Investing in the Gold Bear to Profit on the Next Bull

The Gold Report |

The gold sector has always had a boom-and-bust mentality. Ron Stewart of Macquarie Equity Research says the flip side to the bear market is that the next bull market will produce phenomenal gains, and the companies leading the pack will be those that can still flourish at $1,000/ounce. In this interview with The Gold Report Stewart identifies low-cost, high-grade miners, several of which are likely to excite interest from cashed-up suitors.

The Gold Report: There was a widespread assumption in 2011 that the price of gold could only go higher. As we have seen, this assumption was very much mistaken. Today the mood is much more pessimistic. Could this pessimism be just as mistaken as the optimism was?

Ron Stewart: Yes, it could, but it's my experience that markets tend to overshoot on the upside and downside alike.

TGR: Why has gold lost so much value?

RS: Several reasons. Gold tends to rise in times of high inflation, and inflation is pretty low right now. The U.S. economy is doing well compared to other countries, and gold has a negative correlation with the U.S. dollar. Money is flowing into the U.S. economy and to the U.S. dollar and exiting other instruments such as gold.

TGR: What do you make of the argument that financial institutions such as Goldman Sachs are using shorts to beat down the gold price?

RS: It's really hard to point a finger at any one institution or entity that could drive the gold price one way or another. There are so many factors in play. For example, Russia now has the fifth-largest central bank holding of gold and continues to accumulate it. Should Russia become sufficiently distressed economically and need to acquire foreign currencies, it might become a gold seller.

It's important to remember that the gold sector is a relatively small one in the global economy, and so its volatility is exacerbated as a consequence.

TGR: How long will the price of gold remain depressed?

RS: The last time the gold and gold mining sectors were so out of favor lasted from roughly 1998 to 2002. We're now two to three years into the current bear market. How long will it last? That's the $64,000 question.

TGR: In 2008, economic shocks led to rapid gold appreciation. Do similar conditions exist today?

RS: The situation today is considerably different than in 2008. Back then, several major banks were on the brink of collapse, and the markets were basically frozen almost overnight. Today, we have a weak European economy and a slowdown in China. But I don't consider another almost catastrophic failure in the financial system to be imminent.

TGR: What are your near- and longer-term predictions for the price of gold?

RS: In the near term, we're looking at a range of $1,150 to $1,300 per ounce ($1,150–1,300/oz). Could it go lower? Yes. Over the next three to five years, we see the opportunity for a constructive price increase.

TGR: The Gold Report interviewed Oliver Gross in October, and he told us that all-in sustaining costs for gold producers are now above $1,150/oz and that increased production will require a gold price of at least $1,400/oz. That being the case, doesn't it suggest that absent a significant rise in the gold price many mines will become marginal or will be shuttered?

RS: We are seeing some margin squeeze at the top end, but the recent fall in the oil price helps miners by reducing operating costs. More important, any analysis based on the U.S. dollar price of gold fails to consider the local impact of different currencies. For instance, if one considers the Canadian or Australian dollar, the gold price fall in these currencies hasn't been as dramatic, and so Canadian and Australian operations haven't been squeezed quite as badly as operations priced purely in U.S. dollar terms.

Mines don't shut simply because they are losing money in the short term. Mines are long-term investments, and their owners have taken and will take steps to further reduce costs.

TGR: Toward the end of last year, hundreds of precious metals stocks reached 52-week lows. Will investors consider this a buying opportunity?

RS: Buying and selling are individual decisions, so it's hard to make sweeping predictions. Investors who take the long view should consider Warren Buffett's advice: Be fearful when other investors are greedy and greedy when other investors are fearful.

TGR: Investors in gold companies are fearful, so what are the critical factors they should consider before buying shares?

RS: We look for good management teams, good balance sheets and projects that are not highly leveraged. Investors should also take care to choose stocks that have sufficient liquidity to allow them to get out, should circumstances change or they change their minds.

TGR: Which junior gold producers today are your favorites and why?

RS: We like smaller Canadian producers because of the currency advantage I mentioned above.

TGR: Could you give some examples?

RS: AuRico Gold Inc. ($AUQ:CA) ($AUQ) and Richmont Mines Inc. ($RIC:CA) ($RIC) are two. Both are well managed and have bright futures. In the case of AuRico, it is currently gearing up its Young-Davidson mine in Ontario. We expect this to be a long-life, low-cost asset.

Richmont is developing a deep, high-grade zone at its Island gold mine. At around 9.5 grams per tonne (9.5 g/t), this zone is almost double the 5.5 g/t of the upper zone that it has been mining. We expect this high-grade will drive strong cash flow and earnings for some time.

Alamos Gold Inc. ($AGI:CA) has $350 million ($350M) cash, no debt and is producing at a profit. Rio Alto Mining Ltd. ($RIO:CA) ($RIOM) is also profitable and can weather the storm. SEMAFO Inc. ($SMF:CA) has no debt and is generating cash. These are companies that could still do relatively well with gold at $1,000/oz.

Teranga Gold Corp. ($TGZ:CA) is producing over 200,000 ounces (200 Koz) annually at about $1,000/oz all-in costs at Sabodala in Senegal. Its balance sheet is somewhat weaker than the companies I've just mentioned, but Teranga is working through that problem. I can see a really good opportunity for returns should it execute its plan, but it might take a little bit longer for this company to get its value reflected in the market.

TGR: Are mining operations in Senegal affected by the Ebola epidemic?

RS: There was only one case of Ebola in Senegal, and now the country has been declared Ebola free. Teranga is on guard against the disease and has secured its supply lines. So Ebola has had no material effect on the operation, but it might have had an effect on market sentiment.

TGR: What are the prospects for production expansion at Sabodala?

RS: Teranga's mine plan is 225–250 Koz annually for 8–10 years. The opportunity to make another discovery, even a game-changing discovery is there, but that depends on the success of the aggressive exploration campaign it is pursuing.

Teranga is a good, solid company with competitive costs. We have an Outperform rating for it, with a 52-week target price of $1.40/share, close to three times its current valuation.

TGR: Which near-term U.S. gold producer are you keen on?

RS: Romarco Minerals Inc.'s ($R:CA) Haile mine in South Carolina is now fully permitted, and its debt is secured. The company still needs to complete its financing, but Haile is shovel-ready. Haile should produce 150–175 Koz per year for 10–12 years. Its reserve is about 2.6 g/t, which means an all-in sustaining production cost of less than $700/oz.

TGR: Until the company suspended exploration in 2013, Romarco was regularly getting outstanding assay results. Now that mine construction is close, will exploration recommence?

RS: Haile has a current gold reserve of 2 million ounces (2 Moz), with a Measured and Indicated resource of 4 Moz. So the possibility of expansion is already contained in the mining plan. Romarco's priority is money. It was successful in organizing a bank syndicate to give it a $200 million ($200M) term sheet, but it still needs to secure an additional $250M or so needed to build the mine. I would expect to see news on that front ahead of exploration news.

We believe that Haile will be built and that it will be a success. We've given Romarco an Outperform rating, with a target price of $1.15/share, which is over an 80% premium over its current share price.

TGR: Which U.S. gold exploration company are you keen on?

RS: We like Castle Mountain Mining Co. Ltd. ($CMM:CA) ($CTMQF) and its Castle Mountain mine in San Bernardino County in California, just over the Nevada border. This is a past-producing mine, in production as recently as 2001, and is still permitted. It has an NI 43-101 resource (at a 0.34 g/t cutoff) of 2.56 Moz gold Indicated and 828 Koz Inferred.

The company is currently working through a feasibility study to decide what scale of operation could be built and at what cost. Castle Mountain has a very capable group of people shepherding this.

TGR: The new chairman, Mark Wayne, was formerly chairman of Alamos Gold. What does he bring to Castle Mountain?

RS: As well as a new perspective, Wayne brings the experience of advancing companies through feasibility and construction to production. He complements what is already a strong team. I know these people quite well, and there is depth across the board.

We rate Castle Mountain Outperform with a $1.75/share target price. This stock currently trades at $0.32/share.

TGR: Which African near-term producer is your favorite?

RS: We've recently resumed coverage of Roxgold Inc. ($ROG:CA). Its Yaramoko project in Burkina Faso is fully financed. This is an extraordinarily high-grade deposit with an Indicated resource of 1.6 million tons at 15.8 g/t for 810 Koz gold.

Roxgold is developing a small underground mine, probably 750 tonnes per day, capable of producing 100 Koz per year, with outstanding exploration upside. All-in cash costs are in the $700/oz range. The internal rate of return we have on its $100M capital expenditure (capex) is 48.4%, a spectacular return on investment.

TGR: How is the political turmoil in Burkina Faso affecting Roxgold?

RS: A popular uprising forced the resignation of President Blaise Compaoré on Oct. 31. The country is currently under martial law. Roxgold just got its exploitation agreement in place with the administration of the interim government. It still needs to have that signed by a sitting president, and is waiting for a president to be appointed from the civilian ranks. This should be imminent. Following that, construction will begin, with production expected toward the end of 2015.

We've given Roxgold an Outperform rating and a 12-month target of $1.35/share, more than double the current share price.

TGR: There's a gold mine currently under construction in Mexico you rate highly, correct?

RS: That's Torex Gold Resources Inc.'s ($TXG:CA) El Limon in Guerrero State. It's a 2.5 g/t open pit with a $700M capex. It's fully financed. Torex has already started the pilot mine, and it is stockpiling ore. Pre-commercial production will begin August 2015, with a nine-month ramp up to full commercial production. That will be over 300 Koz per year at about $700–800/oz all-in cost.

This is a compelling story made even more so because the company has a 5.8 Moz gold equivalent discovery to the south of El Limon, Media Luna. Torex is considering development options that would allow it to bring that forward and combine it with El Limon to enable yearly production of 500 Koz. This is a very well-managed company.

TGR: Guerrero State has been racked by turmoil since 43 students were abducted by police in September. Has this had any effect on Torex?

RS: There is a national and international outcry about this. And it happened only 60 kilometers from the Torex site, so there's heightened security there. We spoke to CEO Fred Stanford. He's mindful of the situation, but it has not affected the company at this stage.

We rate Torex Outperform, with a target price of $2.25/share, a 64% appreciation over the current share price.

TGR: Are any of the companies we've discussed likely takeover targets?

RS: Torex, Roxgold and Romarco all have one asset, and single-asset mining companies rarely remain independent for long. The industry covets low-cost commercial mines, and so the opportunity for acquisitions over the lives of these mines is quite high.

TGR: Given the state of the industry, juniors with deep-pockets joint venture (JV) partners are sitting pretty. Which such junior are you particularly interested in?

RS: Reservoir Minerals Inc. ($RMC:CA), which has a JV on its Timok copper-gold project in Serbia with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). Reservoir has come up with what is shaping up to be a world-class system with fantastic opportunity to the upside.

Freeport has the right to buy 75% of Timok, and in return Reservoir is fully funded to feasibility. I know Simon Ingram, Reservoir's CEO, quite well. He's working with and negotiating with Freeport on an operating JV agreement right now. This is a process that's been ongoing for the better part of a year because Ingram is determined to establish the best possible working arrangement.

TGR: Will Freeport buy out Reservoir?

RS: Well, Freeport certainly has a lot on its plate, but Freeport's CEO Richard Adkerson has recently made it clear just how bullish he is on Timok. So a takeover is possible. That said, I believe Simon and his team will do everything they can to unlock maximum value for Reservoir's shareholders. We think Reservoir brings some welcome excitement to a sluggish market.

We've given Reservoir an Outperform rating with a $9/share target price. As you know, the stock was recently up around $5/share, but now it's back down to $4.15/share. This is an example of the volatility I've spoken of. We see a considerable opportunity for value in Reservoir with continued exploration success.

TGR: What reasons do precious metals investors have to be cheerful?

RS: Investors really have to look at their timelines and determine what's motivating them to put money into any sector and when. Certainly anyone who's been invested in precious metals over the last three years is feeling a lot of pain right now. I understand that, but going back to the famous Warren Buffett quote, fear has become dominant across the entire materials spectrum: gold, silver, copper, iron ore, etc. But the world is not going to stop needing metals.

There are good places to invest, if you have the patience and fortitude to ride out the downturn. When the next bull market begins, returns will be phenomenal. When that's going to happen I leave to a higher authority.

TGR: Ron, thank for your time and your insights.

Ron Stewart, P.Geo., has over three decades of experience in the mining industry and is currently a research analyst of metals and mining with Macquarie Equity Research in Toronto. He was formerly executive vice president at Dundee Securities, CEO of Belo Sun Mining and senior vice president of exploration at Kinross Gold.

Source: Kevin Michael Grace of The Gold Report 

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DISCLOSURE:
1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher ofThe Gold Report, The Energy Report, The Life Sciences Report and The Mining Report,and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Richmont Mines Inc. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Ron Stewart: I own, or my family owns, 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. Within the past year I have visited the material operations and development assets of the following companies mentioned in this interview: Castle Mountain Mining Co. Ltd., Reservoir Minerals Inc. and Romarco Minerals Inc. My company has a financial relationship with the following companies mentioned in this interview: Reservoir Minerals Inc., Richmont Mines Inc., Romarco Minerals Inc., Roxgold Inc., Teranga Gold Corp. and Torex Gold Resources Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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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