Short Supply, High Demand for Platinum Group Metals: George Topping and Michael Scoon
Source: Brian Sylvester of The Gold Report (7/11/12)
Labor problems and low prices have platinum mines closing up shop in South Africa, and the potential for acquisitions is ripening. Senior Mining Analyst and Managing Director at Stifel Nicolaus in Toronto, George Topping believes that companies with shallow deposits and near-term production will be prime targets. In this exclusive interview with The Gold Report, Topping and Associate Analyst Michael Scoon discuss how supply shortages are shaping the landscape for platinum group metals and some bulk commodities.
The Gold Report: George and Michael, we're here today to discuss platinum group metals (PGMs), as well as some bulk commodities. It's no surprise that each of the 15 commodities you follow has suffered double-digit price declines over the last year, except for potash, which was up about 9%, and gold, which was up a mere 3%. The hardest hit was nickel, down more than 27%. With commodity price performances like that, why should investors stay in the mine commodity sector?
George Topping: Investors are focused on the immediate economic conditions rather than seeing commodities as a store of value during times of currency debasement. Make no mistake about it; the only way out of the current predicament is the printing of money and the debasement of currencies. This short-term focus on European worries and investors reducing risk is putting pressure on most metal prices, but it won't last. As weak as the global economy is, it is interesting that commodities are still historically strong.
TGR: Is what's happening in the market a bit of an overreaction?
GT: Yes, it is. The market is too focused on the short term instead of the consequences of the solution to the economic woes.
TGR: George, you're on the record as saying that large gold companies need to materially boost their dividends in order to compete with gold exchange traded funds (ETFs), which are funneling away billions of investment dollars. How high do dividends need to be to staunch the bleeding?
GT: I'd aim for a 5% dividend yield to attract fund flows back into the sector.
TGR: Big mining companies like Vale SA (VALE:NYSE) and BHP Billiton plc (BHP:NYSE; BHPLF:OTCPK) have dividends that are much higher than the gold companies. Why haven't gold companies taken that approach?
GT: The gold companies have been trying to grow gold production at any price. We call it "GAAP," growth at any price. Circumstances have changed. Growth is now unaffordable due to inflation. Capital costs have doubled in the last four years. It's time for the gold mining companies to wake up, stop building these new $6 billion mining projects and pay more dividends to shareholders.
We calculated that if Barrick Gold Corp. (ABX:TSX; ABX:NYSE) just deferred the obvious low internal rate of return (NYSE:IRR)/high capital expenditure projects, it would have a free cash flow yield of 8%. Goldcorp Inc. (G:TSX; GG:NYSE) would be 8.5%. Kinross Gold Corp. (K:TSX; KGC:NYSE) would have 12%. Newmont Mining Corp. (NEM:NYSE) would have 9%. There's a lot of free cash flow if they stop wasting it on these low IRR projects.
TGR: PGM-focused companies are also losing dollars to ETFs. Should they raise dividends, too?
GT: Unfortunately, it's a different situation for PGMs. PGM prices are not high enough for most of these companies to generate sufficient cash flow to pay a healthy dividend.
TGR: How do these companies lure investment dollars?
GT: They should take some free cash flow and invest it in operational improvements. Don't build new mines. Improve existing mines through capital injection, by updating equipment and providing incentives to the workforce. They need to bring about profits per ton rather than focusing on headline production.
TGR: The prices for platinum and palladium are both down more than 20% since June 2011. Is there any relief in sight?
GT: Yes, we're finally starting to see closures. Aquarius Platinum Ltd. (AQP:ASX) shut down its Everest and Marikana mines recently due to low prices, rising costs and labor problems. The mining industry in South Africa, which produces 70% of the world's platinum and 35% of the world's palladium, has been disseminated. It won't be long before prices start to move higher.
TGR: The region has also had issues with electrical blackouts and whispers of nationalization. How are those issues affecting supply?
GT: I was in South Africa recently and I'm not impressed with the way the country is going. Corruption is rife. I must have taken about 15 taxi rides and all 15 taxi drivers told me corruption was endemic such that you couldn't move without paying a policemen or civil servant-jobs that they are meant to provide you for free. Safety inspections are another issue. The competence of inspectors is a problem. It affects the industry very negatively.
If I were a mine manager or a chief executive of a platinum company, I'd aim for the highest grade I can find now because I don't know what's going to happen next. I don't want to leave money in the ground for five years. I'd also be less likely to invest in the next generations of shafts. I wouldn't spend a couple of billion dollars when I wouldn't see the first cash flow for the next six years. I'd be looking outside of the country for growth. It's negative in the short term, but it's going to get even more negative as the consequences of that lack of investment become clear.
TGR: Are those problems creating a lot of value in the space or is it just too risky for investors?
GT: There are pockets of value. Companies that have shallow ore, are closer to cash flows and have large resources are the ones that are likely to get taken out. Rather than spending a couple of billion dollars on deep shafts, it's easier to buy any available assets with shallow ore next to an existing operation. Platinum Group Metals Ltd. (PTM:TSX; PLG:NYSE.A) comes to mind.
TGR: Have you visited the Waterberg property in the Northern Bushveld?
GT: I visited Platinum Group Metals in February. It's developing the WBJV project and is exploring its Waterberg property. Waterberg is important to Platinum Group Metals because it has the potential to be very large. It could be alluring to senior mining companies-Jinchuan Group Co. Ltd. and Impala Platinum Holdings Ltd. (IMP:JSE), for example. It's the sort of project that could attract a bid for the entire company.
TGR: When is production expected to begin there?
GT: Waterberg is still early-stage exploration. It's many years away. In the meantime, it's providing exploration results to the market while WBJV is developed. It's exciting exploration. WBJV should be in production in 2014.
TGR: Are you more bullish on platinum or palladium?
GT: Platinum, mostly because production is challenged in South Africa. Platinum also has a major jewelry role, particularly in China. There's a tremendous amount of growth to come. Palladium will do well, but platinum is safer in the long term.
TGR: The biggest single use for both of these metals is in catalytic converters in automobiles. How far off is global economic growth for that application?
GT: The weightings of platinum, palladium and rhodium in catalytic converters are generally increasing. As countries become more developed, they become more environmentally conscious. There should be a tightening on auto catalytic converters in developing nations just as we have had here. There should be increased usage based on that. In fact, last year North American and European governments mandated that large and off-road trucks have to have catalytic converters.
TGR: Let's move to iron. On June 28, BHP Billiton was offering 80,000 metric tons (mt) iron ore grading 62% for $137/mt on the globalORE trading platform. The best bid was $129.50/mt, which says something about iron ore demand. Overall iron ore prices were down 8% in the second quarter, mostly on weak demand from Chinese steelmakers. Do you expect that price weakness to continue in the near term?
Michael Scoon: Yes. The summer is a seasonally weaker period for all industrial commodities. Low-volume trading activity in the spot market can result in price volatility on any given day, but year-to-date the price has averaged about $145/mt. And, as you said, prices are down about 8% over the quarter. However, I saw a report this morning that the spread between bid and ask-on-the-spot exchange has narrowed substantially.
TGR: The iron ore market used to be governed by yearlong contracts, but Chinese steelmakers would default on those in order to take advantage of lower near-term prices. Do you think we'll get back to the point where the prices are set for a year or will the spot market continue to dominate as it is now?
MS: The spot market is here to stay for the foreseeable future. It was quite an undertaking to change the term of the contracts. Today, there's a substantial amount of iron ore transacted on either monthly or quarterly pricing. Shorter-term contracts are going to be the way of the future.
TGR: What's Stifel Nicolaus's forecast for iron ore prices through 2013?
MS: I forecast prices softening in the summer months in line with the 8% decline over the 2Q12. I see prices remaining soft in the third quarter, but recovering in the fourth quarter to average around $140/mt in 2012. Prices could fall in 2013 to $131/mt, but settle around $125-130/mt in the long term, based on the marginal cost of production.
Over the course of the next five years, new supply from the three major producers-BHP, Vale, Rio Tinto Plc (RIO:NYSE; RIO:LON; RIO:ASX)-may push the high-cost producers off the cost curve into uneconomic territory. However, the Big Three will be incentivized to keep that marginal cost of production high as they sell more iron ore into shorter-term contracts.
TGR: The Big Three carry a reasonably high dividend-at least relative to the mining space. In 2009 and 2010, and even into 2011, steelmakers were going downstream and buying iron ore companies to control the cost of their raw materials. Does that trend have any momentum left?
MS: That trend does have some momentum left in it. The number of transactions has slowed as steelmakers aren't as active as they were. However, large new sources of iron ore supply are coming from risky jurisdictions, such as West Africa. Steel producers will continue to look for joint ventures or to own projects in safe jurisdictions to help control their supply. Steel producers want to avoid being caught in a supply squeeze. It's to their benefit to secure 30-50% of their iron ore requirement through joint venture partners and offtake agreements in order to derisk their businesses.
TGR: There are a number of players in Québec's north, which is considered a safer jurisdiction. What are their prospects for being taken over or developing into producing assets?
MS: There are a number of development-stage companies in the Labrador Trough, the most advanced of which is Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.A). It has a partnership with Chinese steel producer Hebei Iron and Steel Co Ltd. (000709:SHE) to develop its Kami iron ore project near Cliffs Natural Resources Inc.'s (CLF:NYSE) operations. Its preliminary economic assessment suggests 8 million tons per year (Mtpa). Hebei is committed to offtake 60% of that. The prospects for development for Alderon are quite good as it's the most advanced of its peers and it has a joint venture partner established.
TGR: How favorable to Alderon were the terms of that joint venture agreement?
MS: Alderon did commit a lot of its future sales to secure the partnership. However, Kami is a project that can be expanded. If it can prove that it can expand to 16 Mtpa, then it may have the ability to attract another steel producer or further investment from Hebei.
TGR: Does it have enough at 60% that a takeover wouldn't be prudent?
MS: Hebei does have a toehold in the project. However, if Kami can be expanded to 16 Mtpa, then the offtake falls to only 30% of production, which wouldn't be a hindrance to a takeover by a third party.
TGR: Indeed. What are some of the other players in that area?
MS: I prefer projects in the southern trough for their easier access to infrastructure. Champion Minerals Inc. (CHM:TSX) has a project located near ArcelorMittal's (MT:NYSE) operations. It has a very similar development timeline to Alderon, with the potential to produce 8 Mtpa growing to 16 Mtpa as it develops proximal land next to its key Fire Lake North asset.
And there are others. Labrador Iron Mines Holdings Ltd. (LIM:TSX) and New Millennium Iron Corp. (NML:TSX.V) are located further to the north. Labrador Iron Mines is in production. New Millennium is in construction. Even further to the north is Oceanic Iron Ore Corp. (FEO:TSX.V; FEOVF:OTCQX), which has a very large project, but is more infrastructure-challenged. Oceanic proposes to export from a port that it will construct itself from the northern shore.
TGR: Could Oceanic Iron Ore have a joint venture partner build a port facility given the substantial cost?
MS: There is an opportunity for Oceanic to bring a strategic partner to help absorb some of the upfront capital costs. However, it does come with a degree of uncertainty. There is a fixed pool of potential partners out there. If I were one of those steel producers, I would first consider projects with more familiar technical challenges.
TGR: Do you think Oceanic has an advantage in terms of grade and size of project that could be particularly alluring to a suitor?
MS: Most definitely. It does have a very large resource that has the potential to produce a lot of iron ore. However, it is located in the north. On paper, that large-scale production may seem more feasible than it will prove to be, given the rather harsh working conditions and challenging shipping.
TGR: George, in June 2011 you told Reuters that you believed zinc would be a 2013 story. After reaching roughly $2,200/mt in January 2012, zinc prices have trended steadily lower to around $1,760/mt, or about $0.79/pound (lb). Meanwhile, the London Metals Exchange has almost 1Mmt of zinc in stockpiles that are at a historical high. What underpins your thesis that zinc prices will have climbed dramatically higher by this time next year?
GT: Two things: Nothing cures low prices like low prices. Second, the market is forward looking. In 2013, it will be looking at 2014 and reacting accordingly.
TGR: What's your price forecast for zinc into 2014?
GT: I forecast average prices of $0.90 this year going to $1.08 in 2013 and $1.15 in 2014.
TGR: What companies are currently being developed and positioned for the up-tick in zinc prices?
GT: HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) springs to mind. It's developing the Lalor Lake property in Manitoba, which will start small-scale production this year and ramp up seriously in 2013.
TGR: What is its cost per pound?
GT: About $0.60.
TGR: How does that rank relative to the rest of the industry?
GT: It's in the lower half.
TGR: What are some other companies on your radar?
GT: A small cap that I really like is Foran Mining Corp. (FOM:TSX.V), a sub-$50 million market-cap company. It's very cheap for a company that has a 22 mt volcanogenic massive sulfide (VMS) deposit grading 3.8% zinc, 1.1% copper and 0.7oz/t silver.
It's one-hour away from HudBay's 777 Mine. HudBay is in Manitoba, but Foran is actually just over the border in Saskatchewan. They're very close to one another. If I were HudBay, I wouldn't want anybody coming into my camp and competing with me for labor and supply services. I would be thinking about taking Foran out before it gets too close to production.
TGR: You note in a recent research report on Foran that future equity financings may be necessary. How much cash does the company have in the till and how long will it take to burn through that capital?
GT: At the end of March it had $8.5M. I'd estimate it has roughly $5M now as it's been continuing to drill.
TGR: It's a greater risk now because financing for small-cap companies is increasingly difficult.
GT: That is true. However, Canada has the Canadian exploration tax deduction. It's much easier to raise money in Canada for exploration than most other jurisdictions. I don't think it'll have any difficulty in raising additional funds to drill out the deposit and move it toward its preliminary economic assessment in the first half of next year.
TGR: How much peace of mind does it give you that Pierre Lassonde, a leading gold executive and investor, is an 11% shareholder?
GT: He's well known in the industry and it certainly doesn't do any harm having him invested.
TGR: Do you have any parting thoughts for us today on the natural resources space and the mined commodity space that may allay some investor concerns?
GT: There's been a tremendous selloff in the equities, so much so that most of the commodity stocks are very cheap relative to metal prices. The past is the past. Investors should look forward to stimulus packages in China and Europe. There is a lot more debasement of currencies to come. The commodities will still have a role to play in protecting wealth. We'll continue to see a lot more M&A activity given that share prices have fallen. In the current environment, it's difficult to raise debt and equity financing, so juniors will be driven into the arms of seniors.
TGR: And midtiers. HudBay would fit into that category.
GT: Absolutely. It's a very good value.
TGR: Thanks, gentlemen.
George Topping joined the Stifel Nicolaus Research Team in connection with Stifel's acquisition of Thomas Weisel Partners LLC in July 2010. Topping joined Thomas Weisel Partners in December 2009 as a senior mining analyst covering base metals. Topping brings 10 years of experience in the mining industry and 14 years as a sell-side analyst. Topping began his mining career in 1985 with a senior South African mining company and worked both in operations and mining strategy roles for the gold and coal sectors. In 1995, Topping became a sell-side analyst covering platinum, coal and base metals with Irish & Menell Rosenberg, a South Africa-based financial services firm. Topping moved to Canada in 1997, where he has continued as an analyst covering base metals, including a six-year tenure at Sprott Securities from 1999-2005, and most recently at Blackmont Capital since 2007. Topping earned his undergraduate degree in mining engineering from the University of Strathclyde in Glasgow, Scotland.
Michael Scoon joined the Stifel Nicolaus Research Team in connection with Stifel's acquisition of Thomas Weisel Partners LLC in July 2010. Scoon is a research analyst covering basic materials, exploration, development and production companies in the mining sector. He joined the firm in January 2008 and is based in Toronto. Scoon received a Bachelor of Science in accounting and international business from Miami University in Oxford, Ohio, and is a Level III candidate in the Chartered Financial Analyst program.
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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: Alderon Iron Ore Corp., Foran Mining Corp., Goldcorp Inc., Platinum Group Metals Ltd. and Prophecy Platinum Corp. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) George Topping: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
4) Michael Scoon: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
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