Eric Coffin: Juniors Playing the Exploration End Game
Source: Interviewed by Karen Roche, Publisher, The Gold Report 03/01/2010
"Gold has been about the best investment around for the past decade," says Eric Coffin, despite having been lukewarm towards the precious metal in the early '90s. Co-editor along with his brother David of the HRA (Hard Rock Analyst) publications, Eric explains why they're sticking with the exploration stories that work and how they prefer mining executives who will "swing for the fence for themselves rather than just option everything" in this exclusive interview with The Gold Report.

The Gold Report: Eric, in a recent HRA Journal you have written that you're not expecting a big gain in the market for 2010. However, you also indicated that it's not required to have big gains in the market to have the mining sector do well. So, as long as the markets don't hit the panic button, you're expecting that metal explorers will continue to be rewarded for their discoveries. Can you expand on that for us? And to what extent do you believe the metals market has decoupled from the major markets?

Eric Coffin: Well, there are indices and there are indices. We have pointed out several times in the last year that if you look at what we call the "creditor countries"—China, India, Brazil—and the "resource supplier" countries—Australia and Canada—none of those country's bourses are technically in secular bear markets, although plenty of people assume they are. On long-term charts those markets didn't break their 2000-2001 lows which New York and most European bourses did. We don't think that is a minor point. It basically reinforces the story about the separation that has been going on in the world economy over the last decade, with developing high growth countries increasingly being the price setters for resources.

Metals prices, in general, are strong enough that companies making and growing real discoveries are going to get rewarded by the market, and we've seen that on our own HRA lists. Some of the companies aren't getting beaten back the way people thought they would. The companies that have succeeded are making discoveries and rapidly increasing their asset values, which the market has been paying up for. We're actually pretty pleased with the Venture Exchange Index (S&P/TSX Venture Composite Index (CDNX: ^SPCDNX)). It's got its issues like a lack of large profitable companies to underpin it, but it's the closest thing to a proxy for exploration stocks we can come up with. You would expect the Venture Index to be the worst performing index in a bear market but it was actually one of the best gainers in the world in 2009 in percentage terms.

Granted, the Venture Index got slaughtered in 2008. At the start of 2009 we said, "Strange as it may seem, we expect the junior market to outperform the senior ones, at least in percentage terms," which it did to the tune of about 60%. People thought we were nuts, but if you start with the assumption that we are still in a secular commodity bull market, it makes sense that a resource stock index would have a big bounce, especially after being pummeled so badly. If you go back 10, 15 or 20 years, you could expect the Venture Index to drop by two or three times the percentage amount of the senior indices and to take much, much longer to come back.

One of the most interesting aspects of last year's resource sector performance was that trading volumes remained strong through the year and the overall amount of financings were high. That was surprising and quite encouraging. New money was scarcer in other sectors and most major indices were plagued by light volume, even the ones with good gains themselves. Exploration is a negative cash flow business so it's imperative that companies are able to raise money.

TGR: Let's talk base metals. What's your outlook on copper?

EC: Dave and I were more bullish about copper than just about anybody a year ago, but we weren't expecting to see the price go up to $3.50 so rapidly. That was a little bit shocking. That's a measure of demand, but it almost seems like it's a "copper-as-money" story too. Dave has said that for years, and he's only half joking. His point is that everybody thinks of gold as the obvious contender as a currency, but you can make a similar argument for a lot of hard asset commodities and it certainly looks like money is being parked in many metals, not just gold. Copper is an obvious choice for traders because it does high volume.

A lot of the metals are not a bad place to hide and hedge against U.S. dollar weakness, but we've gotten a bit cautious about base metals again partially because the relationship you're seeing right now between pricing and inventory levels doesn't seem to make a lot of sense. It defies logic.

TGR: Isn't copper sending out a lot of mixed signals out there?

EC: It's very mixed; if you look at three, or five, or ten-year copper charts, there's a very strong inverse correlation between the copper price and warehouse inventories for copper. When copper warehouse inventories go up to a certain level, the price will start to drop and vice versa. That relationship reversed itself about the middle of last year. Copper inventories were drawn down fairly significantly from the middle of 2008 to the middle of 2009. It was part of the reason we weren't bearish. Everybody else was on base metals. We did point out given the depth of this recession, a 500,000 tonne inventory in early 2009 was not extreme; it was well over a million tonnes at the start of the decade. The inventory fell rapidly for several months, getting down to 250,000 tonnes but then reversed again and climbed back to the 550,000 tonne level. The copper price continued to climb right along with inventory levels and has only backed off about 10% in the past couple of months. Dave and I are sitting there scratching our heads, thinking this is bizarre; the price is awfully strong given the fact that the inventories seem to be climbing fairly quickly again. Because of that we got cautious, though we are still bullish long term.

TGR: So, how do you play the copper market now given that we have all these mixed signals?

EC: We stepped back a little bit. We haven't added any copper deals; we are looking at a few of them, and we're hoping to add a couple more to the HRA list. But we want to see if there's going to be more of a pullback. We were really expecting the price to come back to $2.50; it hasn't done that and may not. Shy of that, we may add a couple of copper deals, but I think if we do, it will be deals where we see big exploration upside and we're comfortable the market can give the company some mark-up based on discovery, not just market based on the copper price moving up and down. We tend to stick a little bit more to the exploration end, anyway. We're recommending people just let that stuff sit for now, and if there's really a big dump, then yes, maybe we can accumulate some. But we're not comfortable telling people to buy producers right now. We want to see if there's more of a drop, because although we're not seeing inventory climb any more, we're not seeing it come down either. As part of that process we suggested people sell First Quantum (TSX:FM), which we were up about 4000% on and take profits on Teck Resources Ltd. (NYSE:TCK) at $45, which we originally started talking about at $5.50.

TGR: Let's talk gold. What's your latest take on that?

EC: In the '90s, when we were first doing the newsletter, we were only lukewarm to gold, partially because of the amount of forward hedging and gold forward sales being used as a financing vehicle by the mining sector. In the '90s, major mining producers were moaning about how much selling there was in the gold market. Dave and I were responding with "What the hell are you talking about? You're the sells. You're forward selling gold left, right and center to finance mine construction." That came to an end when gold prices got so low that it simply made no sense to start production on many projects and the low interest rate regime last decade made the forward sales less attractive relative to straight debt deals. That and the fact that gold miner's shareholders were telling them in no uncertain terms that the idea of effectively shorting gold to finance gold production was crazy. The combination of industry de-hedging, an end to central bank sales and secular equities bear market after the Internet bubble turned things around. We thought when NASDAQ collapsed, the U.S. dollar had probably topped out for all time, and that got us a lot more bullish about gold.

It's had a great run, and we've gotten a little bit more neutral about it in the last little while, but only neutral. You're seeing a run in the dollar right now, but I think the jury is still out as to whether the dollar has actually turned around or we're just looking at a bear market rally. There is no such thing as trading a single currency really; you always trade pairs. So if you sell the dollar what do you buy? The saving grace for the dollar is that the other high volume trading currencies (the euro and the yen) have their own issues. It's a question of how relatively bad a particular currency is at a given time. Politically, I don't see any way out for most of the G-7 frankly, other than printing their way out of this problem, which implies a continued race to the bottom for fiat currencies.

As long as you get a bunch of governments trying to print their way out of the problem I think that there's going to be a place for gold in people's portfolios. I sense that there are many, many people who are not gold bugs but who saw that gold performed very well as a safe haven. Nothing succeeds like success in the investment business and gold has been about the best investment around for the past decade. That gets noticed. Gold prices are going to be strong enough where discovery is going to get rewarded, and that is the important thing for Dave and me. I won't be at all surprised if gold sees new highs this year— $1350, $1250, or whatever. The main question we ask ourselves is whether the price will be strong enough so that companies that make discoveries will get rewarded. As long as the price is good enough for that, we're happy campers.

TGR: When you look at companies making a discovery, what price of gold do you use to see if it's going to be economically viable?

EC: We tend to be a bit conservative about it. We view a mining scenario as one where you've got to look out 10 or 15 years, and especially when you're looking at juniors. Let's face it, for most of these companies, the end game is—and should be—getting taken out by a major. Finding deposits is what the juniors are good at and the best exit is often selling the discovery for a good price then moving on to try and find the next one. When you're trying to wrap your head around the value for these companies, you've got to look at those companies' potential acquirers. What are they thinking and what are they using as a base price.

I think you're going to see M&A activity increasing because companies that have sat on the sidelines waiting for the perfect number before they bid on a company are finding out that they're just not going to get it, and the company they've got their sights on, somebody else gets there first. So, I think you're going to see improving takeover prices, and in some cases I think these majors are probably gritting their teeth and using a $900 or $950 long-term gold price to value things. A lot of them must be using that high a price at least to explain some of the recent bids.

TGR: Right. So, you're looking for juniors who have some type of scale potential with an end-game of selling to majors. Do you have some companies that you're following that you can share with us that fit those criteria?

EC: One company that we're quite high on, and have been for a while, is East Asia Minerals Corporation (TSX.V:EAS). They have a series of projects in Indonesia. It's an interesting company; they started out looking for uranium in Mongolia—Mongolia has not been the friendliest place to be for companies. Interestingly, they're one of the few companies that really got out of Mongolia unscathed, to put it mildly. They actually sold a uranium project to AREVA (ARVCF:OTO) for $83 million and divvied up the money to their shareholders, and then moved on to Indonesia.

The guys that run it are very experienced guys out of the majors; they went into Aceh Province, which your readers may recognize as one of the areas that was hardest hit by the tsunami, and it was an area that was a real political sore point. There had been a lot of local unrest; they don't like the guys in Jakarta very much. It seems like the tsunami just turned things around in the sense that everybody said, "You know what? We've got bigger things to worry about than political machinations." These guys went in there not too long after that in 2005, 2006, and staked a lot of stuff that had been left from previous exploration companies and picked up a really great set of projects.

The one that really caught our eye—and we wrote them up last March at about 43 cents—is called Miwah. Miwah is basically a ridge that contains a large, flat-lying zone of disseminated epithermal gold. We became really interested in it because East Asia had gone in and done several kilometers, literally, of cut channel samples where they go in with diamond saws and get nice composite, very comparable samples across this large area, and the average value was over a gram. There was an Australian company in there 20 years ago that drilled a few holes and got some decent numbers, good but not great. East Asia's theory was that there were vertical structures that carried up and were controlling a lot of the gold deposition. You would need to drill it in several directions, and it looked like the better grades would be near the top of the zone. I won't go into more detail on the geology, but it turns out they've been right so far.

TGR: Wow.

EC: When we first looked at it, we got pretty excited about it, and were banging the table pretty hard with our readers on this one. A lot of them bought it, and they're happy about it. We were the only guys following it for six months, which again, is one of those "scratch your head" situations—we couldn't figure out why no one else seemed interested.

But East Asia has started to pick up more of an institutional following lately. They've added a second drill. A lot of people, including us, are going to keep prodding them to keep adding drills which I think they will do as they get more areas on the project drill ready. They expect to have enough drilling for an initial 43-101 calculation just on the ridge zone itself, probably by the middle of the year. Right now, they're valued to 3 to 4 million ounces, and we think there's a lot more than that; there are large prospective areas near the Miwah ridge that have not even been drilled yet.

Another one that I'll mention is Riverstone Resources Inc. (TSX.V:RVS), which we have followed for a couple of years. It's gone through its trials and tribulations, but really got hot in the last month and a half. All their projects are in Burkina Faso, West Africa. It's part of the Ghanaian Shield that's always been a great gold region. Burkina Faso seemed to have the same potential as better known countries in the region like Ghana and Mali, but for whatever reason it just didn't seem to get any headlines.

Riverstone has been at work there for several years and has proven up a resource of about a million ounces in four separate zones on their main project, Karma. Last year, a local gold rush developed on the eastern portion of the Karma project, about four kilometers north of Riverstone's Rambo zone. This new area, which they are calling Nami, has had thousands of artisanal miners working it, digging hundred of shafts by hand and concentrating the gold in crude sluices. Riverstone went there in December and quickly sampled 30 different shafts and 20 waste piles. The average grade of those 50 samples is 10 grams, which is amazingly high in this kind of situation. The market got pretty excited when it heard about that; the stock went from 23 cents to around 80 cents before settling back in the 60 cent range last week, with a lot of volume. They have raised some more money and have had crews sampling 200 shafts and a couple of hundred waste piles from the hand dug workings. Results should be in and compiled during the next few weeks and RVS plans to follow up immediately with a 3,000 meter drill program.

While we do not expect the actual grade to average anything like ten grams, Nami has a large enough footprint to contain a lot of ounces. The combination of that sort of potential plus the fact there should be a good flow and results for several months makes Nami a target that can hold the market's attention. It's the one component they have always lacked; they have good management, good projects, but there was never anything with that sort of "ooomph" to get people excited, and this seems to be that key factor.

TGR: Are there some other companies that you're following?

EC: Mirasol Resources Ltd. (TSX.V:MRZ) is another company run by very strong professional exploration people in Argentina. We've always considered Argentina to be an area that is going to generate a lot of great deposits in the next 10 years. And much of Argentina is still pretty lightly explored.

Mirasol went down there several years ago and they picked up a very large land package and a very strong one. They are project developers; their forte is applying geological models to areas that have seen very little work. They really get going on large structures and geology. They focus on the very basic, early stage work to see if they can generate discoveries. And then, they winnow things down. They have 30 or 40 projects in early development at any given time. They have made several quite high-grade silver vein discoveries; one of those discoveries, the Joaquin Project, was optioned to Coeur d'Alene Mines Corporation (NYSE:CDE).

Coeur d'Alene started drilling Joaquin in 2008. They did another program last year and got some quite strong results towards the end of it. We wrote them up in the early fall because of the combination of good early drill results at Joaquin that were about to be followed up on and a strong project pipeline, giving them real discovery potential. Coeur D'Alene started drilling again in October and released some pretty spectacular numbers in November. The first set of drill holes that Coeur put out—the best hole was a ridiculous number. It was around 25 meters with 1,100 grams.

So far, MRZ has stuck to their knitting, being a project developer and a project generator, and Dave and I tend to prefer guys who will swing for the fence for themselves rather than just option everything. One thing that was holding them back—and rightly so—was the market wasn't that great. They've made another high-grade discovery on a nearby property that looks like it's very similar to this and they, in fact, have several other properties that have strong potential. Again, this really got the market's attention; this stock was 50 cents when we wrote it up and it's trading now at about $2.70.

TGR: Any others?

EC: I'll update a couple of the other companies we talked about last time. Evolving Gold (TSX.V:EVG, FSE:EV7) drilled a large number of good holes at its Rattlesnake Hills project in Wyoming. The company will report an initial gold resource this spring and will be back as soon as weather allows with a big follow-up drill program and all the zones remain open. EVG also just reported a high-grade discovery hole from its Carlin project in Nevada. Follow-up drilling is required but it looks like the company may have another important discovery on its hands.

Underworld Resources Ltd. (TSX.V:UW) also had a lot of drilling success at its White Gold project in the Yukon. They reported an initial resource estimate of 1.4 million ounces for White Gold, close to what we expected. They too will be busy again this year. Several of the zones remain open and there are some good targets on the main project and in the regional area still to be tested. We are following another company in the area as well and will be watching it closely.

Minefinders Corporation (TSX:MFL, NYSE.A:MFN) continues to see improvement as it brings the Dolores project up to its full commercial production level. Cash costs have been dropping and the company is now stripping and starting to mine a higher-grade area of the deposit so the numbers should continue to improve. They will also be working on a preliminary economic study of adding a full mill to the project. We are very interested to see how that turns out since we have always liked the deeper high-grade zones at Dolores. Higher-grade zones are the main beneficiary when a sulphide milling system that has higher recoveries is added and the deeper zones at Dolores are still open to expansion. We've been watching to see how the recoveries come in on the heap leach operation and they do seem to be still improving.

One important aspect to heap leach operations that traders need to be aware of is that it takes two or three or even four quarters to get to steady state production levels and really see what the recoveries percentages are for gold and silver with this type of mining. MFL also has a couple of exploration projects they have been assembling for the past few years and once Dolores is generating the cash flows projected for it, we would not be surprised to see Minefinders on the hunt for acquisitions.

TGR: Great, thanks Eric. Lastly, we understand that you have a new free report to offer our Gold Report subscribers, as well as an HRA subscription deal. Can you please let us know the details?

EC: Yes, we have just put together an extensive report for your readers, which highlight some of the companies that I mentioned above, plus a few others that we think have significant potential for 2010. It also showcases the power of the Alert service, which we think has been particularly valuable for subscribers since it allows them to quickly get our input and opinion when important, trend-changing results are released.

Simply go to: www.hraadvisory.com/aureport.html for all the details on this offer. If you enter your valid email address on that page we will immediately send you our latest special report for free. Also, we're offering savings of up to $1000 off HRA Alert subscription rates until March 15th! For more details on these different HRA services, please go to: www.hraadvisory.com/subscriptions.html.

Remember, to receive the special discount, use the ‘subscribe' links in the following jump page only: www.hraadvisory.com/aureport.html. The 20% off pricing cannot be accessed via our website.

TGR: Eric, we appreciate your time.

Eric Coffin and his brother David are the co-editors of the HRA (Hard Rock Analyst) family of publications. David is the "rocks side" of HRA, and has been active in mining exploration for over 30 years in roles spanning prospecting through feasibility studies, and now markets commentary. Responsible for the "financial analysis" side of HRA, Eric has a degree in Corporate and Investment Finance. He has extensive experience in merger and acquisitions and small company financing and promotion. For many years he tracked the financial performance and funding of all exchange listed Canadian mining companies and has helped with the formation of several successful exploration ventures.

Eric was one of the first analysts (along with David) to point out the disastrous effects of gold hedging and gold loan capital financing (1997) and to predict the start of the current secular bull market in commodities based on the movement of the U.S. dollar (2001) and the acceleration of growth in Asia and India.

David logs, literally, hundreds of thousands of miles every year, visiting exploration sites on six continents in order to bring back the real goods for HRA subscribers. Eric and David can be reached at hra@publishers-mgmt.com or through their website at www.hraadvisory.com.