Arie Papernick’s formula to profit from Canada’s booming gold exploration

Arie Papernick: Institutional and retail investors invest in gold mining when they believe they will make a return. This belief is driven by an increase in discoveries, merger and acquisition (M&A) activity and larger bought-deal financings closing. M&A deals generate confidence in the longevity of the junior gold mining sector and establish valuation reference points for stocks to trade up to. Mergers and acquisitions have been quiet on the junior side since IAMGOLD Corp.’s (IMG:TSX; IAG:NYSE) takeout of Trelawney Resources Inc. and Yamana Gold Inc.’s (YRI:TSX; AUY:NYSE; YAU:LSE) takeout of Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE).

TGR: How are discoveries a catalyst for building investor confidence?

AP: Bonanza-grade discoveries remind investors that meteoric returns are possible, and that brings people back into the sector. We’ve recently seen a few such dramatic moves. Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX) saw its stock rise dramatically from its discovery on the Martiniere property east of Detour Lake. And JV partner GTA Resources and Mining Inc. (GTA:TSX.V) saw its shares rise on the Hemlo-Schreiber greenstone belt. Other names enjoying really good stock pops are Gold Reach Resources Ltd. (GRV:TSX.V) and Gold Canyon Resources Inc. (GCU:TSX.V). And the jolt that everybody is talking about now is the GoldQuest Mining Corp. (GQC:TSX.V) copper-gold result from the Dominican Republic. Its stock shot from $0.10 to $2/share.

TGR: Where is the capital coming from for these types of investments?

AP: Financings are crucial for the exploration industry. Companies need money to do the drilling to create the news to motivate the investment, and we’ve seen a pick-up in that. Quite recently, Sandstorm Gold Ltd. (SSL:TSX.V) announced a $130 million (M) bought deal. More moves like that will likely build confidence among institutional investors in the sector.

TGR: Where are the most exciting new discoveries for precious and base metals in Canada?

AP: Manitoba is exciting. Mega Precious Metals Inc.’s (MGP:TSX.V) most advanced project there is called Monument Bay. The company is well funded. It has an open and an underground project. It has close to a 3 million ounce (Moz) compliant resource. Mega Precious is currently drilling 20,000 meters with a plan to update the resource in 2013. It has a very large land package with several targets and also has good relations with the First Nations. It kick-started its environmental and socioeconomic studies early on in the program.

There are new iron ore discoveries in the Schefferville area in Quebec. The Plan Nord and the province’s commitment to expanding infrastructure in the north is encouraging to junior explorers. This is in addition to having favorable tax structures for both mining companies and investors. Beaufield Resources Inc. (BFD:TSX.V) has a large land package in a great location in that area. It’s surrounded by New Millennium Iron Corp. (NML:TSX.V), Tata Steel Minerals Canada Ltd. (NML:TSX), Labrador Iron Mines Holdings Ltd. (LIM:TSX), Century Iron Ore Holdings Inc. (FER:TSX.V) and Champion Minerals Inc. (CHM:TSX). It’s undeveloped, but Beaufield just completed a small drill program of 2,000 meters, and the results are encouraging.

We’ve been following another junior in that area, Fancamp Exploration Ltd. (FNC:TSX.V). It monetized its interest in Champion Minerals and now owns 12.5% of it. It also owns 100% of Lac Lamêlée, which is north of ArcelorMittal S.A.’s (MT:NYSE) producing Fire Lake mine. Fancamp has produced some great intercepts. It is doing a drill program right now, with the expectation of delivering an NI 43-101 by the end of the year. Plus, the company just released some great news on a nearby property belonging to privately held Magpie Mines Inc., of which Fancamp owns 46%. The project recently made its billion ton historic resource compliant. It also has an agreement with a Chinese company, Sichuan Nonferrous Material Technology Co. Ltd., to perform metallurgical analysis. Positive feedback from the metallurgy study would be great, as Fancamp plans to spin the venture off as a public company.

TGR: What potential aquisitions are poised to take advantage of initiatives in Canada by the juniors?

AP: Large firms with positive cash flows and companies looking to diversify their assets among resource classes and jurisdictions are in the buy market.

TGR: Looking at the Alberta region, is there a synergy between metal mining and the oil tar sands operations that are already in place?

AP: Not yet, but there’s a company called DNI Metals Inc. (DNI:TSX.V; DG7:FSE) that is attempting to change that. Its large Alberta property has expansive black shale hosting low metal concentrations. Its initial resource estimate for Buckton, which covers a fraction of its total land package, contains about 250 million tons with low parts-per-million grades of a host of different minerals like molybdenum, nickel, uranium, vanadium, zinc, copper, cobalt and even rare earths. It’s a new type of deposit in Canada, but there are companies developing similar types elsewhere in the world. Talvivaara Mining Company Plc (TALV:LSE) in Finland is probably the first of that sort to go into production. DNI is taking advantage of infrastructure that’s already in place for the mining of oil sands and applying that to bulk metal mining, instead of building everything from scratch.

TGR: DNI proposes to bioleach the black shales. How does that work?

AP: Bioleaching operates with very low concentrations of various metals that cannot be efficiently smelted because there is no leading metal in these shales. In bioleaching, bacteria is cultured from a host shale, which is a living organism, and then used to extract the metals out of the ore. It’s similar to, but much cleaner than, the traditional heap-leaching technique, which uses cyanide. It’s a low-cost method and it’s well known, but it takes a long time to process the ore and separate the metals out. Difficulties arise because of the different chemical behaviors of the metal mixes embedded in the shale. Metals respond differently to different chemical environments. DNI has been working on perfecting this technique with the CanmetENERGY technology center in Ottawa.

TGR: There are advantages to exploring for metals in the areas in which the oil and gas companies are making a lot of headway. To what degree will the majors allow the juniors to keep absorbing the exploratory risk before investing in new projects?

AP: What makes acquisitions attractive to a major is a quick, derisked addition to reserves. Juniors traditionally have absorbed the risk inherent in exploration work, and a major company generally won’t pay an acquisition premium for a project that hasn’t been derisked. Especially in the current climate, majors are looking for no loose ends, projects with everything ready to go so they can put in their capital and get into production. Of course, there are always exceptions, such as when the exploration potential is really, really strong, and a major will take over the exploration work before it gets to development.

TGR: Are the seniors willing to compete against each other over these prospects in the junior space?

AP: I think so. Right now, deposits with high-grade, multimillion-ounce potential are becoming rarer, especially in low-risk countries, such as those in North America, which is why you’re seeing more and more acquisitions in foreign, high-risk countries. It’s not by choice that the firms end up dealing with nationalization risk, high royalties and other political risks. We’ve also seen some movement away from the high-risk countries. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) is selling its stake in African Barrick Gold Plc (ABG:LSE) due to security risk and blackouts in the region. Properties with all the right features will definitely see competing offers from the majors.

TGR: Alongside the opportunities in base and precious metals that you’ve mentioned, are there any junior energy firms that you like in the same regions?

AP: One of the companies that we follow in the energy space is Aroway Energy Inc. (ARW:TSX.V; ARWJF:OTCQX), located in Alberta’s Peace River Arch. It’s a well-managed, fast-growing company. It has a joint venture with a private company with significant infrastructure, which has lowered Aroway’s operating costs. Aroway has expanded its land package significantly over the past year with positions near five majors. Current production is 650 barrels oil equivalent per day (boe/d), and 90% of that is oil. Management plans to double that production by the end of the year to 1,200 boe/d. They have a great track record and are exceeding their production targets; it’s refreshing to see a team setting goals and meeting them.

TGR: Are there any exciting developments in Ontario?

AP: The IAMGOLD acquisition of Trelawney that was announced in early spring has major implications for Ontario miners. IAMGOLD has stated that it expects its gold production in North America to increase to 36% from 3% when Côté Lake goes into production. What’s interesting here is that IAMGOLD inherited a joint venture partner called Sanatana Resources Inc. (STA:TSX.V) when Trelawney acquired Augen Gold Corp. Sanatana will complete its earn-in very shortly to be a 50% joint venture partner. The joint venture lands surround the Côté Lake deposit and may be needed for mine waste and tailing storage. Recent drilling indicates that the Côté Lake Trend could continue through some of those joint venture claims.

Another name we like in Ontario is Northern Gold Mining Inc. (NGM:TSX.V), which just announced that Greg Gibson, former CEO of Trelawney, is its new CEO. The property package is along the Destor-Porcupine Fault zone, with unexplored ground along strike. So far, the company has announced over 1 Moz in the Measured and Indicated category with grades seeming to increase at depth. Northern Gold has just raised $13M, so it’s well funded and will aggressively drill the property to convert resources to reserves and produce a prefeasibility study. Greg Gibson has many fans after the completion of the sale of Trelawney, so future work on Northern Gold will get noticed.

Another name that we’ve covered with Ontario properties is a producer, St Andrews Goldfields Ltd. (SAS:TSX). The company has three producing mines in the Timmins Camp. Operating costs have been coming down. It just announced strong Q2/12 and Q1/12 earnings, and production has been ramping up at its Holt mine. Management has been meeting guidance. It is forecasting 90–100 Koz production for this year and seems to be in a good position to meet that. Once the Taylor mine is put into production—the company hopes by 2014—production will increase to 120–130 Koz. Meanwhile, it continues to do exploration around the surrounding areas to increase reserve life and mine life.

TGR: Your investment firm, Secutor Capital Management Corp., specializes in “defensive capital management.” Can you explain how that investment strategy applies to looking for solid investments in the junior metals mining space?

AP: My practice at Secutor is restricted mainly to sophisticated, institutional portfolio managers who specialize in junior mining, as well as high net worth investors who meet the accredited investor criteria. I provide my clients with fundamental research and strategies to provide pricing advantages, which help create a defense to price swings in a volatile market. One way that I find pricing advantages is through initiating flow-through private placements, which provide investors with a reduced after-tax cost base. Also, many of the private placements that we organize and participate in include warrants. These provide extra leverage and an option of keeping exposure after a position has been sold to conserve capital.

I also organize off-market transactions priced at discounts to the market for those who need to trade restricted shares. This process can only be done with accredited investors. Most of the institutional investors that I deal with have the capacity to buy large baskets of stocks in the sector, and I think this kind of diversification is just as, or even more important than, fundamentals in the sector. It’s increasingly difficult to pick out the next major discovery, in advance, with only limited exposure.

TGR: How can retail investors best manage a portfolio of investments divided between junior and senior sectors?

AP: A basket approach is mandatory when investing in the junior gold market space. It’s really the only way to increase the chance to get exposure to the so-called home run events before those results hit the market. The best way for individuals to do this is through a fund. Pinetree Capital Ltd. (PNP:TSX), which trades on the exchange, can be bought and sold like a stock. It basically represents a basket of juniors. It’s managed by Sheldon Inwentash, who is a seasoned professional. It is clearly focused on the junior side of the market. You won’t get much exposure to producers in this stock.

If you’re looking for producers, people like the well-respected Kevin MacLean, at Sentry Select Capital Corp., are more focused on cash-flowing names.

TGR: What would reasonable ratios be for a retail investor looking to invest in both juniors and majors?

AP: I can’t really pinpoint a blanket ratio because it really depends on an individual’s risk tolerance and net worth. Investing in the mining space, regardless of the size of the company, is risky, and it’s clearly not for everyone.

TGR: For the firms that you recommended, do you have any target prices that you’re suggesting?

AP: On our company reports, we do not include target prices. We do comparison tables so the clients can see relative value. Our clients are generally experienced investors and will pick their exit points as required when they’re managing their portfolios. I think retail tends to put too much importance on actual target prices, whereas institutional investors want to be shown good ideas, and they figure out their own entry and exit points.

TGR: Are there any tips, either for institutional or retail investors, on how to pick an exit point and stick to it?

AP: The more important exit point is on the downside, needed for preservation of capital. I think to be a successful investor long term in any sector, you need to pick and stick to your downside exposure threshold. It’s always harder to sell at a loss, but that’s the more important discipline. It gets much easier as the stock is moving into a profit territory. Frankly, my feeling is that where you get out on the upside isn’t as important as where you get out on the downside.

TGR: Is this fundamentally part of a hedging strategy?

AP: Hedging is a synonym for the preservation of capital. The only way to stay in the sector long enough to make sure that you have exposure to the next home run is to be in the game long term. The only reliable way is to focus your strategy on preserving your capital. That’s just common sense.

TGR: Thank you for your time.

Arie Papernick runs the Equity Capital Market’s team at Secutor Capital Management Corp. in Toronto. His team specializes in raising private placement financings for the junior resource sector with a focus on those conducting exploration in Canada. Papernick brings over 17 years of hands-on capital markets experience to his clients. After completing an Honors Bachelor of Commerce degree at McMaster University in Hamilton, Ontario, he started his finance career in Toronto. He completed the Chartered Financial Analyst program in 2000. Papernick has established a successful role for himself among issuers, institutional and high net worth investors.

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DISCLOSURE: 

1) Peter Byrne of The Gold Report 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: Extorre Gold Mines Ltd., Balmoral Resources Ltd., Gold Canyon Resources Inc., DNI Metals Inc. and Pinetree Capital Ltd. Aroway Energy Inc. is a sponsor of The Energy Report. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Arie Papernick: I personally own shares of the following companies mentioned in this interview: Sanatana Resources Inc., Beaufield Resources Inc., Fancamp Exploration Ltd., DNI Metals Inc. and Pinetree Capital Ltd. 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 story.

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