Mining’s old guard needs strong medicine
A new report details subpar investor returns in the mining industry over the last decade, particularly big cap diversified companies which have not adapted to new realities.
Even in the worst resource market in history, companies with good management teams can increase in value. In this interview with The Gold Report, U.S. Global Investors CEO Frank Holmes talks about whether this is the right time to get back into gold, and Portfolio Manager Ralph Aldis reports on the performance of companies in the portfolio and shares some of the names in Australia that have done so well he almost feels guilty about how easy it is to make money off them.
The Gold Report: A number of thought leaders in the larger investing community have come out lately in favor of gold. How do you know it is time to move into the resource?
Frank Holmes: You have to consider the source. If it is a Goldman Sachs or a J.P. Morgan, ask whether they are talking their book. Do some homework and find out if they are long or short. The secret is to find people who are delivering great outcomes and ask what their processes are and what is their passion.
TGR: What is your process for finding the best time to move in the resource sector?
FH: We look at the two pillars of demand, the love trade and the fear trade. This is the beginning of the wedding and holiday season in Asia so the love trade is just ramping up right now. The fear trade is based on the machinations taking place in China and at the Federal Reserve right now. Just before the big United Nations meeting in New York, China devalued its currency. This was a signal to the U.S. that it will be going in a different direction from where the Federal Reserve is taking the dollar. What most people don’t know is that real interest rates have already increased from negative 3% in 2011 to positive 2% compared to the rates in Japan. That means the Fed will be looking at easing them, which is bad for the dollar, but good for gold.
TGR: China’s markets are not very transparent. What do we really know about how much gold that country is buying?
Ralph Aldis: The Shanghai Gold Inventory tells us how much gold is delivered to that exchange, although there is much controversy regarding the possibility of double counting there. I also examine the earnings reports of some of the Chinese retail jewelry shops. The data indicate an increase in retail gold buying after the Chinese stock market crash.
Worldwide, we could be seeing an increase in gold purchases due to concerns about growing geopolitical risk, most recently Russia’s decision to intervene militarily in Syria.
TGR: When we interviewed you in March, you explained the five principles of capital allocation and named several management teams prospering by the application of these principles. Despite 2015’s relentless bear market, many of these companies have continued to prosper. Can you bring us up to date on your favorites?
RA: The company we like best based on its continuing potential is Klondex Mines Ltd. (KDX:TSX; KLDX:NYSE.MKT) and its Midas and Fire Creek gold-silver projects in Nevada. Shares trade at $3.32 today, up almost a dollar from March, but our price target is almost twice that.
Klondex has been exceedingly busy. It raised $26.3 million ($26.3M) to pay off debt and expand its drill program. It published a revised resource estimate in September, which not only replaced all depletion due to mining, but also added ounces. The company will publish another resource update by year-end with likely similar results. Ultimately, the company will add 50,000–100,000 ounces (50–100 Koz) to the resource statement in the near term, an excellent way to increase share price.
The company just got its NYSE.MKT listing, KLDX. That should mean greater exposure, liquidity and index accumulation. Klondex could soon be included in the Market Vectors Junior Gold Miners ETF (GDXJ:NYSE.Arca).
TGR: What about some of the other companies you praised in March?
RA: Claude Resources Inc.’s (CRJ:TSX) share price has gone from ~$0.40 to around $0.72. We calculate that its fair value is closer to $1.80. The Street doesn’t necessarily see it that way, but this is due to a problem with the net asset value (NAV) model. Typically, NAVs systematically overvalue low-grade deposits and undervalue high-grade deposits such as Claude’s Seabee gold mines in Saskatchewan. This is because the NAV model assumes that a dollar of revenue from a low-grade deposit has the same probability that a high-grade deposit has in dropping a dollar of revenue to the bottom line. And that is simply not true, thus the price targets advertised for low grade are too high and those for high grade are too cheap.
Claude announced this month that gold production was up 13% year-to-date and that it was increasing its 2015 guidance to 70–75 Koz. This is a vindication of CEO Brian Skanderbeg. He knows the geology and he has a great plan. He continues to deliver value to shareholders.
TGR: How about another management success story?
RA: Richmont Mines Inc. (RIC:NYSE.MKT; RIC:TSX) has a new president/CEO in Renaud Adams, and is entering some high-grade zones at its mines in Ontario and Quebec. Earlier this month, it announced a cash balance of $76.5M and confirmed that it would meet the high end of its 2015 guidance of 87–95 Koz gold.
Richmont shares have oscillated up and down since summer, but there was an analysts’ tour this month, and they seemed fairly impressed. I think we should still see some value creation on this one. Our fair-value determination is ~$5.85.
TGR: Is that a 12-month target?
RA: I don’t know if it will take six months, three months or whatever, but I do believe that Richmont is a deep-value proposition that will increase in value.
TGR: You had earlier mentioned two other Canadian gold miners as turnaround stories.
RA: The first would be Kirkland Lake Gold Inc. (KGI:TSX) and its new CEO George Ogilvie. That stock is up about $1.50 from March. Ogilvie has reduced his company’s debt opportunistically. Kirkland needs to continue to execute its plan and build cash reserves.
The second would be Lake Shore Gold Corp. (LSG:TSX). There is the possibility that Goldcorp Inc. (G:TSX; GG:NYSE) could move and consolidate there in northern Ontario, control the whole camp and extend the mine life. Of course, Lake Shore has itself consolidated with its takeover of Temex Resources Corp. The share price hasn’t reacted too much yet, but that’s not unusual. We’ll have to wait and see what Lake Shore intends to do with the properties Temex brought to the table.
In the meantime, Lake Shore published in September some very promising intercepts from the 144 Gap Zone of its Timmins West mine, including 6.29 grams per ton gold (6.29 g/t) over 36.8 meters (36.8m), 7.83 g/t over 18.8m, 10.97 g/t over 14.4m and 8.16 g/t over 10.3m.
TGR: Beside Klondex, which other companies are you following in Nevada?
RA: There are two. The first is Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX). It lifted off in the spring but then came back down. The company is concentrating now on derisking its Lincoln Hill gold-silver project. It is doing metallurgical studies on a 10-ton bulk sample with a view to optimizing a mining plan. Lincoln Hill is right next to Coeur Mining Inc.’s (CDM:TSX; CDE:NYSE) Rochester property, so Coeur might decide to take it out in order to extend Rochester’s mine life.
The second is Comstock Mining Inc. (LODE:NYSE.MKT), which has assembled an extremely interesting land package in the historic Comstock district. It is looking at a potential pit at its Dayton project, where it’s had some good drill results from its quartzite-type PQ target.
The company will probably go back and do some additional infill drilling and then put together its mine plan for higher-grade ores underground. I think that the production profile will probably stay much the same in the next six months. Nonetheless, I expect positive things because this area remains largely underexplored by modern methods.
TGR: What are the companies investors want in their portfolios regardless of what happens to the resource market in the short term?
RA: I want to own companies where management can increase the value proposition. Going back to many of the companies we’ve already discussed, their share prices have risen even in the midst of arguably one of the worst gold markets on record.
One such company would be Integra Gold Corp. (ICG:TSX.V; ICGQF:OTCQX), which has the near-term, high-grade Lamaque South gold project in Quebec. Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) recently invested $14M in Integra. There may be potential tax write-offs for Eldorado in this, but I would also imagine that it has given Integra guidance with regard to the future of Lamaque South. I expect that Integra will get taken out by Eldorado or someone else. Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) could certainly have an interest in that region, too.
TGR: Integra released drill results from Lamaque South on Oct. 8, including 22.6 g/t over 2.6m and 11.95 g/t over 4.8m. Is the market taking notice?
RA: To some extent. There’s also been a block of shares out there, originally about 16M shares and now about 8M shares, that some investors been looking to place. The share price may not have immediately reacted to this, but once this is cleared, the picture should become more positive.
TGR: Can you mention another big value creator?
RA: Orex Minerals Inc. (REX:TSX.V). Last year it negotiated a joint venture (JV) with Agnico Eagle on its Barsele gold property in Sweden. Orex has a couple of properties in Mexico, including a JV with Fresnillo Plc (FRES:LSE) and a property in Canada. Orex has now spun out Barsele 1:1 for each share that it had. After the spinout, the combined pieces were almost twice as much as what the company was worth the day before. It was a nice lift for us.
Orex wanted Barsele separated out as a clean vehicle, so if Agnico Eagle wants to take out Barsele as it continues to do additional drilling on it this year, then it’s basically separated from Orex’s properties in Mexico. Agnico Eagle likes Mexico but, again, Orex has a joint venture already with Fresnillo on one of its properties. Orex has used networking to create value for shareholders. Management is a big holder of stock, which is very much part of our philosophy.
TGR: Do you see mergers and acquisitions (M&A) as a possible upside for investors on a number of these stories?
RA: The M&A part always comes, but it tends to come not so much at the beginning of the cycle. We’ve seen some M&A stuff here, and most of it has been asset rationalization where companies have peeled off assets to pay down debt. But we haven’t seen too many people go in there and do just a strategic deal to try to create some value. Typically, we see that a little bit later in the cycle, when valuations start to go up.
What normally happens right now is that the senior stocks’ prices get lifted up first because there are money flows. Then that puts a company in a position where it can sometimes take out some of the junior miners, but that’s why you see these bigger premiums on them, whether it’s 40%, 50%. I’ve even seen 100% premiums on some of these stocks here. Yes, there is certainly opportunity. I’m not expecting it to be extremely intense yet, but it’s something that probably will come later.
TGR: Would you tell us about one company you got out of but then got back into?
RA: That’s Tahoe Resources Inc. (TAHO:NYSE; THO:TSX). We were out of it because of the political risk in Guatemala and the likelihood that it would do a transaction to try to diversify that. We were very fortunate that we owned Rio Alto Mining, so we kind of got our shares back when Tahoe took over Rio. But then, as I mentioned earlier, there was the transitional period where the stock is in nowhere land. Another problem was that Goldcorp sold its large block of Tahoe shares, which further depressed its share price. So, yes, it’s the valuation that’s gotten us back into Tahoe.
TGR: Is there a catalyst you’re looking for in the rest of 2015 or the beginning of 2016?
RA: One would be its advancement of Shahuindo in Peru, showing the Street what kind of progress it’s making there. That’s what I’ll be looking for.
TGR: You have a number of companies listed on the Australian Securities Exchange (ASX) or operating in Australia in your portfolio. Does exposure to African and Asian markets and a favorable exchange rate make those more attractive to you?
RA: Yes. Just as the Canadian dollar has weakened, so has the Australian dollar. In Africa, the euro has weakened, which is very positive for some companies operating there.
I almost feel guilty that it’s been so easy to make money in Australia. Northern Star Resources Ltd. (NST:ASX) has been one of our bigger positions. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) wanted to get out of Australia desperately, so it transferred almost a billion dollars’ worth of assets to Northern Star for less than $100M. Northern Star has done a great job rationalizing this property and buying additional assets. It didn’t step into the last rounds of auctions where I think properties went for prices that were too high.
Another one of our large Australian positions is St. Barbara Ltd. (SBM:ASX). This is another company that has benefitted greatly by new management. The prior operators at its Gwalia mine were sending trucks down and bringing trucks up to the same drift with two different access points. Bob Vassie, the new CEO, rationalized this process. He connected the routes at the bottom and eliminated the congestion. The productivity gains have resulted in St. Barbara shares being up almost 300% this year. It’s been a great winner for us.
Cardinal Resources Ltd. (CDV:ASX) has a new discovery, the Namdini project in Ghana, which is a great jurisdiction. The company has found gold of 2-3 g/t from surface to 100 meters, so I think it is definitely on to something. Simon Jackson, ex-Red Back Mining and Mark Thomas, ex-Macquarie Bank, have joined the board and I think put money into the most recent placement. After that, Macquarie came in for a $1M private placement. What will happen next is it will go back and try to infill drill and extend the strike of this ore body to see how big it is. There could be some very positive things happening on that one.
TGR: How soon might we have the results from that drilling?
RA: By year-end.
TGR: Another of your holdings has itself become a consolidator.
RA: Yes, Newmarket Gold Inc. (NMI:TSX; NMKTF:OTCQX), which has taken some of the assets that AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) and Crocodile Gold Corp. (CRK:TSX; CROCF:OTCQX) had previously. I don’t think anybody really paid that much attention to Newmarket in terms of what it could do. The company had been private for some time.
Management was actually able to buckle down and turn these operations around. It is trading at something like only two times cash flow, as opposed to the industry average of four or five. Newmarket needs to get out and tell its story and let investors know what it is doing. I think the stock was $1 a month or so ago. It’s moved up to maybe the $1.45 area. But it’s probably more like a $4 stock.
TGR: Are you optimistic about higher gold prices?
RA: We may see a turn in the gold market soon. Some of the brokers who have been so bearish on gold are now saying that it could begin to perform better because it appears that the Federal Reserve will not raise rates as high and as fast as some thought. The U.S. dollar has started to weaken a little bit, and that is good for gold. I’m hoping for a gold rally in Q4/15.
TGR: Thank you for your time and your insights.
Ralph Aldis, CFA, rejoined U.S. Global Investors as senior mining analyst in November 2001. He is responsible for analyzing gold and precious metals stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX). Aldis also works with the portfolio management team of the Global Resources Fund (PSPFX) to provide tactical analyses of base metal, paper, chemical, steel and non-ferrous industries. Previously, Aldis worked for Eisner Securities, where he was an investment analyst for its high net worth group and oversaw its mutual fund operations. Before joining Eisner Securities, Aldis worked for 10 years as director of research for U.S. Global Investors, where he applied quantitative skills toward stocks, portfolio tilting, cash optimization and performance attribution analysis. Aldis received a master’s degree in energy and mineral resources from the University of Texas at Austin in 1988 and a Bachelor of Science in geology, cum laude, in 1981, from Stephen F. Austin University. Aldis is a member of the CFA Society of San Antonio.
Frank Holmes is CEO and chief investment officer at U.S. Global Investors Inc., which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and gold and precious metals. Holmes purchased a controlling interest in U.S. Global Investors in 1989 and became the firm’s chief investment officer in 1999. Under his guidance, the company’s funds have received numerous awards and honors including more than two dozen Lipper Fund Awards and certificates. In 2006, Holmes was selected mining fund manager of the year by the Mining Journal. He is also the co-author of “The Goldwatcher: Demystifying Gold Investing.” He is a member of the President’s Circle and on the investment committee of the International Crisis Group, which works to resolve global conflict, and is an adviser to the William J. Clinton Foundation on sustainable development in nations with resource-based economies. Holmes is a much sought-after keynote speaker at national and international investment conferences. He is also a regular commentator on the financial television networks CNBC, Bloomberg and Fox Business, and has been profiled by Fortune, Barron’s, The Financial Times and other publications.
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Source: JT Long of The Gold Report
DISCLOSURE:
1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Klondex Mines Ltd., Richmont Mines Inc., Rye Patch Gold Corp., Comstock Mining Inc., Integra Gold Corp., Tahoe Resources Inc. and Newmarket Gold Inc. Goldcorp Inc. is not affiliated with Streetwise Reports. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Ralph Aldis: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. As of 9/30/15 funds operated by U.S. Global Investors hold the following companies mentioned: Klondex Mines Ltd., Claude Resources Inc., Richmont Mines Inc., Kirkland Lake Gold Inc., Comstock Mining Inc., Rye Patch Gold Corp., Integra Gold Corp, Orex Minerals Inc., Tahoe Resources Inc., Northern Star Resources Ltd., St. Barbara Ltd., Cardinal Resources Ltd. and Newmarket Gold Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Frank Holmes: I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. As of 9/30/15 funds operated by U.S. Global Investors hold the following companies mentioned: Klondex Mines Ltd., Claude Resources Inc., Richmont Mines Inc., Kirkland Lake Gold Inc., Comstock Mining Inc., Rye Patch Gold Corp., Integra Gold Corp, Orex Minerals Inc., Tahoe Resources Inc., Northern Star Resources Ltd., St. Barbara Ltd., Cardinal Resources Ltd. and Newmarket Gold Inc.
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