Assessing Gold Mines in Far Flung Places

Posted by Cosmos Chiu - CIBC World Markets

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Cosmos Chiu, executive director of precious metals equity research at CIBC World Markets, doesn’t just stick to mining companies in North America. About one-third of gold comes from Africa, Chiu says in this interview with The Gold Report, so he likes to dedicate a similar amount of coverage to companies there. But knowing what to look for in intriguing districts around the world is what sets Chiu apart—that and his decidedly bullish forecast for the gold price.


The Gold Report: Cosmos, with U.S. economic data putting pressure on gold and silver prices, Moody’s is forecasting an average of $1,100/ounce ($1,100/oz) for gold in 2014 with almost identical all-in gold production costs. Bank of America Merrill Lynch is forecasting an average of $1,150/oz. What’s your view?

Cosmos Chiu: The U.S. economic data is nothing new. Last year certainly wasn’t the best for gold. However, the bad news has already been priced in. We’ve seen some pretty robust U.S. data come out first thing in 2014 and gold prices have held up at the $1,200/oz level.

CIBC has an average gold price for 2014 of $1,350/oz, which is predicated on robust Asian demand for physical gold. An all-in gold production cost of $1,100/oz is pretty realistic from our perspective.

We have wide-ranging coverage at CIBC from gold mining companies to royalty companies. Yes, there will be some companies in trouble. Investors have to be pretty picky about where they invest. They need to focus on the companies that have strong balance sheets and the flexibility to cut costs and focus on the cash cost.

TGR: Most people would say that $1,350/oz is quite bullish.

CC: It’s not conservative. Is it overly bullish? I think it’s doable.

TGR: We will soon see Q4/13 earnings reports from gold producers. Will those reports show investors that gold producers can still perform with gold hovering around $1,225/oz?

CC: We’ve seen glimpses of what Q4/13 could look like through production reports. It’s becoming a market where there are good producers and there are bad producers. The difference is especially visible right now. For the better producers, some will continue to see cash costs come down. We saw that in Q3 versus Q2. I would expect that to happen again. The better producers will continue to make money even at today’s gold price.

TGR: What are some names that could surprise?

CC: Q4/13 is going to be a lot cleaner than what we saw earlier this year with the write-downs. It might even be a little bit boring which, to be honest, is a good thing. Companies will be able to prove that they can make money. It won’t be one of those noisy, messy quarters that we saw earlier last year.

Looking into 2014, I like Franco-Nevada Corp. (FNV:TSX; FNV:NYSE)Osisko Mining Corp. (OSK:TSX)and Eldorado Gold Corp. (ELD:TSX; EGO:NYSE). These three companies exhibit the ability to excel, even at today’s gold price.

On the lower end of the cost curve, I like Franco-Nevada; it doesn’t really have operating costs at all. It has quite a few accretive acquisition opportunities in the current environment for gold producers.

Osisko fits into a theme of seeking a stronger balance sheet. Things are stabilizing and even optimizing at the Canadian Malartic mine. It’s generating positive free cash flow and there’s optionality. If the gold price environment is supportive once again, and it will be, then there will be a lot of organic growth opportunities within that portfolio. That gives investors that upside potential, as seen by Goldcorp Inc.’s (G:TSX; GG:NYSE) bid.

Eldorado has always been one of the lowest-cost producers no matter how you dice it. It’s got one of the better growth profiles and has a very strong balance sheet.

TGR: Osisko is based in Canada and Mexico. Eldorado is mostly Turkey, Greece, China and South America. Franco-Nevada is everywhere. This is a still a risk-adverse market where most precious metals analysts are sticking to safe mining jurisdictions like Canada, the U.S. and Mexico.

About 30% of your coverage, however, includes names that primarily or exclusively operate in Africa. Why do you lean heavily on equities with key assets in Africa?

CC: I try to give broad coverage to the different areas in the world where gold is produced. Looking at the world, about one-quarter to one-third of the gold production is coming from Africa. A lot of Africa’s production is coming from South Africa. I try to pick out the better or more prospective parts for future growth. Mainly, that’s coming from West Africa.

TGR: Can you tell us about some of the companies that you cover?

CC: Teranga Gold Corp. (TGZ:TSX; TGZ:ASX) recently signed an agreement to sell a gold production stream to royalty titan Franco-Nevada for $135 million ($135M). Teranga management said it would use the cash to purchase the remaining interest in the Oromin Joint Venture Group. I upgraded Teranga’s shares from sector performer to sector outperformer on the back of that news.

This is a story that I’ve followed for a long time. There are a lot of synergies to be realized. The Oromin Joint Venture partnership no longer has to build a second mill. Despite Teranga now selling some of the upside off to Franco-Nevada, my net asset value still increased by about 40%.

TGR: It also consolidates the exploration potential of that area, which is a 60-kilometer strike.

CC: It just makes sense to have the two companies together.

TGR: On the other side of that deal is Franco-Nevada. It recently had a market cap of $6.5 billion. Does the deal impact Franco-Nevada’s bottom-line in any tangible way?

CC: It adds good cash flow in the near term. Franco-Nevada is getting in from day one. There’s a lot of potential for future production increases. Teranga could grow into a cornerstone royalty. Franco-Nevada offers a diversified portfolio. It’s everywhere. It’s a less risky way to get involved in the gold space, but at the same time get that upside when gold prices go higher.

TGR: Franco-Nevada’s purchase price per ounce is set at 20% of the spot price. Doesn’t that really speak to the management at Franco-Nevada and its shrewd negotiating tactics?

CC: It’s the first time I’ve seen a structure at 20%. Most royalty deals are set at $400/oz or $500/oz. The financials on this deal are a little bit more favorable to Franco-Nevada. However, I don’t believe that Teranga would have gotten a deal done with OJVG if not for Franco-Nevada. That’s how it works out to be a win-win situation.

TGR: What are the most likely performers among the other companies that you cover that operate in Africa?

CC: I have two sector outperformers in my West African universe: Teranga and SEMAFO Inc. (SMF:TSX; SMF:OMX) in Burkina Faso. SEMAFO’s flagship mine is Mana. What’s most exciting about SEMAFO these days is that it made the Siou discovery, which is scheduled to be in production midway through 2014. It’s going to be a satellite deposit, which means there won’t be a lot of capital expenditure (capex) involved.

The great thing about Siou is that the grade is about twice as high, at 4+ grams/ton (4+ g/t), as the Wona-Kona pit, which has been in production for several years. There’s not a lot of capex. It’s feeding higher-grade material through the mill, so we expect costs to come down and production to increase.

TGR: You also cover a number of companies operating in Canada. In a recent research report you praised Osisko Mining for its Q3/13 performance, which met most of the Street’s expectations. Not far away at another low-grade, high-tonnage open-pit mine, Detour Gold Corp. (DGC:TSX) shut down its mill in December as it attempted to work out the kinks in production. What’s your prognosis for Detour? Will it get this thing on track?

CC: I would consider the problems with Detour to be teething issues. It’s good that you brought up Osisko. It has had its share of issues in the past as well. Given the size of these operations—Detour included—it takes time. I firmly believe that as Detour opens up the pit and continues to work out the teething issues at the mill, it should meet what it has set out to do when it first engineered the mine. It’s certainly got a lot of people worried about the financial position of the company. It doesn’t help that there’s been a changeover in management. However, all in all, it’s just a timing thing. Detour should work out.

TGR: Detour has published production guidance of 457,000 oz in 2014 at cash costs of $945/oz. Is that realistic?

CC: I think it is realistic because those are my numbers. If we annualize what happened in Q4/13, even with the two-week shutdown in December, Detour would work out to something that’s close to that. There were signs in Q4/13 that point to its ability to meet that guidance in 2014.

TGR: There’s a technical report that’s scheduled to be out this quarter on Detour Lake. What are you expecting from that?

CC: I’m expecting a fine-tuning of 2014 numbers. Detour had difficulty meeting 2013 guidance. It learned quite a bit about mining rates, which should be factored into the new mine plan. If I recall correctly, based on an old technical report, 2014 grades were expected to increase to 0.98 g/t. My expectation for 2014 would be less than that. Based on this new knowledge, the company will likely put out a fine-tuned number.

TGR: You recently rerated Lake Shore Gold Corp. (LSG:TSX) from a sector underperform to a sector perform. Is that based on its record production in 2014?

CC: I’ve followed this story for a long time and things are finally turning the corner. We saw its cash balance increase from $15M to $34M between Q3/13 and Q4/13. Lake Shore increased the grade profile for three consecutive quarters. It set targets that are reachable for 2014 that would represent another 20% increase in production between 2013 and 2014. It’s no longer a sector underperformer; things are looking much better.

TGR: If you could, please leave our readers with an investable theme or two to chew on.

CC: Focus on the companies that have a stronger balance sheet, stable operations and growth potential.

TGR: Thanks, Cosmos.

Cosmos Chiu, director of Precious Metals Equity Research, CIBC World Markets, joined CIBC in June 2006 to provide coverage of development and production-stage companies in the gold sector, as well as royalty companies. Chiu has a specific focus on mining assets in North America, Europe and Africa, covering companies with market capitalizations ranging from $200 million to $10 billion. He was ranked fifth overall best stock picker by Starmine in 2010. He is consistently ranked in the top 10 in the Brendon Wood International survey for the Precious Metals—Small/Mid Cap sector.

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