- In the recent past, companies paid too much attention to the size of resources and potential scales of production.
- It would be difficult to find another junior gold project as good as Fekola. It has 5.15 million ounces [5.15 Moz] at 2.4 grams per ton [2.4 g/t] with good.
- Many companies on the Australian Stock Exchange, the TSX Venture Exchange and London's AIM exchange are not going to make it, and that consolidation will be a good thing.
With gold hovering around $1,300 an ounce, there's not much room for error, says Duncan Hughes of RFC Ambrian. In this interview with The Gold Report, Hughes counsels that investors should seek high-grade, low-cost projects with exploration upside in stable jurisdictions. He suggests three such companies in West Africa and another with silver, gold and antimony resources in Chile and Australia.
The Gold Report: After hitting $1,380 an ounce [$1,380/oz] in March, gold fell below $1,300/oz and has hovered around there since then. Do you expect the price to change much either way in the next few months?
Duncan Hughes: That's not easy to predict. I think $1,300/oz seems a sensible assumption for 2014. If it were to fall much below that, most of the sector would be operating at a loss.
TGR: Assuming a gold price of $1,300/oz, what are the qualities that will distinguish the junior gold companies that become successful?
DH: In the recent past, companies paid too much attention to the size of resources and potential scales of production. The focus now is profitable production scenarios. Low-cost producers and undervalued developers that look likely to become low-cost producers are the key for investors.
One way to achieve stronger profit margins is through higher-grade ore bodies. Grade has always been king but is now even more so. Low-cost producers are not only most likely to survive this difficult market; those making profits may also pay dividends. Given that share-price appreciation is more challenging than previously, dividends have become more attractive.
TGR: To what extent should investors restrict themselves to companies with management teams with winning track records?
DH: If I were an investor, I'd look for management with a track record. If management doesn't have that track record-not only finding mines but bringing them to production-then the asset is the overriding factor. If the asset is strong enough, I'd want board members with a nice mix of technical skills-a geologist, an engineer, perhaps even a metallurgist-complemented by members with financial skills and access to equity and debt finance.
TGR: After rejecting a bid from Osisko Mining Corp. (OTCPK:OSKFF) has agreed to a friendly takeover by Yamana Gold Inc. (NYSE:AUY) and Agnico-Eagle Mines Ltd. (NYSE:AEM) . Does this battle over Osisko suggest we will see an increase in mergers and acquisitions [M&As]?
DH: There have been rumors about Barrick Gold Corp. (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM) getting together. I do anticipate an increase in M&As in the gold space. Capital expenses [capexes] are generally smaller there, as compared to the iron ore space, where they run into the billions.
Many gold explorers are looking to reinvent themselves to stay alive. Companies with projects but no money will look for companies with cash but no projects and vice versa. There are a lot of opportunities out there at current pricing.
TGR: Which type of company is most likely to be taken out?
DH: Because funding is much harder to secure than it once was, the main focus will be developers with strong projects that require significant initial capital expenditures. We saw this with the takeover of PMI Gold Corp. by Asanko Gold Inc. (NYSEMKT:AKG) . Asanko had a large cash balance, and PMI had a good project. Other examples would be Endeavour Mining Corp.'s (OTCQX:EDVMF) buyout of Adamus Resources Ltd. for its Nzema project in Ghana and B2Gold Corp.'s (NYSEMKT:BTG) acquisition of Volta Resources Inc. for its Kiaka project in Ghana.
We're also seeing this in the Australian junior space. Gold producer Northern Star Resources Ltd. (OTCPK:NESRF) has recently acquired Barrick's West Australian gold assets.
TGR: Are there any likely takeover candidates among the companies you cover?
DH: Two quality juniors with good projects facing capex challenges are Papillon Resources Inc. (OTCPK:PAPQF) and its Fekola project in Mali. Fekola will cost about $300 million [$300M] and Natougou about $200M. It would have been pretty easy for these companies to have found such financing in 2007, but it's difficult now.
The likes of Randgold Resources Ltd. (NASDAQ:GOLD), Endeavour or B2Gold might be looking at these opportunities.
TGR: Is there a capex sweet spot for these midlevel project takeovers, $200-300M, perhaps?
DH: That sounds about right. Papillon's market cap is $416M, so when you add the takeover premium, you're getting up there.
TGR: What's your top Buy recommendation?
TGR: You called Papillon's Fekola gold project in Mali "good." How good is it?
DH: It would be difficult to find another junior gold project as good as Fekola. It has 5.15 million ounces [5.15 Moz] at 2.4 grams per ton [2.4 g/t] with good metallurgy and low strip ratios. It could be mined from one open pit, and recent company work has suggested that there may be opportunities for shallow satellite pits as well. Production is forecast to begin in 2017: 320,000/oz per year over the first 11 years at an all-in cost of $740/oz.
And Papillon has strong management. Mark Connelly is the CEO. He worked at Adamus and has developed projects from exploration through to production. The non-executive Chairman, Ian Middlemas, has a strong track record of developing projects to the point of being taken out. Fekola is close to Randgold's 17.9 Moz Loulo-Gounkoto projects, AngloGold Ashanti Ltd.'s (NYSE:AU) 13.1 Moz Sadiola project and Endeavour's 3.8 Moz Segala/Tabakoto project. Given Middlemas' track record, I would say that Papillon has to be a target.
TGR: How should investors balance potential reward and risk in West Africa, specifically with regard to the various gold-producing jurisdictions?
DH: Several years ago, gold companies in West Africa traded at a premium because of the excellent exploration opportunities engendered by the geology. Since then markets have changed, and investors have become risk averse. In Africa, we have seen the Arab Spring, a push for nationalization and the coup in Mali. These events remind investors that the African political landscape is not as secure as some other parts of the world.
But the geology of the Birimian Greenstone Belt hasn't changed. A number of countries, such as Côte d'Ivoire, Liberia and Burkina Faso, have vast fortunes in land that is still relatively underexplored. Ghana has a track record of political stability and stable gold production. Next door, in Côte d'Ivoire, which lacks this stability, there is the same geology but many fewer mines. Guinea is working through a new mining code, and I would say that it is still a risky place to consider.
Burkina Faso, on the other hand, is a great place. It has got seven gold mines coming into production there.
TGR: Liberia was considered a failed state for decades. How great has its recovery been?
DH: I see real opportunity there. It's like Burkina Faso, at an earlier stage of development, obviously. I visited after the 2011 election, which was peaceful. Ellen Johnson Sirleaf, who won the Nobel Peace Prize that year, was re-elected.
I met the minister of mining and came away with the feeling that the Liberian government is very supportive of mining. Before the political strife began in 1980, Liberia was a significant iron ore producer and retains that infrastructure.
TGR: Which gold company in Liberia do you rate a Buy?
DH: Aureus Mining Inc. (OTC:ARSMF) is looking to bring Liberia's first gold mine, the New Liberty mine, into production in Q1/15. The government demonstrated its support of the company by amending its mineral development agreement and reducing the corporate tax rate from 30% to 25%, while reaffirming the 3% royalty.
The government takes a 10% free carry. This is typical in West Africa. New Liberty's license has been affirmed for 13 years, which is more than Aureus needs based on current reserves.
TGR: Aureus closed a $15M offering April 22. What's the significance of that?
DH: I wasn't expecting it because the company went to the market late last year to raise money for exploration. That made sense because Aureus has excellent exploration upside. Going back to the market now suggests that it might be falling slightly short of the $125M New Liberty capex requirement. I would hope that only a small part of the $15M financing will be needed for New Liberty and that the rest will be used for exploration.
TGR: What's the size of the resource at New Liberty?
DH: It is 924 Koz at 3.4 g/t and a quite high strip ratio. According to the definitive feasibility study, the mine is expected to produce 119 Koz annually for the first six years of production at $900/oz. This should be a profitable operation.
TGR: That's a short mine life. How much exploration potential do you see?
DH: A lot. Not necessarily at New Liberty itself but instead at Aureus' Ndablama project about 40 kilometers away. In that part of the world, that's probably a bit too far to truck to New Liberty, but what's exciting about Ndablama is that it is shaping up to be another standalone gold operation. New Liberty is the present, but Ndablama is probably the future.
TGR: SEMAFO (OTCPK:SEMFF) has had a great deal of trouble in recent years, and in response the company has consolidated its operations. SEMAFO is pretty well just Mana now. How much difference will this make?
DH: I think it will make a difference. SEMAFO Inc.'s other operations in Niger and in Guinea were not the big picture; Mana has always been the prize asset. It's a great project: 2.3 Moz at a pretty good grade of 2.8 g/t. The question for the company is whether its billion-dollar market cap can be justified based solely on Mana.
TGR: Sticking with Burkina Faso, how do you rate B2Gold's assets there?
DH: B2Gold, because it has assets throughout the world, which B2Gold acquired from Volta. I think that in this market it would be very difficult to get it up and running.
Kiaka looks to be a project waiting for the gold price to lift substantially because in order to justify the high capex, B2Gold would need to put through a lot of tons to get the economies of scale with the low-grade ore.
TGR: We recently did an interview with analyst Richard Karn and he pointed out that 200 of the 700 ASX-listed mining and resource companies are effectively moribund.
DH: You could make a similar judgment about the TSX Venture Exchange.
TGR: Certainly. Karn argued that the culling of these "zombie" companies would be a positive step. Do you agree?
DH: Yes. Many companies on the Australian Stock Exchange, the TSX Venture Exchange and London's AIM exchange are not going to make it, and that consolidation will be a good thing. As I mentioned earlier, investors in the recent past just looked at the size of a resource and said, "Wow. There's 2 Moz there, and this stock looks cheap." But they weren't looking at the quality of those ounces. I think investors have since wised up. Too late, however, for many companies.
TGR: Some 12 months ago, when it seemed that gold might fall to $1,000/oz, financing pretty much dried up. Now that gold seems to have stabilized around $1,300/oz, has the funding picture improved?
DH: I don't think it has improved that much yet. You said that the gold price seems to have settled, but let's face it, this stability has only existed for a very short time. I think major financiers and the equity markets need to be persuaded that there is a floor of perhaps $1,200-1,300/oz. When this occurs, funding will improve.
TGR: Duncan, thank you for your time and your insights.
This interview was conducted by Kevin Michael Grace of The Gold Report.
Duncan Hughes has been head of research for RFC Ambrian Ltd. in Perth, Australia, since 2010. A geologist, he has more than 15 years of experience in the resources industry and managed the discovery and development of the Prospero, Tapinos and Alec Mairs ore bodies for Jubilee Mines/Xstrata. He worked previously for CD Capital and Linq Capital. He holds a Bachelor of Science [Honors] from Oxford Brookes University and a Master of Business Administration from Imperial College London.
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