The Maven Letter: June 14, 2016
Maven Mondays
Gold closed today at US$1,283 per oz., putting the yellow metal almost back where it was before the May ‘correction’. I couch that word because it wasn’t much of a slide: gold gave up a max of 7% after gaining 20% and has now rebounded in very short order. Add in that gold equities levered the decline only two-fold, versus the four or five-fold leverage they showed on the way up, and you have a pretty tepid correction!
I went through this with my subscribers in last week’s Maven Letter and the macro article is below.
First, though, two In The News items: a comment on Lundin Gold’s feasibility study for Fruta del Norte and a look at Paul Matysek’s latest success, the sale of Goldrock Mines to Fortuna Silver Mines.
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In The News
In this section I discuss interesting and important news from the mining sector. Companies mentioned are not necessarily in the portfolio and coverage does not represent a recommendation.
What Grade Giveth, Royalties Can Take Away
Fruta del Norte is one of the largest high-grade gold deposits in the world, home to 4.8 million oz. gold in reserves grading 9.67 g/t gold, out of a resource that totals 14 million oz.
The gold is reasonable to access, with plans in a new feasibility study calling for twin spiral declines and a combination of long hole stoping and drift and fill mining. Recovery requires a combination of gravity, flotation, and leaching, a process that recovers 91.7% of the gold and 81.5% of the silver.
The plan is to produce 340,000 oz. gold annually over a 13-year mine life.
The study projects Fruta would be able to produce each ounce for an all-in sustaining cost of US$623, putting it in the lowest cash cost quartile globally.
Sounds great, right? The initial capital of US$669 million is a bit high, but the low production costs should carry that, right?
Yes – if Fruta were not in Ecuador. But it is. And to be able to advance this asset (something Kinross couldn’t do, spurring the major to sell Fruta for US$240 million in 2013 versus the US$1.2 billion it paid for the project just five years earlier), owner Lundin Gold had to negotiate an exploitation agreement that ensures the government’s share of cumulative benefits is not less than 50%.
That means the low-cost mine is only able to generate a 15.7% after-tax internal rate of return (using US$1,250-per-oz. gold). And its net present value of US$676 million is basically equal to its construction cost. (To boot, the capital estimate does not include taxes that actually lift the total by another US$91 million. Those taxes are returned once production begins, but it still means Lundin will have to access US$760 to build the mine.)
The need to please Ecuador is evident even in how the feasibility news was announced. One of the first sections of the release was Benefits to Ecuador, outlining how construction would employ 2,000 people, operations would employ 900, the region would enjoy infrastructure upgrades, and the government would get almost a billion dollars in royalties, taxes, and profit share over the life of mine.
That billion dollars is a minimum. The windfall portion of the exploitation agreement means Ecuador will get more if gold prices rise, while Lundin will get little benefit.
National benefit is essential to project success, don’t get me wrong. I am glad the people of Ecuador will get jobs and significant cash from a Fruta mine. As an investor, though, the plan doesn’t interest me.
If you are investing in gold stocks because you believe the price is heading north, Lundin’s exposure is capped by the windfall tax. If you really like Fruta, LUG shares are hindered in their ability to reflect the quality of the asset because the exploitation agreement keeps the payout limited.
To be sure, Lundin Gold is not done yet. The company presented a long list of opportunities to improve the project, and some of them very likely carry merit. They will investigate using more long-hole stoping and less drift and fill, they will conduct more metallurgical work focused on recovering free gold via gravity concentration, they will assess options for buying construction aggregate at lower costs, they will look to upgrades resources to reserves and continue exploring.
And some of those efforts will improve economics. So would shortening the development timeline. But I see limited investment appeal in buying a stake in a mine if more than 50% of the benefits are guaranteed to someone else.
Matysek Does It Again
Paul Matysek knows how to make things happen. And he knows it involves risk and foresight.
In late 2012, with gold’s ascent over, Matysek took the helm at Goldrock Mines (then called Mansfield Minerals) when no one else – literally, no one else – would touch Argentina. He saw in Lindero the characteristics he demands: great geology, simple development options, a discount for a reason (Argentina) he thinks will change, and a good share structure.
In short order, under Matysek the company produced a strong feasibility study. Six months later, Matysek raised $9.2 million at a 78% premium to market by bringing an Argentinean-focused miner into the stock. Using that money, Goldrock went ahead and bought the longest lead-time item needed to build a Lindero mine, which was a High Pressure Grinding Roll crusher, for US$5 million.
Through 2014 the company continued to push the project ahead despite terrible markets by strengthening the board, contracting out basic engineering, inking a gas contract, and securing permits.
Then Matysek did it again: by acting as the middle man between players who had become hostile to each other, Goldrock enabled Waterton Precious Metals Fund to buy Chaparral Gold – and in doing so secured a partnership with a wealthy precious metals fund that shortly thereafter invested $5 million into GRM at a 50% premium.
Two months later, Orion Resource Partners put another $5 million into Goldrock – at a 92% premium.
Then Argentina had its presidential elections. Mauricio Macri won and the investment landscape changed, immediately and dramatically. Argentina was again open for business and Salta Province, where Lindero is located, is mining’s favorite part of the country.
An updated feasibility study incorporated updated costs, 22,000 man-hours of engineering work, the purchase and delivery of long lead-time equipment, and additional drilling. Stand out points include a strip ratio of just 1.22 to 1, an after-tax IRR of 26%, all-in sustaining costs of US$777 per oz., and average annual production 108,000 oz. gold over 12 years.
And importantly: because the project is fully permitted and long lead-time items are already in hand, Lindero could go from construction decision to production in 14 months.
It was enough to attract a bid: yesterday Fortuna Silver Mines announced a deal to buy Goldrock by exchanging each GRM share for 0.1331 Fortuna shares. Based on closing prices, the deal is worth $1.08 per share, which is a 58% premium.
The premium is notable. Credit goes in part to a share structure that includes only 120 million shares fully diluted, even though Goldrock spent millions advancing Lindero during the dark days of the bear market.
Paul Matysek really has an eye for these things. He saw potential in Argentina far before anyone else. His public markets success – this is a man who has built and sold three, now four, companies in deals totaling over $2 billion – enabled him to raise money for Goldrock at a premium three times in the bear market. He knew to hold on through gold’s downturn because opportunity would arise again.
With Goldrock sold, Matysek will now turn all of his attention to his other deal: Lithium X Energy, of which he is chairman.
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On The Macro: Gold Stands Corrected
Gold sure did a turnabout since my last letter! As I’m sure most of you know, on Friday the US jobs number missed in a huge way. May payroll reported as a measly 38,000, almost 130,000 less than expected. In addition, the number for April was revised down by 37,000.
The official unemployment rate was also reported to have fallen from 4.9% to 4.7%, but don’t be fooled. It’s not that more people got jobs, it’s that fewer people looked for work: the labour force participation rate slid 0.2%.
Gold responded immediately, adding US$20 in a few minutes. And importantly, the yellow metal held onto this rebound for several days before inching higher again today.
The impact was like a shot of caffeine to the mining sector. My phone started ringing. IR folks who had been fearing a summer slide jumped back to attention. Financings are underway.
If that was the correction we have all been awaiting since gold started to move in January, it was pretty minimal. I know if felt big, seeing gold give up 7% – had the whole rally just been a head fake? But as I’ve been counseling of late, it helps to zoom out.
The correction doesn’t look like much on a five-year chart. Yes, it was the biggest slide since the market turned, but if you are a big picture investor what matters is the change of trend, the supporting rationale, and the fact that the price not only recovered on the jobs report but maintained its gain for several days before climbing again today.
Gold equities, meanwhile, had barely registered gold’s correction before it ended.
The GDX lost only 13% before bouncing right back. The junior gold miners ETF, GDXJ, fell 16% over two weeks and then regained all that ground in two days.
The limited declines suggested sustained interest in gold miners through gold’s dip, which reinforces to me that many buyers remain interested in gold. The rapid rebound says the same thing.
And adding to that: a few hot gold explorers did not even notice gold’s dip, while many explorers and developers levered gold’s decline only two-fold (versus three to five-fold on the way up) and then rebounded immediately.
Above are share price charts for a couple current gold exploration market darlings: Sirois, TriMetals, and Gold Standard. They basically didn’t care that gold corrected.
Orex, a hot silver exploration story, didn’t even notice that silver had tracked gold down. Orezone, a near development gold story, blinked and recovered within a week.
The point is: interest in equities remains very strong. And now the bull is back – or more precisely, the bull has gone through its first correction and remains on track. The details of that track still depend on what happens next week but the overall story is solid.
Next week is still a mystery, though the jobs fail certainly decreased the odds of a rate hike. I’m still not placing a bet either way and, as I’ve said, I think gold stands to do well either way, responding immediately if there is no hike or gradually if there is a rate hike.
