TGR: Could you comment on Linear Gold Corp. (TSX:LRR)?

KS: Linear is an exploration company and in this cycle, few new greenfields or grassroots discoveries have been made. We had Éléonore (Virginia Mines (TSX:VGQ); Fruta Del Norte (Aurelian Resources (TSX:ARU), Penasquito (with Western Silver, which became Glamis, which became Goldcorp), Gold Eagle (which has just been bought by Goldcorp) and Ixhuatán (Linear’s discovery in Mexico).

Out of all those deposits, the only company that hasn’t been acquired yet is Linear, but Linear did a deal on that discovery with Kinross Gold Corp. (K.TO). It’s not a big discovery—only a couple million ounces—but it was one of the few new discoveries. So Linear is sitting there with about 28 million shares outstanding and about $25 million in cash and it’s basically trading at cash. They still have a residual interest in Ixhuatán. The deal is set up for Kinross to spend $15 million in exploration by next October to earn 70% in the project and pay Linear $100 million in cash.

Kinross is continuing to drill, but we won’t really know their intentions until this time next year. Linear may wind up owning it all because I don’t think Kinross would exercise their back-in option if they don’t find 3.5 million or more ounces there. And if they don’t find anything else, Linear will get it back with Kinross’s extra $15 million of exploration invested.

Ixhuatán isn’t the 4 million to 5 million ounces everybody thought when the stock went to $12, but 1.7 or 1.8 million ounces. That’s still a mineable deposit, and certainly at $1,000 gold, you can make pretty good money. It would interest a mid-tier gold producer, who for $100 million could build a mine that produces 100,000 to 150,000 ounces a year for eight to ten years. So they could generate some nice cash flow from it and bump up production.

But as I say, Linear has a lot of cash and has now gone to Brazil looking to make another discovery. As an exploration company, it’s pretty cheap—pretty much trading at cash, and there’s residual value for the Ixhuatán project. Either Linear will own a 100% of Ixhuatán or they will have a 30% free carry, and they’re spending exploration dollars in Brazil, one of the better geological areas of the world for gold endowment. It’s a good place to be looking for gold, and they’ve got the cash to do it. They don’t need to finance. But management is going to be careful with cash in a market like this—not aggressive.

So I’d say Linear is one of the better exploration plays, given where it’s trading at and what’s in its portfolio. If you buy this one, you can buy it at cash and stick it away. Linear is a cheap exploration play, and there could be significantly more value if they were to get a $100 million of cash from Kinross on a back-in—that’s almost $3.50 a share in cash incrementally.

TGR: How about First Quantum Minerals Ltd. (TSX:FM)?

KS: First Quantum is another copper stock that seems ridiculously cheap. It’s trading at about three times cash flow, which seems pretty low. And First Quantum has a good growth profile, with a number of projects in the pipeline. It holds a 65% interest in the Kolwezi copper-cobalt tailings project under development in the Congo. It’s a very simple project and will generate a great return. First Quantum also bought Scandinavian Minerals with its big Kevitsa nickel-copper-PGE project in Finland. That’s probably the next project they will bring on stream, probably three or four years out. They also own 20% of Equinox, another copper producer in Zambia. They don’t have to buy anything. In Q2, First Quantum generated $300 million in cash flow, up from $270 million in Q1. That’s $1 billion of cash flow for the year, and their current market cap is about $3 billion.

Freeport-McMoRan (NYSE:FCX) also seems ridiculously cheap to me. If I were to buy copper stock today, I wouldn’t necessarily buy Anvil or First Quantum. I would just buy Freeport.

TGR: What fundamentals would make Freeport more appealing than First Quantum or Anvil?

KS: Freeport has big mines and two big operating centers; one in the southwestern U.S. with the old Phelps-Dodge assets, and also Grasberg (Papua province, Indonesia), the world’s biggest copper and gold mine. There’s a higher level of political risk with Indonesia, but the stock was recently trading at $60; about 3.5 times cash flow. I have First Quantum trading at 3.3 and Anvil at 3.0 times cash flow. But Freeport is not trading at an expensive multiple; so that’s probably my starting point.

It’s the same with the golds, such as Agnico or Kinross or Barrick or Goldcorp—all those stocks look pretty cheap to me. That’s where you could start, and then on top of that you’d want to own some development-stage companies or near producers such as an Anvil—which is trading at a pretty modest valuation, and it’s not a big-cap company—or a Detour Gold, an Andean, an Osisko or CGA Mining or Bear Creek. All those names seem pretty cheap to me. You just have to buy them and be patient.

TGR: With prices so beaten down, is this the time for a long-term investor to be loading up?

KS: Yes, I would agree with that. If I had a longer-term horizon, more than a couple of years, I would want to own maybe a couple of the big-cap golds—Goldcorp or Kinross, for instance—and a couple of mid-tiers such as Eldorado and Red Back, and three or four of the emerging producers/development-stage companies—CGA, Detour, Osisko, Bear Creek. Because if somebody comes along and buys Detour, I can guarantee they won’t get it for $10 a share. It will be double, $20. I don’t know when that will happen, but it’s going to happen with a company like this, assuming the gold price does not collapse.

The big-cap golds cannot find enough ounces to replace their production. They’ve never done it historically, and I wouldn’t expect them to do it on a go-forward basis. Certainly a lot of these companies grow by acquisition—Barrick, Goldcorp, Eldorado.

And if you look at the value—Gold Eagle, with a $1.2 billion market cap and not even one resource ounce in the ground, got taken out at a pretty big price. Or even Aurelian, with a current market cap of $750 million. It’s a great discovery—no question. It’s in Ecuador, which isn’t as bad as people think. Another interesting one is B2Gold (TSX.V-BTO), which has a really nice exploration portfolio in Colombia and a really good VP of Exploration. At some point a discovery will come out of that.

Detour, with a market cap is $400 million, is easily worth a valuation similar to Aurelian’s, $750 million. So if you own something like a Detour with a 12 million ounce gold deposit in Canada that’s in feasibility; that deposit could be in production within three years. That’s worth looking at if you’re in the gold business. A number of companies would like to own a project like that it. It’s not a question of if it happens, but when.

I don’t know how long these things will take, but if you’re patient, I think that’s where the opportunities are.

Analyst Kerry Smith has consistently ranked among the top 15 for precious metals and diamonds research, and earned top analyst ranking for junior mining companies in the Brendan Wood International Survey in 1997. In 2001, he brought his 20-plus years of experience in the industry to Haywood Securities, joining the firm’s Toronto office as a senior mining analyst. Kerry focuses primarily on companies with production in the precious metals, base metals and diamond sectors. Kerry holds a bachelor's degree in mining engineering from the University of Alberta and a master's degree in business administration from the University of Western Ontario.

Courtesy: www.theaureport.com

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