Rick Mills: Low-Cost Producers Trump Larger Mines in Costly Market

The Gold Report: Rick, is this a good time to be buying gold?

Rick Mills: There are three key reasons to have exposure to gold bullion. The traditional reason is to protect against inflation. We're printing money. More quantitative easing has taken place and inflation looks to be coming down the pike. I buy groceries. I pay for gas. I can see inflation. I firmly believe it's going to get higher over the coming months and years. Buying gold as a protection against inflation is realistic.

The second reason investors have traditionally bought gold is as a safe-haven investment. There's a lot going on in the worldfrom secession talk in the U.S. to turmoil in Israel, Iran, Syria, the South China Sea region and Turkey.

One of the things that most investors don't know about gold is that adding a gold allocation to your portfolio, especially over the last decade or so, has provided substantial enhancements to the portfolio's return.

Gold helps minimize the downside deviations in an overall portfolio. In 2002, the SP 500 was down 23%. Emerging market equities were down 6%. International equities were down 16%. Yet gold was up 25%.

TGR: That was early in the bull run in gold.

RM: Even in 2008, the SP 500 was down 37%, international equities were down 43% and emerging market equities were down 53%. However, gold was up 8%.

TGR: It felt like the end of the world in 2008. Gold has saved the portfolios of a lot of investors who were smart enough to start collecting it in 2001 and onward. However, there are investors who don't believe that gold has the multiples now.

RM: It's true. I believe gold producers have shot themselves in the foot because of their reporting methods. They use cash cost for reporting. In 2001 and 2002, miners were producing gold for below $180/ounce (oz). By 2005, cash costs had risen 45% to $250/oz. Data from research consultancy Thompson Reuters GFMS shows that world gold production costs for the first half of 2009 averaged $457/oz. In 2011, they were $657/oz. GFMS' Gold Survey 2012 says it's now $727/oz.

"Buying gold as a protection against inflation is realistic."

But if investors have been looking at that, they've been misled because that's not really the cost of producing gold. These average cash-cost figures include only the costs directly associated with the production of gold, such as wages, energy and raw materials. The problem is that gold cash costs are not the only costs associated with mines. Investment bank CIBC just produced a complete breakdown of costs. Yes, operating costs are $700/oz, but there is also sustaining capital, construction capital, discovery costs and overhead. CIBC pegs those at an average of $600/oz. Add in $200/oz for taxes on average, and you're looking at $1,500 to produce an ounce of gold.

TGR: In that environment, many of the gold mining producers would be out of business.

RM: The gold price is $1,700/oz. Companies are not making a lot of money here. The funny thing is that the sustainable costs for goldthe sustainable number gold miners needaccording to CIBC, is $1,700/oz. You can see why investors are leery to jump into the space with numbers so tight.

TGR: But you're a gold bull. You believe that people should be investing in bullion. The bullion has to come from somewhere. What's an investor to do when he believes in the fundamental reasons for owning gold, but doesn't understand how the equities can perform?

RM: Historically, the precious metals equities have given investors the most leverage to a rise in gold and silver prices. We need to have a rise in gold and silver price. We need to get into that environment again, like it was from 2001 to 2006 when gold equities went up 900%.

Let's look at why companies aren't making a profit. One of the biggest reasons is capital expenditures (capex), which is the basic cost of building a mine and its supporting infrastructure. There are lower grades being mineddown 23% over the last five years and expected to drop another 4% this yearand more complex metallurgy. Companies are increasingly going into more remote areas that lack infrastructure. Environmental regulations are increasing. We are seeing more money-grabbing governments and resource nationalization. There's a serious shortage of skilled personnel and labor unrest is pretty much everywhere: strikes, protests and unions demanding higher wages. Everything you can imagine is working in a perfect storm to increase costs and risks on mining companies.

Costs are going through the roof, yet gold is stuck in a holding pattern at $1,700/oz. Then, when people want exposure to the sector, they buy an exchange-traded fund (ETF). In the past, a lot of that money would have gone into mining equities.

"Gold helps minimize the downside deviations in an overall portfolio."

There's a huge increase in exploration spendingmore than $8 billion ($8B) in 2011but a serious lack of new discovery. There have been very few large, high-grade deposits discovered during the past few years. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) said at the Precious Metals Conference 2012 that of the "super giant" discoveries, those that are more than 20 million ounces (Moz), 18 were discovered in the 1900s. Fast-forward to the 1980s when 14 were discovered. In the 1990s, 11 were discovered. In the 2000s, only five were uncovered.

The number of annual gold discoveries of more than 5 Moz since 2007 is six in 2007, one in 2008, one in 2009, three in 2010 and one in 2011. None is producing yet. A lot of people who think that they're going to produce are in for a disappointment because of resource nationalism, permitting problems, environmental problems, lack of water, labor unrest and protests.

TGR: Assuming gold demand will continue to escalate due to macroeconomic pressures, will the price of gold continue to increase?

RM: Gold demand is still rising. Five-year average quarterly demand is rising, so that's correct.

TGR: What do you forecast for the 2013 gold price?

RM: That's a mug's game, trying to predict gold prices, but it'll be higher.

TGR: You believe the price of gold can only go up.

RM: That's right. Inflation, world events, diversificationgold does offer leverage. So do equities, or at least they will again. I'm not looking at huge mines with billions and billions of dollars in capex. I'm much more comfortable with the smaller mines with lower capex and under-control operating expenditures. I like the lowest-cost producers. That's where the money is going to be made over the next two years.

TGR: Canada, the U.S. and some places in Latin America are the preferred jurisdictions for risk reduction, infrastructure, rule of law and reliability of government.

RM: Absolutely. Look at the Muslim Brotherhood in Egypt canceling a nearly 20-year-old license for a mining company. In Madagascar, a DJ gets elected president and the first thing he wants to do is cancel permits and do a review. That's not happening in Canada, the U.S. or politically stable places like Greenland. There is enough risk in this business as it is without intentionally inviting more.

TGR: Given that backdrop, what are some companies you find interesting right now?

RM: Let's stick with soon-to-be producers or companies that are going to be very low-cost producers. They're all in geopolitically acceptable countries with superior management teams.

According to a July 2012 research report by Natural Resource Holdings, there are only 164 undeveloped gold deposits globally, with more than 1 Moz of gold in all categories, that are owned by non-major mining companies. The average grade of all these deposits is 0.66 grams per ton (g/t). Since we're mining +80 Moz a year, that makes these non-major-owned deposits quite valuable.

The total current gold resource on Altair Gold Inc.'s (AVX:TSX.V) Kena property sits at 1.06 Moz. In the Kena Gold Zone, Measured and Indicated (MI) resources are 300,000 oz (300 Koz) at 0.64 g/t Au, and Inferred are 85 Koz at 0.70 g/t Au. In the Gold Mountain Zone, MI resources are 249 Koz at 0.71 g/t Au, and Inferred are 428 Koz at 0.60 g/t Au.

"Everything you can imagine is working in a perfect storm to increase costs and risks on mining companies."

I like Altair Gold because the company has an amazing technical team and they are putting some serious money into their project. Altair put $1.75 million ($175M) into the Kena property in British Columbia this year. The company drilled 7,400 meters (m) and got some results back, but is going to put a comprehensive plan together based on the complete results. That will be exciting. Altair has proven it can raise money. It can run a technical drill program. It can get the word out to investors. With the right results, this management team can take this project all the way to being one of those low-cost producers. Altair could have something spectacular.

TGR: Bob Archer, who has had great success with Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT), is behind this company, as well as Fayyaz Alimohamed.

Do you foresee a problem with Altair getting permitting due to the rise of the green movement and First Nations issues?

RM: Most of the companies in British Columbia that have had problems with the First Nations created their own problems by not getting the First Nations involved in the projects early. They show disrespect to the traditional ways. A company that engages the First Nations, is willing to work with them and is willing to provide jobs and help them, isn't likely to be road-blocked by them. The First Nations are not against resource development. They want jobs. Engage them early in a project and you won't have a problem.

As for the greens, Altair is a historic mining district. There is not really much you can say when you're in an area of past-producing mines.

TGR: It sounds as if it won't be an issue.

RM: The next one we'll talk about is NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK). I like this project, which is a joint venture with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT). There has been some uncertainty surrounding it. Aurizon was supposed to have made a decision to invest in the third phase, but it is going to wait and see the next NI 43-101.

The first NI 43-101 didn't have phase two results and was very conservative. The phase one report has delineated 2.1 Moz, most of that in the Marban deposit. The goal of the phase one drilling on the Marban deposit was to bring as many surface ounces as possible into a pit shell. The stripping ratio looks pretty high, but the grade is good and that should compensate for the high strip. Now, NioGold is going to look at the open pit, the high grade and strip ratio.

TGR: When does NioGold expect to publish the updated NI 43-101, and how good was the grade in the first NI 43-101?

RM: Next March. Phase two included $5M of drilling, and that is being added to the NI 43-101 report now. The NI 43-101 shows 1.58 g/t and that compares with 1.07 g/t across the road at Osisko Mining Corp.'s Canadian Malartic mine. And the 43-101 report was quite conservative, using a punitive grade capping that discounts the contained metal by as much as 30%. The phase two report will be more detailed, using tighter intervals and high- and low-grade envelopes to more accurately detail the deposit, and this should capture more of the ounces.

TGR: So if the phase 2 report shows improved ounces and grade, what happens next?

RM: This is the best part of the story. Aurizon has already spent $11M and at this stage the company has not earned anything. If it doesn't continue with phase three, the entire deposit reverts to NioGold and it will have 100% ownership of a 2.1 Moz deposit. Assuming Aurizon continues with the earn-in, then another $9M is spent over 912 months. Then a final 43-101 is delivered to Aurizon and it has to make a resource payment to NioGold for half of the gold in the deposit at a rate of $40/oz for Measured and Indicated, and $30/oz for Inferred. This payment is already estimated at $39M, just including the gold outlined with phase one. The payment could easily grow to $5060M by the end of the program. And that is only for half of the deposit. NioGold gets to keep the other half. Aurizon would then be the operator and it can go to 60% by delivering a feasibility report, and up to 65% by arranging project financing. But that last 5% is at NioGold's option.

Don't forget that this deal with Aurizon is for only part of NioGold's propertyabout 8% of its land package. The company has several other gold discoveries and showings to follow up on its own.

The stock is trading in the low $0.30s, and with just a little over 100M shares that's a cap of about $32M. The payment from Aurizon is already going to be bigger than the entire market cap right now.

TGR: What is your third pick?

RM: Terraco Gold Corp. (TEN:TSX.V) has several irons in the fire. Nutmeg Mountain, the Almaden project, is putting out an updated NI 43-101. It has 887 holes that were inherited. They were rotary air blast (RAB) drilling and reverse circulation (RC), but those types of drilling wouldn't give you the best representation. The company has done 52 core holes and four 4-inch metallurgical holes that it is going to include in the new NI 43-101.

Institutional interest in large-scale gold and copper discoveries has dropped off mainly because every time it puts some money into them, its interest just gets totally destroyed. It gets delay after delay. It gets cost increase after cost increase. These smaller ones, which have low costs to put into production along with low-cost producers, are going to be the way that we're looking at things as retail investors.

"I like the lowest-cost producers. That's where the money is going to be made over the next two years."

Almaden seems to be a perfect example of a low-cost deposit. We're looking at a new NI 43-101 with better recovery in the cores, and the holes support that. The diamond-drill holes were 2040% better grade than the RAB and the RC. We're waiting on metallurgical results that should be out shortly. The biggest knock on this deposit is that it has only been able to recover 63% of the gold. It doesn't absolutely kill you economically, but it's not a huge incentive either. However, there are reasons for the lower recoveries, namely that the column tests weren't leached for a full 90 days. It never separated the sulfide, oxides and the mix into separate columns.

Terraco should have a preliminary economic assessment (PEA) early in 2013. It could come up with some superior numbers that show Almaden as a serious low-cost producer. It's heap leach. The company has $1.8M in the treasury. Terraco is going to do its PEA and see if it can produce out there.

TGR: Terraco has the benefit of its primary asset being in northern Idaho, where mining is well accepted, and in Nevada, which is a fantastic jurisdiction. What CEO Todd Hilditch has done with his career is impressive.

RM: I was lucky to get in on his company Salares Lithium Inc., which merged with Talison Lithium Ltd. (TLH:TSX). The buyout by Talison was 400% of what I originally bought it. Of course, now we have the bidding war for those who got Talison shares.

TGR: That's been a wonderful thing for the shareholders of Salares.

RM: Then Hilditch turned around and did something that is almost as impressivebuying the royalty on the Barrick deposit.

TGR: That's part of the assets in Terraco, right?

RM: Yes, it's on a project in Nevada, the Spring Valley joint venture (JV) project of Barrick and Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.A). Midway's Spring Valley deposit is at 3.5 Moz. That's $40M net present value (NPV to Terraco. After $13M to exercise its option, that's a $27M NPV, which is $2M more than its current market cap.

TGR: Just on the royalty.

RM: Yes. If it does expand that deposit to, say, 6 Moz, which is certainly not out of the realm of possibility, that's a NPV of $64M. After exercising its options, it's a NPV of $51M. That's double the market capjust on the royalty.

There is also a lot of blue-sky potential. The Barrick/Midway JV's best hole is on the north end of Spring Valley. They have in hand a permit to drill toward the north, which is the south end of Terraco's Moonlight project. If the JV hits Moonlight is in play.

TGR: What's up next?

RM: My next one for your readers is Northern Vertex Mining Corp. (NEE:TSX.V; NHVCF:OTCQX). This is a company that is fast-tracking its Moss project in Arizona.

In the last six weeks, Northern Vertex has drilled 200 percussion holes and raised $9.1M. Ken Berry just stepped aside as CEO to bring on Dick Whittington, a mining engineer. Whittington took Farallon Mining Ltd.'s (FAN:TSX) project in Mexico to production in four years. He's also put a voice behind mining interests in Mexico. He gathered together miners and explorers worth $50B in assets and they speak to the Mexican government as a single voice. Whittington is well respected and is very good at what he does. The mission is to fast-track Moss into production. When this happens, Northern Vertex is definitely going to be one of the lower-cost producers out there.

TGR: Tell me about the asset.

RM: Moss is a gold and silver project in northwestern Arizona with all the necessary infrastructure nearby. It has a gold-equivalent (eq) NI 43-101 resource of 950 Koz Measured and Indicated and 266 Koz Inferred gold eq, and it's growable. It's got a low strip ratio and is amenable to low-cost, heap-leach open pit mining. It's a major stockwork vein system that outcrops at the surface for 5,500 feet. It has a unique three-phase plan. The third phase will be paid for by production. It's a smart plan run by some very smart people. I have no doubt that this one is going to be successful.

TGR: The fact that it was able to raise $9.1M in this environment is pretty impressive. That's been within the last 30 days.

RM: Exactly. Its management team is extremely popular with investors and institutions for several good reasons. When they say they're going to do something, they go out and they do it. They're a no-nonsense team.

TGR: This has been an interesting list. Thanks, Rick.

Richard (Rick) Mills is the founder, owner and president of Northern Venture Group, which owns Aheadoftheherd.com, as well as publisher, editor and host of the website. Focusing on the junior resource sector, Mills has had articles appearing in more than 400 different publications, including the Wall Street Journal, Safe Haven, the Market Oracle, USA Today, National Post, Stockhouse, LewRockwell, Pinnacle Digest, Uranium Miner, Beforeitsnews, Seeking Alpha, Montreal Gazette, Casey Research, 24hgold, Vancouver Sun, CBS News, Silver Bear Cafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FN Arena, UraniumSeek, Financial Sense, GoldSeek, Dallas News, VantageWire, Indiatimes, ninemsn, IBTimes, jsmineset, the Association of Mining Analysts and Resource Clips.

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DISCLOSURE:
1) Sally Lowder of The Gold Report conducted this interview. She personally and/or her 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: Altair Gold Inc., Great Panther Silver Ltd., Aurizon Mines Ltd. and Terraco Gold Corp. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Rick Mills: I personally and/or my family own shares of the following companies mentioned in this interview: None. Great Panther Silver Ltd., Altair Gold Inc., NioGold Mining Corp., Terraco Gold Corp. and Northern Vertex Mining Corp. are paid sponsors of Mills' website, aheadoftheherd.com. I was not paid by Streetwise Reports for participating in this interview.