Peak Gold Is Here to Stay

The Gold Report: Earlier this month, the broader equities markets suffered huge losses as gold made significant gains. Then, after the broader markets recovered, gold fell. Is there now an inverse relationship between the health of the broader markets and the price of gold?

Oliver Gross: This kind of inverse relationship between gold and the broader equity markets isn’t really new. It has been observed since fall 2011, when the price of gold peaked. Since then, gold has fallen more than 35%, while the S&P 500 has risen 70%.

“Columbus Gold Corp. is indeed a very attractive takeover target.“

The current situation resembles the early 2000s, when the broader equity markets were in the final phase of the dot-com bubble, while gold traded as low as $340 per ounce ($340/oz). Then, of course, the broader equities markets collapsed, while gold rose above $1,900/oz.

TGR: Some analysts believe that the broader equities market is dangerously overvalued. To give one example, Netflix was recently trading at 144 times earnings. What do you think?

OG: After a 5+-year bull run leading to new all-time highs in the broader equity markets, there are many signs of bubble formations in the Internet, high-tech and biotechnology sectors. Again, this feels like the early 2000s. The extremely high price-to-earnings ratios in stocks such as Netflix indicate investor euphoria and huge amounts of speculative capital provided by the central banks.

“Excelsior Mining Corp. offers fantastic leverage on the copper price.“

It is shocking to compare valuations in the broader sectors of the equity markets to valuations in the precious metals space. Alibaba (BABA:NYSE) has a market valuation of more than $220 billion ($220B). This company, with sales of less than $10B, is now worth far more than the 10 largest gold and silver producers put together. We see similar speculative booms with Facebook, Amazon, Tesla and Apple.

TGR: How should investors react to this bubble?

OG: Speaking for myself, as one who follows an anticyclical strategy, I like to invest when there is blood in the streets, and that is certainly what is happening with precious metal equities. Today, investors can buy gold and silver stocks at decade-low valuations and historically low bullion-to-equity valuations.

“Fission Uranium Corp. is the most attractive discovery story in the global uranium space.“

Nobody cares about precious metals equities today, but when the bubble in the broader markets bursts, we will see a massive shift in market sentiment and in the behavior of investors. That said, investors must stick to best-in-class stories and must demonstrate constancy and patience.

TGR: Could the collapse of the bubble lead to a crisis similar to that which occurred in 2007–2008?

OG: Yes, the possibility of another Lehman Brothers event is there. When the largest and most influential players in the financial industry want to exit this market, we could see a 2008-like selloff very, very fast. I also think that it is only a matter of time before a further big player in our financial industry will go the same way as Lehman.

TGR: Geopolitical turmoil today is greater now than it has been for quite some time: Gaza, ISIS, Ukraine and now Ebola. Traditionally, this would have resulted in a significantly higher gold price, which has not happened. Is what we have seen this year an anomaly, or is the price of gold no longer affected by external events?

OG: That is a question not easily answered. Traditionally, gold has been regarded as the ultimate crisis protection, so geopolitical turmoil usually resulted in a higher gold price. What has changed is the incredible power of the central banks. They have changed the rules of the game. This is a major financial experiment with no historical precedent. The combination of unlimited liquidity, historically low interest rates and historically high debt levels has, for the moment, mitigated geopolitical risk factors and guaranteed faith in the U.S. dollar as the world’s reserve currency.

“Pilot Gold Inc.’s managers and geologists are some of the best in the industry.“

Gold has fought incredible odds since fall 2011. It is the most hated asset class, the official enemy of the U.S. dollar reserve and our global monetary system. And so the biggest financial institutions have no interest in higher gold prices. They still control the gold futures and the paper-gold market, so it is easy for them to attack the gold price. But this can’t continue forever, and it’s just a matter of time before all the money created since 2008 will no longer simply inflate asset bubbles. Inflation will return, and gold will again respond positively to external crises.

TGR: Where do you see gold and silver prices going in the short term?

OG: I see a 50% chance of a final panic selloff across the gold and silver space. In this scenario, gold could fall to $1,000/oz, and silver could fall as low as $12/oz.

TGR: Wouldn’t such prices lead to widespread curtailment of bullion production?

OG: The current all-in costs of gold producers are now above $1,150/oz, even after massive cost reductions and a focus on higher-grade mining. Such expedients can have only a temporary effect. At a gold price of $1,000/oz, there will be many shutdowns.

We need a gold price of at least $1,400/oz to support sustainable production, and that number will rise, as early as 2015 or 2016. We have reached Peak Gold, and it’s here to stay. The highest-grade and most-profitable deposits are gone. The bear market in the gold mining space has been so long and painful that the major producers have their backs to the wall. Barrick Gold Corp. (ABX:TSX; ABX:NYSE), Newmont Mining Corp. (NEM:NYSE), Goldcorp Inc. (G:TSX; GG:NYSE), AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) and Kinross Gold Corp. (K:TSX; KGC:NYSE) have dramatically cut exploration and development budgets.

“Red Eagle Mining Corp.’s San Ramon deposit has amazing economics.“

Most discoveries of the last five years need a far higher gold price to be mined. In addition, many recent discoveries are located in jurisdictions with high country or environmental risks and lack infrastructure, resulting in multibillion-dollar capital expenditures (capexes).

TGR: As a result of the factors you’ve mentioned, can we now expect a big increase in mergers and acquisitions (M&As)?

OG: Not so much among the majors. Most of them have weak balance sheets and too many in-house projects to risk expensive and dilutive takeovers. I see only Goldcorp and Newmont as potential bidders among the majors. Goldcorp lost the Osisko takeover battle to Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), while Newmont refused to merge its Nevada operations with Barrick’s. So Goldcorp and Newmont might attempt different takeovers when the time is right.

TGR: What are the attributes possessed by those companies likely to be taken out?

OG: When the influential players in the gold mining space think that the gold price bottom is in, and a new bull market is likely, M&A interest will grow big time. Such a consolidation could create a perfect storm for the strongest junior gold producers and quality gold developers with robust, competitive projects.

Specifically, takeover targets will have financeable mine capexes with a good relation to the discounted net present value (NPV) of their projects. They will be profitable with gold at $1,100/oz, and at least break even at $1,000/oz. Their projects will be in pro-mining jurisdictions with stable laws, the sustainable support of regional and local communities, and solid infrastructure.

TGR: What about management?

OG: Takeover targets must have managements with strong track records, or, failing that, existing investment from the larger precious metals companies or previously successful strategic investors. And, of course, healthy financials. There are many evaluations to be made, and there aren’t any “no brainers” here. Due diligence and continuous research are critical. When you think you haven’t spotted any weaknesses, you’ve likely missed something.

“True Gold Mining Inc. belongs to a small and very exclusive circle of gold developers, those that own a fully permitted and fully financed high-margin gold project.“

TGR: Which gold junior or mid-cap gold producer is your current favorite?

OG: I like B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX) at this price level for many reasons. First, I like its takeover of Papillion Resources and its Fekola project in Mali. Fekola will be a very large and very profitable gold mine. Second, I like its CEO Clive Johnson, whose team has built one of the fastest-growing gold producers in one of the toughest environments ever. Third, B2Gold has three operating mines: two in Nicaragua, which are running smoothly, and one in the Philippines. Fourth, it has a diversified portfolio of attractive gold projects with massive growth potential.

B2Gold has proved it can succeed in difficult regions and, despite the collapse of the gold price, has maintained strong cash flow and a strong balance sheet. Its gold production has grown from 158,000 oz (158 Koz) in 2012 to about 400 Koz this year, with operating costs of around $680/oz and all-in sustaining costs of $1,025–1,125/oz. After its Otjikoto Mine in Namibia ramps up, production should hit 580 Koz in 2016, and after Fekola ramps up, production could reach an amazing 900 Koz in 2017. B2Gold is on the verge of becoming a major gold producer and a lucrative takeover target.

TGR: As you mentioned, B2Gold has two operating mines in Nicaragua. Can we expect further success stories from that country?

OG: Nicaragua has huge potential. Gold is already its most important export, and the government intends to be a growing producer. One company I follow is Calibre Mining Corp. (CXB:TSX.V), which has generated much interest this year after good assay results, and because 11% was bought by the legendary Pierre Lassonde, founder of Franco-Nevada Corp. (FNV:TSX; FNV:NYSE). I like Calibre’s business model: attracting partners to spend exploration capital. It has optioned a part of its large project portfolio to IAMGOLD Corp. (IMG:TSX; IAG:NYSE), which will invest $5 million ($5M) over three years, and has formed a joint venture with B2Gold to explore a huge land package with many promising gold targets. Calibre has the potential to found an entire gold camp.

TGR: Which companies do you like in South America?

OG: I closely track Columbus Gold Corp. (CGT:TSX.V; CBGDF:OTCQX) and its 4.3 Moz Paul Isnard project in French Guiana. This is another company with strong investors. A prominent private U.S. investor bought 9.9% of the company in September, and the major Russian gold producer Nordgold N.V. (NORD:LSE), which has the option to buy 50.01% of Paul Isnard, bought 9% of Columbus in October.

TGR: Why did Nordgold make a direct investment in Columbus?

OG: I expect to protect itself from a lowball takeover offer from another gold producer, as Columbus is indeed a very attractive takeover target.

I met Columbus’ CEO Robert Giustra in Paris this year. He is committed to dramatic and dynamic expansion. The company will finalize an extensive drilling program this quarter, which should lead to an increase in the quantity and quality of identified gold resources. A preliminary economic assessment (PEA) is scheduled for Q1/15. In addition, Columbus will undertake a significant drilling program at its Eastside gold and silver project in Nevada. This could become a company-maker in its own right.

TGR: You have a particular interest in Colombia. Which companies do you like there?

OG: I like two junior gold companies in the Antioquia Department: Red Eagle Mining Corp. (RD:TSX.V) and Continental Gold Ltd. (CNL:TSX; CGOOF:OTCQX). Red Eagle’s key deposit, San Ramon at its large Santa Rosa gold project, has amazing economics. Its September feasibility study outlines average production of 50 Koz gold per year over eight years with operating cash costs of only $596/oz and all-in costs of $763/oz. Positive economics include cash flow of $132M, an NPV of $104M and an internal rate of return of 53%. The capex is only $75M, and the payback period is just 1.3 years. Red Eagle needs one more permit to build one of the world’s most profitable gold mines.

What is really important to understand here is that this smaller-scale underground operation is only a starter point, and Red Eagle has clear plans to significantly expand gold production in the future. I visited San Ramon this year, and it exceeded my already high expectations. It has great infrastructure and exploration potential, great management and project team, and almost peerless community relations. I completely trust in the skills and visions of Red Eagle’s CEO, Ian Slater, as well.

TGR: What impresses you about Continental?

OG: Its Buriticá gold project is already world-class, and could be a cornerstone asset for any large gold producer. The deposit has grown from 3 Moz in 2011 to 7 Moz in 2014, with grades higher than 9 grams per ton (9 g/t). The company intends to begin underground production in 2017, with the goal of outlining 10+ Moz. Its next big milestone will be its PEA, which should be completed by the end of this quarter. The permitting process in Colombia is challenging, but it helps that Continental’s largest shareholder is one of Colombia’s leading mining entrepreneurs. And the company has more than $80M in cash.

TGR: What else do you like in South America?

OG: My favorite gold story in Brazil is Brazil Resources Inc. (BRI:TSX.V; BRIZF:OTCQX).

TGR: Didn’t its share price take a huge hit this month?

OG: The last weeks have been very tough, yes, but the company will weather the storm. I am greatly impressed by Brazil Resources’ founding chairman, Amir Adnani. Both prudent and vigorous, he has acquired a large project portfolio with a multimillion-ounce gold resource. At its current valuation, Brazil Resources offers excellent leverage on the gold price, and it is backed by first-class, financially sound investors.

TGR: Which Nevada gold companies are your favorites?

OG: In Nevada, I like Gold Standard Ventures Corp. (GSV:TSX.V; GSV:NYSE) and its Railroad-Pinion gold project in Nevada. The company has successfully consolidated a large land package and proved close to 1.5 Moz in very lucrative, exposed oxide deposits. This deposit is open in multiple directions and is located in an active gold mining camp next to Newmont. This should be a straightforward heap-leach gold mine with low capital intensity, and represents another takeover target.

A company both in Nevada and Turkey is Pilot Gold Inc. (PLG:TSX). Its Kinsley Mountain project in Nevada contains a high-grade and promising discovery. In Turkey, the company is successfully exploring and developing the TV Tower project with Teck Resources Ltd. (TCK:TSX; TCK:NYSE). TV Tower could become an entire mining district, containing several gold, copper and silver deposits. Pilot’s managers and geologists are some of the best in the industry, and both Teck and Newmont are strategic shareholders.

TGR: And which gold companies do you fancy elsewhere in the world?

OG: In Burkina Faso, there’s True Gold Mining Inc. (TGM:TSX.V), which is led by the same people who masterminded Pilot Gold. Founding Chairman Mark O’Dea plans to grow True Gold into a midtier gold producer. Its flagship project, Karma in Burkina Faso, already contains a multimillion-ounce gold resource and still has outstanding exploration potential. Investors have to love True Gold’s fundamentals. It belongs to a small and very exclusive circle of gold developers, those that own a fully permitted and fully financed high-margin gold project. Construction has begun, and gold should be produced by the end of 2015. True Gold will be one of the world’s profitable gold producers.

Mark O’Dea is also a director of Pure Gold Mining Inc. (PGM:TSX.V), which has consolidated a large land package in Ontario’s Red Lake District, the highest-grade gold mining district in the world. Pure Gold now controls 100% of the Madsen gold project, which contains a high-grade gold mine with historic production of 2 Moz. I see the potential to discover a high-grade, multimillion-ounce resource in the next few years. This could lead to a takeover by a larger gold producer, such as Goldcorp, the major Red Lake player.

My favorite gold play in Europe is Dalradian Resources Inc. (DNA:TSX), which owns the Curraghinalt gold project in Northern Ireland. It has 3.5 Moz already at 10+ g/t, with great exploration potential and compelling economics. In my opinion, Dalradian could become a high-margin gold producer. This is another attractive takeover target for any midtier gold producer. Sprott is now a large shareholder and funded this story until the prefeasibility study, which is scheduled in 2015. Dalradian did an impressive financing of $27M+ at $0.90/share, but investors can buy it now for less than $0.70.

TGR: Moving on to copper, we’ve seen three companies with advanced projects taken out this year: Lumina Copper Corp., Augusta Resource Corp. and Curis Resources Ltd. Who’s next?

OG: There aren’t many attractive cooper projects left that are controlled by junior miners. I’ll name two. The first is Reservoir Minerals Inc.’s (RMC:TSX.V) Timok project in Serbia. This contains a large deposit with extremely high copper and gold grades, so much so that copper major Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) will pay for Timok all the way to a bankable feasibility study in exchange for 75%. That means zero cost for Reservoir with unlimited exploration and development potential. As Reservoir owns a very large, diversified and promising project portfolio next to many active mines in Serbia, and Freeport always targets large world-class deposits with attractive locations, I think it’s more than obvious that Reservoir will be taken over by Freeport, perhaps sooner than later.

The second junior copper company with takeover potential is Excelsior Mining Corp. (MIN:TSX.V), with its Gunnison in-situ project in Arizona. The company released a stunning prefeasibility study in early 2014 with industry-leading economics. More than 25% of the company is now owned by Greenstone Resources, a solid London private equity fund. At its current share price, Excelsior offers fantastic leverage on the copper price.

TGR: You are now more bullish on uranium companies, correct?

OG: Uranium prices have just enjoyed their first recovery in years. We may have seen the bottom here, so I think investors should put uranium stocks back on their watchlists. In my opinion, the most attractive discovery story in the global uranium space in view of grade, size and quality is Fission Uranium Corp. (FCU:TSX) and its outstanding discovery at its Patterson Lake South (PLS) project in Saskatchewan’s Athabasca Basin. What is really awesome is that Fission is still achieving a very successful drilling rate. I think it’s clear that PLS will be taken over, and this might happen after the release of the first resource estimate, scheduled for the end of this year.

TGR: Who are the likely suitors?

OG: As the construction of major new uranium mines is so expensive, I see only Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), Cameco Corp. (CCO:TSX; CCJ:NYSE) and AREVA SA (AREVA:EPA) as potential bidders.

TGR: What other companies do you like in Saskatchewan?

OG: Two companies. To focus on PLS, Fission Uranium spun out many interesting projects to Fission 3.0 Corp. (FUU:TSX.V), a company led by the same management team. Fission offers huge leverage on exploration success in view of its strong project portfolio and low valuation.

The other Saskatchewan play I like is NexGen Energy Ltd. (NXE:TSX.V). Initial drilling at its Arrow project hit solid mineralization in 30 of 32 holes. This is an emerging first-class uranium discovery with a vast number of attractive exploration targets.

TGR: Is there an American uranium play you like?

OG: Assuming a real turnaround in the uranium space, my long-term bet would be Uranium Energy Corp. (UEC:NYSE.MKT), which offers one of the greatest leverages out there and has one of the best management teams. The company controls a large, well-advanced and much-diversified project portfolio in Texas. This company needs a higher uranium price to really move forward, but this is true for the whole industry. Uranium Energy could become a significant uranium producer, and is the only substantial uranium story in the U.S.

TGR: Finally, given that so many current investors in gold companies want out, does the M&A flurry you’ve suggested offer a special opportunity for contrarians?

OG: Absolutely. Both specific and general valuations are among the lowest for the last 30 years, so this could be the most attractive environment for contrarian investors in a couple of generations.

TGR: Oliver, thank you for your time and your insights.

Oliver Gross is a passionate resource expert, prudent investor and adviser with more than 10 years of experience in the mining and junior sector. He is the chief editor and analyst of the newsletter Der Rohstoff-Anleger (The Resource Investor), which specializes in the global junior resource sector. It is backed by the GeVestor Financial publishing group, the largest online publishing house in Germany.