Brian Sylvester: Junior gold explorers are in a predicament; despite record gold bullion prices, stock valuations are suffering. Many of them, even those on the heels of exciting discoveries, are faced with either rounding up the cash and teams needed to build out mines themselves or turning the projects over to companies with the money and infrastructure already in place. In this exclusive interview with The Gold Report, David Goguen, director of institutional sales at PI Financial in Vancouver, discusses the merger and acquisition landscape.
The Gold Report: China posted its worst growth rate in more than two years during the third quarter. China is one of gold’s biggest buyers and largely drives demand. Should gold bugs be concerned?
David Goguen: I don’t think so. While it was the worst growth rate in two years, China still had a very respectable growth rate of 9.1%. Also adding to demand is China’s growing middle class and its affinity toward gold bullion that has lasted centuries and will likely continue for centuries both as a savings vehicle (through retail investment demand) and as the central bank continues with its purchases to diversify its foreign currency reserves. According to figures released by the World Gold Council, China and India accounted for 54% of global bar and coin investment and 55% of global jewelry demand in 2010. These markets for gold have been growing at a remarkable 30% per annum.
TGR: Global markets seem confident that a plan can be reached to solve the Eurozone’s sovereign debt problems. As more details about a solution emerge, how do you expect gold will react?
DG: There’s a possibility for a pullback in the bullion price if investors perceive that the global macroeconomic risk has been reduced or that systemic risk within capital markets has been reduced because of these measures.
I believe that the bullion price should be well supported by government policies and the entitlement programs that exist in North America and Europe are unsustainable in the long term. Until that has been dealt with, we are still going to accrue large annual fiscal deficits. In that environment people are going to question the soundness of fiat currencies.
I can see gold trading in a range of $1,500–2,000/ounce (oz) through the remainder of 2011.
TGR: Do you think that the gold price has established something of a floor for now?
DG: I believe that we’re probably within 10–15% of a floor. There is still an element of speculative risk capital in the bullion price. Some of that may exit as alternative opportunities present themselves in a more stable, “risk on” type capital market environment.
TGR: In 2010, there were some big takeovers in the sector with Newcrest Mining Ltd. (NCM:ASX) buying Lihir Gold Ltd. for almost $10 billion (B); Kinross Gold Corp. (K:TSX; KGC:NYSE) buying Red Back Mining for $7.2B; and Goldcorp Inc. (NYSE:GG) paying $3.4B to acquire Andean Resources. So far in 2011, the only big deal we’ve seen is Newmont Mining Corp.’s (NYSE:NEM) takeover of Fronteer Gold Inc. for about $2.3B. Why haven’t we seen more big deals in 2011?
DG: It is probably a combination of factors. There has been a lack of big new discoveries made by junior explorers. Also, some of the larger deposits that are under development are considered “wait and see” deposits in terms of their ability to deliver name-plate production results. Having some of these single-mine, large-deposit companies come onstream successfully will derisk these potential acquisition targets and the majors will be more comfortable stepping in and buying them.
TGR: With gold above $1,500/oz, the major producers are selling their gold at somewhat unprecedented margins and have a lot of cash flow. Meanwhile, a number of the juniors have seen their share prices erode throughout 2011. These junior metal explorers have extremely cheap ounces in the ground right now and it seems like the stage is set for a fresh wave of merger and acquisition (M&A) activity.
DG: I agree. Select Golds, our Latin focused, quantitative publication tracking junior gold companies has seen a lot of M&A activity. We see a number of juniors that have made important discoveries advance those projects from resource definition to pre-development. Now they find themselves in a situation where they are forced to choose between building out the mine themselves or putting the company up for sale.
It is at this decision junction that companies need to assess their ability to raise the very substantial capital and recruit the critical personnel, the “build it” personnel that allow them to credibly develop these projects on their own or to put themselves up for sale.
As a result, some takeovers reflect the idea that some junior companies are in the business of making discoveries and are not mine builders. Junior companies at the end of the day have to realize that in many instances the best way to surface and preserve shareholder value is to allow an intermediate or major mining company to develop the deposit through sale of the company. Shareholders often underestimate the execution risk and shareholder dilution required to reach production. At this stage in the mining cycle more juniors are increasingly in this position, hence our expectation of more M&A on the horizon.
TGR: Why is the market not providing full value in these equities with advanced projects?
DG: Mainly because equity valuations across the board are heavily discounted. There exists at the moment a big disconnect between asset values and equity market prices. This can be seen in some of the large premiums we are seeing on announced transactions. They also reflect the market’s aversion to risk.
Acquiring companies are recognizing the long-term value in specific assets. The asset in the sweet spot at the moment is one where capital expenditure (capex) budget is in the order of $150–300 million (M), is fairly defined, and is limited in its probability of unforeseen big capex blowout that would impair the acquiring company’s returns.
Those attributes make a project attractive to an acquiring company. It is easily executable with respect to the capital investment required and also the complexity of project construction. An acquirer with a strong development team can develop projects in an 18-month period as opposed to a two-to-three year build.
The new sweet spot used to be considered too small for intermediates. But it is a really competitive environment for the larger deposits. Some of the better values in the marketplace are for the 2 million ounce (Moz) deposits that have an annual 100,000–150,000 oz production. Those projects are being sought after.
TGR: Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) recently paid about $258M, or a 66% premium, for Grayd Resource Corp. Agnico-Eagle was mostly interested in Grayd’s La India deposit, which has an established resource and simple metallurgy located about 70 kilometers from Agnico-Eagle’s Pinos Altos Gold Mine in Mexico. Is this typical of the deals you expect to see?
DG: Each deal will have its own motivating factors. In the case of Grayd, Agnico-Eagle had capital equipment at Pinos Altos that it foresaw becoming available and the acquisition benefited from that obvious capital savings. It represented a continued commitment by Agnico-Eagle to a geographic region that it was already building competencies in and had a demonstrated track record of being able to execute in. Grayd’s La India project is expected to have a capex of $110M and a fairly simple capital infrastructure required to put it into production. It was a logical transaction for Agnico-Eagle to do.
TGR: What are some juniors in Latin America that have made discoveries that could lead to either mine build-outs or takeovers?
DG: Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:Fkft) in Argentina has very high-grade ounces at their Cerro Moro project—likely 2 Moz and growing. The resource grade is 24 grams per ton (g/t) gold equivalent—these are near surface ounces that according to a preliminary economic assessment (PEA) could generate internal rates of return in excess of 80%. The anticipated capex is $150M and cash cost are expected to be sub $300/oz.
TGR: Goldcorp bought Andean Resources, which had a gold project in Argentina. Before Goldcorp wound up with Andean, Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) had made a bid. Do you see Eldorado being a potential suitor for Extorre since it was looking at acquisitions in that area?
DG: Eldorado must have become comfortable with the region and its geology through its due diligence. They viewed Cerro Negro as a world-class asset and as a stepping-stone to other potential acquisitions in the area. I still see acquisitions in Santa Cruz, Argentina, as a possibility for Eldorado.
TGR: Extorre hasn’t put out a feasibility study on Cerro Moro, its gold project in Argentina. When do you expect that?
DG: We’re expecting an updated PEA study early in the first quarter of 2012. That will be preceded by an updated NI 43-101 resource in mid-November.
TGR: What is the top end of your estimate for that resource?
DG: Goldcorp has grown Andean’s Cerro Negro from 2 Moz to in excess of 5 Moz since the acquisition. I think that the geology at Extorre’s nearby Cerro Moro deposit has that kind of growth potential.
TGR: What is another junior that you see as being a potential target?
DG: Newstrike Capital Inc. (NES:TSX.V) in the Guerrero Gold Belt of Mexico has acquired a resource from Goldcorp that was north of 1 Moz at the time of acquisition, but has grown that through an extensive drill program. It is probably north of 3 Moz now. It has also benefited from the discovery of high-grade breccia material proximal to the mineralized intrusive body itself. That higher-grade breccia material may very well represent the starter pit material that will provide for some early project payback and thereby impact the project economics positively.
Given some of the existing producers in the area, there’s a ready audience of companies with operating competencies that would see this as a very logical opportunity.
TGR: Newstrike has had some impressive results. It had about 231 meters (m) of 7.5 grams (g) gold. It recently had another intercept that was almost 120m of 3.76g gold. This looks like it could be a high-grade open pit. Is that what you’re seeing?
DG: I think it will be about a 1 g/t Au open-pit scenario that will benefit from some specific higher-grade zones of which the ultimate tonnage has yet to be defined
TGR: What are your thoughts on the management’s ability to continue to derisk that project and perhaps attract a potential suitor?
DG: The exploration team in Mexico has been exploring in that region for over 15 years. They have a good understanding of the geology and a good understanding of local relations. The control of the company largely rests with companies related to Lukas Lundin. Lukas is no stranger to surfacing value in corporate transactions. The company benefits highly from his involvement. Richard Whittall, as president and chief executive, is also guiding the company’s pace of exploration well and is great at communicating its story to the capital markets.
TGR: Which other companies might be ripe for acquisition as they derisk?
DG: Kimber Resources Inc. (KBR:TSX; KBX:NYSE.A) is a good example of a discovery from the early 2000s that is going through a process of derisking. It is currently drilling to expand the resource at their Monterde project for inclusion in a revised NI 43-101 resource calculation. The new data will be incorporated in a prefeasibility expected in Q212.
The prefeasability will effectively assist in derisking the asset and leaving the company open to possible acquisition or a decision to go it alone. There are a number of existing producers in the Sierra Madres for whom this asset would make a good fit. Kimber’s Monterde is profiled to produce 60 thousand ounces gold and 1.9 Moz silver per year for about 12 years. The capital costs there are going to be somewhere in the order of $125M. It’s the typical profile of a small, yet executable, profitable, low-risk acquisition that companies can achieve without getting involved in an extremely competitive process on overly sought-after assets.
Kimber is gaining a better understanding of the geological controls at depth and making some discoveries on its Monterde deposit in the Sierra Madres below the 400m level. It is encountering high-grade, multi-ounce material and opening up the specter of a significant increase in the deposit size. This puts a little fire under any potential acquirers to make a move as Kimber exhibits the continued propensity for new ounces at the Monterde project.
TGR: Could Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX) in Peru be a company that acquirers would be interested in?
DG: Sulliden is mostly pure gold with some silver. The model there is for a heap-leach operation producing 150,000 gold equivalent ounces per year with a 10-year mine life and an expected capex of $200M. Sulliden is going down two paths at once. It continues to make large increases in its resource, now in excess of 4 Moz, while refining prefeasibility and feasibility studies. The company expects that ultimately the scale of the operation will need to be expanded in order to accommodate the growing resource. Sulliden is now in feasibility mode and refining the engineering parameters and nailing down costs and project economics.
The simplicity of the operation could leave Sulliden in a position where it could credibly proceed with the development of the asset on its own but more likely it will be acquired before ever breaking ground.
TGR: In another deal, B2Gold Corp. (BTO:TSX; BGLPF:OTCQX) recently bought Auryx Gold Corp. (AYX:TSX) to consolidate gold properties in Namibia. B2Gold already has two operating mines in Nicaragua. Most of the B2Gold management team was with Bema Gold when Bema was bought by Kinross Gold in 2007. It looks like the B2Gold team is setting itself up as a takeover target once again. What are your thoughts?
DG: It is a possibility. However, I would characterize B2Gold as a team that is still looking to build on its assets through both organic growth and acquisition. It has a team that has a proven track record of being able to enter new jurisdictions, understand the local landscape and successfully build and operate mines within that landscape. I would expect B2Gold to evolve into a bonafide intermediate gold producer over the next two to four years.
TGR: Another scenario that has grown in popularity in recent years is large companies, like Barrick Gold Corp. (NYSE:ABX) acquiring cooper-gold porphyry deposits. These tend to be large deposits, which really boost reserves, but at the same time, companies are also getting a tremendous byproduct credit with the copper. Are there any projects with established resources that are proximal to other operations that could be targets as well?
DG: There’s a real dearth of large quality gold deposits that fit Barrick’s scale of doing business. The number of politically stable jurisdictions to build operations has shrunk over the years as well. Therefore, Barrick needs to look outside of the strictly gold bracket. I think you will see Barrick add to its portfolio of copper-gold deposits going forward.
TGR: What’s going on in Guyana with copper-gold porphyry deposits? The country has established resources. Are companies like Guyana Goldfields Inc. (GUY:TSX) and Sandspring Resources Ltd. (SSP:TSX.V) on the radar of companies like Barrick?
DG: Guyana Goldfields probably is on the radar as an acquisition candidate. Guyana Goldfields is currently working toward completion of a feasibility study on the 6.9 Moz Aurora project, which is due to be complete in January 2012. The project is expected to profile 300,000 oz of annual production with a life of mine operating cost of $400/oz. The company plans to begin construction on the project in Q112, which is expected to cost $375M.
TGR: If Guyana Goldfields gets up and running, doesn’t that increase Sandspring’s value because it’s not far away?
DG: I think it will have the effect of validating the ability to construct within Guyana successfully and overcome some challenging logistics. Sandspring’s Toro Paru is now moving toward completing a prefeasability study. Through that process the company will continue to refine the amount of capital investment that is going to be required and what kind of returns on a per-ton basis it can expect to generate. It has to refine project economics through more detailed engineering that will provide some comfort that the capex of $637M is indeed the right number. The present valuation on Sandspring, while inviting, does reflect a market awareness of these risks.
TGR: How do you recommend investors play these takeover targets?
DG: Every company is unique. Every deposit is unique. Investors want to focus high-grade deposits that are valued exponentially higher by acquirers because of the margins they tend to generate. While these ounces in the ground appear to trade at premium valuations in the market, they are still some of the best risk-adjusted values in our Select Golds screen.
Investors should also want to be looking at situations where there’s a high propensity to double or triple the existing resource that’s in place. It may be that the target company is focused on engineering instead of exploration and it’s leaving all that value on the table for someone else down the road. The acquiring company recognizes it as being an opportunity and is able to afford to pay a larger premium on the front end knowing that value is going to get backfilled amply with new discovery and additional ounces on that resource itself.
TGR: Thanks for sharing your thoughts with us.
David Goguen focuses on the mining sector at PI Financial Corp. as director, institutional mining sales. Goguen’s focus includes Select Golds—advanced, exploration, emerging producers and junior producers. Goguen earned a bachelor’s in economics from Carleton University and holds the Chartered Financial Analyst designation.
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1) Brian Sylvester 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: Newstrike Capital Inc., Sulliden Gold Corp., Goldcorp Inc., Extorre Gold Mines Ltd., Kimber Resources Inc., B2Gold Corp., Guyana Goldfields Inc., Sandspring Resources Ltd.
3) David Goguen: I personally and/or my family own shares of the following companies mentioned in this interview: Newstrike Capital Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. PI Financial and/or its affiliates have received compensation for investment banking services in the preceding 12 months from Kimber Resources Inc.
Related Tickers: SPDR Gold ETF (NYSE:GLD), Market Vectors Gold Miners ETF (NYSE:GDX), iShares COMEX Gold Trust (NYSE:IAU), iShares Silver ETF (NYSE:SLV), Market Vectors Junior Gold Miners ETF (NYSE:GDXJ).