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Peak Gold Has Arrived

By John Ing,
President & CEO
Maison Placements Canada Inc

We believe markets are vulnerable to a serious correction on four fronts: runaway deficits, property bubbles, mounting inflation and geo-political tensions. With America’s outsized international funding requirements and a debt to GDP ratio of 100 percent made worse by a long spell of strong growth and easy money, the greenback is in for a long-term downward spiral. America itself is a bubble. For too long Wall Street has viewed America’s problems as long term, but eventually the long term becomes the short term.

To be sure, the Trump administration and Congress have been successful in kicking the can down the road. Although the debt ceiling was raised only a few months ago, Trump’s tax package has accelerated the day of reckoning. Debt on debt is not good. Two-thirds of the world’s assets are denominated in a fiat currency issued by a country whose leaders are taking policy actions, which will inevitably lead to its debasement. The US has a serious problem with its deficits and the dollar.

Furthermore, increased use of financial sanctions have forced countries to move away from the dollar and the American-led SWIFT system. High bond yields, geopolitical uncertainties on top of an ageing bull market has left stock valuations at historic highs and, the dollar vulnerable to a currency crisis club. Is America to be next?

Within this backdrop, gold is going to be a good thing to have when stores of value are highly priced. Gold is an alternative to currency debasement, and Mr. Trump. If gold was overbought seven years ago, it looks unloved today. We continue to believe gold which recently tested $1,365 an ounce five times will successfully break through with a target of $1,700 and $2,200 an ounce within 18 months.

Recommendations

Gold has surprisingly performed in line with most markets despite a strong dollar which is more of a cyclical correction in a bear market. Gold seems stuck in a trading range after two years of gains but is poised to break out. However the gold miners shares have not enjoyed the same result, falling 5 percent in the same period despite restoring their profitability with wider margins.

One reason for the non-performance is that bullish stock markets have caused investors to forego the traditional hedging characteristics of the gold miners. And of course, the rise in resource nationalism from the Democratic Republic of the Congo, to Mongolia, to Tanzania, to Mauritania and now Indonesia who decided to kill the golden goose with threats of increased taxes and even outright nationalization of mining operations, tearing up long standing agreements. However, underpinning a turnaround in gold stocks is the curbs on supply – both voluntary as heavy capex limits production and involuntary, as cash starved governments create inevitable stoppages. Peak gold has arrived.

An old adage is the best place to find a gold mine is where one is. Kirkland’s Fosterville is a good example where drilling beneath a mature orebody opened up new reserves.

Barrick’s success in Nevada after Goldstrike led to a core district. Organic growth is the key and the paucity of discoveries has led the industry to dust off old mine plans to exploit their own reserves. For that reason, the majors continue to look appealing because the future discoveries are in their own backyard.

We believe that change is coming and gold shares will begin to outperform gold. While recent M&A activity has been confined to tuck-in acquisitions, the senior companies have taken a portfolio approach and have financed the junior exploration programmes.

Reserves are the lifeblood of the mining companies and less than half of the majors replaced their reserves last year. Agnico Eagle, Goldcorp and recently Barrick have financed the treasuries of juniors hoping that they will discover additional deposits and the next round of mines. Finally, reserves in the ground are at the cheapest ever and we believe the producers will discover that it is cheaper to buy ounces on Bay Street than to explore. Moreover since there is a shortage of top-tier deposits, we believe the cashed up majors and Chinese state owned players will compete for those same ounces. Mining is capital intensive and billion dollar mines projects are the norm so location and execution will go at a premium. Thus, we continue to favour the seniors like Barrick and Agnico Eagle. We also like the mid tier players like B2Gold and Kirkland Lake. Among the junior developers, we like McEwen Mining.

Agnico Eagle Mines Limited (AEM) – Agnico Eagle maintained their guidance for this year reaffirming a goal of producing 2 million ounces in 2020. Agnico Eagle will spend $1 billion this year and produce 1.53 million ounces, a transition year. Flagship La Ronde and 50 percent owned Canadian Malartic had a strong quarter.

Agnico also closed the acquisition from Yamana of the exploration portfolio of Canadian Malartic which included promising Hammond Reef. The acquisition broadens Agnico’s exploration pipeline. LaRonde produced 90,000 ounces at a low cash cost of $427 an ounce due to higher grades. Agnico is continuing to work the lower part of the mine and LaRonde Zone 5 will be the next producer. Agnico has $465 million in cash and cash equivalents and $1.2 billion in undrawn credit lines. We continue to recommend the shares here for its growing production and reserve profile.

Barrick Gold Corporation (ABX) – Barrick Gold produced about $181 million in free cash flow in the latest quarter, allowing it to further pay down debt. Barrick’s priority was to redress its balance sheet and was rewarded with Moody's and Standard & Poor's upgrading Barrick's credit rating. Nonetheless investors were disappointed by the drop in production this year to between 4.5 million to 5 million ounces at AISC of $800 an ounce which was mainly due to asset sales. Barrick had a cash balance of $2.4 billion and three quarters of its outstanding debt is due after 2032 so Barrick can now focus on exploiting the largest reserve position among the gold producers. Turquoise Ridge in Nevada for example is a key asset and a third shaft is planned with a production start in 2022. At Goldrush also in Nevada, a 32 infill drilling program is planned. Barrick has an enviable base in Nevada and its future is from largely that area.

In Tanzania, 64 percent owned Acacia is fighting a $190 billion tax bill and is mired in negotiations. Barrick has written down these assets while an agreement with the government is still being negotiated. At that other disappointment, Pascua Lama, Pascua is being wound down and Barrick is looking for a joint venture to share the risk – unlikely at current prices. Nonetheless, we continue to recommend Barrick here for its large reserve base, management and growth plans. • B2Gold Corp (BTO) – Intermediate producer B2Gold had a strong quarter as it brought Fekola in Mali into commercial production.

Otjikoto in Namibia also made a strong contribution. B2Gold will produce 1 million ounces this year at an all in cost about $800, joining the senior producers in terms of output. On a consolidated basis, B2Gold produced 239,000 ounces, which was 16,000 ounces better than budget. B2Gold built Fekola under budget and the mine is a company builder. B2Gold also paid down $75 million on the revolver, which is sitting at $250 million drawn, and there is still $250 million available. Given B2Gold’s growing production profile, long life reserves and experienced record of mine builders, we like the shares here.

Centerra Gold Inc. (CG) – Centerra’s $200 million sale of royalty portfolio salvages the $310 million deal for Aurico over a year ago for which they paid a whopping 38 percent premium. Kemess North was always a tough deal. The latest study by SRK calls for a build-out cost of $600 million to spend with only a 12.6 percent IRR and payback of almost 4 years. The project alone calls for a conveyer belt from deposit to mill over a distance of 6.5 km to go through mountains and tough terrain.

Permitting will be lengthy and financing will be tough. Centerra’s swing for the fences to minimize Kumtor exposure has seen the company acquire Thompson Creek (Mt Milligan) where they are producing gold and copper but at a loss (AISC in last quarter was $1,554 an ounce). Kumtor is stuck in limbo since a strategic agreement with Kyrgyz Republic is in abeyance with a new government. The unsolicited bid by Chaarat Gold may be a squeeze play.

Detour Gold Corporation (DGC) – Detour Gold had a disappointing quarter and disclosed plans for yet another revised mine plan. While guidance was maintained, the company has not been able to produce according to the last mine plan because of operating issues, which adversely affected throughput. Detour produced 150,000 ounces at a grade of 1.17 g per ton and all in cost of $1000 an ounce. However, mining rates were down due in part to the loss of a rope shovel and equipment failures. The usage of contractors also boosted costs. Costs are a major problem at Detour due in part to the low mine grade where there is little room for error. For Detour, it is back to the drawing board and the search for another president. In addition, the expansion of Detour South is mired in negotiations with the Moose Cree, which could take some time. Given the uncertainties, and likelihood of writedowns we remain sellers.

Franco-Nevada Corporation (FNV) – Franco-Nevada is a royalty/streaming company that has just celebrated its 10th anniversary. The “desk and chair” miners have outperformed both bullion and mining shares over that period.

Franco is undergoing, a third generational leadership change, ensuring another decade of success. The players have been important financiers to the mining industry. Franco is making final payments on First Quantum’s Cobre Panama, which will be in production late this year. While royalty/streaming companies have been successes, their valuations remain sky high when compared to the miners they support and while there is less operating risk with the royalty players, the premium paid for that safety is often 4 X times that of a comparable producer. For that reason we have not rated the royalty companies.

Goldcorp Inc. (G) – Goldcorp produced 590,000 ounces in the first quarter at an all in cost of $810 per ounce but output was lower than the first quarter last year due in part to lower output from Penasquito in Mexico. The Pyrite Leach project at Penasquito is almost complete which should revive production, some time late 2018. Cerro Negro in Argentina is also expected to be a key contributor in the third quarter. On an annual basis, Goldcorp will produce between 2.5 million ounces and 2.7 million ounces in 2019. To date, Goldcorp has also achieved about 84 percent of estimated an $250 million in cost savings and optimization. At Eleonore in Quebec, output is finally in line and the company is boosting tonnage to 6,200 tpd at average grade of 5.39 g/t. While Goldcorp shares have recovered, the heavy lifting still must be done with big capex ahead for Nueva Union, Coffee and Norte Abierto. Phase I NuevaUnion capex alone is $3.4-$3.5 billion. Consequently, we prefer Barrick shares whose growth profile is largely from its own reserve base and will not need to spend the mega billions required by Goldcorp. • Kinross Gold Corporation (K) – Kinross had solid contributions from Bald Mountain in Nevada, Fort Knox and Paracatu in Brazil.

Kinross however has $1 billion in cash and $2.6 billion in liquidity with no debt maturities until 2021. Kinross strong quarter was offset by Mauritania's surprise rejection of the key permit to expand Tasiast Sud. This is a major setback since Tasiast was to be a stronger contributor. Also Kinross’ Russian mine exposure (1/3 of assets) was impacted by the imposition of Russian sanctions. First Mauritania and now Russia, so Kinross has taken on a high geographic risk complexion. Kinross’ Tasiast Phase 1 only has $50 million left to spend and tonnage is to increase from 8,000 tpd to 12,000 tpd. To put in perspective, Tasiast I contributed 113,000 ounces at a cost of $751 per ounce. Kinross notes however that since 2010, operating cash flow has been negative $72 million but the company has paid to the government, some $400 million in taxes, royalties etc.

Mauritania had a better deal than Kinross shareholders. Tasiast II might be stillborn anyway. We believe the uncertainties with Mauritania will overhang the shares. We prefer B2Gold here.

Kirkland Lake Gold Ltd. (KL) – Kirkland Lake had exceptional results producing 148,000 ounces in the quarter. Kirkland Lake has a stellar balance sheet and its mines produced free cash flow. The company ended the quarter with $275 million of cash and no debt. Reserves increased 36 percent to 4.6 million ounces at an average grade of 11.1 g/ton, driven by Fosterville. Taylor in Timmins is to be Kirkland’s next producer. Kirkland increased its stake in Nuvo, an exciting high grade exploration bet in Pilbara, Australia. Kirkland Lake also has an exploration program in the Northern Territory of Australia where it has two drills underground. The discovery would be of benefit since Kirkland has infrastructure in the area. We like Kirkland Lake here.

Iamgold Corporation (IMG) – Iamgold had a positive quarter producing 229,000 ounces at $1,000 AISC due to major contributions from Essakane in Burkina Faso and Westwood. Iamgold installed a 15 MW solar power plant at Essakane which is the largest hybrid solar thermal plant in the world. A reserve estimate from Saramacca is expected and the play is to be in production next year. Partner Sumitomo is expected to complete a feasibility study by the first half of next year which allowed Côté Gold’s reserves to be returned do the balance sheet again. Production is planned in 2021 but we are doubtful they will meet that target because continuity plagued the project. Iamgold has a strong balance sheet with $811 million in cash, cash equivalents and short-term investments with only $400 million of long-term debt, not due until 2025. We prefer Agnico Eagle here.

McEwen Mining Inc. (MUX) – McEwen Mining's first quarter saw the construction of Gold Bar in Nevada. Gold Bar will replace declining El Gallo mine in Mexico whose production switched to sulfide from oxides. McEwen will also spend $15 million on exploration at newly acquired Black Fox Complex. In addition, the company will ship ore to the Black Fox Facility.

McEwen will produce 170,000 ounces this year with some production from Black Fox and El Gallo mine in Mexico. McEwen plans to produce 215,000 ounces nest year with output from Gold Bar, Los Azules is for the next cycle as the PEA revealed a 3.6 year payback but a price tag at $2.4 billion. We like the shares here.

New Gold Inc. (NGD) – New Gold surprised the Street with the need for yet another mine plan and disappointment over delays in bringing Rainy River into production. Costs were higher and newly commissioned Rainy River still has teething problems resulting in a loss of $20 million. New Gold produced 97,000 ounces in the quarter. New Gold only has $191 million in cash and $34 million is drawn on the credit facilities but finances are tight. The problem was that Rainy River’s execution was flawed and the mine plan was obviously poorly planned. Given that low grades, tonnage and recoveries were disappointing, costs have been too high. Consequently, New Gold replaced yet another president, appointing Ray Threikeld, the former head of Rainy River and a seasoned executive. Nonetheless, we would avoid the shares until the problems, both operational and financial are fixed. The company has maintained guidance between 525,000 ounces and 595,000 ounces but we are skeptical. Sell.

Newmont Corporation (NEM) – Senior player, Newmont had a strong quarter, spending $600 million on development and building seven projects. The company is building out Northwest Exodus, Twin Creeks underground, and Subika underground later this year. Newmont also advanced Ahafo North in Ghana, Yanacocha Sulfides in Peru (FS) and Long Canyon Phase 2 in the US (PFS). Newmont maintained its guidance for the year and cost profile, guiding between 4.9 million ounces and 5.4 million ounces this year. Cash from continuing operation was $266 million and the company has stellar liquidity of $6 billion. About 70 percent of Newmont's production is located in the United States and Australia but Ahafo underground and Subika in Ghana is questionable given that country's new nationalism and desire for a larger pound of flesh. Newmont has a strong pipeline of projects, free cash flow and a strong balance sheet. The shares are a hold here.

Yamana Gold Inc. (YRI) – Yamana Gold had another loss reflecting the $160 million write down from the spin-off of Brio gold. Yamana’s balance sheet debt load is strained by the $1.6 billion of debt and thus the company has not much room to maneuver. The ramp up of Cerro Moro in Argentina is about 70 percent complete and will produce about 85,000 ounces. We prefer B2Gold here.

Editor’s Note: John Ing is President, CEO of Maison Placements Canada Inc. Mr. Ing has over 45 years of experience as a portfolio manager, mining analyst and investment banker.

Maison Placements Canada Inc. is recognized for providing the highest quality research for emerging growth companies with an emphasis on in-depth analysis instead of the quick synopsis in vogue today. For more information visit www.maisonplacements.com.

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