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"The case has never been better for having a
position in precious metals as a store of value," says Mike Niehuser, founder of Beacon Rock Research, LLC,
especially in light increasing amounts of government debt. In this exclusive interview
with The Gold Report, Mike talks about his goal of finding mining stocks with
good management and assets with defined pathways to value creation and two in
particular that he's keeping an eye on that "have excellent exploration
upside."
The
Gold Report: Mike, has your outlook for precious metals changed
given the recent strengthening of the U.S. dollar?
Mike Niehuser: From a U.S. perspective, we still
see gold between $900 and $1,200 an ounce, and continue to believe that we
could see gold at $1,500 by year end. Likewise for silver, $15 to $20 an
ounce appears to be a reasonable trading range, and with silver we would
expect to have greater volatility. The case has never been better for having
a position in precious metals as a store of value. With the bailout of Greece
or Portugal, the euro may be in trouble, and yet the U.S. is also becoming an
increasingly uncertain place to do business. So long as the U.S. is perceived
to be relatively more stable than most other parts of the world, and the federal
government can manage its problems, the U.S. dollar will periodically
strengthen and you may expect volatility with metal prices. The uncertainty
being generated should have the offsetting effect of increasing the
attraction for precious metals as a store of value, but over 2010 to the
longer term, increasing amounts of government debt relative to a constant
total supply of precious metals will allow metals to remain a store of value.
TGR: Is this a good
time to invest in mining equities?
MN: We have a bias
that over the long run, for mining stocks with good management and assets
with defined pathways to value creation. So long as metal prices are above
cost of production, we are in business, which seems to be the case today.
Look at it this way, would you want to hold assets in the form of I.O.U.s
from the government that has no will to stop the printing press, or would you
rather have an interest in an outfit that actually produces hard currency?
The difficulties faced by mining companies to profitably produce gold and
silver—read hard currency —is what makes them rare. In the
current environment, holding shares of mining companies is an option to
holding physical metals or in an ETF. The key to stock selection is locating
companies that are either on a path or have achieved profitable production.
Certainly, the deleveraging over the last couple of years has even taken down
companies that have met investor expectations, and we may not be out of the
woods yet. So yes, we don't see a bubble in precious metals or mining stocks,
and so stock selection is still important.
TGR: What silver
mining companies are you recommending to investors?
MN: There are two
that come to mind. Minefinders Corporation (TSX:MFL;NYSE.A:MFN) has achieved their first profitable quarter mining
gold and silver, or silver and gold, depending on metal prices from their
open-pit Dolores mine near Chihuahua, Mexico. We also like Alexco Resource Corp.
(TSX:AXR;NYSE.A:AXU), which has an early jump on constructing their
modest but high-grade silver and base metal underground mine in the Yukon
Territory. Both companies have excellent exploration upside with solid
balance sheets, good management, and relatively fewer shares outstanding
compared to other companies in their space. Interestingly, both companies are
not trading far from where they were without significant improvements and at
much lower metal prices.
TGR: Mexico has
been getting a lot of bad press—do you have concerns?
MN: Look, sure,
but I have concerns about the U.S. as well. We just got back from visiting
Dolores and actually it seemed calmer than our last visit. Interestingly, it
appeared that given room availability at the hotel and number of small
airplanes in the hanger at the airport, they may be experiencing their own
economic downturn. This may be both good and bad; we would expect that the
government would appreciate a stable long-term operator like Minefinders. They have successfully relocated the village
and the blockaders from years ago were nowhere in sight. You may attribute
this to management working with the federal government and the locals.
TGR: So why would Minefinders, for example, be trading at lower than
expected levels?
MN: Once again, Minefinders' stock is now trading at a price that is
close to that when they had just finished the road to the project prior to
construction. So that is a good question. They are now in production and it
would appear to have worked out the bugs from startup and have recently
completed their first earnings-positive quarter. This is a somewhat amazing
statement to say that a mining company is now profitable.
TGR: If Minefinders keeps mining ore should the value drop from
here?
MN: Only if there
was no upside for exploration or increasing recoveries or if metal prices
declined as they are unhedged. This should be a
pretty good year from Minefinders for a number of
reasons. Management reports that they have solved their screen issue of last
year and that they should be processing at the 18,000 tons per day rate. In
addition, having moved the village, they are now in position to pursue higher
grades of both gold and silver. Silver grades should double through the end
of the year and gold grades should step up in the second half as they move
into higher grade areas of the pit. It will be important for investors to
watch recoveries. Gold is fairly easy to recover in the leach process but
silver can take longer. On the whole, they have reported that leaching has
met their expectations, but they learn as they go, and this is a good reason
for their contemplating a mill to boost recoveries of higher-grade silver.
TGR: Could the cost
of a mill be a concern to investors?
MN: It may be a
concern for some. Minefinders is in the process of
reviewing different scenarios of different types and sizes for a mill
operation. They question is not an easy one as the terrain is a factor and
power is always an issue. The nutshell for a mill is to boost recoveries of
higher-grade silver that otherwise may be left on the leach pad. Even more
important and not in the current resource model is the potential to process
even higher grades from underground and outside the current resource model.
This expansion of the resource underground or expanding the pit to the south
plus the potential for increasing recoveries does not appear to be in the
stock price. The company is also profitable and has available credit and
fewer shares outstanding, so they have options to make the best of the
opportunity.
TGR: What is the
life of the Dolores Mine?
MN: As
contemplated in the Feasibility Study, the life of mine is 15 years. This
will change with the mill; it could actually shorten by increasing processing
or be extended with additional resources added to the project. Investors
should also know that Minefinders should be making
decisions on its La Bolsa heap leach project on the
Arizona-Mexico border near Nogales. This was Minefinders'
initial project that was put on the back burner after Dolores was discovered.
We have seen La Bolsa as well and it is a
relatively simple project. La Bolsa could produce
40,000 to 50,000 ounces of gold over four to five years with relatively
little cost. Potentially more important than La Bolsa,
Minefinders reported on its new La Virginia target,
which is a Dolores look-alike but with potentially higher grades of gold and
silver. This should address some of your questions about Minefinders
potential for value creation beyond the start up of Dolores.
TGR: Have you seen Alexco's project recently?
MN: We were up
there last summer for the analyst tour of the Bellekeno
underground work. It is still a little cold in the Yukon, but they are
reported to be experiencing an unusually early spring. This should have
allowed them to get a jump on construction having buttoned everything up for
the winter and put them in good position to move into production in 2010.
Unlike Dolores, Bellekeno is part of the Keno Hill
Silver District, which has completed infrastructure from past production. In
addition, Alexco is mining some of the highest
grades of silver in the world, which allows them to build a relatively
modest-size and low-cost processing operation.
TGR: So Minefinders and Alexco are
apples and oranges?
MN: As far as
being different types of silver projects and locales, you are correct. In
addition to high grades of silver with base metals, the Yukon Territory is
becoming more interesting to investors based on recent discoveries in the
area plus the area's long mining history and friendly political jurisdiction.
Alexco is also a bit different from a management
perspective as Minefinders are exploration
geologists while Alexco has the unique background as
an environmental services firm, which is how it came into ownership of the
Keno Hill Silver District.
TGR: Why was it
important that Alexco had environmental expertise?
MN: Alexco acquired the Keno Hill Silver District from the
government with the agreement to clean up environmental damage left over by
previous operators. So Alexco will be paid by the
government in the Yukon to clean up the district while having the opportunity
to mine resources to current standards. The Keno Hill Silver District has past
production of over 200 million ounces of silver averaging about 40 ounces of
silver per ton, yet the district has never been comprehensively explored with
modern mining methods. We would expect that the market is only giving value
for Bellekeno, while there is potentially much more
beyond the initially identified resource for about a five-year mine life.
TGR: How can you be
sure that there are additional resources left to discover?
MN: Well, point
well taken. In Alexco's case, investors may
consider the manner in which it financed the development and construction at Bellekeno. Alexco commenced
construction prior to completion of a bankable feasibility study by selling
25% of the silver production at about $3.90 an ounce to Silver Wheaton Corp.
(NYSE:SLW;TSX:SLW). The deal allows Alexco
to remain full ownership of the remaining 75% of the silver production, plus
lead, zinc, and any gold found on the property.
The
funding by Silver Wheaton allowed Alexco to forgo
completing the expensive and time-consuming feasibility study, which allowed
them to accelerate the time to construction with metal prices at record
levels. Funding by Silver Wheaton also allowed Alexco
to advance to construction without issuing shares and diluting existing
shareholders or securing debt financing, which may have required restrictive
bank covenants and hedging. The very interesting part of the Silver Wheaton
deal is that it would not have been justified on the existing resource at Bellekeno, so it begs the question exactly what is the
upside at Keno Hill.
TGR: Well, what is
Silver Wheaton expecting?
MN: It is hard to
say; this may be the first silver stream purchase by Silver Wheaton on a more
or less pre-feasibility level project. As I said, though the diverse
ownership interests had been consolidated over the years by the United Keno
Hill Mines, the prior owner never completed a comprehensive analysis of the
district and never established a resource ahead of a couple years of mine
life. The ore was never mined below a couple
hundred meters was well. Although the operation was large and had scale over
the oldtimers', United Keno Hill only pursued high
grade veins until they were offset by faults and then mining ceased. Not
until recently did Alexco consolidate and complete
a study of the volumes of historic data.
TGR: So why is the
historic data important?
MN: Alexco digitized and assimilated rooms of data that allowed
them to identify targets to potentially locate extensions of high grade veins
that were lost or dead ended due to faulting. Alexco
successfully used this data to potentially locate extensions of the high-
grade Lucky Queen and Silver King past-operating mines. These vein
continuations may now be visible to Alexco while
the previous operator was in the dark.
TGR: What do you
mean by high grades?
MN: The Lucky
queen produced 11 million ounces at 88 ounces per ton and the Silver King
produced 11 million ounces at 53 ounces per ton. But even more interesting
than just locating extensions of lost veins on high grade veins, Alexco was successful at stepping out well beyond
historic mines and producing significant drill results elsewhere. The
Birmingham, for example, is several kilometers away any known mines. Alexco hopes to locate another Hector Calumet at Keno
Hill, which produced over 96 million ounces. As Keno Hill has produced over
200 million ounces of silver and has never been explored beyond following
surface expressions of mineralization, as the district is about 10 by 20
miles, there is significant upside, which is what Silver Wheaton is banking
on.
TGR: So do you
expect Alexco to be profitable in 2010?
MN: It could be
close. We would expect Bellekeno to be highly
profitable for a mine of its size and expect additional ore to be located to
either extend the operating life of the mine or to the acceleration of an
expansion or an additional mill on the project. It is still too early to
tell, but in addition, Alexco has an environmental
business in that is active in North and South America.
TGR: What is this
all about?
MN: It was Alexco's environmental expertise in mine remediation and
closure that allowed it to be successful in acquiring the Keno Hill Silver
District from among a number of bidders. Alexco is
the government's sole contractor for the cleanup of historic mining activity,
all the while being held harmless for prior mining activities while free to
extract precious and base metal resources. The combination of the contract
for cleanup plus the operation at Bellekeno should
place Alexco in both an envious operating position
and cash-flow generation. We have visited two other environmental sites
cleaned up by Alexco, one in South Carolina and one
in Colorado, and we are expecting that this year may be the year their
environmental business takes off.
TGR: Mike, we
appreciate your time.
Mike Niehuser is the founder of Beacon Rock
Research, LLC , which produces research for an institutional
audience and focuses on precious, base and industrial metals, and
substitutes, oil and gas, alternative energy, as well as communications and
human resources. Mike is also on the faculty of the Pacific Coast Banking
School and was nominated to BrainstormNW magazine's
list of the region's top financial professionals in 2007.
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