Storm-tested Canadian equity picks

December 15, 2015 02:15 PM

Amid a tempestuous year for the U.S. dollar gold price, gold has quietly moved up about 6% in Canadian dollar terms, squarely placing the focus on gold producers with Canadian operations that generate cash flow, says Ryan Hanley, mining analyst with Mackie Research Capital.

In this interview with The Gold Report, Hanley lists his storm-tested top picks, shines light on names with M&A potential, and sees smooth sailing ahead for some companies with near-term catalysts.


The Gold Report: Why haven't the recent Islamic State attacks in Paris spurred a greater safe-haven gold trade? Does it mean the concept of gold as a safe haven is, for the most part, dead?

Ryan Hanley: I don't believe so. Despite the recent attacks, this is the first time in a long time we've seen the United Kingdom backing France, and the U.S. and Russia on the same page. Gold continues to have an inverse relationship with the U.S. dollar, and with the U.S. posting strong employment numbers, we continue to believe that the focus is still on the U.S. dollar and the implications of a rate hike in December.

TGR: What sort of interest rate hike are you modeling?

RH: Our expectation would be about 25 basis points. We believe about 65–70% of that is already priced into the market.

TGR: Where do you peg the low end of the support range for gold in the near term?

RH: With continued economic strength in the U.S., we expect some near-term pressure to remain on the gold price. We could see it briefly dropping below $1,000/ounce ($1,000/oz) in the near term, but in the long term we're much more bullish, especially given the average all-in sustaining cost of production among the companies we have under coverage is slightly above $1,000/oz. Typically, we've seen seasonal strength in the second half of the year. We could see gold rebound as early as H2/16.

TGR: Your investment thesis roughly consists of low all-in sustaining cost production names in safe jurisdictions with near-term catalysts. Did I miss anything?

RH: That's basically it. I might add that Canadian gold producers continue to benefit from the depreciation of the Canadian dollar versus the U.S. dollar, which has helped a lot. For example, the gold price has gone down by about 10% over the previous year in U.S. dollar terms, but in Canadian dollar terms, once you apply the exchange rate, it's actually up by about 6%.

TGR: At a recent RBC Capital Markets conference in London, a number of companies presenting said they had further room to cut costs. Are the CEOs and management teams in your coverage universe echoing those statements?

RH: For most of the names we cover, there's not significant room for much cost-cutting. We could see slightly lower input costs in terms of mill re-agents, diesel prices, and drilling, so there is a bit of room to boost margins, but not by any significant measure.

TGR: You cover some drilling companies. How much lower are drilling costs now versus five years ago?

RH: I'd say they've come off about 50% on average, but in some cases, it's significantly more. It depends on whether you are in a well-developed camp like Red Lake, Ontario, or Val d'Or, Québec versus northern British Columbia (B.C.), where helicopters are used to deliver drills. In prime mining camps, drill costs are probably 50% lower, if not more. You can get down to about $60 per meter ($60/m) on your base costs, but in some cases that doesn't include geology or fuel. Forage Orbit Garant Inc., for example, drills primarily in Canada, and its average drilling costs are about $90/m, which is toward the low end of the historical average.

On the positive side for the drillers, we have seen some signs of stabilization, with the number of meters drilled and price per meter continuing to increase slightly year-over-year for several consecutive quarters.

TGR: AuRico Gold Inc. and Alamos Gold Inc. merged earlier this year as equals. AuRico had assets. Alamos had cash. These types of mergers tend to happen in small- and micro-cap equity names. Are mining mergers and acquisitions (M&A) moving up the food chain?

RH: I think so. These tend to be opportunistic events that have recently focused more on companies generating cash flow. Alamos and AuRico were a good fit because Alamos had permitting delays in its development pipeline, specifically in Turkey, and AuRico had Young-Davidson, a gold asset in northern Ontario that's ramping up on time and that will provide organic growth.

TGR: Is Alamos going to have any long-term permitting issues with either Kirazlı or Ağı Dağı in Turkey?

RH: We've never been overly optimistic on the timing of permitting in Turkey. That being said, we think it will happen. Other gold companies, like Eldorado Gold Corp., have proven they can build and operate mines in Turkey.

TGR: Do you expect other companies under coverage to engage in M&A in 2016?

RH: There may be a couple of other names in our coverage universe where M&A could happen and we expect companies to explore those opportunities throughout 2016. A lot of companies that have production assets in riskier parts of the world could start to target companies with operations in Canada to take advantage of the safer jurisdiction and Canadian gold price.

But the focus is still going to be on cash flow. Investors are typically looking at gold companies generating cash at the current gold price and are not moving down the food chain to exploration projects just yet.

TGR: What are some names you cover that could be involved in M&A?

RH: We see the most likely candidates as producers with good balance sheets that probably want to further diversify. Klondex Mines Ltd. would be a good example. The company has performed quite well. It has a strong balance sheet and it might be interested in going after something that would fit its underground gold mining expertise.

Another one might be Lake Shore Gold Corp., which has successfully turned around its operations in northern Ontario. The company is building up its balance sheet after several consecutive good quarters. It might want to acquire something bigger than Temex Resources Corp. by using its slightly higher valuation to its advantage.

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