Brian Sylvester: Volatile markets. Natural disasters. Geopolitical turmoil. Last year was definitely one for the record books, according to Carlos Andres, managing editor and publisher of the Frontier Research Report. With the world in turmoil, is there any upside for mining investors? Andres believes there is for investors courageous enough to look past the perceived risk and snap up battered, but fundamentally sound, junior mining stocks. In this exclusive interview with The Gold Report, Andres talks about why historical data points to a breakout year for gold and perhaps gold shares.
The Gold Report: In a recent edition of the Frontier Research Report, you wrote, “As perplexing and disconcerting as it may be, the performance of major global stock markets currently has a much stronger influence on share prices in the mining sector than the actual performance of the underlying commodity.” How is that different from previous cyclical dips in the resource commodity space?
Carlos Andres: It’s not different at all. The commodity space tends to be viewed with a bit of fear and skepticism by most retail investors and analysts generally. By extension, mining companies are viewed skeptically also, especially those in emerging and frontier markets. As a result, resource companies in emerging and frontier markets tend to be the last to receive investment capital during a bull market in stocks and the first that investors exit when markets get rattled.
TGR: Do you see a time in the near future when mining equities are influenced more directly by commodity prices instead of overall market conditions?
CA: It happens in the mature phase of a commodity bull, but the dynamic just described isn’t going to disappear. However, I wouldn’t be in this space if I didn’t expect there to be appreciation in the shares. Although rising commodity prices drive the process, investors and analysts cannot ignore rising profits at mining companies as commodity prices rise. Analysts begin to look foolish by ignoring sectors that are outperforming. Generally, these rising profits begin to attract the investment herd to the mining space. Some of this money will also find its way into the junior resource exploration companies we cover. Because this market is relatively small compared to the overall market, it doesn’t take much investment capital to drive share prices significantly higher, often many multiples higher than where the share prices bottomed.
TGR: In your latest edition of the Frontier Research Report you wrote, “Gold outperformed all major stock markets (in 2011) with a gain of +10%, confirming its role as the ultimate safe haven.” Yet many pundits believe gold plays second fiddle, if not third or fourth, to the U.S. dollar in terms of “safe haven” investments and that gold’s fall in the latter half of 2011 severely tarnished gold’s reputation as a safe haven. Whom should retail investors believe? [Related: SPDR Gold Trust (NYSEArca:GLD), iShares Gold Trust (NYSEArca:IAU)]
CA: Since January 2000, the dollar is down 22%. During that same period, gold is up 497%. During this same period we have had a tech bubble, 9-11, wars in Iraq and Afghanistan, a global financial crisis in 2008 and the global train wreck that characterized 2011. This is a hint at the answer to your question. In 2011, the dollar was flat, while gold was up 10%. You be the judge.
TGR: Last year marked the 11th straight year of gains for gold. It has only returned less than 10% in four different years: 2001, 2004, 2008 and 2011. That pattern suggests that gold slumps slightly every three years. It begs the question: What’s the pattern in the years immediately after a slump?
CA: Gold has performed very well after the years with single digit gains. For example, gold returned 1% in 2001, but then returned 26% in 2002 and 20% in 2003. In 2004, gold had a 5% gain, but in the following years it was 17%, 23% and 32%. In 2005, it returned 5% again. However, in 2009, it reached 25%, and in 2010, it hit 30%.
Based on historical returns, gold could perform quite well in 2012. It could also break the pattern and underperform, and that wouldn’t shock me or cause me to change my outlook on gold. If gold didn’t perform well in 2012, I would still keep my eye on the supply and demand fundamentals, which are as positive, if not more so, than they were at the beginning of the gold bull more than a decade ago.
TGR: The gold price is already off to a good start for the year.
CA: That’s right. It’s up 14%. As you say, we’re off to a good start.
TGR: What role could China play in gold’s performance this year?
CA: China’s role could be huge. China is the largest gold producer on the planet. It is also the second largest consumer behind India. However, China’s demand is rising at a torrid pace and thus will likely pass India in the near future. No other countries even come close to the level of demand from these two. The Chinese government has become extremely aggressive in building up the country’s gold reserves as well as promoting gold ownership for its citizens. It has adopted a long-term policy of accumulating gold reserves with a goal of catching the U.S. Believe it or not, China would ultimately like to see the yuan established firmly as a global reserve currency like the dollar. The government is also encouraging the public, which has a historic affinity for gold anyway, to accumulate a significant portion of its already large savings in gold. Therefore, China will continue to be a huge driver underpinning a rising gold price.
TGR: If there were transparency in China’s purchasing patterns, would we see a rise in the gold price?
CA: It’s widely believed that the Chinese are buying far more than it admits to. It’s only recently that China has admitted to having over 1,000 tonnes, which was a surprise because it was believed to be much smaller than that. This revelation provided strong support for the gold price. We know that over the short term, China wants to catch up with the reserves of Germany, France and Italy at around 3,500 tonnes and ultimately the U.S., which has around 8,000 tonnes. If China’s true activities were revealed, I suspect it would drive the gold price to much higher levels.
TGR: You haven’t ditched gold because of events in 2011. What opportunities are you looking at this year?
CA: No, I haven’t steered away from gold. The fundamentals look fine to me, so I’m happy to buy junior gold explorers in emerging and frontier markets at these distressed levels.
TGR: What does your research process involve when you’re investigating a mining company?
CA: I generally visit exploration projects, interview management and perform extensive due diligence on all public and private information I can get my hands on. I’m very interested in looking for opportunities in emerging and frontier markets because they tend to be shunned for their perceived risk as opposed to actual risk.
Our approach is to take a close look at these companies, their projects, the jurisdictions they operate in, their management teams, financing, and investor relations as factors to get a feel for their prospects, regardless of the fact that they may be in emerging and frontier markets where perceived risk is fairly high. We pick the best of the best.
Honestly, the more risk associated with these companies, the more we like it. It means we’ll be able to buy the shares at depressed prices that don’t reflect their inherent value.
TGR: What are some of those names?
CA: Sulliden Gold Corp. (TSE:SUE) in Peru is a favorite. It has an excellent management team. Its Shahuindo gold project represents a large, low-grade, bulk-tonnage affair with a deposit that is literally open in all directions, including at depth. The company continues to find mineralization in all directions that’s consistent with what it has already found. It had 1 million ounces (Moz) defined when we first recommended the company in 2010. Since then the resource has grown to about 3.4 Moz and it likely has a long way to go before Sulliden finds its limits. We wouldn’t be surprised if it has 5 Moz by the end of the year, and in our opinion the sky’s the limit beyond that.
In terms of jurisdiction, Peru is one of the biggest gold producers on the planet with a mature mining industry; however, it has had a few hiccups on the local level lately. Some mining operations have experienced protests, sometimes violent, from the local communities, including Newmont Mining Corp.’s (NYSE:NEM) giant Conga project, which was under construction. There were serious local protests and, as a result, it shelved that project temporarily. The project appears to be back on track and Newmont expects to begin production from the new mine in 2015. Although we are watching all aspects of the situation in Peru closely, events have not been sufficient to cause us to turn negative on the country as a mining jurisdiction.
TGR: Sulliden recently purchased a 1.5% net smelter return royalty on Shahuindo for $11 million (M). Was that a good price, or did it create a lag on Sulliden’s stock?
CA: I don’t believe it caused a lag on the stock. Sulliden’s stock price has retreated in lock step with the overall markets in general and along with the gold mining sector in particular. The current mine plan calls for 105,000 oz of annual production with a 10-year mine life. We think the mine life will ultimately be much larger than that. However, using these figures and a $1,500/oz gold price, Sulliden paid $11M now to obtain $24M in revenue over the 10-year mine life. That’s not a bad deal and given that the deposit and the mine life are likely to grow, this is probably a shrewd move by management.
TGR: Sulliden recently had a drill intercept of about 54 meters (m) at 0.85 grams per ton (g/t) gold and 71.4 g/t silver in the central corridor of Shahuindo. What’s interesting about that is the high-grade silver aspect of that intercept. Do you believe that this is becoming more of a silver play than a gold play and may garner some interest from some of the big silver players?
CA: It certainly has the potential. At current market prices, the gold deposit is roughly 2.6 times bigger than the silver deposit. If Sulliden continues to encounter silver grades and intercepts like this going forward, it may indeed reduce that ratio further, making it more attractive to silver players over time.
TGR: What other companies interest you right now?
CA: Because we are talking about Peru, let’s talk about Minera IRL Ltd. (IRL:TSX). It has a strong management team led by Courtney Chamberlain, a man whose capabilities we highly respect. Although considered a junior explorer, the company has a producing gold mine, Corihuarmi, in Peru, which is helping to finance exploration at its flagship project named Ollachea, a much bigger project in Peru. Existing production is always nice as it diminishes the company’s need to raise capital and dilute shareholders.
Ollachea, so far, has 1.4 Moz of Indicated resources, of which 1.1 Moz are classified as “Probable,” and an additional 1.2 Moz of Inferred, with strong grades between 2.8 g/t and 4.0 g/t. That’s 3.6 Moz in all. To make things more exciting, the deposit consists of two separate zones and both are open in all directions. The company is on to something very large. This will be an underground affair, and as such, Minera is currently digging a lengthy tunnel into the mountain that will be both the basis for production as well as for further exploration deeper into the existing deposit. The project is advancing rapidly as Minera has already completed a prefeasibility study and the definitive study is expected by the 3rd quarter of this year. It currently expects to bring the deposit into production in 2014 at a rate of 117,000 oz (117 Koz) per year. To top it off, the company maintains outstanding relationships with the local community.
The company also hopes to rapidly advance production on its Don Nicolas project in southern Argentina. Don Nicolas is in a highly prospective gold district known as the Deseado Massif, where many of the majors are located. It’s turning into a gold-silver district of significant proportions. The project already has an established resource of over 500 Koz with respectable grades between 1.5 g/t and 2 g/t. Minera is planning to bring this deposit into production in 2013.
Don Nicholas is right next door to another promising company that we cover, Mariana Resources Ltd. (TSE:MRY). Minera and Mariana actually own separate halves of the same deposit. The property line between them bisects the deposit. As each company makes progress, it actually helps both to assess the geology.
TGR: Don Nicholas’s recent feasibility study indicates that at $1,250/oz gold, it would create an internal rate of return (IRR) of about 35%. If the price of gold increases by $300/oz, the IRR could top 50%. However, Pan American Silver Corp. (NASDAQ:PAAS) has had some issues with permitting its Navidad project in Chubut province in Argentina. Is Minera likely to encounter problems, too?
CA: No, we don’t think so. Don Nicholas is in the Santa Cruz province, which is known to be extraordinarily mining-friendly. The agriculture and ranching economy of Santa Cruz was destroyed 20 years ago by a blanket of ash dropped by a volcano in Chile. The area has welcomed mining to restart a dead economy, but other provinces in Argentina have proven to be unfriendly to mining.
TGR: Are there any other unusual jurisdictions that you’re looking at?
CA: Lion One Metals Ltd. (CVE:LIO) is advancing the Tuvatu gold deposit in Fiji. A previous owner had defined an underground deposit and prepared a feasibility study. The project was shelved due to low gold prices in the late ’90s. This was all prior to the advent of NI 43-101 standards so Lion One has to carry out definition drilling again to define the deposit based on current standards. The bottom line is that we know there’s gold there; the question is how much. All indications are that there is a great deal. In addition, survey work and drill results have caused the company to reinterpret the geology of Tuvatu in a way that suggests the potential for a large open-pit bulk mining operation.
TGR: Lion One has split Tuvatu into a number of development areas. It would like to expand the high-grade underground epithermal system in addition to proving up the larger bulk tonnage target. Is this accurate in your view? And what do you think the upside potential is?
CA: We should know a lot more by the end of the year. There is an underground situation with an existing tunnel, so it doesn’t have to dig a new one. It allows the company access into the heart of the mineralization that’s already been discovered. Lion One can explore from there. But this tunnel is about 200m underground, and there is mineralization between the surface and the top of the tunnel. If the mineralization is sizeable enough, a bulk-tonnage low-cost open-pit mine may indeed be what makes sense there. That, combined with the fact that it’s identified a few other target zones close by that have consistent geology, means the size and scope of the deposit may be very large. Some important milestones are going to be reached in 2012. We should see a maiden resource estimate and some light should be shed on whether the mineralization conforms to an open-pit bulk-mining solution.
TGR: Fiji is a beautiful place. A large, open-pit gold mine doesn’t seem to fit with the country’s tourism-based economy.
CA: That’s a good point and worth talking about. We can’t guarantee that there won’t be issues, but the government of Fiji has historically been friendly to mining. The Vatukoula gold mine has operated for decades just 50 kilometers up the road. In addition, China recently opened a bauxite mine there. We are not overly concerned about it. But an open-pit mine in this particular area of Fiji is new territory, so there will be environmental issues that will have to be addressed successfully.
TGR: Do you have some parting thoughts on this space?
CA: The markets, natural disasters, financial crises, economic upheaval, geopolitical events like the Arab Spring—all of these things made 2011 one for the record books. It created a great deal of fear in the minds of investors, even though the junior gold mining sector had positive fundamentals. The markets were overwhelmed, even in the places where there was some light. Investors need to stay dialed into the fundamentals because, over the long term, fundamentals will assert themselves regardless of short-term shocks to the marketplace. I encourage investors to be bold enough to take advantage of price weakness when it comes. This is one way in which you mitigate risk in the sector. Buy strong companies where the underlying fundamentals are also extremely strong. Even when those companies get hammered during hard times, investors should use those as buying opportunities to add new companies to your portfolio or reduce the basis in your existing holdings.
TGR: Thank you for your time, Carlos.
CA: It was my pleasure, Brian.
Carlos Andres is the managing editor and chief analyst of the Frontier Research Report, a natural resource-oriented monthly investment newsletter focused on high-risk, high-reward junior exploration companies in emerging and frontier markets. Andres applies a potent mix of world-class expertise and lengthy experience in identifying countries and companies where “perceived” risk is much higher than “actual” risk, providing opportunities to profit significantly on the difference. Andres has been a natural resource analyst and investor for over 15 years.
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DISCLOSURE: 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: Sulliden Gold Corp., Lion One Metals Ltd. Streetwise does not accept stock in exchange for services. 3) Carlos Andres: I personally and/or my family own shares of the following companies mentioned in this interview: Sulliden Gold Corp., Lion One Metals Ltd. Minera IRL Ltd., Mariana Resources Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise for participating in this story.
Related: Market Vectors Gold Miners ETF (NYSEArca:GDX).