Gold News

Looking Beyond Flashy Drill Results

Trained metallurgist and mining analyst on spotting value in junior miners...
DEREK MACPHERSON is a mining analyst at investment bank M Partners in Toronto, Canada. Before joining, he worked in mining research for a bank-owned investment dealer. And prior to entering capital markets, MacPherson spent six years working as a metallurgist. 
Now studying underappreciated companies, Derek Macpherson says they can be opportunities to buy, not sell. Don't be dazzled by flashy drill results, he advises in this interview with The Gold Report. Investors are better looking for junior explorers with long-term vision, high grades and simple operations in good jurisdictions.
The Gold Report: Derek, when it comes to junior mining equities you're something like a shark cruising for prey, seeking an opportunity to strike. What common buying opportunities do you look for that other investors might overlook?
Derek Macpherson: We seek out assets that have been underappreciated or unjustly tossed aside, companies whose stories are starting to change. That change might be an operations turnaround, a turnover in the management team or a revision to the capital structure.
TGR: One of your recent research flashes reported on the Mexican government's consideration of imposing a royalty on Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) on companies that mine commodities in Mexico. Tell us about that.
Derek Macpherson: Whenever that topic comes up, it puts pressure on Mexican producers and developers. We are seeing the potential of a royalty getting priced in to those companies, and priced in as a worst case scenario.
Initial discussions centered on a 5% EBITDA royalty, which could affect company valuations significantly. However, Mexican mining companies are working with the government to find a more reasonable solution. If the proposal gets ratcheted down to a 2.5% EBITDA royalty or perhaps a 2% net smelter return, then company valuations could recover.
In Mexico, you want to look for companies that have low all-in cash costs. They will be somewhat insulated from the royalty because their margins won't be as compressed as higher cost operations.
TGR: What common events lead you to undervalued equities?
Derek Macpherson: One of the most obvious is when management teams disappoint; the mining space is littered with those.
In those instances, we look at the underlying value and whether the management team can turn the operation around. We ask ourselves if the selloff was excessive, potentially creating a buying opportunity if the damage is recoverable.
TGR: Do you think management teams are being punished too harshly for performance shortcomings?
Derek Macpherson: I think it's partly a function of the commodity price environment. In a rising gold price environment, there was more room for error and setback didn't have as large an impact on project economics.
In a volatile price environment, investors have shown very little patience. If production results or a resource update aren't in line with projections or better, the market pushes the stock down.
TGR: Do you watch for seasonal opportunities, or has seasonality become less predictable?
Derek Macpherson: Seasonality has been a bit less predictable. It has been dampened, first, by gold being driven by macro events and, second, by it being technically traded.
This year, in particular, investors should be looking at the season for tax-loss selling. I expect to see an accelerated selloff near the end of 2013, as investors try to capitalize on their tax losses. This should create a buying opportunity for a lot of good stocks. This is the time for investors to do their homework and find the stocks they want to pick up as they sell off later in the year.
TGR: What types of stocks do you think will sell off more than others?
Derek Macpherson: I think it will be a function of the company's year-to-date performance. Companies that had a tough time from January to October will be the most affected. That doesn't speak to the quality of their projects, which could create buying opportunities.
TGR: News flow used to dry up in the summer and start to flow again in September with the publication of summer drill results. Does news flow still matter?
Derek Macpherson: To a certain extent, yes. Drill results became a bit of a selling opportunity or a liquidity event this summer. However, we are seeing that abate, particularly in September.
TGR: Haywood Securities produces a quarterly report on the junior exploration companies that looks out three months to forecast how the companies listed will perform quarter to quarter. Do you look for quarter-to-quarter performance or do you look more long term?
Derek Macpherson: In the junior exploration space, you have to look a little bit longer term. It often takes time and money to determine the value of a deposit. We try to look through flashy drill results that might move the stock over the short term but don't necessarily indicate anything about a company's long-term economic viability.
We try to hitch our wagon to companies that take a long-term approach to how they do their work and a long-term approach to driving value.
TGR: Speaking to those of our readers who are new to the junior mining space, what are some effective approaches for novice investors?
Derek Macpherson: You certainly need to account for commodity volatility. Pick companies that have lower risk and can withstand volatility.
When it comes to projects, we look for one of two things: a project needs to have very high grade or it needs to be technically simple. Having one of those two features can reduce the risk of your investment.
The next thing to be aware of is jurisdiction. In the current market, there is an increased discount for political or permitting risk, and for the additional capital expense (capex) needed to put infrastructure in a remote location. Consequently, we tend to focus on North America, Mexico and some South American jurisdictions. In South America we look for jurisdictions with an existing mining culture, which can mean focusing on a specific region or even town in a given country. Peru is a good example; mining is welcome in some areas and is more challenging in others.
TGR: What about playing the volatility itself in metals prices?
Derek Macpherson: That's very difficult to do because investors have to guess right on which way metal prices go that day. If investors want to play that volatility through equities, they have to get into more leveraged names, which tend to have a higher risk balance sheet. Playing the volatility can be very difficult and very expensive if you guess wrong.
TGR: Your thesis seems to prefer companies with cash and those that can raise cash with low-cash projects. Is that accurate?
Derek Macpherson: Yes. That is, in part, a function of the current market environment.
TGR: Do you have any parting thought for our readers?
Derek Macpherson: Even though markets are challenging for mining equities, some high-quality names have sold off, creating an opportunity for investors to get involved at a reasonable price. Despite the overhang that equity markets have put on the space, it will get better; it's just a matter of when.
TGR: Derek, thanks for your time and insights.

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