Nana Sangmuah: African Takeouts on the Menu

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Clarus Securities Analyst Nana Sangmuah was born in Ghana, West Africa-a growing hot spot for gold exploration. He believes several gold juniors operating in West Africa are prime takeover targets and expects merger and acquisition (M&A) activity to heat up as the major gold producers seek to replenish their diminishing project pipelines. In this exclusive interview with The Gold Report, Nana reveals a few juniors on both sides of the Atlantic that could fall prey to larger predators.

The Gold Report: Nana, tell us about your coverage sector.

Nana Sangmuah: My coverage universe consists mainly of the junior golds with market caps under $500 million, but some of those are creeping up in size. An example is Semafo Inc. (TSX:SMF) , which is currently worth about $3 billion. Obviously, the idea is to pick up names with a growth trajectory that could give upside to investors.

Currently, my universe includes some of the little ones like Azumah Resources Ltd. (ASX:AZM) , which has a good growth trajectory, a $175 million market cap, significant exploration upside and a good management team to move it along the path. Other names in our coverage universe include Cluff Gold PLC (TSX:CFG;LSE:CFG) , which is significantly undervalued and poised for a rerating in the near term and developers like Keegan Resources Inc. (TSX:KGN; NYSE.A:KGN) and Perseus Mining Ltd. (TSX:PRU; ASX:PRU) . They are prime takeover candidates in West Africa, which is heating up. We also cover very seasoned, disciplined players in the space like Randgold Resources Ltd. ( GOLD ) , which probably has the best growth trajectory in the universe, and all of that can be fully funded internally with operating cash flow.

TGR: So, you're looking for companies that are on a growth trajectory. How do you arrive at that decision? What's your methodology for finding companies that fit that thesis?

NS: Obviously, you need a sizeable resource. Geology is key, and that plays into the size of the land packages because bigger land packages, potentially, hold bigger resources. And the land package should be on a greenstone belt because that is where we've seen most of the world's recent significant gold discoveries. Once the location and the geology check out, then you ask questions about the management team behind the asset. Does it have the know-how? Has it developed other deposits? Does it have people working with it that could unlock value on the asset? And then you have to make sure the company has the cash to execute the strategy. You can have the best asset but if the balance sheet is not strong enough, there will be a lack of news flow and investors will probably turn their attention to other projects.

TGR: You're from Ghana and West Africa in general has received a lot of attention lately due to Kinross Gold Corp. (TSX:K; NYSE:KGC) acquiring the assets of Red Back Mining. One of these was the Chirano gold mine in Ghana, and the other was the Tasiast Gold Mine in Mauritania. This has people talking about some other companies that could be takeover targets in West Africa. What are majors looking for in takeover targets?

NS: In the takeover category, most majors look for production visibility and exploration upside. One of the guys in my coverage universe fits the bill quite well: Perseus Mining, which is totally cashed up and on track to launch production at the rate of about 220 (Koz.) per year, starting in Q311.

Aside from the fact that Perseus will be graduating into the producer category, it has enormous exploration potential. The company is doing just about the most aggressive drilling in the region on its Central Ashanti Gold Project (formerly the Ayanfuri). Perseus is drilling 30,000 meters a month companywide, which is definitely going to provide a lot of news flow to sustain investor attention during development.

The project was owned by AngloGold Ashanti Ltd. (NYSE:AU; JSE:ANG; ASX:AGG; LSE:AGD) before it was abandoned and Perseus took over. Perseus has since delineated about 5.3 million ounces (Moz.) of gold at Ayanfuri alone. With a companywide global resource of 7.3 Moz., Anglo is one of the largest resource holders in West Africa that's not owned by a major mining company; that makes it a prime takeover candidate. There is going to be a site visit trip for analysts in November to showcase the progress of development, which seems to be going well.

Aside from that, it also has assets in Cote d'Ivoire-mainly the Tengrela Gold Project (1.3 Moz.), which is also on track with a definitive feasibility study in November. That project could sustain head grades of about 3-4 grams per ton (g/t) for the first four years of production at cash costs in the low $300s. The market is not assigning a lot of value to this asset at this stage.

The exploration results from Tengrela show that the whole project is growing with recent new discoveries. There is further exploration upside in Cote d'Ivoire as the company has ground right next to Rangold's Tongon Project (4.6 Moz.), which is starting production in Q4 at the rate of 250,000 oz/year. This is yet to be drilled by the company.

TGR: How much value do you put on ounces in the ground? For instance, if it's an inferred resource, do you ascribe a different value to it than actual reserves?

NS: If it's an actual reserve that could easily make its way into the discounted cash flow (DCF) profile, you would have a discounted cash flow valuation on the reserves. The inferred resources would be valued based on a peer market average for an ounce in the ground, and that is currently creeping up. It's around $100 per ounce now based on my peer comparable tables.

TGR: You recently attended the Denver Gold Forum in September, and apparently there was quite a fierce debate there between Martin Murenbeeld, who's the chief economist with DundeeWealth Inc., and Paul Walker, the CEO of precious metals consulting firm GFMS. Murenbeeld was bullish on gold and Walker was bearish. What side is Clarus on?

NS: Well, we're obviously on the bullish side for the next couple of years and we raised our forecast to $1,300 for 2011 and 2012. But we're reverting it back to $1,000 by 2013.

Now, the reason is that there's no sign of real recovery out there yet. This is probably one of the rare occasions where we've seen a lot of countries fall into recession at the same time, and everybody is mirroring each other in the ways they're trying to get themselves out of this equation. This will likely go on for a while, and I think people will continue to look for alternative places for investment. This will prompt further increases in gold investment demand and physical demand, which traditionally gets stronger in the fourth quarter.

Frankly, the supply side of the equation has not really improved as the number of new discoveries over the last 10 years has kept diminishing. For the next while, I think we can solidly bank on having some strength in the gold price going forward, based on pure fundamentals.

On the other side, if there's a recovery, we will probably have to start rotating out of gold investment and looking elsewhere.

Before that happens, I think inflation is definitely going to be the gatekeeper. If a real recovery comes through, inflation should hit hard, and that would drive gold prices to a higher level before we roll over. I think the logical time frame to get that happening would probably be around the 2013 mark.

TGR: At that point, you think enough gold supply will have come onstream, the global economy will have recovered and that those two things will conspire to lower the gold price. Is that what you're saying?

NS: Supply in itself might not necessarily increase drastically, but as interest rates creep up, I think people will start looking elsewhere for investment alternatives and gold will no longer be the "go-to" choice. People might even start to sell off positions.

TGR: There is a theory that suggests the geology in West Africa is very similar to the geology on the east coast of Brazil because these continents were attached millions of years ago. Do you believe that theory?

NS: It's logical if you look at the plate tectonics that have been in existence for a long period of time. I would highlight, though, that the mineralogy and the grade profile on those zones are quite different. Even within West Africa, you find different grade profiles along different belts.

The prospectivity of eastern Brazil, though, is impressive. Based on my statistics, so far around 90 Moz. has been delineated in that region, with grade profiles of about 2-3 g/t, and there's still more drilling to be done.

Some of the companies that are active in this space will probably be adding to the tally in the next little while, like Rio Novo Gold Inc. (TSX:RN) . It's currently returning about 3-4 g/t rates on the Almas Gold Project, and Rio is about to tap into the Guarantã Gold Project, as well.

TGR: One of those Rio Novo projects is in a greenstone belt that is similar to the greenstone belts of West Africa. Do you see potential for Rio Novo to continue to expand its resources there?

NS: Well, based on the NI 43-101-compliant resources, it would probably be under 1 Moz.; but historical, non 43-101-compliant resources come in about 1.5x higher. And the company's doing a lot of infill drilling. The prospectivity remains. I think it could easily meet and exceed 1 Moz. based on additional targets yet to be chased on the project.

I will be seeing the project in a few weeks to do some level of due diligence. But it's not wholly a matter of growing the resource, which oftentimes becomes the focus for a lot of people. The key is whether a company can get those ounces in the ground into meaningful production. And that's what excites me about the Rio Novo group-the management is really proven. The technical team has built mines operating at a capacity of 55,000 tons per day (tpd), so putting these less-than-10,000 tpd operations into production should prove less of a challenge. And the geological team has actually proven a lot of discoveries in the belt. Technically, I think these people are savvy, and I think the company should probably rerate itself into producer in a very short while.

TGR: You mentioned that you have an upcoming site visit to see Perseus' projects in Africa, and that you've got another Rio Novo project to see in Brazil. You recently visited Colombia for a conference in Medellin and conducted some site visits in the area. Tell us about your trip.

NS: Continental Gold Ltd. ( CNL ) is a company I visited, and I was very impressed by what I saw walking in these adits at the Buriticá project. There's nothing to make you disbelieve that there's gold in those veins. I think the key here is how big the potential resource is going to be, because the dimensions are not well established yet. We should know all these dimensions soon with five drill rigs turning on the property, as the company aims to complete an initial resource in 2011. With a current market cap of around $570 million, the resource is being counted at 5 Moz. Is that a stretch? I believe its strong portfolio of assets covering 160,000 hectares in Colombia gives it huge, untapped exploration potential.

Some of the other assets like Berlin, which has some drills currently turning on it, look much more exciting. Historically, Berlin has produced about 400 Koz. gold in a single lode with a thickness of about 20 meters. That is just about 20% of the whole strike length. The rest of the asset has yet to be tested, but Continental currently has almost $100 million in cash to put into all of these projects. The ability to delineate the resources to back the valuation, and even exceed it, is told there.

Continental has a great management team; and good geologists that have delineated significant resources at other projects are working on this asset, so it's just a matter of time. I always encourage investors to sit tight and watch for results to come out. The results here are typically very high-grade zones that have not really been closed off at depth. There's still huge potential in the initial veins that we've seen at Buriticá. The company has come up with some new samples and there are geophysical anomalies that have yet to be tested, as well. The growth prospects are quite enormous.

TGR: Continental's an interesting story certainly in part due to its management. You've got an Aurelian Resources reunion with Patrick Anderson and Tim Warman on the board, and now Keith McKay as CFO. These guys were all part of Aurelian, which was sold to Kinross for about $1 billion in 2008.

NS: Exactly, that's one of the key points I try to find in these early stage companies. The assets should be prolific, which shakes out on Continental, and management should know what it's doing because it's done it before. Thirdly, it should have the cash to drill these veins aggressively-and Continental has that, as well. It all lines up.

TGR: It sure does. What are some other companies you're following?

NS: It's a broad list. It includes Cluff Gold and its West African assets, which produce about 100 Koz. per year. But Cluff is grossly undervalued because people are discounting the life of the current operations-the Kalsaka mine in Burkina Faso and the Angovia project in Cote d'Ivoire. Based on current drilling information, there could be extensions to these resources that could extend the mine life, but that is not the only key value driver of the stock. The flagship asset is the Baomahun gold project in Sierra Leone; only 25% of a 12 km. strike length has been tested, and 2.5 Moz. has been delineated. Cluff has picked up nine similar prospects along the strike length that have yet to be tested. The company is cash-flow positive and will be chasing some of these zones aggressively.

Cluff is trading at roughly 7x cash flow-quite a huge discount compared to its peers, which trade at around 18x. And even on an in-situ valuation basis, which is often used for early stage junior gold companies, it trades at $55/oz., which is still below companies that have yet to show any production visibility that average about $100/oz. New COO Peter Spivey will take the reins officially in January, and he will continue to guide the turnaround story. There's a lot of upside at these levels. Cluff is pouring gold and is unhedged with great exposure to the gold price right now.

TGR: You mentioned that Cluff's flagship project is in Sierra Leone. I think when a lot of people hear Sierra Leone, they think of jurisdiction risk. What are your thoughts on that?

NS: Well, I think the company's had a challenging past, but that's probably where the opportunity lies. There's stability in the region now. You probably have to add a little bit to your cost estimates because the infrastructure is not great. But in talking with peers and colleagues working in the country, there's little perceived political risk. I mean we are seeing investment demand increase with significant investment made in the country by China. I think Sierra Leone is at ground level in terms of exploiting its natural resources, and that's probably where you're going to get the most upside.

TGR: One company that you mentioned earlier is also exploring in Ghana, and that's Keegan. Tell us about that one.

NS: Keegan has the Esaase gold project in Ghana; within 18 months, it's been able to delineate 3.5 Moz. And I think this resource could easily be pushed closer to 5 Moz. We're expecting an update in Q4, but Keegan is another company that I think should be reaching the radar screens of a lot of people looking to acquire gold assets in West Africa. It's also shown production visibility by completing a preliminary economic study that shows it's capable of reaching production by 2013.

Keegan currently has about $30 million to continue derisking the asset, and one good thing about the project is the underground potential. Most people realize there's potential to dig deep in a greenstone belt. Currently, the company's chasing rich veins to a depth of 2.5 kilometers. A deep intersection on the Esaase project, at about the 400- to 500-meter level, is coming up with grades of about 10 g/t over 24 meters, suggesting this potential is available.

The other aspect to Keegan is its other Ghana asset, the Asumura gold property. This property is close to Newmont's 16 Moz. Ahafo gold operation, which has yet to be fully tested. Keegan has two rigs turning on it, and no analyst on the Street has a valuation on this asset yet. Decent exploration success is going to spike another wave of growth in the stock.

TGR: In March, Barrick Gold Corporation (NYSE:ABX; TSX:ABX) spun out its African assets into African Barrick Gold Plc. ( ABG ) . Is that company looking to expand its project pipeline and production profile in Africa?

NS: Yes, and I think it's just about time because it had some level of production from its mines in Tanzania, but that has not been smooth. I think the company revised guidance downward on that twice this year, and that's had an impact on the stock. People are waiting for African Barrick to tell investors where the growth is going to come from.

I see them as potential acquirers, and that adds to the list of companies who are looking in West Africa. I don't see a significant team of geologists in African Barrick that can start looking at the grassroots projects and build upward. Obviously, if it had those people, it would take a lot more time to get the growth that it is seeking.

TGR: Any parting thoughts on the junior gold sector?

NS: Well, we've seen all kinds of M&A activity. But I think it's going to accelerate because a lot of the majors still have a decline in their production profiles, and few have had much success with exploration. There's only one way to boost your production profile and that is to acquire a junior. I think most of these juniors, particularly those in my coverage universe, are well cashed up. In the next 6-18 months, they will be attacking their assets with a lot more vigor as part of an effort to grow their resource profiles. That would definitely be enticing to a lot of these majors looking to boost their resource and production profiles in those regions.

Clarus Securities Analyst Nana Sangmuah obtained his BSc (Honors) Engineering at the University of Mines and Technology (Tarkwa, Ghana) in 1999. His previous industry experience includes state-owned Prestea Underground Mine in Ghana (currently owned by Golden Star); AngloGold Ashanti's Obuasi and Iduapriem mines (Tarkwa, Ghana) and Goldfields International's Damang gold mine (Tarkwa, Ghana). Nana completed his postgraduate MBA finance degree at University of Toronto, Rotman School of Management in 2004. He has roughly seven years of global mining equity research experience that covers more than 60 mining companies worldwide in the gold, base metals and diamond sectors and has in-depth knowledge of mining projects in West Africa.

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DISCLOSURE:
1.) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2.) The following companies mentioned in the interview are sponsors of The Gold Report: Continental.
3.) Nana Sangmuah: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.

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