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Eric Lemieux: Gold’s Behavior Flies in the Face of Every Theory
Source: The Gold Report 10/31/2008
In an exclusive interview with The Gold Report, Eric Lemieux, metals and mining analyst with Laurentian Bank Securities, describes gold’s inexplicable descent as a violation of market fundamentals. Eventually the worsening supply deficit will energize the precious metals sector and when it does, he believes the junior explorers will be well positioned to benefit. He focuses on the emerging mineral wealth of the James Bay area of Quebec and discusses his favorite explorers.
TGR: You cover 25 to 30 mineral exploration properties, primarily in the James Bay area, owned by four exploration companies. Although there are 20 to 30 exploration and mining companies are in the area, you focus on only a few of those companies. Why the James Bay area, and why these companies: Midland Exploration Inc. (TSX.V:MD), Virginia Mines Inc. (TSX:VGQ), Eastmain Resources Inc. (TSX:ER) and Sirios Resources Inc. (SOI) (TSX.V:SOI)?
EL: Let’s start with “Why James Bay?” In the 1970s, Hydro Québec wanted to harness the rivers to build hydroelectric power stations in the James Bay area. As part of its due diligence, the company hired consultants to assess the geological potential of the area. The report came back stating that there was very little potential. This proved not to be the case, but by then the perception had already been created that the area had low mineral potential. James Bay was considered the little brother of Abitibi—the poor little brother. Then in 2004 Virginia Mines made a major discovery, the Éléonore deposit. This is a world-class, perhaps 6-million-ounce plus deposit currently being developed by Goldcorp Inc. (TSX:G) (NYSE:GG) —and it wasn’t supposed to be there.
TGR: And it’s in an area where, thanks to Hydro Québec, there’s good infrastructure.
EL: That’s right. Hydro Québec built roads and airports providing access in the James Bay area. When you consider the infrastructure, plus the discovery of the Éléonore deposit, the area becomes very interesting. In addition, the Québec government is favorable to the mining industry. Also, James Bay is located in the Cree First Nations area and, unlike the situation in other jurisdictions in Canada, there is a 40-year history of partnerships between Hydro-Québec and the Cree as well as other participants. And then, of course, there’s the question of electrical power. The hydroelectric dams and power stations are already there. Any company that requires electricity for a long period of time can negotiate with Hydro Québec, which has a reputation for providing cheap electricity for sound industrial development. When you add it all up, the area has promising mineral potential, a good social framework, existing infrastructure, and a favorable permitting environment.
TGR: There’s also access to a skilled work force because Abitibi is just south of there.
EL: Exactly. The Abitibi has a rich mining heritage. So the proximity means you have access to that work force as well as a depth of knowledge. That’s a tremendous advantage.
TGR: What do you think are the prospects for another discovery the size of the Éléonore deposit?
EL: This is an underexplored area, so I think it’s just a matter of time. It’s been four years since the discovery of the Éléonore deposit. We’re just starting to scratch the surface and there could be some surprises in the years ahead.
TGR: Does the fact that existing infrastructure makes exploration in the James Bay area less costly give mining companies operating there an edge in today’s market?
EL: I think so, depending of course on how far commodities drop. If you can find high-grade deposits in this area, all of the advantages we discussed help offset lower commodity prices. In the current financial crisis, projects that require huge capital investments will be almost impossible to finance. That’s a huge handicap compared with smaller, high-grade projects that require less capital, and have a high payback or a quick payback time. So I think projects in the James Bay area are well positioned in today’s economic climate. Equally, exploration costs are less as road and dam infrastructure provides access and adds to beneficial logistics.
TGR: That explains why you like the geography. Let’s return to the second part of the question—why just these few companies out of the 30 or so that have property in this area?
EL: Based on the criteria I use, these companies are the best. The first criterion is the quality of the management team. If you have solid management, everything else falls into place. Then I assess the quality of the projects, the geological potential, and the share price.
TGR: Given the financial turmoil, do you think the junior companies you’re focusing on can withstand this downturn?
EL: The companies I’ve selected have what I call a partnership approach. They farm out part of their property to a JV partner who finances the exploration. Midland Exploration uses this model. Of course, the financial health of the partners is also important, because if the partners are not healthy, the work will not get done. Three of my four companies have great financial health, so they’ll be able to continue through the downturn. Some of them were able to finance last spring when the market was rather favorable. For example, Eastmain Resources did a $16 million financing that puts them in a strong financial position. And Virginia’s business model has always included a very large treasury, which stands at about $45 million. Plus the company has structured its agreement with Goldcorp to include an advanced royalty on the Éléonore deposit that will start bringing in US$100,000 per month in April 2009.
TGR: Who is Midland’s JV partner?
EL: Midland has several partners. One of them is Agnico-Eagle Mines (TSX:AEM), a major Canadian gold producing company. It’s in a good financial position and has a good asset base. Another is Breakwater Resources Ltd. (TSX:BWR), which was struggling a little even before the recent financial crisis, so that’s a bit of an unknown. My understanding is that Breakwater is still living up to its commitments. Midland has more than $4 million in its treasury, so it will be able to weather the storm. Keep in mind that in addition to looking at a company’s financial strength, you also have to review its obligations. A company may have cash, but if it has entered into agreements that require it to do work and spend money, it doesn’t have the freedom to just sit on its money in a downturn. In evaluating these companies, it’s important to examine how their agreements are structured.
TGR: Is Eastmain also following the JV concept?
EL: Eastmain, which has a sizeable portfolio of properties, has a few agreements with partners, including Barrick Gold Corp. (ABX). But for the most part, Eastmain owns 100 percent of its properties, which gives it the advantage of being able to step back and preserve cash. So I think both Eastmain and Midland are in very good positions. Virginia is probably the best one as a junior mining exploration companies because it has a great financial position, has strong management and has developed the expertise required to be successful in any economic environment.
TGR: Do Virginia, Midland, Sirios and Eastmain have contiguous properties? So if one of them makes a substantial discovery, we could expect the others to follow suit?
EL: That’s only partially true. They have a few contiguous properties, but also some that are very separate. I think each one possesses a different expertise, and is focused on a different area. That said, if there were another major discovery, it would put benefit the whole area and any property there will gain some indirect value.
TGR: When do you think the market will return to a supply-and-demand dynamic and what will it take to get the prices of well-positioned juniors back up?
EL: At the first sign of an economic downturn, investors pull their money out of the most speculative stocks. That’s why the junior explorers started to decline at the end of 2007, before the rest of the market. It’s a bit like the canary in the coal mine. The downfall started much earlier than September of this year and I think that’s unfortunate because it’s been a slow, agonizing downward process. The situation has been compounded by the fact that we’re having this huge financial economic crisis that appears to be spiraling out of control. I think we’ll eventually hit bottom, and then the markets will stabilize and start picking up again. When it does, I think the junior exploration industry will be well positioned. Why? The supply imbalance existed before the downturn and this deficit can only get worse. At some point, people will realize that we have to invest in the commodities and that will energize the industry.
TGR: It’s difficult for most of us to understand why, given the supply imbalance, commodity prices—especially gold—have declined so much recently. What’s your take on this?
EL: The decline in gold prices flies in the face of every theory. The U.S. dollar has been appreciating and the U.S. economy is going through a recession. Gold should be increasing in value in the face of all this uncertainty. To see the price of gold going down right now is almost unexplainable in my opinion. It begs the question, is this due to some type of manipulation, either directly or indirectly?
Eventually people will realize that you can’t sustain both very low commodity prices and a very high U.S. dollar because it violates certain fundamentals. Back in February 2002, an article in The Economist talked about a potential crisis resulting from businesses using financial instruments that they didn’t understand (credit risks). But everyone just turned their backs and carried on. I think it’s a matter of restoring common sense to the market. I am, in particular, in agreement with a written statement made by the general manager of the Québec Mineral Exploration Association, that says that markets must return to their original mission—to finance economic development and not speculation.
TGR: Hedge funds and money markets have had to liquidate, which is causing a lot of turmoil. Once that settles out, won’t supply and demand start to play a stronger role again?
EL: Agreed. And when that happens, I think the metals commodities industry will be in a strong position to benefit.
TGR: When do you think this might happen? Three months? Six months? A year?
EL: I estimate six months.
TGR: When we get back to supply and demand as the market drivers, and the commodities come back, what range do you think gold and copper will trade in?
EL: I think they’ll return to the levels we saw at the beginning of 2008, and I think these were fair prices. I don’t like skyrocketing prices because that’s not good for the long-term viability of the industry. I think gold was trading around $850-$920 in January. It may have touched $1,000 later in March. Good companies are able to make money when gold is in that $850 range. Copper was trading around $3.50, a price that made sense in terms of the supply and demand. These are viable long-term prices. There will be fluctuations and I wouldn’t be surprised if we see a huge spike when the markets initially rebound. But for the overall health of the industry, as long as it is a normal price, everyone comes out a winner.
TGR: To what extent do speculators play a role in these huge spikes?
EL: I think much of it is due to speculators. Having said that, I think speculators have their right to be there. I think it makes the market more fluid. Unfortunately, as we’ve seen with the financial crisis, when there’s excessive abuse, it’s unhealthy. I think we’re in the mess we’re in now because Wall Street really went to an extreme, to total deregulation.
TGR: So you think the market will regain equilibrium over time.
EL: Yes. I believe we’re experiencing the results of probable financial industry fraud. Time will tell who was responsible. I hope we will hold the perpetrators accountable. Unfortunately, I think certain elements are trying to sweep all this under the rug.
When I was young, banks were always viewed as being very conservative. They were the blue chips. Now that we’ve witnessed fraud and abuse in the banking and insurance industry, I hope people will see that banks are not necessarily the best, safest investment. And perhaps this will change their perception of a speculative market or industry, like mining, and they will be able to invest in these markets knowing that a dollar spent there will be a dollar well spent.
I hope the perception of the mineral exploration industry will change because I think there are a lot of good players and, fundamentally, people are trying to discover, develop, or produce a tangible asset. In this day and age, I think something that is tangible has its worth. Once people get to know the industry they will realize that it does have value and maybe has been undervalued for many years. At the very least, I hope that people will be more diligent in regards to what was regarded as a conservative industry (financial) and realize that the mining and mineral exploration industries have made much progress and deserve a better appreciation.
Éric Lemieux, MSc, P. Geo., is a Mining Analyst who joined Laurentian Bank Securities (“LBS”) in January 2008. Prior to joining LBS, Eric worked for nine years as a consultant responsible for applying Regulation NI 43-101- for the Autorité des marches financiers (“AMF”) as well for the New Brunswick Securities Commission. Eric had previously worked at the Montreal Exchange and prior to that had managed exploration projects for Cambior, Noranda and Soquem. Eric holds two master’s degrees, one in Mineral Economics from the Colorado School of Mines (1997) and in another in Metamorphic-Structural Geology from Laval University in Quebec City (1992). Eric hold a B. Sc. in Geology from Laval University (1989).