Ron Struthers: Have Flake Graphite Prices Bottomed?

The Metals Report: In 2011, there was a spike in flake graphite prices, a proliferation of publicly traded graphite equities and some speculation by investors. Since then, graphite prices have fallen and most investors lost money. How do graphite investors make money now?

Ron Struthers: If you've already bought in, the best thing is to hold right now. Graphite equities have probably hit a bottom. Going forward, investors should stick with companies that have good odds of getting to production in the near term. It's a very small market, so if a few new mines come on, production can make a difference.

TMR: Do you believe the price of flake graphite has bottomed?

RS: I think so. But it's a different market compared to other mining sectors in that the price is mainly set by negotiated contract. There is no futures exchange. In 2011, when prices were rising, buyers, who for the most part are end users, got scared. They thought prices were going to climb higher still, so they bought more to lock in at a relatively lower price and keep ample supplies for their manufacturing requirements. Of course, because they were buying more, it drove demand—and the price—higher, until the market got to a point where buying slowed as inventories were built higher.

Then the exact opposite happens. Buyers become leery and prices start to drop off. The buyers say, "Well, I have a year's supply of this stuff because I bought it on the way up. I'm just going to sit back now." The demand drop-off in 2012 wasn't about less graphite being used; it was more about a change in the market psychology. The fundamentals haven't changed. There have been no new mines come on. In fact, supply probably has come down a bit as China has consolidated some of its industry. At this point, prices have been stable for a few months. That's an indication that the market is at equilibrium.

TMR: What price range do you expect flake graphite to trade at for the rest of this year and through 2014?

RS: It will probably trade within a couple hundred dollars of the current price—$1,200–1,600/share—but more than likely, it won't fluctuate that much. There will be more of an upward bias next year if we get through this change in the market psychology and the fundamentals come back into focus. Demand is still growing from new areas like electric cars. And although a lot of companies are advancing their projects, we still haven't seen a new significant mine, especially in North America, where new mines are still a few years from production.

TMR: Most gold and silver companies tell specifics about how they will make money and grow production in company presentations. But graphite companies don't really talk so much about the specifics of their project or mine. Do they believe that investors don't understand this space yet?

RS: It's early on in the industry for public graphite companies. We don't have a good handful of pure graphite companies in production that we can point to for historical information on costs. We have the preliminary economic assessments (PEAs) from some of the explorers, but unlike gold and silver, we don't have any pure public producers in North America to use as comparables. There are just two producing mines in North America and they are private.

TMR: What don't investors understand about the graphite space?

RS: The main thing is understanding the percentage of carbon content in the deposit, the flake size distribution and purity on recovery. An ounce of gold is an ounce of gold—we know what the price is. It's simple. But graphite value involves more variables. Recovery rates are very important in evaluating a graphite project. Some gold mines can operate with 60–80% recoveries and produce valuable byproducts that refiners can handle like silver and copper, but graphite needs 94% purity on recovery or better to get the proper pricing, and then that pricing varies by flake size—the larger the flake, the better the price.

TMR: What about production costs? An average ton of flake graphite is going for about $1,500. Are there companies that can profitably produce graphite at that price?

RS: Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) is the most advanced. It can make money, as most of its graphite is large and jumbo flake. There will be others, too. Graphite is actually fairly easy to mine. The costs aren't much compared to other mining projects, it's all about the flake size distribution and purity.

TMR: Northern Graphite estimates that it is going to cost about $103 million ($103M) to build its flagship project Bissett Creek. How much of that money does Northern Graphite have?

RS: Northern Graphite has $7M in cash and a $17.5M financing from Caterpillar for equipment. So it's part of the way there, but realistically the company needs the mine permit first to secure the debt portion of the financing. It can't put the cart before the horse, so to speak.

TMR: What's the earliest this mine could be in production?

RS: It is waiting on a final permit and will need a final round of financing. It could be into production in H2/14 at the earliest.

TMR: There is some speculation that TIMCAL Graphite & Carbon, a division of Imerys (NK:PA), is probably going to need a new mine before long when the Lac-des-Îles mine comes to the end of its life cycle. Could TIMCAL buy an emerging graphite asset in Ontario or Quebec?

RS: It's interesting that you mention TIMCAL as they just temporarily shut down production, so that will help tighten the supply side of the market. It would make a lot of sense to me. Producers in gold and other sectors where the market has come down are taking advantage of low prices. It wouldn't surprise me at all to see the same thing in graphite.

TMR: Which company do you think will be the first one to ship flake graphite?

RS: Northern Graphite is fairly close and should be the first of its peers to ship graphite. Focus Graphite Inc. (FMS:TSX.V) has a project with a PEA. Focus is a little different than most projects. It is the only one directly invested in the graphene market with a private company called Grafoid Inc., which is devoted to developing a standard for economically scalable, affordable graphene. It's unique in that it is both a play on graphite and graphene. Focus is well financed with $17M and over $5M in Grafoid.

TMR: Do you believe that it can commercially produce graphene profitably?

RS: It's been demonstrated on small bench-scale tests that it can be done. They're getting refining purity levels up to 99.9% using natural graphite, which is the level needed for graphene. They're practically there now. However, we need to see this on a commercial scale to know for sure. There's been bench-scale testing from a number of projects and from renowned metallurgy companies. It's something we'll see down the road.

TMR: How is the grade at Focus' Lac Knife graphite project?

RS: That's another advantage that it has. It does have a higher grade than most projects, around 15–17%, which goes quite a way in reducing mining costs. Its graphite occurs in pod-like formations, so there might be a little more overburden in the removal process, but the grade definitely makes up for that and more. Focus has the potential to be the lowest-cost producer based on its recent PEA.

TMR: Are there any other graphite stories you're following?

RS: Valterra Resource Corp. (VQA:TSX.V) has a project in Bobcaygeon, Ontario, with high grades and from the initial sampling, about 24–28% carbon. In Valterra's metallurgy testing, purity levels ran as high as 99.96%, so there's graphene potential in this project.

Valterra approached its project differently than other companies might have. It took some bulk samples right off the bat and found it had the high-purity, high-grade graphite. That made it a very interesting story. Now it has to prove it has enough graphite there for a mine.

It's at the point of mapping out the zones, and then it will be drill testing to see if it can put some tonnage together. It's an early-stage stock with a very low price, and a lot of blue sky in front of it.

Also Alabama Graphite Co. (ALP:CNSX) just announced its first NI 43-101 resource of 38.2 million tons at 2.6% carbon. The deposit is on surface and the company should get mine permitting very quickly in Alabama. If the metallurgy and feasibility studies come back positive, Alabama Graphite could be among the first to production. The company just completed a $335,000 financing at $0.15/share above the market price and is well subscribed by management, which is a very good sign of confidence in the project.

TMR: Is there enough room in the graphite space for multiple players, after the first project makes it to production?

RS: There is room for a few new mines to come in, probably enough for three and four, depending on how much they produce. But they're going to trickle in over the next several years; it's not going to be a flood onto the market anytime soon.

TMR: Could there be a consolidation phase in the graphite space?

RS: Quite a few juniors have come into the market, but quite a number will fade away because it's difficult to raise money right now and the nature of exploration means that most projects will not be economically viable.

TMR: What's your near- to medium-term outlook for the rare earth element (REE) space?

RS: There's potential here. A lot of the REE prices haven't gone down nearly as much as other minerals. There's some good stories, like Pacific Wildcat Resources Corp. (PAW:TSX.V).

TMR: That project is located in Kenya, East Africa. Are there jurisdictional advantages there?

RS: Kenya is right on the coast. There is good infrastructure near Pacific Wildcat's project, including hydropower, paved highway and ports. It's one of the more advanced countries in Africa. It has expanded strongly in tourism, telecommunications and its traditional tea market. It is a liberal market with minimum government involvement and British-based common and mining law.

TMR: Does Pacific Wildcat's project lean more toward the heavy rare earth elements (HREEs)?

RS: It has a good mixture of HREEs and light rare earth elements. At about 5%, it is a high-grade deposit. Its basket of REEs is valued at around $35–45/kilogram ($35–45/kg). It also has a 100 million tonne niobium deposit that's quite advanced.

TMR: Why should investors be interested in niobium?

RS: It's not a well-known material, but it's a strategic element and has been used a long time in the steel industry for strength in different alloys and super alloys. Some of these super alloys are used in jet engines and space programs. There are only a few producing mines in the world, as it is very rare to find niobium in economic concentrations. At $40/Kg, it provides a very attractive potential return on investment for miners. It's a fairly stable market price wise.

TMR: What got you interested in Pacific Wildcat?

RS: It has a lot going for it. It has a large niobium project with a high-grade zone that could be a cash cow. It has a smaller tantalum project that's already proven out. It has a processing plant. It just needs a little bit more money to finish some spiral concentrators and can go into production this year. It has a world-class REE project that could have 5% grade or better. Recent assays show 105 meters (105m) at 6.97%, 105m at 7.17% and 100m at 6.18%, all starting from surface.

TMR: What about management?

RS: It is very strong in that regard. Management has a lot of experience in putting mines into production. CEO Darren Townsend is an engineer and previously worked as general manager of Sons of Gwalia, which operated the world's largest tantulum mine. Terry Lyons, who is the chairman, has more than 30 years' experience. He was a past chairman of Northgate Minerals Corp. (NGX:TSX, NGX:NYSE.MKT). The company has management with experience in the tantalum industry. It also has some directors with experience in Africa.

TMR: What is tantalum used for?

RS: Tantalum is used in alloys but mostly in capacitors for electronics like computers and phones. It is highly corrosion resistant. The tantalum price has moved up quite a bit, from about $80/pound ($80/lb) last year to $130/lb currently. It's one of the few metals or minerals that has seen an increase in price this year.

TMR: Why should investors be interested in this space overall right now?

RS: A lot of these materials are an important part of our future. Technology we're developing requires more graphite and REEs. If you can find companies that can put these into production soon, you'll see strong cash-flow, earnings and even dividends.

TMR: Dividends in the REE space? That's interesting.

RS: I'm talking down the road, after companies outside of China go into production. A number of the graphite stocks—Focus, Northern Graphite, Alabama, Valterra—have come down in price. So has Pacific Wildcat. Any of those would be a good place for investors in the graphite or REE spaces.

TMR: Thanks Ron.

Ron Struthers founded Struthers' Resource Stock Report almost 20 years ago. The report covers senior and junior companies with ample trading liquidity. Since 2000, $1,000 invested in Struthers' Model Portfolio ended 2012 at $9,251. Struthers Newsletter Stocks went from $1,000 to $20,934. Struther's Millennium Index, which started in 2003, began at $1,000 and was worth $4,133 at the end of 2012.

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DISCLOSURE:
1) Brian Sylvester conducted this interview for The Metals Report and provides services to The Metals Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Metals Report: Northern Graphite Corporation. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Ron Struthers: I or my family own shares of the following companies mentioned in this interview:Northern Graphite, Focus Metals, Valterra Resources, Alabama Graphite, Pacific Wildcat. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview. 
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