The Gold Report: Heiko, in late June gold had its biggest weekly drop in two years. What's your take on that?
Heiko Ihle: It was set off by far-reaching talk of a slowdown in quantitative easing. However, an awful lot of U.S. dollars are still floating around and the price of gold is pegged to the U.S. dollar. In the long run, companies can't sell gold for less than it costs to take it out of the ground. At some point something has to give.
TGR: So, what's going to give?
HI: Either the cost of mining or the price of gold. Quite frankly, the cost of mining has been reasonably sticky thus far.
TGR: Can miners profitably mine gold at $1,200/ounce ($1,200/oz) and silver sub-$20/oz?
"In the long run, companies can't sell gold for less than it costs to take it out of the ground."
HI: This is the first time in quite a while they've dipped this low, but there are miners that are able to produce profitably at these prices. One is Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE). The company's mine-site cash costs were about $5/oz last year, and we forecast less than $6/oz this year. Even at $19/oz silver, Fortuna will be quite profitable.
TGR: Fortuna is planning in the third quarter to begin a 1,500 ton per day (1,500 tpd) mill expansion at its San Jose mine in Mexico.
HI: At current prices, Fortuna is more concerned about cutting costs than trying to increase production. That said, San Jose is a very profitable mine. It is a great location, fully permitted and operational. The site has a large amount of ore that can be mined over the next decade or two. I would continue to encourage the company to expand the mine.
TGR: What's your price target on Fortuna?
HI: It's $4. Given where the stock is trading, it's actually pretty aggressive.
TGR: What are some of the companies under coverage doing to curb costs in this environment?
HI: There have been some cutbacks in every department. There have been layoffs. I've talked to a number of CEOs who are going to be doing more layoffs. Marketing budgets have been cut. A number of road shows have been flat-out canceled. There are cutbacks on exploration and general improvement budgets. Would Fortuna be expanding its mill if it started the whole process today? Probably not.
TGR: How does this trough compare to previous ones?
HI: There is general disinterest in nonproducing assets. Clients ask me almost every day: Why would I deal with a permitting process if I can get a producing asset for cheap? There's also less interest in small-cap names because investors can buy Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) at a discount. Overall, it's been quite hard to get investors excited about some of the names that we follow just because of a lack of interest in the space all together.
TGR: Many of the companies you cover have operations in Latin America, particularly Mexico. Mexico was the world's largest silver producing country in 2012, with about 162 million ounces (162 Moz), up 6% from 2011. Silver production was up 4% globally in 2012 to 787 Moz versus 757 Moz in 2011. Tell us about your favorite precious metal stories.
HI: Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE), run by Brad Cooke, has a reasonably low cost of production of about $8/oz this year. We forecast about $7/oz next year as the El Cubo plant should be fully on-line.
"There are miners that are able to produce profitably at these prices."
Endeavour Silver has a great business model. It buys underappreciated mines, puts some money into renovations and puts them into production at much lower cash costs with more efficient operations. The company tends to get a lot closer to reserve grade than the prior owners.
Today, for the first time since I've been looking at this company, Endeavour traded under $3/share. It's a very good value play.
TGR: El Cubo was purchased from AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) and turned around. Are there other underperforming assets that Endeavour could work its magic on?
HI: Certainly in this environment, where everybody wants to sell and nobody wants to buy. However, I don't think Brad is going to make any acquisition that's going to be transformational for the company, given the overall capital market conditions. These are scary times for all these guys. The cost structure that they operate under has changed substantially in those 34 months.
TGR: Endeavour's Guanaceví mine in Mexico has cash costs around $16.70/oz silver. With silver currently trading at around $19/oz, does that put that mine at risk of a short-term shut down?
HI: Not yet. The overall headquarter costs remain intact. The company will likely start mining the high-grade veins and leave everything else behind. It lowers production, which leads to overall lower cash costs.
TGR: What about some other Latin American plays that you have under coverage?
HI: I like Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL). The company has the La Arena project in Peru. It's a great company with good management. CEO Alex Black is a great manager.
Rio Alto is producing about 200,000 oz gold at slightly more than $700/oz this year. It is expanding its sulfide operation. The grades are decent. The company has been lucky because it kept hitting higher grade zones than it anticipated, which helped it beat production figures every quarter last year. Those times have, unfortunately, ended. The stock has dropped substantially over the past two months. Its shares are currently below $2. There's speculation in the marketplace that one of its largest holders is selling, which is creating an overhang on the name, but I think it's a valuable asset. Rio Alto has proven that it can perform.
TGR: What is the next catalyst for Rio Alto?
HI: When the sulfide goes on line, but that's not until around 2016.
TGR: One more precious metals story in Latin America?
HI: Fortuna Silver. CEO Jorge Ganoza is a third-generation miner. The family knows exactly what it is doing. Peru remains a politically safe environment. Labor costs are pretty decent. The company has a fairly low cash cost, in fact the lowest cash costs of companies I follow. That's in part because of the decent gold byproducts, but it's also because its San Jose mine in Mexico is a very efficient operation with fairly low tonnage costs. The mine site in Peru is fairly remote, however. I've been there. It's an eight-hour drive from the beautiful little town of Arequipa. It's high-altitude mining, but the grades are good.
TGR: Gold and silver prices are down about 3% today, but you still have a number of companies with buy recommendations. You still see upside. What are some turnaround stories?
HI: The whole market could be a turnaround story. In markets like this everybody remembers that gold is down $160/oz over the past 30 days. Well, guess what? Gold could be up $160/oz in the next 30 days. There is demand, but it is on the sidelines because everybody is scared. Ultimately, I genuinely believe that gold is money. I believe that companies need to be able to make a profit in addition to their cost of mining because otherwise the overall supply is going to dwindle down. I believe once that happens, either production costs will decrease or the gold price will increase. It will happen. Something has to give. We can't have every single company in the space losing money for eternity.
"Long term, gold cannot sell below the cost of production."
There is another company that I like, but it's not in production yet. Romarco Minerals Inc. (R:TSX) doesn't have a full permit, but I feel strongly that it will be able to get permitted. The mine is going to have about 91 million tons of ore at 1.6 grams per ton for a total of 4.8 Moz gold. You are essentially buying this thing for $50/oz at the current trading price of $0.39/share. I believe Romarco will get up and running, because its management knows a lot of large institutional shareholders who would be willing and able to front them some more cash. I believe the Haile project in South Carolina will be a mine in a couple of years.
TGR: How does that $50/oz compare to its peers?
HI: They range from $40/oz to almost $120/oz. It is definitely in the lower range, and it should be because it doesn't have a permit. It is not as derisked as a producing mine.
TGR: How likely are those permits to come within the next year?
HI: If you asked me that question a year ago, I would have said about 75%. Today, I am going to give you the same answer. There is a very decent chance that the permits are going to come reasonably soon. The permitting process, especially in South Carolina where there are no real mines, is not easy. The company has to have constant discussions with the U.S. Army Corps of Engineers. Romarco claims to be making progress. I am inclined to believe that, but these things always take a lot longer than you would like.
TGR: Meanwhile, Romarco has increased its resource and it has brought in more experienced personnel. What institutional support does it have?
HI: Van Eck Global, BlackRock, Baker Steel Capital Managers, Oppenheimer & Co., Tocqueville Asset Management and so on, the usual suspects. Seventy percent of shares are institutionally owned. Those firms haven't owned this and watched the stock sink in order to throw in the towel when it actually comes time to build a mine.
TGR: Can this management team get the permitting done?
HI: Yes, it should be able to do it.
TGR: How much lower can gold go?
HI: That question is a trap! Long term, gold cannot sell below the cost of production. One of the two things has to give. Either the cost of production has to go down, which is doubtful, or the price of the gold has to go up, which is the camp that I fall into.
TGR: We are into the summer months, which are some of the quietest months for precious metals equities in general. How should investors approach the summer months?
HI: For one thing, don't panic. Next, look at the companies you own or want to buy and see what they have done lately. Have they delivered on what they said they would? I am not talking about the price of gold. I am talking about production, grades, recovery and cash costs. If they have delivered, the overall thesis remains intact and hold on—as hard as that might be to do.
TGR: Thank you very much.
Heiko Ihle joined Euro Pacific Capital in November 2011 as a senior research analyst covering companies in the mining and engineering & construction (E&C) industries. Prior to joining Euro Pacific, Ihle spent over six years with Gabelli & Company, more than five of which as a research analyst. While at Gabelli, he was awarded second place in the 2010 Financial Times/StarMine Top Analyst Awards for the engineering & construction space. A native of Germany, Ihle received his bachelor's degree in finance and management from the University of Illinois at Chicago in 2004 and his Master of Business Administration from the University of Miami in 2006. He has been a CFA Charterholder since 2010 and is currently a member of the CFA Institute and the Stamford CFA Society.
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DISCLOSURE:
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Fortuna Silver Mines Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Heiko Ihle: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Endeavour Silver Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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5) Euro Pacific Capital owns warrants in Endeavour Silver Corp.
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