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The Metals Report: George, what do Doctor Copper and other indicators tell you about global economic performance over the medium term?
George Topping: You can't take the value of any commodity as a true indicator of physical demand these days. For example, a fortnight ago, copper prices shot up 6% from $3 per pound ($3/lb) to $3.19/lb in a heartbeat. That resulted from financial players pushing the copper price around. It represents what the financial markets think of the world economy. The indicator has some value in that it reflects a collective body of knowledge, but the underlying physical market is not as bad as the financial players would have you think.
Copper consumption will start to pick up. I expect the price of copper will increase because the number of dollars in circulation has tripled in the past five to six years. There's been an incredible printing of currencies and currency debasement in the U.S., Japan, Europe and Great Britain. The U.S.-adjusted monetary base is now over $3 trillion, up from $800 billion ($800B).
"While it's easy to put copper into warehouses, it's not easy to get it out."
Another important angle on the physical copper market involves warehouses. Copper consumers are learning that we may look like we're well supplied from the London Metal Exchange, but while it's easy to put copper in, it's not easy to get it out. There are restrictions on the amount of copper that can come out of warehouses on a particular day. Warehouses are supposed to restrict volatility and make it less of a tradable commodity, but it can make it more volatile to the upside because when you want your copper, the companies that control the warehouses can take their time, causing premiums to rise.
TMR: Do you believe that volatility could provide investors with entry points?
GT: Absolutely. Pullbacks, like when the copper price came down closer to $3/lb this year, are an excellent entry point. When prices fall, it's a good time to stock up. It's human nature.
TMR: What is your thesis for small-cap base metal equities?
GT: Small-cap equities are out of favor, which makes them more attractive to larger companies that have the cash to move in and acquire them. There's a surplus of assets for sale right now. The major companies like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) and Barrick Gold Corp. (ABX:TSX; ABX:NYSE) are selling off their noncore assets.
TMR: What do these companies look for in an asset?
"Pullbacks, like when the copper price came down closer to $3/lb this year, are an excellent entry point."
GT: They're looking for quick cash flow. The market has moved away from the "we'll build this, and in five years we'll see some cash flow" model. Until we work our way through this period of oversupply of producing assets, these juniors will trade at very cheap prices.
TMR: How long will it take to wash the surplus assets out of the system?
GT: It depends on metal prices. The push to sell lower-quality assets is on, but a lot of those assets will be taken off the table if base metal prices run higher. Juniors like Foran Mining Corporation (FOM:TSX.V) are trading at very low prices compared to the worth of their deposits. Smarter, more long-term-oriented companies can buy these smaller assets and tuck them away for later development.
TMR: What's your rating and target for Foran right now?
GT: We have a Buy rating on Foran. The target price is $1.50. A few months ago the stock was trading at $0.55. It's now down to $0.38. The management is a cut above the rest. President and CEO Patrick Soares, the chap who sold Hammond Reef to Osisko Mining Corp. (OSK:TSX), has a track record of selling assets at a premium. Chairman Darren Morcombe is connected and has done very well. He sold a gold refinery to Newmont Mining Corp. (NEM:NYSE) for a good profit. Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) Chairman Pierre Lassonde owns about 11% of the company. That's an endorsement, if you ask me.
TMR: What's next for Foran in terms of development?
GT: It's advancing engineering studies and met testing, so it can quickly put together an economic study.
TMR: What other development stage base metal projects are you following?
GT: Lumina Copper Corp. (LCC:TSX) in Argentina. Its Taca Taca project is trading at a deep discount due to Argentine risk, but we'll get a view on that in October when we see the legislature elections.
TMR: Where is Taca Taca along the development curve?
GT: Lumina has delineated the deposit and done the economics, but it's waiting for a bit. In any other country, it would've been taken out at three times the current share price. It's a waiting game.
TMR: What's your rating and target?
GT: I have a Buy rating on it. The target is $15. I also recommend Duluth Metals Ltd. (DM:TSX) in Minnesota.
TMR: It's on a big belt there.
GT: You got it. That belt continues up into Canada. It's a massive deposit. Polymet Mining Corp. (POM:TSX; PLM:NYSE.MKT) is also there.
TMR: But Polymet has all kinds of trouble. What makes the thesis better at Duluth?
GT: Duluth has a contract with Antofagasta Plc (ANTO:LSE), which owns 40% of the joint venture. Once the bankable feasibility study is completed, probably in two years, Antofagasta has the option to buy 25% of the Maturi project for a pro rata share of 1.0x net asset value (NAV), which will be determined by the bankable feasibility study. We've modeled it at a NAV 10% discount rate, $2.80 copper, and we get a value of over $2B for the deposit. That's $500 million ($500M) for the 25%, but Duluth is trading only at a couple of hundred million market cap. If I'm Antofagasta, I'm just going to buy Duluth, and then I get 60% for less than I can buy the 25% for. What I like most is that there's a catalyst that encourages Antofagasta buy Duluth much sooner. My target is $5.
TMR: Can you talk about a couple of the producers you cover?
GT: We're recommending First Quantum Minerals Ltd. (FM:TSX; FQM:LSE). It's the go-to name for copper exposure in North America since its competitor, Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), bought into oil and gas.
TMR: Where is the growth coming from?
GT: It has a lot of growth projects, maybe too many at one time, actually. It's got expansion at its existing mine, Kansanshi, in Zambia. It's building a smelter, which will supply Kansanshi and also handle production from Sentinel, another huge project in Zambia. It's building the Enterprise nickel deposit in Zambia. The completion date for the next phase of expansion at Kansanshi is 2015. Sentinel should be commissioned in mid-2014.
TMR: Is it overleveraged in terms of development projects?
GT: There is a delivery risk, but it is better than most at delivering. That's the only concern. If you're not fazed by quarterly hits and misses and can look at it as a trend, you'll be fine.
TMR: Is there another copper producer in your book?
GT: Capstone Mining Corp. (CS:TSX), obviously. Its acquisition of BHP's Pinto Valley mine changes everything. Its copper production will be up more than 130%. Ironically, it may become more of a target because of that. It's always been seen as a small mine in the Yukon that was good quality, but didn't move the needle. But now it's got Pinto.
TMR: Did you see the Pinto acquisition coming?
GT: Yes, it was well signaled. The rumors in the market are that Capstone was not the highest bidder but was paying cash, whereas the others were saying, "Here, take our shares."
TMR: Let's shift to zinc. What's your price forecast for the remainder of the year?
GT: We're going to see metal taken off the visible inventories. For this year, $0.94/lb is the average. Next year, we expect it to spike up to $1.26/lb. We don't know when the cycle's going to turn, but when it does, it'll be rapid.
TMR: This is based on supply levels and a lack of a growing supply of zinc?
GT: At these price levels, companies are starting to shut down. The silver price has fallen significantly, and silver and zinc occur together. China is the major zinc supplier, but labor costs in China have been rising at 15% a year, meaning access to cheap labor to mine these deposits has dried up. On a currency basis, the Chinese yuan is fairly strong, so they're not getting a benefit from their currency.
TMR: Do escalating labor costs in China help raise the share price of a junior like Foran, given the amount of zinc at McIlvenna Bay?
"Very few zinc companies are left given the bear market we've had since 2007."
GT: Absolutely. Companies like Lundin Mining Corp. (LUN:TSX), HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) and Foran should benefit tremendously, Foran especially, given its 25 million ton McIlvenna resource [Indicated and Inferred] and proximity to Hudbay's Flin Flon zinc smelter. Very few zinc companies are left given the bear market we've had since 2007. Six years later, there's hardly anything available to invest in. These polymetallic companies are the only survivors. HudBay and Lundin produce about 40% of their revenue from zinc.
TMR: What's your forecast for platinum and palladium in the near and medium term?
GT: For platinum, we're at $1,758 per ounce ($1,758/oz) for this year and $1,775/oz for next. For palladium, my forecast is $754/oz this year and $863/oz the next.
TMR: That's a healthy increase. Should investors sell their gold and buy palladium?
GT: I do like platinum and palladium. The problem is finding companies to invest in. One reason behind the forecast is that South Africa is in dire straits. If you can buy the physical platinum and palladium exchange-traded funds, I would.
However, Platinum Group Metals Ltd. (PTM:TSX; PLG:NYSE.MKT) is in South Africa, but it's a shallow deposit so its energy requirements are much lower. It has this remarkable discovery called Waterberg, which is a massive deposit of platinum and palladium. It's lower grade, but it's thick and extensive. You should have a look at that one.
TMR: Is that company being unfairly punished because it's in South Africa?
GT: I think all companies in South Africa carry a discount. Platinum Group Metals has some advantages. It already has a JV with the Chinese company, Jinchuan Group Ltd. Of course, the rand is devalued as well, which is good for the company because by building a mine on a weaker rand, you're probably saving about 20% on your U.S. dollar capital expenditures (capex).
TMR: Is production in late 2014, like it's predicting, realistic?
GT: Initial production will start then, but it will be more of a 2015 story. My target there is $1.75.
TMR: Any last words of Topping wisdom for retail investors?
GT: The amount of currency debasement and stimulus we're seeing means that there has to be a role for hard assets, be it gold, copper, platinum or palladium. I would seek protection against fiat currencies. I think inflation is unavoidable once the economy starts to pick up in a serious way, and all commodities do well in inflation.
George Topping joined the Stifel Nicolaus Research Team in connection with its acquisition of Thomas Weisel Partners LLC in July 2010. Topping joined Thomas Weisel Partners in December 2009 as a senior mining analyst covering base metals. Topping brings 10 years of experience in the mining industry and 14 years as a sell-side analyst. He began his mining career in 1985 with a senior South African mining company and worked both in operations and mining strategy roles for the gold and coal sectors. In 1995, Topping became a sell-side analyst covering platinum, coal and base metals with Irish & Menell Rosenberg, a South Africa–based financial services firm. Topping moved to Canada in 1997, where he has continued as an analyst covering base metals. From 1999 to 2005, he was at Sprott Securities and since 2007 at Blackmont Capital. Topping earned his undergraduate degree in mining engineering from the University of Strathclyde in Glasgow, Scotland.