The Gold Report caught up with Neil MacDonald, CEO and Director of NovaDX, an investment firm that provides capital investment, investment banking, financial and business advisory services to early-stage natural resource exploration companies. NovaDX has a growing portfolio of early-stage companies focused on the discovery of new mineral deposits and petroleum reserves. NovaDx's wholly-owned subsidiary, Canadian Small Cap Resource Funds (www.cscrf.ca), creates and distributes limited partnerships that invest in flow-through shares of Canadian junior mining and energy companies.
TGR: Let's start with the juniors. Why aren't they participating in this cycle as they have in the past?
NM: People are rethinking their portfolios and speculative capital is one of the first casualties during a credit crisis such as the subprime mortgage situation in the U.S. The liquidity has gone out of the junior markets. That's why juniors are finding it much more difficult than they did even six months ago to raise capital for their exploration programs. So you’re seeing quite a disconnect between the buoyant commodity prices and the value of the exploration companies.
TGR: Is it mostly individual capital that has disappeared from the speculative market or is it the funded capital too?
NM: It's a combination. Capital from both individuals and institutional investors has declined in the last six months.
TGR: Has money that would normally have gone into juniors shifted over to the ETFs?
NM: That’s definitely a factor, although we don’t see as much of that here in Vancouver.
TGR: What is it going to take to get the juniors to reconnect?
NM: A fundamental confidence has to return to the markets first but I don’t think we’ve seen the end of this mortgage debt crisis. Speculative capital won't come back until investors are comfortable again. That being said, a new discovery of substantial size could accelerate the entry of speculative capital back into this market.
TGR: So you're saying a stock like Canplats Resources Corporation (TSX:CPQ) that announced a discovery last fall and saw a fivefold increase in their share price—a discovery like that could re-energize the junior explorer space?
NM: It could, but it would have to be a substantial discovery and be accompanied by general confidence in the market.
TGR: Many believe that this recession/depression will be limited to the U.S. and China will take up the slack. Do you think that's a valid perspective?
NM: There are roughly 300 million people in China who are in the process of becoming affluent. That burgeoning consumerism will continue to drive demand. It is, however, unrealistic to expect the same rate of growth we've experienced over the last three to four years. Nonetheless I don't see Asian markets sliding into a recession. At the same time, I don't expect to see near-term growth here in the U.S. Debt on a per-capita basis has reached historic proportions and something has to change.
TGR: So the Asian markets will be the source of continuing demand for some of these commodities?
NM: Definitely. South Korea, the world's largest shipbuilder, is a good example. It has a very large industrial base and imports all of its raw materials. There’s very little domestic production. To offset concerns about rising commodity prices, the South Koreans are starting to stockpile inventories to hedge against future price increases.
You've got to look at the supply side too. Although there are new copper, zinc, and moly mines planned to come into production, there's still a gap between projected supply and demand. That shortfall will support commodity prices at current levels. We won't be seeing the low commodity prices of the not-too-distant past anytime soon. We're not going back to $40 a barrel for oil.
TGR: I know you said earlier that in China you wouldn’t be expecting the rate of growth that we've seen over the last two years; growth will continue but at a slower pace. And we see the U.S. going into a recession, or at least to a period of flat growth. If that's true, why wouldn't commodity prices level out now?
NM: Looking at the numbers—China’s growing “middle class” now has a population equivalent to the entire U.S. that is just starting to consume the kind of goods that support its newly emerging affluent lifestyle.
TGR: Over the last several years, we've seen exponential growth, now it’s starting to slow down. Is this out pricing the market already?
NM: That’s a good question. I don’t believe it is. The demand will continue to be there but not the growth in demand. Again you have to consider the supply side. Let’s face it—new deposits are taking longer and costing a lot more to bring into production.
A good example of that is the situation at Galore Creek with NovaGold Resources (NG: AMEX,TSX). Here you have a fantastic mega project that initially looked very good and the economics made sense. Then all of a sudden—largely due to rising energy, steel and other development costs—you have to reevaluate everything.
TGR: I understand this isn't the only such reevaluation.
NM: You hear about these reevaluations occurring with great frequency now. New supply isn't coming as fast or within the cost profiles that were originally anticipated.
TGR: Do you have views on specific commodities, or because you’re more of a value investor, does it matter as much if copper goes to $8 or gold goes to $2,000?
NM: We are a value investor and we look for unique opportunities. Copper is one commodity we believe will have sustainable demand. Again, this is reinforced by supply constraints.
Gold's a more interesting one. Supply and demand are obviously drivers but the economy plays a huge role too. People use gold more as a hedge against currencies, but I do believe the outlook for gold is favorable and will likely drag silver along with it.
TGR: So, when you say the outlook is favorable for gold and copper, can we extrapolate that to mean higher prices?
NM: I certainly think copper has some room to rise, as does gold. Some see $2,000 gold. I am not as bullish as that, but I don’t see it falling back to $600 either.
TGR: With this as background, let's give our readers some companies that your fund is currently holding or companies that you think warrant consideration.
NM: First I will explain why we invest in particular companies. We look for situations that allow us to mitigate the controllable risks such as those related to management, finance, and general corporate risks. What we can’t control, of course, is the risk at the end of the drill bit. Only Mother Nature does that.
We select companies whose management teams have a demonstrated track record. Our companies have projects with an above-average opportunity for making a new discovery. Too many junior exploration companies hang their hats on a single project, and spend too much time exploring that one project before they give it up.
One company in our portfolio that meets this criteria is Gold Quest Mining Corporation (CDNX:GQC.V). They are focused on the Dominican Republic. This is a company with a group of geologists that are mostly ex-Anglo [AngloGold Ashanti Limited (NYSE: AU)] people who believed that the western part of the Dominican Republic was relatively unexplored, which, indeed, it was. They conducted a very broad regional program to identify anomalies capable of supporting a portfolio of diverse properties. That program was actually quite successful, and today they have a pipeline of properties. They were able to attract Gold Fields (NYSE & JSE: GFI) in a joint venture to develop some of those properties, and are also exploring other properties excluded from the joint venture in which they maintain 100 percent ownership.
They made a new volcanic massive sulfide discovery on one of their earlier properties, Las Animas. We believe that there are more discoveries to be made by the company on properties that it has not yet had a chance to explore. We’re really excited about Gold Quest Mining. They’ve already made one good discovery that’s continuing to evolve. We’re hoping to see some resource calculations soon, but even if that project doesn’t measure up, they have a number of other properties with potential. This is a good example of a situation where you’re mitigating your risks through a pipeline of properties with a very good geological team in a well-financed situation.
TGR: Are there others like that you might want to discuss?
NM: Eagle Plains Resources (TSX-V:EPL) is focused primarily in British Columbia, the Yukon, and most recently in the western part of the Northwest Territories—a total of about 33 different properties. Their most successful exploration project has been the Copper Canyon property. They optioned it to NovaGold Resources (NG: AMEX,TSX) as part of the Galore project; then it spun out and became its own company. Eagle Plains still has about 33 properties. This year they’re exploring on 12 of them— everything from zinc to gold. Right now they’re drilling an iron ore property. This is another example of great management and a very well financed situation.
TGR: Is their model to develop properties to a certain level, like they did with Copper Canyon and then spin it out, or is that an exception?
NM: No, that’s certainly the model. The strategy is to find deposits, bring them to a stage where a more senior company with experience in taking a deposit into production would find it attractive.
TGR: Why do you think this stock is under so much pressure?
NM: The entire junior market is under a lot of pressure.
TGR: Do you have a few more ideas?
NM: Sable Resources (SAE.V) is unique in our portfolio because it's currently producing.
TGR: Did they just start producing?
NM: Yes they did. We got involved a little over a year ago to finance their business plan. What hasn’t been articulated very well to the market is that this is a company with the assets to produce. The Toodoggone area of British Columbia has been explored extensively and hosts some high-grade epithermal and some porphyry deposits, and, in the case of Sable Resources, gold and silver. These epithermal deposits tend to be too small on their own to exploit from a production standpoint. The unique opportunity for Sable is to become what I would call a self-funding exploration company. Since it's in production, Sable can utilize its existing resources from that operation to generate cash flow and then put it right back into either exploring for additional resources or acquiring other known deposits in the area.
I can't quote exact numbers—but there are probably two to three million ounces in that area scattered around in a lot of small deposits. Sable acquired a mill at a very low cost. Now that it's operational, it will help leverage them into becoming a larger company.
TGR: Do they have their 43-101?
NM: They don't have it on the deposit they are currently mining. Once they have all their data, it's likely they will complete a 43-101 resource calculation.
TGR: Do they have another portfolio of projects?
NM: They do have a net smelter royalty interest in another property in Northern British Columbia, but they own the property that they’re working on and it’s their only property for the moment.
TGR: For the moment…
NM: You can see in this business model that for a speculative investor in the exploration sector, we look for companies with a pipeline of projects, experienced management, and innovative strategies for raising capital. Right now there's something like 1,300 or so exploration company listings on the TSX Venture Exchange and a very large number of them have issued a lot of paper to raise capital. They are up to capitalizations of 70, 80, 100 million plus shares. Unfortunately, they haven’t been that successful in finding very much. That kind of share structure, particularly in this market, makes it extremely difficult to attract additional investment because the leverage simply isn’t there.
A new discovery, unless it’s quite large with a very attractive valuation isn’t going to do much for the share price when there are 100 million shares outstanding. When good news does come from some of these companies it tends to be more about liquidity than value building. But I think that’s a sign of the times.
TGR: Let's start with the juniors. Why aren't they participating in this cycle as they have in the past?
NM: People are rethinking their portfolios and speculative capital is one of the first casualties during a credit crisis such as the subprime mortgage situation in the U.S. The liquidity has gone out of the junior markets. That's why juniors are finding it much more difficult than they did even six months ago to raise capital for their exploration programs. So you’re seeing quite a disconnect between the buoyant commodity prices and the value of the exploration companies.
TGR: Is it mostly individual capital that has disappeared from the speculative market or is it the funded capital too?
NM: It's a combination. Capital from both individuals and institutional investors has declined in the last six months.
TGR: Has money that would normally have gone into juniors shifted over to the ETFs?
NM: That’s definitely a factor, although we don’t see as much of that here in Vancouver.
TGR: What is it going to take to get the juniors to reconnect?
NM: A fundamental confidence has to return to the markets first but I don’t think we’ve seen the end of this mortgage debt crisis. Speculative capital won't come back until investors are comfortable again. That being said, a new discovery of substantial size could accelerate the entry of speculative capital back into this market.
TGR: So you're saying a stock like Canplats Resources Corporation (TSX:CPQ) that announced a discovery last fall and saw a fivefold increase in their share price—a discovery like that could re-energize the junior explorer space?
NM: It could, but it would have to be a substantial discovery and be accompanied by general confidence in the market.
TGR: Many believe that this recession/depression will be limited to the U.S. and China will take up the slack. Do you think that's a valid perspective?
NM: There are roughly 300 million people in China who are in the process of becoming affluent. That burgeoning consumerism will continue to drive demand. It is, however, unrealistic to expect the same rate of growth we've experienced over the last three to four years. Nonetheless I don't see Asian markets sliding into a recession. At the same time, I don't expect to see near-term growth here in the U.S. Debt on a per-capita basis has reached historic proportions and something has to change.
TGR: So the Asian markets will be the source of continuing demand for some of these commodities?
NM: Definitely. South Korea, the world's largest shipbuilder, is a good example. It has a very large industrial base and imports all of its raw materials. There’s very little domestic production. To offset concerns about rising commodity prices, the South Koreans are starting to stockpile inventories to hedge against future price increases.
You've got to look at the supply side too. Although there are new copper, zinc, and moly mines planned to come into production, there's still a gap between projected supply and demand. That shortfall will support commodity prices at current levels. We won't be seeing the low commodity prices of the not-too-distant past anytime soon. We're not going back to $40 a barrel for oil.
TGR: I know you said earlier that in China you wouldn’t be expecting the rate of growth that we've seen over the last two years; growth will continue but at a slower pace. And we see the U.S. going into a recession, or at least to a period of flat growth. If that's true, why wouldn't commodity prices level out now?
NM: Looking at the numbers—China’s growing “middle class” now has a population equivalent to the entire U.S. that is just starting to consume the kind of goods that support its newly emerging affluent lifestyle.
TGR: Over the last several years, we've seen exponential growth, now it’s starting to slow down. Is this out pricing the market already?
NM: That’s a good question. I don’t believe it is. The demand will continue to be there but not the growth in demand. Again you have to consider the supply side. Let’s face it—new deposits are taking longer and costing a lot more to bring into production.
A good example of that is the situation at Galore Creek with NovaGold Resources (NG: AMEX,TSX). Here you have a fantastic mega project that initially looked very good and the economics made sense. Then all of a sudden—largely due to rising energy, steel and other development costs—you have to reevaluate everything.
TGR: I understand this isn't the only such reevaluation.
NM: You hear about these reevaluations occurring with great frequency now. New supply isn't coming as fast or within the cost profiles that were originally anticipated.
TGR: Do you have views on specific commodities, or because you’re more of a value investor, does it matter as much if copper goes to $8 or gold goes to $2,000?
NM: We are a value investor and we look for unique opportunities. Copper is one commodity we believe will have sustainable demand. Again, this is reinforced by supply constraints.
Gold's a more interesting one. Supply and demand are obviously drivers but the economy plays a huge role too. People use gold more as a hedge against currencies, but I do believe the outlook for gold is favorable and will likely drag silver along with it.
TGR: So, when you say the outlook is favorable for gold and copper, can we extrapolate that to mean higher prices?
NM: I certainly think copper has some room to rise, as does gold. Some see $2,000 gold. I am not as bullish as that, but I don’t see it falling back to $600 either.
TGR: With this as background, let's give our readers some companies that your fund is currently holding or companies that you think warrant consideration.
NM: First I will explain why we invest in particular companies. We look for situations that allow us to mitigate the controllable risks such as those related to management, finance, and general corporate risks. What we can’t control, of course, is the risk at the end of the drill bit. Only Mother Nature does that.
We select companies whose management teams have a demonstrated track record. Our companies have projects with an above-average opportunity for making a new discovery. Too many junior exploration companies hang their hats on a single project, and spend too much time exploring that one project before they give it up.
One company in our portfolio that meets this criteria is Gold Quest Mining Corporation (CDNX:GQC.V). They are focused on the Dominican Republic. This is a company with a group of geologists that are mostly ex-Anglo [AngloGold Ashanti Limited (NYSE: AU)] people who believed that the western part of the Dominican Republic was relatively unexplored, which, indeed, it was. They conducted a very broad regional program to identify anomalies capable of supporting a portfolio of diverse properties. That program was actually quite successful, and today they have a pipeline of properties. They were able to attract Gold Fields (NYSE & JSE: GFI) in a joint venture to develop some of those properties, and are also exploring other properties excluded from the joint venture in which they maintain 100 percent ownership.
They made a new volcanic massive sulfide discovery on one of their earlier properties, Las Animas. We believe that there are more discoveries to be made by the company on properties that it has not yet had a chance to explore. We’re really excited about Gold Quest Mining. They’ve already made one good discovery that’s continuing to evolve. We’re hoping to see some resource calculations soon, but even if that project doesn’t measure up, they have a number of other properties with potential. This is a good example of a situation where you’re mitigating your risks through a pipeline of properties with a very good geological team in a well-financed situation.
TGR: Are there others like that you might want to discuss?
NM: Eagle Plains Resources (TSX-V:EPL) is focused primarily in British Columbia, the Yukon, and most recently in the western part of the Northwest Territories—a total of about 33 different properties. Their most successful exploration project has been the Copper Canyon property. They optioned it to NovaGold Resources (NG: AMEX,TSX) as part of the Galore project; then it spun out and became its own company. Eagle Plains still has about 33 properties. This year they’re exploring on 12 of them— everything from zinc to gold. Right now they’re drilling an iron ore property. This is another example of great management and a very well financed situation.
TGR: Is their model to develop properties to a certain level, like they did with Copper Canyon and then spin it out, or is that an exception?
NM: No, that’s certainly the model. The strategy is to find deposits, bring them to a stage where a more senior company with experience in taking a deposit into production would find it attractive.
TGR: Why do you think this stock is under so much pressure?
NM: The entire junior market is under a lot of pressure.
TGR: Do you have a few more ideas?
NM: Sable Resources (SAE.V) is unique in our portfolio because it's currently producing.
TGR: Did they just start producing?
NM: Yes they did. We got involved a little over a year ago to finance their business plan. What hasn’t been articulated very well to the market is that this is a company with the assets to produce. The Toodoggone area of British Columbia has been explored extensively and hosts some high-grade epithermal and some porphyry deposits, and, in the case of Sable Resources, gold and silver. These epithermal deposits tend to be too small on their own to exploit from a production standpoint. The unique opportunity for Sable is to become what I would call a self-funding exploration company. Since it's in production, Sable can utilize its existing resources from that operation to generate cash flow and then put it right back into either exploring for additional resources or acquiring other known deposits in the area.
I can't quote exact numbers—but there are probably two to three million ounces in that area scattered around in a lot of small deposits. Sable acquired a mill at a very low cost. Now that it's operational, it will help leverage them into becoming a larger company.
TGR: Do they have their 43-101?
NM: They don't have it on the deposit they are currently mining. Once they have all their data, it's likely they will complete a 43-101 resource calculation.
TGR: Do they have another portfolio of projects?
NM: They do have a net smelter royalty interest in another property in Northern British Columbia, but they own the property that they’re working on and it’s their only property for the moment.
TGR: For the moment…
NM: You can see in this business model that for a speculative investor in the exploration sector, we look for companies with a pipeline of projects, experienced management, and innovative strategies for raising capital. Right now there's something like 1,300 or so exploration company listings on the TSX Venture Exchange and a very large number of them have issued a lot of paper to raise capital. They are up to capitalizations of 70, 80, 100 million plus shares. Unfortunately, they haven’t been that successful in finding very much. That kind of share structure, particularly in this market, makes it extremely difficult to attract additional investment because the leverage simply isn’t there.
A new discovery, unless it’s quite large with a very attractive valuation isn’t going to do much for the share price when there are 100 million shares outstanding. When good news does come from some of these companies it tends to be more about liquidity than value building. But I think that’s a sign of the times.
