Reservoir Minerals thoughts plus why silver’s move is good for gold
The Maven Letter: April 26, 2016
Maven Mondays
I love starting the week with good news. And this morning’s news was good.
Nevsun (TSX: NSU) announced a deal to take over Reservoir Minerals (TSXV: RMC). Reservoir’s key asset is Timok, a Serbian property that boasts a very high grade Upper Zone of massive sulphide mineralization and a large, lower grade Lower Zone of porphyry mineralization. RMC is partnered with Freeport McMoRan on the asset, with Freeport holding 55%.
In March Lundin Mining (TSX: LUN) inked a deal to buy Freeport’s stake in the Upper Zone for US$263 million. However, Reservoir held a Right of First Refusal to match any such offer within 60 days.
Enter Nevsun and its bank account.
The deal will see NSU first take a 19.9% stake in RMC through a $114-million private placement.
Nevsun will also extend a US$44-million loan to Reservoir. Reservoir will use the cash to match Lundin’ offer, thereby consolidating ownership of the Upper Zone.
Then Nevsun and Reservoir will merge, in a deal that values RMC at US$365 million. When the dust settles Nevsun will own 100% of Timok Upper Zone and 45% of Timok’s Lower Zone. And Nevsun will still have almost US$300 million in the bank, enough cash to carry the Upper Zone much of the way into production.
The deal is good in several ways.
First, it carves out a new path forward for Nevsun.
Nevsun’s Bisha mine is a great operation but its location – Eritrea – has always given investors pause. Timok project is in Serbia, not the most secure jurisdiction but a big improvement on Eritrea. And it is a fantastic deposit, one that NSU will turn into a mine within a few years time.
Second, it highlights the hunger for good assets. Lundin wanted Timok. Nevsun did too. Guaranteed other companies also tried to angle in on the opportunity. For a company notoriously protective of its bank account – Nevsun – to negotiate a merger in order to act on a Right of First Refusal to one-up a well priced offer for an exploration-stage asset – those are not bear market moves.
Third, it provides a near-term path forward for Timok.
Reservoir made a phenomenal discovery but had limited access to cash and in Freeport had a joint venture partner that moved at glacial speed. Nevsun, by contrast, has cash and wants to grow.
Fourth, it provides a nice bonus to Eurasian Minerals (TSXV: EMX), which like Nevsun is also in the Maven portfolio. Eurasian owns a 0.5% royalty on Reservoir’s attributable production from Timok. Until today, that meant a royalty on 45% of the asset. Now the royalty covers all of the Upper Zone and 45% of the Lower Zone.
If anyone has questions for Nevsun about the deal, NSU is presenting at the Metals Investor Forum. If you will be in Vancouver on May 14 and 15, come down and ask what you will. Click here to reserve your tickets.
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Speaking of the Maven Portfolio…
I want to include a short note about how I operate my business, to ensure the premise is clear.
In my newsletter, The Maven Weekly, I write about my ideas and opinions in the world of mineral exploration, development, and mining. I start with a section called In The News to try to keep readers abreast of interesting news from across the sector, not just from companies in the portfolio.
Next I provide some macroeconomic commentary. It might be specific to one metal, it might be about investment fund flows, it might compare the options to finance a new mine, or it might dip into the endless debate about interest rates. Macroeconomics matter because mining is first and foremost a cyclical sector, which means successful investing requires an informed macroeconomic perspective.
Then I explain a new stock recommendation, if there is one that week. Finally I go through news from companies in the Maven portfolio and suggest actions when they suit, such as selling part of a holding to lock in gains, buying more to average down, or selling all.
The stocks I recommend are what I am buying.
The Maven portfolio is my portfolio. I do not buy a stock before I recommend it and I do not sell before I say. I only participate in private placements of stocks that are already in the portfolio.
I rely on a few other people to help me with this endeavor. First, like any good professional I have a network of friends and peers off of whom I bounce ideas and questions when I come across something I don’t understand (which happens with good regularity!). Second, researching and writing this letter, operating the business end of things, and corresponding with subscribers takes up all of my time. As such I have someone who helps me with marketing my letter and I work with a group of people to put on the Metals Investor Forum.
None of these people know in advance when I will recommend a stock.
Certainly none of them have a say in which stocks I will buy. If some of them are invested in the same equities, great; that means we see similar opportunities. But their investment accounts are separate from mine.
If anyone ever has any questions about this kind of thing, please ask. I believe that my advice is only as good as my credibility.
Now, on to this week’s snippet from the letter. Two In The News articles on Canadian jurisdictions and the first part of the macroeconomic commentary. Hope you enjoy.
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In The News…
Seabridge Acquires Snipgold as the Golden Triangle Gains Traction
There’s a gold jurisdiction gaining traction that I haven’t talked about enough. News out today gives me good reason to rectify that.
Seabridge Gold (TSX: SEA) is buying Snipgold (TSXV: SGG) in a $10-million deal aimed at SGG’s Iskut property. Iskut is 40 km northwest of Seabridge’s KSM project, which is adjacent to Pretium’s Brucejack property. The area is known as British Columbia’s Golden Triangle.
The Golden Triangle hosts some doozie deposits, led by Pretium’s Valley of the Kings’ 13.6 million proven and probable tonnes grading 15.7 g/t gold and followed closely by Seabridge’s Deep Kerr deposit, with 781 million inferred tonnes grading 0.33 g/t gold and 0.54% copper. Both companies have other, smaller resources defined as well.
Pretium’s recent success at Valley of the Kings reignited interest in the area and there are now multiple companies at work in the Golden Triangle. Colorado Resources (TSXV: CXO) is working the blue block in the above map, under an option agreement with Snipgold, while IDM Mining (TSXV: IDM) is pushing its nearby Red Mountain deposit into production.
Millrock Resources also moved into the Golden Triangle recently, closing a series of deals with small landholders to consolidate a nice package south and east of Pretium’s ground.
It’s no surprise investors are attracted to the Golden Triangle. When an area offers one of the best high-grade gold discoveries of the decade (now being built into a mine) alongside large, lower-grade porphyry deposits and swaths of untested ground, geologists are going to be interested. And interest ramped up last year when BC government geologists published a paper that, for the first time, tied the area’s discoveries together with a structural explanation.
Geologist Jeff Kyba gets credit for the idea, which is that the geologic contact between the Triassic age Stuhini rocks and the Jurassic age Hazelton rocks is the key marker for large-scale porphyry and intrusion-related gold-copper mineralization. Most of the region’s major deposits occur within 2 km of this contact, which Kyba and his team dubbed The Red Line.
The potential to discover another Valley of the Kings or another Deep Kerr along this Red Line is what has attracted so many explorers to the Golden Triangle – and it is undoubtedly what compelled Seabridge to acquire Snipgold.
The deal will see Snipgold shareholders get one-63rd of a SEA share for each SGG share held. That’s an implied price of $0.291 per SGG share, which represents a 115% premium based on both companies’ 30-day average share prices.
It’s a great deal for Snipgold, which has been largely inactive for several years with a share price languishing below ten cents. It’s interesting too for Colorado Resources, which now (1) will have Seabridge as its joint venture partner instead of Snipgold and (2) is earning into a property in between two Seabridge projects.
Also from the Golden Triangle this week, IDM Mining is not having trouble raising money. The company announced a $7.5-million raise on April 7th and then increased it to $10 million a week later. The total will be even higher, as I understand the overallotment also sold.
IDM just updated the resource estimate for Red Mountain, which now hosts 1.6 million measured and indicated tonnes grading 8.36 g/t gold plus 548,100 inferred tonnes averaging 6.1 g/t gold. The new estimate increased the resource confidence and expanded several zones.
Red Mountain is an interesting asset. It saw a whack of exploration in the early 1990s, including 466 drill holes and 2,000 metres of underground development. The deposit has five tabular zones that appear amenable to bulk underground mining methods. A 2014 PEA figured the mine could be built for $76 million and would generate a 32% after-tax IRR.
The current raise will give IDM enough capital to complete a feasibility study and the permitting process, which is already well underway. Rob McLeod is at the helm, a member of the McLeod mining dynasty that has its roots in the Golden Triangle.
IDM is certainly one of the reasons so many people are interested in the Golden Triangle today. The Seabridge-Snipgold deal is another. An area to watch, for sure.
Pure Gold Produces a PEA
A nod to a company that I think is doing things right. Pure Gold Mining (TSXV: PGM) assembled a large land package in Red Lake, one of Canada’s great gold regions. The property includes the Madsen mine, which produced more than 2.4 million ounces of gold from high-grade rock. It also includes a 1.2-million ounce deposit and a list of exploration targets, all arranged along the 12 km Madsen gold trend.
The company’s initial thought was: let’s find something new, big, and exciting. It was a good thought, in that the Madsen trend is pretty underexplored and lots of sniffs were never followed up. I visited the project in fall 2014 and I really liked the exploration potential, especially because Pure Gold’s technical team has, collectively, decades of experience finding and mining gold in Red Lake.
Pure Gold followed that plan through the 2015 exploration season. They got some nice results, including high-grade gold from interpreted structural targets – exactly the kind of result you want from a group looking for a new Red Lake deposit.
As the bear market dragged on, however, the Pure Gold team changed focus. The Madsen project has not only a defined resource; it also has a 500-tonne-per-day mill, a 1,275-metre deep shaft, 24 levels of underground workings, a headframe, and a permitted tailings management facility, all connected to roads and power.
Pure Gold realized its focus meant it was being categorized as an early-stage exploration story; the market was giving it no credit for all this infrastructure and opportunity. How to change that? Demonstrate value with a PEA that shows a short and low-cost pathway to profitable production.
That is what they have now done. The study looked at mining a portion of the resource using existing underground workings and processing it with the existing mill and tailings facility. The results are good.
Using a gold price of US$1,175 per oz., a Madsen mine producing 47,190 oz. gold annually for 6.5 years would generate a 62% after-tax IRR. It would cost just $20 million to get the mine into production. Head grades would average 8.3 g/t gold and all-in sustaining costs would come in at just under US$700 per oz.
The idea here is twofold. First, demonstrate to the market that Madsen is far more than an early-stage exploration play. That is now done – talking about the change of focus has been helping the share price for several months and now the PEA itself has created another boost.
The second purpose of the PEA is to prepare for potentially going into production. Pure Gold doesn’t want to be a small-scale gold producer, but it does want to make a big new discovery. The challenge is that Red Lake gold usually comes in small packages – the gold is high grade, but the zones are hard to find, so a lot of drilling is required. That demands money, which is why Pure is considering a small mining operation: to fund exploration.
A PEA is the first step, but don’t expect a feasibility study soon. Instead I expect Pure Gold to focus on drilling to expand the defined resource, which would put more of it into the mine plan and enhance the already strong economics.
The company has two rigs turning on site right now working on that goal. Later one drill will move to test the exploration targets that showed the most promise last year.
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On The Macro: A Tour Around Today
Gold continues to consolidate. I said weeks ago that the yellow metal would stay sideways through April, proving its early-year gains were justified and preparing for another move up. That move will require some kind of impetus and there are many options to provide the push: more stimulus announcements in Europe or Japan, weak Q1 earnings, increasing inflation expectations, rising general economic uncertainty, US dollar weakness, and interest rate roulette, to name a few.
We don’t know if all these things will transpire, let alone when. The US dollar is certainly declining:
That helps gold, from both the fundamental angle that gold is priced in greenbacks and the investment rationale that a declining greenback encourages savers to find another safe haven hideout for their savings.
Earning season will be interesting. In 2015 after-tax adjusted corporate profits slumped by US$243 billion, a 15% decline that brought profits to their lowest point since early 2011. Over the last eight quarters profits are down 6.6%, the steepest drop since the Financial Crisis. And the economy has only once in the last 68 years avoided a recession following an eight-quarter profit contraction.
Inflation is a topic of endless debate. Are we in an inflationary environment? Or is deflation a bigger concern? Both sides make good points and I do not, at this point, know which is correct.
The great thing, as I’ve mentioned before, is that gold performs in both environments and especially when economic uncertainty reigns supreme, as it does today.
US markets are stubbornly holding on to their bull run, with the S&P almost back at its November high. How this plays out in the near term, I am not sure. The big picture, however, does not look good. One economist I hold in high regard is Dr. Lacy Hunt of Hoisington Investment Management. He publishes a quarterly review and outlook (available here) from which I will pull a few quotes.
“The striking aspect of the U.S. economy’s 2015 performance was weaker economic growth coinciding with a massive advance in nonfinancial debt. Nominal GDP, the broadest and most reliable indicator of economic performance, rose $549 billion in 2015 while U.S. nonfinancial debt surged $1.912 trillion. Accordingly, nonfinancial debt rose 3.5 times faster than GDP last year. This means that we can expect continued subpar growth for the U.S. economy.”
“The Federal Reserve, the European Central Bank, the Bank of Japan and the People’s Bank of China have been unable to gain traction with their monetary policies. The common element impairing the actions of these four central banks is extreme over-indebtedness of their respective economies. Excluding off balance sheet liabilities, at year-end the ratio of total public and private debt relative to GDP stood at 350%, 370%, 457% and 615%, for China, the United States, the Eurocurrency zone, and Japan, respectively.”
“The debt ratios of all four countries exceed the level of debt that harms economic growth. As an indication of this over-indebtedness, composite nominal GDP growth for these four countries remains subdued. The slowdown occurred in spite of numerous unprecedented monetary policy actions – quantitative easing, negative or near zero overnight rates, forward guidance and other untested techniques. The only year in which nominal GDP was materially worse than 2015 was the recession year of 2009.”
Dr. Hunt is not optimistic about our near-term economic outlook. Again, the details of how it will play out I do not know – but I do know uncertainty, recessions, concerns about recessions, and more uncertainty are all good for gold.
Alongside debt and tepid GDP growth, the US labor market is concerning. Yes, payrolls continue to show good gains. But the devil may be in the details.
Take temporary-help employment. These workers are the first to be laid off when times tighten, which is why temporary-help employment peaked 11 months before the 2001 recession and 16 months before the 2007 crisis. Guess what? Temporary-help employment has fallen two of the past three months and is down 1.8% so far this year.
No matter what you think are the odds of a recession in the near to medium term, the fact is we are in uncharted waters. Very low or zero or negative interest rates had their intended effect, which was to force savers and investors into riskier assets like bonds and equities. That created a seven-year bull market in equities and bonds – but one not representative of the actual economy, which remained stagnant.
That is what already happened. Of interest now is what will happen next.
Bonds have long been the go-to hedge against equities. Bonds are supposed to rise in price when recessionary periods push equities down, because in response to recession central banks lower interest rates and that lifts bond prices.
How’s that supposed to work when interest rates are already rock bottom? Bonds will not hedge stocks if we enter a recession because central banks can’t do anything to support bonds.
That means investors will look elsewhere for a hedge. Gold will be a natural conclusion. As John Hathaway of Tocqueville Asset Management calculated, if investors were to increase their gold allocation from 0.55% (the current level) to 1.55%, that would represent 56,075 tonnes of demand. That’s more gold than is currently available in London. In fact, a 0.1% increase swamps the supply of physical gold.
That is the kind of logic that backs the idea that gold has a good run ahead.
Gold’s consolidation supports the view that gold’s run has truly begun. The way equities are acting adds weight.
Gold stocks outperform gold at the start of a bull cycle. Take a look back to the last cycle: gold bottomed in April 2001 but then ascended slowly, not making a new 52-week high until early 2002 and not establishing a higher high until almost the end of that year. Meanwhile, gold stocks as per the HUI more than doubled during 2002 while many juniors moved far more.
Gold stocks outperform the yellow metal the most at the start of the bull cycle. We are seeing that kind of outperformance now.
Then there’s silver, which has finally started to move.
It doesn’t look like much on the five-year chart, but silver seems to have carved out a bottom. It is up 21% this year, making it the best-performing metal.
And silver has more ground to regain. Gold may have lost 45% in the bear market, but silver lost more than 70%.
The fact that silver is moving now matters. Silver never moves lock step with gold.
When uncertainty prompts investors to seek out safe havens, they look to gold long before silver because gold is a far more straightforward safe haven. Silver, by contrast, is also an industrial metal, which means demand waxes and wanes with the economy.
However, after a time silver’s safe haven status starts to catch up. And once it starts to look like a safe haven, it acts increasingly so. That process usually starts when gold is consolidating its first big move and preparing to take out its next resistance.
In other words, we’re seeing gold consolidate, which gives confidence in the new price range, and gold is trailing gold equities, which is precisely the pattern we see to start new bull markets. Silver’s move only confirms the pattern.
