Photo by: Duane Daws
TORONTO (miningweekly.com) – With its favourable mining policies, ease of operating and permitting, solid infrastructure and a skilled workforce in the mining sector, along with significant exploitable gold and silver reserves, analysts at Desjardins Capital Markets this week said they expected Mexico would continue to rank as one of the more competitive jurisdictions in attracting mining investment.
Authored by analysts Michael Parkin and Adam Melnyk, and associates John Sclodnick and David Lee, the 84-page report provides a broad overview of the precious metals mining sector in Mexico and also announces that Desjardins has initiated coverage of four gold resource companies focused in the North American country.
The analysts said that they liked gold producers Argonaut Gold and Primero Mining, as they had relatively low‐cost operations with silver by‐product credits, and gold developers Newstrike Capital and Torex Gold Resources, as they had relatively high‐grade projects with promising economics – all attractive features in the current gold price environment.
Mexico has a long tradition of mining that dates back to the earliest explorers in the 1500s, who discovered deposits near Zacatecas, Real Monte and Guanajuato.
According to a May report by professional services firm PwC, the most significant Mexican mining areas currently were Sonora, Zacatecas, Chihuahua, Coahuila and Durango, with about 22 249 mines open in 2011, a majority of which used underground mining methods.
The Mexican mining industry had received more than $23-billion from global investments over the past decade, and the report noted that in 2012, the industry ranked fourth highest in foreign and direct investment, behind the mining industries in Canada, Australia and the US, which highlighted investor comfort in the country.
Of the top 15 gold‐producing countries, which accounted for 76% of global production, or 2 861 t, Mexico ranked ninth, accounting for 3.3% of global output, or 95 t, in 2012. The country’s gold output rose by 118% between 2007 and 2012, and it was what PwC called “a key growth area” in its ‘Direct Economic Impact of Gold’ report, commissioned by the World Gold Council (WGC).
In 2012, the gold mining industry in Mexico directly employed 15 700 people according to company accounts, not accounting for any artisanal mining, and added about $4-billion in direct gross value to the national economy, representing less than 1% of gross domestic product.
Mexico ranked ninth in the world in terms of capital investments, with $773-million invested in the gold mining industry in 2012.
Globally, Mexico ranked seventh by value of gold exports at $7.99-billion, representing 2.2% of its national merchandise exports in 2012/13.
SOMETHING HAS TO GIVE
As of the close on December 5, gold was trading at $1 225.17/oz and silver was at $19.40/oz, 12.5% and 17.4% below Desjardins’ 2014 forecast, respectively. The analysts expected gold to trade at about $1 400/oz and silver at $23.50/oz during next year.
One of the critical factors keeping gold prices lower recently had been weak investment demand, which was a key driver for gold’s rally over the last decade.
“A potential risk to our near‐term outlook for gold and silver is continued weak investment demand. An example of this weak investment is how the holdings in the global gold ETFs [exchange traded funds] have changed to date,” the analysts said.
As of December 5, the SPDR ETF, the world’s largest physically backed gold ETF, held 26.97-million ounces of gold, equivalent to about 29.3% of the yearly global mine output. The SPDR holdings had fallen 37.9% in the year to date, and 7.4% since October 1.
“In our opinion, if these holdings continue to come back into the market, the gold price could trade down and silver would likely trade in a similar pattern,” the report noted.
The analysts said that based on their long‐term gold forecast on the calculation of all‐in sustaining costs (AISC) for a peer group of the world’s top ten largest gold producers the all‐in cost measure had averaged $1 363/oz of gold equivalent over the second quarter of 2012, to the first quarter of 2013.
Further, the analysts added a 10% inflator to the average AISC calculations for the peer group, to represent a minimum margin required to entice gold companies to invest in existing mines or to develop new mines as reserves from existing operations are depleted.
“The implication of our analysis is clear – the gold price has fallen below the AISC of production. Long term, miners cannot make money at the spot gold price given their current cost structure.
“Something has to give,” the analysts declared.
They said that if the current gold price environment persisted, there would be a significant supply‐side response as operating mines were closed and development plans for new projects were delayed and/or cancelled.
Miners globally would be faced with one of two broad choices: To either close down uneconomic mines; or to ‘high grade’ operations by lowering reserve prices used in economic models, thus raising cutoff grades in an attempt to reduce per-ounce costs, which might shorten mine lives.
MORE TAXES
Meanwhile, the new Mexican tax reform, approved in October, maintained the corporate tax rate at 30% going forward, despite previous plans for it to fall to 28% by 2015.
However, a new mining tax, a 7.5% tax on earnings before interest taxes depreciation and amortisation (Ebitda), and a 0.5% net smelter return (NSR) royalty on precious metals sales, both corporate tax deductible, would be implemented beginning on January 1, 2014.
The analysts viewed the Mexican tax reform as a negative for the industry and believed it could cause companies to re‐evaluate their project development initiatives in the country.
However, they believed Mexico remained a relatively lower-risk jurisdiction – the new mining taxes aligned Mexico with the fiscal regimes of other Latin American mining regions.
The analysts said they were now modelling the new 7.5% tax on Ebitda as an income tax; thus, raising the effective tax rates for the companies under coverage with exposure to Mexico.
For the 0.5% NSR on precious metals mining, the analysts had assumed that this would be reported as a contributing factor to the affected companies’ total cash costs, or to the AISC standard, which by their estimates would be a minor factor.
Desjardins said that going forward, the mining industry might look to focus more on contractor mining, over owner-mining opportunities, given that with owner mining, a greater portion of the work to maintain regular operations was capitalised. Thus, the reported Ebitda of the operation would be higher than if a contractor miner were to be used.
“After speaking to some companies with exposure to Mexico, we believe companies may move to capitalise less and expense more of the costs associated with running/sustaining the mine(s) in Mexico as this could help reduce the new Ebitda tax.
“With the industry moving to adopt the new WGC reporting standard for costs that factor in sustaining capital, we do not believe this approach would be viewed negatively by the market, since this accounting change would have no impact on the new AISC figure,” the analysts said.
RISING STARS
Desjardins on Tuesday started coverage of two gold producers and two gold developers, which have their primary assets in Mexico.
Newstrike Capital is an exploration‐stage company whose flagship asset is the 100%‐owned Ana Paula gold project, located in the Guerrero Gold Belt of Mexico. The analysts saw production at Ana Paula starting in the first quarter of 2019, and forecast the average yearly output of 154 000 oz of gold at total cash costs of $636/oz over a six‐year mine life.
Desjardins underlined the project’s high‐grade breccia as underpinning its valuation with a ‘buy’ rating and a target of C$1.50 a share. The analysts’ discounted cash flow model, which was based on the March $600/oz pit shell for the 1.27-million-ounce, 3.77 g/t project, generated a 7% net present value at $1 500/oz of gold of $146-million – more than three times Newstrike’s current enterprise value.
The analysts also viewed the exploration potential at Ana Paula in a favourable light. However, at current trading levels, investors were believed to exclude any value for resource expansion potential in the company’s market value, they said.
The other development company added to the analysts’ watch list was Torex Gold Resources, which was given a ‘speculative buy’ rating and a price target of C$1.90 a share.
Torex is an advanced development‐stage company whose flagship asset is the 100%‐owned Morelos gold project, in Guerrero, Mexico, comprised of El Limon‐Guajes and Media Luna.
Desjardins said that in its view, El Limon‐Guajes fell into a select group of large‐scale gold development assets not controlled by a major mining company.
The analysts expected El Limon‐Guajes to start production in the third quarter of 2016 and forecast average yearly output of 321 000 oz of gold at total cash costs of $590/oz over a 10.5‐year mine life. They expected that the company would have a cash requirement of $245-million to fund El Limon‐Guajes, assuming $250-million of project debt was available.
“In our opinion, the asset’s primary distinguishing feature is its above‐average grade profile (2.61 g/t gold average reserve grade) for an openpit development project. Clearly, the discovery of Media Luna was a significant development for the company. Based on our estimates, this deposit has both the scale and grade to develop into a profitable mine.”
The analysts also initiated coverage of Argonaut Gold at a ‘buy’ rating despite having “above‐average risk”, with a target price at C$7.50.
By the analysts’ estimates, Argonaut had the potential to nearly triple its gold output to more than 340 000 oz by 2018, through developing three projects, two of which were fully financed. Argonaut’s relatively low AISC profile was expected to remain flat, to down, over the next several years, driving growth in the cash flow per share as the production base expanded.
Desjardins’ mining analysts also placed Canada-based Primero Mining on their radar, giving the precious metals producer a ‘speculative buy’ rating with a C$7 price target.
The report said Primero had the potential to grow gold output by more than 60% to 171 800 oz by 2017, through a successful expansion currently under way at the flagship San Dimas mine and development of the Cerro Del Gallo mine. The company currently held a 69.2% interest in Cerro Del Gallo and was working to consolidate the remaining interest from Goldcorp before year‐end.
Primero’s AISC profile was expected to remain below $1 100/oz over the next several years, making Primero one of the lowest-cost producers among its peer group.
“We believe the market is somewhat concerned with Primero’s tax position as it pertains to the silver stream agreement with Silver Wheaton. We believe this will prove to be a non‐issue later next year, assuming the company seeks a renewed ruling on its advance pricing agreement from the Mexican government. This is a key driver in our speculative rating,” the analysts said.