Western Copper & Gold: Developing one of the Largest Advanced-Stage Copper Gold Resources

Stefan Ioannou has spent the last eight years as a mining analyst covering mid-cap base metal companies at Haywood Securities. Prior to joining Haywood, he worked with a number of exploration and mining companies, as well as government agencies as a field geologist in Nevada and throughout the Canadian Shield in both the gold and base metal sectors. Stefan holds a degree in Mining Engineering and a PhD in Economic Geology.

RIN: To start off with, could you give me a brief overview of the current copper market?

SI: If you look at a lot of the forecasters, for instance GFMS, the market is looking at a surplus of 350,000 tonnes this year (noting annual global demand is on the order of ~22 Mt). Earlier this year, we saw a lot of “horse trading” as copper inventories appeared to be moving from the London Metal Exchange (LME) to Chinese warehouses. Copper wasn’t actually being consumed, it was just being moved in support of Chinese “shadow lending,” which basically uses the metal as collateral to back higher-yielding short-term investments versus actual physical consumption. However, within the last few weeks, speculation pertaining to fraudulently using single stockpiles of the metal to back multiple loans could set the stage for tighter regulations.

Nevertheless, as of now inventories across the board appear to be falling. LME inventory is down more or less 70 percent over the last year, currently at around 166,000 tonnes, which is actually less than three days’ consumption. Similarly, the Shanghai Metal Exchange (SHME), which was climbing earlier this year, is actually down about 56 percent over the last three months. A lot of that comes on the back of China tightening financing rules and skepticism stemming from the country’s first domestic bond failure in March.

RIN: What needs to happen before we see some more positive upward price movement?

SI: I think at the end of the day it is still a looming market surplus until at least next year. We likely need to see inventories continue their decline. The market is not expected to move into a supply deficit until late 2015. In the meantime, we anticipate copper prices will remain range bound between $3 and $3.25 per pound. For the next year and a half, pricing is probably is going to be relatively flat.

In the interim, price strength will be largely driven off of Chinese economic data. The country posted a modest PMI gain and increased export data during the month of May, which should support the Government’s 7.5-percent GDP growth target.

Europe is also a key consideration, noting its PMI index decreased to 52.2 in May (from 53.4 in April). A reading over 50 indicates growth in manufacturing. However, decreasing numbers suggest a fragile market that warrants caution.

RIN: One of the things that has been highlighted to me in regards to the copper market is LME stockpiles. Now before getting too deep into this, can you explain how LME stockpiles can be an indicator of the copper market overall?

SI: You have to be a little bit careful with respect to copper. It’s unlike some of the other base metals, which post most of their inventory on the LME. If you take zinc, for example, about 60 percent of the world’s zinc is held on the LME. When you look at the LME inventory number and it’s declining, its a good indication that global zinc supply is falling. With the case of copper, the inventory “pie” has been cut into more pieces (in addition to the LME, it includes the SHME, COMEX, mine inventories, recycled material). Hence, though it’s one of the largest single and most transparent pieces, the LME inventory figure on its own does not necessarily reflect the global supply picture.

RIN: You’ve mentioned this a little bit — the deficit that’s looming in the back half of the decade — can you elaborate on that?

SI: Over the last few years, we have seen major miners shift focus from developing new large-scale mines (which by association are typically low grade and high cost) to cutting costs at existing operations. While this is good for the majors’ near-term bottom line, the lack of new development will almost undoubtedly lead to a market supply deficit in the future.

When we are talking about the majors, we are talking about the “mega” projects that cost billions to build and also take years to permit. Hence, the deferral of targeted development timelines beyond 2016, 2017, 2018 will likely have a significant impact on the copper market’s medium- to longer-term outlook.

RIN: One of the things I have heard of also is that there are fewer high-grade projects coming online. Does that play into the deficit at all?

SI: You have to be a little bit careful about grade. When we talk about big projects, for the most part they are typically low grade. Grade is a great thing to have; however, you don’t usually get size and grade together, though there are always exceptions to that, obviously. But when we are talking about the major development projects — and just to generalize — most of them tend to be lower-grade copper porphyry deposits either in South America, Western North America or China.

The key criterion for the majors is size. Hence, a project needs to produce enough pounds of copper to move the bottom line. High grade is good, but usually high-grade mines just don’t produce enough pounds to move the bottom line for a major.

RIN: Are there many copper deposits currently in the development phase that could come online in the future?

SI: There are a number of large-scale, advanced stage deposits that are at/near the bankable feasibility stage of development that could arguably be brought into production within the next two years.

A lot of them again, because they are these large, low-grade copper deposits, typically need higher copper prices to really have a meaningful economic return. Most investors want to see an after-tax IRR on the order of at least 18 percent. So some of these lower-grade deposits, we’re talking about deposits that may grade as low as 0.3-percent copper, would probably need at least $3.25, if not $3.50 or $4 per pound copper to work.

And because of that, and the lack of attractiveness to potential investors, it’s hard to secure financing to actually build these projects. They are large projects, so we are talking billions of dollars, not hundreds of millions. So financing is a huge consideration. That’s a stumbling block, especially for a lot of juniors right now. A project looks good on paper, but financing is hard to come by.

The other thing to consider is permitting. Across the globe now, permitting timelines are increasing. Governments are becoming more stringent on the process and due diligence. So permitting itself can take years and years, which can really hold back projects.

RIN: As far as large projects is concerned, one that comes to mind is Western Copper and Gold’s (TSX:WRN) Casino project in the Yukon. What is important for investors to note about this project?

SI: Hands down, Casino is underpinned by one of the world’s largest advanced-stage, undeveloped copper-gold resources. In terms of advanced-stage projects, it’s at the feasibility stage. And, like many of the other “elephants,” it is a relatively low-grade deposit that is best suited to the economies of scale — as is apparent by the proposed 120,000-tonne-per-day operation’s $2.5-billion initial capital cost estimate.

RIN: Okay. Well, $2.5 billion, is that on the high end or the lower end of the capital-intensive projects?

SI: Surprisingly, in terms of the mega projects, that’s probably within the lower half. It’s all relative. But there are some large projects that are in the $5-billion-and-up range.

RIN: And jurisdictionally, being in the Yukon, is that good for the company?

SI: I think that’s a big advantage for them relative to their peers. The Yukon is a mining-friendly jurisdiction. Five mines have been permitted there in the last seven years, which clearly demonstrates the government is pro-development.

And one of the things that the Casino project stands to benefit from going forward is that the territory in general is making a large shift to bringing liquefied natural gas (LNG) into the region. If they can power the project using LNG that could lower their costs significantly.

RIN: Now, in terms of infrastructure. I don’t generally think in the Yukon there are roads leading everywhere. How does that factor in?

SI: Some of the regional infrastructure still needs to be established, and that’s impart why there’s a $2.5-billion CAPEX figure in front of it. It’s not right on the highway or anything, so there is some infrastructure consideration. Obviously power is one piece of that pie, but road access and everything else that goes with it will need to be established to support a full-scale mining operation.

But the bottom line is when it’s in production, you are talking about 170 million pounds of copper and 265 thousand ounces of gold a year. It is a big project, and as we move down the road and large companies look to potentially add large-scale projects to their portfolios, this is probably one that they will take a closer look at.

RIN: Strip ratios — in this case for copper — can be an important early indication of a project’s upside. With Western Copper, for instance, the strip ratio is 0.59:1 for the life of mine. Can you help our readers understand what that means?

SI: Strip ratio is mining term pertaining to open-pit operations — it reflects the amount of waste rock that needs to be mined to access each tonne of ore. In the case of Casino, Western Copper will have to mine, on average, 0.59 tonnes of waste for every tonne of ore taken from the pit. Obviously the lower the strip ratio the better because it is going to entail an overall lower mining cost.

Generally speaking a strip ratio of less than 1:1 would be considered low, so 0.59:1 is a relatively low strip ratio, which is good.

RIN: So does that mean that there is a lower cost at all?

SI: Well, it is only one cost component, but in your mining costs, having trucks in an open pit moving rocks around is one of the more significant costs. The less waste that you have to move around, the better.

RIN: Since we’re talking a little bit about prices, when it comes to pricing, companies always use a base case in their feasibility studies. With copper prices where they are currently, that base case price has come down a bit. Where do companies get the base case figure?

SI: It’s always a bit of a black box when it comes to doing a feasibility study. Base case metal prices do bounce around a bit. What companies typically do is use analyst consensus numbers, which are currently on the order of $3 to $3.25 copper long term. Or they look at the trailing three-year average, or they pick some other number that they deem is reasonable in the context of overall markets, including forward curve consideration.

But you are right, with the copper price languishing here over the last six months to a year, we’ve seen the general base-case copper price come down in a lot of studies. It used to be that $3.25, or even $3.50, wasn’t that unheard of, but now we are seeing numbers closer to the $3 range and some are even down at $2.75.

Typically, we like to see something a little more conservative. Because if it works at a lower numbers it will work at a higher number.

RIN: So should investors be concerned when they see studies with lower base case prices than they might have seen a few years ago?

SI: Most studies, if you are using something in the range of $2.75 to say $3.25 long-term copper, then I think that is a number that people should be comfortable with.

If it delivers a decent IRR at $2.75, I think that is a pretty positive indication. I would argue that the realities of $2.75 long-term copper are pretty thin. One of the big paradigm shifts in the mining industry is that we are mining lower grades, and as a result, operating costs are getting higher, which in turn is squeezing margins.

And as the margins get squeezed, the copper price has to go up. These days, the median copper price is on the order of close to $1.50 a pound, and copper producers and higher-cost producers are producing at $2-$2.50 a pound. If copper were to drop down to $2.75 or $2.50 a pound you are actually going to start knocking copper production off the map. We are already talking about a longer-term supply deficit, and this impact of lower copper prices would likely contribute to it even more.

We’ve had a pretty rough year, especially through 2013, but the fact that the copper price has averaged over $3 per pound is a pretty good indication of where the floor price is. It will probably be another year or so before we see the LME and the other inventories come down in unison before we see the “panic” start to set in. Again, we are probably going to see some flat pricing for the next little while.

Mining is a cyclical business, and we’ve read this book before. From an investment point of view, it’s all about timing the supercycles — unfortunately that’s not necessarily the easy part. It’s anyone’s guess if it’s going to be a year from now or three-plus years from now. Only time will tell.

RIN: My last question is some advice for investors looking at copper projects. What are the most important things investors should look for when assessing copper projects?

SI: I think it really comes down to three things:

1. Grade is king. Higher-grade deposits buffer operational challenges and metal price fluctuations. That’s a luxury not shared by lower-grade counterparts, which can be quickly rendered uneconomic under unfavorable circumstances. Whereas a higher-grade deposit can weather the storm.

2. Geography — not geology — should never be overlooked, Unfortunately, some of the world’s greatest deposits are still just deposits as opposed to mines because of the challenges imparted by political considerations. A pro-development government within an established mining jurisdiction is a huge asset.

3. Finally, management is key — a good project will only bear fruit if it’s backed by a team that is capable of advancing it through development, setting the stage for production or a sale.

RIN: That’s great, a good place for investors to start. Thanks for speaking with me.

SI: Thanks.

Editorial Disclosure: Western Copper & Gold is an advertising client of the Investing News Network. This interview was conducted as part of their advertising campaign. This is paid-for content.

Stefan Ioannou did not received compensation from the company for participating in this interview.

Securities Disclosure: Vivien Diniz holds no investment interest in any of the companies mentioned.

Neither Stefan Ioannou nor Haywood Securities hold any stock in Western Copper & Gold.