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 Fri Sep 6, 2013
Spec Value Hunter Comment: Recommendation Strategy for Midas Gold Corp
    Publisher: Kaiser Research Online
    Author: Copyright 2013 John A. Kaiser

 
Midas Gold Corp (MAX-T: $0.95)
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Spec Value Hunter Comment - September 6, 2013: Recommendation Strategy for Midas Gold Corp

Midas Gold Corp is recommended a Good Absolute Spec Value Buy at $0.96 with a $2 price target by mid 2014 premised on 1) completion of a prefeasibility study (PFS) on the Golden Meadows project in Idaho whose cost and recovery assumptions do not change much negatively from those in the Preliminary Economic Assessment (PEA) published in September 2012, and, 2) a gold price scenario where gold remains bound in a $1,300-$1,500 range during this period. The $2 target reflects a time discount for the 3-5 years expected to get Golden Meadows permitted, a process that will not begin until completion of a positive PFS expected in H1 of 2014. A discounted cash flow analysis which relies on the PEA base case assumptions shows that Golden Meadows would have an after-tax net present value of $684 million at 10% or $1.1 billion at 5% and a 27.4% internal rate of return at a $1,367 per oz gold price. Based on 141.3 million shares fully diluted and a 100% net interest these valuations translate into NPV per share targets of $4.84 at a 10% discount rate and $8.10 at 5%.

While the primary rationale for this recommendation is to capture the value created by de-risking this project at the current gold price in a context where the market is biased to expect lower rather than higher gold prices, a secondary rationale is to place an indirect bet on higher real gold prices whereby during the next 12 months gold re-establishes a base in the $1,500-$1,700 range that forces a perceptual switch back to the view that within the next five years when Golden Meadows might be expected to achieve production gold will be trading above $2,000 per oz in real terms. At $1,800 gold our DCF model, which seeks to emulate the complex ore scheduling of the PEA mining plan, generates an NPV range of $8.95-$13.83 per share; should gold return to $1,800 by the time the PFS is published in 2014 we would expect Midas Gold to be back in the $4-$5 range where it was priced before the PEA was published and while the market was still inclined to believe $2,000 plus gold was likelier than a return to $1,000. My after-tax sensitivity chart also shows what happens to the NPV should gold reach a fantasy target of $2,500 per oz.

A tertiary rationale for liking Midas Gold reflects our fondness for long term geopolitical speculation and the security of supply opportunities certain outcomes entail. Golden Meadows will have an antimony by-product credit that is too small to affect global pricing of antimony supply, but large enough to create a strategic interest on the part of the United States to see Golden Meadows go into production. Midas Gold's CEO Stephen Quin cautiously warns permitting will take 3-5 years in a state that is not hostile to mine development, but does have its share of individuals very opposed to mining in their own backyard. However, Golden Meadows is a brownfields mining district deliberately carved out from surrounding parks and wilderness areas because the Stibnite Mining District served America's war metal needs during World War II at a time when not only zero environmental standards existed, but strategic priorities trumped all other considerations with the result that the Golden Meadows property is an environmental mess taxpayers would rather see remediated through private sector gold cash flow than their tax dollars. Not only is Midas Gold's mine development plan going to clean up the predecessors' mess, but it will re-open the fertile Thunder Mountain drainage system beyond the property boundaries to fish migrations that have been cut off by the mining legacy.

Our recommendation is not an "out on a limb" act of original thought; during the past three months two highly respected entities have provided funding to Midas Gold that would have been based on vastly more detailed and knowledge driven due diligence than we could ever hope to muster. On May 7, 2013 Pierre Lassonde's Franco-Nevada purchased a 1.7% NSR royalty on the gold stream for $15 million. This deal raised eyebrows because Franco-Nevada apparently does not like to bet on royalty streams where feasibility demonstration has not yet achieved the 20%-25% uncertainty level of a PFS (the uncertainty margin of a PEA is 30%-35%). On July 2, 2013 Midas Gold raised $9.8 million from Teck Resources Ltd through a private placement of 12,740,000 shares at $0.77 which gave Teck a 9.9% equity stake it has the right to maintain by participating in any future dilution. Franco-Nevada's royalty purchase would generate $116 million over the life of the mine at the $1,400 base case gold price, which has a present value of $35 million at 10% assuming production startup five years from now (the discount rate implied by the $15 million payment is 19%). Teck's entry price could be construed as just a bottom-fishing bet, but Teck also has an eye for establishing strategic equity footholds in juniors. Normally Teck likes to combine such investments with punitive option deals whereby the junior is obligated to spend the equity money on a project which Teck can option on pre-determined terms if the results meet its criteria. If they don't, the junior is stuck finding a new home for Teck's paper before it can get a new speculation cycle underway. Midas Gold did not fit the definition of a weak junior, and Teck normally does not place visible bets on pure promotion related stock gains. What Teck appreciates, and most likely also Franco-Nevada, which may be why Midas insisted on the right to buy back one third of the 1.7% NSR for $9 million, is that the Golden Meadows project is a very large gold system whose tectonically scrambled architecture is not yet fully understood and which has numerous untested targets not just laterally but also at depth. This is the sort of project which lends itself very well to minesite exploration with terrific opportunity to discover new zones that, while likely requiring underground mining, could eclipse the near surface zones that are the focus of Midas Gold's PFS. This makes it an ideal target for a major producer such as Teck because a buyout would likely get it much more than for which it has to pay up; I see Teck's equity investment as a well-thought out strategy to acquire a ringside seat and a leg up on the competition when it comes time for a bidding war that establishes who will own and operate Golden Meadows. Although most of the drilling currently underway is of an infill and geotechnical nature, Midas does have an exploratory drilling program underway on untested targets such as in the Scout area. While I am not counting on it, Golden Meadows has potential to surprise us with fresh discovery news.

CEO Stephen Quin has a proven track record putting deposits into production, and his company with over $25 million working capital is sufficiently bankrolled to deliver the PFS by mid 2014. While the market may have concerns about the mine permitting timeline in the United States, I believe we are at a turning point where the mining industry has adapted to the new environmental standards that are just starting to be thought about in many third world jurisdictions, and while there are still citadels of opposition in "wetlands" states such as South Carolina, and Idaho has its share of NIMBY residents, the security of supply aspect created by the antimony by-product will help Golden Meadows become a case study in the emerging "Back to America" self-sufficiency dream that the shale oil-gas revolution has spawned.

Although I regard Midas Gold as a buy and hold recommendation, with reconsideration to be done when it hits the $2 price target, it also lends itself well to short term trading strategies. Midas Gold, which has been public for just over two years, traded at a peak of $4.90 on January 16, 2012 and a low of $0.66 on May 17, 2013. It tracked the rebound of gold after its price touched below $1,200 on June 28, peaking at $1.28 on August 26, 2013, from which it is currently retreating in conjunction with the recent gold rally reversal. Midas Gold is market sensitive to gold price volatility in the $1,200-$1,500 range because its relatively high 1.72 g/t average gold grade and significant antimony by-product credit result in a net all-in cost of only $600 per oz before taxes and royalties calculated on the basis of life-of-mine gold production of 4,982,500 ounces. This allows Golden Meadows to be profitable in this range but with significant variation in tandem with gold price fluctuations. For example, the NPV hits zero at $858 gold using a 10% discount rate and $763 at 5%. At $1,000 gold, namely the target set by the banking establishment that orchestrated the bear raid on gold, the IRR drops to 15.7% and the 5%-10% NPV range is $1.36-$3.25 per share. At $1,000 gold one could expect Midas Gold to end up in the $0.50-$0.75 range, which represents the non-catastrophic downside for my Spec Value Hunter Buy recommendation. (Catastrophic downside resides mainly in the permitting department such as unexpected legislation which prevents Midas Gold from developing the optimal mining plan.)

Midas Gold's plunge below $0.70 earlier this year reflected partly redemption run inspired selling by hedge funds and the market's inclination to believe bank targets for gold backed by a massive anti-gold mainstream media campaign. Midas Gold's stock price will follow the gold price's wobbles, but Spec Value Hunters not interested in trading should ignore these fluctuations, provided they subscribe to the view that in 3-5 years a higher real price for gold will prevail, possibly at the $1,800 level we dub as our optimistic price. I regard it as optimistic because I believe higher real gold prices, namely higher prices that are not just adjusting for inflation that also drives up costs and does little for the profitability of a gold mine, will track the rise of prosperity on a global basis, which assumes that a reviving US economy will allow developing economies to grow at faster rates which collectively diminishes the relative size of the US economy in global GDP terms (see the KRO Gold Resource Center for a detailed description of the Prosperity Argument for Gold). At $1,800 gold the DCF model generates an NPV range of $8.95-$13.83 per share; should gold return to $1,800 by the time the PFS is published in 2014 we would expect Midas Gold to be back in the $4-$5 range where it was priced before the PEA was published and while the market was still inclined to believe $2,000 plus gold was likelier than a return to $1,000.

Midas Gold proposes to put three deposits (Yellow Pine, Hangar Flats and West End) at its Golden Meadows project with an indicated and inferred resource of 101.3 million tonnes grading 1.72 g/t gold and 1.6 g/t silver into production as a 20,000 tpd open pit mine with a flowsheet involving milling, flotation, pressure oxidation (POx) of the sulphides (the PFS will explore bio-oxidation (BiOx) as a cheaper, more flexible alternative), and cyanidation to produce over a 15 year mine life 4,892,500 ounces gold and 680,000 oz silver. The capital cost is projected at $879 million and sustaining cost at $303 million with average operating cost of $29 per tonne. The LOM waste stripping ratio is estimated at 3.7:1. The deposits are related to an intrusion which generated a hydrothermal system that allowed mineralization to form within the intrusive rocks (Hangar Flats and Yellow Pine) as well as in the country rock metasediments near the contact. The map above shows the spatial location of the known deposits and exploration targets while the map below is an idealized geological model depicting the various deposit and target styles on the property.

Hangar Flats and Yellow Pine also contain antimony zones which at a 0.1% cutoff represent 17.4 million tonnes of 0.45% antimony that will be processed through a separate flotation circuit to produce a concentrate with 65% payable antimony. The mine model will produce 139 million lbs of antimony, mostly during the first 8 years, with the rest during the final 3 years. The LOM payable antimony (65%) would have a value of $544 million at the base case price of $6/lb antimony (current spot price is $4.58/lb). Most likely the concentrate will have to be shipped to Asia for processing, hence the low payable. However, given the potential strategic importance of antimony supply for the North American market, the PFS will investigate domestic onsite or offsite processing of the antimony concentrate. Although the antimony output is only 8% of the $7 billion worth of gold Golden Meadows would produce at the PEA base case price of $1,400 per oz, its presence as a by-product is important from a security of supply perspective. As the chart below shows, China's share of global antimony supply has grown from 16% in 1980 to 83% in 2012. Antimony is a minor metal that stayed off everybody's radar because its primary use is as a flame retardant and the value of annual global production was stable at about $200 million until 2003 when the China driven super-cycle drove up demand and prices so that the 2012 output was worth about $2.3 billion. Antimony prices peaked at $7.69/lb in April 2011 but have since retreated in the face of a global economic slowdown and a supply surge from small high grading operations in China. The Chinese supply structure is poorly understood because, as in the case of tungsten and heavy rare earths in whose supply China also overwhelmingly dominates, much of the supply comes from small scale, often illegal and polluting mines. The sustainability of Chinese antimony supply at prevailing prices could be jeopardized by three factors: 1) rapid depletion of the low hanging fruit, 2) a regulatory crackdown on illegal or polluting antimony mines, and, 3) the shutdown of very polluting smelters and refiners which process the concentrates.

Antimony is generally thought of as a boring metal, with its flame retardant usage demand linked to global GDP growth, but this metal is the subject of innovative materials science research that could explode demand. An example would be Donald Sadoway's Magnesium-Antimony Liquid Battery, a molten salt battery aimed at large scale grid energy storage that is particularly relevant to solving the renewable energy sector's intermittency problem. Until a commercialization breakthrough is achieved such innovation based antimony demand drivers are just a possibility, but such possibilities coupled by a shortage of antimony supply for its more mundane usage have prompted the US Department of Defense to rank antimony after tin as a stockpiling priority. The LOM antimony supply of 63,000 tonnes from Golden Meadows spread mainly over the first 8 years is only 4% of annual global supply, so Midas Gold is unlikely to make much of a difference. However, given that the Golden Meadows property supplied two-thirds of America's tungsten and antimony needs during World War II, which left the site an environmental mess that the Golden Meadows mine development plan would fix, the antimony by-product will likely prove very helpful in getting a mining permit in a state perceived as hostile to mine development. When you consider the geographical distribution of the world's antimony reserves as estimated by the USGS, namely in major competitors to the United States such as China and Russia, with the rest in unfriendly or destabilizing regions such as Bolivia and South Africa, it is not hard to imagine that Stephen Quin gets Golden Meadows permitted in 3 rather than 5 years.

In conclusion, I rank Midas Gold Corp at the top of the group of Canadian listed resource juniors which are not yet producers, are conducting feasibility demonstration work, and have a net interest in a primary gold project that exceeds 3 million ounces, namely the KRO 2013 Major Non-Producer Gold Index which currently has 46 members. For details about the Golden Meadows project see the Economic Study Section of the KRO Midas Gold Corp Profile where the after-tax sensitivity and IPV graphs below based on a simplified LOM average based DCF model get updated on a daily basis. What the IPV chart below tells us is that in the context of the rational speculation model the $134 million value implied for Golden Meadows based on 141.3 million fully diluted, 100% net interest and a $0.95 stock price represents poor speculative value for the $219 million NPV (10% discount rate) based on a pessimistic $1,000 per oz gold price, and good speculative value for the $873 million NPV that would be the outcome at the $1,387 per oz spot price as of September 6, 2013. According to the rational speculation model a project would represent fair speculative value if it was priced at 25%-50% of the most likely valuation when the project goes into production. Thus if all our DCF model parameters hold, at $1,000 gold where the 10% NPV is $219 million the stock represents fair value in the price range of $0.39-$0.78. At the $873 million NPV that the $1,388 spot price would generate the fair value range is $1.54-$3.08. This assumes that no further equity dilution is required, as would be the assumption in the event of a takeover bid by a producer with ample capital to develop the mine. Should gold overnight open at $1,800 per oz and all reasons to fear a return to lower prices had vanished, the NPV would be $1.57 billion, the fair value range would be $2.78-$5.56. Should the project proceed to the feasibility and permitting stage, the uncertainty discount from the NPV would be 50%-75%. If Midas Gold's PFS is positive with little change in the cost/recovery assumptions and the project proceeds to permitting, and gold is still at the current level, the fair value range for the $873 million NPV would be $3-$6. I have set $2 as a price target to reflect the fact that at this stage we do not know if would take 3 or 5 years to get the project permitted, though by then we should have a better idea about governmental support for the project.


 
 

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