinny or the capex is so prohibitively large that even if they did manage to drill it off and get a feasibility done, they'd have no way to finance it. And those projects aren't the kind the majors want to buy.
The gold is not going bad in the ground. Just sit on the project. Wait until the market is more receptive and live to fight another day.
TGR: The report notes that financings dropped to less than 600 year-to-date versus more than 1,275 financings during the same period of 2012. The total cash raise dropped to about $2.25bn in 2013 from $8.83bn in 2012. Is that trend showing any sign of a slowdown or reversal?
Kerry Smith: It's not getting any better. The only money out there for a junior exploration company is flow-through, which means it has to be in Canada.
Additionally, if larger companies can deliver growing, free cash flow and can raise their dividends, share prices will move up. Eventually, the valuations on the majors will reach a level where they would be prepared to buy something.
Companies just have to hunker down and conserve their cash as best they can. It's not an easy market.
TGR: Thanks for your insights.
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