What if the shockingly low valuations of some junior mining companies are really all they're worth? As the market shakes off years of exuberance, Brent Cook, co-editor of the Exploration Insights newsletter, searches for the truly undervalued—finds as rare as gold itself. In this interview with The Gold Report, Cook talks about high-margin deposits that the rest of the market can't see.
The Gold Report: Brent, 2012 was difficult for many gold investors, and you paint a pretty bleak picture for certain junior mining companies in 2013 as well.
Brent Cook: We've actually had two pretty tough years on the TSX Venture Exchange. It is off about 30% from its peak in 2012 and around 20% for the year. That comes on top of a 35% decline in 2011. I do think much of the froth is washed out and we will see some opportunities in 2013.
"Since about 1995, the number of gold ounces discovered has been trending straight down."
During the most recent boom years, 2009 and 2010, roughly $11 billion ($11B) was raised on the Venture Exchange. Most of that has been spent without much success. Going by John Kaiser's database of about 1,800 Venture Exchange listed companies, there are around 600 that now have less than $200,000 in the bank and a full 62% of the 1,800 companies have a median working capital of only $1.1 million ($1.1M) or less. These companies are trading at less than $0.20/share, which means that unless things improve dramatically in the next year, many of these companies are going out of business or will push excessive dilution on current shareholders just to stay alive. The Venture Exchange will truly be the land of the walking dead.
This coming year will be a cleaning-out process that in the long run is good for the sector.
TGR: The Exploration Insights portfolio was not immune to what happened in 2012. It was up 4% from early January 2012 to late November. Are you convinced all of the companies in your portfolio should remain there?
BC: We've got to go through a cleaning-out process as well. We've had some real disasters, where the investment thesis didn't pan out. We've also had a couple of big winners. The majority of the stocks that we own are undervalued, but they have held up well compared to the indexes. I just finished reviewing our 2012 performance and we have so far done surprisingly well on stocks we bought and sold in 2012, with an average gain of about 49%. Unfortunately, the stocks we have held for over a year didn't do as well, taking our year over year average gain down to about 13%. I'll have the final numbers out in our Jan. 6 issue.
TGR: What are you telling your readers to give them hope?
BC: The truth. Hope is the worst reason to own a stock. We're not going to see $3,000/ounce (oz) gold, and we are not going to see junior stocks go to the moon this next year. If an investment thesis doesn't pan out, we sell and take the loss. If, however, the thesis continues to work, we hold onto the stock or buy more. This is very speculative money in a very high-risk sector. Unless the risk trade comes back into favor this next year, and I don't think it will, it's going to be another tough one for the explorers and junior miners.
That's all negative, right? But this is the smart time to pick up selective companies that have something of value. This is when investors can make money by buying intelligently and patiently. We may not be at the bottom, but it certainly isn't the top.
TGR: What sort of trading range do you see for gold in 2013?
BC: What's more important to me than gold's trading range, at least with regard to the junior explorers, is that the industry is not able to supply new deposits and discoveries to replace what is being mined. This is a serious issue that in the long run bodes well for this sector. Since about 1995, the number of ounces discovered has been trending straight down. According to the Metals Economic Group, in 2011 approximately 10 million ounces (Moz) were discovered, but 83 Moz were mined. That gap in production versus discovery is the opportunity, regardless of the gold price, which I think is flat to marginally higher in 2013.
TGR: A lack of discoveries is hurting the industry?
BC: It's getting tougher and more costly to find gold. That is the real issue. A company that raises $5M gets half as far as it did eight years ago.
"This coming year is going to be a fantastic time to buy undervalued, high-margin deposits that the rest of the market doesn't recognize."
During the past six years, the major gold-mining companies have spent the equivalent of 40% of market capitalization developing new deposits. It is projected that they would spend another 60% of their capitalization developing the new mines they have on the books just to keep production even. Moving reserves to production comes at a big cost. I've posted an article on my website that goes into a lot more detail regarding the dismal state of both the gold miners and explorers that should help readers understand the depth of the problem and opportunity.
TGR: Let's get into your process. One phrase you use a lot is: "How much is it going to take to turn this rock into money?" What calculations do you use to help determine that?
BC: There aren't any easy numbers I can throw out there. Every deposit presents different challenges and companies spend tens to hundreds of millions of dollars figuring out how much it is going to cost to turn the rock into money.
Actually, one rule of thumb is the cutoff grade used in estimating the tonnes and grade of a deposit. In theory, that cutoff grade should be what a company or resource estimator projects is the break-even point between making money and losing money. If the cutoff grade is, say, 0.5 grams per tonne (g/t), then I like to see an average grade that is at least twice that, say, over 1 g/t, because above that is where you really make the money, if the cutoff assumption is close.
Then you've got to look at metallurgy. This is probably the most important aspect of any deposit once it has been found. For instance, an oxide deposit sitting on the surface in Nevada with a cutoff grade 0.2 g/t can still make money, whereas another deposit in Nevada at 5 g/t cutoff won't.
It is highly variable. All that the retail investor can do is guestimate if the grade and tonnes are sufficient to cover the probable capital and mining costs.
TGR: It's pretty easy for the average retail investor to get lost in a feasibility study. They are quite technical. I'm certainly guilty of this: It's easy to look at the internal rate of return (IRR) and judge a deposit based on that. Is there a way to determine whether the IRR number is realistic?
BC: IRR is a good metric to look at, especially if it is after taxes.
TGR: Is there a minimum threshold?
BC: I think 20% after tax, although it depends on where the project is located and on the exploration upside. That upside is the intangible that often decides if a deposit gets bought or not.
TGR: What are some practical ways a retail investor can do due diligence?
BC: Talk to management. Get comfortable with the team. There are a lot of good people in this industry and they are not hard to recognize once you start talking to them.
"The long-term prospects for the exploration sector look real good to me, but you better know what you are buying and why."
Go to the company's website. How accessible it is? How much information does it give in news releases? Does it back up the data? Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) and Mirasol Resources Ltd. (MRZ:TSX.V) include details, details, details. Be wary of a company that puts out a news release with no maps, no sections and no data. Watch for news releases that report high grades smeared over long intervals, and always search for historical data from the property being promoted. Most properties have a history that gives you some insight into possible tonnes and grade.
TGR: Almaden recently announced assays from four drill holes testing the eastern limits of the main zone at its Ixtaca gold-silver discovery in Mexico. The company has discovered gold-silver mineralization hosted in volcanic rocks versus limestone, and shale host rock in the rest of the deposit. What do you make of that?
BC: I went down to Almaden's Ixtaca project two and a half years ago and bought the company then. This is a very big hydrothermal system and, potentially, precious metal deposit. The drilling to date has almost exclusively found gold and silver mineralization in sediments. My take is it's just touching the edges of the mineral system and the most recent drill holes are pretty encouraging. We'll see if Almaden can extend it 50 meters to the southwest or not.
TGR: You don't believe that the company has found the heart of the deposit, but is Almaden any closer to the promised land?
BC: The next drill hole will be either great or a bust, but is not the deciding factor for this deposit. The important aspect to me is that this is a big system, and big systems make big deposits.
TGR: Some pundits have suggested that the success Almaden is having at Ixtaca has caused it to largely forgo the prospect generator model and focus on this deposit. Do you agree?
BC: The company still has a number of projects ventured out, but you're right, it is drilling Ixtaca and will be drilling El Cobre. With the prospect generator model, a company generates ideas and vends them out when they get to be too high risk and costly. Therefore, the company doesn't dilute the shareholders to drill every low probability target it turns up. Most prospect generator companies are run by geologists who are good enough to recognize something above average when they stumble across it at which time they have the money and tight share structure that benefits long-time shareholders. It takes a long time to work through projects and find something worthwhile and this model addresses that problem.
A number of companies have morphed out of that business model to the benefit of shareholders, including Almaden, Mirasol and Kaminak Gold Corp. (KAM:TSX.V).
TGR: Have any other companies recently published important results?
BC: Belo Sun Mining Corp. (BSX:TSX.V) just came out with 4.1 Moz Measured and Indicated and 2.8 Moz Inferred, or nearly 7 Moz at 1.7 g/t at its Volta Grande project in Brazil. That's a really strong resource number. These are broad coherent zones of mineralization. It'll be easy to mine. Yet, the stock's gone nowhere on the news. We can buy this company at the same price we could before the announcement, but it's got 2M more quality ounces.
TGR: Is it a lack of faith or did the news get lost in a mass of information?
BC: The sector has been so hammered that a lot of trading is now among a small circle of friends and enemies who are basically picking each other's pockets. That doesn't bode well for this next year. I don't know what it will take to bring new money in. We've got nearly $1,700/oz gold, but nobody cares. Without new money entering the sector we will struggle.
TGR: Would a company like Belo Sun, given its board and the merchant bank that is behind it, have any trouble raising cash?
BC: It's got plenty of cash. And its deposit will likely get bought down the road by a larger mining company.
TGR: It also has an exceptional board that has turned over a number of companies. Can you mention another company?
BC: Lydian International Ltd. (LYD:TSX) has a 3 Moz deposit in Armenia. It's an oxidized deposit that will have low processing and production costs. Capital expenditures are relatively low. A recent feasibility study shows a net present value at 5% with gold at $1,500/oz of just over $1B. That's a $1B valuation at $1,500/oz for a market cap of $250M.
TGR: Is it falsely being priced as if Armenia were a risky country?
BC: Perhaps. Based on my visit to Armenia, I don't consider it a risky country. Maybe it's such a new location that many investors are leery.
TGR: Lydian recently announced that it was going to modify its crusher design and try to reduce the footprint of its Amulsar deposit. Is that a good plan?
BC: It is. It will increase production, make it a simpler operation and make Amulsar more valuable.
TGR: Does Lydian have the money to build it?
BC: It has the money to move forward this year and will begin site development. It is my understanding that the International Finance Corp. (IFC) and European Development Bank want to put money into it.
TGR: What are some other companies that you find interesting right now?
BC: MAG Silver Corp.'s (MAG:TSX; MVG:NYSE) Juanicipio project in Zacatecas, Mexico, is probably the best or second-best undeveloped silver deposit in the world. MAG discovered the deposit with Fresnillo Plc (FRES:LSE). Fresnillo is going to put it into production. Because the deposit is part of its namesake silver district, and there are without a doubt more veins to be discovered, it would make sense for Fresnillo to buy MAG Silver's 44% stake, eventually.
TGR: MAG also has silver at the Cinco de Mayo project. Will Fresnillo buy its interest in Juanicipio or do an outright takeover?
BC: I don't know. Fresnillo is a rather secretive Mexican company and it is hard to know what it actually thinks. Cinco de Mayo is a polymetallic deposit. It's got silver, lead, zinc and copper. I'm not sure if that interests Fresnillo. My bet is that Fresnillo will take Juanicipio and MAG Silver will spin out Cinco and the rest of its projects into a separate company. I just don't know when.
BC: Rye Patch is making a bet that the mining law of 1872 holds up. I think it will, but it's going to be a long legal battle. Coeur d'Alene has a plan of operation with the Bureau of Land Management that it believes gives it priority over claims that it failed to keep current. However, if a company does not keep its claims up to date in the U.S., those claims are open to staking. It is clear to me what the end results should be but we are dealing with a David and Goliath scenario.
TGR: Global Minerals Ltd. (CTG:TSX.V; DPF:FSE) hasn't done so well since you put it in the portfolio in March 2011, yet you still own it. Why?
BC: Global Minerals has a good, easy-to-mine silver deposit in a Slovakian mining town. The infrastructure is more or less there. The underground silver and copper mineralization is there. I can show on paper that this project is considerably undervalued for its silver resource, and that doesn't even account for the exploration potential on trend. It is, however, a development story and these take time.
TGR: Kaminak Gold Corp. published the first resource estimate on its Coffee gold project in the Yukon. It's 64 million tonnes at 1.56 g/t, which equates to roughly 3.2 Moz at a 0.5 g/t cutoff for the oxide and transitional material and 1 g/t cutoff for the sulfide material. What are your thoughts?
BC: I was impressed. Kaminak came out with more ounces than I expected. The grade is pretty good. The oxide material is positive from a processing perspective. I was more surprised at how the market reacted, which was basically flat. Kaminak is the market darling in Canada. Good guys, new all Canadian discovery; everybody loves it. But it publishes a 3 Moz resource and the stock goes nowhere.
TGR: If it were 2007 and Kaminak had the same deposit and the same resource, what do you think it would be valued at?
BC: It would be at least double what it is now. Back in 2007, everybody was happy and smart. We were all making money. The hedge funds were pumping money into the exploration sector. Now it's just about the opposite.
TGR: Maybe we never return to those days, but when will the market properly value these types of deposits again?
BC: It may be properly valuing many of them now.
TGR: Oh my.
BC: There are a few deposits—Belo Sun, Lydian and a few others—that are definitely undervalued. But when it comes to the resource and exploration stages, the odds of making an economic gold discovery are about 1 in 1,000. How do you properly value that?
Andina Minerals Inc. (ADM:TSX.V) was bought by Hochschild Mining Plc (HOC:LSE). It had about 7M low-grade, tough ounces up in the high Andes in Chile. It got about $10/oz and it may have overpaid. That's what it agreed to be paid, so we have to assume that that is a proper valuation for those ounces.
TGR: Does a mine need to come into production and be successful before valuations go up in areas like Colombia, where there's a lot of exploration but not much coming up yet?
BC: I was looking at the share prices of a number of companies that jumped into Colombia and put out initial results that many considered good. They excited investors with spectacular surface samples, and even some drill results. The results took many of the companies straight up and subsequently straight back down. Reality has set in. A lot of those discoveries turned out to be small plugs or narrow, high-grade veins that don't offer much size potential. For the most part, it was pretty obvious what was being promoted but people wanted to believe. Now they don’t seem to believe anything.
We only own one Colombian company: Galway Resources Ltd. (GWY:TSX.V), which was acquired and will be spinning out two new companies.
TGR: Is there a company that could have a good 2013?
BC: Mirasol. I've spent a lot of time with this group of geologists. They find deposits. They're good at it. They've made several discoveries in Argentina. Mirasol just sold 49% of one discovery to Coeur for $60M in cash and stock. It has another discovery it will be putting out a resource report on, and another it might release some good drill holes on. It has moved into Chile. You're paying $30M enterprise value for all of that and I'm willing to bet that the company makes another discovery in the next year or two.
TGR: Is there a parting thought you'd like to leave us with? A crumb or two of hope?
BC: This coming year is going to be a fantastic time to buy undervalued, high-margin deposits that the rest of the market doesn't recognize. The long-term prospects for the exploration sector look real good to me, but you better know what you are buying and why. I am afraid most of the fools have been washed out of the market.
TGR: Thanks for that, Brent.
BC: My pleasure.
Brent Cook brings more than 30 years of experience to his role as a geologist, consultant and investment adviser. His knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. Brent's weekly Exploration Insights newsletter focuses on early-discovery, high-reward opportunities, primarily among junior mining and exploration companies. Cook will be speaking at the Cambridge House Vancouver Resource Investment Conference Jan. 20-21.
Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.
1) Brian Sylvester 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: Rye Patch Gold Corp., MAG Silver Corp., Lydian International Ltd., Almaden Minerals Ltd. and Global Minerals Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Brent Cook: I personally and/or my family own shares of the following companies mentioned in this interview: Global Minerals Ltd., MAG Silver Corp., Rye Patch Gold Corp. 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 interview.