During a time in which the mining sector is struggling to survive a darwinian period, legendary mine developer Rob McEwen was kind enough to share perspective on the state of the market.
Rob was the founder and former Chairman and CEO of Goldcorp Inc. (Stock Profile: TSX:G & NYSE:GG), which is by market capitalization, the largest gold producer in the world. Today, he is the top guy at the company that bears his name – McEwen Mining (Stock Profile – NYSE:MUX & TSX:MUX).
Rob, you and the team there at McEwen Mining recently announced a change of game plan in terms of development and production growth for the company in response to the extremely challenging conditions we’re seeing in the mining sector today.
Can you explain the thrust of that announcement and what it means from a strategic standpoint?
Well, we wanted to inform our shareholders and the market that the decline in metal prices did have an impact on us and wanted to keep them informed. So at the beginning of the year, we were projecting production growth going from about 100,000 gold eq. oz. to 130,000 oz. this year, and then 280,000 oz to 290,000 oz. on an annualized basis by the end of 2015.
The bulk of that growth was coming from our second project in Mexico called El Gallo 2, which had a capital cost of about $180 million. At the beginning of the year, we looked at it and thought well, based on the prices of silver and gold at that time and our cash holdings–for that $180 million, we should get about a third of it from our cash and cash flow, a third from capital leases, and the balance we thought we would be able to cover with the proceeds from the sale of our Los Azules copper project.
What we found was that the metal prices dropped, and our projected cash flow shrank considerably. Los Azules we put up for sale at the beginning of the year and had expectations that it would bring in several hundred million dollars—but we found there was no market for mega copper projects and Los Azules is a large copper project in Argentina. We further found there was no appetite for Argentinean assets amongst investors, and so the result was no sale.
So when we looked at it, we saw our cash flow was down, part of our funding for El Gallo 2 hadn’t materialized, and the access to equity and debt markets as we progressed through the year– became effectively closed to junior producers, exploration companies, and for that matter, most of the market.
Even for the producers in the market, it’s closed. Investors have said this isn’t the place they want to be. They would rather be in the broad market, and gold prices are still falling.
So that made us start looking into the alternatives. We found one in that we were having good exploration success around our El Gallo 1 mine which started commercialized production beginning this year. So we were having good exploration results and we thought maybe we could increase our production there.
The more we looked at it, we saw that we could expand our pads, crushing circuit, processing plant, and for a small amount of capital, $5 million—we could more than double our production and lower our operating costs.
So that was a positive.
Then we looked at our El Gallo 2. El Gallo 1 is gold and El Gallo 2, which is located some five miles away from El Gallo 1, is a silver deposit and we were going to process it with a mill. When we looked it, we realized we had already done some studies to see how much we could recover if we did a heap leach operation, and we were getting recoveries between 45 and 65 percent of the silver by means of a heap leach method.
So we looked at it and saw the capital cost of a heap leach is about 20% of the cost of a mill. So rather than spending $180 million, we’re looking at a cost of about $20 million, which is about 10% of the cost of the mill. We wouldn’t be producing the 90% silver that we were projecting…but we would be getting 60% by spending 20% of the money. Getting only 60% of the metal would be a good trade-off–it would improve our internal rate of return, reduce our capital requirements and should allow us to fund most of it internally. In this market, the ability to fund all of your production growth internally without accessing the debt or equity markets is a great advantage.
So we’re going through further metallurgical testing at El Gallo 2 and looking at a bulk sample, and if it proves viable with recoveries greater than 50%, we’ll be looking to expand our facilities at El Gallo 1 to accommodate ore that would be trucked from El Gallo 2. We’ll be using a common production base.
Now if you look at the net effect, we were [originally] looking at producing on an annualized basis, 290,000 ounces of gold and gold equivalent, converting the silver to gold.
[By] increasing the production in El Gallo 1 and altering the method of El Gallo 2…we would be producing 280,000 ounces of gold and gold equivalent. So it’s only about 10,000 ounces less than the original projection and we would be able to finance that internally rather than having to access the debt and equity markets. So I think that’s positive and in the interim we’re continuing exploring on the Mexican property which has been giving us some pleasant returns.
The last time we spoke you mentioned a bit of surprise and frustration when you stepped into mining from the finance industry in terms of realizing how slow things moved. You said it was like putting your feet into a bucket of quick dry cement.
And as you point out, by using 10% to 20% of the initially intended capital at El Gallo 2, and achieving about 60% of the initially intended production, the IRR would be much greater. What advantage does a higher speed of return offer in this market?
Being able to get up and running faster improves your return and reduces your risk, whether it’s geopolitical, operational, etc. The ground is moving very rapidly in terms of government regulations, taxations, expectations, etc., so I think if you can go in and get your money back, and then start getting a return on your investment…the sooner you do that, the better off you are. So it definitely reduces your risk as opposed to say a big project.
If you look at Barrick’s Pascua Llama (Stock Profile: NYSE:ABX & TSX:ABX), it was coming in at just under $3 billion originally, and now they’re forecasting it can be as high as $8.5 billion dollars, and for environmental reasons, they had to delay the project, and I think they’re into it right now for $4.5-$5 billion. They were hoping to get it up and running by 2014 and now, they have to clear some environmental hurdles and they won’t get those out of the way until mid-2016.
So when you’re building a mine of that size in the High Andes, you got a huge workforce and everybody is coordinated. Those delays are going to move the costs up considerably, because you have to [most likely] reassemble teams, as you’re not going to keep certain people going for two years while you’re waiting for a permit.
Has this market been a tougher competitor (or opponent) than the markets you’ve faced in the past especially during your time with Goldcorp? I know there were some very tough years that you’ve spoken about in the past.
Well, there have been a number of corrections in the market that I observed during my career. They all come very suddenly, and they all vary in severity. With this one, you start to remember that government-induced hurdles get thrown into the mix every once in a while. You tend to forget about those when you’re running along.
But with the benefit of looking back, you can say, “Oh, yeah, they did that before.” More taxes, more royalties and maybe a little bit of nationalization taking place. So the industry is not without that risk and that goes back to your earlier question about timing. If you can shorten it, hopefully you have a little more time to get your money back and get a profit.
What’s different in today’s market is the existence of the ETFs. ETFs really started taking off for both gold bullion and gold mining shares (NYSE:GLD). I think it was in 2003 and 2004 that the gold bullion ETFs started appearing. After that, the mining share ETF appeared.
So in the hands of the very few, you have large holdings of bullion and [mining] shares, much larger that what you’ve seen before. When the market swings, there’s a lot more pressure now as those holdings and funds sell. I think they’ve had a much bigger impact on the run-up because there was more demand to carry [them]; but also on the way down when it feels like the world is ‘getting better’ and you don’t need gold anymore–which I don’t think is the case. But it exaggerates the move from the up and the downside.
You’ve also spoken about the non-existent interest rates accelerating the stock market, and as being sort of a theft from savers, from the builders of society, the conservative element.
The recent pick-up that we’re seeing in interest rates over the past month or so–is this a sign of health returning or is it a sign of potential danger in your opinion?
Well, higher interest rates definitely help savers. They might slow down the economy because I think right now there’s a misallocation of capital. Investors in general would like to assume that all the problems are behind us and that the economy is going to pick up.
[Rising stock markets have] disguised the fact that debt levels around the world by governments are continuing to increase, that the trillions of dollars that have been pumped into the system are having a small impact on reducing unemployment levels, and that there’s problems in the European common market, particularly with the members from the south around the Mediterranean. Demand in China has also been fluctuating, and causing some hesitation in people’s views of what is going to happen to commodities. So it’s not a time to be complacent and I think interest rates will start to move up, and as they do, there’s going to be some concerns about how we sustain ourselves with higher interest rates.
If you look at the US gross national debt, it’s just under $17 trillion. One way the Federal Reserve and other central banks around the world are able to take out all this debt is because the interest rates are so low. Those rates go up. We’re going to see a very different situation and I think as people perceive risk in the right light, they will demand more for the money than what they currently receive.
As the readers probably know, you own 25% of McEwen Mining. Are you adding to your position here?
I haven’t yet because we keep putting out news. But I’m thinking this is a time to be looking at opportunities, and it may be opportunities that we can put into McEwen Mining by acquiring another asset. I would be inclined to do that.
In terms of my investment, I own 25%, and my cost basis in McEwen Mining is $125 million, so I have a keen investment interest in the company.
On the Dow to gold ratio as of late – do you have any thoughts there?
We’re at twelve ounces to buy the Dow and not too long ago, we were as low as seven ounces to buy the Dow. It looks something akin to what happened in the ‘74 through ‘78 period where gold went from $200 an ounce, down to the mid-$90s per ounce, then back up to $200 before it moved on to $850 an ounce.
So it feels like we’re entering the second half of this cycle, and that ratio number maybe will go to thirteen, but then it’s going to go back down towards seven and ultimately below that considerably.
Winding down, are there any items that we may have missed about any aspect of the conversation so far?
From a McEwen Mining perspective, we have cash in the bank about $40 million right now. We don’t have any debt so we don’t have to service or repay it. We have projects we can fund without accessing the outside markets, and to me that’s a much better position than a company that is halfway through a build and finds it’s having to raise more money, or a company that has a project to build to which the cost of building is bigger than the market cap.
So I like the position we’re in right now and I think we would be looking outside to join forces possibly with other companies to build a stronger company that can take advantage of this opportunity.
For the readers, if they’re looking for gold exposure, we are best described as a speculative investment because we’re a junior producer.
But some of the seniors might also be considered speculative because of the levels of debt on their balance sheets. There have been more than fifteen CEOs removed from intermediate and senior producers in the last eighteen months, and their boards are probably feeling a little vulnerable right now because they backed the people they fired and so they’re telling the new CEO, “Don’t go out and buy anything new, fix up what’s not working, don’t think about developing new projects and cut all discretionary costs…start improving the operating margins and maybe think about increasing the dividends…and maybe even think about doing a share buyback.”
You’ll probably see large write-downs this quarter, but over the next couple of quarters, operating margins [will improve] because they’ve written down their costs, so that might be one area for someone [to look] who’s risk-averse if they want exposure to gold.
The difference between the performance in gold and gold stocks is enormous right now and therefore on a relative value basis, you can get a yield with some of the senior gold stocks, and they have been badly beaten up. So it’s not a bad time to enter.
If readers are looking for something more speculative (maybe a higher beta), then you look to intermediate and junior producers and then to the exploration companies, that are just crawling along the ground right now in terms of price… [but] I do think we are close to the bottom.
So there’s a low cost of entry, good relative value. We seem to be near the bottom of this correction, and I think there is more to be made on the upside than lost on the downside right now.