Categories: Base Metals
Topics: General Base Metals

Kevin Puil: Copper Stocks Gleaming in Gold's Glow

Blinded by the glare of gold's rocketing rise over the last several years, investors may want to follow the leads of the Barricks, Thompson Creek Metals, Goldcorps and other major miners targeting the copper space, according to Kevin Puil, portfolio manager at Malcolm H. Gissen & Associates and senior analyst for its Encompass Fund. In this exclusive Gold Report interview, Kevin tells us that major gold miners increasingly want to diversify and are turning to the red metal on the opposite end of the economic spectrum.

The Gold Report: The biggest news to rock the copper world for quite some time hit late last month with Barrick Gold Corp. (TSX:ABX; NYSE:ABX) announcing a deal to buy Equinox Minerals Ltd. (TSX:EQN; ASX:EQN) for a cool $7.8B. What do you think about Barrick's acquisition of Equinox, Kevin?

Kevin Puil: Although many view this acquisition as expensive and say that Barrick overpaid, I don't think so. I think it's a good move by Barrick. It was a friendly, all-cash bid of $8.15/share, which trumped Minmetals Resources' hostile bid of $7/share. With this acquisition, I think Barrick management has clearly stated that its outlook for copper is bullish, and its outlook for the expansion potential at Equinox's Lumwana deposit in Zambia is definitely bullish.

It's a good way for Barrick to get back into African copper after having spun off African Barrick last year. The deal is definitely accretive. I saw the C-1 per-pound operating cost at about $1.90 with the average copper price Equinox sold this last quarter at about $4.30/lb. Those are good margins. The impact on net asset value (NAV)/share is negligible to Barrick, while it should increase per-share cash flow by almost 10% this year and close to 20% next year.

TGR: Given this acquisition, do you see more of the seniors that are heavily weighted toward gold following suit and adding more base metals to their portfolios?

KP: I definitely see more M&A in the copper sector, and I also can see more gold companies actively looking for projects that will give them exposure to both gold and copper.

TGR: Will that confuse investors who traditionally have a different reason for investing in copper than they do in gold?

KP: A lot of the senior gold producers have exposure to copper, whether investors know it or not. They typically produce a lot of copper as a byproduct. I don't have the numbers in front of me, but I'd suspect that close to 10% of Barrick's revenue comes from copper, especially with copper at $4/lb. At that level, it's arguably more profitable than mining gold.

TGR: What are your feelings about copper? And where does Encompass Fund stand?

KP: I'm definitely bullish on copper over the medium and long term. The new world reality is increased consumption of raw materials by emerging classes in big countries with accelerated development. Demand is back on track, while supply isn't. It's taking longer to repair the damage to the supply side than to the demand side.

A few factors play into this. Companies are mining lower ore grades because new quality projects are scarce. In addition, political instability, as well as mining service and equipment supply problems are becoming major challenges for copper miners.

TGR: As you pointed out, with spot copper prices hovering around $4/lb., copper mining is still profitable for most of the seniors, and several seniors already have fairly significant copper credits or copper assets. Against that backdrop, will we see more juniors entering this space? And where would you expect to see more copper mining?

KP: Definitely. I do see more juniors getting involved in copper exploration and I think the majority of these projects will be found in Latin America, Canada and Australia. We're seeing more activity—not just in the copper, but the gold/copper combination projects. We've already seen a number of acquisitions during the last year.

TGR: Aside from Barrick, what acquisitions come to mind?

KP: Thompson Creek Metals Company Inc. (TSX:TCM; NYSE:TC) acquired the Mount Milligan project in British Columbia from Royal Gold, Inc. (TSX:RGL; NASDAQ:RGLD). Goldcorp Inc. (TSX:G; NYSE:GG) acquired the remaining interest in El Morro, another Chilean copper project, from Xstrata PLC (LSE:XTA). And before Equinox, Barrick acquired the remaining interest in Cerro Casale in Northern Chile from Kinross Gold Corp. (TSX:K; NYSE:KGC).

TGR: Given the level of activity in the sector, could you tell us about any off-the-mainstream-radar companies that may have significant copper assets? Any compelling stories, particularly in mining-friendly jurisdictions?

KP: Yes, we've identified a few companies. Exeter Resource Corp. (TSX:XRC; NYSE.A:XRA; Fkft:EXB) has its Caspiche project. Again, it's one of those copper/gold projects, with about 20 million ounces (Moz.) of gold and about 5 billion pounds (Blbs.) of copper. That comes with its own challenges, however, including lack of infrastructure and a large capital expenditure (capex) requirement.

Closer to home, Nevada Copper Corp. (TSX:NCU) has the Pumpkin Hollow deposit in the Walker Lane mineralized belt of Western Nevada. That deposit has about 9 Blbs. of copper with a couple million ounces of gold as well. Nevada Copper may be facing some permitting and financing hurdles, but it has good infrastructure in a stable political environment.

We also like Candente Copper Corp. (TSX:DNT). Its Cañariaco Norte deposit, with 7 or 8 Blbs. of copper has been significantly de-risked with the completion of a pre-feasibility study. Capex is probably going to be about $1.5B. Cañariaco Norte is in Peru, where the mining sector may see some instability in the post-election period, as both candidates have indicated an intention to increase taxes.

One of our favorites for potential acquisition is located in Arizona—Redhawk Resources (TSX.V:RDK; Fkft:QF7). Its Copper Creek project is located in a mining-friendly district in Arizona, which leads the U.S. as a copper-producing state, with 12 active mines. Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) and Rio Tinto (NYSE:RIO; ASX:RIO) are also operating in the area. The project is within eyesight of Grupo México's (BMV: GMEXICOB) ASARCO Ray mine and Hayden smelter and BHP Billiton Ltd.'s (NYSE:BHP; OTCPK:BHPLF) now-closed Kalamazoo Mine.

The 100%-owned project is 7 sq. mi. and has had more than 400 drill holes and 160,000m of drilling to date, with more than 75% of the property still unexplored. Redhawk's deposit has already been adequately de-risked, with an NI 43-101 compliant resource and scoping study identifying approximately 3.5 Blbs. of copper and 50 Mlbs. of molybdenum, with plenty of exploration upside remaining. In addition, more than 400 high-grade breccias appear on the property, although only three have been fully drilled. This definitely has the potential to be a world-class deposit the size of the legendary Resolution or Safford mines.

TGR: When were the tests completed at Redhawk?

KP: They were released last year, and we're expecting an updated resource estimate, probably in a month or two. It's a well-positioned resource with a grade of close to 1% copper, a projected operating cost of $1/lb. and capex of less than $500M. I believe Redhawk's a very attractive acquisition target, too, because it's well down the permitting path and has great infrastructure. It could be ready for production within 18 months. Not only that, but Redhawk is trading at less than $0.03/lb. copper in the ground, not counting the molybdenum credit, and acquisitions have been more in the range of $0.07–$0.10/lb.

TGR: Is it fair to assume that some of the seniors located in the same district would be interested in an accretive asset such as Redhawk?

KP: Yes, the natural suitors would be ASARCO, Freeport McMoran or Rio Tinto, but I wouldn't discount foreign nationals such as China and India. Both of those countries have long time horizons and are looking now to nail down supply streams for concentrate 10 to 15 years out. I wouldn't count them out at all.

TGR: Tell us a little bit about Redhawk's management, treasury, market cap and so on.

KP: It has a market cap of about $90M, which I think is undervalued by at least 50%. Just by doing easy calculations of copper in the ground, the base case tells me that the project is worth at least $1.25/share, whereas it's trading at about $0.65 a share.

Redhawk has very strong management, probably more than 40 years of mining experience with one of its top executives coming from BHP. It's well-capitalized with more than $20M in the bank right now, no debt and no need to go to the market. I think it's extremely well positioned.

TGR: But no U.S. listing to date?

KP: Not yet, but soon. I believe that they'll be listing on the OTCQX within a matter of weeks.

TGR: With so much emphasis on gold as it continues climbing to new heights, it might be easy for investors to overlook copper, but you've made it clear that the copper space is heating up and there are some exciting stories to tell.

KP: As I said early on, I'm bullish on copper and so are a lot of senior miners. They're looking to diversify, and for gold miners, copper is an easy way to do it. As companies have to look toward increasingly more difficult geography and geologies to meet demand, it's going to take more time and a lot more money to bring new copper supply online. We can probably expect more senior miners to get involved with copper as the supply/demand structure holds up for different reasons than the supply/demand structure for gold.

TGR: Thank you Kevin, you've given us a lot to think about.

A Chartered Financial Analyst (CFA) with more than 15 years' experience in the investment management business, Kevin Puil currently serves as portfolio manager at Malcolm H. Gissen & Associates Inc. in San Francisco, and as senior analyst for its Encompass Fund. The Encompass Fund, which focuses on global resource companies exploring for and producing gold and silver, copper, uranium and rare earth elements, racked up a healthy 60% return in 2010, following a spectacular 139% in 2009. Before relocating to California, Kevin worked in Canada, where he also studied economics at the University of Victoria and the University of British Columbia.

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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: Royal Gold, Goldcorp and Exeter.
3) Kevin Puil: I personally own shares of the following companies mentioned in this interview: Redhawk Resources. I personally am paid by the following companies mentioned in this interview: None.