by Travis Johnson, Stock Gumshoe | June 28, 2013 3:59 pm
This week there were a couple things that cropped up on the site as articles for the Irregulars — I made one purchase, adding Ligand Pharmaceuticals to my personal portfolio, I answered a more detailed question about a Thai investment I had covered in the past, and I took a quick look at a legal dispute brewing over at Americas Bullion Royalty, a snake-bitten company (even before gold prices collapsed) that’s been a speculation for me and a watchlist stock on the site for a while.
We also published Myron Martin’s next installment for the Irregulars earlier this afternoon, so we’ll keep this brief today and give you some time to read his look at a handful of little companies — he tends to be focused on small caps and junior mining stocks and follows them more closeely than I care to, so we’ve asked him to share a monthly column with you and cover some of his favorites, which will hopefully be interesting given the collapse of the junior mining and energy sectors in Canada, his preferred hunting ground.
But the questions I’ve been getting personally have mostly been about gold — no surprise, given the incredibly rapid fall in the gold price this Spring. And more specifically, I’ve been getting questions about my largest gold-related holding, Sandstorm Gold (SAND). So even before the stock jumped like a jack-in-the-box today, I was planning to take another look and see how things are looking for them.
Sandstorm Gold is no longer my largest single holding (it was at the top of my portfolio, if you include warrants, for quite a long time), but that’s because the share price has been clobbered — not because I’ve been selling. I did sell my 2014 warrants and roll much of that money way out to the 2017 warrants a while back (I tried to get the 2015s at the time, but the price didn’t work), but all the warrants have also seen their prices decimated this year so that hasn’t helped much.
I very much like the strategy and management of Sandstorm, and this is the kind of environment that can allow them to make good new royalty or streaming deals, since mining companies are essentially cut off from the private markets now that gold has fallen from $1,900 to $1,200 with the rapid rejection of gold as a financial asset over the pst six months.
But this is a company that pays other firms up front for their future gold production, then effectively gets repaid in gold over time (most of their assets are streaming deals, where they purchase an ongoing set percentage of gold produced at a fixed price well below the spot price — their price currently averages a bit over $400 an ounce). So they are, quite obviously, clearly and rightly, levered to the price of gold. The reason I like Sandstorm Gold and their larger compatriots, Royal Gold (RGLD) and Franco-Nevada (FNV), is that while they do get the leverage to gold prices over time, and even better they get somewhat diversified leverage since they own streams or royalties on more than one or a few mines, they don’t face the cost overruns or production cost problems that are endemic to miners.
But they are not immune to mining costs, because if mining costs get too high mines shut down. Mines can shut down for any reason, of course — the largest copper/gold mine in the world, Freeport McMoran’s Grasberg mine in Indonesia, was completely shut down for about six weeks after a tunnel collapse killed miners and is still partially shut down (open pit operations only) — but unless there’s a water flood or a safety issue mine shutdowns are usually based on economics. If the cash costs exceed the price they can get for the ore, then they’d lose money by operating the mine. That might be OK for a relatively brief while if prices are just slumping temporarily, since shutting down and starting back up are time-consuming and can be expensive … but if you think the economics are not going to improve markedly you’d want to shut down, preserve the asset, and wait until pricing improves to restart operations.
So that’s the real concern for a passive stream owner like Sandstorm — not only do they see margins compressed as gold drops (if they buy at $400 an ounce it’s more fun to sell at $1,800 than it is to sell at $1,200), but they can also see streams disappear if their partner mine shut down, or see slower development from their anticipated streaming partners if those mines that are currently being planned or built are delayed due to either bad economics or, in this environment especially, a lack of capital to complete construction.
That’s why I haven’t been pouring more money into Sandstorm as the price has collapsed — because I don’t know what gold will do, and I’m not sure how strong their partners are going to be with falling prices. It seems quite likely that their current core producing assets are in decent shape, since the mines that are cash-flowing now were started or planned two, three, four or more years ago and SAND’s deals were inked in 2008 and 2009 in some cases, when gold was first tickling the $1,000 line on the charts. But it’s probably worth checking, so I looked at the recent filings from a couple of the key streaming partners.
Aurizona, their largest cash-flowing asset now (it’s expected to generate 35% of SAND’s cash flow this year), is owned by Luna Gold. As of now, the share price of Luna has dropped from about $3.50 to $1 this year. They had a cash cost per ounce of $757 per ounce and an all-in cost of production of $1,033 per ounce on average in the first quarter, with estimates that their cash cost will be coming down to a little over $700 as they expand. Some of that all-in cost is not written in stone, but the cash costs are not likely to fall unless energy prices fall substantially.
Black Fox, owned by Brigus, is the newest of their streams that’s a major contributor to expected cash flow, about 15% of SAND’s expected revenues this year. Brigus has been cutting costs even before the collapse in the gold price, their current cash cost for the first quarter was $630 and they lowered their annual cash cost guidance to $650-700. Their total operating costs were $946 an ounce in that first quarter.
Santa Elena is a small mine owned by Silvercrest, but it’s one of the earliest SAND deals and therefore it’s a pretty big contributor, 17% of 2013 expected cash flow thanks to the high share of gold (35%) and the low SAND cost ($350/ounce). Silvercrest is generally also considered a low cost producer, but they’re also a substantial silver producer so they calculate based on their cost per ounce of silver, not gold. This Seeking Alpha contributor estimates their real all-in costs (more inclusive than most such calculations) at about $1,045/ounce, or $945/ounce if you exclude writedowns. That’s likely to rise as the underground mining begins next year, and SAND has an option to buy in for a share of the underground mine as well, but for now they’re doing OK.
The only other mine that’s expected to contribute as much as 10% of cash flow this year is Bachelor Lake, owned by Metanor. They are just now starting up mining operations, they’ve done a couple months of relatively limited mining as they ramp up, and I expect the cash flow to Sandstorm will be back-loaded to later this year for the most part. We don’t know what the cash costs at Bachelor Lake will be in real life, I’ve only seen their reported cash cost of around $450 from their pre-feasibility study, but this collapse in the gold price is rough timing for Metanor and put them in a bit of a cash crunch. They just did a private placement for a few million dollars (this is a tiny company, market cap is under $20 million now), and they were able to amend their loan agreement to push back the beginning of repayment to August 31 (the loan is from the Quebec government, so they’ll probably be flexible), which means they have a bit of breathing room as they ramp up production. If the cash costs are really that low, they should be OK as long as there aren’t extended problems with ramping up the production.
The two largest new contributors to expected cash flow a few years out are Serra Pelada in Brazil, operated by Colossus Minerals, and the Deflector project in Australia, owned by Mutiny Gold. Colossus appears to be in good shape, mining is about to commence and they have most of the expensive construction done and a lot of the funds already raised — we don’t know what production will be like, since they haven’t released traditional reserves statements and it’s a tough site to assess, given the decades of mining already done there, but it should be quite low cost and they’ve got platinum and palladium to juice the project as well. Colossus is a substantial reason for my long-term optimism about Sandstorm, I think that might turn out to be a really important deal for them in a few eyaers.
Deflector, on the other hand, is in a really tough spot — they are all ready to go and all permitted to develop the mine but they need more financing. Sandstorm sounded upbeat about Deflector’s progress in getting through that financing hurdle in the last quarterly call, and SAND doesn’t have to pony up the remaining $29 million of their up-front payment until Mutiny has reached “certain funding conditions.” The shares are trading with a minuscule $12 million market cap in Australia right now, and it looks like if gold remains low they may be distressed borrowers or partners for whoever will put up the cash they need to actually move forward.
So what does that mean? Well, at current prices around $1,200 most of even the big and well-known miners are in at least a little bit of trouble and will be either losing money or seeing their profit margins get quite tight. We’ve already seen some relatively small mines get mothballed or their development delayed, but I expect that most miners, being perpetual optimists, are cutting costs and holding out for higher prices. I expect that as long as gold remains above $1,000, Sandstorm will be getting solid cash flow this year and next year. IF gold falls to $1,000 then their SG&A costs will eat up most of that cash flow, since the cash flow is lower than would have been projected and they expanded their team and have been growing in anticipation of doing more deals, but they should be in OK shape given that their three biggest cash flow producers should continue producing. They are not in serious danger, largely because they built Sandstorm (so far) without debt and they have some cash cushion, but they will obviously see dramatically lower earnings if gold prices are dramatically lower — and if gold falls much below $1,000 for any appreciable length of time, it’s going to be ugly, some of their mines will likely at least pause production and future developments or expansions will likely be scuttled.
So looking forward, Sandstorm’s sensitivity to the gold price will continue to be pronounced. The Sandstorm folks are fond of saying that “mine finance is dead” as we have known it for a long time, and that their primary competition is from the public markets and debt markets — so if miners can’t raise money by borrowing it or by selling equity on the stock market, Sandstorm and the other royalty and streaming buyers are the only viable option for financing. Of course, they also say that they will continue to focus on dealing with companies who are in the lower half of the cost spectrum and which have the access to capital they need to, with Sandstorm’s help, actually get to production (meaning, they want to deal with low-cost mines, and they won’t buy in to projects that still also need substantial outside capital to proceed). Sandstorm’s goal is to be the last one in to the capital structure — to be the final payment that a miner needs to get to production (or to increase production). There should be plenty of opportunity for SAND to make new deals now, but there’s been such an opportunity for several months now and we’ve not heard anything substantial recently, so it’s a bit of a waiting game. SAND has pretty good liquidity, with just under $100 million in cash and a $100 million line of credit that they haven’t tapped yet, so if they see some good deals they can pounce.
I should be rebalancing to restore the percentage of my investable assets that are tied to gold, putting a bit more into Sandstorm now or into the other royalty stocks, and buying a bit more physical gold now that the price has fallen, but I haven’t gotten the nerve to do so personally just yet. I didn’t expect the fall in gold to be so overwhelming or dramatic, but it really built on itself, particularly as ETF speculators in GLD and other paper gold assets ran for the exits, which more than made up for any bargain buying of the physical metal in China or elsewhere. I am holding, and I still think gold is an important asset class as the US and every other country around the world tries to depreciate its currency over the long term (whether they admit they’re doing so or not), but that doesn’t mean it will necessarily go up in dollar terms on as steady a basis as we had gotten used to — particularly if, as a result of rising interest rates, the dollar continues to climb and attract more “risk averse” capital.
Gold as a a financial asset has benefitted from the expectation that the increase in the money supply will lead to depreciation and inflation, and just from those who have used it as a place to hide during times of panic, but as a weak economy has kept inflation under wraps and the stock market has surged, investors are looking for higher returns and gold, as a financial asset held in paper and super-liquid entities like ETFs, does not generate any income or grow its business, it just is. I like gold as a long-term store of value that I hope won’t go down over time, for the most part I think of it as savings, not investment or speculation when I buy physical gold, but Sandstorm is obviously more levered and speculative — much safer than junior mining stocks or even, I would argue, than a lot of large mining stocks, but definitely still levered to gold. Leverage elates when prices are rising, and hurts when prices fall. I haven’t had the courage yet to buy with the “blood in the streets” here, since I don’t know if gold bottoms out at $1,200 or falls to $800 and causes a real collapse of gold mining around the world, but I probably should be buying a little bit now. If you’re doing so, you’re either braver, more prescient, or more foolhardy than I, and more power to you.
Sandstorm Gold, by the way, has been off like a rocket today as I finish up my commentary for you, up 15-20% at times. There’s plenty of speculation about why, whether it’s that the short-covering on the futures market has driven gold up by 2%, or there’s just sentiment that gold has bottomed, or simply that the beating had been overdone and the gold price was driven down too low given physical demand and the costs to produce it, and SAND ran out of sellers. But I have no idea why SAND would move so abruptly — other than the fact that, in my opinion, this $1,100-$1,200 price range is a pretty critical base for SAND’s mining partners to keep producing profitably, so a bounce higher from there would bring a “sigh of relief” reaction.
The miners are generally doing very well today, showing again their leverage to gold prices and their tendency to get out ahead of both falling and rising gold prices, but SAND is dramatically outpacing larger royalty peers RGLD and FNV. Still, it’s a noticeable bounce but it just means SAND’s share price is … back where it was at the beginning of the week, before this latest leg of the collapse. It’s perhaps slightly reassuring that the stock is still capable of going up as well as down, but doesn’t mean anything broader to me, not yet, and I can’t tell you where SAND will be in six months unless you can tell me what the price of gold will be at that time.
Stock Gumshoe will be closed in the second half of next week as we celebrate the July 4th holiday, so we won’t have a Friday File again until July 12. If something crops up in my crowded brainpan between now and then, or I make any trades with my personal accounts, I’ll let you know. Have a great weekend!
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