Michael Curran goes down-market shopping for winners

Most of the low-cost gold producers are fairly valued, says Michael Curran, managing director and mining analyst with Beacon Securities, so he's heading down-market to the advanced development opportunities and early-stage explorers that he thinks could become low-cost producers. Sure there is risk, as Curran explains in this interview with The Gold Report, but the reward could come via either a takeover bid by an established producer seeking to lower its overall costs or by supporting these companies as they transition into emerging producers.

The Gold Report: Please give us two or three key investment themes that you envisage happening in the mining equities space in 2016.

Michael Curran: A couple of themes we'll see in 2016 are arguably continuations of the themes we've seen in 2015. The first would be turnaround stories. With a lot of producers there's a tangible emphasis on lowering operating costs and improving their balance sheets. Some made strides toward that in 2015, but most still have work to do.

Another theme that we've seen snippets of in 2015 but will continue into 2016 is merger and acquisition (M&A) activity. Some of the bigger producers are probably in acquiring mode. Those producers either need to bolster their asset base or lower costs by acquiring higher-quality assets.

At the other end of the spectrum, there were at least two instances in Q2/15 where four or five companies joined together. We're likely going to see more small companies that can't raise money throw in together to create one stronger exploration and development company.

TGR: When those smaller companies join together, one result is an abundance of projects. How do you choose which asset to develop?

MC: The company has to focus on projects that make sense in this commodity price and financing environment. Five years ago, everybody was looking for the 5 or 10 million ounce (10 Moz) deposit. Osisko Mining and Detour Gold Corp. (DGC:TSX) raised the $1.5 billion ($1.5B) and $2B necessary to turn their respective gold deposits into mines, but that window is probably closed. When I see juniors still looking for really low-grade gold deposits, they better have some other levers they can pull-either low capital costs or strong infrastructure-because I don't see small-cap companies raising $500+ million ($500+M) to build mines. Some might be able to raise $200M or $300M but the days of raising $1B are gone-at least for now.

TGR: Do you see private equity becoming a bigger theme in this space in 2016?

MC: It probably has to because for two or three years we've been hearing about these great pools of private equity money on the sidelines looking for mining assets. We haven't seen a lot of that capital get deployed. I expect to see more transactions where producers are vending assets into private equity. In the last three or four months we've seen private equity make investments into publicly traded mining companies, so we'll probably see more of that, too.

TGR: Will gold producers be looking at a relatively static gold price environment in 2016?

MC: Static and gold don't tend to go together. During the last couple of years we've seen over $200/ounce ($200/oz) moves between the spot price high and low each year. That's down from previous years when there were $400 or $500/oz spreads between the high and low. We're expecting to see similar moves in the gold price in 2016. If gold can finish 2015 close to $1,100/oz, we could see $1,300/oz gold or higher sometime during the next year.

TGR: Please outline Beacon Securities' investment strategy in the gold equities space as we move into 2016?

MC: Our core investment strategy is to stick with quality assets and management. Quality assets doesn't restrict us from a certain group of companies. There are producers with quality assets. There are advanced development companies with strong assets and good management. There are even early-stage companies with good assets. We still can draw companies from throughout the mining cycle, while sticking with our quality focus.

TGR: You've said publicly that you look for companies with potential low-cost assets. Why not simply seek producers that already have low-cost assets?

MC: Among the producers there are definitely companies that have one or two low-cost mines, but most producers could not be considered low-cost producers. There are some low-cost producers like Alacer Gold Corp. (ASR:TSX; AQG:ASX), Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) and Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), but when we look at those stocks, they tend to be fairly valued.

That's when we turn to risk versus reward, and that drives us down-market into some of these advanced development opportunities or even early-stage explorers where we like the asset and think the company could become a low-cost producer. There is certainly a little more risk because these companies are not in production, but for the reward, you can win a couple of ways: these assets could be targeted by established producers as part of an effort to lower their costs, or these companies will likely have greater success securing financing to build their mines and become emerging precious metals producers. Either way, we believe those rewards are going to outstrip the risks.

TGR: Some larger gold producers have sold off higher-cost mines. Are those producers seeking to replace those ounces?

MC: Five years ago, it was all about growth and increasing production. Most producers no longer talk about growth for growth's sake. They talk about profitable growth and they've definitely culled some of their higher-cost mines. Moreover, a lot of them have curtailed exploration spending, and to gain new investor interest they need a pipeline of new mining projects to replace the mines and projects that aren't economic at these gold prices.

I think we're going to see a lot of these producers acquire other lower-cost assets. Most producers are saying that they're looking for cash flow and accretive return on investment. All of these things probably push producers to look at low-cost opportunities. As for the types of assets, they're always going to prefer lower political risk countries that are mining friendly and that have good infrastructure.

TGR: What are some junior developers with high-grade resources?

MC: There are probably half a dozen or so advanced development companies with high-grade resources that aren't yet in production but are getting close like Roxgold Inc. (ROG:TSX.V), Rubicon Minerals Corp. (RBY:NYSE.MKT; RMX:TSX), Continental Gold Inc. (CNL:TSX; CGOOF:OTCQX), Dalradian Resources Inc. (DNA:TSX), Integra Gold Corp. (ICG:TSX.V; ICGQF:OTCQX) and Klondex Mines Ltd. (KDX:TSX; KLDX:NYSE.MKT).

TGR: What separates those companies from each other?

MC: General things. Those companies all have projects in different countries so you have different levels of mining friendliness and permitability. Most of these companies have different capital requirements, but all of them are looking to have fairly low-cost production because these are high-grade gold deposits.

The biggest issue for this group is the market's degree of confidence in the quality of the assets and/or the management. Some of these companies have stumbled. Rubicon has had to shut down its Phoenix mine in Red Lake, Ontario, for about six months because it is not getting the grades that it thought it would. It will take some time to reassess the geology there. Continental Gold also had a hiccup on the permitting side. It was hoping to get its permits sorted out locally but had to shift things to the federal level, so that's going to take longer.

TGR: Let's talk about those companies in alphabetical order. Does Continental have the political clout to get Buritic?? permitted in Colombia?

MC: Buritic?? has been designated a "Project of National Interest," so that should help speed up permitting. I'm optimistic that Continental can move it through.

TGR: Dalradian is conducting infill drilling to confirm previous drill results for a feasibility study at the Curraghinalt deposit in Northern Ireland. Is there more gold there outside the resource that could extend the proposed mine life?

MC: In the medium to long term, we definitely expect Dalradian to find more ounces beyond the 3.5 Moz resource it has already outlined. Our view is that it only has 1 Moz of the 3.5 Moz in the Indicated category, so infill drilling is more important than expanding the resource. The company is going underground to drill this off. The idea is to get most of those 3.5 Moz moved to the Measured and Indicated category because those are the ounces you can use in a feasibility study. It doesn't need to have a bigger resource at this stage.

TGR: Dalradian Chairman and CEO Patrick Anderson likes to tell analysts that the company is going to mine Curraghinalt and that it doesn't have plans to sell. What do you believe?

MC: We think it's economic. We also think the capital costs are reasonable enough for Dalradian to raise the money itself and build a mine. There are lots of people with Irish names with Dalradian that would love to finish their careers with a new mine in Northern Ireland. It's very doable, but if Dalradian can prove up Curraghinalt and show solid economics, it is one of those gold deposits that would be attractive to established mid-tier producers.

TGR: Integra plans to drill 100,000 meters (100,000m) over this year and next at its Lamaque South project in Quebec's Val-d'Or camp. Is that the correct strategy to build shareholder value?

MC: The difference between Dalradian and Integra is that Integra only has a 1 Moz resource. The company is doing the right thing by expanding the resource with a large drill program. One Moz of high grade is probably already economic, but because it has a mill next door that is bigger than it needs to be, Integra now has the capacity to build a bigger mine. It could have a 100,000 ounce a year (100 Koz/year) mine with the current 1 Moz resource. But it's definitely worth the effort to find out if there is 2 or 3 Moz there, and maybe it can have a 200-250 Koz/year mine because the mill could probably sustain that kind of production. Integra is definitely in a position to create value by expanding the resource.

TGR: Does the company have to over-derisk these assets given their history?

MC: Integra has a very different strategy than the last couple of owners. The owners of this property or the neighboring property tried to make money by creating a big open pit. From day one, Integra said, "Let's go back to the companies that made money in Val-d'Or historically, which were Placer Dome Inc. and Teck Resources Ltd. (TCK:TSX; TCK:NYSE), and they made money running underground, high-grade mines." Integra already has a low-risk starting point. A lot of the underground information exists from historical mining. Integra already knows the metallurgy. Plus there is the mill that actually processed this ore. Lamaque South is starting from a much more derisked point than any other deposit out there.

TGR: Klondex recently received approval to list on the NYSE Market exchange. Will that bring it greater visibility to U.S. investors?

MC: Klondex already has pretty good visibility because U.S. investors love investing in assets that are in their country, and Klondex's assets are all in Nevada. But having a U.S. listing will certainly not hurt the company. But most U.S. shareholders are comfortable owning stocks that list in Canada.

TGR: Is Klondex a takeover target?

MC: I haven't really viewed that company as a big takeover candidate because it's on the small side, even if its operating costs continue to be rather low. If it can keep those operating costs low, Klondex will remain an attractive target for established producers because they can roll in that production at a much lower cost to bring their overall costs down.

TGR: The biggest risk with Roxgold is probably jurisdiction. Do you see it that way?

MC: I don't cover Roxgold but we have seen a number of mines get built in the last five years in Burkina Faso in West Africa, but this will be the first underground mine. So the company has had to train local laborers as underground miners. The scrutiny will come with how the Yaramoko operations fare with a newly trained staff compared to all the other gold mines in Burkina Faso, which are open pits where they drill, blast and truck the ore to the mill. That's certainly the challenge Roxgold faces.

TGR: What are some other companies with assets that could be coveted by larger players?

MC: We would have had Sunridge Gold Corp. (SGC:TSX.V; SGCNF:OTCQX) at the top of that list but a Chinese company recently made an offer to buy Sunridge's main asset in Eritrea for just over US$65M. Sunridge has already indicated that it plans to distribute whatever remaining cash it gets after the sale and delist the company.

Columbus Gold Corp. (CGT:TSX.V; CBGDF:OTCQX) would be another one. It has the 5 Moz Paul Isnard gold project in French Guiana. It is low-grade but Columbus Gold has a strong joint-venture partner in Nordgold N.V. (NORD:LSE) that's earning just over 50% interest by completing a feasibility study before March 2017. History says most mid-tier or senior producers prefer to own much more than 50% of a project, so we think there's a reasonable chance that Nordgold would be interested in acquiring more than 50% of Paul Isnard.

Falco Resources Ltd. (FPC:TSX.V) is another company with assets that could be coveted by larger players. Its 2.2 Moz Horne 5 gold project is in Rouyn Noranda, Qu?(C)bec, a strong mining jurisdiction. It had some solid drill results toward the end of the 2015 program-100m intercepts of 2-2.5 grams per ton (2-2.25 g/t) gold, and you add in silver, zinc and copper, it is around 3 g/t. It sounds low grade for an underground mine, but not that far away Agnico Eagle operates the cash-flow positive Goldex underground mine at basically 2 g/t. We'll probably soon see a resource update and then a preliminary economic study in H1/16. If it's 3+ Moz gold and the company can get the economies of scale of bulk underground mining, that's something a bigger company might be interested in.

TGR: What are some producers that you cover that are positioned to grow production in 2016?

MC: Our favorite precious metal producer these days is Tahoe Resources Inc. (TAHO:NYSE; THO:TSX). It has a low-cost silver mine in Guatemala and a low-cost gold mine in Peru. That's a strong start. Then it is completing construction of Shahuindo, another gold mine in Peru. That should definitely deliver some production growth for 2016.

TGR: What sort of production do you envisage at Shahuindo in 2016 and at what cost?

MC: 2016 will be a partial year with our forecast of 70,000 oz gold, but the new open-pit mine should achieve a run rate of 100,000 oz/year by the end of next year. Shahuindo should also be a low-cost mine, with total cash costs