Mike Niehuser: Silver Producers Who Shine

Source: The Gold Report interview with Mike Niehuser 3/29/10
“The case has never been better for having a position in precious metals as a store of value,” says Mike Niehuser, founder of Beacon Rock Research, LLC, especially in light increasing amounts of government debt. In this exclusive interview with The Gold Report, Mike talks about his goal of finding mining stocks with good management and assets with defined pathways to value creation and two in particular that he’s keeping an eye on that “have excellent exploration upside.”

The Gold Report: Mike, has your outlook for precious metals changed given the recent strengthening of the U.S. dollar?

Mike Niehuser: From a U.S. perspective, we still see gold between $900 and $1,200 an ounce, and continue to believe that we could see gold at $1,500 by year end. Likewise for silver, $15 to $20 an ounce appears to be a reasonable trading range, and with silver we would expect to have greater volatility. The case has never been better for having a position in precious metals as a store of value. With the bailout of Greece or Portugal, the euro may be in trouble, and yet the U.S. is also becoming an increasingly uncertain place to do business. So long as the U.S. is perceived to be relatively more stable than most other parts of the world, and the federal government can manage its problems, the U.S. dollar will periodically strengthen and you may expect volatility with metal prices. The uncertainty being generated should have the offsetting effect of increasing the attraction for precious metals as a store of value, but over 2010 to the longer term, increasing amounts of government debt relative to a constant total supply of precious metals will allow metals to remain a store of value.

TGR: Is this a good time to invest in mining equities?

MN: We have a bias that over the long run, for mining stocks with good management and assets with defined pathways to value creation. So long as metal prices are above cost of production, we are in business, which seems to be the case today. Look at it this way, would you want to hold assets in the form of I.O.U.s from the government that has no will to stop the printing press, or would you rather have an interest in an outfit that actually produces hard currency? The difficulties faced by mining companies to profitably produce gold and silver—read hard currency —is what makes them rare. In the current environment, holding shares of mining companies is an option to holding physical metals or in an ETF. The key to stock selection is locating companies that are either on a path or have achieved profitable production. Certainly, the deleveraging over the last couple of years has even taken down companies that have met investor expectations, and we may not be out of the woods yet. So yes, we don’t see a bubble in precious metals or mining stocks, and so stock selection is still important.

TGR: What silver mining companies are you recommending to investors?

MN: There are two that come to mind. Minefinders Corporation (TSX:MFL;NYSE.A:MFN) has achieved their first profitable quarter mining gold and silver, or silver and gold, depending on metal prices from their open-pit Dolores mine near Chihuahua, Mexico. We also like Alexco Resource Corp. (TSX:AXR;NYSE.A:AXU), which has an early jump on constructing their modest but high-grade silver and base metal underground mine in the Yukon Territory. Both companies have excellent exploration upside with solid balance sheets, good management, and relatively fewer shares outstanding compared to other companies in their space. Interestingly, both companies are not trading far from where they were without significant improvements and at much lower metal prices.

TGR: Mexico has been getting a lot of bad press—do you have concerns?

MN: Look, sure, but I have concerns about the U.S. as well. We just got back from visiting Dolores and actually it seemed calmer than our last visit. Interestingly, it appeared that given room availability at the hotel and number of small airplanes in the hanger at the airport, they may be experiencing their own economic downturn. This may be both good and bad; we would expect that the government would appreciate a stable long-term operator like Minefinders. They have successfully relocated the village and the blockaders from years ago were nowhere in sight. You may attribute this to management working with the federal government and the locals.

TGR: So why would Minefinders, for example, be trading at lower than expected levels?

MN: Once again, Minefinders’ stock is now trading at a price that is close to that when they had just finished the road to the project prior to construction. So that is a good question. They are now in production and it would appear to have worked out the bugs from startup and have recently completed their first earnings-positive quarter. This is a somewhat amazing statement to say that a mining company is now profitable.

TGR: If Minefinders keeps mining ore should the value drop from here?

MN: Only if there was no upside for exploration or increasing recoveries or if metal prices declined as they are unhedged. This should be a pretty good year from Minefinders for a number of reasons. Management reports that they have solved their screen issue of last year and that they should be processing at the 18,000 tons per day rate. In addition, having moved the village, they are now in position to pursue higher grades of both gold and silver. Silver grades should double through the end of the year and gold grades should step up in the second half as they move into higher grade areas of the pit. It will be important for investors to watch recoveries. Gold is fairly easy to recover in the leach process but silver can take longer. On the whole, they have reported that leaching has met their expectations, but they learn as they go, and this is a good reason for their contemplating a mill to boost recoveries of higher-grade silver.

TGR: Could the cost of a mill be a concern to investors?

MN: It may be a concern for some. Minefinders is in the process of reviewing different scenarios of different types and sizes for a mill operation. They question is not an easy one as the terrain is a factor and power is always an issue. The nutshell for a mill is to boost recoveries of higher-grade silver that otherwise may be left on the leach pad. Even more important and not in the current resource model is the potential to process even higher grades from underground and outside the current resource model. This expansion of the resource underground or expanding the pit to the south plus the potential for increasing recoveries does not appear to be in the stock price. The company is also profitable and has available credit and fewer shares outstanding, so they have options to make the best of the opportunity.

TGR: What is the life of the Dolores Mine?

MN: As contemplated in the Feasibility Study, the life of mine is 15 years. This will change with the mill; it could actually shorten by increasing processing or be extended with additional resources added to the project. Investors should also know that Minefinders should be making decisions on its La Bolsa heap leach project on the Arizona-Mexico border near Nogales. This was Minefinders’ initial project that was put on the back burner after Dolores was discovered. We have seen La Bolsa as well and it is a relatively simple project. La Bolsa could produce 40,000 to 50,000 ounces of gold over four to five years with relatively little cost. Potentially more important than La Bolsa, Minefinders reported on its new La Virginia target, which is a Dolores look-alike but with potentially higher grades of gold and silver. This should address some of your questions about Minefinders potential for value creation beyond the start up of Dolores.

TGR: Have you seen Alexco’s project recently?

MN: We were up there last summer for the analyst tour of the Bellekeno underground work. It is still a little cold in the Yukon, but they are reported to be experiencing an unusually early spring. This should have allowed them to get a jump on construction having buttoned everything up for the winter and put them in good position to move into production in 2010. Unlike Dolores, Bellekeno is part of the Keno Hill Silver District, which has completed infrastructure from past production. In addition, Alexco is mining some of the highest grades of silver in the world, which allows them to build a relatively modest-size and low-cost processing operation.

TGR: So Minefinders and Alexco are apples and oranges?

MN: As far as being different types of silver projects and locales, you are correct. In addition to high grades of silver with base metals, the Yukon Territory is becoming more interesting to investors based on recent discoveries in the area plus the area’s long mining history and friendly political jurisdiction. Alexco is also a bit different from a management perspective as Minefinders are exploration geologists while Alexco has the unique background as an environmental services firm, which is how it came into ownership of the Keno Hill Silver District.

TGR: Why was it important that Alexco had environmental expertise?

MN: Alexco acquired the Keno Hill Silver District from the government with the agreement to clean up environmental damage left over by previous operators. So Alexco will be paid by the government in the Yukon to clean up the district while having the opportunity to mine resources to current standards. The Keno Hill Silver District has past production of over 200 million ounces of silver averaging about 40 ounces of silver per ton, yet the district has never been comprehensively explored with modern mining methods. We would expect that the market is only giving value for Bellekeno, while there is potentially much more beyond the initially identified resource for about a five-year mine life.

TGR: How can you be sure that there are additional resources left to discover?

MN: Well, point well taken. In Alexco’s case, investors may consider the manner in which it financed the development and construction at Bellekeno. Alexco commenced construction prior to completion of a bankable feasibility study by selling 25% of the silver production at about $3.90 an ounce to Silver Wheaton Corp. (NYSE:SLW;TSX:SLW). The deal allows Alexco to remain full ownership of the remaining 75% of the silver production, plus lead, zinc, and any gold found on the property.

The funding by Silver Wheaton allowed Alexco to forgo completing the expensive and time-consuming feasibility study, which allowed them to accelerate the time to construction with metal prices at record levels. Funding by Silver Wheaton also allowed Alexco to advance to construction without issuing shares and diluting existing shareholders or securing debt financing, which may have required restrictive bank covenants and hedging. The very interesting part of the Silver Wheaton deal is that it would not have been justified on the existing resource at Bellekeno, so it begs the question exactly what is the upside at Keno Hill.

TGR: Well, what is Silver Wheaton expecting?

MN: It is hard to say; this may be the first silver stream purchase by Silver Wheaton on a more or less pre-feasibility level project. As I said, though the diverse ownership interests had been consolidated over the years by the United Keno Hill Mines, the prior owner never completed a comprehensive analysis of the district and never established a resource ahead of a couple years of mine life. The ore was never mined below a couple hundred meters was well. Although the operation was large and had scale over the oldtimers’, United Keno Hill only pursued high grade veins until they were offset by faults and then mining ceased. Not until recently did Alexco consolidate and complete a study of the volumes of historic data.

TGR: So why is the historic data important?

MN: Alexco digitized and assimilated rooms of data that allowed them to identify targets to potentially locate extensions of high grade veins that were lost or dead ended due to faulting. Alexco successfully used this data to potentially locate extensions of the high- grade Lucky Queen and Silver King past-operating mines. These vein continuations may now be visible to Alexco while the previous operator was in the dark.

TGR: What do you mean by high grades?

MN: The Lucky queen produced 11 million ounces at 88 ounces per ton and the Silver King produced 11 million ounces at 53 ounces per ton. But even more interesting than just locating extensions of lost veins on high grade veins, Alexco was successful at stepping out well beyond historic mines and producing significant drill results elsewhere. The Birmingham, for example, is several kilometers away any known mines. Alexco hopes to locate another Hector Calumet at Keno Hill, which produced over 96 million ounces. As Keno Hill has produced over 200 million ounces of silver and has never been explored beyond following surface expressions of mineralization, as the district is about 10 by 20 miles, there is significant upside, which is what Silver Wheaton is banking on.

TGR: So do you expect Alexco to be profitable in 2010?

MN: It could be close. We would expect Bellekeno to be highly profitable for a mine of its size and expect additional ore to be located to either extend the operating life of the mine or to the acceleration of an expansion or an additional mill on the project. It is still too early to tell, but in addition, Alexco has an environmental business in that is active in North and South America.

TGR: What is this all about?

MN: It was Alexco’s environmental expertise in mine remediation and closure that allowed it to be successful in acquiring the Keno Hill Silver District from among a number of bidders. Alexco is the government’s sole contractor for the cleanup of historic mining activity, all the while being held harmless for prior mining activities while free to extract precious and base metal resources. The combination of the contract for cleanup plus the operation at Bellekeno should place Alexco in both an envious operating position and cash-flow generation. We have visited two other environmental sites cleaned up by Alexco, one in South Carolina and one in Colorado, and we are expecting that this year may be the year their environmental business takes off.

TGR: Mike, we appreciate your time.

Mike Niehuser is the founder of Beacon Rock Research, LLC , which produces research for an institutional audience and focuses on precious, base and industrial metals, and substitutes, oil and gas, alternative energy, as well as communications and human resources. Mike is also on the faculty of the Pacific Coast Banking School and was nominated to BrainstormNW magazine’s list of the region’s top financial professionals in 2007.

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1) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Minefinders, Inc.
2) Mike Niehuser: I personally and/or my family own the following companies mentioned in this interview: Minefinders, Inc. and Alexco Resources. I personally and/or my family am paid by the following companies mentioned in this interview: None.

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