It seems to defy logic: Even though gold prices are at historic highs, the stock in many junior gold companies has been languishing. Now is the time to give those shares a second look, says Vishy Karamadam, managing director of Ubika Research in Toronto, which runs the Ubika Gold 50 Index. In this exclusive interview with The Gold Report, Karamadam reveals which companies are poised to announce big news this fall.
The Gold Report: The United States narrowly averted defaulting on its debt obligations at the beginning of this week. What do you make of this high-stakes game of chicken that was played out on the global stage by U.S. politicians?
Vishy Karamadam: It shows the difficult situation in the U.S., and to a similar extent, in Europe. Too many promises have been made to citizens without the resources to deliver on those promises. The debt ceiling is a symptom of the larger problem in all these countries as they deal with, "How do I cut down and where do I cut down?"
For the U.S., it is also indicative of a more fractured political system, which is preventing the debt ceiling from being raised, a fairly routine exercise under Ronald Reagan, George H.W. Bush and George W. Bush.
TGR: Basically, the GOP doesn't want President Obama to have two terms. Politicians put people's livelihoods at risk in order to achieve political goals. Even if this legislation gets the country past this hurdle, doesn't it seem like this system is permanently flawed?
VK: The American system of divided government has served the country well for more than 200 years. The process of raising the debt ceiling, while it looks messy, is the case with pretty much all democratic processes. While there may be political agendas behind it, the U.S. is at a turning point.
TGR: Do you believe a deal will return the gold price to below $1,500/oz. (ounce) as it was before this crisis started to escalate?
VK: If the debt deal is to the liking of the market, there may be a short-term correction. However, larger themes are driving gold prices. One is the inability for many developed nations to manage their government debt. The other is the inflation scenario in emerging economies. Both of these have to play out over many years to come. While the debt ceiling may have an immediate impact, I don't think it will change gold's strong, long-term trajectory.
TGR: In late July, managed money funds increased their net long position in gold to 238,319 contracts, which is approaching the all-time high set in October 2009. Do you put much faith in those numbers when you make projections for gold?
VK: When we make projections, we tend to look at emerging markets. Overall demand for gold is roughly around 1,000 tons per quarter. Most of it is coming from the emerging markets. Gold had traditionally served to fight against inflation. That is a better indicator for gold prices.
We also watch the central banks because they tend to have a long-term view about macro factors. In the first quarter, Mexico added around 100 tons of gold into its reserves. Emerging market central banks are trying to add more weightage to gold. In the previous cycles, central banks were net sellers of gold. Emerging market central banks have around 2% of their assets in gold. That shows that while the price of gold seems to suggest there is a bubble, the portfolios of central banks don't hold a lot of gold yet.
TGR: Since your index, the Ubika Top 50 Gold Index, was launched on Feb. 1, 2010, the cumulative market cap of the 50 junior gold companies in the index has increased to $14.6 billion, or about 80%. That compares to a 36% increase during the same time for its benchmark, the TSX Venture Index. The gains are impressive, but the index is actually down so far this year due to share price declines for some notable juniors and mid-tier explorers.
VK: The index had a better run last year than so far this year. That is partly based on sectoral rotation away from junior gold stocks as some risk aversion has come into the marketplace. While the underlying commodity has been strong, the junior market's drivers are not always correlated with the commodity. I would note that the TSX Venture Index is also down year-to-date. It's not that there is not potential in these companies. It is a general market capital rotation away from junior companies.
TGR: Your index has moved steadily higher so far this month, however. You attribute this to investors turning their attention to relatively undervalued junior miners given the high price of gold. What are some companies that are riding that wave of renewed investor interest?
VK: One company showing signs of promise is Rye Patch Gold Corp. (OTCQX:RPMGF). It's an excellent example of an undervalued gold junior with around 4 million ounces (Moz.) in Nevada, which probably is the safest jurisdiction for gold with so many acquisitions happening. It had some fantastic new drill results that could increase the resource estimate by more than 5 Moz. by the end of the year. Now that some of these companies have hit their lows, there is some interest in getting back into those quality juniors like Rye Patch.
Another example of a quality junior is Lexam VG Gold Inc. (OTCQX:LEXVF). It is a Timmins gold camp (in Northern Ontario, Canada) play that went through a correction when all the gold juniors were going down, but it is seeing some new interest. Quality gold juniors with strong resources located in safe jurisdictions with capital to expand those resources - particularly those that can advance and develop the projects - will start to see some interest in the fall.
TGR: What sort of news are you looking for after Lexam VG Gold's summer exploration program?
VK: After the merger between Lexam and VG Gold, the company had a strong balance sheet with more than $15M. It has a $10M exploration program this year. Four rigs are turning and the company is trying to acquire a fifth rig. Between its Buffalo Ankerite, Paymaster and Fuller properties, there is a lot of resource to come. The company issued some good results recently, but the market did not fully appreciate it. It was a fairly significant development of high-grade gold in a new mineralized zone within the Buffalo Ankerite property. If it can continue those types of results, Lexam VG will have room to increase its resource estimate in the coming year.
TGR: Are there some other companies that offer value at their current price positions in the market?
VK: A number of companies we cover have taken a hit and come down in value. They are ripe for a re-rating of the stock and investor interest to return. La Quinta Resources Inc. (OTCPK:LQRCF) is a Nevada gold junior company which is exploring the Easter property. It has found some good mineralization extension of its current zones. The company has 110,000 ounces (Koz.) in the indicated category right now, but it has promise of extending the mineralized zone. With the current drill program, the company could see some improvement in its resource estimations and that will start being reflected in the share price.
LaQuinta has a joint venture with an option to own from Pilot Gold Inc., which was spun out of Fronteer Gold Inc. (FRG) after its acquisition by Newmont Mining Corp. (NYSE:NEM). If the company can show some promise of a half-million to a million ounces, we think La Quinta will have a good chance of being taken out by Pilot or a company of that caliber.
TGR: La Quinta has had some trouble raising money. Have those issues been taken care of?
VK: It did have some challenges raising capital, but they have raised enough capital to continue with the current drill program. Interest in the stock should increase as results start coming in. It has already made some moves from its lows as the drill program has gotten underway.
TGR: What about Meadow Bay Gold Corp. (OTC:MBYCF)?
VK: Meadow Bay is another interesting Nevada play. It acquired the Atlanta Gold Mine project. The advantage of this project is that it is not a greenfield project, so the company is not starting from zero. It does have a lot of data from the past ownership. Kinross Gold Corp. (NYSE:KGC) had already estimated an internal resource of close to 0.5 Moz. within the Atlanta project. On top of it, Meadow Bay also acquired a lot of infrastructure. The company paid approximately $6M as part of this Atlanta Gold Mine project acquisition, when the replacement value of the current infrastructure on the site could be easily $20M to $25M.
TGR: You said in a research report on Meadow Bay that there would be medium-term cash flow. Will that come from Atlanta?
VK: The company's goal is to commence small-scale production in the medium term. The company believes it can get a medium-term production scenario with an open-pit because it has infrastructure already there. The company is currently working toward making the resource compliant and expanding it to 1 Moz. We have a model price of $3.62 and it is currently trading at about $1.
TGR: NWM Mining Corp. (OTCPK:NWMMF) has the Lluvia de Oro and La Jojoba projects in northern Mexico, very close to the border with Arizona. It just launched small-scale production in June of 303 oz. Can you tell us about that company?
VK: It's an interesting story, which is on the cusp of moving from an exploration company to a production company. It's aiming to produce around 12 Koz. this year and close to 40 Koz. in 2012. The Lluvia-Jojoba project is a fairly large land package of more than 5 kilohectors. The gold reserve is around 384 Koz. It is currently implementing all the project work to get going on a production scenario and that process is already well underway.
The company has a good management team. The chief operating officer, who ran the Mulatos Mine for Alamos Gold Inc., is now managing NWM's mining startup operations.
While the company is ramping up production, it also has simultaneously identified multiple areas of high-grade mineralized zone. That could help NWM to get to the 1 Moz. resource mark.
At that point, NWM could become an attractive target for other junior gold producers. The closest is Timmins Gold Corp. (OTC:TMGOF). Capital Gold, which was also in the neighborhood of NWM, was in a bidding war, and was taken out by AuRico Gold Inc. (NYSE:AUQ). Timmins Gold lost that battle. Timmins is waiting to find another junior gold miner to add to its production. NWM is in the same neighborhood. It would be an easy consolidation target. The only challenge is that it has a lot of shares outstanding at 400 million, making it a bit harder to move the price.
TGR: It produced 303 oz. of gold in May and expects to produce between 10 Koz. and 14.5 Koz. for all of 2011. Next year, the company forecasts it will produce between 35 Koz. and 42 Koz. Do you think that is realistic?
VK: It is realistic because it basically has two deposits. Right now, it is bringing one online. Over time, it will bring the next one online. With heap leach operations, companies have to get a lot of ore on the pads and the production kicks in down the road. It is quite possible as NWM is building all the leach pads to get the ore on there and then will have a fairly significant capital infrastructure already in place to get the leach going. I think it is a realistic scenario.
TGR: Chris Berlet, president and chief executive of NWM, comes from your side of the business: He was once an analyst. What do you think about the management team of NWM?
VK: The company has put a good team in place. The mine operation is headed by John Van De Beuken, the chief operating officer in charge of Mexico mines. John is a veteran of producing heap leach mines and is quite experienced in mine start-up and production scenarios. The company has a good team in place locally to achieve the production scenario it is projecting, which is what gives us the comfort that they could hit those production numbers.
TGR: Atlanta Gold Inc. (OTCPK:ATLDF) is developing a gold-silver project in Atlanta, Idaho. The company has outlined more than 1 Moz. of gold in all categories and it is hoping to expand its resources with further drilling. What more do you know about the company?
VK: Atlanta was a past-producing property. Atlanta Gold has improved the resources significantly after its 2010 drill program. It now has around 1 Moz. of gold and gold equivalent. The interesting thing is 719 Koz. are in the higher indicated category. The average grade for the resource is fairly high as well at over 3.45 grams per ton (gpt). These are fairly impressive numbers for a junior gold exploration company.
The company delivered everything it set out to do in 2010, which gave us good confidence in the management of the company. The board and management have broad and deep experience, which you don’t normally see at junior gold companies.
The only downside is that it has close to 150 million shares outstanding, which could be acting as a drag on the stock price. The market hasn't fully reflected what the company has delivered in its share price.
TGR: What is going to take Atlanta to the next level?
VK: Atlanta is continuing with a fairly aggressive drill program. The company will look to raise its resource estimate further. It's also simultaneously working on getting into a production scenario in two to three years. Catalysts for investors in Atlanta Gold will happen as it develops projects and hits milestones. The company has strong exploration potential and an opportunity to expand and upgrade resources as it continues to drill at various targets.
TGR: Are there any other junior gold companies that have a good chance at publishing favorable drill results from their summer programs?
VK: HY Lake Gold Inc. has assembled a fairly impressive property package in the Red Lake District, one of the premier gold districts in Canada. That district literally made Goldcorp Inc. (NYSE:GG) what it is today. Hy Lake's flagship property is the Rowan Property, which is a joint venture with Goldcorp. This is one of the rare junior companies that has a fully earned joint venture with Goldcorp where Hy Lake owns 60%, while Goldcorp only owns 40%. It has been hitting some really good grades and found a number of vein systems that it is exploring further. The company will have a lot more drill results to come this year as it is implementing a fairly aggressive drill program both on Rowan and two other properties that it owns outright. Hy Lake is significantly undervalued compared to the better known Red Lake District junior gold companies.
TGR: If it's undervalued, what has held the stock back?
VK: The drag on Hy Lake's stock is likely because it's listed on the Canadian National Stock Exchange, which is not as well known as the TSX Venture or the Toronto Stock Exchange. The company is currently working to move to a bigger exchange. That should substantially improve the profile of the company because the underlying property, the assets and the location are fantastic.
TGR: Do any other companies have promising drill results expected later this year?
VK: Eagle Hill Exploration Corp. could deliver some good results and news flow in the latter part of this year. It is developing the Windfall Lake project in Val d'Or, Québec, which it acquired from Noront Resources Ltd. Noront had already done a lot of work on the project, but Eagle Hill further developed it with a 10,000m drill program last year. It will do another 6,500m drill program soon. The company has identified more than seven mineralized zones, and found fairly high-grade gold near surface. More important, all of them seem to be open. The company engaged SRK Consulting to come out with a resource estimate. Looking at all of the results and our research, we believe that they could come out with a substantial resource deposit right away. Another very interesting thing about this potential deposit is that it could be relatively high grade as Eagle Hill has obtained some very impressive high grade results during the drilling undertaken over the last 18 months. That is a significant development for a junior company to come out with a big resource number right off the bat. Eagle Hill seems to have all the data points to get there. Investors should watch this company.
TGR: Give us one more company that you follow and we will leave it at that.
VK: Another interesting company that we follow is Focus Gold Corp. It is focused on acquiring and developing gold mining properties primarily in the Americas. The company’s flagship project is the Huicicila project in Mexico in the state of Nayarit (over 29,000 hectares), which is in the same region where upcoming junior gold producers such as Capital Gold (now owned by AuRico Gold are active. The company recently filed an updated NI 43-101 technical report on this project that suggests that this property could be hosting a buried porphyry copper-gold system. Porphyry deposits are generally very large in scale and potentially contain enormous amounts of gold and copper, providing economies of scale for large operations. As the company pursues a focused exploration program and finds more evidence of such a deposit, the valuation for the company can increase significantly. Focus Gold's market value is currently at only $25M. This clearly does not reflect the potential ownership of a porphyry deposit system and can increase substantially if the company can successfully establish such a deposit.
TGR: Excellent. Do you have some parting thoughts for us?
VK: Junior gold companies haven't been so good for investors this year, but investors should focus on finding high-quality junior companies developing projects with good management. Those types of companies are not a bad place to park some investment dollars because they will be rewarded eventually.
Vishy Karamadam, co-founder and director of Ubika Research, has over 15 years of management experience in corporate finance, management consulting, customer knowledge management and retail banking strategy. He has worked for blue chip organizations in Toronto, Canada and India. He is focused on investment research, content management and advanced analytics for Ubika Research. He holds a Bachelor in Technology degree in electronics and communication engineering, Masters in finance from University of Mumbai, India, and an MBA from McGill University, Montreal, Canada. Vishy was a recipient of McGill International Student Scholarship.
Ubika Research specializes in small-cap companies where market capitalization amounts to less than $500 million and offers fresh and timely market insights to end investors and market participants. Ubika Research provides access to all research reports and investment ideas through the exclusive online destination SmallCapPower.
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/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: Lexam VG Gold Inc., Timmins Gold Corp., La Quinta Resources Inc.
3) Vishy Karamadam: I personally and/or my family own shares of the following companies mentioned in this interview: Hy Lake_Gold Inc.
4) Ubika Research has received fees from the following companies mentioned in this interview to provide analyst research coverage: Lexam VG Gold Inc., Hy Lake Gold Inc., NWM Mining Corp., Atlanta Gold Inc., Eagle Hill Exploration Corp., Focus Gold Inc., Meadow Bay Capital Corp., Rye Patch Gold Corp. and La Quinta Resources Corp. Ubika Corp. also has an agreement in place to receive shares and/or options from the following companies mentioned in this interview: Hy Lake Gold Inc., NWM Mining Corp., Focus Gold Inc., Meadow Bay Capital Corp., Rye Patch Gold Corp. and La Quinta Resources Corp.