Christos Doulis Separates the Precious Metals Saints from the Sinners

The Gold Report: In September 2014, you told us that investors needed to own bulletproof, low-cost producers that can survive lower gold prices. What is your investment thesis for this point in the bear market?

Christos Doulis: Unfortunately, not much has changed. We certainly do not appear to be in a bull market for gold. All of us would like to see higher prices. They may come at some point in the future but no one knows when that will be. So in the short and medium term, I would continue to recommend owning the lower-cost producers in order to protect oneself from the chances of insolvency.

TGR: What is your technical analysis of the recent performance of gold telling you about what we're headed for?

CD: I am still negative. When I look at the trend over the last year or so, there's been quite a bit of volatility, but in general, the highs keep getting lower, and the lows are getting a bit lower as well. For instance, in January 2014 we had a rally that went close to US$1,400 per ounce (US$1,400/oz) before it petered out. Then we had another rally in January of this year when gold got closer to US$1,300/oz, not to that US$1,400/oz level, before it started to give back the gain. If you draw a channel on the gold price, it certainly looks as if we have not reversed course yet. The highs keep getting a bit lower on the volatility, and the lows have been lower. Then again, gold popped US$20/oz in early April. If gold could sustain a rally to US$1,250/oz, I would start feeling a little more enthusiastic about the space.

TGR: What is your prognosis for this bear market?

CD: My personal view is that I'm hoping for higher gold prices in the second half of 2015, and hope to see a return to an upward trend in the metal's price. My view is that we are still in a long-term bull market for gold but that after a 10-year bull run, we needed some pullback. This pullback has been particularly vicious, but what else is one to expect after gold went from US$300/oz to US$1,800/oz in a decade?

TGR: What price would gold have to sustain before you were willing to declare the bear dead?

CD: If I saw gold trading north of US$1,350/oz, I would start to think that even higher prices might be coming and the bear market was dead.

TGR: What are your price decks for gold and silver?

CD: We use US$1,250/oz gold and US$19/oz silver.

TGR: You have seen a few cycles in your 20 years in the space. What are two or three things you have learned about this bear market that were perhaps not evident in others?

CD: The one thing I've taken away from this bear market is the longer the run-up, the more painful the correction. I thought that last year would probably be the worst. When gold peaked in 2011, I was not surprised to see a correction. I certainly thought that US$1,300/oz gold was in the cards, but I did not see US$1,150/oz gold as likely. I have definitely concluded that the market can be much more pessimistic than you can, and it certainly isn't going to turn just because you want it to. As I said, I was thinking 2014 would be the year when we would see a reversal in gold prices. Now, I'm hoping for the second half of 2015.

TGR: Miners have reduced their costs in order to boost margins at US$1,200/oz gold, but some, not all, are doing that by mining the higher-grade portions of their deposits. Were miners high grading to the same degree in previous downturns?

CD: My take on it is some miners are definitely high grading, but good miners aren't. They understand that if you high grade a mine, you not only reduce its longevity by removing the high grade, but in effect you reduce it even more because all that you have left is low grade, which might never be economic. Imagine you have a deposit that has different zones grading various grades. If you blend them all, you can deliver, call it, 8 grams per ton (8 g/t) to the mill, but if you high grade it, you can deliver 12 g/t. The problem is that means you deliver the high grade for a couple of years, but then you're stuck with delivering 6 g/t or 4 g/t material to the mill. It could mean that entire portion of the deposit is no longer economic. Good CEOs are loath to high grade and, instead, they focus on cost reduction. That is the bigger trend.

TGR: Do you learn more about a management team in a downturn?

CD: Absolutely. When gold is trending upward, it covers a lot of mistakes, and the market is more forgiving. When gold is trending downward, we see who the quality executives are because they're the ones who are able to reduce costs without jeopardizing the longevity of their operations. It goes back to the concept of high grading. Good CEOs in the last couple of years have been the ones who have said, "We're going to reduce costs," and have actually done so.

In bear trends like this, if you promise X and you deliver half of X, you get penalized. This is a market where sins are not quickly forgiven. Therefore, the people who don't sin, vis-à-vis the better CEOs who meet their prognostications, are the ones that the market rewards. Also, as an analyst it allows you to figure out what groups really know their asset(s) and understand how to drive the business from a cost perspective.

TGR: Who are the saints? Who are the sinners?

CD: When I look at the saints in my universe, Rio Alto Mining Ltd. TSX has just been stellar. Not only has President and CEO Alex Black delivered at La Arena, but to do a deal on Shahuindo and then to do a deal with Tahoe Resources Inc. NYSE within a year is impressive. He is focused on operations, but certainly hasn't left mergers and acquisitions (M&A) off the table.

I like Endeavour Silver Corp.'s TSX management. The company has reduced costs at its Mexican mines but the silver price has fallen harder and faster than the cost savings Endeavour has delivered.

Another company I would like to talk about is Orvana Minerals Corp. TSX, which I just launched coverage on. It has the El Valle-Boinás/Carlés mine in Spain that produces 65,000 ounces (65 Koz) a year and the Don Mario mine in Bolivia that produces around 20 Koz/year. Management has driven costs down at both operations.

Orvana was in a tough financial situation a couple of years ago with US$64 million (US$64M) in Credit Suisse debt looming. Falling metals prices brought challenges at its operations but the company paid off the Credit Suisse debt, so other than some minor (~US$5M) bank debt, Orvana is essentially debt free. That shows you what good management can do. Orvana appointed Michael Winship, a mining engineer by trade, as CEO a couple of years ago after a stint as director. He was facing challenging times given Orvana's debt and falling metals prices but he helped bring the company out of the wilderness and establish it on much more sound footing. He recently announced his retirement as CEO, although he remains a consultant to Orvana.

The biggest challenge with Orvana is that one shareholder owns around 52% of the stock, which limits trading and appeal to institutional investors. I'm hoping that Orvana will grow by acquisitions, which could dilute that holder from 52% down to where that concentration of ownership no longer scares off Canadian institutions. Plus, you get a bigger story by adding an asset or two. I feel comfortable talking about mergers and acquisitions (M&A) with Orvana because with the addition of Gordon Bodgen and Gordon Pridham to the board—both of whom have extensive M&A experience—the company is clearly looking at strategic alternatives.

TGR: And the sinners?

CD: When it comes to groups that have done poorly, the senior producers are in the penalty box from the investors' perspective. Many of those companies have made big acquisitions at the top of the market and failed to deliver on either the cost savings or other promises made to the market. Senior producers like Kinross Gold Corp. TSX and IAMGOLD Corp. TSX have been considered out of favor for some time due to large acquisitions at the top of the market.

TGR: What are some companies you're covering that are positioned to weather another two years of stagnant or lower gold and silver prices?

CD: From my coverage universe, one company that is positioned to really weather the storm is GoGold Resources Inc. TSX, which is producing at Parral at cash costs of around US$6/oz silver and all-in costs certainly below US$10/oz. So it's well positioned to weather ongoing low silver prices.

TGR: When do you expect Parral to reach commercial production?

CD: I have been told that it is imminent. We should see that happen in this month.

TGR: The Santa Gertrudis project in Sonora, Mexico, is at the preliminary economic assessment stage. When do you expect a production decision? Could GoGold fund development alone?

CD: The company recently received an environmental permit for Santa Gertrudis and is waiting for a change of land use permit and final engineering on some of the specifics relating to the project. I expect it to begin construction fairly soon, sometime around Q2/15. I don't think GoGold is in a situation to finance it out of existing resources, so it will likely need to do an equity raise or some other form of capital raise. It has Parral up and running, so one would think it could borrow a little more.

The jury is certainly out on Santa Gertrudis, but on paper, it looks as if it's going to be a low-cost asset. Although I was skeptical initially of Parral, GoGold management has done a great job. If you believe that they knew what they were doing on Parral, hopefully, they'll know what they're doing on Santa Gertrudis. GoGold is certainly one to watch over the next while, as is Orvana.

TGR: What are some companies you cover with noteworthy news?

CD: I cover Premier Gold Mines Ltd. TSX, a development company that has effectively no revenue. It just inked a deal with Centerra Gold Inc. TSX for its Trans-Canada gold project in northern Ontario. As part of the deal, Premier received an immediate CA$85M cash payment, which goes a long way in this environment. While Premier, as a development company, is subject to market availability for capital, right now it is basically fully cashed up. Centerra will spend CA$185M on the project before Premier has to spend another dime. So Premier's CA$85M from the deal plus the cash that it had previously gives it a lot of flexibility to advance its other projects even in a weak metals price environment.

TGR: What's the earliest Trans-Canada could enter production?

CD: It's pretty far out there. I'm hoping to see the first gold pour in 2017 and commercial production in 2018.

TGR: Premier sold a 50% interest in Trans-Canada for CA$185M. Why didn't Centerra just buy Premier outright?

CD: In order for it to be a friendly deal, Premier wanted to maintain its independence. Premier wants to continue advancing its other projects, like those in Nevada. I wouldn't be surprised if that discussion happened but I don't think Centerra wanted to pay a big premium for the whole enchilada, given that Hardrock is the focus.

TGR: Any others with news?

CD: Sierra Metals Inc. TSX just significantly expanded the resource at Yauricocha, its flagship mine in Peru. The previous resource was in the neighborhood of 6 million tons (6 Mt). It's now 11 Mt, so huge growth. The challenge is that the grade has gone down. My net take here is, yes, the mine is going to run for a lot longer, but that doesn't necessarily add a lot of value given that grades have gone down. The grade had been in the 70 g/t silver range; it's now in the 50 g/t silver range. More marginal material is getting included in the resource. Part of that is driven by lower per-tonne costs that the company is experiencing. It's good to show the longevity of the asset, and I don't think it changes the cash flow from the asset in the short term. Its guidance for 2015 is already out, and I suspect 2016 will be a similar year.

TGR: Could you give our investors a reason for optimism in this space?

CD: One reason for optimism is the abounding pessimism in the marketplace. An old adage is "buy when others are selling." Nothing has changed in the grand perspective of post-financial crisis money creation. The only thing that has not happened is visible inflation, and that's why we've seen interest in this space decline. There has never been an economic recovery that has been solely created by monetary expansion that doesn't come with inflation.

While everyone is worried and nattering about deflation, if we ever see a real economic pickup, which we haven't yet, I think that precious metals will start moving up again. And I want to remind your audience that gold had a run from US$300/oz to US$1,800/oz before it came back to US$1,200/oz. Even at US$1,200/oz, that's four times where it was at the beginning of the 21st century. One of the biggest cases for optimism is that nobody is telling you to buy gold stocks today. When everybody and their uncle are telling you that this is the asset you have to own, whether it's gold, Internet stocks or whatever, it's likely that you already missed the market.

TGR: Thank you for your insights, Christos.

Christos Doulis, a mining analyst with PI Financial, has spent 20 years in a wide variety of roles within the mining industry. Doulis was a mining research analyst at Stonecap Securities from 2010 to 2014. Previously he was a partner at Gryphon Partners Canada, an advisory firm in the mining industry that was acquired by Standard Chartered, and a vice president at Blackmont Capital. Doulis began his career as a research associate in 1994 at Scotia Capital. He covers a variety of gold and silver companies in the small- to mid-cap market with a focus on producers and late-stage development companies. Doulis obtained a Bachelor of Arts in economics from Queen's University and holds the CFA designation.

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1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
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3) Christos Doulis: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: All but Tahoe Resources Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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