Buy gold stocks like a price taker

Brian Post: ROTH saw an opportunity in the resource space, but lacked exposure to it. Once I familiarized myself with the technical aspects, I felt my previous experience was transferable. I now cover precious metals and some base metal assets, and in the last two years we have brought on an additional analyst who looks at resources from a cleantech perspective, which includes rare earths, other industrial metals and renewable energy, including uranium. We plan to build on this platform.

TGR: When you speak to clients in Southern California, are they receptive to investing in resource stocks?

BP: Looking solely at Southern California, investors are sparse. However, my contacts and outreach are global, including accounts in Europe, and we are gaining traction in investment hubs like New York, Toronto and San Francisco.

ROTH is a small-cap, growth boutique bank. Our strategic direction in the resource space has been to educate our existing institutional investor base—those who are comfortable with growth stories—about the value of investing in mining stocks. They are familiar with the risk-reward profile of healthcare and biotech companies, which are relatively similar to resource companies.

TGR: Looking at your coverage list, I see a lot of precious metals in Mexico, including several silver names. What is your rationale for investing in Mexico as a jurisdiction?

BP: Given the geopolitical risk around the world, I made a conscious effort to look at companies operating in Mexico. It is one of the countries most friendly to mining development in today’s environment.

From a U.S. point of view, there is concern about some social aspects in Mexico. However, global investors are much more comfortable and there is plenty of opportunity. The Mexican economy is growing, the resources are there and the government appears to have a pragmatic approach to balancing environmental and social protection needs with the economic impact of opening up mining projects. We believe Mexico is the place to be right now.

TGR: Mexico is a premier address for silver, isn’t it?

BP: That is a function of the geology; Mexico hosts both silver and gold. My coverage universe has evolved to include a lot of silver names at the present time.

Given the amount of investment and the activity from larger silver players in the region, we are comfortable with the infrastructure and the skill level of the labor force in Mexico. All the ingredients are there for continued development and exploitation of what nature has given the country.

TGR: Would you call yourself a goldbug? A silver bull?

BP: First and foremost, we are price takers. I have a positive bias on both gold and silver and have a stable to favorable outlook on both metals. We are not in the business of predicting price. We are, however, comfortable looking at projects and analyzing cash flows that assume metal prices, costs and cash margins sufficient to support the projects.

TGR: In essence, you believe in the viability of a price that might not appreciate greatly, but will be stable.

BP: That is a fair assessment.

TGR: I would like to talk about the companies you cover that you believe have a growth profile in the next 12 months, starting with the producers.

BP: Sure. SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) is a growing producer with an exploration element to the story. It opened and is operating a straightforward, open-pit, heap-leach mine. However, the company is now making the move to underground development, where the grades on both silver and gold improve. It also is constructing a full-on mill to process and recover some of the metal left behind from the heap-leach operations, and to better exploit the higher grades it is encountering at depth.

The picture for SilverCrest is getting better, with drill results showing even higher grades than anticipated. We expect a feasibility study in the next two to three months to provide some visibility into the value it is building underground.

TGR: SilverCrest just announced a new vice president of corporate development.

BP: That is part of the company’s maturation. There is always the prospect of consolidation among companies like SilverCrest that have one or two institutional-class portfolio assets. We may start to see some merger and acquisition activity in the junior resource space as a whole, which is something investors have been clamoring for. SilverCrest may be in a position to participate, potentially as either a target or as an acquirer.

TGR: One would think that a good, low-cost producer like SilverCrest might interest a large silver player like Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ), First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) or even Fresnillo Plc (FRES:LSE).

BP: I agree that there are synergies from the production and geographic standpoints. But I think SilverCrest is focused on ensuring its operations as now configured are productive, proving out some of the incremental value that comes with going underground, and derisking its exploration asset.

Speaking of SilverCrest’s exploration activity, the size and composition of La Joya, its exploration asset to the south, is growing. The company is just beginning to define the polymetallic opportunity there: gold, silver, copper, molybdenum and tungsten. There is a lot of potential in the shift from pure exploration and definition to defining an economic case for development.

TGR: SilverCrest is trading around $2.50/share. Do you have a target price on it?

BP: Our target price is $5.

TGR: What other producers have silver assets in Mexico?

BP: Aurcana Corporation (AUN:TSX.V; AUNFF:OTCQX) has assets in both Mexico and the U.S. It has been running its main operating mine, La Negra, a silver-base metal mine in Mexico, for a couple of years. It recently opened the Shafter project, a primary silver mine, about two hours outside of El Paso, on the Texas-Mexico border. That is a growth story, in that Shafter’s production is expected to ramp up.

Aurcana ran into a few roadblocks getting the mine to commercial production. It underestimated the challenges of bringing mining labor back into that region, which really has not seen any mining for decades. I speak with Aurcana’s management frequently, and the team has mechanisms in place to address these challenges and get the mine closer to its full potential.

The Shafter mine should be up and running by the end of 2013, dispelling any concern about its viability. Shafter’s ramped-up production profile, paired with the growing operation at La Negra, should give Aurcana an attractive production profile. Its cash flow and financial metrics will move along in turn.

TGR: Who else is active in Mexico?

BP: Esperanza Resources Corp. (EPZ:TSX.V) has been taken over by a new management group from Minefinders Corp., which was itself acquired by Pan American Silver. Esperanza is still relatively unknown, but we expect that to change quickly. Management is key to revitalizing the project. The project—originally called Cerro Jumil—has been around for a while but it is now on a fast track.

The production-versus-capital expense (capex) profile here is attractive. It is shaping up to be a simple, open-pit, heap-leach operation capable of producing nearly 100,000 ounces (100 Koz) gold equivalent annually. The company is sitting on a treasury of about $40 million ($40M) in cash. We estimate up-front capital costs to be less than $100M.

When you see a junior mining company with something this strong in the predevelopment stage, blended with a strong cash position relative to cost, the dilution profile down the line is significantly less than other projects. With the combination of a potent mine, low capex, good management and a good location, it is pretty easy to get excited about Esperanza.

TGR: Does Esperanza also have silver credits?

BP: There is a relatively small silver component. The geology is somewhat heterogeneous, but there is enough silver to provide a bump in ounces from the equivalent standpoint. Also, the silver provides the potential for streaming out that secondary production to bridge the equity after development. The silver adds incremental flexibility to the development plan, another important factor in getting projects like this going.

TGR: With financing so difficult right now, it is good to have options.

BP: Right. If you run the cash versus cost-to-develop numbers—even assuming a conservative 50% debt financing—we think there is less than a $20M equity gap to get this up and running. Compared to Esperanza’s market cap, that is impressive.

TGR: Where is the company in the development process?

BP: Esperanza has submitted its plan and is working on permitting from the local jurisdictions and federal environmental perspectives. The Secretaría de Medio Ambiente y Recursos Naturales is reviewing the plan. Based on the statutory timelines and even baking in some conservatism about delays, we think it can get all the necessary permits by the end of Q3/13.

TGR: Are there any other companies in Mexico you would like to talk about?

BP: We like Vista Gold Corp. (VGZ:TSX;VGZ:NYSE.MKT). It has Mexican assets, but its flagship Mt. Todd project is in Australia. Mt. Todd posed challenges to its previous owner during a tough gold price environment in the mid-1990s. Vista Gold has invested time and money to better understand the root causes of these difficulties and we believe the project will become a mine again. Vista’s new approach involves using high-pressure grinding roll (HPGR) technology, which was not around in the 1990s, to handle the very hard rock on site. It has also figured out the rock chemistry, specifically how to handle the presence of copper in the deposit, which negatively impacted the past owner’s operations.

Mt. Todd has more than 4 million ounces (4 Moz) of established reserves. We expect that could go above 5 Moz, with the release of a feasibility study in H1/13. If this were a greenfield development, I would be less excited about it, especially given its capital cost profile. However, because it has been previously mined, infrastructure is in place and there is some flexibility and scalability in how the company can develop the project, we don’t shy away from a project.

TGR: Let’s move back to North America. Are there other names that you like in this part of the world?

BP: In addition to precious metals, we like a handful of copper opportunities.

TGR: We hear talk of a global economic recovery, which would be positive for the price of copper. Do you like copper based on the prospect of a global economic recovery, or do you just like the metrics and valuations of specific companies in the copper space?

BP: It is a blend of both. I am not ready to say I expect a very robust global recovery. But, given the growth in China and other emerging markets, demand for products that use copper remains at a healthy level. Pair that with the fact that some large mining projects around the world have been scaled back or delayed, and I am comfortable assuming the copper price will remain stable enough to give some copper projects a feasible environment. We feel comfortable with copper above $2.75–3/pound to support development of some of these projects.

TGR: Given that backdrop, which copper names do you like?

BP: One that I cover in the U.S. is an early- to midstage exploration company called Redhawk Resources Inc. (RDK:TSX; QF7:FSE; RHWKF:OTCQX), based in Arizona. It has been defining the Copper Creek project near Tucson as a viable, relatively large-scale, emerging copper project in the shadow of other big operations nearby.

TGR: Have you visited?

BP: I have visited and spent time with management. Redhawk has transitioned the development plan, which started out targeting the higher-grade breccias scattered throughout the site, to incorporate a porphyry system that sits underneath the breccias. The porphyry portion exhibits favorable geology that compares to some of the bigger projects in the U.S. and South America. It is still early days, and the company will need deep pockets to realize the grand plan. But as far as scope, geology and location go, it is a good mix.

TGR: The copper business in Arizona appears to be alive, well and moving forward. Augusta Resource Corp. (AZC:TSX; AZC:NYSE.MKT) just received a key permit there.

BP: We do not cover Augusta and its Rosemont project, but we keep close track. It is a good, but not perfect, proxy for permitting.

Rosemont is in Pima County. The Copper Creek project is in Pinal County. I know it may sound like minutiae, but which county you are in influences the permitting process. Given some of the other major operations are located in Pinal, it is even friendlier than Pima County.

TGR: Are there other copper assets you like?

BP: One that we cover as a firm and that has always been on my radar is Amerigo Resources Ltd. (ARG:TSX). It is based very close to Corporación Nacional del Cobre de Chile’s (CODELCO’s) operation, El Teniente, in Chile.

People overlook Amerigo because of a misconception about what the company does. It processes copper using fresh, lower-grade tailings from CODELCO’s operations as feedstock. The company also has contractual access to reprocess some of the historic tailings from El Teniente dating back to the 1970s and 1980s. Today’s technology and operations are so much more efficient that you can recover higher portions of copper, even from tailings.

In 2012, Amerigo’s production profile eclipsed 50 million pounds (50 Mlb) copper. It also got about 1 Mlb in molybdenum production from its operations. It may be better suited to look at it as an industrial processing company and production story.

TGR: Does Amerigo process its own tailings as well?

BP: No, it has two feedstocks. Roughly two-thirds of the material coming into its plant are direct, fresh tailings from a channel out of the mouth of El Teniente. This fresh feedstock is processed with modern equipment and is low grade.

The older feedstock comes from El Teniente’s old tailing dumps. The older feedstock is much richer in copper. Aside from the unique material, Amerigo looks like a typical copper production. There are ball mills there, flotation, thickening ponds.

TGR: What is the agreement between Amerigo and CODELCO?

BP: Amerigo pays a per-pound royalty to CODELCO.

TGR: Where is Amerigo headquartered?

BP: In Vancouver, however, the operations are all on site just outside of Santiago, Chile.

TGR: Amerigo is a very lightly traded stock, with around a $120M market cap, showing some share price appreciation in recent weeks.

BP: It has had a good year to date. Underlying the story itself is a dramatic shift in the company’s cost structure, effective Jan. 1.

A bit of background: Under the terms of its original power contract, Amerigo’s cost of power was dictated by the marginal costs of production of power in Chile, which are quite high. Years ago, Jan. 1, 2013, was chosen as a date for an automatic reset to another pricing equation. This equated to a 40–50% decrease in Amerigo’s electricity costs, or roughly 25% of the company’s overall per-pound cost.

Looking at the whole story, you have a growing and improving production profile paired with a decreasing cost profile. This makes the financial metrics very attractive. And to sweeten the story, Amerigo pays a semiannual dividend at a run rate of about $0.04/share per year.

TGR: That is rare in a company with this kind of market cap.

BP: Correct. In addition, Amerigo is negotiating with CODELCO to potentially increase production by gaining access to even richer tailings. Right now, Amerigo’s infrastructure and contract rates limit it to roughly a 50 Mlb/year run rate in copper. Increasing production would require some infrastructure investment, but CODELCO may be willing to help with project financing. There are a lot of interesting elements to this story; a lot of positive tailwinds.

TGR: Where does it stand from a treasury perspective?

BP: It has not yet reported its full-year balance sheet. It ended Q3/12 with $35.6M in cash.

TGR: Brian, thanks for introducing our readers to ROTH and for sharing your insights.

Source: Brian Post of The Gold Report

Brian Post is a research analyst covering the Resources & Industrials sector. Post rejoined ROTH Capital Partners in March 2010. Prior to ROTH, Post was an acquisitions analyst at Cascade Affordable Housing, a $100M+ private equity fund focused on commercial real estate investments throughout the U.S. Prior to Cascade, he held a variety of positions in the investment industry including fixed income management, equity research and investment banking. Post is a CFA charterholder, a member of the CFA Institute and the CFA Society of Seattle. He received his Bachelor of Science degree in finance and business economics from the University of Idaho.

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DISCLOSURE: 

1) Sally Lowder of The Gold Report conducted this interview. She personally and/or her 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: SilverCrest Mines Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Brian Post: 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) ROTH Capital Partners Disclosures:
–Within the last 12 months, ROTH has received compensation for investment banking services from SilverCrest Mines Inc.
–ROTH makes a market in shares of SilverCrest Mines Inc. and as such, buys and sells from customers on a principal basis.
–Shares of SilverCrest Mines Inc. may be subject to the Securities and Exchange Commission’s Penny Stock Rules, which may set forth sales practice requirements for certain low-priced securities.
–Within the last 12 months, ROTH has managed or co-managed a public offering for SilverCrest Mines Inc.
–Shares of SilverCrest Mines Inc. may not be eligible for sale in one or more states.