2 Gold Juniors Trading At Massive Discount To Peers

| About: Red Eagle (RDEMF)


While gold has pulled back 5% the past two weeks, the junior gold miners index has fallen 12% from its 52-week high.

Gold juniors continue to significantly outperform the gold miners as speculation is rampant due to continued M&A activity in the sector.

Despite the average GDXJ component having corrected by over 10% since early July, Atlantic Gold and Red Eagle Mining have made new 52-week highs.

As gold digests its Brexit gains, most gold miners have spent the past two weeks retreating from their 52-week highs. The mild correction they've undergone is nothing to be alarmed about, given the fact both the GDX and GDXJ have doubled already this year. While many precious metals investors are looking for bargains in miners with the largest pullbacks, I am doing the opposite. My current pursuit is for junior miners that are making new highs while gold and GDXJ are busy consolidating. The rationale behind this is two-fold. The first reason is that if these stocks do not need a rising gold price to make new highs, they should perform even better if gold does continue higher. The second reason is that as these stocks are not as correlated as much as others to the GDXJ, they are likely to continue higher with or without gold's help.

After several hours of digging, I've come across two junior miners that are relatively underfollowed and extremely undervalued. While neither company boasts the large deposit sizes I usually highlight, both companies provide great value given how far through the development stage they are currently. The companies which caught my attention and continue to defy gravity despite gold's pullback are Atlantic Gold Corporation (OTCPK:SPVEF) and Red Eagle Mining (OTCQX:RDEMF).

Atlantic Gold Corporation: Eastern Canada Gold Explorer

When you think of Canadian gold exploration, there are two provinces that come to mind, Ontario and Quebec. In both provinces, there are several different mining camps where miners are currently situated and juniors have surrounded them with prospective mining claims. Atlantic Gold does not fit this bill at all as it has done what most gold juniors would not even consider, and set up camp in the eastern provinces in Nova Scotia. In the third quarter of 2014, Atlantic Gold acquired and consolidated several development properties in Nova Scotia. The company took ownership of four known open-pittable deposits: Touquoy, Beaver Dam, Cochrane Hill and Fifteen Mile Stream, one of which (Touquoy) already has all majors permits in place. The company has since completed a feasibility study on its Moose River Consolidated Project (MRC), which comprises the Touqouy and Beaver Dam deposits. Atlantic Gold has also completed a definitive credit agreement with Macquarie Bank and Cat Financial for a project loan facility that will fund the majority of the construction costs at its MRC project.

Moose River Project - The company's Moose River project is comprised of both the Touquoy and Beaver Dam deposits and is the most advanced of the company's deposits. The feasibility study completed last year has shown the potential for an eight-year mine life with an annual production rate of 87,000 ounces a year. The all-in sustaining cash costs during the mine life are exceptional at $690/oz, well below the average all-in sustaining cash costs of junior miners acquired thus far in 2016. The feasibility study has also shown capex for the project of a meager $137 million. The MRC pit design is for a mid-grade open-pit mining operation with an average head grade of 1.44 grams per tonne gold. The operation will provide significant cash flow for Atlantic Gold and allow it to continue exploration at its Cochrane Hill and Fifteen Mile Stream deposits while seeking out potential acquisitions in close proximity to its Touqouy central processing facility.

Cochrane Hill Deposit - Atlantic Gold's Cochrane Hill deposit is its second most advanced deposit, which currently hosts a resource of 550,000 ounces of gold at an average gram of 1.7 per tonne. The company completed a preliminary economic assessment on the project in 2014, which showed very robust metrics. The PEA showed the potential for an eight-year mine life with annual production rates of 141,000 ounces a year. The PEA was done assuming the use of ounces from the Moose River Project, therefore it is unlikely there will be a mine built at Cochrane Hill as Moose River has made Cochrane Hill obsolete. Instead, it can be expected that the Cochrane Hill deposit will add six years of mine life at Moose River once all of the resources are moved to reserves.

Fifteen Mile Stream Deposit - The company's Fifteen Mile Stream deposit is located 57 kilometers from Touquoy by road and has seen over 30,000 meters of drilling completed on the property to date. The deposit currently hosts a resource of 584,000 ounces of gold at a grade of 1.55 grams per tonne gold. The property is relatively unexplored and will see further drilling to test the deposit on strike and down dip from the current resources.

Atlantic Gold Corporation has 220 million shares fully diluted giving it a current market capitalization of $174 million. The company has $40 million in cash, which, subtracted from its market capitalization, leaves it with an enterprise value of $134 million. The company is expecting construction to commence immediately now that all financings are complete, with commercial production at its Moose River Project slated for Q4 2017. The company continues to explore all four of its deposits with the goal of extending the eight-year mine life at its MRC project.

Red Eagle Mining

Red Eagle Mining is a Colombian junior miner currently developing its 100%-owned Santa Rose Gold Project. To say the company has fast-tracked its junior-producer life cycle would be a massive understatement. The company is currently on track to see only a five year gap between its first discovery hole on the property to its first gold pour, a very rare occurrence for any gold company. Red Eagle is expecting initial production Q4 of this year, with construction currently over 70% complete. This is the first South American gold company I have covered and is a very rare occurrence for me. I normally stick to North American gold juniors, but believe Red Eagle is a special situation where it's worth leaving my usual top mining jurisdiction comfort zone.

Red Eagle's high-grade Santa Rosa deposit is situated in between Continental Gold's (OTCQX:CGOOF) Buritica deposit and B2Gold's (NYSEMKT:BTG) shared Gramalote deposit. The deposit currently hosts proven and probable reserves of 405,000 ounces at 5.20 grams per tonne gold. In addition, the deposit holds a resource of over 610,000 ounces at an average grade of 3.3 grams per tonne gold. The feasibility study completed on the project in 2014 showed the potential for an eight-year mine life with an annual production rate of 70,000 ounces a year. The all-in sustaining cash costs for the mine were anticipated at $758/oz with an average head grade of over 6.5 grams per tonne gold. The feasibility study provides a payback period on the initial capex of a measly 1.5 years using a gold price of $1,300/oz. Since the feasibility study, all-in sustaining cash costs have been estimated to be below $700/oz, well below the average of $782/oz for gold juniors acquired this year in acquisitions.

In addition to having more robust economics than most of the acquired juniors thus far in 2016, Red Eagle is significantly undervalued compared to its peers. While Red Eagle is the smallest scale producer of the five companies shown above, this does not justify such a massive discount. The company's current enterprise value based on 233 million shares outstanding is $190 million. As shown by the table below, the company trades at less than a 3x multiple for 2017 price to cash flow, less than half of its closest peer. Of its peer group that it does compare, Red Eagle is arguably is in as unfavourable of a jurisdiction as Australia or Burkina Faso, neither of which is much more geopolitically stable than Colombia.

Red Eagle will be a 70,000 ounce high-grade producer as of late 2016 and should pump out significant cash flow to aid in exploration activities to test multiple other targets across its Colombian land package. The current resource is located within the first 200 meters from the surface, and the shear zone remains open down dip and to the east. With a relatively unexplored property and several other magnetic anomalies left to drill, it is very possible for Red Eagle to prove up another 1 million ounces on its land package over the next two years. Red Eagle's operational excellence moving from explorer to producer in less than a five-year span cannot be ignored, and there continues to be huge potential for the company going forward.

Red Eagle & Atlantic Gold Compared to 2016 Acquisitions

I have compiled the below table to aid in comparing current gold juniors to those acquired thus far in 2016. Instead of looking at all acquisitions over the past five years, I believe it makes much more sense to look at recent acquisitions as they are much more indicative of what future M&A deals should look like. Given that gold is trading at the lower end of its five-year range, I find it more relevant to look at gold companies being acquired at current levels, than those acquired with gold near record highs. Below is a table showing all of the acquisitions of the past six months in addition to the two gold companies profiled in this article:

Looking at the table, we can see that Atlantic Gold Corporation is being valued at roughly $61/oz based on its 2.2 million ounces of gold across its four deposits. This figure is almost half the average valuation of Canadian acquisitions this year. While Atlantic Gold's average grade of 1.5 grams per tonne gold is less than half of the average grade of other Canadian takeovers in 2016, the company is closer to production than any of the other companies taken over in 2016, with the exception of Lake Shore Gold (NYSEMKT:LSG). I believe the company's discount is not justified at all at current prices and expect to see the company receive a re-rating with a market capitalization of closer to $300 million once it begins production. This would represent nearly a double in share price over the next year with production slated for late 2017.

Looking at Red Eagle Mining at first glance, it may seem that the company is overvalued compared to its peers. The average international valuation per ounce is $68.63 at time of takeover, and Red Eagle is currently valued at $155.73 per ounce of gold. I believe Red Eagle's higher priced valuation per ounce is more than justified when compared to Amara Mining (OTCPK:CLUGF) and Goldrock Mines (OTC:MFMNF). For starters, Red Eagle's grades are 300% higher than the majority of its international comparisons. In addition to this, Red Eagle's all-in sustaining cash costs are almost 20% lower than its international comparisons to past acquisitions. This shows that Red Eagle is a higher-grade and higher-margin gold producer and should not be placed in the same category as Goldrock Mines, Amara Mining and True Gold Mining (OTCQX:RVREF). I expect Red Eagle to also receive a re-rating upon the beginning of its commercial production to a $300 million market capitalization, a 30% jump in current share price by the end of this year.

Risks Associated With My Thesis

Both Atlantic Gold Corporation and Red Eagle Mining are micro cap gold juniors with market capitalizations sitting around the $200 million level. There are always risks in investing in smaller junior gold companies as future financing potential and declines in the gold price can be very detrimental to the company's wellbeing. Fortunately, for these two companies unlike most other micro-caps juniors, they are both well financed with over $35 million in their treasury. These substantial cash positions allow them some wiggle room while moving into the construction phase of their life cycle in case there should be any hiccups during the process.

In terms of risk with the price of gold, both companies have industry-leading all-in sustaining cash costs. Even with a dip to the $1,000/oz level, both companies would still be seeing $300/oz margins on their gold sales as their all-in sustaining cash costs come in at the sub-$700 level. Atlantic Gold has gone a step further and hedged over 1/3 of its eight-year mine life (215,000 ounces) at an average gold price of $1,500/oz. This means that despite where the price of gold goes over the next three years, Atlantic Gold will have 215,000 ounces of gold sales secured at the $1,500/oz level. Red Eagle Mining has not done any hedging and thus is exposed to the gold price on both advances and declines. Having said that, its all-in sustaining cash cost is at a very reasonable level and it is currently working with nearly 50% margins. Should these margins erode in the future, the company still has lots of leeway in terms of staying profitable as a producer. Red Eagle Mining would be in serious trouble and likely have to shut down operations if the gold price moves to the $600/oz level, but the same can be said for 99% of gold producers in the world, and I don't see the price of gold even touching the $1,100/oz level in the next two years.

The one worry for me about Red Eagle Mining is its deposit size. While it does have a very high-grade resource of over 1.2 million ounces, it would be nice to have some confirmation of gold mineralization at its soon-to-be-drill-tested targets. There is always the possibility that these targets will not show any favorable gold bearing mineralization and the company will be unable to prove up a larger resource. Having said this, the company is still moving forward to produce for eight years at a run rate of over 70,000 ounces a year. This will provide substantial free cash flow to the tune of well over $50 million after tax over the mine life. The main risk involved with Red Eagle Mining is its ability to prove up a larger resource so it can extend beyond the current eight-year mine life. While I am confident that it will be able to find at least one magnetic anomaly (of the three on its property) that shows favorable mineralization, if the drill targets all come up empty, this could affect the share price moving forward. Red Eagle Mining will still continue as a junior gold producer, but this would significantly cap its future as a gold producer after the year 2024.

Technical Outlook and Summary

Looking at the technical side of things, both companies are sporting very impressive charts. Red Eagle Mining has currently broken out to new 52-week highs and is consolidating above its recent resistance level. We can expect to see the stock base at this level before continuing to trend higher, and it can be noted that it is doing this while most other gold companies have fallen 10% from their highs.

Atlantic Gold has spent most of the year going sideways, but has recently broken out to the upside over the past two weeks at $0.73 CAD. I purchased the stock at this point and currently have a stop on my position below $0.55 CAD on a closing basis. We can expect to see Atlantic Gold find support at the $0.70 cent level where it broke out of after three months finding resistance at this level. If the $0.70 level does not hold, the uptrend line made from connecting the lows thus far this year comes in at the $0.69 level and should also act as strong support going forward.

Looking at the below GDXJ chart, Atlantic Gold and Red Eagle are charted beside it with line charts. Atlantic Gold is represented by a pink line and Red Eagle by an electric blue line. As you can see, while GDXJ has pulled back the past two weeks, these two companies have done the opposite and made new highs. This is extremely bullish and shows their resilience in a time when the price of gold has come under some pressure.

I believe both of the companies highlighted in these articles to be takeover targets due to the depressed valuations they are currently trading at. While many people will criticize me for buying these stocks while they are up over 100% this year, I have used this same strategy to buy several stocks already this year, and my current portfolio is up 24% year to date using this same strategy. I employ a Turtle Trading strategy in my portfolio, which enters new long positions on new 55-day highs, and exits them when their uptrends are invalidated. I have included a snapshot of my current accounts below to show my money is where my mouth is as I am currently holding significant gains in several miners and not taking profits. I believe profit targets are profit limiting and only sell my positions when the trend is broken.

While Red Eagle Mining and Atlantic Gold may not have the most glamorous massive deposits that some juniors that I have highlighted this year share, they are significantly undervalued compared to their peers. I believe the current entries provide a depressed valuation into companies which are moving into production and can expect a re-rating over the next 12 months. I do not believe either company's deposits are impressive enough for gold majors to want to take them over solely for their assets. Having said that, at the valuations they are currently trading at, these companies are a steal to any suitors. I would not be surprised to see them taken over on a purely valuation basis if they do not see a re-rating in the near future.

Disclosure: I am/we are long SPVEF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have included the Canadian charts for these stocks in the article as I believe they are much better for trading given the increased volume and cleaner charts which give a better idea of support and resistance levels. If you liked this article and found it useful, please feel free to follow me by clicking on my name next to my avatar at the top of this article. I also invite you to check my performance at TipRanks.com where my average return this year is 60% on new long positions.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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