Heiko Ihle, senior research analyst at Euro Pacific Capital, wants to warn investors and companies about the perils of "pawnshop lending"—predatory lending scenarios that many junior miners find themselves in as a result of the current commodity price climate, overall financing climate, lack of interest from the buy side and incremental deals. In this interview with The Gold Report, Ihle outlines some alternative financing options and describes the three things he looks for in junior miners at the start of 2014.
The Gold Report: In 2012, the top 100 firms on the TSX Venture Exchange (TSX.V) raised $1.6 billion. In 2013, that dropped to a mere $795 million. What are the financing prospects for junior miners in 2014?
Heiko Ihle: It all depends on the price of gold, silver or whatever commodity the company is trying to get out of the ground.
If, as some people predict, gold hits $1,000/ounce ($1,000/oz), financing will be a whole lot tougher in 2014. I would think that for an asset that's not very high grade and is fairly small, it will be close to impossible. If the gold price stays where it is now, financing will be more or less the same as in 2013, with the caveat that quality projects will get funding and lower-grade projects probably won't. If the price of gold goes up significantly, everybody's a winner, and we shall see what happens.
I personally do not believe we will ever see prices like this again, since this is below the global cost of production.
TGR: What are your forecasts for gold and silver in 2014?
HI: I'm not a macroanalyst, but for the net asset value (NAV) analysis in our reports we're using $1,250/oz for gold and $20/oz for silver, with both numbers increasing slightly over the next couple of years.
I typically use the spot price as an indicator to value companies, rather than speculating on the price of the commodity.
TGR: We're starting to see predatory financings: institutions acquiring huge equity positions for relatively little cash. You call it "pawnshop lending." What do these deals tell the investment community?
HI: These are lenders of last resort. A couple of companies—and I won't shame any publicly—specialize in giving people just enough rope to hang themselves with the ultimate idea of eventually owning the company or its primary asset outright through a default on the debt. Clearly, companies don't do this by choice; they are forced into it.
Companies forced into pawnshop lending tend to have lower-grade, lower-quality projects. If they had more of the good stuff, they might get better funding from the markets.
Given the current commodity price climate, the overall financing climate, lack of interest from the buy side and incremental deals, we are seeing more pawnshop lending.
TGR: In general, what should investors expect next in 2014 if we start to see more pawnshop lending? How will the market react?
HI: If I were a shareholder and my company was on its last leg, I would debate what to do: Infuse additional equity through a capital raise and maintain my stake? Sell my stake with the belief that it may or may not work out? Hang on tight, hope for the best and not participate in any additional raises? I think the third choice is probably the toughest one to do.
TGR: Brokered financings are declining in favor of non-brokered private placements. What's behind that trend?
HI: Three things. First of all, there is a lack of interest from institutional investors for anything mining related right now. Second, companies save money going the non-broker route. And, finally, private placements are sometimes so small that some brokers don't get them on their radar screen.
TGR: Is this hurting the brokerages?
HI: Absolutely. Some of the smaller boutiques shut down their mining business in 2013.
TGR: That happened at Casimir Capital Ltd.'s Canadian office, which was mostly a resource-based outfit. Are the U.S.-based brokerages pulling away from mining, too?
HI: I don't know of any U.S.-based offices shutting down, but I do know of two other shops in Canada that have sharply curtailed operations or just shut down altogether.
TGR: Typically, junior mining companies raise cash by issuing more shares, but when financings become too dilutive, companies look at other options. What are your preferred alternatives for cash-hungry juniors?
HI: Many get funding through some sort of silver or gold stream. I'm usually not in favor of that because the streaming doesn't go away. I prefer gold or silver loans. Once the loan is repaid it's no longer an issue, plus you don't dilute shareholders.
The next best choice is to sell shares. That does dilute existing shareholders, and you're diluting the management team. That's something companies generally try to avoid.
TGR: But hundreds of juniors have that problem.
HI: Correct. I heard people quoting statistics at the March 2013 Prospectors and Developers Association of Canada convention that 20–25% of the juniors on the TSX.V would be out of business by the end of the year because they don't have the cash to fund their office space.
TGR: What is your investment thesis for making money in this environment?
HI: I look for three things in a company: An asset with ideally high grades in geopolitically safe areas and an experienced management team. That sounds simplistic, but those three factors will help increase the success rate quite a bit.
I've preached the virtues of good management teams for a long time. If we look at the trends over the past year, companies with good management teams and proven decisionmaking abilities have outperformed those that just can't seem to get it together.
A good project has accessibility and infrastructure. A good location has minimal geopolitical risk. A good management team can get things done. If a project is in the permitting phase, how advanced and how likely of success is the permitting process? We look at current balance sheets. Lately, some management teams are trying to raise equity without a compelling need for it. I understand having a war chest at the ready, but you can overdo it.
TGR: Going back to your thesis, if a promising junior with a project in West Africa came to Euro Pacific to raise money, would you turn it away for jurisdictional reasons?
HI: No. If you can find a company that hits on all three points, that's terrific. But most of the time, something is going to fall short.
I'm flexible as to what we really look for when I believe in the story. That sounds very simplistic and ad hoc, but if you brought me a decent company with a decent project, I'd be very willing to listen to you. If nothing materializes, so be it, but at the very least, I'd be willing to listen. My gut feeling is most analysts and bankers are the same way.
TGR: You deal with European investors. What's their attitude toward this sector now?
HI: It's actually somewhat better than it is in the United States. European investors, in general, tend to take a buy-and-hold approach; they don't pay too much attention to what happens quarter by quarter.
Some companies in my coverage universe have smaller and fewer price swings just because—I'm making numbers up—20–30% is owned by, for example, 10 Swiss or German families who have no intention of ever selling a single share.
TGR: Some Canada-based analysts are rolling back their 2014 target prices, sometimes as much as 25%. Are you doing the same?
HI: We've lowered target prices on many companies, largely because we use NAV models for most of our company valuations. With the gold price declining as it did in 2013, we have lowered our NAV, which translates into quite lower price targets over the course of the year. This holds true for pretty much everything in our coverage universe.
TGR: What do you say to people who don't see the value in gold, who don't see it appreciating any time soon?
HI: Gold has been a store of value for thousands of years. I think it is wrong to say that it is going through a bust right now and will never come back.
Here is a quote that I love: "Be fearful when others are greedy; be greedy when others are fearful." That's not a bad way to look at it.
If you can get fire sale prices on these equities—those that will survive the current environment—I think you may do quite well.
TGR: Let's talk about your coverage universe and some of the equities you're following.
HI: I recently visited Pershing Gold Corp. (PGLC:OTCBB) in Nevada. Its mill is more or less ready to flip the switch.
I spent a whole day with the management team. Although we do not have coverage, a price target or any valuation numbers on Pershing Gold, I would not be surprised to see it moving forward over the next couple of years, or quarters, for that matter.
We also cover Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE), a silver company headed by Brad Cooke that has a couple of projects in Mexico. This is a company with good management, people who have done this before. However, there is still a lot of "hate" for its El Cubo project, a mine it bought in 2012 from AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE).
That acquisition took longer than everybody anticipated and has been a gray area for Endeavor. However, the turnaround has been progressing nicely. Once we're in a rising environment for the silver price, all of Endeavor's projects should look quite good.
TGR: Do you have another silver name in Mexico?
HI: I've been to visit only one of Great Panther Silver Ltd.'s (GPR:TSX; GPL:NYSE.MKT) mines. CEO Bob Archer has seen silver cycles before, and I think the management team knows what it's doing. Its Topia plant is not making a whole lot of money at current prices, but even in the challenging environment of FY/13, there should be some cash flow from that site. Great Panther also is cost cutting wherever it can. Even if we were to hit only $24–25/oz silver, Great Panther should start making decent money again.
TGR: Mexico introduced a new royalty regime on earnings before interest, taxes, depreciation and amortization (EBITDA). Does that change how you look at the companies operating there?
HI: The mining tax was not a surprise to anybody, despite how the media tended to spin it.
On the margin, yes, the tax is a negative. However, the Mexican government actually took the companies to the negotiation table since it wanted to keep Mexico somewhat competitive in the world. Everyone realized that if the government just came in and started charging exorbitant taxes, nobody would want to invest and the government wants to keep investment in the country going.
Frankly, I'm more concerned about some of the drug wars throughout the country and the overall geopolitical risks facing Mexico than its tax regime.
TGR: Do you have any specific information about the direct impact of drug cartel activity on the mining industry?
HI: I've had firsthand experience being stopped by the army with machine guns because the mining site happens to be located in the same area as where the cartels grow their drugs.
TGR: Are there any other equities you'd like to tell us about?
HI: I visited Fortuna Silver Mines Inc.'s (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE) Caylloma project in Peru. The family that runs the company has a long history in the mining space. The CEO, Jorge Ganoza, is a third-generation miner. Simon Ridgway is also behind the company and serves as board chairman.
Overall, Fortuna did reasonably well in 2013. The stock held up fairly well, by which I mean it was down less than some others. I attribute that to its cash-cow project in Mexico, helped by another decent cash-flow project in Peru. Plus, the management team realizes that times are tough and it is doing all it can to cut costs and increase cash flow.
TGR: What has been done to cut costs?
HI: There have been layoffs at the corporate and the mine levels. Management is also picking and choosing the veins to be followed to maximize cash flow.
TGR: Can you give us a reason to believe in the junior mining equities in 2014?
HI: If you believe that quantitative easing will continue in some form, and you believe in the price of the underlying commodity, you may see a leveraged impact on the share price this year. This is especially true for companies with high-grade projects in good locales with good management that can get funding to move their projects into production.
If you buy an ounce of gold, and it goes from $1,200 to $1,400, that's great, but if you buy a share at $2 and it goes to $10 because of good management, aided by that increase in the spot price leading a project to become a mine, that's a whole lot better.
If you believe, as I do, that a lot of these companies are undervalued at current prices, and you think that the price of the underlying commodity will increase, you're buying leveraged investments on what you believe in. Just realize that leverage cuts both ways.
TGR: Indeed it does. Heiko, thanks for your time and your insights.
Heiko Ihle joined Euro Pacific Capital in November 2011 as a senior research analyst covering companies in the Mining and Engineering & Construction industries. Prior to joining Euro Pacific, Ihle spent more than six years with Gabelli & Company, more than five of which as a research analyst. While at Gabelli, he was awarded second place in the 2010 Financial Times/StarMine Top Analyst Awards for the Engineering & Construction space. A native of Germany, Ihle received his bachelor degree in finance and management from the University of Illinois at Chicago in 2004 and his MBA from the University of Miami in 2006. He has been a CFA Charterholder since 2010 and is currently a member of the CFA Institute and the Stamford CFA Society.
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Source: Brian Sylvester of The Gold Report (1/15/14)DISCLOSURE:
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Reportas an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Pershing Gold Corp., Great Panther Silver Ltd. and Fortuna Silver Mines Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Heiko Ihle: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Endeavour Silver Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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