Junior exploration sector poised for value investment, say analysts

The beaten-down junior mining complex currently sits at an attractive investment entry point as the sector continues to trade lower relative to gold and other equities, Haywood Capital Markets analysts conclude in their third Junior Exploration Report for 2022.

Haywood's analysts argue that with the GDXJ trading down about 21% in the year to date, as of Aug. 25, and several high-quality juniors are down even more, the junior segment offers deep contrarian value at a low-risk entry point.

"Exploration by definition is a high-risk endeavour, with economic discoveries coming very infrequently, and extraordinary share price gains if a junior explorer can make a discovery," wrote lead author Pierre Vaillancourt.

According to Haywood, Filo Mining (TSX: FIL) is probably the latest example of a big success story in exploration (the shares traded in the $2 per share range in early 2021 and rose to over $27 per share in May 2022), with Rupert Resources (TSXV: RUP) a close second with its Ikkari gold discovery in Finland.

"In both cases, senior producers BHP (NYSE: BHP; LSE: BHP; ASX: BHP) and Agnico Eagle Mines (TSX: AEM; NYSE: AEM) have contributed significant equity funding to advance these projects, along with conventional equity funding from risk-tolerant mining investors. It takes good science, adequate funding, and a strong management team to deliver a discovery," wrote the Haywood analysts, adding that junior explorers are much more efficient at grassroots exploration than larger mining companies.

Market volatility

The market is currently characterized by volatility in the gold price and the equity share prices, which conspire to reduce the availability of risk capital for exploration. However, strong management teams with prospective projects are still getting funded, although perhaps not to their desired levels.

After retracing its run to above US$2,050 per oz. in March, the gold price traded as low as US$1,681 per oz. in July and is now holding in the US$1,750 per oz. range. Silver is currently trading at around US$19 per oz., after reaching a low of about US$18 per oz. in July and a high of US$27 per oz. in March.

Haywood describes base metals prices at "reasonable" levels, with copper around US$3.70 per lb. today after the low of US$3.15 per lb. in July. While a recession would not help base metal prices, Haywood analysts expect supply constraints in the industry are likely to keep copper prices above the US$2.75-per-lb. level going forward.

"We believe gold remains in a longer-term secular bullish uptrend - acting as a quasi-hedge to inflation; and with mining equities trading at multi-year lows relative to both gold and the broader equities overall, they still present an attractive investment opportunity," wrote Vaillancourt.

Royalty opportunity

Exploration Insights analyst Joe Mazumdar says that juniors are having to get creative to deal with the current finance crunch that is especially pronounced in the precious metals sector.

"It's now harder for them to raise money through equity financing than last year at this time, and so some companies are using alternative ways of funding themselves," he told The Northern Miner in an interview.

For example, G Mining Ventures (TSXV: GMIN) recently turned to the capital markets to raise a significant part of their upfront capital to build the Tocantinzinho project in Brazil. It included a US$250-million stream on the future gold output of the project, which now represents one of Franco-Nevada's (TSX: FNV; NYSE: FNV) most significant gold streams on a primary gold mine.

The company had initially stated the cost of capital at the prices used for the 2022 feasibility study (US$1,600 per oz. gold), would be less than 5%. "But if you use the spot price or higher, we're talking about a 15 to 20% cost of capital," said Mazumdar who had crunched the numbers on the impact of the bigger than expected gold stream sale.

"The problem there for an equity investor who buys any of these companies is that they're buying it for leverage to the gold price; essentially as a call option. But in the case of a deal like this, the company has just sold part of that call option to somebody else. It's another form of dilution in terms of the valuation," Mazumdar said.

Another example entails Integra Resources' (TSXV: ITR; NYSE: ITRG) Aug. 4 convertible issue with a private capital firm Beedee Capital Inc. "They're looking at raising money at a higher price that they are currently trading at, but even that price is still a big discount to where they were trading at the beginning of the year," Mazumdar said.

With juniors being forced to look for alternative finance sources, much of the funding they are finding comes from angel investors, private equity firms and in particular, cash-flush precious metals royalty and streaming companies.

Joe Mazumdar, an economic geologist and analyst at the popular newsletter Exploration Insights. (Credit: Henry Lazenby).

"This current environment is positive for royalty companies. Last year, it was hard for them to get access to royalties and streams when spot prices were doing substantially better. Now, more companies can't go to the equity market with their offerings because of their low valuations," Mazumdar said.

The problem boils down to investor sentiment. "As holding gold generates no yield, the gold price does better in an environment of low to negative interest rates. General investors see no reason to hold gold in a rising interest rate environment," Mazumdar adds.

On a positive note, the gold price is doing better in foreign-denominated currencies. "It's the relative strength of the U.S. dollar that's weighing on the gold price. The U.S. dollar (DXY) is hitting new 52-week highs and is up 10 to 15% in 2022 year-to-date," he said.

In addition, Mazumdar points out that junior exploration companies with good management teams that are able to churn out good exploration results in the current market are still able to tap the equity markets.

For instance, Snowline Gold (CSE: SGD; OTC: SNWGF) recently published strong exploration results from its Rogue project in the Yukon, returning 2.3 grams gold per tonne over 282.9 metres from close to surface, including 3.24 grams gold per tonne over 146 metres.

"They have managed to raise more than $20 million to continue with an expanded drill program. The point is that there are tiny pockets of success in the current environment because of discovery holes, good results, etc.," said Mazumdar.

Majors look to add ounces

The sector has also witnessed majors reaching down via strategic investments into the junior and mid-tier companies to bolster their respective project pipelines.

Haywood argues that despite the equity performance in the sector of late, producers are by-and-large adding material cash to their balance sheets and still need to augment their portfolios through acquisitions.

"The recent acquisition of Yamana Gold (TSX: YRI; NYSE: AUY) by Gold Fields (NYSE: GFI; JSE: GFI) was partially driven by Gold Fields looking to add meaningfully to their development pipeline," said Haywood's Vaillancourt.

However, investors don't always see the rationale behind these deals, including in Gold Fields' all-scrip, US$6.7-billion bid to buy Yamana.

"The deal makes about as much sense to me as Goldcorp and Newmont's merger. Not a lot of synergy between the two; they have distinct corporate cultures," Mazumdar said.

"It smells of 'consolidation for the sake of consolidation' to increase size (market capitalization), improve access to capital, lower its cost of capital and also increase liquidity. It may also be the new Goldfields CEO's way of trying to put his stamp on the company for the future. Obviously, shareholders didn't like it when it was announced therefore both management teams are going around selling the positive attributes of the combination to win shareholder support," said Mazumdar. The merger is expected to close later this year, pending a Gold Fields shareholder vote towards the end of October.

"But in my view, Gold Fields brings all the near-term value, with better cash flow and the discovery at Salares Norte in Chile that's coming into production by 2023. So, on all the near-term metrics, Gold Fields beats Yamana."

The one thing Yamana has is a growth profile, in Mazumdar's view. The company's MARA project, the result of an integration completed in December 2020 of the Agua Rica project with the Minera Alumbrera plant and infrastructure, is a copper-gold porphyry opportunity in Argentina.

"Glencore is keen on taking that concentrate and treating it at its Alumbrera operation, so they don't have to reclaim it. If that works, that could unlock some significant upside value," noted Mazumdar.

With the U.S. Fed's chair, Jerome Powell, recently stating that interest rates are not coming down anytime soon, Mazumdar believes it could be an uphill battle for many marginal precious metal projects in the near term.