Klondex Mines: One of the Highest Grade Gold Mines in the World

Derek Macpherson is a mining analyst at M Partners; before joining M Partners he worked in mining research for a bank-owned investment dealer. Prior to entering capital markets, Macpherson spent six years working as a metallurgist. Macpherson has a Bachelor of Engineering and Management in materials science and a finance-focused MBA.

RIN: Gold seems to be unable to break through the $1,300 mark. Can you talk a little bit about the factors that have been influencing gold prices lately?

DM: In our view, there are two competing factors impacting the gold price at the moment. First is the political unrest around the globe, particularly in Ukraine. From that you have safe haven trade that has been supporting the gold price.

On the flip side, however, we’ve seen improving economic data in the US, which has implied that the US Federal Reserve is likely to continue reducing its tight monetary policy, which could result in investors moving away from inflation trade, which can negatively impact the gold price.

We are of the view that liquidity created by global central banks over the last several years could create inflation that would then push the gold price higher, but the timing of that move is uncertain at the moment

RIN: Do you think gold will be stuck in this range for a while?

DM: We are using $1,300 gold to value companies. I think we are of the view that until we see a significant move through $1,400, we are going to be stuck at this price for a while.

RIN: How are resource companies — majors, mid-tiers and in particular junior gold companies — impacted by the lower gold prices?

DM: Gold companies of all sizes have had to reduce their spending and bring their costs in line to reflect the lower gold price. For a lot of the majors and mid-tiers, this meant reducing their general and administrative costs, reducing exploration spending and focusing on higher-grade assets with lower operating costs.

Junior companies, in particular those at the exploration and development stage, have been further impacted. Since with the downturn in gold prices, investors have shied away from gold equities, meaning there’s been reduced availability of capital.

The silver lining is that with the majors and mid-tiers reducing their exploration spending, exploration and development companies with attractive assets are likely to become targets as larger companies work to maintain their current production levels.

RIN: We’ve been seeing some M&A recently — should investors should see that as a positive for the sector?

DM: Companies are comfortable enough with the gold price that they are selectively adding assets. The combination of friendly and hostile offers that we have seen lately suggests to us that valuations remain attractive enough for resource companies to be stepping in.

RIN: With a market saturated with gold exploration and development companies, what are some of the key characteristics that you look for when assessing companies?

There are four things that we look at when we are assessing companies:

1. Assets: We are interested in grade, size potential and also ease of development. What does the operating scenario look like, and how easy is it to bring that to fruition.
2. Location: We have seen jurisdiction becoming more important, particularly with some governments increasing mining taxes and making it more difficult for mining companies operate in those regions.
3. Management: You can have a great asset and a great location, but without the people who can help deliver on that asset’s promise, investors won’t realize their value.
4. Balance Sheet: Does the company have capital available to keep moving the project forward or do they have access to that capital? Is this an experienced group that can raise money even in this capital-constrained environment.

RIN: One of the companies you cover is Klondex Mines (TSX:KDX,OTCQX:KLNDF) . How does Klondex fit into the model that you just mentioned?

DM: Klondex is a company that checks all the boxes we just talked about. The first is exceptional grade. Fire Creek is one of the highest-grade underground gold mines in the world. Second is the location. It’s in a great location in mining-friendly Nevada. After that, we’ve got the management team. They have strong operational experience, particularly at these assets. It’s a real strength of the company.

Finally, they have the capital to deliver on the promise of Fire Creek. They were able to raise a significant amount of money over the last six to eight months to advance Fire Creek and acquire the Midas mine and mill. I think that that bodes well for them moving forward.

RIN: And they raised money in a short period, correct?

DM: They raised $19 million in October 2013, and then in early 2014 they closed on just over $100 million of debt and equity financing to fund the acquisition of Midas.

RIN: Recently Klondex released a preliminary economic assessment( PEA) for the Fire Creek project. What are the most important points that investors should note about this assessment?

DM: I think there are two things that investors should take note of. First is the elevated head grades. The mine plan forecasts a head grade of 20 grams per tonne, which should result in a low cash cost of $459 an ounce. These high grades allow for high margins and low low-capital-intensity start up and generate a significant number of ounces.

The second point is that the PEA appears to be very conservative. Based on the asset and the infrastructure that is already in place, we think that the ramp up of throughput to only 330 tonnes per day is on the conservative side. Also, the mine life of five years is likely on the short side as we believe that they are going to able to add ounces at the project. We modeled throughput of 500 tonnes per day and a mine life of over nine years.

It is still a project at a development stage taking a first conservative step and achieving those results is an important point. That conservative approach allows the company to build an operating track record.

RIN: Alongside Fire Creek, Klondex purchased the Midas mine and mill. How was this purchase a game changer for the company?

DM: Prior to acquiring the mine, Klondex was going to have to toll mill the ore from Fire Creek. This option could be very costly as terms are normally in favor of the toll miller. And the company wouldn’t have control over when the ore was processed, which could make cash flow kind of lumpy.

If Klondex had wanted to build its own mill, it would have taken several years to build and several years to permit and it would have cost substantially more than what it cost to acquire Midas. From Fire Creek’s perspective that was game changing.

The other part is that it moved the company from a late-stage development company into a producer as the Midas mine is in commercial production.

RIN: With Midas, the company will be able to self-fund exploration and development. Can you speak a little about the value of that, particularly with today’s financing environment?

DM: That’s an important point. In this environment of capital constraints and valuations on the low side, the less you have to come back to the market and dilute your shareholders the better that is.

With Klondex, the Fire Creek PEA highlighted that the company is going to generate cash flow this year. They are basically able to self-fund the development of both Fire Creek and Midas and the current exploration plans. This really sets them apart from other peers in the development stage or early stage producers that often need additional capital to get through this late stage.

RIN: In early May, Klondex started initial drifting on the Karen vein at Fire Creek. With samples from the Karen vein showing an average of 74.9 grams per tonne, what are you expecting to see from continued exploration on this area of the project?

DM: I think the Karen vein represents potentially another operating area, which is part of where our 500-tonne-per-day scenario comes from. The existing resources are on the east side of the ramp whereas the Karen vein is on the west, which should create an additional operating area and allow for increased throughput.

We expect Klondex to continue to drift along this vein as well as complete additional drilling to define its extent.

RIN: What can investors expect next from Klondex?

DM: I think the key things on the horizon are ongoing exploration results from Fire Creek and Midas. Those are the key elements to what is going on moving forward and as they look to extend the mine life of both assets.

The other part of that is that we should get updated resource estimates for both Fire Creek and Midas towards the end of the year. Finally, with the Midas operation investors are going to be interested in seeing what the costs look like and what the head grades are. So I think that as Klondex delivers those results that will help investors get more comfortable with that acquisition.

RIN: Well great, thanks for your insight. 

DM: Thank you.

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

Derek Macpherson 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. 

Derek Macpherson does not hold any stock in Klondex Mines. Klondex is an investment banking client of M Partners.