The Junior Gold Mining Cull

Lack of financing is hitting the gold mining space...

A DEARTH of financing is culling the junior mining herd. Who will be left? Philip Ker, a mining analyst with PI Financial in Toronto, believes cash-flow generators in safe jurisdictions will continue to perform in this market. Read more in this interview with The Gold Report.

The Gold Report: The financing situation is grim. Not one junior mining company conducted an initial public offering (IPO) in the first quarter, correct?

Philip Ker: The IPO space is pretty thin right now. The overall climate and appetite for junior startups is pretty bleak. Until we see a resumption in investor demand for mining, I think new IPOs will be limited to very special situations.

The window is tight for financing as well and debt options are becoming more attractive. Projects with high-quality management, strong economics, a high internal rate of return (IRR) and near-term cash flows could get some traction in this environment. With this market, investors are seeking companies with sustainable cash flows from producers or short pay back periods with low capital expenditures (capex) costs for developers.

TGR: Given the tight climate for IPOs and financings, could the merger and acquisition (M&A) environment pick up over the course of the year?

Philip Ker: By Q3/13 or Q4/13, we expect to see significantly more activity on the M&A front as the senior and cash-rich mining companies look to acquire sound projects at lower prices from the most cash-strapped companies forced to do a transaction, especially if the equity financing window remains shut. Because the equity markets are tight, strategic investments by majors may also become more common. 

TGR: What's your investment thesis for precious metals producers against this economic backdrop?

Philip Ker: I'm focusing on operations that are in low geopolitical risk environments, such as Mexico, Canada and the US I like companies with strong management and operations that are continuously providing positive operating cash flow. I like companies that have a solid growth strategy, whether it's through increased targeted grades, development of a new project or increasing production.

TGR: The gold-to-silver price ratio is growing as silver slips faster than gold. Today's gold price is $1,550/ounce ($1,550/oz). It would take roughly 57.7 oz silver to make 1 oz gold. Are you issuing silver plays given the recent price drop?

Philip Ker: Typically, silver does have a higher beta so it tends to be more volatile than gold. I am not shying away from silver companies given that silver has more industrial uses than gold and should benefit from a recovering US and world economy. 

TGR: Do you believe Société Générale's forecasted gold price of $1,375/oz by December 2013 is valid? If so, does that mean gold's bull run is over?

Philip Ker: We don't agree gold will fall this sharply—even though 2012 was the first time in 10 years that there was a reduction in the gold price. We think the US Dollar will remain volatile due to the continued US debt expansion, economic uncertainty and the general macroeconomic environment. We think these, among other factors, should ensure a buoyant gold price.

Furthermore, a lot of mining operations I focus on are working with all-in costs of around $1,100/oz. If we see a continued weakness in the gold price toward $1,375/oz, companies will look to close marginal operations or delay new mining expansion.

TGR: Thomson Reuters GFMS recently published some numbers that said that all-in cash costs for gold producers in 2012 averaged $1,211/oz. Is that close to the numbers you're seeing?

Philip Ker: That's about right. If the gold price did dip toward $1,375/oz, capex budgets would be cut resulting in reduced drilling, and lower general and administrative expenses.

TGR: There was record gold production in 2012 of about 2,861 tons. This is the fourth straight year of gold production growth. Is too much production behind the price weakness?

Philip Ker: I don't think so. Monetary reserves around the globe are always accumulating gold and continuing to hold it; we think this will continue. I think the major factor causing weakness in gold prices is a strengthening US Dollar. The US and its Dollar are attracting capital from around the globe as US equities have been outperforming and the US is now seen as a safe haven once again. As long as the US Dollar continues to rise, I think gold prices will have downward pressure. However, the US is not out of the woods yet and with all of this uncertainty, we think demand for gold will return.

TGR: How are you mitigating risk when it comes to exploration-only mining equities?

Philip Ker: It all comes down to my due diligence process. I tend to like sound projects with some sort of history. I tend not to jump on new discoveries, such as those made in the Caribbean. There's too much hype that follows these stories and it just ends up driving up the valuation. I stick with assets that have had some historical activity on the project that quality technical teams can re-investigate and delineate and grow the deposit into a feasible mining project.

TGR: Some mining experts believe that the game has permanently changed in the junior mining space and that it's not going to come back as it did following previous downturns or cyclical lulls. What's your view?

Philip Ker: I am not as negative. Let's not forget we have seen a very strong bull market over the past decade, and it is not surprising to see such a sharp correction with junior mining companies. The bull market has spun out close to 1,700 mining companies and we are likely to see a weeding out of many of the weak or more marginal companies. We view this as positive and only makes a stronger set of companies and investment choices available. We expect investors will remain more selective in the near to mid-term. While it is hard to say how long this bear market will last, one thing is for sure: The global economy continues to grow, emerging economies continue to build and expand and they will need more metals and minerals.

TGR: Thank you for your insights.