Michael Gray: Is Goldcorp’s bid for Osisko a harbinger of a gold renaissance?

Michael Gray: Number one is the gold price being in the $1,330–1,370/ounce ($1,330–1,370/oz) range. Few people expected that at the start of the year. Indeed, many were predicting gold below $1,200/oz. Number two, a number of companies have received a stay of execution. There is a fertile environment for raising capital. Equity deals and a number of small merger & acquisition (M&A) deals are being done. That leads to number three, and the most important, which is Goldcorp Inc.’s (G:TSX; GG:NYSE) bid for Osisko Mining Corp. (OSK:TSX). That is the kind of big M&A activity we haven’t seen for a long time.

TGR: As far as equity deals go, how does your deal flow today compare to January and February 2013?

MG: I would say it’s night and day. There was very little activity in the markets for most of 2013. The tax-loss selling that happened toward the end of 2013 put the squeeze on the juniors and there was a marked increase in small-scale M&A during Q4/13. In early 2014 a stronger gold price combined with further M&A and sector outperformance generated more optimism. That momentum continues. It has been important to see more deals come through on equity financing. We’re seeing a healthy number of deals, many of them underwritten.

TGR: Is a gold price above $1,300/oz sustainable for 2014?

MG: Our house view is that the price will be softer in the second half of the year. However, a number of wild cards could come into play: increased buying of gold by China and the controversy over the official versus the unofficial gold sales in India along with the gold import tax dynamic, to name two.

TGR: Every Canadian small-cap gold producer was trumpeting the benefit of a weak Canadian dollar at PDAC. Is the impact of a $0.90 loonie really that much of a boon?

MG: It is as long as the operating costs and the sustaining capital costs are in Canadian dollars. Typically reagents and some materials are in U.S. dollars, so producers don’t get the same leverage on those costs.

For example, Richmont Mines Inc. (RIC:TSX; RIC:NYSE.MKT) has more than 95% exposure to the Canadian dollar as far as its operating costs, sustaining capital and exploration go.

We have to analyze it case-by-case, but we’re finding that the majority of the small-to-intermediate Canadian asset producers have great leverage against a weakening Canadian dollar.

TGR: Can you elaborate on the Goldcorp-Osisko merger?

MG: There are very few 500,000+ ounce/year (500+ Koz/year) assets out there for the seniors to buy, let alone in North America. Out of the 11 operating mines in Goldcorp’s portfolio, on a pro forma basis, Osisko’s Canadian Malartic asset would be among the top three production-wise, if the bid succeeds. This is the biggest dollar value deal we’ve seen for a long time.

It also speaks to Goldcorp’s increased focus on Canada, and with the Éléonore development project in Québec in particular, as it will be in production in November 2014. No question in our view, Goldcorp is highlighting the value of being exposed to a weakening Canadian currency.

Of all the seniors, Goldcorp has the best pipeline of quality assets. After getting through this particularly high initial capital cost (capex) year—2014—the Street will increasingly shine a light on Goldcorp, in our view. With Osisko in its portfolio, the light would shine even brighter.

TGR: Is this a harbinger of further M&A?

MG: Yes, in the sense that the seniors are looking to buy quality production and pipeline assets. If the Goldcorp-Osisko deal goes through, other producer targets in the 500+ Koz gold/year category in the Americas include Detour Gold Corp. (DGC:TSX) and in the eventual 300+ Koz/year category AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE).

Among the 300 Koz/year undeveloped projects out there, Midas Gold Corp. (MAX:TSX) with its 100%-owned, 7-million-ounce (7 Moz) Golden Meadows project in Idaho, along with Torex Gold Resources Inc. (TXG:TSX) and its ~5 Moz, 100%-owned Morelos project in Mexico are attractive high-margin assets. We don’t cover Romarco Minerals Inc. (R:TSX), but its 4.8 Moz Haile project in South Carolina, certainly has 200+ Koz/year production potential.

Probe Mines Limited (PRB:TSX.V) hasn’t reached critical mass yet with its 100%-owned Borden Lake asset, but Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) has put its marker down for an equity interest in Probe. Probe has a compelling new high-grade discovery at Borden that signals that Canadian gold belts have lots more new, raw discoveries to give.

Latin America has struggled to some extent. Even in Mexico, the new mining tax reform package forced companies to make adjustments. In terms of M&A, precious metal assets in Latin America need to be carefully scrutinized.

TGR: Probe is aggressively drilling the new high-grade zone at its Borden project in Ontario. When do you expect Probe to issue a preliminary economic assessment (PEA)?

MG: Our analyst who covers Probe, Pierre Vaillancourt, believes Probe could be in a position to publish a PEA as early as before the end of 2014. Probe has plenty of cash and the ability to raise more. Its share price has defied a lot of investors who might have taken money off the table on its run up.

TGR: You have Outperform ratings on several Canadian producers. One is Richmont Mines, which had issues in 2013 with rising costs due to processing lower head grades. Is this a turnaround story in 2014?

MG: In our view, it’s definitely a turnaround story. Richmont found a new deposit of just above 1 Moz of approximately 10 grams per ton (10 g/t) gold immediately below its Island Gold mine near Wawa, Ontario. This deeper zone (Deep C) at Island Gold transforms the company from one that was living on a small reserve base to one with the potential for a 10-year mine life with higher margins.

Despite the issues on grade it encountered in the upper portions of the Island Gold mine last year, the company has ramped down to the top of its Deep C zone with nearly 1 Moz of high-grade ore. It is drilling that off to 20-meter (20m) centers right now. This is a perfect scenario: the development is getting put in place; Richmont just has to extend the ramp infrastructure, develop stopes and feed the mill with higher grades.

The true thickness of the Deep C zone averages 4.5m versus 2.7m in the upper portion of the mine. That will mitigate dilution, bring higher grades to the mill and increase production, based on our analysis.

TGR: What caused the problems in 2013?

MG: At the Island Gold mine, Richmont was mining lower grades in 2013 of 4.65 g/t; recoveries were also lower and milling costs were higher than expected. Its cash costs were fairly high at CA$946/oz in Q4/13. That grade just isn’t going to cut it at $1,200/oz gold once sustaining costs are added.

The high-grade Deep C deposit is the game changer. Approximately 60% to 70% of the drill holes have documented visible gold, at a depth between 450m and 1 kilometer. This can be a prolific vertical depth window in a lot of Canadian gold belts.

We believe that the more robust continuity and geometry of this Deep C zone, in terms of thickness and grade, make it a winner. Richmont is also starting to document parallel veins with good grades on the flanks of the Deep C zone, including those getting incorporated into the latest resource statement.

TGR: What other companies do you rate Outperform?

MG: Tahoe Resources Inc. (THO:TSX; TAHO:NYSE), which recently achieved commercial production at the Escobal mine in Guatemala and has issued production guidance of 18–21 Moz for 2014. The company has an A team at Escobal. It delivered with minimal slippage in the timelines. It also delivered on corporate social responsibility initiatives. Escobal is an underground mine where the company has brought to bear all the latest technology to ensure that it is an environmentally responsible underground mine as it lies in the region of a farming community. That was a really important box ticked for Tahoe.

TGR: Is Tahoe’s $75 million ($75M) debt an issue?

MG: It’s a minimal debt for the production profile and the cash flow we see coming from the asset. At the same time, we would expect to see management address the debt before instituting a dividend policy.

TGR: What other companies that you cover with Outperform ratings would you like to talk about today?

MG: MAG Silver Corp. (MAG:TSX; MVG:NYSE) is one of our high-conviction calls in the precious metals space. The Juanicipio project in Mexico, the joint venture between MAG Silver and Fresnillo Plc (FRES:LSE), is one of the best, highest-grade silver development projects out there. We visited the asset five weeks ago to confirm that the underground development access to the vein is progressing. It will take 3.5 years or so to fully access the ore and establish production at Juanicipio.

We believe this mine will have a production profile close to 15 Moz silver/year for the first seven years. Its all-in sustaining cash costs will be approximately $3/oz silver. The PEA shows a 21% internal rate of return at $10/oz silver. This is all on an initial capex of approximately $320M. MAG Silver has a 44% share of that to contribute.

TGR: There was talk about Fresnillo eventually buying MAG Silver out. What are you hearing?

MG: There is a lot of history there. Back in 2008, a “takeunder” bid caused some acrimony. There are different faces on the joint venture technical committee now. George Paspalas is now the CEO of MAG Silver; Octavio Alvidrez is CEO of Fresnillo.

From our vantage point, it makes sense for Fresnillo to consolidate the other 44% Juanicipio interest it does not control. It would have to be a friendly transaction, given that Fresnillo owns 17% of MAG Silver. Bottom line: things are more positive from a relationship point of view by our estimation, but that doesn’t mean a takeover is imminent.

TGR: You mentioned Midas Gold as a possible takeover target. What is the premise there?

MG: Midas Gold’s 7 Moz 100%-owned Golden Meadows gold project is an attractive asset and potential pipeline project for an intermediate or senior producer as it a North American asset that could be producing 300–400 Koz Au/year by 2019 or 2020. There are very few assets like this in North America. The closer Midas gets to submitting its environmental impact statement (EIS) and gets into Idaho’s joint review process (late 2014/early 2015), the more it will be on the radar screens of intermediate and senior mining companies, in our view.

Golden Meadows is a past-producing brownfield open-pit operation. The company will have some permitting challenges, including restoring a former salmon stream that currently flows into the Yellow Pine pit. However, it is our understanding that the environmental groups aware of the project recognize that mining the deposits at Golden Meadows will ultimately transform and remediate the legacy issues toward a more natural state at the end of its life as a mine and is a good news story.

Midas will issue a prefeasibility study in midyear. We estimate that the company will be in a position to submit its EIS and essentially put a pin in the project scope and permitting toward the end of the year. That might be the time for a producer to take on the project via M&A.

The other angle that we think is important is that we see Golden Meadows as a Donlin Creek analog. Both have similar geology, and Donlin Creek has more than 40 Moz of gold [in the Barrick Gold Corp. (ABX :TSX; ABX:NYSE) and NOVAGOLD (NG:TSX; NG:NYSE.MKT) joint venture]. We believe on this basis Midas’ Golden Meadow asset has the pedigree to be very big.

TGR: When it comes to taking positions in these companies, do you recommend accumulating on dips or taking full positions when possible?

MG: It varies by company. If it’s a high-conviction call and you take a 12-month view as we do, we would gain exposure to the best of breed assets, companies like MAG Silver and Midas Gold.

Among our Outperform ratings, companies we consider buying on the dips include Elgin Mining Inc. (ELG:TSX), which we recently moved from a Neutral to an Outperform rating. At 166%, it has one of the highest year-to-date returns in our coverage universe. Elgin is a bit of a show-me story when it comes to its Björkdal gold mine in Sweden.

TGR: Any final words of wisdom for us?

MG: Even though we’ve turned one corner, investors need to be aware that we could turn another corner—not necessarily a positive one. I think we should be very prudent. Focus on quality companies with low cost structures, attractive assets and good management.

TGR: Michael, thank you for your time and your insights.

Michael Gray is a mining equity analyst with Macquarie Capital Markets and covers a range of precious metal explorers and producers with an emphasis on North and South America. He is an exploration geologist and holds a Bachelor of Science in geology from the University of British Columbia and Master of Science in economic geology from Laurentian University. His career of more than 25 years in the mineral exploration business started with senior mining companies including Falconbridge, Lac Minerals, Cominco and Minnova where he worked throughout Canada and the USA. He co-founded Rubicon Minerals in 1996. He is also a past President of the 5000+ member BC & Yukon Chamber of Mines (now AME BC). Gray joined the mining analyst world in 2005 where he brought to bear his technical skills to identify new precious metal opportunities at an early stage with outstanding exploration potential; he has covered a number of these opportunities that were subsequently taken over by gold producers.

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