Rather than shoot for the stars, Paul Adams of DJ Carmichael argues that junior miners should focus on more modest projects best suited to maximizing shareholder value. This means projects with reasonable capex, good grades and short turnaround times. In this interview with The Mining Report, Adams suggests gold, copper, iron ore and rare earths projects that can weather the complete commodities cycle, as well as a fascinating gold-silver outlier in Peru.
The Mining Report: After over two years of gloom, we're seeing renewed optimism regarding mining equities in North America. Is there similar optimism in Australia?
Paul Adams: There is, but the change in sentiment is pretty much in its infancy down here. We recently undertook some analysis of the returns from the various subindices in the market. The small resources index here in Australia is at about +4.3% for 2014 compared to a -8% return for December. The recent surge in the gold price has certainly helped lift the mood. Newcrest Mining Ltd. ($NM:CA) (NCM:ASX), our largest-cap gold stock, has risen about 63% since its recent lows in December.
The materials sector in Australia is tied closely to sentiment on Chinese growth, and headwinds there tend to have major repercussions. Both BHP Billiton Ltd. ($BHP) ($BHPLF) and Rio Tinto Plc ($RIO) (RIO:ASX) (RIO:LSE) ($RTPPF) have had really strong starts, but they're pulling back a little now as the price of iron ore landed in China has dropped about $10. But those two companies have such a heavy weighting on the materials index that it's really difficult to get a full picture of what's going on.
TMR: With regard to China, how much growth do you foresee?
PA: Five years ago, China's GDP growth was around 12%. Obviously, as the size of the Chinese economy increases, they can't continue growing at that speed. We expect growth in the 6.5–7.5% range for the next year or two.
TMR: What's your 2014 outlook for precious and industrial metals prices?
PA: We think the current gold price is about right, plus/minus $100 per oz ($100/oz). Wobbles in the emerging markets have prompted gold's recent move up into the $1,300/oz range. We're seeing gold coming back as an alternative investment, a bit of a safe haven.
We're relatively bullish on platinum and palladium given conditions in Southern Africa.
TMR: What about silver?
PA: I don't see a major diversion from the current gold/silver ratio.
TMR: How about industrial and critical metals?
PA: The consensus data for the industrial metals generally looks positive for 2014 and into 2015. Obviously, we want to see what effect the Indonesian ban on raw exports will have. That's very important to nickel prices.
Zinc and lead should be reasonably well supported. There is very muted mine supply growth. As the global economy improves, there are going to be some increases in industrial demand for those particular metals. There's softness in the copper market. With the consensus price probably falling below $7,000/ton, inventories are growing. These data are conflicting, however, and copper has a history of staying up longer than many had anticipated.
TMR: You've said that juniors should choose appropriately sized projects in order to have the best chance of generating shareholder wealth. Could you expand on that?
PA: In a post-global-financial-crisis and post-metals-boom world, we're seeing a lot of companies with large projects that can't get financed. Investors today want to see projects that can weather the complete commodities price cycle. Our view is that we would rather see a good management team take on a Tier 2 or Tier 3 project in a good jurisdiction with a reasonable capex and a reasonable timeframe, rather than a Tier 1 project they ultimately won't be able to develop without joint ventures.
TMR: With regard to timeframe, how long is too long?
PA: A project that looks like it's going to take much longer than four to five years to get into production is probably a little bit too far out.
TMR: What's the danger zone for capex?
PA: It depends on the economics of the individual project, but I think a capex north of about $600–700 million ($600–700M) is pretty high. The sweet spot for small companies is somewhere up to $200–250M.
TMR: Is it difficult for mining companies to keep expectations modest? Isn't there a natural tendency to shoot for the stars?
PA: With many mining companies, management has come from majors such as BHP, Rio Tinto or Freeport-McMoRan Copper & Gold Inc. ($FCX). They're used to dealing with big projects and big budgets. There's a degree of relearning when you're in a small company; you have to be quick, nimble and you must count the pennies. There is a tendency to shoot for the stars, with the belief that maybe you'll settle for the moon. But the statistics tell us this isn't likely to happen.
We look for teams that have a measured approach to development because smaller projects are easier to develop without overly diluting shareholders in the process. Some management teams forget about that. They're so intent on making a huge discovery that they forget about the shareholders along the way.
TMR: Which jurisdictions do you like best now?
PA: Certain parts of South America offer good opportunities. We particularly like Chile. The other emerging jurisdiction for Australian Stock Exchange (ASX)-listed companies is the United States. Nevada would certainly be front and center, then Arizona, then parts of Utah and Wyoming.
TMR: Chile is politically and socially stable, but concerns have been raised about infrastructure, in particular, deficiencies of water and electricity. What do you think of this?
PA: We've been to Chile three or four times over the past three years, and water and electricity are major issues. For instance, Barrick Gold Corp.'s ($ABX:CA) ($ABX) Pascua Lama capex has blown up. To get water to the high Andes, it must be pumped from the coast. And if you're not close to existing infrastructure, power costs are a major hurdle.
TMR: What companies do you like in Chile?
PA: We've followed Hot Chili Ltd. (HCH:ASX) for quite a long time now. We like the way management went about targeting its copper projects. Back in 2009, there really wasn't much of a junior presence in Chile. Two or three companies dominated most of the belts, in particular, Corporación Nacional del Cobre (CODELCO). Hot Chili didn't go into the country looking to see what was on offer. It went there with certain criteria in mind. It then sought areas that fulfilled that criteria and found, negotiated and acquired three projects very quietly.
Hot Chili chose projects in the iron-oxide-copper-gold (IOCG) belt. The advantage there over the high Andes projects is stark. They're low altitude, close to the coast and close to infrastructure, so development hurdles will be lower.
TMR: Hot Chili did over 100,000 meters (100Km) of drilling at Productora last year. How productive was it?
PA: Productora has increased in size quite dramatically. If you have a footprint several kilometers long, that requires quite a bit of drilling to get it up to reserve status. The company wants to move its current resource, now mostly in the Inferred category, into the Measured and Indicated categories. And its delineation drilling at Productora has enabled it to do just that.
In addition, Hot Chili made several new discoveries through the application of some very clever geochemistry. That opened up a second front for exploration to keep expanding the resource base and that required further drilling over and above the delineation drilling.
TMR: When can we expect a reserve announcement from Productora?
PA: Very soon. Toward the end of Q1/14.
TMR: The estimates that I've seen for Productora's capex are in the $600–650M range. How will Hot Chili raise that capital?
PA: That's a good question, and I have to note that a capex of this size is pushing our envelope with respect to what we think is appropriate for a small company. But Hot Chili is in a favorable position. The relationship between the company and its major partner in the project, Compañía de Acero del Pacífico (CAP), Chile's largest iron ore producer, is extremely important.
I think we shall see an infrastructure agreement between Hot Chili and Compañía de Acero del Pacífico, which will bring access to port and rail and access to an infrastructure corridor to bring seawater to Productora. An agreement would facilitate capex certainty and perhaps reduce the capex slightly. Of course, it is no secret that there are other majors interested in this project.
TMR: Lundin Mining Corp. ($LUN:CA) owns more than 8% of Hot Chili. How significant is that?
PA: Lundin has been very active in Chile and has a strategy to expand its presence there. Will it be part of Productora at the end of the day? We'll have to wait and see, but we wouldn't be surprised.
TMR: What do you make of Hot Chili's second project, the Frontera copper-gold project?
PA: Like Productora, Frontera is surrounded by Compañía de Acero properties. It has quite a lot of potential to become a project that would feed into this infrastructure hub idea Hot Chili is trying to generate. It's a porphyry deposit, larger than Productora but lower grade. But, again, its geographical location gives it certain advantages.
TMR: What's your rating and target price for Hot Chili?
PA: We rate it a Buy with a target price of $0.99. We think that 2014 is going to be a critical year for the company. We expect that the ownership of Productora will become somewhat more certain.
TMR: Which ASX iron ore project do you like?
PA: Amex Resources Ltd. (AXZ:ASX). It has the Mba Delta Ironsand project in Fiji. Initial capex is about $125M, and in December it secured a $100M debt-financing facility. In January, it entered into a $100M construction and procurement agreement. The project has, in fact, started. We like this because operating costs are less than $30/ton for its product. Mine life stands currently at 20 years, and there is a lot of opportunity to push that out to 45 years.
The Fijian government wants the delta dredged because it will reduce the risk of flooding to the surrounding area. So it's a win-win, really: increasing employment and government revenue, as well as improving the environment. Mba is a really good example of a long-life, cash-producing asset with 100% ownership. This is what we mean when we talk about an appropriately sized project.
TMR: From this side of the world, Fiji is not a name one normally associates with the mining industry.
PA: Recent political events in Fiji have raised concern, but don't forget, Fiji has a very long mining history. Most famous is the Emperor gold mine, which operated for decades. Placer Dome, before it got taken over by Barrick, had a big copper exploration project called Namosi.
TMR: What's your rating and target price for Amex?
PA: We rate it a Speculative Buy with a target price of $2.15.
TMR: Let's talk about critical minerals projects.
PA: One manganese project we liked the look of a couple years ago was Spitfire Resources Ltd. (SPI:ASX) South Woodie Woodie project in the Pilbara district in Western Australia. The company was looking to follow up on its initial exploration success at Contact and Contact North. Numerous lookalike geophysical targets were generated through 2012 and 2013. These were drilled last year, and manganese was discovered.
Management decided subsequently that the exploration necessary to fully assess its numerous opportunities would result in an uncertain outcome, and potentially very dilutionary to shareholders. So the company elected to try and find a partner.
TMR: What's your rating and target price for Spitfire?
PA: Because of pending negotiations on South Woodie Woodie, we rate it a Hold.
TMR: How about rare earth elements (REEs)?
PA: Considering the activities of Lynas Corp. (LYC:ASX) and Molycorp Inc. ($MCP), we believe pricing in the light rare earth elements (LREEs) is going to be soft going forward. So we decided that our interest is only in projects dominated by heavy rare earth elements (HREEs). There are only three or four of those on the ASX.
We've elected to look at Northern Minerals Ltd. (NTU:ASX), which has the Browns Range HREE project in Western Australia. Northern has recently announced a massive increase to its resource base, which is now close to 50,000 tons (50 Kt) contained total rare earth oxides (TREO). That's from a resource of 6.5 million tons (6.5 Mt) at about 0.75%, of which the Wolverine project is the flagship. A Wolverine feasibility study is scheduled for completion in late 2014.
The key to all REE developments is definitely metallurgy. Northern Minerals is blessed with one of the simplest mineral assemblages, dominated by xenotime. So here we have a company with 100% ownership, a fraction of the capex common to its peers and a very reasonable potential timeframe to production.
TMR: I've been told that REE projects that require huge production to become profitable are dubious because of the scarcity of end users. How does Northern stack up in this respect?
PA: The important thing here is the distribution of metals. Molycorp, for instance, does have to move very large amounts of material because the pricing for the lights is relatively soft. They can't produce a lot of HREEs without producing a lot more LREEs. That's the catch-22. But if you have a small, high-grade project like Northern's that is dominated by HREEs, then you get a pricing advantage, and overproduction is not a problem.
TMR: What's your rating and price target for Northern Minerals?
PA: We rate it a Speculative Buy, but don't currently have a price target. We are awaiting results from their pilot project. So far, however, TREO recoveries are looking extremely good.
TMR: Are there any ASX-listed gold producers that have caught your interest?
PA: We look to low-cost gold producers that, again, can withstand the commodity price cycle. In 2006, for example, we took an early position in Medusa Mining Ltd. ($MLL:CA) (MML:ASX) (MML:LSE). Medusa had a high-grade, vein-style system in the Philippines, and its valuation exceeded $1 billion ($1B). Some of the personnel who were involved in Medusa moved to Kingsrose Mining Ltd. (KRM:ASK), which is exploiting a similar, high-grade, narrow-vein deposit in Sumatra in Indonesia called Way Linggo. Its costs after silver credits are going to be somewhere in the region of $300–400/oz, similar to Medusa's.
TMR: Kingsrose trades now at $0.35. That's rather modest considering its outstanding production cost, no?
PA: You're right. Kingsrose currently has a market cap of about $116M. It has made a number of alterations to its milling circuit. It also had a tough year in 2013 following the death of a miner. However, after going through the necessary administrative hurdles, the company now anticipates full approval to recommence its production. We believe that when production begins again, likely in March or April, it will ramp up to its 40 Koz target relatively quickly.
TMR: What's your rating and target price for Kingsrose?
PA: We rate it a Speculative Buy with a target price of $0.60.
TMR: How about ASX-listed gold projects in Brazil?
PA: We had followed Cleveland Mining Co. Ltd. (CDG:ASX) and its Premier gold mine. We liked its team, but we've also seen that Brazil has been very hard for ASX-listed gold producers. I think most of the problems there are geological because the gold tends to be very nuggety and discontinuous in some of these high-grade veins. We want to see Cleveland get a little bit further down the track before we feel comfortable reinitiating coverage.
Orinoco Gold Ltd. (OGX:ASX) has the Cascavel project in Brazil. We're waiting for some further confirmation on its continuity of mineralization. It's very hard to get a grade determination in some of these projects because of the nuggety nature of the gold.
TMR: Any other ASX companies you'd like to mention?
PA: One that has caught our eye is Inca Minerals Ltd. (ICG:ASX). It has the Chanape project in Peru. Several midtier and major mining houses are now requesting site visits and signing confidentiality agreements. So that gives you an indication that there is something going on there. Initial exploration was centered on gold- and silver-rich breccia pipes that outcrop on surface. More than 90 have been identified.
Our view is that these breccia pipes coalesce at depth to some degree, but a hole drilled from surface came up with a 108m interval at 2 grams per tonne (2 g/t) gold and 41 g/t silver. The last three holes drilled have targeted the deeper porphyry parts of the system. Through some really good geochemistry and some geophysics, Inca has determined the vectoring on the central parts of the system. So the indications are that it is getting closer. Hole 11 intersected a 460m-long intersection of porphyry and hydrothermal breccias with the most amount of visible metal seen so far. That tells you they are on the right track. Technical comparisons have been made to the Toromocho project, located 30Km away.
TMR: Whose project is that?
PA: Chinalco (Aluminum Corporation of China Limited) ($ACH). That's a 2.15 billion ton (2.15 Bt) project bought for $750M and currently in construction. Inca is not saying that it has another Toromocho. What it is saying is that it has geological characteristics that display a similar complexity and similar alteration to Toromocho: near-surface, epithermal breccia-style mineralization that overlie a porphyry system.
Inca is ticking boxes with respect to the technical aspects of the project, and that's what has piqued the interest of the majors that now want to have a look. Chanape does not fit our thesis of small companies choosing small projects, but there are always exceptions to the rule. It's early days yet, but this could be quite exciting.
TMR: You don't cover Inca Minerals yet?
PA: Not yet. We've written a couple of short notes on it. We're extremely interested to see where their latest hole comes in with respect to grade. If results are similar to the first, we'll be looking at this company a lot more seriously.
TMR: Paul, thank you for your time and your insights.
Paul Adams is a geologist and head of research at DJ Carmichael. He has 16 years of experience in the mining industry, in Australia and elsewhere, and was previously chief geologist and evaluations manager at Placer Dome's Granny Smith mine. He is a member of the Australian Institute of Mining and Metallurgy and has a Graduate Diploma in Applied Finance and Investment from the Financial Services Institute of Australasia.
Source: Kevin Michael Grace of The Mining Report (3/11/14)
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1) Kevin Michael Grace conducted this interview for The Mining Report and provides services to The Mining Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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