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SVH Tracker - February 11, 2015: Recommendation Strategy for Midas Gold Corp
 Midas Gold Corp was continued on January 2, 2015 as a Good Relative Spec Value Buy at $0.46 based on its status as an advanced gold project with the capacity to produce over 300,000 ounces annually over a 12 year mine life that will likely run much longer when the Stibnite project's potential has been fully explored. The recommendation was down-graded from Good Absolute Spec Value because the PFS released on December 15, 2014 was less robust than the September 2012 PEA and relies on a $1,350 base case gold price that is above current levels. It is normal for a project to become smaller and less valuable as it moves from a 30-35% error margin PEA that relies on an inferred resource to a 20-25% error margin PFS with a measured and indicated resource, and then again to a 10-15% error margin FS with a proven and probable reserve. The 2012 PEA projected an after-tax NPV (5% discount rate) of $1.48 billion and 27% IRR using $1,400/oz gold and $6/lb antimony for a 20,000 tpd operation that would have produced 4.9 million oz gold and 200 million lbs antimony over a 13 year mine life (see SVH Comments Sept 6, 2013 and Mar 31, 2014). The Dec 2014 PFS projected an after-tax NPV (5%) of $832 million and 19.3% IRR using $1,350 gold and $4 antimony for a same scale operation that would produce 4 million oz gold and 100 million lbs antimony over a 12 year mine life. Pre-Production CAPEX climbed from $879.3 million to $970.3 million while Sustaining CAPEX dropped from $245 million to $98.5 million, OPEX increased from $25.87/t to $27.47/t (the PEA was reported in metric tonnes but the PFS switched to short tons - I have converted all numbers to metric). The PFS thus did not deliver any cost sticker shock. Most of the decline in NPV and IRR is due to lower metal prices and decisions by the PFS consultants to exclude certain parts of the deposits from the mining plan because of reliability concerns about historic drill hole data and portions that could not be converted from inferred to indicated status due to insufficient drill hole density. The latter contributed to the loss of 900,000 oz gold output and half the PEA antimony output, much of which would have been produced during the early years from the Yellow Pine deposit. There is nothing Midas management can do about the metal prices, but there is a strong likelihood that additional infill drilling will bring this excluded resource back into the mining plan, which will cost $22 million to bring to a full feasibility study. Although the market yawned at the PFS, in my view it represents a major derisking milestone and has turned Midas Gold into an exceptionally leveraged bet on higher gold prices for Spec Value Hunters as the junior settles into the final feasibility and permitting stage of the exploration-development cycle.
To help Spec Value Hunters understand the "optionality" on gold that Midas Gold's Stibnite project represents I have created an after-tax NPV sensitivity analysis that utilizes the detailed ore schedule outlined in the technical report. The chart above shows that at the current $1,222 gold price Stibnite has an after-tax 19.3% IRR with an NPV ranging from US $331 million to $636 million for 5% and 10% discount rates. I am not a big fan of using 5% for a mine whose revenue relies on something so fickle as the price of goal, but the company chose 5% and $1,350 gold as the base case because the NPV comes close to matching CAPEX which is generally regarded as development decision threshold (the IRR in excess of 15% is fine for larger CAPEX projects). Using this metric the Stibnite project becomes ripe for development at a gold price above $1,400. At $1,600 gold the NPV ranges from $840 million at 10% to $1.3 billion at 5%. The chart below, which plots the NPV in Canadian dollars per share against the price of gold, indicates a price target of $6.43 to $10.09 for Midas Gold if it does not have to incur any further dilution and gold hits $1,600. Even at the current $1,222 gold price the target ranges $2.53 to $4.87, a price range in which Midas Gold started out when it came to market.
Yet the market is assigning a valuation of only US $65.3 million to Stibnite based on 163.2 million shares fully diluted, a CAD $0.50 stock price and 100% net interest. That is just a little more than half the US $124 million Midas Gold has spent on the project since acquiring it for $82 million in stock in April 2011. The market seems to be pricing Midas Gold as if it expects the long term price of gold to be below $1,100 where Stibnite would never be developed. Given that nobody is paying attention to the gold juniors except investors who have a much more optimistic outlook for the long term real price of gold, it seems strange that Midas is not attracting a bigger gold optionality premium. A mere 30% increase in the price of gold to $1,600 would drag the project well into the money where a production decision is likely, but the corresponding valuation increase for Midas Gold's stock price would be a whopping 1,000%-2,000%. At a $1 stock price the leverage would be 500%-1,000%, a five to ten bagger. It looks too good to be true, but there is another reason Midas Gold is not trading at $1 while gold remains bound in a $1,200-$1,300 range.
Midas Gold is haunted by the perception that the Stibnite project will never be approved for mining in the state of Idaho. According to CEO Stephen Quin 60%-70% of the mining analysts at least somewhat familiar with the project hold this view, with the result that the market is penalizing Stibnite with a heavy permitting risk discount. This represents opportunity for Spec Value Hunters if the permitting risk is lower. The project, which sits in an area that was brutalized during World War II when it supplied the American war effort with tungsten and antimony, and further damaged by subsequent gold mining until the end of the fifties, has attracted the attention of the NGO community whose fund-raising success depends very much on at least appearing to stop mine development. This cynical view of Stibnite creating a feeding frenzy for anti-mining NGOs weighs on its market. But NGOs are also self-conscious of being cast as hypocrites who happily rely on raw materials extracted in distant backyards where the downstream victims have no means to ever make a donation to an anti-mining NGO. Some of these NGOs are thus more interested in seeing a mine developed with full attention to all social license and environmental issues than just blocking them for the sake of blocking them. The Stibnite project is easy for an NGO to be friendly towards because in one sense it is a reclamation project funded by a gold-antimony mine that government officials have been reluctant to undertake with taxpayer dollars. If Stibnite never goes into production, the legacy mess will never be fixed.
In its PFS announcement Midas Gold went out of its way to address the permitting risk which in the short run may have contributed to market unease about serious environmental opposition, but which marks a shift by management from trying to demonstrate to equity markets the economics of developing Stibnite, to bringing all the other stakeholders into the process. Although Midas expects it will need to spend another $22 million to deliver a permit and final feasibility study, most of this work is unlikely to generate news of any interest to equity markets. The next milestone will be to file a Plan of Operations in July, a very detailed document that will kick off what could be a three year permitting cycle.
The biggest headache facing Midas is that the Forest Service in Idaho is not currently up to the task of running a mine approval regime. In fact, the failure of the Forest Service to operate according to its own rules has riled up the Nez Perce Native Americans in whose "territory" the project sits. Midas is caught in the middle of this feud which has also attracted the NGOs to the bigger cause as to how the state of Idaho manages itself. Neither the Nez Perce nor the NGOs are necessarily opposed to developing Stibnite, especially given the predicted restoration of fish migration access to a large area. Of course the mining industry has a long history of abuse and broken promises, so part of Midas Gold's marketing challenge is to convince stakeholders that it is part of a new generation of responsible mine operators. The fact that the market remains skeptical is a reason why Midas Gold represents such good value as a speculation on modestly higher gold prices.
But there is another wrinkle which may reduce the permitting risk beyond what Midas management's community relations efforts may accomplish. The Stibnite project was renamed from Golden Meadows to emphasize that its development would not just be another frivolous gold mine but also a strategic domestic source of antimony, 85% of whose global supply now comes from China and the rest from islands of stability like Russia, Bolivia, Tajikistan and South Africa. (Stibnite is the sulphide mineral that contains antimony.) After getting briefly worked up about rare earths the world seems to have settled back into the complacent view that security of supply concern is not relevant in a globalized economy. But it may be time to rethink that attitude.
The gold bug narrative is shifting away from the being a safe haven from hyper-inflation and fiat currency debasement to being a safe haven from geopolitical disruption. This variation of the gold bug narrative does not involve an inverse relationship between the US dollar and the price of gold. It is also free of the ideological taint that has alienated such a large part of potential capital pools. As the prospect of political turbulence becomes more worrisome than financial turbulence the security of supply narrative will regain prominence, especially if the trend of reshoring manufacturing to the United States gains momentum. Just in time delivery of "minor" metals from wherever in the world will turn into a dubious strategy if major suppliers go "off-line". The Stibnite Mine has the capacity to supply all of America's domestic need for antimony which is largely used as a fire retardant. Furthermore, although antimony demand tracks the global business cycle, there may also be new demand on the horizon from innovations such as molten salt batteries for grid energy storage. The antimony by-product is an extra reason why Spec Value Hunters should own Midas Gold Corp as a leveraged bet on gold, for not only could this metal generate a greater urgency for mine approval, but a higher price than $4/lb would deliver extra cash flow, especially if the feasibility study brings the missing 100 million lbs of antimony back into the ore schedule.
Midas Gold Corp had about $10 million working capital left at the end of 2014 which management believes will carry the junior through 2015. There are about 7 million warrants at $1.20 that expire in March 2016 that could replenish the treasury in Q1 of 2016 if we have a stronger gold price to which Midas has responded. But management will likely seek to finance in H2 of 2015 before it runs out of money, so there is risk that equity dilution will snatch away some of the upside a higher gold price would bring to the valuation of Midas Gold. Although I am cautioning about dilutionary equity financing at SVH recommendation prices, the actual financing price may not be a fair bit higher. If Midas Gold's permitting work bears fruit, and we end up with a gold market biased more to $1,400 plus price expectations than sub $1,200 doom and gloom, there will emerge a strong appetite for the leverage implicit in the Stibnite mining plan. Institutional capital is not as picky as Spec Value Hunters about very big reward to risk ratios. They are not looking for 5-10 baggers. The stock is not overly liquid at current prices in the current general outlook, so a quick doubling in the stock price ahead of a major financing that takes care of the FS delivery cost and positions institutions for what would end up as 300%-500% fully diluted stock adjusted leverage to a 30% move in the price of gold In terms of exit strategy is quite plausible. Part of my Midas Gold recommendation is the capture of a 100% perceptual arbitrage. Burton Malkiel is generally correct with his efficient market hypothesis that reduces returns to a random walk. But markets are not always efficient, especially when they get hijacked by ideologues whose domineering influence distorts the proper functioning of a market as a rational discourse about likely outcomes. The launch of Midas Gold in 2011 was engineered by market fundamentalists who have had their heads handed to them. Ironically, a pragmatist like CEO Stephen Quin cannot avoid alienating his company's initial backers; the Spec Value Hunter opportunity arises through the market support vacuum created by the transition from apocalyptic gold bug fantasies to realism.
In terms of exit strategy the potential for over 300,000 ounces annual output makes Stibnite potentially interesting to million ounce plus producers such as Agnico-Eagle and Goldcorp, both of whom have been on the acquisition trail. Other potential buyers are the bigger producers Barrick and Newmont which have under-utilized autoclave capacity in Nevada. The Stibnite ore is refractory and the mining plan includes a flow-sheet of flotation followed by pressure oxidation in an autoclave which will be located on the minesite. Trucking the sulphide concentrate 400 miles to Nevada would add to the operating cost, but there would be an economy of scale cost offset. Furthermore, the trucking option would eliminate the POX portion of the $336 million processing plant CAPEX. But Barrick and Newmont are still sorting out problems incurred during gold's run toward $2,000 and are not likely to look at acquiring Midas until a year or two from now, provided gold prices have strengthened. The only producer with a disclosed equity stake in Midas is Teck which is dealing with problems created by oil's sharp decline. The rest of Midas Gold's shareholders are unlikely to tender to a predatory bid from Goldcorp or Agnico-Eagle unless the price is well above $1, and smaller producers are simply not viable candidates to take on a big CAPEX project like Stibnite. I like Midas Gold Corp as a Good Relative Spec Value Buy because it is an excellent two year leveraged call option on gold rising above $1,400.
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