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Feelin' Lucky?

Speculative Gold Mining plays need a lot more than luck to strike it rich for investors...

small- to medium-capitalization precious metals companies with strong growth profiles, Drew Clark joined Byron Capital Markets research team as a mining analyst in November 2009.

Bringing several years of research experience – and, most recently, two years in the Institutional Equity Research division at CIBC World Markets – with him, Drew speaks here to The Gold Report about Gold Mining companies in all categories that he believes are respectable investment opportunities.

The Gold Report: Tell us about your coverage sector and why you're covering precious metals.

Drew Clark: I am one of the two analysts covering the mining space at Byron Capital Markets. My counterpart, Jeff Wu, is located in our Vancouver office. My coverage universe breaks down into two groups: producers and developers. All of the companies in those spaces have growth prospects, either through production growth or the development of new operations. Our goal is to provide a universe of companies that present investors with proven management teams, economic projects in their pipelines and ultimately, favorable value propositions.

Why precious metals? I believe we're in the middle of an historic run in the price of gold, which is highly favorable for all participants in the industry. As a result, in this environment I view both the prospects and investors' appetites in the gold sector as being much more favorable than other sectors.

TGR: You said in a recent research report that "gold companies that are several years away from achieving commercial production track the movements in the price of bullion almost as closely as producers. It's almost as if the market is attributing value based on cash flows as if their profile is a function of current, not future, commodity prices." When do you think that started, and what is it a function of?

Drew Clark: Primarily over-exuberance. People aren't looking at the big picture and what drives the value of these development stories. As I said, one would assume these movements are the result of the market attributing spot prices to their cash flow profile. But if you calculated the implied price based on these current market prices, they're consistently lower than prevailing spot prices. It's a curious relationship where the share price movement is tracking the spot prices, but the actual valuation is being calculated by lower, more realistic, long-term prices.

Market participants are simply not properly identifying the intrinsic value of a company, which is more a function of these more realistic prices. Let's say there's a company with a resource evaluating the economic viability of a potential development. We don't know with any certainty if that company's project will be developed or when it could potentially enter commercial production or even what its output may be. What we do know with certainty is they're not going to be selling their output at today's prices.

Now, in terms of production companies with profitable operations, such relationships make perfect sense because market participants primarily evaluate them on their ability to generate cash flows and less so on their intrinsic or net asset value.

TGR: We recently saw the Gold Price trade at an all-time high of $1282 last week. Gold typically climbs higher in the fall with the Indian wedding season and Christmas jewelry buying. Do you expect gold to eclipse that mark again before the end of the year?

Drew Clark: Long answer and short answer – yes. But accurately predicting the future price of bullion is very difficult. However, we believe Gold Prices will move in a clearly higher direction over the long term.

One thing I would point out is that although jewelry has historically been a key source of demand, investment demand is quickly overshadowing it. It is becoming more of the key component from the demand side of the equation.

TGR: Are the ETFs driving that?

Drew Clark: Yes, ETFs are now holding well over half of the worldwide production in vaults, a source of demand that is a newcomer to the gold party.

TGR: Going back to your research for a moment, you recently compiled something you call the "Lucky 21," which is a fairly comprehensive list of precious metals companies including producers, developers and explorers, all of which are poised for growth. We know how you spent your summer. What are some of the criteria needed for a company to make the "Lucky 21"?

Drew Clark: The Lucky 21 list was inspired by taking a step back and looking at what enables a company to add value without relying on rising bullion prices. What are the principal characteristics of these companies? The ability to accomplish resource expansion, exploration success (making a discovery), production growth and the ability to generate returns with positive cash flow growth.

However, the bias in our "Lucky 21" companies are those with an above-average ability to grow their resource base in a meaningful way. These companies have added value through the drill bit by either growing their assets or extending the mine life of their current operations.

We've also highlighted companies that are expanding production or are commissioning projects that are relatively easy to expand, in addition to companies that have a high likelihood of discovering or delineating a new ore body.

TGR: But geological promise is one thing. How much importance do you put on things like management? Cash costs?

Drew Clark: Obviously, the first thing we look at is the deposit and its geology when considering an exploration or development play. Once we have determined that there's a high probability of success, we look at the management team, in addition to the potential economic viability of the project. Have they found big projects in the past? Have they been able to raise the money? And have they been able to develop projects into mines? At the same time, there are sometimes very high impediments to development like a lack of infrastructure or political problems in the country where they're operating. Just because it's an economic deposit doesn't mean it will be put into production.

TGR: Heading back to the "Lucky 21," explorers and developers have the most potential for gains given their already low share prices. Let's start with the explorers and tell us about a handful of those companies that you like.

Drew Clark: I tend to like the exploration plays that are conducting programs to test areas similar to those that have been successfully drilled before or of a similar geological model. We tend to shy away from programs drilling the first or second holes on projects and more towards drilling step-out holes to test mineralization along trends for example.

As I mentioned before, although we evaluate exploration companies based on their growth of resource potential, we are always highly cognizant of infrastructure and other crucial impediments to developing a mine that could render such an economic deposit worthless because of factors that have nothing to do with what's in the ground.

TGR: Do you have any parting thoughts on the precious metal sector in general and what's happening there right now?

Drew Clark: Yes, for the most part what we're trying to tell investors is that you need not rely on a rising Gold Price to find value in these companies. Look for good management, good resource upside and obviously, people who are going to be able to develop a proper mine at the end of the day.

TGR: Drew, thanks so much for your time.

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