Paolo Lostritto: Don't Retreat, Reload Your Gold
Source: Brian Sylvester of
The Gold Report
When it comes to the 2011 gold price correction, Wellington
West Senior Analyst Paolo Lostritto says he's seen worse. He
counsels investors to "use this opportunity," if they haven't
already, to rebuild gold positions because he foresees upside by
the second half of 2011. Of the 19 companies he covers, only a
handful will outperform the broader market in any given year. We
know you want those names. And in this exclusive interview
The Gold Report,
Paolo gives them to you. His colleague, Senior Research
Analyst Steve Parsons, also shares his insights on a few of his
The Gold Report:
Reuters reported that for the fourth time in two months, China
has boosted the reserve requirement ratio (
) for their largest banks in an effort to curb inflation.
Thailand and South Korea have made similar moves in recent weeks,
and the first RRR move in China was made after inflation reached
above 5% in November. Do you expect this to have an impact on the
We've seen a reaction in the gold price over the course of the
last several weeks in response to these tightening measures.
Historically, North American players have experienced inflation
pressure in the form of labor inflation, like during the 1970s.
This time around, we're seeing inflation problems in the
developing economies such as Asia and Brazil. However, these
inflation pressures are starting to get exported around the
globe. An example would be the recent focus on food price
inflation. The reserve requirement adjustments are in response to
these types of issues. Should the velocity of money accelerate to
more traditional levels, this problem is only going to get
We're continuing to see some significant downward movement in the
gold price this week. What's Wellington West's position on the
ongoing volatility in the gold market?
In the last 10 years, there's been a slow and steady progression
of the gold price in response to the amount of fiat currency that
has been issued; this is an attempt to stimulate economies around
the globe. During that progression, there have been many examples
of much more volatile corrections than the recent one. Wellington
West still believes this is just a short-term blip in a long-term
secular trend, and that weakness should be looked at as a buying
A perfect example is Sprott Asset Management's recent efforts
to buy silver for the
Sprott Physical Silver Trust (NYSE.A:PSLV)
. Sprott has been purchasing silver for the past 2.5 months, and
they're still trying to take delivery of that physical silver.
Silver prices have corrected despite a tight physical market.
There's a severe disconnect between the fundamentals and the
price action. The one silver name that I cover is
South American Silver Corp. (TSX:SAC;
, which is in the exploration and development phase and has only
tested 30% of its exploration target and yet has yielded a
resource of over 330 million ounces of silver.
Is the same thing happening with exchange traded funds (ETFs) and
gold? Are they having trouble taking delivery, too, or is this
strictly about tightness in the silver market?
The one advantage of having eyes and ears on the ground in terms
of the physical market is that you're able to see the ebb and
flow of true physical demand. We have contacts in the industry
that we tap every once in awhile, and this is pretty fresh data
on a large scale. That's hard to ignore.
How much does gold have to fall before you and the Street become
worried about high cash-cost gold producers and their
We look at it on a case-by-case basis. At Wellington, we are
using $1,400/oz. gold for 2011 and 2012, and use a long-term gold
price thereafter of $1,000/oz. Gold equities have been in a sweet
spot since 2008 whereby costs have been somewhat contained while
commodity prices have improved. The time to make serious money in
the equity markets is during phases when you have margin
expansion, similar to the 2001 to 2004 period. However, during
the 2004 to 2007 period, margin compression despite higher
commodity prices was a bit of an issue, which was reflected in
the lack of equity performance. We are starting to see signs that
costs are creeping up again. Consequently, one is more inclined
to lean toward producers that have the majority of their capital
expenditures behind them, or alternatively, royalty companies
Franco-Nevada Corp. (TSX:FNV)
that give you exposure to the commodity but not to potential cost
Franco-Nevada recently took over
Gold Wheaton Corp. (TSX.V:GLW)
. What do you make of that move?
I thought it was a brilliant move by Franco-Nevada Chairman
Pierre Lassonde, President and CEO David Harquail and their
entire team to add value through an asset that was
underappreciated by the market. After that deal, we changed our
rating from a market perform to a buy. This recent correction is
starting to look very, very interesting from a valuation
Let's go back to the creeping cost escalation that you talked
about. What factors are behind those rising costs?
We're starting to see a little bit of cost inflation in steel and
oil prices, but the majority of cost inflation is coming from the
shift in labor and currencies. This is effectively the same
problem that we had in the 1930s, when every nation was trying to
entice economic growth through competitive currency devaluation.
But if everybody is doing it, it's a race to the bottom, and who
really wins? That economic backdrop presents some difficulties to
investors trying to preserve wealth, and that's why some are
turning to gold as a means of protecting themselves.
One high-cost producer that you follow is
Avion Gold Corp. (TSX:AVR; OTCQX:AVGCF)
. Avion is mining gold from several deposits in Mali. That
company had a remarkable run in late 2010, going from less than a
dollar in early November to above $2 by the end of the year, made
possible by the impressive cash flow numbers from its gold
production. You have a market perform rating on that stock now.
What needs to happen to get Avion to the next level?
Avion has been a great turnaround story and that speaks to the
high level of professionalism within that organization, from the
production guys to the geologists. Their attention to detail has
allowed them to unlock the value of those assets. In the next six
months, Avion is going to have impressive cash flows from their
existing operations. It has a market perform rating because, from
our perspective, the current market capitalization has already
priced in a significant portion of those expected better results
that should occur over the course of the next three to six
months. In order to get to the next level, we believe the company
has to have another significant, near-surface discovery that will
allow them to access relatively high-grade, inexpensive ore to
keep those cash flows going.
Now, Avion is accessing some underground mineralization, and
we think there's a real opportunity to demonstrate further value
by extending those mineralized zones at depth. But traditionally,
underground operations take a bit more time and have a tendency
to run into dilution issues; hence, our cautious approach to
valuing this company. But the team there has done a tremendous
job in unlocking value. We were pounding the table on Avion back
when it was around $0.45-$0.50.
Well, they recently completed 22 holes of drilling in the
cross-structure part of the Kofi deposit, and one hole hit 27
meters running 6.1 g/t gold. Is this something that the Street
was looking for, or is this part of the expectation that you
talked about before?
No. This is an asset that Avion recently acquired, and the
company tested a cross-structure theory and confirmed it in
drilling. Those assays prove that the theory, in fact, holds
together. There's a lot of value yet to be unlocked in some of
these peripheral assets. The difference, of course, is that some
of these other assets are farther away from the Tabakoto mill.
The ounces found near a mill are worth more than ounces that are
farther away. Kofi is roughly 35 km away as the crow flies, but
from a road and infrastructure standpoint, it's about 55 km away.
We tabulate that to be about $6-$8/ton in costs, so you would
have to look at maybe mining some of the higher-grade material
before you started trucking it. Alternatively, if it's big
enough, you build its own stand-alone operation. We're still in
the early days of trying to unlock additional value from Kofi.
Avion's team is planning to do about 22,000 meters of drilling
there. It will be an interesting year from an exploration
What's Avion's cost per ton from operations near the Tabakoto
It's an open pit area called Dioulafoundou, and their
costs-hauling costs, mining and milling-are something on the
order of $50-$60/ton. That's a function of being in the early
stages of the open pit. However, we would suspect that the strip
ratio is going to increase as they get a little bit deeper.
Probably by the end of this year, costs will shift closer to $85,
maybe $90/ton at that deposit. But offsetting that, you're
dealing with some phenomenal grades for an open pit; you're
talking 4-6 g/t, and any time you can mine open-pit material at
between 4-6 grams a ton with that cost base, it's a license to
print money. We think that the next three to six months are going
to be pretty special.
Let's head in a slightly different direction. Wellington West
recently published its top stock picks for 2011.The companies on
Wellington West's 2010 Top Ten Picks list averaged a return of
72%. Not bad.
Not bad at all.
Indeed. I won't ask you about all the names on that 2011 list
because some of them aren't gold or base metals names, but there
are three companies with gold properties among the 2011 picks.
Can you tell us about those?
The two names that I covered in last year's Top Ten report were
Anatolia Minerals (
Kirkland Lake Gold Inc. (TSX:KGI)
. Anatolia was a 111% performer last year, and Kirkland Lake was
up about 78%. Anatolia has gone from being an emerging producer
to being in the process of merging with an Australian group
called Avoca, to form a new company called Alacer Gold. Assuming
that the merger happens as planned, Alacer could soon be
producing more than 400,000 oz. per year and become a significant
player in the mid-tier space.
And Kirkland Lake?
It was a hell of year for them . They went from being an obscure,
under-followed, under-appreciated company producing roughly
50,000 oz. per year to being covered by several analysts; their
market capitalization went from roughly $300 million to close to
$1 billion. I think Kirkland Lake is just getting started in
terms of being able to demonstrate production and cash flow
growth over the coming two or three years.
Well, getting that kind of coverage certainly helps. But let's
get back to Wellington's 2011 picks. Please tell us about
I've only submitted one pick this year, and it's a company that
exited 2010 with some challenges. And it's in light of those
challenges that I think there's tremendous value and opportunity
going forward. My top pick was
Victoria Gold Corp. (TSX.V:VIT)
. At the tail end of last year, Victoria had to retract a portion
of its resource statement in Nevada. Data was incorrectly entered
into the database by their consultants. Unfortunately, the error
was caught after it was published. It was a bit embarrassing, but
we are not too concerned.
We think there's an opportunity because the drilling at the
Cove Project in Nevada was never tight enough to suggest that we
had a great understanding of the mineralized system at depth.
Victoria really had only enough information to justify
constructing an exploration ramp. Victoria Gold's plan of
operations has been approved by the Bureau of Land Management.
Consequently, the company is now in the short strokes of
finalizing their required permits before driving the ramp in the
first quarter of this year, with the hope of getting first
pre-production by the third quarter.
In addition to that, there is Victoria's Eagle Project in the
Yukon. The prefeasibility study on Eagle was less than well
received, but what most people don't realize is that the pit
walls were designed using a 30-degree slope. The rock qualities
have since been tested and may justify using a pit slope of 40 or
maybe even 50 degrees. Under that scenario, significantly more
mineralization would fall in the pit design, and that would have
a huge positive impact on the project's internal rate of
Those are two big value drivers and there are several "blue
sky" exploration targets that are not priced into the stock.
You're saying Victoria is going to build this underground ramp at
Cove to get to the mineralized ore at depth and that we could see
some gold production in the third quarter?
It will take roughly six months to get there, and the company
will do two things once it gets underground. One, it will conduct
advanced exploration drilling in order to understand the deposit
dimensions and ideally expand the resource. Secondly, it will be
able to "teaspoon" some of that material, roughly 400 tons per
day, and ship it to one of the local smelters. There are three
smelters in the area; one is owned by
Barrick Gold Corporation (NYSE:ABX; TSX:ABX)
, one by
Newmont Mining Corp. (
, and another by
Yukon-Nevada Gold Corp. (TSX:YNG)
. I think there's enough competition there for 19-gram gold
material to suggest that Victoria has a pretty good chance of
securing an off-take agreement. As a result, we believe Victoria
Gold should be ready to snap back in 2011.
There are two other mining companies on Wellington's list that
are covered by another analyst in your shop, Steve Parsons. I
know analysts don't usually comment on companies covered by other
analysts, so, Steve, would you like to comment on those
Sure. One is
Sulliden Gold Corp. (TSX:SUE; OTCQX:SDDDF)
. Sulliden is focused on developing its Shahuindo gold-silver
project in Peru, near Barrick Gold's Lagunas Norte mine and
Newmont/Buenaventura's Yanacocha mine. It really does fit the
bill for a two-part theme I've been talking about for a while.
The first part involves my expectation that building cash
balances in the mid-cap producer space will spur a pick-up in
M&A activity. The second part of the thesis is that the glut
of development projects planned for 2013-2016 will undoubtedly
create a very tight market for qualified labor and input cost
inflation. With this market dynamic in mind, I look to mid-size
deposits as probable targets. In particular those projects
offering low capex intensity that are relatively easy to build
and easy to operate. Shahuindo fits the bill given the open pit,
heap leach configuration. As this theme plays out (and it is
still early days), I expect the merits of Shahuindo to
crystallize and drive Sulliden shares substantially higher. My
target price is $3.90.
The other one is
Aura Minerals Inc. (
. Aura is a gold producer and operator of the San Andres Mine in
Honduras, and the São Francisco and São Vicente mines in Brazil.
Aura also has material base metal exposure with the 100% owned
Aranzazu Cu-Au-Ag mine in Mexico and the Arapiraca
copper-iron-gold development project in Brazil. At 0.7x P/NAV,
ORA shares are the cheapest in our gold producer universe and by
a wide margin; average of peers is closer to 1.2x. The
opportunity is that I expect Aura to be in a state of abundant
positive news flow starting in Q1/11 led by a step-change
improvement in production and cash costs at the company's
flagship San Andres mine. I also view as positive the potential
for Aura to surface value from the large Arapiraca copper project
What are some other names you're following in the gold space,
I cover 19 companies, and other than Victoria Gold, I only have
two strong buys in my space. One is Kirkland Lake, which we
talked about. I expect their growth, both in cash flow and in
resource, to continue over the next two to three years. I've also
got a strong buy recommendation on
Lake Shore Gold Corp. (TSX:LSG)
. It's the same story as Kirkland Lake; there's enough critical
mass and production that through expanding the resource through
the drill bit, and through future cash flow, those
valuations-Kirkland Lake and Lake Shore-should move up over the
next two or three years on a relative basis. A comparison would
be something like
Alamos Gold Inc. (TSX:AGI)
, which is producing between 150-170 Koz. per year with a market
capitalization of roughly $2.2 billion. With Kirkland Lake and
Lake Shore, you've got two companies that are roughly $1-$1.3
billion that are going to produce that amount of gold in the next
One more for the road?
Aurizon Mines Ltd. (TSX:ARZ; NYSE.A:AZK)
. Aurizon is set to have a banner year in 2011. They've moved
from mining at a faster rate in 2010, but at mildly lower grades,
to being in an area in the Casa Berardi mine where they're aiming
to have higher grades; closer to 8-grams per ton. This company
could be set up to produce record cash flow and earnings in 2011.
Aurizon is poised to do well. Their balance sheet is rock-solid
and should benefit from improved grades during 2011. The company
is positioned to either develop existing assets or use that war
chest to expand their asset base.
That's something the Street's been expecting for awhile, and it
hasn't happened. Is there a particular reason for that?
David Hall is a very prudent president and CEO. As part of the
construction and ramp-up of Casa Berardi, he went through a
period of repairing a balance sheet that had some debt on it.
After demonstrating that the mine would work, generating some
cash flow, and paying off that debt, Aurizon has built up not
only a substantial cash balance, but several other projects to
which it can deploy that capital in order to advance both growth
in production and growth in cash flow. Aurizon has had a fairly
robust move over the last couple of years because it's heavily
sensitive to the gold price. It's gone from roughly $0.50/share
back in 2002 to about $6.50/share now.
Before we part ways, what's your outlook for the gold market in
We exited 2010 with a lot of fervor. There were a few generalists
who would not normally participate in the space who entered it,
and it was a bit frothy there for a time. We are currently
experiencing a little bit of retracement, which is shaking out
some fast money. But we've seen this before, over the course of
the last 10 years. I still have faith in the investment thesis,
especially given that some Central Banks have gone from net
sellers to net buyers of gold. There continues to be examples of
large pension funds looking for a means to protect their wealth.
And there are numerous examples of oil-producing nations quickly
converting their oil cash into gold as a means to protect that
I look at what's going on now as a short-term correction; I am
not quite sure how long it will last, but I would use this
opportunity, if you haven't already, to rebuild your gold
position, because I believe the second half of 2011 is going to
be a lot of fun.
Paolo, thank you for your time.
Paolo Lostritto currently serves as a mining analyst for
Wellington West Capital Markets Inc.
He has formerly worked with Scotia Capital and MGI Securities.
Paolo holds a B.A.Sc. in geological and mineral engineering
Senior Research Analyst Steve Parsons, P.Eng., has been a
member of Wellington West Capital Markets' equity research team
since April 2008. After earning his bachelors of engineering
degree in mining at Queen's University, Steve worked as a
metallurgical engineer for Placer Dome, and then moved on to a
metallurgical consulting firm. Shifting to the investment side
of the business after that, he signed up as a research
associate with GMP Securities, concentrating on base metals
initially and later joined MGI Securities as a research
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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:
2) The following companies mentioned in the interview are
The Gold Report:
Franco-Nevada, Avion, Sulliden and Aurizon.
3) Paolo Lostritto: I personally and/or my family own shares of
the following companies mentioned in this interview: South
American Silver Corp. I personally and/or my family am paid by
the following companies mentioned in this interview: None.
4) Steve Parsons: I personally and/or my family own shares of the
following companies mentioned in this interview: Sulliden. I
personally and/or my family am paid by the following companies
mentioned in this interview: None.