Gold Chart Forecast – Outperform

The Gold Report: Since November, there’s been a decisive break between the S&P 500 and gold, bullion and the AMEX Gold BUGS Index (HUI:NYSE). The HUI has provided leverage to gold, but it’s been leverage to the downside. There are new highs on the S&P 500 almost daily. Does that mean that you’re looking for new lows in mining equities?

Jordan Roy-Byrne: There’s been a negative correlation between precious metals and the equity market that became quite pronounced in November. However, the negative correlation really began in the summer of 2011, when gold peaked at $1,900/ounce ($1,900/oz) and the HUI gold stock index and Market Vectors Gold Miners ETF (GDX:NYSEArca) also peaked.

JRB: Precious metals will be the best performing sector over the next three to five years. I focus on gold and silver companies with cash-flow growth, which comes from production growth. A royalty company produces cash-flow growth from more accretive transactions.

“The precious metals complex has likely bottomed due to extreme bearish sentiment.”

The reality is that in any bull market, no matter what the sector or industry is, the market always wants growth. The producing companies that have been able to grow cash flow and production without diluting shareholders and taking on huge amounts of debt are the companies that have performed the best in this difficult period. I call them growth-oriented producers.

TGR: Are there examples of companies that are role models of what you look for?

JRB: Primero Mining Corp. (PPP:NYSE; P:TSX) is a company that I really like. The stock had a huge move in 2012 because of a positive resolution to its tax status. The stock peaked at about $8/share and it has digested that huge run. It bottomed just above $5/share. I forecast that it will likely trade in a range from $6–8/share during the next four to five months.

Fundamentally, Primero has very strong cash flow from its San Dimas mine in Mexico, which is a world-class asset. The company also has more than $100 million ($100M) in cash.

Primero has a strong management team and a world-class board of directors. The roster of people involved with this company is simply stellar. They have done this before, so Primero is a good model for what I’m looking for.

“If interest rates are rising because of inflation concerns and rising inflation expectations, that could be positive for precious metals.”

The company has already been a huge winner for us because we got in at less than $3/share. Primero has the capital to continue to grow the San Dimas asset, but it also made an acquisition last year and is hoping to put that asset into production in 2015.

This is a company that’s very strong financially. It’s strong on the charts. It’s not falling apart during this downturn. It has the financial strength to grow its production. I think Primero is going to be the nextArgonaut Gold Inc. (AR:TSX). Argonaut is a very strong model and one we’ve been very positive on for several years now. Primero is where Argonaut was about a year ago.

TGR: Most producers are facing a lot of cost increases across the board in production. But it appears Primero and Argonaut have maintained cost per ounce of production during the last several years.

JRB: In Primero’s case, San Dimas is a very high-grade underground mine. Argonaut’s assets may not be as high grade, but it’s done a really good job managing them.

In both cases, I chalk it up to having management teams with enough exp

erience in this industry to know how to control costs. They’re thinking ahead. They’re thinking about what could potentially affect costs next year and the year after. For example, last year Argonaut sensed a cyanide shortage in Mexico and was able to secure cyanide for the next several years. Now the cyanide price is more expensive.

TGR: You also believe there is potential for rising valuations among the producers. Wouldn’t that require a sustained bullion price increase in a market that hasn’t shown a lot of belief in high metals prices?

JRB: That’s why valuations are at a trough. The gold price isn’t going up. It is going sideways. The market needs the gold price to reach $1,800/oz or more to see valuations increase. There’s a lot of potential for these companies to see tremendous increases in their value because, assuming gold breaks out, valuations will naturally increase. Because they are currently at a floor, they have substantial room to move higher. Valuations are currently near 2000 and 2008 levels, and those were the two best buying opportunities in this bull market.

Many stocks are trading at cheap valuations, but that’s because those companies don’t have the pipeline needed to grow. I’m looking for companies that have the ability to grow production and cash flow in the coming years. Over time, they will be rerated.

TGR: Are there additional companies with good cash flow that are undervalued or ignored?

JRB: The cheapest stock that I’m aware of is producer Lachlan Star Ltd. (LSA:TSX; LSA:ASX) in Chile. The management team acquired a woefully underperforming mine and is currently ramping up production and methodically reducing costs.

The company is not cash-flow positive at the moment. Its all-in costs last quarter were above $1,800/oz. However, costs are trending down and will likely come down this quarter by 15%. It has implemented its own mining fleet, which could save it about $150/oz. The company is also mining its highest-grade pit, which it wasn’t mining last year. The company expects to be cash flow positive in Q2/13 and I think all-in costs will be below $1,400/oz in Q3/13.

On the production side, Lachlan should produce 75,000 oz (75 Koz) this year and is targeting 100 Koz in 2014.

The company has a $54M market cap, $7M in cash (as of January) and took out a $10M debt facility. It’s going to be fine as long as the gold price doesn’t drop below $1,500/oz.

This is a very cheap stock that has strong potential to trade at $2–3/share if the gold price exceeds $1,800/oz.

Related articles

• Are You Prepared For Hyperinflation? SPDR Gold Trust, Coeur d’Alene Mines Corporation, First Majestic Silver Corp (etfdailynews.com)
• Money Stimulus Marathon’ Good for Gold Juniors and Price: Eric Winmill (ampgoldportfolio.com)