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Fascinated to see gold soar in a period of low
inflation, Beacon Rock Research Founder Mike Niehuser
won't be surprised if it crosses the threshold into 2011 at above the $1,500
price point. Whether it levels off or reaches new heights, Mike explains
where to seek investment opportunities in this exclusive interview with The Gold Report. According to him, companies with
improving near-term production, pipeline projects to expand reserves and
promising exploration prospects present better-than-average potential for
returns. Because the market is pricing some pessimism into equities these
days, he also sees good opportunities in companies with strong potential to
increase fundamental value.
The
Gold Report: Considering the turns we've seen in the relationship
between gold and the U.S. dollar, what is your view on gold prices these
days?
Mike Niehuser: We are really quite happy with
where the prices are now. Our beginning of the year guess for gold in 2010
was a range of $900 to $1,200 per ounce. We saw a greater potential for gold
exceeding that range and going to $1,500 than for retreating to below $800.
While gold prices have been closer to the high end of our range, this has
pretty much been the experience so far this year.
Over the
last eight years, precious metal prices moved up beginning in the early fall
through spring, due to increased seasonal demand in Asia, then flattened over
the summer months. This pattern broke in 2009 as investor demand offset
reduced demand by jewelry fabricators. For 2010, gold prices have remained
surprisingly strong given the increasing perceptions of a double dip in the
economy, low inflation and low interest rates.
It is
fascinating to see gold at record highs during a period of record low
inflation. It makes one think something else must be supporting current
prices. In any event, with renewed seasonal demand coming in August and
September and the potential for government monetizing debt or other stealth
stimulus programs, $1,500 gold prices at year-end are not out of the
question.
TGR: Do higher gold
prices translate into opportunities for gold stocks?
MN: Obviously,
higher metal prices should bode well for gold stocks, but this is not
necessarily so across the board. For a company's stock to do well we would
assume that there must be some combination of improving company-specific
fundamentals or interest in the mining sector. On the continuum of investor
tradeoff between risk aversion and return requirement, institutionalized
concerns over a double dip in the economy has led fear to win out over greed.
Mining
and gold exploration stocks are considered to be on the riskier end of the
spectrum for all equities. Over the last couple years, even companies with
good projects and a track record for meeting guidance are not getting the
respect they deserve. There are probably a number of concerns weighing on the
minds of investors that will persist through the end of 2010.
TGR: Are you
implying that this may be a good time to reduce holdings of mining and metals
companies?
MN: Not at all. It
is really more a factor of time horizon and expectations for return. We
continue to believe that companies with improving fundamentals will
outperform companies that do not create value. A lot of pessimism may be
priced into the market now, which creates an opportunity for careful stock
selection opportunities for investors looking for companies with the
potential to increase fundamental value. We are living in historic times, and
growing expectation of a double dip in the economy is all too reminiscent of
the stagnation in the economy during the 1970s.
TGR: What parallels
or factors do you see influencing the economy?
MN: It is starting
to look a lot like the Nixon and Ford years. As if the '60s were not
unsettling enough, the Nixon administration brought forward new regulations
including the EPA and OSHA, deep-sixed Bretton
Woods for a floating exchange rate, enacted wage and price controls, and
introduced the earned income tax credit, which was a redistributionist
negative income tax.
The
current administration has accelerated deficit spending and intervention into
private markets. Clearly, deficits can either be reduced by increasing tax
revenues or financed with more debt. Fortunately, we are in global markets
and for the time being, the Chinese are maintaining an artificially low
exchange rate while the U.S. dollar has been strong against the euro. As the
exchange rate moves into balance, interest rates in the U.S. should increase
and the government may be forced to monetize the debt.
This is
why we like gold producers; while the government produces and monetizes debt,
diluting intangible assets, gold miners are
producing the ingredients of real currency. From a stock point of view, many
companies with operating mines are still trading below levels seen just years
ago before the mines were built or in operation. These appear to be among the
best opportunities to preserve principal with some upside potential.
TGR: Given the
uncertain outlook for the economy and investing, what do you look for in gold
stocks?
MN: It would
appear that the market may become less efficient, not more. Small investors
have a bad taste in their mouth and computerized trading by institutions
suggests stocks are being influenced by factors that aren't company-specific.
It is not clear what the market will identify in an individual company stock
that will lead to a full valuation. If metal prices appreciate rapidly, the
market may look for exploration upside. If metal prices are flat and
investors more defensive in looking for value, they may want production and
cash flow, or improving balance sheet fundamentals. It makes sense to me that
good stock selection would look for one or the other, and if possible both.
This may include companies that have improving production profiles in the
near term, project pipeline to expand production or reserves in the near
term, and competitively promising exploration prospects on the horizon. As
the market may not currently recognize more than one of these
characteristics, when it does it would be logical that those stocks have a
better-than-average opportunity for performance.
TGR: Could you tell
us about some companies that fit the investment profile for a range of
opportunities?
MN: The first is Brigus Gold Corp. (TSX:BRD;
NYSE.A:BRD). This is the recent business combination of Apollo Gold and Linear
Gold. Apollo brought in the gold-producing Black Fox mine and mill near
Timmins, Ontario and Linear brought in cash, which immediately improved
Apollo's capital structure. This appeared to be a good fit as it was a merger
of equals, and strength was matched with weakness, immediately resulting in a
less risky and more financially flexible company. The stock price has not
reflected this perspective, but by optimizing production they should continue
to reduce project debt and the gold hedge that will both increase
profitability and reduce risk in the near term.
Brigus in the
mid-term has good exploration upside at the Black Fox mine. Deep drill
results below the identified resource with even better grades may expand the
current mine resource. It is not unknown for underground mines along the
fault structure in the Timmins area to go several hundred meters deeper.
Apollo had also acquired the Grey Fox and Pike River along another fault that
has reported very good drill results near surface. As the Black Fox mill is
being optimized, there is very good potential with additional exploration
success to demonstrate that potential resources in these new areas are
reserves increasing the mine life.
Brigus also brought
in its Goldfields Projects. I have not visited these, but they are a reserve
level of classification, which means they are advanced assets and should be
economic. Both exploration at Black Fox and advancement of Goldfields are
reasonable mid-term opportunities. Both Apollo and Linear brought reasonably
prospective long-term exploration projects into Brigus,
particularly Apollo with its Huizopa target near Minefinders Corporation's (TSX:MFL; NYSE:MFN) Dolores mine in Chihuahua, Mexico.
TGR: Does Minefinders fit your investment thesis?
MN: It does. It is
interesting that Minefinders is now profitable and
selling at or below where it did earlier, even before there was a road built
to the Dolores mine site. Minefinders also has good
potential to outperform market expectations this year. Mining in the open pit
is moving into the heart of the deposit, encountering higher grades of both
gold and silver. Company guidance for the year anticipates higher grades of
gold in the second half and silver grades stepping up each quarter. They also
appear to be focused on improving the recovery rates of silver, which also
should lift production. As Minefinders is unhedged, it should benefit from higher metal prices, and
with increasing production, costs per ounce of production should decrease. A
combination of these events should provide good opportunity for increasing
profitability in 2010.
Minefinders is also
studying the addition of a 3,000 ton-per-day flotation mill. This would allow
Minefinders to access ore underground below the pit
or in the pit wall in parallel high-grade structures. As with Brigus, the ability to process additional ore potentially
would allow additional resources to come into reserves, increasing Dolores
mine's economics and mine life. This would also lead to higher and more
consistent recoveries of both gold and silver and even higher levels of
profitability.
Minefinders also recently
reported a prefeasibility study on its La Bolsa
gold project on the south side of the U.S.-Mexican border. La Bolsa is anticipated to be a
profitable, low-cost heap leach gold operation. The project has a low
strip ratio with low risk profile and, like the opportunity of a mill at
Dolores, provides a solid mid-term component to the investment profile. The
management team at Minefinders
are explorationists at heart, and it would
appear that with their discovery at La Virginia they may have located a
Dolores "look alike." La Virginia, with Minefinders'
other exploration prospects, provides good long-term upside.
TGR: Any other good
fits?
MN: Alexco Resource Corp. (TSX:AXR; NYSE.A:AXU) is not in production yet, but considering the
modest size of operations, it has very good potential to be at a full run
rate by the end of 2010. Alexco is on schedule for
constructing its 408 ton-per-day flotation mill at its Bellekeno
mine at its wholly owned Keno Hill Silver District. Alexco
has applied for its water license, its critical last step before commencing
production. Upon receiving this important permit, the mill will begin
production and thus eliminate much of the remaining risk.
In
addition to the relatively lower risk of a small operation, Bellekeno will be among the most profitable high-grade
silver mines in the world. Historically, the Keno Hill Silver District
produced over 200 million ounces of silver at about 60 ounces per ton. The
ore contains lead and zinc and should be desirable for smelters. Alexco's exploration team has consolidated and studied
historic data on the district and has had good success with blind targets.
The company also has embarked on an aggressive 30,000-meter-drill program in
2010 that may reveal additional blue-sky upside in the near term.
It is
interesting that Silver Wheaton Corp. (NYSE:SLW;
TSX:SLW) contributed C$50 million for the development of the Bellekeno mine in exchange for purchasing only 25% of the
district's silver stream at $3.90 per ounce. As the identified resource does
not provide a significant return on investment for the investment, it must be
apparent to them that the Keno Hill Silver District has enough exploration
upside to complete the transaction. The current drill program is devised to
focus on 5,000 meters of underground drilling at Bellekeno
to expand the deposit and mine life, as well 25,000 meters to locate the next
mine at Keno Hill. As Alexco is also being paid for
environmental cleanup of earlier mining operations, they have other upside
over the long term.
TGR: Great. That's
a lot of good information about Brigus, Minefinders and Alexco. Thank
you.
MN: All three of
these companies appear to be well managed with competent individuals for
exploration through production. In addition, all three trade on both the TSX
and the NYSE Amex, so they should have exposure on both sides of the border.
Metals
and mining Analyst Mike Niehuser is the founder of Beacon Rock Research, LLC, which produces research for an institutional
audience and focuses in part on precious, base and industrial metals, oil and
gas and alternative energy. Named after what Mike describes as the largest
monolith in the western hemisphere, Beacon Rock Research is an independent
investment research firm committed to help investors "attain an
uncommonly better understanding of opportunities and risks, enhancing the
possibility of timely and informed investment decisions." Its work is
designed to withstand the "torrential flows of contrary and fickle
opinions and beliefs" and go beyond the "cramped conventional
wisdom (that) often spoils natural curiosity and optimism, the attributes
fundamental to learning, understanding and making the intuitive connections
that help us perceive what might be around the next bend." Previously a
vice president and senior equity analyst with the Robins Group, a registered
broker dealer, Mike also served as an equity analyst with The RedChip Review, where
he initially followed bank stocks but expanded to a diverse industry range. A
graduate of Pacific Coast Banking School—where he now serves on the
faculty—Mike spent 18 years with U.S. Bank, with expertise in all areas
of real estate lending and valuation. A life-long learner, he earned his B.S.
in Finance at the University of Oregon. He has written hundreds of research
reports and related articles on investing in small cap companies.
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