Thinning the junior mining herd tough but necessar

Thinning the junior mining herd tough but necessary: Philip Ker
The Gold Report | April 13, 2013

A dearth of financing is culling the junior mining herd. Who will be left? Philip Ker, a mining analyst with PI Financial in Toronto, believes cash-flow generators in safe jurisdictions will continue to perform in this market. In this interview with The Gold Report, Ker talks about a few favorite companies that fit the bill.

The Gold Report: The financing situation is grim. Not one junior mining company conducted an initial public offering (IPO) in the first quarter, correct?

Philip Ker: The IPO space is pretty thin right now. The overall climate and appetite for junior startups is pretty bleak. Until we see a resumption in investor demand for mining, I think new IPOs will be limited to very special situations.

The window is tight for financing as well and debt options are becoming more attractive. Projects with high-quality management, strong economics, a high internal rate of return (IRR) and near-term cash flows could get some traction in this environment. With this market, investors are seeking companies with sustainable cash flows from producers or short pay back periods with low capital expenditures (capex) costs for developers.

TGR: Given the tight climate for IPOs and financings, could the merger and acquisition (M&A) environment pick up over the course of the year?

PK: By Q3/13 or Q4/13, we expect to see significantly more activity on the M&A front as the senior and cash-rich mining companies look to acquire sound projects at lower prices from the most cash-strapped companies forced to do a transaction, especially if the equity financing window remains shut. Because the equity markets are tight, strategic investments by majors may also become more common. A good example lately has been the activity of Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) and its recent strategic investments into companies such as ATAC Resources Ltd. (ATC:TSX.V) and Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX; SUE:BVL) of $13 million ($13M) and $24M, respectively. These companies have great projects and Agnico has recognized this accordingly and taken a substantial position in both. I like how aggressive Agnico has been lately and imagine we could see more activity from it over 2013.

TGR: What's your investment thesis for precious metals producers against this economic backdrop?

PK: I'm focusing on operations that are in low geopolitical risk environments, such as Mexico, Canada and the U.S. I like companies with strong management and operations that are continuously providing positive operating cash flow. I like companies that have a solid growth strategy, whether it's through increased targeted grades, development of a new project or increasing production.

TGR: The gold-to-silver price ratio is growing as silver slips faster than gold. Today's gold price is $1,550/ounce ($1,550/oz). It would take roughly 57.7 oz silver to make 1 oz gold. Are you issuing silver plays given the recent price drop?

PK: Typically, silver does have a higher beta so it tends to be more volatile than gold. I am not shying away from silver companies given that silver has more industrial uses than gold and should benefit from a recovering U.S. and world economy. I am paying particularly close attention to Excellon Resources Inc. (EXN:TSX), SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) and Silver Bull Resources Inc. (SVB:TSX; SVBL:NYSE.MKT).

TGR: Do you believe Société Générale's forecasted gold price of $1,375/oz by December 2013 is valid? If so, does that mean gold's bull run is over?

PK: We don't agree gold will fall this sharply—even though 2012 was the first time in 10 years that there was a reduction in the gold price. We think the U.S. dollar will remain volatile due to the continued U.S. debt expansion, economic uncertainty and the general macroeconomic environment. We think these, among other factors, should ensure a buoyant gold price.

Furthermore, a lot of mining operations I focus on are working with all-in costs of around $1,100/oz. If we see a continued weakness in the gold price toward $1,375/oz, companies will look to close marginal operations or delay new mining expansion.

TGR: Thomson Reuters GFMS recently published some numbers that said that all-in cash costs for gold producers in 2012 averaged $1,211/oz. Is that close to the numbers you're seeing?

PK: That's about right. If the gold price did dip toward $1,375/oz, capex budgets would be cut resulting in reduced drilling, and lower general and administrative expenses.

TGR: There was record gold production in 2012 of about 2,861 tons. This is the fourth straight year of gold production growth. Is too much production behind the price weakness?

PK: I don't think so. Monetary reserves around the globe are always accumulating gold and continuing to hold it; we think this will continue. I think the major factor causing weakness in gold prices is a strengthening U.S. dollar. The U.S. and its dollar are attracting capital from around the globe as U.S. equities have been outperforming and the U.S. is now seen as a safe haven once again. As long as the U.S. dollar continues to rise, I think gold prices will have downward pressure. However, the U.S. is not out of the woods yet and with all of this uncertainty, we think demand for gold will return.

TGR: What precious metal producers should post strong numbers in 2013 given the rise in all-in costs?

PK: SilverCrest Mines and Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT) in Sonora, Mexico, have been producing at their heap-leach operations during the past several years.

SilverCrest is continually beating its guidance and is also beating analysts' estimates with its forecasts. The company is shifting to an underground mining scenario and is in the midst of constructing a new conventional processing plant that should start realizing higher recoveries and production numbers once commissioned in 2014. Given the success of its past production and management's conservative guidance, we're still optimistic that we will see moderate growth in 2013. Currently, I have a target of $4/share on SilverCrest.

As for Timmins, I believe this is a pivotal year. It is working toward increasing gold production from about 95,000 oz in 2012 to 130,000 oz in 2013, while reducing cash costs through several different initiatives. The major increase in production comes as a result of increasing its crushing capacity. Several new crushing components have been installed during 2012 with a new circuit anticipated to come on-line for the nearby La Chicharra deposit that will ultimately bring daily crushing capacity up to 30,000 tons per day (30,000 tpd). Presently, I have a target of $3.90/share.

TGR: Timmins is conducting a 200,000 meter (200,000m) drill program in 2013. What's the company hoping to achieve with that somewhat extraordinary amount of drilling?

PK: I would call it more of mine exploration and definition. I wouldn't call it regional exploration, although Timmins does plan to test a new target just a few kilometers to the north of the San Francisco mine. The 200,000m of drilling should better define and bring a lot of the Measured and Indicated resources up into the Reserve category. This will aid in extending the total mine life of San Francisco as well as prove up additional reserves at its nearby satellite pit, La Chicharra.

TGR: Do you know what SilverCrest plans to do with all the cash that it's generating?

PK: SilverCrest has a strong balance sheet and is continually adding to this with its strong operating cash flows from Santa Elena. The main focus and budget item for 2013 is the construction of the new processing plant, which has a capex at roughly $60M. SilverCrest is also working toward completing a preliminary economic assessment on its La Joya project in Durango, Mexico. Management anticipates completing about 40,000m of drilling and collecting more metallurgical samples this year to incorporate data within the study.

TGR: Are there any other companies in North America that you're bullish on?

PK: Atna Resources Ltd. (ATN:TSX) has been one of my favorites for quite some time. I like the management team and the pipeline of projects in the company's portfolio. The most near-term producer is in Nevada, the underground project at Pinson, which it acquired from Barrick Gold Corp. (ABX:TSX; ABX:NYSE) several years back. Currently there are three operating stopes in production with a fourth under development. The goal by year end is to have 9 to 12 working stopes in order to be mining approximately 800 tpd from underground.

Atna should start to recognize revenues from Pinson underground in Q3/13 once the daily ramp-up period has been targeted at a proper rate. This scale-up of production should more than double the amount of gold sold in 2013, so we could see a considerable jump in earnings and cash flow per share for Atna, particularly during Q3/13 and Q4/13. I expect a rerating of the stock once it demonstrates positive cash flows from Pinson underground.

TGR: Atna has the Briggs gold mine in California in production. It's going to move to Pinson underground, and then to the Reward mine in Nevada. Is there enough cash to do all that in one year?

PK: This is what is so compelling about Atna. It has a great pipeline of projects that will generate cash to fund its future projects. The company is generating cash from Briggs on a consistent basis and the mandate from management right now is to commence construction at Reward upon achieving positive cash flows from Pinson underground. Reward is a project that is already fully permitted and could easily be a project in a standalone company. I don't feel as if the market is giving any value to it whatsoever.

TGR: Atna has strong institutional coverage: PI Financial, Canaccord Genuity, Global Hunter Securities and Jacob Securities. It has an interesting price-to-net-asset-value valuation.

PK: The analyst coverage speaks loudly for the attractiveness of the company and the potential that can come from investing in this story. Its price to net asset value is quite low on paper. It's an execution story to get these projects into realizing cash flows. I expect a rerating once management delivers on these initiatives.

TGR: It's currently trading at $0.76/share and your target is $2.35/share.

PK: That's primarily due to the market not giving any value to the potential cash flows that it should start to see from Pinson. Once the risk is removed from development at Pinson and gold sales are realized, the market should respond accordingly.

TGR: How are you mitigating risk when it comes to exploration-only mining equities?

PK: It all comes down to my due diligence process. I tend to like sound projects with some sort of history. I tend not to jump on new discoveries, such as those made in the Caribbean. There's too much hype that follows these stories and it just ends up driving up the valuation. I stick with assets that have had some historical activity on the project that quality technical teams can re-investigate and delineate and grow the deposit into a feasible mining project.

TGR: What explorers live up to that?

PK: I'm very keen on near-term producer Northern Vertex Mining Corp. (NEE:TSX.V; NHVCF:OTCQX), which is focused on the Moss gold-silver property located outside of Bullhead City, Ariz. The company is looking to commence production first under a 90,000 ton heap-leach pilot plant that, once it proves metallurgical lab studies of around 75-80% recovery, it will look to expand to a 5,000 tpd operation, where it can target more than 40 Koz gold equivalent per year.

TGR: Northern Vertex bills itself as a near-term production story. Is that fairly accurate?

PK: Yes. for a junior that not many people know about, it's well funded with more than $8M in working capital. This is more than enough to meet costs of $3.5M for the pilot plant. Phase two has a low capital expenditure of only $26M, which is based upon the 5,000 tpd scenario and could even be in construction later this year. This project has an incredible IRR of 117% with a rapid payback of 15 months and is a perfect candidate to begin attracting attention of major institutions. Moss has the qualities to become a real company maker for Northern Vertex.

TGR: Have you visited the Moss property in Arizona?

PK: I've actually been there twice. The company has a new chief executive officer, Mr. Dick Whittington, who was CEO of Farallon Mining Ltd. He sold that company to Nyrstar N.V. (NYR:BSE) for $409M. His track record is quite strong and I am confident he and his team may be able to do it again.

TGR: What were some of your takeaways from your firsthand experience?

PK: The project is located in a remote historic mining district in northwestern Arizona. It's got gravel roads right to the site. The property is on patented land with no significant permitting hurdles to overcome. The area has about 9% unemployment and the local officials are very supportive of mining, Northern Vertex and the potential job creation for the surrounding communities.

TGR: Is there another interesting story you'd like to share with us?

PK: I toured Silver Bull Resources' Sierra Mojada project in Mexico last December. This is rapidly becoming a development story. The company's recent resource estimate impressed me, as Silver Bull significantly increased the overall grade, particularly in the silver zone that it looked to target in an open-pit mining scenario initially.

There are also some other targets on the Sierra Mojada property along strike that Silver Bull is looking to drill test this year. Given that this is a typical carbonate replacement deposit, the company still hasn't identified the source of these manto lenses that contain the mineralization. If any significant sulfide material was found potentially at depth, it could be a huge game changer and add a substantial amount of tonnage to the project.

TGR: Silver Bull's project has roughly 168 million ounces in the Indicated category grading at 72.5 grams per ton (72.5 g/t) silver and a 25 g/t cutoff and 2.2 billion pounds zinc in the Indicated category. This isn't something that just falls off the truck.

PK: Silver Bull got the project through a takeover of Metalline Mining. This exactly fits my thesis: This is a historically producing mine with infrastructure right to site including rail and power. There is an operating dolomite mine next door owned by Industrias Peñoles (PE&OLES:BVM) and the local community has generations of mining experience.

TGR: Is this a potential open-pit operation?

PK: Yes, I think so. Silver Bull management states it would target a higher-grade core initially, but the primary open pit would target what it designates at the shallow silver zone. Positive drilling in this zone has returned abundant assays with silver grades exceeding 100 g/t over considerable widths.

TGR: Some mining experts believe that the game has permanently changed in the junior mining space and that it's not going to come back as it did following previous downturns or cyclical lulls. What's your view?

PK: I am not as negative. Let's not forget we have seen a very strong bull market over the past decade, and it is not surprising to see such a sharp correction with junior mining companies. The bull market has spun out close to 1,700 mining companies and we are likely to see a weeding out of many of the weak or more marginal companies. We view this as positive and only makes a stronger set of companies and investment choices available. We expect investors will remain more selective in the near to mid term. While it is hard to say how long this bear market will last, one thing is for sure: The global economy continues to grow, emerging economies continue to build and expand and they will need more metals and minerals.

TGR: Thank you for your insights.

Philip Ker is a mining analyst for PI Financial. He has field experience as an exploration geologist working across Canada on gold, diamond and base metal projects. He holds a Master of Business Administration degree in finance at the University of Alberta and a Bachelor of Science degree in geology.

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Source: Brian Sylvester