Derisking gold juniors, step by step
Source: Sally Lowder of The Gold Report (1/18/12)
If you're among the many who consider investing in the junior resource sector nothing more than a crapshoot, look into Ahead of the Herd Publisher Rick Mills' steps to derisk the inherently risky business of investing in junior resource companies. In this exclusive interview with The Gold Report, Mills not only spells out the steps involved in the derisking process, but also cites specific examples of juniors he especially likes and discusses the features that put them ahead of the herd.
The Gold Report: We have seen some incredible volatility in the market over the last three or four months, with many junior resource stocks on the Toronto Venture Exchange beaten down, even if they have proven resources and substantial cash treasuries. We have also seen some volatility in the price of gold and a disconnect between the price of gold and the price of juniors. In this environment, how should investors approach risk in the junior resource space?
Rick Mills: I agree with Baron Nathan Rothschild who became a legend during the financial crisis right after the Franco-Prussian War. As the story goes, a panic-stricken investor came screaming into his office yelling, "You advise me to buy securities now? Now? The streets of Paris run with blood!" Rothschild replied, "My dear friend, if the streets of Paris were not running with blood, do you think you would be able to buy at the present prices? Buy when there's blood in the streets, even if the blood is your own."
I'm pretty sure things today are not as bad as they were back then, but this market offers contrarian-minded investors an opportunity to take huge advantage of discount share prices and, as you pointed out, many are trading below cash in the bank. Many, many are way undervalued compared to what they have in the ground and what they will have. The thing to do is to even further derisk.
Everything we do has some level of risk, from flying in a plane to walking across the street. All our lives we identify and quantify risk, so it's second nature and part of our makeup. Everyone has his own risk profile, of course. For instance, maybe you won't bungee-jump off a bridge or willingly parachute from an airplane, but you'll happily get crazy driving around on an ATV or a snowmobile. You have a risk profile. You will do this; you won't do that.
TGR: So far, so good. So how do you derisk these stocks?
RM: The way to derisk investments into junior resource companies is to know your risk profile. Then wisely deploy capital into the right management team in the right stage, for you, of company development.
TGR: What steps would investors take to identify companies they're comfortable with? How can they make better-informed choices and thus create less risk?
RM: The most important things are to know yourself and to know that juniors are inherently risky. Understand how much volatility you can handle and how much patience you have to wait while a story plays out. Develop the discipline not to get faked out of your position or chase after hot tips or listen to the cheerleaders. Have a clear and complete understanding of why you're here in the first place. Know the different development stages of a junior, because risk lessens as a company moves a project through drilling and post-discovery resource definition, then into the various mining studies, and finally into raising money, building the mine, and ultimately, mining. You really have to know who you are invested with and the story. Monitor the progress of your management team with its project and make sure they're meeting goals and timelines.
TGR: And when you find companies that suit your risk profile and pass muster in terms of development stage and management performance, you jump in?
RM: You don't want to just walk in and buy all your shares. Develop a plan to buy shares over time . I don't use stops, because these stocks can make huge moves down in a day and you could get knocked out just before they move back up and go on a tear the next day. I'm here long term so short-term moves don't bother me; stops in juniors, for non-traders, create more problems than they solve.
TGR: Could you elaborate a bit on evaluating the various development stages?
RM: The most upside and the greatest risk come with the greenfields, the junior resource companies when they are exploring. It takes a lot of patience with them and with the management teams to let stories play out. Some of these stocks are very thinly traded, so it doesn't take much to make them jump in either direction. Make a discovery, get some good drill assays and they explode in the share price. Get some bad assays and they implode to the downside—make sure they have a back up play, a plan B, already secured and ready to go. They are the riskiest plays by far, but they offer the highest reward.
Next is what I call the post-discovery resource definition stage. A company at this stage already has found something, its share price has exploded and now the company is undertaking a nice drill program. After the price has settled back, decide on an entry point and start to get in. Let the company build an NI 43-101-compliant resource. The risk has been greatly reduced, and of course there's no longer any waiting for a discovery.
The study stage comes next. After the company has its NI 43-101-compliant resource, it gets into scoping, prefeasibility and feasibility studies. Companies at this stage are so much further down the development path that much of the guesswork about grade, size, cost and metallurgy has been taken out of the equation for investors. These companies have done sufficient work to give investors a certain level of confidence that they'll successfully move their projects along.
TGR: Haven't a lot of companies at this stage also been derisked in the sense that their share prices are depressed as well?
RM: Oh, absolutely. A lot of these companies not only have the value, but they continue working and adding to that value every day. It's a fantastic opportunity to buy some companies not only on the path to production but also on the path to some pretty decent cash flows.
TGR: Could you talk about any companies you like that are enroute to production and positive cash flow?
RM: Not yet. We haven't finished derisking. Let's look at gold mining. Even though the price of gold has gone up roughly six times, global gold production has been falling since 2001, which tells us that higher gold prices are not bringing on more gold supply. The money being spent on gold exploration is finally starting to climb, but very few big new deposits are being found, so gold miners are adding to their resources by buying them from smaller-cap miners and explorers—the companies making the new discoveries. The majors need them to replace their reserves and depend on them for their upstream flow of new projects for development. That's what juniors do; that's their function in the food chain. So it removes even more risk from the equation for the juniors that are sitting on existing deposits; they are becoming more valuable day by day.
The majors have gone through mergers for much of the last decade, and every round of mergers obviously leaves fewer majors. That said, large Asian miners have been entering the sector. They love not only the gold deposits, but copper-gold porphyries and base metals as well. All of this makes juniors with discernible deposits moving down a path to production all that much more valuable.
TGR: And less risky. So are you ready to tell us about some of those companies, the ones with discernible deposits that are close to production?
RM: Not quite. What is the biggest risk all junior companies face—not investors, but the companies themselves?
TGR: Running out of money?
RM: Move to the head of the class because that is the absolute major risk, the most serious risk all the juniors face—remember most do not have cash flow. So if the markets look a little wonky and you think juniors will have a hard time raising money, you can further derisk by looking at companies with treasuries full enough to keep them working—to get by for a couple of years. And you can derisk even more by narrowing these companies down to those that have cash now and that will actually get some cash flow from production in the next little while.
TGR: You've given us a good group of filters for investors to use.
RM: We're doing some pretty serious research here and we have a very strong plan in place. We have directly targeted risk with the objective to lessen it yet leave potential major share price upside.
With careful due diligence and by thoughtfully choosing the development stage of companies we invest in, I think we can make some money.
TGR: So are we ready to hear about some of those companies?
RM: Yes. And these are in no particular order. Let's start with Cangold Ltd. (CLD:TSX.V). This is Bob Archer's gold company, which is working the Ixhuatan gold project in southern Mexico. Archer also has a silver company called Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A). The Ixhuatan property encompasses seven or eight different zones, all within a kilometer or two of each other, and all viable targets in their own right that Cangold intends to evaluate. So far, the most drilling has been done on the Campamento deposit, so bringing that into production is the main focus.
Cangold has stepped into something that is already well defined, based on 342 holes and 89,000 meters (m) of drilling, so it won't have to spend $500,000 a year drilling to try to find something or basically drilling this off. This deposit has a Measured and Compliant resource of 1.041 million ounces (Moz) gold and 4.4 Moz silver, with another 0.7 Moz gold and 2.2 Moz silver in the Inferred category. The deal Cangold made with Brigus Gold Corp. (BRD:TSX; BRD:NYSE.A) calls for Cangold to earn 75% interest by taking this through feasibility.
Campamento is at the scoping study level right now, and Cangold plans to move it as fast as it can through prefeasibility and feasibility. The work needed to advance this project to the mine stage is almost all engineering studies. Optimizing the open-pit shell, looking for the best place to locate a plant and tailing ponds has already started. So this is basically a kit mine that Cangold will develop and put into production.
And Cangold already has done a 5:1 rollback. It didn't have any problem raising money at $0.50, has a very tightly held share structure and has all that gold and silver in the ground to bring out via an open-pit mine. And it's trading at $0.30/share.
TGR: Why did Brigus make this partnership with Cangold when it already is a producer, running the Black Fox Mine up in Canada?
RM: I really think it's because of Bob Archer and his experience with Great Panther. He's well-established in Mexico, has excellent contacts and knows how to work there. Also, major shareholders such as Sprott back this deal up.
TGR: Certainly Archer has had great success with his mine at Guanajuato.
RM: That's right. I was buying Great Panther years ago in the high $0.30s and talked with him at the time. He laid out what he wanted to do and has basically delivered on everything. He has built a very strong team that works hard and gets the job done.
TGR: What are some of those other companies?
RM: Okay, the next one is Kootenay Gold Inc. (KTN:TSX.V), which has the 100%-owned Promontorio silver project in Sonora, Mexico. Like Cangold, Kootenay already has a significant resource. AGP Mining Consultants' resource estimate puts Indicated mineral resource at 5.2 million tons, with 8.9 Moz silver, 99 million pounds (Mlb) lead and 111 Mlb zinc. It grades 52 grams of silver, 0.86% lead and 0.96% zinc.
Since that estimate, Kootenay has drilled 53,000m into Promontorio at an average depth of 300m; the results from two-thirds of that drilling will go into a new resource estimate, which is due out in another month or two. Going back through the results on the website, you see some pretty decent assays, and I expect a very definite resource increase—a doubling or even tripling in the new estimate. Then Kootenay will launch another big and aggressive drill program. It wouldn't surprise me to see 50 Moz silver and quite likely the equivalent to that in lead and zinc after that drilling.
With all of that, plus a very good share structure with heavy management participation, a very healthy treasury, and more news coming, I refuse to believe that Kootenay won't be revalued much, much higher over the coming year.
TGR: With the flagship property actually focused more on silver than gold, is it odd that this company is Kootenay Gold rather than Kootenay Silver?
RM: The company took its name from the Kootenay region of British Columbia, where it started, and it has eight or nine serious joint ventures (JVs) with some pretty good junior resource companies on gold properties there and in other parts of B.C.—Copley, Red Lobster, Deer Creek, Jumping Josephine and Rosetta Stone.
Kootenay has the best of both worlds, and operates on the prospector generator business model, taking property dilution instead of share dilution. It uses the money that generates along with money raised to work on its 100%-owned Promontorio. I don't think most people realize that Promontorio, as a standalone, will be able to potentially produce 3–5 Moz silver a year plus another 3–5 Moz silver equivalent over a 10-year-plus timeframe. In the context of other silver producers in Mexico, that's a pretty significant asset. It usually takes these producers two or three mines to get up to production numbers like that, and Kootenay will get there with a single asset. That's pretty uncommon and pretty valuable.
TGR: A lot of great silver producers in Mexico certainly would be interested in this project.
RM: Oh, one project with the potential to produce that much silver and silver equivalent in a year has to be on every radar screen. Don't get me wrong, Kootenay can take this to production. It absolutely can. It's just a matter of whether an offer is too good to refuse.
TGR: Well, you've named two companies with assets in Mexico. It certainly is a great mining location.
RM: It is, but let's move up north into Nevada and Idaho with Terraco Gold Corp. (TEN:TSX.V). Terraco has two exciting projects—the Almaden, northwest of Boise, and the Moonlight, northeast of Reno.
The Almaden project could go into production today; it's very similar to deposits such as the Hollister mine and the Ken Snyder Midas mine in northeast Nevada. It has almost 1 Moz of Measured, Indicated and Inferred NI 43-101-complaint resources, based on almost 900 drill holes. Some of the mineralization outcrops, in fact the bulk of the deposit, lies within 100m of the surface. The exciting thing about this deposit, as with the Hollister and Midas mines, is that the deposit has substantial evidence to suggest higher-grade—maybe bonanza-grade—feeder shoots at depth.
I think Terraco will boost the resource quite a bit just due to the type of drilling program it is using and the fact that it is improving the metallurgy. So even if Terraco does not hit any more gold, I expect a significant increase in the resource. But if the model the drilling is based on proves to be correct and Terraco hits these feeder zones, the impact will be huge.
TGR: Terraco's chart suggests it has been beaten down quite severely, roughly about 50% in the last nine months.
RM: That's right. But Ken Snyder and Charlie Sulfrian, who are running the drill program, have discovered several mines. Snyder is one of the foremost geologists and explorationists working today and Sulfrian is a mine finder as well and a very good metallurgist. When he says he might be able to work on the recoveries, you have to anticipate a measure of success. When I asked him if the Almaden could be put into production as it is, he said yes. As I said, with the different drill methods and improved metallurgy, you're going see the resources at Almaden expand, and when you add in the blue sky of the feeder zones, you're looking at something pretty exciting. The story gets better and better all the time.
As you indicated, it's a little beaten up and has been a little worked over—who isn't—but Terraco has money in the bank and continues to increase shareholder value. Management isn't turtling up and crawling into a hole and crying themselves to sleep at night. When the market turns around—I fully believe the market's going to turn around—the companies we're talking about will be ahead of the herd. They're out there working and building shareholder value.
TGR: How about the Moonlight project?
RM: Moonlight is a call option on gold discovery. It sits directly north of Spring Valley, a resource of 4.1 Moz. Since that estimate, Terraco has secured the Black Ridge Fault property and incorporated it into Moonlight, hired Tom Chadwick to map it and has now started drilling.
TGR: Terraco also closed a very creative financing in December, with the royalty deal it made on the Spring Valley gold project.
RM: Yes. That deal is a hell of an example of how to create value for shareholders. Spring Valley is a JV between Barrick Gold Corp. (ABS:TSX; ABS:NYSE) and Midway Gold Corp. (MDW:TSX; MDW:NYSE.A), where Barrick has the right to earn 60% interest in the project by completing work expenditures totaling $30 million (M) by the end of 2013. But that sliding royalty from the Barrick/Midway JV is really interesting. I did the math.
TGR: Okay, let's hear about it.
RM: Terraco receives no royalty on the first 500,000 ounces (oz) of production. After that, Terraco pays $12.5M and gets a 2.5% royalty on 76% of the deposit or, as it stands today, 2.15 Moz. A very conservative 70% recovery means 1.51 Moz gold. Using $500/oz as the cost and a very conservative gold price of $1,100/oz means $600/oz net. On 1.51 Moz gold, that adds up to $22.6M. It will cost $12.5M to get that, of course, which takes Terraco down to $10.1M. Terraco has already received $5M as an initial payment for doing the deal. So with the $10.1M coming from the Barrick/Midway JV net smelter returns royalty and the $5M already in the treasury, Terraco is cashed up today and has a future royalty stream.
It's a good example of a pretty smart, on-the-ball management team increasing shareholder value. I think investors will find some joy in this one.
TGR: Excellent. Heading further north, do you have any Canadian projects to talk about?
RM: VMS Ventures Inc. (VMS:TSX.V) is a solid junior, among the smartest explorers around using all the modern techniques, and it's a survivor. VMS Ventures has been through the tough times, back in 2000 and again a few years ago in 2008. This company knows how risky it is for a junior to run out of money, and it isn't going to do it. It has $10M in the treasury to start 2012—enough to keep exploring and going on its own until cash flow starts. Let's talk about that cash flow.
VMS Ventures has a JV with HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) on its Reed Lake copper deposit that will take the company to production next year. It will get 30% from this operating mine—that's many, many millions of dollars a year. When you look at the kind of cash flow that this carried-to-production scenario at Reed Lake will give the company, you have to expect an upward revaluation in the share price. Another factor that helps derisk VMS Ventures is HudBay's Trout Lake Mine is coming offline, its plant in Flin Flon is underutilized, so it needs the feed from production at Reed Lake.
In addition to the JV, HudBay has optioned some of VMS Venture's properties. One discovery, Reed North, has enormous potential to be an absolute monster of a deposit.
Something like 98% of VMS's properties are 100% owned. The company did several drill programs last year and will be following up on three discoveries made on three different 100%-owned properties. VMS also owns 45% of North American Nickel Inc. (NAN:TSX.V), which has a possible district-size nickel play in Greenland. With all it has going—its considerable treasury, the cash flow, the exploration upside, the management—VMS Ventures is a poster child for how juniors should manage capital. As we agreed, the most dangerous thing for a junior is to run out of money. This company absolutely doesn't have that problem. And, as a matter of fact, the closer it moves to production, it's just going to get better and better.
Fully cashed up with $10M in the bank and financing costs for its 30% of the mine covered, VMS Ventures also focuses on some of the safest areas for investment. It has no geopolitical risk.
TGR: Because VMS is a copper play, you must anticipate somewhat stable demand for copper, too.
RM: We're never going to see $0.85/pound (lb) copper again. With copper at $3–4/lb, Reed Lake should be wildly profitable. Put $71M into building a ramp down to the deposit and who knows how much more copper it will find? It's not only that this deposit has 5% copper equivalent over a couple of million tons, but these deposits come in pods. So far, VMS has not drilled off to the side or underneath because it simply doesn't make economic sense. But once it has the decline into the deposit, it will build side rooms, set up drills and start fan-drilling and see what it gets, right?
TGR: Right. And the idea of diversifying a little bit into base metals makes sense for the typical investor. Any more juniors that you'd like to talk about?
RM: I really like NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK), which is focused in Quebec. These people at NioGold are smart. They can put land packages together, and they have. And look at the deal that they've done with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A). Aurizon right now can earn 65% interest in NioGold's Marban Block property, an initial 50% by spending $20M over three years, completing an updated NI 43-101-compliant mineral resource estimate, which will be done this March, and then making a resource payment for 50% of the total gold ounces defined by that resource estimate.
So far, Aurizon has completed a first phase, drilling 50,000m, spending $6M and identifying two new gold zones. The second phase will be a $5M, 34,000m diamond drill program, updated resource estimate and basic technical studies this year. If it sees what it needs to see in the resource estimate—and I don't see why it won't, because it already has two new discoveries—it just doesn't make sense for Aurizon to do a third year, buy those ounces and carry NioGold with it to production. Instead, I would think that Aurizon would buy NioGold out as soon as it gets a feel for what's there.
TGR: Aurizon certainly has the capability to do that. It's had so much success with building the resource base at the Joanna gold project. So yes, that's very logical.
RM: And the thing about NioGold is it is fully cashed up. It has lots of money in the treasury. It is also going to have this resource payment. And it has a discovery right beside Osisko Mining Corp.'s (OSK:TSX) Malartic deposit. It also looks as if NioGold has the extension of the Marban deposits, Marbanite and Norbenite, on its 100%-owned block of ground just north of where Aurizon's drilling. So, NioGold has immense blue-sky potential as well as the deal with Aurizon.
TGR: With the stock trading at around $0.35, NioGold would seem to be a bargain at this point. Any more names in that hat, Rick?
RM: One more. And this might be the cheapest safest gold ounces you'll find on the Venture Exchange and quite an opportunity. It's a story that's been dormant for a long time, but revived itself with acquisition of a hell of a property.
TGR: Tell us more.
RM: On Jan. 3, Altair Ventures Inc. (AVX:TSX.V) put out a news release to announce signing a letter of agreement for an option to acquire from Sultan Minerals Inc. (SUL:TSX.V) up to a 75% interest in the Kena gold project, located close to Nelson in southeastern B.C. At 7,600 hectares, this is a fairly large property in a safe jurisdiction with access to infrastructure. But more important, it covers 8,000m of strike length on a district scale gold and copper-gold system. It has a 1.1 Moz gold resource now, with the potential to double or triple that resource. I have a prospector buddy who's worked all over the area and on this property. He absolutely loves this property, has been following it for years and always wondered why nothing was ever done with it.
TGR: Do you know why?
RM: Well, Sultan spent about $500,000 tying up this property, which is a lower-grade, bulk-tonnage target, between 2000 and 2003, and had the resource defined by 2004. At that time gold wasn't as high as it is now, and low-grade bulk-tonnage properties didn't really come into vogue until later.
TGR: I see Bob Archer is involved with this one as well.
RM: Yes he is. I think at around $0.07/share, with 42M shares outstanding, it has to be some of the cheapest gold on the exchange. The property is severely undervalued, and with the exploration potential to double and possibly even triple the resource, this is pretty exciting stuff. Now it is going to rollback three for one and will have to raise some money. So maybe this isn't as derisked as others we have mentioned, but this is, in my opinion, incredibly undervalued based on the existing resource and exploration upside as shown from results on other areas of the property.
TGR: You've given us a lot of interesting ideas, Rick, and investors certainly will appreciate your explanation of how to lessen their risk as they venture into the junior space. Is there anything you'd like to add before we say goodbye?
RM: Maybe just to emphasize the importance of doing your homework. There's absolutely no way around it. As an investor, you can rely on other people to do some of it—Ahead of the Herd and Streetwise just did by showcasing, for free, several excellent companies to do further due diligence on—but the ultimate decision and the ultimate responsibility for every decision you make rests with you. That's why you need to satisfy yourself that what you put your money into is run by a competent management team.
Know your risk profile. Pick your stock. Plan your entrance, and have the patience and discipline to let a quality management team go to work for you and build value. But be sure to have an exit plan as well; pick the stage at which you get out, because you don't make any money until you sell—stick to your plan.
TGR: Excellent. Thank you, Rick.
RM: Thank you.
Richard (Rick) Mills is the founder, owner and president of Northern Venture Group, which owns aheadoftheherd.com, as well as publisher, editor and host of the website. Focusing on the junior resource sector, Mills has had articles appearing on more than 300 websites, including: The Wall Street Journal, SafeHaven, Market Oracle, USA Today, National Post, Stockhouse, Lewrockwell, Uranium Miner, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy/Critical Metals Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FNArena, Uraniumseek, and Financial Sense.
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1) Sally Lowder of The Gold Report conducted this interview. She personally and/or her 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: Great Panther Silver Ltd., Terraco Gold Corp., Aurizon Mines Ltd. Streetwise Reports does not accept stock in exchange for services.
3) Rick Mills: I personally and/or my family own shares of the following companies mentioned in this interview: None. The following companies are sponsors of my website aheadoftheherd.com: Kootenay Gold Inc., Terraco Gold Corp., VMS Ventures Inc., Cangold Ltd., Altair Ventures Inc., NioGold Mining Corp., Great Panther Silver Ltd. I was not paid by Streetwise for participating in this story.
Richard (Rick) Mills
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