Contributed Commentaries
Will Sandstorm’s Newest Risk Pay Off?
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
The mining sector continues to sell-off much more than the gold price as the market continues to discount the up-coming VanEck GDXJ Junior Gold Miner ETF re-balance I touched upon last week in this column. More than $800M was collectively taken out of GDX and GDXJ on April 26th, which was the largest one day out-flow in their trading history.
Nevertheless, the M&A in the space also continues to heat up with another high profile proposed merger which was announced on April 26th. Gold-copper developer/explorer Mariana Resources Ltd (MARL.V) said this past Wednesday it has reached an agreement to be acquired by mining company financier Sandstorm Gold (SSL.TO), which currently holds a 7% stake in the company.
Under the terms of the agreement, Sandstorm will acquire the remaining share capital in Mariana and merge into a new mid-tier stream and royalty company. The new firm will have a diversified portfolio of 155 streams and royalties including 20 producing, 23 development-stage, 26 advanced exploration-stage and 86 exploration-stage assets. This will include a 30% stake in the gold-copper Hot Maden project in Turkey while Mariana will hold a 19% stake in the new Sandstorm.
The Hot Maden project is a world-class asset and is globally one of the highest-grade gold-copper discoveries made in recent years. Current exploration activities have been focused on expanding the known gold-copper resource (3.43 Million oz AuEq in Indicated Category and 0.43 Million oz AuEq in Inferred Category) within a central 800m long portion of the Hot Maden Fault Zone.
A Preliminary Economic Assessment (PEA) was completed in January this year which has a post-tax IRR of 153% with an NPV US$1.37B @8% at a NSR cut off USD 100/in situ tonnes. This equates to an approximate resource cut-off grade of 3.3 g/pt AuEq.
According to its most recent corporate presentation, the high-grade, multi-million-ounce gold equivalent Hot Maden development project is expected to produce 250,000 ounces per year, with approximately $8 million in annual royalty revenue to Sandstorm.
The only problem with this asset, as I see it, is the location of the deposit. I believe Turkey may be slipping dangerously towards a dictatorship after a very close referendum vote earlier this month, which essentially handed President Recep Tayyip Erdogan the reins of supreme power.
Moreover, the integrity of the vote was seriously questioned and the slim margin of victory with just 51.4% approving a series of constitutional changes has converted Turkey’s political system from a parliamentary to a presidential one. This means there is most likely going to be tension in Turkey going forward as there will be no real checks and balances in place, which leads me to believe Turkey could now be one step closer to civil war.
Just last year there was an attempted military coup in Turkey to overthrow its president and government. The coup plotters issued a statement through the military saying they wanted to take control “to reinstall constitutional order, democracy, human rights and freedoms, (and) to ensure that the rule of law once again reigns in the country." The coup attempt was quickly put down, but I would not rule out more hostilities taking place in the very near future with President Erdogan now having much more power.
Furthermore, the country has been targeted by terrorist groups who have staged several recent attacks damaging the country’s tourism sector. I witnessed first-hand an unfortunate tragedy in Turkey which took place in June of last year. My wife and I had the misfortune of being in the wrong place at the wrong time while traveling in Europe last summer. We had a connecting flight lay-over in Istanbul’s Ataturk airport in June 2016 just before a terrorist attack had begun, turning our 2-hour lay-over into a 12-hour nightmare.
The on-going political situation in Turkey, combined with the growing amount of terrorist attacks in the country, is most likely the reason Sandstorm was able to do this deal so cheaply. If the Hot Maden deposit were located just 250km to the east in Armenia, the market would have most likely bid Mariana’s share price much higher before this deal was made.
Sandstorm CEO Nolan Watson has a penchant for investing in under-valued risky assets in the past. In September 2012, the company made an ill-fated C$60M investment in Colossus Minerals Serra Pelada Project. The gold deposits at Serra Pelada have a very storied past and were discovered by workers on a nearby farm in late 1979. Geological surveys showed there could still be 20 to 50 tons of gold in these deposits as the original mine is believed to have contained 360 tons.
After the initial gold discovery, it soon became the largest open-air pit in the world, with roughly 100,000 artisanal miners (garimpeiros) who migrated from across the entirety of Brazil working there at its peak. Most were armed, while murder, prostitution, gambling and drugs were routine. The scene was immortalized by photographer Sebastião Salgado, who captured the garimpeiros swarming like ants in the vast open-air pit and clashing with federal police brought in to keep order. At the height of the boom, battles over discoveries of gold were commonplace with 60 to 80 murders recorded on average every month. Salgado was quoted as saying when he saw the mine, “Every hair on my body stood on edge. The Pyramids, the history of mankind unfolded. I had traveled to the dawn of time”.
After announcing plans to re-open the Serra Pelada mine, Colossus Minerals, who had gained a 51% stake in the mine in July of 2007, had spent $300 million over eight years. However, progress was slow with the firm having trouble keeping water out of the shaft and by December 2013, Colossus said it had run out of money and needed another $70 million to be able to start extracting gold. With the price of gold unstable and the project mired in complex litigation, the additional investors could not be found.
In January 2014, Colossus filed a notice of intention under Canada’s Bankruptcy and Insolvency Act and was taken over by its creditors in April of that year. Records from the Office of the Superintendent of Bankruptcy in Canada show the firm ended up with liabilities of just over $125 million and assets of only $390,000.
Around the same time of this investment, the company also made the first of a series of deals on another soon to be troubled Brazilian deposit with Luna Gold and it’s Aurizona Gold Project. Unfortunately, the gold price began to tumble below $1500 per ounce soon after an initial C$10M investment on the project was made. However, Sandstorm then decided to up the ante on the Luna Gold investment by taking a 19.8% stake in the company for C$30M in May of 2015 as Luna had suspended mining operations at Aurizona until at least 2017.
Sandstorm CEO Nolan Watson was quoted as saying at the time: “The Placement is necessary due to a combination of lower than estimated cash flow and cost overruns at Aurizona, also requiring Luna to delay the completion of the Phase One Expansion at the mine.”
After having already invested C$40M into the company and with nearly 20% ownership, on Feb. 1st of 2017, Sandstorm announced that Luna Gold Corp. and JDL Gold Corp. entered into an arrangement agreement to combine their businesses, creating a multi-asset mining company.
That company is now Trek Mining (TREK.V) and Sandstorm continues to hold the US$30 million convertible debt facility that is due from Luna. Sandstorm also holds a 3% to 5% sliding scale net smelter returns (NSR) royalty on Aurizona and at gold prices less than or equal to $1,500 per ounce, the royalty is a 3% NSR.
However, the market has not been kind to this merger as the first pour at the now flagship Trek Mining project Aurizona has been pushed back to Q4 of 2018. The Trek share price has sold off over 35% since the deal was announced on February 1st of this year, while the Sandstorm share price had been trading sideways up until the just announced all-paper Mariana deal. This tells me the market still views the Aurizona mine as a high-risk project.
Although I am not a shareholder in Sandstorm, as a gold mining sector investor, I am hopeful CEO Nolan Watson’s strategy of continuing to invest in under-valued, riskier assets will eventually pay off. I did not agree with this strategy during the bear market, as it was my belief at the time there were higher quality, less questionable assets also on sale which the company could have invested in. However, if we are indeed in the first stage of a long-term bull market, then Sandstorm shareholders could very well be handsomely rewarded if/when the gold price reaches a solid $1500 floor by 2018.
