Gold mining is offering a lifeline to many struggling areas...
UNEMPLOYMENT. Economic strife. Many mining jurisdictions around the world are seeing Gold Mining as a lifeline.
Joe Mazumdar, a senior mining analyst with Haywood Securities in Vancouver, discusses the phenomenon with The Gold Report...
The Gold Report: What is your thesis for covering junior mining?
Joe Mazumdar: I break out the sector into different stages: exploration, development and production. In exploration, I look for a company with a good geological concept or model. So in the exploration space, I look for a proven geological model on a significant land package attractive to a major/intermediate gold company with a management team that is more than capable of delivering on the catalysts.
For developers, I predominantly focus on companies that can come into production within a three-year timeframe. I consider geopolitical jurisdiction, but I compensate geopolitical risk with some advantages in grade, cost or other factors. I like plays in areas that are old mining districts that haven't been touched in a long time. The rising Gold Price has brought people back to these districts, which tend to be in less geopolitically risky areas, such as Spain and the US (Idaho, Michigan and Nevada), among others.
Management is also very important because they have to bring this project to fruition. They have to manage it. They have to permit it. They have to develop a critical path. I want to know how long the permit is going to take. When will they get the long lead items?
Producers are not unlike the developers. I look for a growth profile from perhaps 50 thousand ounces (Koz.) to 150 or 200 Koz. within three years.
TGR: There are literally hundreds of junior exploration companies. How do you break it down into 30 or so names that get on your list?
Joe Mazumdar: Exploration companies are mostly run by geologists and most of those guys aren't really interested in bringing anything into production. They're interested in doing grassroots exploration, which is currently an area of less interest to larger companies.
I'm looking for companies that are searching for assets with the right people on the ground, a history of exploring for these kinds of assets and a significant land package that would interest a major. I'm looking for them to drill it and come out with a resource to sink one's teeth into.
TGR: Are there some stories on this side of the ocean that fit your thesis?
Joe Mazumdar: We have seen projects in Michigan and Idaho that people have told me would never get permitted and nothing would happen. But I've seen permitting in Michigan. The Kennecott Eagle project was permitted. Areas that were off limits are now being reviewed.
Politics, I believe, is local. In areas of high unemployment, whether it is Michigan, Idaho or the Carolinas (among others), it's enticing to show residents that a project could bring jobs. Some areas are also offering refunds on infrastructure capital investments that could reduce overall capital expenditures.
The US is very good jurisdiction for reviewing and bringing up projects within old mining districts that were seen before as non-starters but lie in areas of high unemployment, where manufacturing has gone away.
TGR: What about Nevada? Unemployment rates in Nevada haven't been extraordinarily high, but it's certainly an old mining district in a very safe jurisdiction.
Joe Mazumdar: Nevada housing prices were hit hard during the mortgage debacle. Elko, which is one of the bases of the gold mining industry in Nevada, is one of the places that have kept employment going. Housing prices there have remained stable because the city has some major and junior miners with a lot of exploration, development projects and operations.
TGR: You evaluate risk on five levels: forecast, financial, valuation, people and technology, and geopolitical or political risk. Can you explain how you evaluate those?
Joe Mazumdar: Forecast risk is assessing the direction that the company says it's going and comparing it to my estimates. And sometimes there is no direction. You're on your own. For example, if I say the mining costs for an open-pit in this area are going to be x, then I'll use the comparables with a similar facility or development project in the area that has been costed to arrive at our estimate. If the company's statements are in the lower quartile of that cost comparables, I may estimate a larger cost for the company. I do the same thing for processing and capital costs.
Financing risk is much bigger for developing projects because they don't have any cash flow. They're going to have to go to the debt and equity markets as opposed to having organic cash flow to finance its development play. To quantify that in the model, I bring in the financing component and dilute the stock to compensate for future financing, if I believe it will develop the project themselves.
The technical and execution risk is a lot about the permitting, mining, and metallurgy of a project, among other factors. I was looking at one project that had a new type of floatation circuit that hadn't been used at the same scale this company was planning. There was a risk component because we couldn't be sure that the company could reproduce that scale. There is a risk around mining. Can the company get the aggregate to do a cement rock fill? What is the cost going to be like? Can the company actually get the permit in that timeframe? What does the critical path look like? I cannot mitigate risk, only attempt to quantify it. Risk mitigation is primarily the management's responsibility.
Political risk, such as mining in the Congo, for example, means an investor would really need to be compensated with a higher grade of metal.
TGR: How do you quantify the degree of geopolitical risk in a discounted rate?
Joe Mazumdar: The volatility for gold is less than for other commodities such as oil, copper or silver, so the discount rate for gold tends to be lower. We usually use discount rates of about 5%, but for places like Bolivia or for some copper projects, we've used more than 10%. The geopolitical component is there, but the commodity plays a part in the discount rate.
TGR: If the rate of return is still fairly robust and you use a steeper discount rate, doesn't that make you sit up and take more notice of an asset?
Joe Mazumdar: A project in a geopolitically uncertain area with a target about 100% over where it's trading can be something that investors are willing to take a risk on. If a company can only show a 15% or 20% return in a very geopolitically risky area, then an investor is probably not interested in that risk-return ratio. But that return might be acceptable for Nevada or British Columbia.
TGR: There can also be risks associated with a company's staff. Quite frequently I hear about mid-tier companies poaching people from juniors and a lot of staff shifting between companies because there really aren't enough people to go around.
Joe Mazumdar: It's definitely an impact. Although junior explorers can operate with a smaller group and require less manpower, they range from a grassroots level up to drilling an advanced stage project. Once a company starts into development, it needs teams of miners, metallurgists, legal, compliance and so on. As a company moves downstream and begins development, fewer people have that kind of experience.
TGR: Is that boosting costs? Is a lot of financing going toward payroll?
Joe Mazumdar: I have noticed that the G&A of companies have been trending higher especially for those who are closer to development and need to ramp up their staff. Some compensation is rolled up into stock as well. That's part of the impetus for somebody to leave a big company with a decent salary to go somewhere with a lower base pay, but the opportunity to make a significant windfall through stock compensation on a successful venture. Some people at larger companies who want to take that plunge are finding a lot of opportunities in the junior sector.
TGR: Is the threat of a double-dip recession in the US and debt worries in Europe causing you to reassess some of your targets and ratings?
Joe Mazumdar: A lot of those issues are global macro-issues that may be a benefit for long-term Gold Prices going forward. We use those trends to revise our Gold Prices that in turn influence our targets and ratings. Another component of those trends is their impact on geopolitical jurisdictions suffering from high unemployment and economic woes, like in Spain, Idaho and Michigan, which may now be more amenable to permitting. Also, rising Gold Prices coincident with the need for tax revenue may increase the risk of higher tax and/or royalty rates in some jurisdictions on mining companies.
TGR: Do you have any parting thoughts for us?
Joe Mazumdar: As we have discussed, risk and reward are two vital components of any investment thesis but the sources of risk and reward vary somewhat depending on the stage of development (exploration, development and production). However, a few common themes would be the quality of the underlying asset and the ability of the management team to mitigate risk and deliver on its plan.
TGR: Thanks, Joe.
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