Thibaut Lepouttre’s Commodity Plays in a Sideways Market

Metals prices have been trading sideways for some time. How can you make gains in your portfolio when commodity prices are in a stalemate? In this interview with The Gold Report, Thibaut Lepouttre, editor of Caesars Report, talks about ways to play metals from gold to copper and tungsten in a market with weak price movement, and scans the globe to find 11 potential winners. 

The Gold Report: The crisis in Ukraine may feel a little bit different in Brussels than in North America. From your point of view, does this look like a civil war? An invasion? Or is this just politics? 

Thibaut Lepouttre: Russia took advantage of the political turmoil in Ukraine to occupy the pro-Russian Crimea region. Crimea has always been closer to Russia than it has been to Ukraine. You could say that Russia is reclaiming a piece of ground it had for more than 200 years that was only separated from it in the past 60 years. Russia wanted to safeguard its interests from the new pro-European Union government in Ukraine. 

TGR: What role should Europe play in restabilizing the area? What about the role of the U.S.? 

TL: I don’t think Europe should do too much. This is a leftover problem from the dismantling of the Soviet Union—it should be dealt with internally between Ukraine and Russia. However, we should react if human rights are being infringed. 

I think the role of the West will be quite limited to acting as some kind of intermediary between Ukraine and Russia. Political sanctions are perilous because Russia has real opportunities to retaliate. Look at the gas imports from the European Union: Germany imports 35% of domestic consumption from Russia, Hungary is about 45–50%, and the Czech Republic and Bulgaria are more than 70%. The moment the West and Europe try to impose some kind of economic sanctions on Russia, the Russians will retaliate. 

TGR: What about actions such as what happened at the airport in mid-April—small, measured attempts to destabilize the Ukraine? 

TL: Russia may attempt to destabilize the pro-EU government, but I do not think that the country will go into a full-on attack or invasion of Ukraine. There may be small infringements on Ukrainian sovereignty, but not full-out war. 

TGR: The West seemed to dismiss Russia’s actions in Crimea as “one and done.” Was that the right approach? 

TL: Yes. The Crimea region was historically Russian and more than 80% of the people speak Russian. Western countries realize that it might make more sense that Crimea be a part of Russia instead of an autonomous region of Ukraine, which could continue to cause political instability inside Ukraine. 

TGR: Do you see this situation as having any further impact on commodities, such as gold, silver and perhaps even base metals? 

TL: Full-on war in the Ukraine could be a real catalyst, but commodities will likely continue to trade sideways at least through the summer. 

TGR: In October, you said you thought gold would continue to trade sideways between $1,200/ounce ($1,200/oz) to $1,410/oz. You’ve been pretty accurate with that prediction. Does a possible realignment in Eastern Europe impact your predictions? 

TL: We saw a short spike in the gold price the moment that Russia flexed its muscles in the Crimea region, but I fail to see a decent catalyst that could catapult the gold price in one direction or the other. 

TGR: After a rough couple of years for gold equities, some companies saw a slight bump in Q1/14. What gold companies have caught your eye? 

TL: I’d like to highlight two companies operating in Quebec: Metanor Resources Inc. (MTO:TSX.V) and Integra Gold Corp. (ICG:TSX.V). Those companies had a very interesting Q1/14. They have more than doubled—but then lost, once again, 40% since mid-March. 

Metanor Resources is producing gold at a rate of 50,000 oz (50 Koz)/year at an all-in cost that is probably lower than $1,000/oz. Further exploration work at the Bachelor Lake mine, where the company is producing its gold, has indicated its main vein is continuing at depth. This will bode well for future resource expansions, which will extend the mine life at Bachelor Lake. Metanor is trading way too cheaply at a market cap of $42 million ($42M). It is producing profitably. It’s an interesting company. It’s had its fair share of bad luck in the past, but it’s on track again. 

TGR: Bachelor Lake reached commercial production. What’s the next catalyst? 

TL: Its financial results from Q1/14. That was the first quarter that the mine was in commercial production and the first quarter where Metanor can prove to the market that it’s a profitable mining company. 

TGR: And Integra? 

TL: Integra also made tremendous progress in Q1/14, as it released another resource estimate and a preliminary economic assessment (PEA). The new resource estimate contains more than 800 Koz gold at an average grade of more than 10 grams per ton. The PEA was quite excellent. Using a gold price of $1,275/oz, the internal rate of return was a little more than 50%. It was mainly the result of low initial capital expenditures, which were $50–65M. On top of that, the all-in sustaining cash cost was about $750/oz. It’s a highly profitable and high-margin project. Furthermore, the PEA just took a part of the new resource estimate into consideration. It’s likely that further exploration will result in a longer mine life and a higher net-present value (NPV). 

TGR: Integra has a reasonably young management team. Should that be cause for concern? 

TL: Young, perhaps, but not inexperienced. CEO Steve de Jong has assembled a good team on the ground. Vice President of Exploration Hervé Thiboutot has several decades of experience under his belt, including time at Alamos Gold Inc. (AGI:TSX). 

TGR: Do you see silver tracking gold throughout 2014 or do you see a bit of a separation occurring? 

TL: There will continue to be some kind of correlation between the gold and silver prices. Silver won’t track gold one-on-one, but the difference in price variations and changes will not be that high. 

TGR: Can silver be profitably mined at current prices? 

TL: Yes, margins are much thinner than if silver were between $25–30/oz, but there are some companies that would be profitable at the current silver price. Golden Arrow Resources Corp. (GRG:TSX.V; GAC:FSE; GARWF:OTCPK), which owns the Chinchillas silver project in Argentina, seems to have its hands on a very interesting one. The project’s current resource is more than 100 Moz silver equivalent (Ag eq). A PEA has shown an after-tax NPV of around $100M using a silver price of $22/oz. The operating expenditures outlined in the PEA were about $11/oz silver, but the NPV could be much higher if more resources can be added. After talking to the management team, I’m convinced there’s potential for probably 200 Moz Ag eq. The mine life could be extended much longer. I think we’ll see a lot more ounces in the ground after this year’s drill program, which is expected to total about 25,000 meters. I’ll be looking forward to seeing another resource update. 

TGR: Let’s talk about copper. The Chilean Copper Commission (Cochilco) revised its copper price forecast downward by about $0.10 to $3.05/pound ($3.05/lb) in 2014. What do you predict for copper prices for the remainder of the year? 

TL: I’ve always been conservative about the copper price because I expect a lot more supply coming on the market than demand. I always use a long-term copper price of $2.75/lb. 

TGR: Are there copper plays that you are following? 

TL: There’s one pure copper play and a silver-copper play. Let me start with Revett Mining Co. Inc. (RVM:TSX; RMV:NYSE.MKT). Revett owns a silver-copper project in the U.S., in Montana. It had to close the Troy mine in December 2012 after a seismic event caused a rock slide. The company is constructing a new drift to access the mineralized zones again. It should be ready by September, so the company can restart stockpiling ore in Q3/14, with a mill restart anticipated in Q4/14 and full production in Q2/15. 

It’s important to look at Revett’s production statistics before the mine closed; it produced 1.2 Moz/year silver and about 9 million pounds (9 Mlb) copper at a cash cost of about $10/oz silver. The copper was used as a byproduct credit. If the company can achieve 1.2 Moz silver again with a cash cost of $10/oz, Revett Mining is probably one of the best choices to get exposure to silver and copper at this moment. 

TGR: Would you say the market beat up Revett too much for what happened at its Troy mine and now it is an undervalued asset? 

TL: That’s exactly what happened. The market was disappointed when the company tried to re-access the mineralized zones throughout a parallel adit. The restart of production was delayed for about a year. There was also a slide in the silver price and, more recently, the copper price, but the impact to the company has been overdone. The company has a market cap of $35M and will produce 1.2 Moz silver at a cash cost of $10/oz. Even at a silver price of $20/oz, the company will generate about $10M in operating cash flow the moment it gets up and running again. The company is trading at 3.5 times its expected operating cash flow and that’s a sign that the market is underestimating the potential of Revett. And then you aren’t even considering the company’s Rock Creek project which contains 230 Moz silver and over 2 billion pounds (2Blb) copper in a historical resource estimate. 

I’m also following Nevada Copper Corp. (NCU:TSX), which is constructing the Pumpkin Hollow project in Nevada. Pumpkin Hollow is a two-phase project. In the first phase, the company is expected to open an underground mine, which is fully permitted and almost fully financed. It still needs about $75–100M. In the first few years of the operation, the underground project should produce about 75 Mlb/year copper. At a $2.75/lb copper price, the after-tax NPV is in excess of $200M. Besides the underground project, Nevada Copper also plans a large, open-pit operation. It has recently completed the feasibility study, forecasting a 70,000-ton-per-day (70 Ktpd) operation. 

There is a land change bill going through Congress that could make the permitting easier for Nevada Copper’s second phase. If the land could get transferred from the federal government to the city and the state, that would shorten the permitting process by about two years. 

The initial capital expenditures for the large, open-pit project are about $1 billion ($1B). Nevada Copper will likely need a partner to build the project. My main fear is that the company will be bought out before it’s producing from the open pit. It’s a huge copper asset containing 5.2 Blb copper, 1 Moz gold, about 33 Moz silver and about 0.5 billion tons iron ore. It’s on the radar of a lot of companies. I wouldn’t be surprised if it were taken out. Fortunately, the CEO of the company has about 9% fully diluted shares, so his interests are aligned with the shareholders’ interests. 

TGR: Let’s move to tungsten. What does the supply-demand picture look like? 

TL: The supply-demand ratio in tungsten is very tight. Tungsten is dominated by a few countries, mainly China. That has led Western Europe and the U.S. to look at the security of their supply of strategic minerals like tungsten. Over the past few years, when the tungsten price started to move up again from $200/metric ton ($200/mt) to in excess of $400/mt, more and more companies have evaluated previously producing assets and tried to reopen them. Assets that were not profitable at $100/mt might be highly profitable at $360/mt. 

TGR: What are some companies that own the rights to some of these past producers? 

TL: Wolf Minerals Ltd. (WLF:ASX), which is constructing the Hemerdon project in the U.K., has secured financing and is targeting a H2/15 start of production. The company will produce about 345,000 metric ton units (345 kmtu)/year at a cash cost of $110/mt. If you extrapolate that and use a $360/mtu price for tungsten, this mine will be a cash cow. The operating margin is extremely high. The initial mine life is about 10 years based on the reserves, but the Measured and Indicated resources could extend that by several decades. It’s an interesting, near-term production story to keep an eye on. 

The second company I would highlight is Blackheath Resources Inc. (BHR:TSX.V), which has assembled an interesting portfolio of past-producing tungsten projects in Portugal, the Mecca of tungsten. Blackheath’s most interesting project, Covas, has a historical resource of about 900,000 tons of 0.78% tungsten. It’s about 720 Kmtu for an in situ value of about $260M at the current tungsten price. I’d like to emphasize that 0.78% is a high grade compared to others, like Wolf Minerals, which will be mining ore at a grade of 0.19%. Blackheath has several other projects in Portugal, as well. It’s getting ready for a busy exploration year. There will be a lot of news flow coming from that company. 

TGR: Does it have cash? 

TL: Blackheath raised $1M in December. Once the exploration results kick in—the company started drilling earlier this month on its main targets—it will probably raise some more money. We will likely see some more dilution down the road.

 The third company I would highlight is Carbine Tungsten Ltd. (CNQ:ASX) in Australia. It will likely restart production from stockpiles for about $15M in capital expenditures. Carbine can produce about 80 Kmtu/year. From an initial $7M, it can double that to 160 Kmtu/year. That’s just low-grade stockpile stuff, but for an additional $45M, Carbine could start a phase-three production, which would feed the hard rock of the project being mined. That would result in an output of about 265 Kmtu/year at a cash cost of less than $150/mtu. If we apply a $360/mtu market price for tungsten, this project will generate about $50M in cash flow. 

The company has an offtake agreement with Mitsubishi Corp. (MSBSHY:OTCPK) in Japan, which validates the merits of the project. It’s important to have a strategic partner like Mitsubishi. Who knows what might happen down the road, as Mitsubishi is clearly keen to secure its future supply of tungsten. 

TGR: Over in Peru, there are a couple of companies that are toll milling gold operations. Tell us about toll mining and the risks involved. 

TL: Toll milling is a very interesting concept because companies that are engaged in toll milling aren’t real miners. They provide service to artisanal miners that have no efficient way to treat their ore. 

The toll milling company pays the miners based on the average gold grade of the expected recovery rate and factor in a little wiggle room in case the gold price changes. It’s a win-win situation because the artisanal miners have a way to efficiently treat ore. If they did it themselves without the right permits, they would be breaking the law and could go to jail for a long time. 

The average recovery will be much higher than what a private person could reach. Most artisanal miners reach a recovery of about 40–60%, while modern toll milling companies with modern equipment can reach recoveries of 90% and higher. It’s a win-win situation. The toll milling company takes a cut of the value of the gold, the artisanal miner has a way to efficiently process ore and the Peruvian government gets more tax income because everything will be formalized. 

The small-scale mining sector in Peru is officially estimated at about $2B/year. Unofficially, that number could be much higher, perhaps even $3–4B/year. As a country that has become serious about formalizing its mining sector, there are a lot of possibilities in Peru in toll milling. 

TGR: What companies are making money in the toll milling business? 

TL: There are two companies that I’d like to highlight that are duplicating Dynacor Gold Mines Inc.’s (DNG:TSX) model. The first one is Inca One Resources Corp. (IO:TSX.V), which currently operates a 25 tons per day (25 tpd) facility in the Chala district, Peru. The company is trying to fine tune its processing facility. The recoveries at the Chala plant have been consistently higher than 90%. The company is doubling its capacity, up to about 50 tpd, and will eventually take it to 100 tpd and then probably to 300–350 tpd. 

In Chala last month, seven illegal gold plants were shut down and destroyed by the army. There is less choice for artisanal miners in Chala to process their ore. It puts Inca One in an excellent position to reach mill capacity. 

A second company in Peru is Standard Tolling Co. (TON:TSX.V). Standard Tolling is not in production yet, but is compiling a study to determine the location of a facility, which is due by early June. It will likely start with a relatively large capacity of 100 tpd because it could benefit from economies of scale. This company has added some interesting people to its board. It has Andrew Neale, who operated a gold milling business in Central America and is knowledgeable about the ins and outs of gold milling. The company also added a Peruvian director with experience on the legal side of mining in Peru. 

TGR: Any other companies you want to talk about? 

TL: There’s one other company I’d like to highlight: Tsodilo Resources Ltd. (TSD:TSX.V). It’s operating in Botswana, which has been called the “Switzerland of Africa” because it’s the African country with the least corruption. There is less corruption in Botswana than Spain, Portugal or Colombia. It’s one of the safest mining jurisdiction, not only in Africa but worldwide. 

Tsodilo Resources has a two-step approach. It has a joint venture with First Quantum Minerals Ltd. (FM:TSX; FQM:LSE) on its copper project. First Quantum will have to spend $6M and an additional $9M in exploration expenditures. If it results in a resource estimate of more than 4.4 Blb copper, First Quantum retains 70% ownership in the project. If it’s less than 4.4 Blb copper, First Quantum keeps a 51% stake. First Quantum has partnered up with Tsodilo because it is hunting for the big elephant. It doesn’t care about a 1 Blb copper deposit. 

TGR: Tsodilo is a story with diamonds, copper, base metals and uranium. Doesn’t that confuse investors? 

TL: Don’t forget the iron ore, Brian. It does confuse investors. The company is trying to rebrand itself as a copper and iron ore company, as those projects are closer to development. The uranium overlaps with the metal licenses so additional resources are not needed for that project and the diamond exploration continues, however with a secondary emphasis at this stage . 

TGR: Botswana is well known for its diamond mining. De Beers has some prolific mines there. What do you know about its diamond assets? 

TL: Diamond mines in Botswana will have to go underground during the next decade, increasing the cost and reducing the output. It’s one of the main reasons why Botswana is supporting the development of other mineral and commodity projects. It’s helping these companies out by trying to unlock the country—it’s a land-locked country with no access to the sea. It signed an agreement with Namibia last month whereby Botswana and Namibia will construct a Trans-Kalahari Railway. That will be important for gold and iron projects because it will provide rail access to the Port of Walvis Bay in Namibia. Botswana understands the needs of the companies working in the country and is trying to accommodate them. It wants to continue to be one of the most important and safest mining destinations in Africa. 

TGR: Do you want to talk about any other base metal companies? 

TL: One company that warrants a closer look is Confederation Minerals Ltd. (CFM:TSX.V). The company owns 50% of the Newman Todd project in Ontario and has encountered very interesting intersections over a length of 1.8 kilometers. In fact, every hole of the 2011 drill program has hit mineralization, which I see as extremely encouraging. More drilling will be needed to connect all the dots, and it will be interesting to see what future drill campaigns will reveal. 

TGR: Do you have any other advice to investors that you’d want to leave us with? 

TL: Do your homework. Understand every aspect of a company and its project. Never be afraid of getting in touch with the investor relations division of the company. Never be afraid to ask questions. You have to make sure you fully understand every aspect of the business before considering an investment. 

TGR: Thank you for your insights. 

Thibaut Lepouttre is the editor of the Caesars Report, a newsletter and mining portal based in Belgium that covers several junior mining companies with a special focus on precious metals and base metals. Lepouttre has a Bachelor of Law degree and two economics masters degrees that have forged his analytical approach to the mining sector. Considered a number cruncher, Lepouttre focuses on the valuations of companies and is consistently on the lookout for the next undervalued mining company. 

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Source: Brian Sylvester of The Gold Report  (4/28/14)

 

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