Gold Stock Bull contributor, Ben Kramer-Miller, covers the 2015 PDAC show for us and offers some great insights into the premier mining convention, plus a few promising stock picks…

PDAC 2015From Monday March 2nd through Wednesday March 4th I had the opportunity to attend the PDAC Convention in Toronto.  For readers who aren’t familiar with this it is among the largest gathering of people in the mining, metals and minerals space in the world, and literally hundreds of companies sent representatives to speak with prospective investors and their peers.

My goal in attending was predominantly to learn as much as possible about two exciting yet misunderstood and esoteric subsectors—graphite and rare earth elements.  While I am heavily invested in gold and related equities I didn’t get a chance to meet with as many companies that I wanted to, including a couple that I own or want to own.

However I did manage to speak with people from three gold companies.  Each of which I think is extremely promising although for different reasons.  These companies include:

  1. International Tower Hill Mines (NYSE: THM) (TSE: ITH)
  2. Lake Shore Gold (NYSE: LSG) (TSE: LSG)
  3. Rye Patch Gold (OTCQX: RPMGF) (TSE.V: RPM)

Those readers who follow my writings on Seeking Alpha know that I have written extensively about all three companies.  I am extremely constructive on all of them even though I would argue that Lake Shore Gold’s share price has gotten ahead of itself.

In what follows I want to give an overview of my experience at PDAC.  I will then discuss the three companies above and explain why I think they are all compelling choices even though International Tower Hill Mines and Rye Patch Gold may be too risky for some GSB readers and even though Lake Shore Gold might be a little pricey at $0.84/share.  Finally I want to discuss a graphite company that I think GSB readers should consider—Flinders Resources (OTCQX: FLNXF) (TSE.V: FDR)—which is not well known to many investors but which has a completely different approach to an industry that in many respects has failed to differentiate what could be from what is.

An Overview of PDAC

One of the first things I noted when coming to PDAC is that attendance was way down relative to last year.  I didn’t do a head count but was told that ~16,000 people attended vs. nearly twice that last year.  This reflects the fact that we are in a bear market in the mining space.  While this is disappointing I am encouraged by this apathy, as it makes my bullish stance on gold and several other commodities appear to be more realistic in my contrarian mind.  As I’ve written on GSB in the past I think gold could fall further, but that the risk is definitely to the upside.  Jason and I have respectfully disagreed on this point and since that article was published the gold price is down about $30/oz.

In speaking with the aforementioned three teams I got the impression that the gold bear market is tired, although no one was so bold as to claim that the market had bottomed or that they saw more downside ahead.  Everybody was confident that gold would move higher eventually.  Most importantly, however, is that none of the three companies mentioned actually needs the gold price to rise in the near-term.  Lake Shore Gold is by far the most leveraged of the three but it is also one of the lowest cost producers in the industry, and given that its operating costs are in Canadian Dollars any gold price weakness has been more than offset by CADUSD weakness.

Before moving on to other discussions I had I think this point needs to be emphasized: as a long term gold investor I want leverage to the gold price (that’s why I like miners) but I also don’t want to lose my shirt if the gold price has more downside.  Investors should therefore seek out investments that make sense even in both scenarios.  They are few and far between but they can be found, and I will explain why the three companies mentioned here are excellent candidates.

As previously mentioned I spent a lot of time speaking with people in industrial minerals and metals—graphite and rare earth elements in particular.

Graphite is an exciting opportunity because graphite is a key input into lithium ion battery anodes, and with batteries being put in electric cars and even in homes this market has an incredible amount of potential moving forward.  There is also steady, cyclical demand in the steel refractory sector, which at this point in time is the market’s largest source of demand.  Graphite executives were largely divided on how to manage their companies.  Some are operating on the assumption that the battery market will generate so much future demand that they are building their businesses on this premise.  Others are operating on the assumption that while these are great opportunities they may be slower to develop than the bulls are anticipating, and this means that the best way to develop a graphite company is to focus on existing markets.

The rare earth element (REE) space is probably the most difficult considering how far prices have fallen from their peaks.  Prices of key REEs have fallen some 85% – 90%, although the decline seems to have abated for now.  Nobody in the space believes that the current  low prices are sustainable.

Like with graphite the people who I spoke with in the REE space were bullish but there is a clear divide in how to best approach the space.  The primary issue with REE mining companies is that these elements are extremely similar to one another chemically, and this means that separating them from one another is difficult and costly.  On the one hand there is a proven method—solvent extraction—which is proven but which is expensive and labor intensive.  It is also not environmentally friendly and therefore can be difficult to permit.  As a result some companies feel that it is worth investing in new technologies.  The difficulty is that these technologies can’t just magically be developed.  It takes a lot of time and money in order to even try.  So in my discussions with REE executives I was either told that such and such new technology is going to be the next big thing and will supplant solvent extraction, or I was told that while it is great to find new separation methods it makes more sense to base a business on proven techniques is the right way to go.

So ultimately everybody who I spoke with at PDAC is bullish on whichever commodities they have in the ground, but they are operationally very different.  As an investor you have to decide which risks are most appropriate for you because there isn’t necessarily a right side to any of these debates.

With that being said this is ultimately a blog aimed at gold bulls, so let’s look briefly at the aforementioned gold companies and what I was able to take away from the talented people who run them.

International Tower Hill Mines

If you are looking for raw leverage to the gold price this is the way to go.  The company’s Livengood project has 20 million ounces in the ground including nearly 15 million ounces of proven and probable reserves.  This number may be higher as a follow-up analysis of some assay results indicate that ore grades may be meaningfully higher than initially thought.  Despite this massive deposit ITH has a valuation of just $47 million fully diluted even though the company has ~$13 million in cash.  That means the company’s gold is being valued at less than $2/oz.

Why is this?

In 2013 the company put out a feasibility study in which management revealed that the project requires much higher gold prices in order to be attractive.   If you count capex and opex the company’s total cost to get an ounce of gold out of the ground is nearly $1,500.

At the beginning of 2014 the current CEO Tom Irwin was approached by general manager Karl Hanneman, who convinced him to come out of retirement.  Irwin saw incredible opportunity here beyond just gold price optionality.  Since last year management has been working towards optimizing the project and in January the company revealed that it is chipping away at the high capex/opex figures.  ITH isn’t there yet but they are certainly moving in the right direction.

Tom and Karl are highly experienced in Alaska’s mining industry—I don’t know of a duo with more experienced as specialized as this.  Not only are they experts in mining but they have strong community ties and a concern for the local environment (being locals themselves) that will ensure that this project is both environmentally sound and permitable.

Given their experience Tom and Karl have no delusions as to what needs to be accomplished.  They know that this is an uphill battle.   The project needs to be improved significantly and it is natural to question whether or not this is possible.   It is difficult to look at the numbers put out in 2013 and the numbers put out in the January press release while coming to the conclusion that this will be a mine at $1,200/oz. gold.  So the stock is a long-shot because optimization can only go so far.

But the market is pricing this in along with the current gold price.  If you start looking at the incredible amount of gold price optionality—which can generate incredible returns—with the potential to see lower costs as another form of optionality, fostered by a highly qualified team, one can see incredible potential in this stock.  For instance with the bad feasibility study and gold trading near its 2011 peak—say $1800/oz. the project has an NPV at 5% of over $700 million.  If the project trades at just 0.2X its NPV the stock can more than triple on a 50$ rise in the gold price.  But if the cost of production falls by $200/oz. from the original ~$1,500 it would be similar to a rise in the gold price to $2,000, which doubles the NPV.  That’s a ~7-fold increase on a 50% gain on the gold price, which is incredible leverage.

Lake Shore Gold

Lake Shore Gold is currently a low cost gold producer with close to 200,000 oz. of annual production at its Timmins West and Bell Creek Projects, both of which are located in the Timmins Gold Camp in Ontario.  This region of Ontario is home to several gold deposits and Lake Shore Gold has found several on its property.  The company’s most recent discovery shows that there is a similar deposit to its Timmins West Deposit just a few hundred meters away, and the company can easily grow production assuming that this new deposit—the 144 Zone—does in fact parallel the Timmins West Deposit.

More generally Lake Shore Gold is confident that it will find several similar underground deposits on its property, and if this theory is true there could be numerous mines in the area which are producing at relatively low costs.

Lake Shore Gold had a phenomenal 2014 despite gold price weakness.  Not only is it making discoveries but it brought its production costs down considerably along with its debt load.  Furthermore the company is comfortably profitable at current prices.  At 10X cash-flow the company appears to be inexpensive and it isn’t in danger if the gold price falls from here.

There are a couple of risks, however, but before I mention them keep in mind that I think they are relatively mild and that I think the long term prospects for this company are excellent, especially given the encouraging exploration results we’ve been seeing.

First, investors have flocked to the stock over the past year and a half and the stock has risen 6-X from its lows.  I think a lot of the smart money buyers are sitting on enough profits so that profit taking makes sense.

Second, the company doesn’t have a large reserve base.  There isn’t a large chance that the company runs out of reserves but if it does it could do so fairly quickly.  I don’t think this is priced into the stock, which is currently assuming substantial reserve expansion or even production expansion from here.

Third, the company has very little room to improve after what we’ve seen in the past 18 months or so.  Costs are down and production is up but I don’t think we can see this on a large scale in the near future.

But given these points this is a company that is extremely well positioned to generate cash-flow leveraged to the gold price with long term growth potential and a margin of safety that I think is valuable in this market environment.  Given these points investors should consider putting the stock on their radars, but I wouldn’t buy it just yet.

Rye Patch Gold

I think Rye Patch Gold more than any other junior miner encompasses everything investors should look for in such a company.  It has cash, cash-flow, quality exploration assets at various stages of development including a late stage asset with a PEA and low initial capital costs, projects located near a massive gold mine—Barrick’s (ABX) Cortez Project—assets in Nevada, and an experienced geologist at the helm in Bill Howald.  They are all quality assets and with no other company do I see this combination that serves to mitigate risk in virtually every way imaginable.

Rye Patch Gold is an exploration company that realized that it makes sense to have a small project and to generate cash-flow.  The company was lucky in that it was awarded a ~4-year 3.4% NSR royalty on Couer Mining’s (CDE) Rochester Project adjacent to the company’s Oreana Trend Projects.  This means the company can operate a very aggressive exploration program for a $16 million market cap company with ~$5 million in cash.  The value of the cash-flow from the Rochester Royalty exceeds the company’s ~$11 million NEV.  But the company also has ~3 million gold equivalent ounces including a starter project at its Lincoln Hill Property that is economic even if the gold price falls.

The company also has exploration assets that are less further along such as the Cortez trend assets.  These are located near Barrick’s ~15 million ounce project and other major discoveries.  Early efforts are very promising and now the company can explore further without diluting shareholders.

Essentially you’re getting more cash plus future cash-flow than the company is currently worth, 2 proven exploration assets with solid resource estimates, project’s adjacent to these, and projects adjacent to some of the biggest ever gold discoveries in North America.

The company is so inexpensive and there are so many ways in which the stock can rise that the risk/reward easily overtakes the exploration risk.  In my discussion with Bill Howald he told me that as a geologist he is more enticed by the exploration promise at Cortez than the existing deposits, which are already sizable relative to Rye Patch’s miniscule valuation.  Maybe he is wrong, and if he is the stock could flounder even if current assets set a floor that I think should be much higher than the current price.  But if he is right this stock can make multiples on your money at today’s prices, especially if you think that the gold price will rise.

Flinders Resources

While GSB is geared towards gold investors I wanted to write something about my favorite non-gold idea from PDAC, and that is Flinders Resources.  Flinders Resources is a little known company in the graphite space.  Unlike its peers it does very little marketing and is not concerned about producing battery grade graphite or graphene because its top priority is generating cash-flow.  This is one of a small handful of western traded graphite companies that will generate cash-flow in 2015 because its Woxna Project in Sweden just began production.  The company is selling small amounts of graphite but it is expanding its market even while its peers struggle to get financed.

The company’s goal is to produce and sell graphite…plain and simple.  But this strategy, which is so basic in its structure, is overshadowed by promises of fortunes by companies trying to sell to the battery market.  Flinders’ peers are all battling to get funding for projects that are simply massive in scale.  They are also predominantly in North America were the current market is just over 60,000 tonnes per year.  By comparison Focus Graphite (OTCQX: FCSMF)  (TSE.V: FMS) wants to produce ~40,000 tonnes, Mason (OTCQX: MGPHF) (TSE: LLG) wants to produce nearly 50,000 tonnes, and Northern (OTCQX: NGPHF) (CVE: NGC) wants to produce 20,000 or 40,000.  These companies need demand to grow so that they can sell as much graphite as they want to, and this means that aggressive battery market growth targets need to be met.

In speaking with representatives of these three companies they jump at the opportunity to brag about how fast battery demand is growing and how substantial it will be in just a few short years.  But what happens if we don’t see this?  What if the Tesla giga-factory isn’t built until 2020 and electric vehicle demand doesn’t grow as quickly as proponents of the technology would like?  While every graphite company wants to see this rapid demand growth basing a business model on such an assumption can be very risky.

Blair Way—CEO of Flinders—certainly likes to talk about these opportunities, and he is familiar with them, but his primary goal is to sell graphite, and that means targeting existing markets and customers.  This may have led to market apathy—the company has a lower value than those that own the mega-projects—but I think long-term the market will reward this strategy.

Where do batteries and the exciting new applications of graphite fit into the Flinders story?

Flinders may not yet be openly experimenting with spherical graphite or other products used in new technological applications but at the same time it has the raw material and the means to produce it (it has ~$6 million in cash).  This means that should a company need spherical grade graphite Flinders will be in a position to sell it immediately after testing its process.  The same company might have to wait 3-5 years for Flinders’ peers to get into production.

Furthermore Flinders has the only producing graphite project in Europe.  Investors should note that shipping graphite is relatively expensive and this means that local mining companies are competitors  when in most other commodity spaces they are often allies allies.  Flinders doesn’t have such competition.

Finally Flinders doesn’t have to deal with permitting or financing, which have caused problems for other graphite companies, and which is a significant risk for mining companies generally.

So if the graphite story plays out as the bulls see it I can definitely see how a Focus or a Mason will outperform Flinders given their ambitious production targets vs. their valuations.  But at the same time Flinders will be in a position to benefit as well while it can also succeed in a more tepid growth environment.  At the current valuation of just $15 million I see very little risk in owning Flinders right now, and for this reason I have made it my top non-gold PDAC pick.

Final Thoughts

The past couple of years have been difficult for the mining industry, and unfortunately there is no evidence that this is about to change in the near future.  Commodity prices continue to melt lower as the Dollar moves higher and money keeps finding its way into commodity consumers rather than commodity producers.  But this won’t be the case forever and now is the time to begin to position yourself for the next upturn in the commodity cycle.  I have provided readers with three gold ideas that appeal to people with different tolerances for risk and an industrial minerals company that I think offers compelling risk/reward relative to its peers.  These stories might not play out as I hope they will but they all appear to be compelling investments based on the numbers, the stories their management teams tell, and the qualifications of the people involved.

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Disclosure: Ben is long Rye Patch Gold and Flinders Resources

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