No-Brainer Opportunities in the Junior Gold Market

September 16, 2014

If you talk to any legend in the resource sector and ask them how it is they created the majority of their wealth, the answer is along the same lines every time. Successful investors such as Doug Casey, Rick Rule, Eric Sprott, and every other household name were buying gold and silver equities en masse during the deader, slower times in the market cycle.

The one thing these greats have in common is that they are not afraid to go against the grain. Being a contrarian is an easy thing to say, but it’s a very tough thing to do. You have to be vindictive in your beliefs and extremely patient, all while ignoring the psychology of the masses.

While I cannot say precisely that we are at a market bottom for precious metals equities, I can say that there are many signs of the market turning that make me optimistic for the near future. Of course, the market could drop a little more, but we are now getting very close to making it out of the woods.

Perhaps the most striking feature of today's market is the ease of which it is possible to identify quality companies. There is massive inequality in the market right now, and this makes it easier than ever to pick up companies that are going to be the targets of mergers and acquisitions (M&A) by the majors.

The Great Divide

In our database, we keep tabs on over 450 junior precious metals companies. We see the fluctuations, anomalies, and changes from quarter to quarter. We also get a good sense of the long-term picture from an equities perspective.

The biggest insight from this that we have today is: there is now a clear and steep separation between the best and worst companies out there. We call this the Great Divide.

What do we mean by this? Well, in every single metric – and we track over 20 of them for each company – you can see massive inequality between cash positions, G&A expense ratios, burn rates, resource economics, or any other measures. This was something that we anticipated, because the companies with poor management teams and projects have not been able to raise capital in the current financing environment for some time.

Here’s an example from our Ontario Explorers dataset which covers 22 companies:

junior gold market

The companies that are doing well all have the same qualities: great management, robust or promising projects, and bulletproof balance sheets. There is no question that many of these companies are going to get taken over by the majors, and investors will receive nice premiums that will help excite the whole sector.

A year ago, it was still tough to see which companies would capitulate and which would rise to the top. However, it is easier than ever to identify the good ones - and they will be the fuel that ignites in the upcoming M&A engine.

The M&A Engine

Each year, we do a report where we look at every gold deposit in the world over 1 million oz in size. It turns out there are 580 of them in total.

Majors and mid-tiers own 54.3% of all total gold resources, and more than 7 of 10 projects that they have are already in production.

Juniors own the rest, but the overall average economics are not very impressive. That's because majors scoop up the best projects through M&A.

Here's the stats on what juniors own: 386 deposits averaging 0.88 g/t with an average size of 4.4 million oz (Note that these numbers are hugely skewed by big projects like Pebble in Alaska which may never go to production in our lifetime).

In a previous article, we looked at all majors to see when they would have to start replenishing reserves. The answer, in short, is almost immediately. On average, each undeveloped project owned by majors has 38% less total gold ounces than assets currently in production.

Since the gold price took a dive in 2012, these majors have been intensely focused on write downs, reducing all-in costs, and returning to profitability. They had to curb their losses before they start figuring out how they are going to get their next key asset.

While the gold price is still giving them trouble, we have seen all-in costs drop dramatically for many majors and mid-tier producers. Now the focus is starting to shift because most majors desperately need to get more ounces in the ground. As a prime example, Gold Fields (NYSE: GFI) has 89% of their gold ounces in projects that are already in production. Their pipeline of undeveloped assets has an average grade of only 0.63 g/t gold, which is only about 60% of the average grade worldwide.

Goldcorp’s President and CEO Chuck Jeannes has even gone as far as to say that we will be reaching peak gold in either this year or in 2015. Why? Because there just aren’t enough quality assets being developed.

The majors are going to have to make tough decisions soon on where they are going to get quality deposits in size and grade. One of the only ways to do it is by taking over the aforementioned premium quality junior companies, and it is not hard to see which ones are at the top of the shopping list.

The Shopping List

At the beginning of September, we released an in-depth report covering the 10 stocks that we believe have the most potential in the fall – many of which will also be targets for the aforementioned M&A activity.

Within a week of releasing the report, our very first pick (Cayden Resources CYD.V) was taken over by major Agnico-Eagle for a solid 42.5% premium for an overall market value of $205 million.

Why did they take over Cayden? Well, Cayden is one of the best performing companies year-to-date on the Canadian Venture exchange. They have been consistently hitting high-grade holes at surface in Mexico and they also have a management team that has made world-class discoveries before. Last, the company’s strategic assets and balance sheet also ensured that the company didn’t have to go back to the market for more money throughout the exploration process.

What is most amazing about this takeover is that Cayden didn’t even yet have a compliant resource yet. Normally majors are quite conservative and want to buy companies with proven resources in the ground. Cayden was not that at all. This means that majors are starting to get more aggressive in scooping up quality assets, which is some excellent foreshadowing for the near future.

Even with the above deal, we believe that M&A activity will primarily focus around development companies with high-quality assets that are sufficiently de-risked. Larger companies want to buy proven resources in safe jurisdictions at rock-bottom prices – and if you can buy these ounces in the ground at a tiny fraction of what they are worth, that is the best possible way to expand your reserves.

Investors should look for developers with a resource of at least 3 million ounces (3 Moz) with a high grade and location in a safe jurisdiction. A takeover offer is rarely made before a company publishes a preliminary economic assessment (PEA) so investors should look for a PEA or feasibility study with a high net present value (NPV), low capital costs (sub-$700M) and a high internal rate of return (IRR).

How to Pick No Brainers

The circumstances are just right: with the Great Divide making it easy to separate the wheat from the chaff, there is less risk of choosing a stock that is a clunker. Meanwhile, majors have project portfolios where undeveloped assets are in the minority and with 38% less size per project. They are in the process of switching focus from all-in costs and write downs to replenishing their reserves. Luckily for them, there are companies with great projects that are trading at cheap valuations.

We’ve already seen more aggressive acquisition activity start. Now, it’s time to get in the quality names before the majors start scooping them up for a premium. As you can see with Cayden, shareholders got an instant 42.5% return even if they had bought the stock just one day before.

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Want to learn about the best opportunities on the market? We’ve already done the work for you. In our Top 10 Stocks to Watch for Autumn 2014 Report, we cover the 10 companies we believe are best poised to create life changing returns.

Within one week of launch, we already had one huge winner (Cayden CYD.V) with a 42.5% return in just a few days. At only $55, this report is the best value in the industry.

In the report, we look at management, financials, projects, and catalysts for each company in over 90+ pages of depth. Check out free examples of our past April report here and here.

China has only 2% of its Total Foreign Reserves in gold.