Brian Mok: Gold Dynamics

Union Securities Analyst Brian Mok gets excited about gold companies with prospects for big-time growth. But then again, who doesn’t? In this exclusive interview with The Gold Report, Brian discusses at length, and offers target prices on, no less than five juniors headed for big increases in gold production.

The Gold Report: Tell me how a strong gold price is changing the companies that you cover.

Brian Mok: Obviously, a strong gold price bodes well, but really, it’s a double-edged sword. You have the nice, high gold price, but the companies I’m currently looking at have functional currencies that inversely correlate to the U.S. dollar. You get the rise in the gold price, but unfortunately, you also get a rise in costs that offsets some of the impact the strong gold price brings to cash flow. That’s what I’m finding right now.

TGR: But have you seen a change in the type of company you’re covering? It’s not so much the explorers now. Almost all the companies you cover seem to be either near-term producers or producers. A lot of them are high-cash-cost operations. I was wondering if that has become something of a trend.

BM: Yes, there is a trend. If you go back to 2006 and 2007, explorers found it quite easy to raise money. It was easier for explorers to get traction with investors. However, during the financial crisis, maybe investors got burned and became a little bit more risk-averse. Now, they’re looking at companies where cash flow is imminent, or at least it’s in the foreseeable future, where there is a lower risk profile. To satisfy that need, companies may be considering gold projects that were marginal two years ago but are now in favor, given where the gold price is. This partially explains the migration toward the group of companies I currently cover.

TGR: But whenever you have fairly high-cost operations, that reduces your margins. These types of companies have to be well managed in order to maximize profits.

BM: An early-stage explorer has nothing in the ground per se when it gets started, very much like a lottery ticket. Which company is going to make a hit? Which company is not going to hit? When you move up into the more advanced explorers, developers and emerging producers, there’s a known quantity of gold in the ground, which offers some comfort. But then it’s a matter of executing a plan to get it out of the ground.

I believe, you can always find people to execute that plan, to help mitigate that risk. In exploration, you can have all the tools in the world and some of the brightest minds building these geologic models, but at the end of the day, you won’t know until you start drilling. Even then, it may just be a one-hole wonder.

TGR: Is there a chance that the gold price could be threatened by small producers bringing their gold to market?

BM: I don’t think so. Not in the short-to-medium term. In the last six or seven years, global gold production actually declined, from about 83 million ounces to 75 million now. I think there’s a bit of a gap that needs to be filled. You’ve got the large projects that will be coming into production, like Osisko Mining Corp.’s (TSX:OSK) Canadian Malartic and maybe Detour Gold Corporation’s (TSX:DGC) Detour Lake. Those scale at a half-million to a million ounces per year, and you could include Barrick Gold Corporation’s (NYSE:ABX; TSX:ABX) Pascua-Lama project. But a lot of other projects coming into production are small. In aggregate, they won’t be able to tip that supply-and-demand balance to the extent that you would start to see a fall in the price of gold. Gold is also used as a hedge against inflation and those themes still play out.

TGR: What does Union look for in small-cap producers?

BM: With small caps, it’s the potential to rapidly expand production. If you’ve got an established resource and plans for 100,000 ounces annually, can you bring it up to 200,000? Are you able to double the mine life, given what you know is in the ground? There is also the upside in exploration. Is there the potential to expand the known resource, or improve the confidence in that resource and eventually bring it into reserves? You can look at a small producer, but you have to go beyond the current production levels and ask, “What else can be done here?”

TGR: But when you’re building your models, how much weight do you allot to management? How much weight do you put on cash flow?

BM: Essentially the biggest one is cash flow. I build my model to see when the gold project will be spitting out cash and when the project will hit its stride. Then I look at exploration upside. Given the setup of the operation, is there potential to easily expand production from the current plan? Some of the management teams with these emerging junior producers don’t have a lot of experience bringing new projects into production. This all plays a role in my decisions. However, I tend to focus more on the technical aspects, because I believe that if a project has merit, you’ll be able to bring people on board with the skills needed to get the project into production. You can always add to your management team, but what you have in the ground is what you have in the ground.

TGR: What gold price are you using in your models, short term and medium term?

BM: In the short term, I’m using $1,200, basically where it’s been the last few weeks. I’ve been conservative in my gold outlook. Next year it’s $1,100, and in 2012 it’s $1,000. Perhaps this is more of an optimistic view on the economy and the ability of central banks and governments to get their act together; that is, ease nerves around the issue of sovereign debt, and manage inflation using the tools available. It may be a conservative view on the gold price, but if a project passes muster at $1,200 per ounce, then at $1,500 gold, you know it’s going to be a really good project.

TGR: You just started covering Century Mining Corporation (TSX.V:CMM). In northwestern Québec, it has the former Sigma-Lamaque mine, which has underground ore that Century is starting to mill. Production is ramping up for 2011. Why did Union decide to focus on Century?

BM: Century is a name that we’ve been looking at for about a year. I went up to the Lamaque site last July to get the lay of the land and meet some of the technical personnel. I was impressed with what I saw at the mill and some of the other ancillary facilities, underground, as well as the fact that it’s in Val-d’Or, Quebec, a mature mining center, where you have lots of labor, the supplies you need, the infrastructure and a cooperative government.

I also felt very comfortable with the technical team’s plan to bring this mine back into operation. I thought the focus on underground production was key. We know the history of the open pit and some of the trouble the previous operators had with them.

The engineers described how they wanted to proceed. All they needed was money, which they finally got at the end of December. In January they started to roll and I kept an eye on it. Were they hitting the milestones that they set for themselves? Yes, they were doing exactly what they said they would do. I have confidence in the team’s ability at Lamaque to bring the operation online.

TGR: What about its production profile?

BM: Century has the ability to ramp up from its target of 40,000 ounces this year to 90,000 next year and eventually 100,000 ounces by 2013. I like that. I’m quite confident that Century will be able to execute the plan to ramp up to 100,000 ounces in the next three years.

There is additional exploration potential at Lamaque based on their historic database, as well as other exploration targets within the complex.

TGR: What about some of their other properties? They’ve got a significant project in Peru.

BM: Yes, San Juan in Peru. It’s a small, narrow-vein, high-grade system. It had been capital- starved when they purchased it, and then they got things rolling. They’re producing about 19,000 ounces a year from San Juan now. There are plans to expand to about 30,000 ounces by 2012, through mill expansion as well as by modernizing and mechanizing the underground mining methods using refurbished equipment from Lamaque.

They also want to use different mining methods to increase throughput and ultimately produce more gold and silver out of San Juan. That’s the plan, over the next two or three years. In terms of reserves, they’ve got six years on the books; that’s what I’ve modeled right now. But the mine has run for 30 years and there’s still significant exploration potential on the zone where they’re mining, as well as the different vein structures within their property. There is also a porphyry target. I think six years is conservative in terms of mine life. Over the next couple of years we’ll see what the exploration efforts bring.

TGR: What about cash flow?

BM: Cash flow is going to be basically flat this year as they ramp up Lamaque. Then into next year, we’re looking at $0.10 per share in cash flow. In absolute dollars, that’s about $36 million. This declines to $0.09 per share as a result of the reductions in my gold price assumptions for 2012.

TGR: Will that be enough to service debt and make reinvestments?

BM: Yes. This year is the critical year. I’ve assumed that they’ll need another $5 million in financing to basically complete development through 2010. Then they’ll start to become cash-flow positive next year, probably in Q2, then they’re home free. They’ll be able to repay the capital leases from cash flow. Right now they’re delivering gold into that prepaid gold forward. I don’t foresee any issues with Century not being able to deliver the gold to meet their obligations.

TGR: They’re hedged?

BM: The $33 million prepaid forward agreement they entered into with Deutsche Bank is a five-year facility, so they’re partially hedged until 2014; it covers 61,183 ounces or 17% of the forecast production during that period. After that, they experience the full gold price.

TGR: What’s your 12-month target on Century?

BM: It’s $0.90.

TGR: Another company that has a similar business model but is a fair distance away is Crocodile Gold Corp. (TSX:CRK; OTCQX:CROCF) in Australia. It’s a high-cash-cost producer that brought some old projects back into play. Tell our readers about that one.

BM: Crocodile Gold’s sole asset is in the Northern Territory in Australia. The asset base consists of the former assets of GBS Gold, which went into bankruptcy protection in 2008. Essentially GBS tried to bring these operations on and ran into operational problems, then faced a cash crunch just as the financial crisis hit. They had to go into bankruptcy.

Crocodile Gold purchased the assets, applied a new mining plan, and essentially started operations in November 2009. I think the company was a bit aggressive in terms of their initial gold production forecast of 120,000 ounces for 2010. They had to subsequently reduce it to 100,000 ounces and the stock took a bit of a hit earlier this year, but they recently announced commercial production beginning in June. June production figures are around 8,700 ounces. I had forecast 7,500, and I was surprised they were able to beat my estimates. They’ve maintained their guidance for 100,000 ounces in 2010, which I think is very positive. I’ll keep an eye on the stock for Q3 and Q4, but I’m fairly comfortable now that the company will be able to execute on this year’s target and line things up for 2011, when they’re aiming for 200,000 ounces.

TGR: It’s not just one mine, though. There’s a lot going on there.

BM: This operation is actually a series of operations. They’ve got two mills, a number of open pits planned and two underground mines. Basically they’re drawing ore from all the mines and processing them in the Brocks Creek Mill, as well as at the Tom’s Gully Mill.

TGR: But if somebody came up to you and asked, “What stands out about Crocodile Gold?” what would you say?

BM: What I like about Crocodile Gold is that, in typical Aussie fashion, they drilled shallow and only drilled a resource large enough to justify a small operation. The previous operators, even prior to GBS Gold, missed a lot of potential. Now Crocodile is going back and doing what we would typically do in North America, in terms of drilling to define a resource. I think there’s significant potential to add resources to enhance the production profile and the mine life. Also, they can ramp up production quickly, and are able to go from 0 to 100,000 and potentially to 200,000 ounces. Those are the main things I like about Crocodile Gold.

TGR: What’s your 12-month target price on that?

BM: My target price on Crocodile Gold is $2.60.

TGR: Another company that you cover is Alhambra Resources Ltd. (TSX.V:ALH). It’s producing similar numbers to Century right now, 20,000 ounces a year in Kazakhstan. It also has a lot of exploration upside. Tell us about that one.

BM: Alhambra has a large, large land package, about 2.7 million acres, in Kazakhstan, right in the Charsk Gold Belt. The property is bookended by two large gold deposits, I believe 10 million ounces to the west and 13 million ounces to the east. Both are operated by Polyus Gold (LSE:PLZL; OTCPK:OPYGY), a Russian-based gold company. There’s potential for very large deposits, just given the swath of land that Alhambra controls.

The Soviets had previously done some work there and focused on a few targets, but there are a number of geochemical and geophysical anomalies that haven’t been followed up on yet. That’s really exciting in terms of being able to build your resource inventory. Also, the roughly 20,000 ounces per year that they’re producing at Uzboy is all oxide heap leach (a relatively simple gold recovery method). It’s a relatively small resource, roughly 170,000 ounces. However, there’s about 1.2 million ounces below that, and it’s open-pittable. There’s the potential to put in a mill and ramp up production from 20,000 ounces to 150,000, 200,000 or 300,000 ounces, depending on the timing of production and so forth. There’s a significant ability there to add to the production profile. The Dombraly and Shirotnaia are two advanced exploration targets that may be two or three years from production. There are many ways that you can add to the production profile and extend the life of the entire operation.

TGR: But what would you say to an investor who’s a little bit leery about tying up equity in a company whose main project is in Kazakhstan?

BM: Kazakhstan is, I guess, democratic, in the sense that the free economy more or less reigns. They haven’t run into difficulties politically in terms of advancing projects. But it’s very bureaucratic in the way projects are approved or advanced. The government doesn’t step in and expropriate your projects. The uranium industry is a good example of that. The government has joint ventures with private uranium companies or companies listed on the TSX. They’re able to advance projects. I look at Cameco Corp. (NYSE:CCJ; TSX:CCO) and their Inkai uranium mine. It’s always a good sign when the majors are there.

TGR: What’s your target on Alhambra?

BM: It’s $0.75.

TGR: What are some other companies that you’re following?

BM: I also follow Dundee Precious Metals Inc. (TSX:DPM). I have a $5.90 target and a speculative buy rating on it. Its flagship asset is the Chelopech gold-copper mine located in Bulgaria. There’s potential here for the stock to appreciate. I believe the overhang on the stock has been its past efforts to obtain regulatory approval to build an autoclave (a high-pressure “oven” which processes ores in order to facilitate gold extraction with cyanide) in Bulgaria. Due to a recent Supreme Administrative Court of Bulgaria decision, the autoclave has now been ruled out, so that distraction is gone. It may be a negative, but the positive is that they’ve purchased a smelter in Namibia where they plan to ship their gold-copper concentrate. This now becomes a story of expansion. They’re in the midst of going from processing 1 million tons per year of ore to 2 million tons. In terms of gold, that’s going from 70,000 ounces to about 130,000-135,000 ounces, plus 50 million lbs. of copper. It’s an exciting story. When they purchased the asset it was severely undercapitalized.

TGR: Who did they purchase Chelopech from?

BM: From a U.K.-based company that had gone bankrupt. Essentially, they turned around the asset. They brought in a good team of ex-pats and Bulgarian nationals to help run the operation. It’s taken them a few years, but the operation is hitting its stride. The near-term catalyst for the stock is the execution of their expansion plans at Chelopech. By the second half of 2012, they should be hitting the run rates needed to double current production.

TGR: What is it about Dundee that gets you most excited?

BM: It would be the growth profile and the fact that a lot of this “country risk” has been removed because of Dundee’s ability to secure the smelter in Namibia. Also, they’ve got another gold project in southern Bulgaria that’s coming online called Krumovgrad. They’re targeting 2013 to bring that online. I think they’re going to avoid a lot of the permitting issues they encountered with Chelopech because they’re not going to use cyanide. They’re planning to produce a concentrate product. Also, they’ve redeveloped the scope of the project to minimize the impact on the local population, and that should help with the permitting process. I think they’re doing all the right things. I’m quite hopeful that this project will come online and add another 100,000-150,000 ounces of production in three or four years’ time.

TGR: Are there any others you want to talk about?

BM: Yes, Corex Gold Corp. (TSX.V:CGE), an explorer in Sonora State, Mexico. Its project is southwest of Alamos Gold Inc. (TSX:AGI). I was initially attracted to it based on some of the initial drill holes. One-plus grams of gold over 100 meters-I mean, that grabs your attention. A lot of that initial exploration was done by soil sampling; there wasn’t a lot of geophysics work at that time. They completed that initial drill program and there’s been a little bit of drilling since. That has resulted in some mixed results, but what’s interesting is that they’ve come across a copper-gold porphyry system closer to the surface at its Benjamin target. That may change their strategy. They’re conducting more geophysics work to further define some of the structures. And they just completed a strategic investment with Gammon Gold Inc. (NYSE:GRS; TSX:GAM).

TGR: Gammon’s Ocampo gold-silver mine is probably not all that far away.

BM: Yes, they’re not too far away, but with that Gammon money, Corex can go back and drill some of the targets that were defined by this extensive geophysics program. We’ll keep our eyes on that.

TGR: It’s a little bit different from the other ones we talked about, given that it is an exploration play.

BM: This one is just pure exploration. However, it caught my eye. I went and visited the site and I was quite excited with what I saw.

TGR: And your target price on Corex?

BM: It’s a spec buy, with a target of $1.20.

TGR: Thanks, Brian. We appreciate your insights.

Brian Mok is senior mining analyst at Union Securities. Previously he worked at Research Capital as a mining analyst, and as an associate as part of Scotia Capital’s Mining and Metals Research Team. Brian began his career as an engineer with a mining contractor working at various projects and operations in Saskatchewan and Nevada. He is a member of Professional Engineers Ontario. Brian holds a Bachelor’s degree in Mining Engineering and an MBA from Queen’s University, Kingston, Canada.

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DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Detour and Crocodile.
3) Brian Mok: I personally and/or my family own shares of the following companies mentioned in this interview: NA. I personally and/or my family am paid by the following companies mentioned in this interview: NA.

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