Jeff Killeen: A Picky Player’s Guide to a Cautiously Optimistic Mining Market

The price of gold may be enjoying a double-digit increase so far this year and some equities may even have doubled their value, but Jeff Killeen of CIBC World Markets says it’s not time to jump into metals with both feet. Be selective, he says. In this interview with The Gold Report, Killeen shares the higher-quality names that have a prospect for development.

The Gold Report: The price of gold has increased 14% this year. Is that due to gold’s safe haven status?

Jeff Killeen: The safe-haven mentality is one element that’s supporting the gold price. There is uncertainty in the market about the strength of the U.S. economy. A number of economic indicators reported during the last two months have not met forecasts. The rebound may be slower than expected. Buyers are coming back to bullion.

Unrest in the Ukraine is also helping to support the gold price, however, to a lesser extent than U.S. economic data. If weaker-than-expected indicators persist—and severe weather in the U.S results in soft data —such a scenario could be positive for gold in the near term.

Even before this rebound, there was very strong physical buying around the $1,200 per ounce ($1,200/oz) level from Asia. The investment community believed that there was a base established and started putting money back into the space with much less risk of a downside move.

TGR: It’s now six years since the economic crisis of 2008. Is it possible that a consensus could form that a traditional economic recovery is not going to occur? And if this consensus does form, would it be a big boost for gold?

JK: Certainly. However, I think that that consensus may take a little while to form because most of the U.S. economic indicators started moving in the right direction in 2013. In the next three to six months the impact from severe weather last winter will obscure the data picture.

TGR: The mood at this year’s Prospectors and Developers Association of Canada (PDAC) conference has been described as “cautious optimism.” Would you agree?

JK: I’d say the tone was divergent—some senior management teams were feeling very cautious about commodity prices and general market appetite for mining equities, whereas a lot of the junior management teams had a much greater conviction that 2014 would be a strong year for the metals and equities.

TGR: If you look at the juniors and mid-caps, a lot of these stocks have gone up 25%, 50% and even 100% this year. I would have thought you would’ve seen a lot of smiling faces at PDAC as a result of that.

JK: Very true, but even a 100% uptick still leaves some share prices below where they may have been at better points in 2012. There is still that rearward-looking view to where the stock prices have come from, and a lot of them are a long way from there.

TGR: As capital returns to the mining sector, would it be correct to say that it will return first to the producers, second to companies with late-development assets and then, third and finally, to explorers?

JK: That succession sounds reasonable; however, new capital investment will certainly be selective. I would expect to see capital flowing into the space across the market-cap spectrum, but those companies or projects that are marginal at the current gold price or require further appreciation in the price to generate acceptable returns are likely to find it difficult to attract any new investments in 2014.

TGR: How can smaller companies, specifically explorers, demonstrate that they are worthy of financing?

JK: The first question anyone should ask when looking at the explorer space concerns the management team. Pick a solid team, especially in a market where accessing capital can be difficult. Spending dollars wisely is important.

Beyond that, a project with strong grades can give a comfort level to the buy side that a project could be profitable in the future, considering it’s very difficult to assess where gold prices might be four, five or seven years from now.

Other benefits—geographic or logistic—such as being in the right region for having a smooth permitting process and having good roadways, rail or power, can add value.

TGR: Which major gold producers do you like?

JK: We like Goldcorp Inc. (G:TSX; GG:NYSE) and Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE)because they have high-quality, high-grade cornerstone assets that generate a large amount of cash flow, have strong balance sheets with a lot of cash and the potential to use that cash to help grow their businesses through mergers and acquisitions. They have strong management teams with good-quality assets that will have secure cash flow even in a softer gold price environment. And that’s where investors should be focusing.

TGR: What are your top picks in the gold sector?

JK: I cover some nonproducing explorers and some producing juniors and intermediates. In the junior nonproducer space, my top picks would be Continental Gold Ltd. (CNL:TSX; CGOOF:OTCQX), Premier Gold Mines Ltd. (PG:TSX) and Pretium Resources Inc. (PVG:TSX; PVG:NYSE). All three have assets with higher grades, are sufficiently financed to complete all planned work for the next year or more in some cases, and will continue to generate meaningful news flow over the next year, which can add value to their assets and keep the investment community engaged.

Continental is expected to release an updated resource estimate for the Buriticá project in Colombia by the end of Q1/14. In addition to increasing resource confidence by upgrading Inferred ounces to the Measured and Indicated (M&I) category, I anticipate there will be growth in total resources as well.

Pretium is expected to file an environmental assessment certificate with the British Columbia government within the next month. That will kick off the formal review process for the mine plan. The company will continue to work toward completion of its feasibility study for the Brucejack project in H2/14. In the meantime, the company will continue underground drilling within the Valley of the Kings and is expected to extract another 1,000 ton sample from the zone for processing.

Premier will continue to work at all three of its core projects. Drilling results from the Cove project in Nevada are looking particularly interesting. Several new mineralized zones have been recognized, both gold mineralization and polymetallic mineralization with gold, copper, lead and zinc. The Hardrock project will have infill drilling completed during the course of this year that will support moving the project from the preliminary economic assessment (PEA) phase to the feasibility stage. Its Red Lake joint venture project with Goldcorp should have drill results from the down-dip area of the Wilmar zone within the next couple of months. The market is anxious to see what this drilling will yield as it is a relatively untested target.

TGR: What did you make of the PEA on Hardrock that was released in January?

JK: It was a quality piece of work. You could certainly tell the skill level that’s been brought into this company in the last couple of years, including Ebe Scherkus coming on as chairman of the board from Agnico-Eagle and bringing quite a few skilled members from the Agnico-Eagle team over to Premier. Hardrock certainly looks compelling. It’s near a highway. It’s very close to power. It should get lots of local support. The projected returns are double-digit. Arguably, some might want to see a few more percentage points on that internal rate of return, but ultimately, Premier will do a good job in proving some of those numbers over the course of transitioning to a feasibility stage.

TGR: Continental’s Buriticá project in Colombia shows high grades in gold. Do you expect these grades to decrease as the resource grows larger?

JK: I expect grades will be similar to what we see today. Most of the drilling between the two principal zones—Yaraguá and Veta Sur—have had very similar numbers since the last resource estimate was produced. It is important to note that the M&I categories within its 2012 resource estimate are substantially higher than the Inferred grade. As we see some of the Inferred ounces converted into those higher-confidence categories, grades may even improve as drilling becomes denser within the zones. I’m not building that expectation into my valuation, but it is a possibility.

It’s also important to note that it’s very small scale, but there is an active producing mine at the site. This mine has been operating and producing gold for more than 20 years with a head grade of roughly 20 grams per ton (20 g/t) in recent times. There is a bit of real-world proof that those high grades do exist at site.

TGR: What other gold companies have you rated Sector Outperformers?

JK: Among the producing companies that I cover, B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX) is my top pick and rated Sector Outperformer. The company has an attractive cost profile across its asset base, and all-in costs are expected to decline in 2015 and capital spending at the Otjikoto mine in Namibia will wind down next year. This is a mine that’s currently being constructed now. We expect all-in costs to be sub-$900/oz in 2015 and that the company will be positioned to generate significant free cash flow by next year. Otjikoto coming on-line will contribute to a nearly 50% increase in gold output from 2013 to 2015.

That does not take into account the recently discovered Wolfshag zone. I would expect that once the company is able to incorporate the higher-grade Wolfshag zone into the Otjikoto mine plan, we’ll see further improvement in cost and gold output from that project.

Beyond the development of Otjikoto, B2Gold’s management has shown improvements at each of the company’s three projects currently in production, and we’re expecting modest increases in output from each of the La Libertad, El Limon and Masbate mines this year. With B2Gold projected to exceed a half-million ounces (0.5 Moz) gold by 2015, that certainly puts it into a fairly substantial production base.

The bottom line is that B2Gold is a company with attractive margins and significant near-term growth that’s all internally funded. That’s a great combination for any producer to have.

TGR: There were concerns raised about B2Gold’s acquisition of Volta Resources Inc. Do you think that’s a good fit?

JK: It was an acquisition the market didn’t expect, but I can understand why the company likes the asset. It liked the exploration and management team. Plus, it was a rather small acquisition, at roughly 3% of its market cap, for something that could be important in the longer term. I think it made sense.

TGR: Which other gold producers do you like?

JK: Primero Mining Corp. (PPP:NYSE; P:TSX). The company put out a revised resource and reserve estimate for San Dimas mine that showed increases in all categories for total ounces and grade. Its acquisition of Brigus Gold Corp. will help bring total production for the company into a new bracket. It remains one of the lower-cost producers in the space.

TGR: Let’s talk about some of the companies you’ve rated Sector Performers.

JK: The names I cover that are Sector Performers include Alamos Gold Inc. (AGI:TSX), Asanko Gold Inc. (AKG:TSX; AKG:NYSE.MKT), Argonaut Gold Inc. (AR:TSX), Belo Sun Mining Corp. (BSX:TSX.V),OceanaGold Corp. (OGC:TSX; OGC:ASX) and Orezone Gold Corporation (ORE:TSX). Each has its rating for different reasons. Some are simply calls on relative valuations. Some are based on project returns and so forth.

For Argonaut and OceanaGold, the rating is largely a valuation call relative to peers in the space. Argonaut is trading at roughly 13x our 2014 cash flow per share (CFPS). The stock trades at a sharp premium to most of the midtier peers in the group. The company has an attractive low-cost profile. It is increasing production as the La Colorada mine comes into full stride in Mexico in 2014.

Orezone is operating an exploration program at Bomboré project in Burkina Faso. The company has completed scoping studies and is trying to move toward feasibility. The project return may be smaller than what many in the investment community would look for in a new developable asset. The company is looking at how it can reduce the upfront capital expenses (capex) and potentially reduce the operating costs for Bomboré, as well as improve the metallurgy. How those elements come together toward the later part of this year certainly could change the way that we view that project.

TGR: Can you tell us about Alamos?

JK: Alamos’ Mulatos mine in Mexico is still one of the lowest-cost producers and better-quality names in the space. But looking at it relative to peers, it is trading at a fairly steep premium. Alamos is trading at roughly 18x our 2014 estimated CFPS compared to 9x for the peer group.

However, I do see some upside. It has one of the strongest balance sheets of any company I cover, with more than $400 million ($400M) in cash. There are very good development assets in Turkey, which are being held up by permitting issues. Until we get more clarity on that, it could be a headwind for the stock.

TGR: What can you say about Belo Sun?

JK: Belo Sun’s Volta Grande project in Brazil looks like a great project with fairly simple geology. It’s an open-pittable, greenstone-hosted gold deposit much like what you find in many places in Canada. The bigger concern has been the capex estimate of more than $700M. That was certainly a holdback for this stock. The company has explored how to reduce that upfront capex and has produced a PEA that effectively cuts the capex in half. It needs a little bit of help from the gold price or reduced costs to improve the overall economics.

TGR: What is interesting about Asanko?

JK: Asanko’s merger with PMI Gold Corp. has been completed. It’s a positive because it gives more optionality for development in Ghana. The merger puts two 5 Moz deposits within about 25 kilometers of each other under one company. Looking forward, Asanko will reassess PMI’s Obotan deposit. I’d like to see more details about how that will look before we can revise the valuation.

TGR: Are there other companies that you can talk about?

JK: Earlier this year Pilot Gold Inc. (PLG:TSX) released two drill holes from its Mount Kinsley project in Nevada; they have very good grades and breadth. The headline hole that it reported was 6.9 g/t over almost 42 meters (42m). This mineralization was within a new shale unit where very little or no drilling had been done by previous operators, and only one hole by Pilot had been drilled in late 2013. That could open up a new horizon at the Kinsley project for exploration that hadn’t been identified before.

TGR: Which streaming royalty gold companies do you like?

JK: My go-to answer would be Franco-Nevada Corp. (FNV:TSX; FNV:NYSE). It has a best-in-class portfolio and management team. It has lots of cash on its balance sheet to make acquisitions. It has cornerstone assets that will continue to generate free cash flow even if commodity prices drop significantly.

I also like Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) because it is the best way to get exposure to the silver space, as silver producers are having difficulty securing positive cash flows and margins.

TGR: Any other companies?

JK: Allied Nevada Gold Corp. (ANV:TSX; ANV:NYSE.MKT) did a good job at turning around the heap-leach operations at its Hycroft mine, but it does have a significant amount of debt. We find it difficult to see the Hycroft heap-leach operations being able to generate enough cash flow to repay that debt at these commodity prices. It would need a fairly significant increase in the price of gold, on the order of $200–300/oz, to be able to generate enough cash flow.

It also has a lot of work ahead of it on its proposed mill sulfide recovery project. At this point, it seems that the test work is going well, but it’s in the early stages.

TGR: Given the recent increase in the price of gold and the significant uptick in a lot of equities, do you think that investors are embracing the sea change?

JK: There is a belief within the investment community that we’re finding a bottom for the commodities. We do know that equities underperformed to the down side of the gold and silver price. Even just to revalue based on current spot prices means that there is probably still some upside to be had in a lot of the equities. With that in mind, investors are feeling better, but not excited to the point where there’s going to be broad-scale investment across the mining space. It’s going to be selective. It’s going to be higher-quality names or those that have a higher prospect for development. It’s not going to be widespread just yet.

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

Jeff Killeen has been with the CIBC Mining research team since early 2011. He covers and provides technical assessment of junior exploration and mining companies worldwide. Previously, Killeen worked as an exploration and mine geologist in several major mining camps, including the Sudbury basin and the Kirkland Lake region. Killeen earned his Bachelor of Science degree from Carleton University and is an executive committee member of the Toronto Geological Discussion Group.

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Source: Brian Sylvester of The Gold Report  (3/26/14)

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