Joe Mazumdar is the Director of Research and a Senior Mining Analyst at Canaccord Genuity Inc. here in Vancouver. He has a particularly interesting perspective on the mining sector, having spent the majority of his early years at large companies including: Mount Isa Mines (Australia), Rio Tinto (Argentina), Phelps Dodge (Phoenix, USA) and Newmont (Denver, CO) where his last position was as the Director of Strategic Planning. Joe has been a sell-side analyst for over four years now (with Haywood Securities for 3 years prior to Canaccord).
I had a chance to sit down with him recently in Canaccord Genuity’s downtown Vancouver offices.
The GDXJ Index:
Joe was keen to speak to me about the GDXJ Index which has become somewhat well known in the investment community for benchmarking the performance of junior precious metals equities.
The GDXJ, Joe tells me, is an ETF whose objective is to replicate the performance of the Market Vector’s Junior Gold Miner’s Index. The Index is composed of junior mining companies whose flagship assets derive their value from precious metals (86% gold, 14% silver) and where the majority are considered producers (>70%).
The majority (80% by weight) of the companies within the GDXJ are Canadian-listed and have a market cap below CAD$1 billion. Only 15% of the companies fall below the CAD$200 million market cap level. The flagship assets of the companies held within the GDXJ are primarily located in the Americas (55%), with the next important geographic centers being Asia Pacific (24%) and West Africa (15%).
GDXJ provides the most realistic measure of performance for the junior gold space (currently).
“It (the GDXJ index) is the best proxy as it's liquid, rebalances quarterly and is geopolitically diversified,” the senior analyst explains.
Joe benchmarks his precious metals picks (which include: Asanko Gold, Castle Mountain Resources, Dalradian Resources, Golden Queen, Goldrock Mining, Midway Gold, Orezone, Roxgold, among others) against the GDXJ and looks for companies that can provide asymmetrical returns.
“We look for names that do at least as well as the benchmark on good days but outperform the benchmark on bad ones,” says Joe.
He says the stories that offer the best asymmetrical beta (returns relative to changes in gold price) are funded, permitted, near-term producers because they have a floor value that reduces the possibility of them going to zero.
While Joe likes names with asymmetrical betas, he was quick to decipher between betas and leverage.
“The company’s beta to gold is the actual percentage change in the stock relative to a 1% change in the gold price, whereas leverage is more theoretical,” Joe explains. “Leverage to gold is the change in the valuation in a changing gold price environment.”
There are companies that provide leverage as an ‘out-of-the-money’ option on the gold price because they have the liquidity to deliver a high beta. Those without the liquidity do not offer the beta despite having projects with high gold leverage.
The issue with some companies that have high betas is that the underlying project may not attract financing due to its marginal economics or a red flag (permitting, geopolitical, remote, among others).
The asymmetry is derived by selecting the companies with capable management teams with relevant experience to advance their higher quality projects that are proximal to infrastructure with low execution and technical risk.
“We are seeing the generalist funds playing the high beta gold names, and even the far out of the money options which offer the highest betas, in order to gain alpha-like returns in the short-term versus trading physical gold,” Joe tells me, “They tend to be attracted to liquidity and geography over management, execution and technical risk.”
In his opinion, the gold space is in worse condition than it would appear if you look at the GDXJ or the select high-beta gold names.
“Where some these names are trading and the price level they can get financed at, if they could mind you, may be at different ends of the spectrum,” Mr. Mazumdar said.
Equity investors can’t foot the entire bill on most of these development stories and because the state of the capital markets has left many skeptical, equity investors are unwilling to invest unless the rest of the financing picture is in place.
When reading sell-side research, some people look at target prices as a sure thing, while others completely ignore the reading altogether however, Joe and his team at Canaccord Genuity try to be intelligent with their assumptions on how they value a company.
“We look at risk-adjusted returns at source, which means we make assumptions about each individual asset’s risk profile. We look at both exogenous (commodity, geopolitical) and endogenous (execution, technical, permitting, among others) risks."
"We adjust our discount rate for each project to account for the exogenous risks and apply a Price-to-Net Present Value (P/NPV) multiple to account for the endogenous risks. We also discount the corporate G&A at a lower discount rate than the project as there is less risk the company’s management will pay themselves."
"Price to net asset value is a result of our sum of the parts risk adjusted valuation versus the current prices, not something we apply,” he says.
Joe believes that since many of the gold mining projects they follow tend to have shorter lives that they can’t be valued as ‘going concerns’. Instead, Joe prefers the application of a discounted cash flow model.
“Most mines aren’t a ‘going concern’ over 15 years, so applying a 10x the current year’s cash flow implies one believes that the current gold price and production will remain the same for the next 10 years, even though the mine may only have a 6 year mine-life,” he tells me.
It is currently a buyer’s market where the buyers have no sense of urgency due to the hangover of writedowns related to dilutive transactions during the peak of the last cycle, as well as the fact that potential suitors are not being asked to grow but rather to provide returns on the their investments.
“We see the M&A bid now as very suitor specific, some may want to add an inexpensive growth option, others may make an opportunistic bid due to current market conditions on low risk or high quality assets while still others see the opportunity to make a synergistic acquisition for the ‘low hanging fruit’," Joe explains.
Joe tells me synergistic transactions include Sulliden and Rio Alto as well as the Asanko and PMI Gold combination.
He says that some companies have been active in M&A with respect to acquiring inexpensive growth options and high quality assets.
“Osisko’s Canadian Malartic mine represented an asset so valuable to companies with the means right now that they could not afford to pass it up,” Joe explains.
Opportunity Knocks Twice in the Junior Sector:
A recent report by Joe and his team highlights the important differences in two key junctions in a junior miner’s life cycle; the exploration to discovery phase and the development to production phase. Both of these transition periods accrete value differently and hence attract different investors.
You have the early-stage exploration concept that is based on geological theories (hopefully). The goal here is to accrete value from concept to discovery. Investors here are long term and more risk tolerant. Their investment is not unlike a lottery ticket based on hopefully good science.
After the discovery is made, you have a period in which the hype subsides and share prices decline with less liquidity.
During this period, if the project is worthy, a new management team is often needed, one with development experience (mining engineers) that can delineate an economic operation from the initial discovery.
Once a plan is in place for the development of the project, a new set of investors come in. These are more risk averse investors who are seeking cash flows.
“As the development team, you have a project that you believe can be built, but now you have to go convince this new group of more risk averse investors that you can permit it, build it and operate it,” he explains.
The transition from speculative investor to risk averse investors drives the change required in management from exploration geologist to mine builders.
Joe thinks companies such as Asanko Gold, Golden Queen Mining, Midway, Roxgold have all transitioned their teams from explorationists to mine developers well. These companies have the teams in place to actually develop and operate their assets, so a takeover is not necessarily the endgame for them.
Given Mr. Mazumdar's experience working for Newmont's strategy team, I wanted to get his response to the statement that senior mining companies are ‘dumb money’ because they constantly sell at lows and buy at peaks.
“Gold companies in the last cycle were valued on their ability to show growth, the larger the production profile (>4 Moz per year) the more ounces required to not only replete their annual reserves but to show a 4-5% compound annual growth rate. The amount of ounces required were beyond the capacity of their project pipeline, such that these ounces were acquired via M&A transactions where accretion was measured by production growth and on an NAV basis but where returns or paybacks were not considered as highly.”
“Investors at the time weren’t looking for returns, they were looking for ounces,” he tells me.
Joe claims that in a rising gold price environment a lot of these transactions may have ended up being successful, but as the gold price fell the premium paid made these acquisitions dilutive and led to many writedowns.
He believes that only 2/3rds of most of these seniors’ production profiles are viable in the current price environment and many of the projects in their respective pipelines are currently marginal.
He believes the largest a company can viably sustain itself may be at the 3 to 4 million ounces per year mark.
Once a company gets above that level, the geological challenges of finding and replacing this production level, make it difficult to sustain forcing a company to make acquisitions that are not always accretive.
What He Likes:
Mr. Mazumdar currently sees the most value in the development arena. He prefers deposits that are economic today but also provide a call option on a bigger deposit that would make sense in a rising gold price environment when companies will be able to finance larger capital projects.
Joe covers Orezone (ORE:TSX) which is developing a two phase project called Bombore in Burkina Faso.
This is an example of the type of project he likes. The first phase is a 2 million ounce oxide, heap leach project that is financeable in the current environment.
Below that, the deposit hosts another 3 million ounce sulphide deposit (the call option).
Below is a video which highlights the Bombore deposit:
Mazumdary likes stories where a lot of the question marks around viability are already answered.
Other names Joe covers include:
Asanko Gold (AKG : TSX)
Castle Mountain Mining (CMM : TSX)
Dalradian Resources (DNA:TSX)
Golden Queen Mining (GQM:TSX)
Goldrock Mines (GRM : TSX-V)
Midway Gold (MDW : TSX)
Rubicon Minerals (RMX:TSX)
We appreciate Joe for sharing some of his time with us. For more information on Canaccord Genuity’s capital markets offerings, please visit: http://www.canaccordgenuity.com/