Well, it looks like another company included in my Top Five Picks Portfolio, Newmarket Gold, is going to leave this portfolio. This time it is due to a merger with Kirkland Lake, an excellent, high-profile miner.
I will deliver a comment on this agreement in my second issue of the Simple Digressions Newsletter at the end of this week.
For the time being - here is what I see as the biggest synergy embedded in that deal:
source: Google Maps
It should take around 5 minutes to go from Royal Bank Plaza, Toronto (the office of Mr. Sprott, one of the biggest shareholders of both companies) to 95 Wellington Street (the office of the combined, new company). On foot!
According to Rappler, Filminera Resources Corp, a company which owns the Masbate Mine in Philippines, is among 20 mining companies recommended by the Philippines environment officials for suspension.
B2 Gold holds a 40% stake in Masbate through Filminera so it is Filminera that should be followed by B2 Gold shareholders (me included). Well, although the mine has not been suspended yet, it is on the list (together with Oceana Gold and other, mainly nickel-related companies).
Both stocks are crashing now:
Well, shit happens....as Lou Bega sings...
The story is developing and here is what I have found:
"Based on the reference to the three findings indicated in the brief received today and based on our subsequent meeting with the Secretary of DENR, B2Gold is confident that these issues will be resolved by working with the government agencies, in the time frame provided.
None of the findings involve any environmental or social issues. They are related to administrative issues only.
Meanwhile operations continue uninterrupted and guidance remains unchanged.
The company awaits formal notification from the Mines and Geosciences Bureau (MGB) and details of the Show-Cause Order"
Well, well, let us see but maybe today's B2 Gold share prices crash was a nice buying opportunity...
In one of my last posts I spotted divergence between the silver / gold ratio and the gold itself. In conclusion I stated that there was a chance for higher prices of gold because such a pattern (silver / gold ratio going up) was an indication of an incoming reversal in the gold trend.
Today the pattern materialized:
The line marked in red shows the downward trend in gold prices accompanied by the line marked in green (the upward trend in silver / gold ratio). Divergence may be easily spotted.
Then, today, both metals exploded (gold gained 1.5% while the price of silver went up by 2.7%). Of course, some may say it was due to no hike in interest rates. Maybe they are right - I do not know what factors were driving prices today. All in all, the facts are clearly visible - we have seen higher prices of gold and silver.
Now, I think that the ultra short term players should closely watch what happens tomorrow, the day after today's enthusiasm.
Lastly - I want to remind my readers that the first issue of my newsletter should be dispatched at the end of this week. Those interested, please, subscribe. It is free.
It seems that huge volumes reported on Friday had nothing to do with changes among shareholders, at least as far as US exchanges are concerned. I have checked other miners and the results are as follows:
- B2Gold - 94.4M shares changed hands (10.1% of shares outstanding)
- Gold Resources (GORO) - 3.9M (7.1%)
- First Majestic (AU) - 27.1M (16.7%)
- Coeur (CDE) - 37.1M (22.9%)
- Hecla (HL) - 73.2M (19.0%)
- IAMGold (IAG) - 32.5M (8.0%)
etc.
So it was a too-early-alert. One of my readers commented on this event and he was right. It looks that these huge volumes were due to GDXJ rebalancing issues. It means that no changes in shareholders structures are expected.
Yesterday I published a post on huge trading volumes reported by Richmont Mines and Newmarket Gold, two stock picks I am closely following. Below you will find the final closing volumes, which were substantially higher than initial ones (posted yesterday):
Richmont (volume accounting for 28.6% of share count):
and Newmarket Gold (volume accounting for 20.7% of share count):
Now, as one of my readers noted, we are waiting for the info about changes in the shareholders line-up.
Today Newmarket Gold went slightly up (+1.19% on TSX) on huge trading volume of 19.3M shares:
source: www.stockcharts.com
or
source: Toronto Stock Exchange
To remind my readers - at the end of June 2016 Newmarket had 177.7M shares outstanding so today's volume accounts for 10.9% of total share count.
Definitely there was a big change among Newmarket shareholders. Expect the info soon.
The similar situation was at Richmont Mines - on AMEX as many as 9.3M shares changed hands (15.1% of shares outstanding). Well, well, the boys are playing big game...
As you know I am not a fan of a typical technical analysis but sometimes a little bit unorthodox approach delivers interesting signals. Look at the chart below:
The chart shows the well known relationship between gold and silver (lines marked in black). Generally, when gold goes up silver goes up even more. And vice versa - when gold goes down silver falls even faster.
When the pattern breaks, be careful because something bigger may develop soon.
The chart above shows such a case. In middle August 22, 2016, although gold was still in its downward trend (downsloping line marked in red), silver started to show its strength (upsloping line marked in green). Shortly after gold renewed its upward trend.
Since September 12, 2016 the same pattern has been drawn. Although gold is going down at the moment, silver is stronger than gold. The chances for higher gold prices are higher now...
Yesterday Newmarket Gold announced drill results from 17 drill holes at Harrier South gold system at its flagship property, Fosterville. This announcement was supplemental to another announcement published in July 2016. Generally, the company is trying to convert resources attributable to the Harrier zone into reserves.
Let me show a map presenting where the main Fosterville gold systems are:
source: Newmarket Gold
To date, the company was mining at three zones: Central, Phoenix and Harrier.
Now, as it is common practise, when a miner wants to find new gold it starts from the current operations (brownfield exploration). Newmarket is no exception and the company drills at Phoenix and Harrier zones at the moment.
Drilling results I am talking about were delivered at the Harrier zone. According to the last mineral base estimates (as of December 2015) the Harrier Zone was holding:
- measured and indicated resources: 497 thousand ounces of gold
- inferred resources: 230 thousand ounces of gold
Measured and indicated resources comprised also mineral reserves. However, these reserves were close to nothing (just 5 thousand ounces).
And that is the point. Newmarket wants to convert resources into reserves. Hence, drilling campaign at Harrier (look at the map, a rectangle on the left).
So, what about these drilling results. Well, it looks like the deeper the drill goes the higher grade of the ore.
Let me cite the company CEO:
“We are pleased to report continued positive results from our underground delineation drilling program in the Harrier South gold system at our flagship Fosterville Gold Mine. In addition to our successful advancement of the Phoenix and Lower Phoenix delineation and expansion drilling programs, we have been able to progressively advance additional high potential Mineral Resource targets at Fosterville. The most recent drill results into the Harrier South gold system have delineated a high-grade zone of visible gold mineralization on the Harrier Base structure and reaffirm an increasing grade profile with depth. We intend to continue drilling with two rigs for the remainder of 2016 to further explore for Harrier South Mineral Reserve expansion opportunities”.
Up to date Newmarket has drilled 74 holes totalling 20,793 metres. And that is not the end of this campaign. However, the market reaction on these results was quite enthusiastic but, to be honest, it is too early to celebrate. Let the company to go on drilling and...celebrate a little bit later.
One of my readers has asked me about the current situation in the precious metals sector. Let me show three charts:
Chart 1
Chart 1 shows the relationship between junior miners (GDXJ) and big miners (GDX). In my previous articles I was claiming that during a bull market in gold GDXJ should be stronger than GDX. Try to assess what trend you see.
Chart 2
Chart 2 shows the relationship between big miners (GDX) and the gold itself. Generally, bull market in gold is supported by big miners being stronger than gold (it is called leverage). The circle marked in black shows that the upward trend has been broken. Now the question is: did this relationship entered the downward trend?
Chart 3
Chart 3 shows the relationship between silver and gold. I believe that during a bull market in gold silver outperforms gold. Try to assess what trend you see.
Note on Technical Analysis
As my readers know I am not a fan of Technical Analysis. Signals generated by this sort of analysis are always delayed and may distract investors from real issues. And the real issue, always, is the value of any company.
What is more, when I was young Technical Analysis was the main tool I was using in my investment decisions. I have to tell you - in most cases these decisions were totally wrong. Now this kind of analysis is just a minor supplement to the tools I am using.
It looks like precious metals stocks (represented by GDX) do not track gold anymore. Look at the chart below:
The chart shows the US broad stock market (represented by the S&P 500 index) and GDX. Both charts are positively correlated which means that GDX behaves like S&P 500. To give my readers a bigger picture - today gold is down 0.3% but GDX, following S&P 500 (dropping 1.6%) is down 4.1%.
Well, it is not a nice picture for gold bugs. In the ultra short - term perspective precious metals stocks do not offer any value.
Generally, gold itself is considered as a safe heaven. When there is a mess in the broad stock market the demand for gold rises. Gold stocks should follow the gold itself. Now, this rule does not work and gold stocks are going down together with regular stocks.
As usually, I do not have any idea why the market behaves in that way. However, if I were to comment I would say:
It looks like precious metals stocks are in weak hands now. Therefore those betting on the continuation of the upward trend in gold should...forget about these fluctuations. Weak hands must go empty handed. Then the prices of precious metals stocks should renew their march up, no matter what the broad stock market does.
Today Richmont Mines announced a positive revision to its 2016 operating guidance. The company expects much better performance of its flagship property, Island Gold.
The table below evidences new estimates:
source: Richmont Mines
Having this data, I have calculated the estimated EBITDA to be delivered in 2016. The table below summarizes these calculations (all figures are in thousands of Canadian dollars):
source: Simple Digressions
Before I go on, let me list basic macroeconomic assumptions:
- the average price of gold: US$1,279 per ounce
- exchange rate between C$ and US$: 1.315
As the table shows, in 2016 the company should deliver an EBITDA of C$50.7M (an increase of 58.4%, compared to 2015). Till that moment all things look fine.
However, there is a problem. In 1H 2016 Richmont reported the EBITDA of $29.9M so it looks like the second half of 2016 should be weaker than the first one. The table below compares 2H 2016 (estimate) to 1H 2016 (actual):
Well, despite higher guidance, the second half of 2016 is going to be definitely worse than the first one. What is more, in 2H 2016 Richmont expects higher cash cost of production (an increase from C$848 in 1H 2016 to C$1,000 in 2H 2016), which is quite a big negative surprise for me.
Summarizing - the management is confident that things are fine at Richmont. And, in my opinion, they generally are. If the company meets its guidance, at the end of 2016 its shares should trade at an EV / EBITDA of 14.4 (if share prices do not change). It is not an elevated figure and I would say that these shares are fairly priced today.
However, due to the fact that the second half of the year is going to be weaker than the first one, I cannot say Richmont shares offer a significant upside at the moment.
It is not common knowledge that there are big changes in US silver and gold markets. Simply put, small speculators are species in danger of extinction.
Let me show these two charts:
source: Simple Digressions
Lines marked in red show the downward trends in the number of positions held by small speculators. Although the outflow of small players is less obvious in silver futures, it is rather distinct as far as gold is concerned.
It looks like small speculators are getting out of gold / silver futures and the question is: "Where are they?". Any ideas?
In its last presentation, Major Drilling enclosed the following chart:
source: Major Drilling presentation (slide 15)
The chart tries to evidence that since 2012 gold reserves (held by the biggest, unspecified world miners) have been declining. I think it is only a half-truth.
Le me explain. There are three main factors, which have a huge impact on the way each mining company calculates / updates its gold reserves:
- depletion
- price of gold
- costs of production
Depletion is the main reason reserves go down. A mining business is a finite one - if a miner is not able to replenish its mineral base it has to close down. It is only a question of time.
However, the other two factors are less obvious.
Generally, reserves are that part of the mineral resource, which is economically viable. When gold prices go down some parts of a deposit may become non-viable. For example, lower grade parts of a deposit may be totally uneconomic to extract. Hence, reserves go down (those uneconomic gold ounces disappear from the reserve).
The same with costs of production. For example, if oil prices go up so does the price of diesel oil, which is the main source of energy in open pit mines, especially those located in remote areas. In such a case some parts of a deposit may be economically non-viable, which results in cutting the reserve estimate.
The chart presented by Major Drilling does not take into account these factors (price of gold and costs of production). Although the company is right that reserves went down we have to know that part of this decrease was caused by two less obvious factors discussed above.
When prices of gold go up the reserves may also increase. In other words, when at the end of 2016 gold stays at, say, $1,400 per ounce, many companies may find additional ounces of gold out of nothing. I am writing "out of nothing" but I mean those ounces, which had disappeared before due to lower gold prices. Those ounces did not go nowhere - they are still in the ground waiting for higher prices.
As for costs of production - well, keeping in mind that in the long-term mining companies have a tendency to increase these costs I am not optimistic (any increases of reserves due to lower costs are rather impossible).
Summing up - provided that gold prices continue their march up, I think that it is highly probable to see higher gold reserves. What is more, this increase will have nothing to do with new discoveries. Going further - such an increase should have a negative impact on drilling companies (lower demand for their services due to the increased mineral base).
Major Drilling is one of the biggest world drilling companies. The company:
- sells its services mainly to gold miners (51% of 2016 revenue was attributed to these customers)
- is focused on specialized drilling - as much as 55% of the company's revenue belongs to this kind of drilling
- main customers are senior and intermediate miners (85% of revenue)
What is specialized drilling? The company explains:
source: Major Drilling (slide 7)
Well, generally Major Drilling expects that in the coming years, due to depletion of the more easily accesssible deposits, mining companies will have to shift their interest to the remoted and technically more complex deposits. That is why the company wants to be the world largest provider of specialized drilling services.
A few days ago Major Drilling released its 2Q 2016 results. To be honest, these results were not impressive. It seems that the company is still facing an industry slump. Although there is some improvement in the precious metals industry (compared to the beginning of this year) the results delivered in 2Q 2016 show that we are still at the beginning of a new leg up in the gold cycle.
The table below summarizes a few basic financial and operating measures:
source: Simple Digressions
Despite these poor results, the company's shares are trading at quite an elevated multiple EV / EBITDA of 34.4 (calculated at the current share price of C$7.15). Somebody could even say that Major Drilling shares are substantially overvalued. Well, I do not think so.
Major Drilling, similarly to the entire precious metals industry, is a cyclical company. It means that its results fluctuate - during good times the company delivers excellent results and during a slump it prints losses or hardly breaks even. In my opinion, to find a fair value of any cyclical company the analyst has to look at historical measures delivered over the gold cycle.
Let me show it, taking "Revenue per rig" and "Margin" as the examples:
source: Simple Digressions
The table shows that during the entire gold cycle (2008 - 2016) in 2012 the company reported the highest revenue per rig (C$1,100 thousand). The lowest value was reported last quarter (C$408 thousand per rig). The average reading over the entire cycle was C$736 per rig. The chart below summarizes all these measures:
source: Simple Digressions
Now, margins (defined as (revenue - direct costs) / revenue) depend on the point of time where the cycle is. For example, when things are fine the demand for the company's services is high and margins are high as well. The highest margin (33.6%) was recorded in 2009, at the beginning of the cycle.
On the other hand, when things are bad so are the margins. The lowest margin (21.6%) was recorded in 2015 when mining companies were cutting their exploration spendings.
However, over the cycle the average margin was 27.5%.
Now, taking these average measures (revenue per rig and margin) as fair measures I may find the fair value of the company's shares.
The table shows my calculations:
source: Simple Digressions
Note: general and administrative expenses and other expenses are calculated taking 2Q 2016 figures multiplied by 4
Now, as the table shows, using the average cyclical measures and the current rig count (678 rigs), the company would deliver the average EBITDA of C$91.7 million.
With such EBITDA Major Drilling shares are currently trading at a EV / EBITDA multiple of 5.9. It is much lower value than the multiple calculated using today's depressed measures (34.4).
So, in my opinion, these shares are not vastly overvalued as it could seem.
Eric Sprott, a notable Canadian investor, has been one of the heavy buyers of precious metals stocks during the ongoing bull market in gold. However, sometimes he stands also on the other end of the market.
Yesterday Newmarket Gold published the info that between July 4 and September 2, 2016 Mr. Sprott sold 3.67 million shares of the company.
After this transaction Eric Sprott owns 26.69 million shares of Newmarket Gold (15.0% of shares outstanding). The graph below shows main shareholders of the company, as of September 6, 2016:
source: Simple Digressions
What does it mean? Well, I had many times noted that it was not a good idea to copy the notable investors. In many cases we do not know what their intentions are. As for Mr. Sprott - despite his long - term view on investing, sometimes he becomes a trader.
My theory is that he, seeing his stocks appreciating strongly and quickly, sells part of his portfolios to invest in other stocks. Essentially, he is full of investment ideas.
Summing up - although Mr. Sprott had slightly decreased its stake in Newmarket Gold he still owns a large holding in the company. In my opinion, Mr. Sprott plays his own game and this game has nothing to do with the company's fundamentals. These are still excellent.
On August 31, 2016 Aurcana published the Preliminary Economic Assessment for The Shafter Mine. Unfortunately, the announcement disclosed only basic metrics but the figures announced were, in my opinion, quite poor (keeping in mind at what prices Aurcana shares are trading today).
Let me present the main economic indicators:
source: Aurcana
All measures were calculated assuming the price of silver of $20 per ounce over the life of the project. It means that Shafter is not an option on prices of silver, which is good (today silver trades around this value).
The project presents an after - tax net present value of $18 million. I think that the discount factor applied by the company (5%) is too low but...let it be.
Now, according to 2Q 2016 balance sheet, at the end of the last quarter the company was holding cash of $1.1 million. There was no debt. It means that Aurcana's equity is worth $19.1 million (the project's NPV of $18M plus cash of $1.1M). At today's share count of 169 milion, one share of Aurcana is worth $0.11.
Further, on September 2, 2016 Aurcana shares were trading at $0.46 a share so it seems that these shares are substantially overvalued.
Summarizing - although the project's parameters look good (high after -tax internal rate of return of 40.9%) the overall figures are not impressive when compared to the current share prices. Therefore:
- decent project's economics should help the company to find financing sources to start the Shafter construction
- current share prices are not supported by the project economics.
Finally, Aurcana should publish the Shafter PEA within 45 days. When it is online I will look at it once again.
In August 2016 GLD reported a high outflow of gold from its vaults:
source: Simple Digressions
As the chart shows, as many as 477.8 thousand ounces of gold went out of GLD. It was a similar amount to that reported in April, when 486.8 thousand ounces left GLD.
Now, a distinct difference. In April, although gold was leaving GLD, GLD price went up. In August, a drop in GLD price was accompanied by an outflow of gold.
Now, let me present another chart. This time it shows the weekly in / out flows:
source: Simple Digressions
Note that in July and August, every time there was an outflow of gold (bars marked in red) next week the price of GLD stayed relatively unchanged.
However, most recently red bars are followed by a weakness in gold (and GLD) prices.
This situation is still intact. Last week there was another substantial outflow of gold from GLD (601.1 thousand ounces).
Now, a small sign of an incoming change. The last-week large outflow of gold was not followed by lower GLD price, which may be an indication of a renewed upward trend.
This thesis is supported by the following two technical charts.
The first one shows the golddollar index:
source: www.stockcharts.com
Most recently this index diverged from its gold equivalent (look at red lines). Such divergences occur when the trend (short, medium or long-term) is going to reverse.
Another chart shows the well - known silver to gold ratio. To remind my readers, during a bull market in gold it is silver that is stronger than gold. The chart shows that this relationship has been trending up since early March 2016. It looks like a few days ago we started another leg up in the current bull market cycle:
source: www.stockcharts.com
Since their peaks, established in August 2016, precious metals stock prices corrected significantly. For example, GDX fell 19.8% and GDXJ 20.3%. There were stocks, which dropped even more:
- Goldcorp: 24.2%
- Richmont Mines: 26.9%
- B2 Gold: 28.3%
- IAMGold: 37.0%
- First Majestic: 37.2%
just to name a few big ones.
Although the correction is still intact, I think it could be interesting to look at current valuation metrics. Below I present the chart showing a multiple of EV / EBITDA (enterprise value to EBITDA), calculated for a number of mining companies as of August 31, 2016:
source: Simple Digressions
The average multiple stands at 13.7 (horizontal line market in red). As the chart shows, the highest multiples are mainly related to silver miners (Impact, Endeavour Silver, First Majestic, Fresnillo, Fortuna etc.).
The lowest multiples are attributed to big miners (Barrick, Newmont, Yamana), companies in trouble (Orvana, Banro, Kinross) or forgotten miners (Dundee, Oceana Gold).
I guess some investors, in their search for hidden value, may consider buying the stocks showing a low multiple because, generally, low multiple means a cheap stock.
Well, generally, yes. But be careful. Sometimes a high multiple is attributed to a company presenting buying opportunity and, vice versa, low multiple means problems and investors should stay away from such a "cheap" stock (for example, Orvana Minerals, Banro Corp or Hochschild plc).
I think I will discuss some interesting cases of miners with high or low multiples soon.
Now, let me summarize the current situation in the following way:
After an impressive bull run in gold / silver stocks (seen in 1H 2016), the ongoing correction presents a number of buying opportunities. Once again.
