Canadian Mining Stocks

By Ian Wyatt, Big Idea Investor | Jun 12, 2007 | comment

Canada Connection: Mining Stocks

by Peter Morton, SmallCapInvestor.com

For most American small-cap investors, the Canadian market usually translates into just one thing - mining stocks.

A resource-rich country, Canada has long been known both in the United States and globally as the source not only for commodities but for the expertise needed to develop those resources.

Not surprisingly then, the recent run-up in commodity prices - driven by tight inventories and a huge demand in Asia - has led to a banner year for Canadian small-cap mining companies.

In its inaugural report, the accounting giant PricewaterhouseCoopers (PwC) said that the market capitalization of Canadian small cap mining stocks grew by 86% last year because of soaring metal prices.

The new report said that total market capitalization of mining companies listed on the TSX Venture Exchange (TSX-V) almost doubled in 2006 to C$27.6-billion, from C$14.8-billion in 2005.

So-called junior mining companies on the exchange had a "tremendous year," said PwC. A junior mining company is generally defined as one that has yet to produce a cash flow from a mine. Its officers or principals are paid through shares, and initial exploration expenses range up to C$1 million. Investors showed their confidence in the stocks of Canadian junior mining companies, and strong metal prices continued to boost the value of the companies themselves.

Is it too late to jump on the bandwagon? As long as demand for commodities continues to grow, analysts say small-cap mining companies will continue to provide opportunities for investors, despite the recent run-up in stock prices and capitalizations.

"The commodity bull is intact," declares Charles Oliver, senior vice-president and portfolio manager at Toronto-based AGF Funds Inc.

One way to shop for a mining investment is to choose a company before it drills the "discovery hole" that leads to what it - and you - hope will be a significant "find." Risky, to be sure. Another tactic is to identify a company that is bringing on a larger management team to develop an actual find.

The PwC survey looked at financial pictures of the top 100 of the 967 junior mining companies on the TSX-V based on market capitalization as of Sep. 30, 2006.

According to Paul Murphy, a PwC partner and the accounting firm's Canadian Mining Practice Leader, "gold was a key reason for the growth on the TSX-V in 2006. Four of the five largest mining companies on the exchange list gold as their commodity of focus."

The survey found that one of the most impressive numbers of 2006 was the C$1.2 billion that exploration companies were able to raise through issuing shares, a 206% increase from 2005.

"The TSX-V is a good home for Canada's junior mining companies who can then graduate to the larger TSX when they become bigger scale producers," he said.

The single greatest investment by TSX-V mining companies in 2006 was the C$409.4 million they put toward mineral properties and exploration - 79% more than in 2005. More money was also spent on property, plant and equipment in 2006, for a total of C$103.9 million, more than double from the year before. "These are the kind of investments that are expected of junior mining companies and could pay high returns to shareholders if new properties are both discovered and developed to their potential," Murphy said.

Last year, all Canadian junior mining companies had C$4 billion in total assets, C$2.6 billion more than in 2005.

The report, called "Mine ? let the good times roll" also looked at how continually strengthening commodity prices have placed the sector in a prolonged boom period. The 40 mining companies included in the report represent over 80% of the total global industry by market capitalization.

It also found that investor confidence in the worldwide mining industry and its prospects has continued to strengthen ? much like it has for junior mining companies on the TSX-V.

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Northern Orion Resources

by Tony Martin, SmallCapInvestor.com

Usually investing in mining companies means having to choose between a junior company that is working to get a mine up and running, and a more stable, mature miner that is already in production.

With the former, you get more risk, at least until the final permit is received, the mining plan finalized, equipment in place, and ore being processed. Of course, that can often mean greater leverage to metal prices. With the latter, you know what you're getting in terms of output from the mine, but that typically limits any blue-sky financial upside for investors.

But then there's Northern Orion Resources Inc. (TSX: NNO, AMEX: NTO), which allows you to put money into both types of play with one stock. The Vancouver-based miner has a minority position in a major gold and copper mine in Argentina that, after a decade of production, is only half-way through its estimated lifespan. And investors also get exposure to the nearby?and soon-to-be-developed?Agua Rica project, which contains copper, gold, and molybdenum.

The stock is now recovering from giving up some 12% in early May due to earnings for the first quarter in 2007 coming in under estimates. But given that the cause was due to temporary setbacks - lower-than-expected recovery, shipment delays, and a higher-than-expected royalty payment - the stock at a recent price of C$5.67 looks attractive, especially once you factor in that the miner is a possible take-over target.

 Here's a snapshot of Northern Orion's two key projects:

Alumbrera

Northern Orion has a 12.5% ownership position in the Alumbrera project, with Goldcorp Inc. (NYSE: GG) having a 37.5% position, and Xstrata PLC (LON: XTA) the remaining 50%. Located some 700 miles northwest of Buenos Aires, Alumbrera is a massive mine. The project covers almost 13,000 acres, directly employs about 1,800 workers, and is served by all-weather roads and air transport. One of the lowest-cost copper and gold producers in the world, Northern Orion's share of production is some 50-million pounds of copper and 75,000 ounces of goal a year. The mine has been in production since 1997, and its mine life extends to 2016, promising healthy cash flow for another decade.

Agua Rica

The Agua Rica deposit is located just 20 miles east of Alumbrera. The deposit has a drill-defined inventory of 21.8 billion pounds of copper, 13.3 million ounces of gold, and 1.7 billion pounds of molybdenum. The mine is expected to be in production by late 2010 or early 2011. Forecasts put annual production at an average of 150,000 tonnes of copper, 125,000 ounces of gold, and 16 million pounds of molybdenum, with an estimated mine life of 23 years. Future sales are completely unhedged, meaning maximum leverage to the price of copper, gold, and molybdenum.

In addition, there are several other factors that support the notion that Northern Orion is headed higher.

1) Positive trends for both copper and gold prices. In particular, copper prices have more than tripled since early 2003, to around $3.30 a pound. And while the U.S. construction industry?which accounts for almost half of all U.S. copper consumption?is slowing, copper is likely to be a hot commodity in much of the rest of the world. Japan's economy is recovering and the auto industry?a major user of copper?is improving. India has strong demand for wire rod. And in China, investment in infrastructure means intensive use of wire and cables, and the auto sector (which is growing at 25% a year) has a big and growing appetite for auto wire.

Over the same period, gold has jumped from under US$345/oz. to over $650 currently, after hitting a ten-year high of US$725.75 in early May 2006. Gold is often talked about in the press as a safe harbor in troubled times, but what's at work here appears to be something much more fundamental. New deposits coming on-stream are fewer and farther between, while demand from new areas - including China's and India's rapidly growing middle classes - continues to increase.

2) Mining the "metal of the day." The share price will likely also get some support from the anticipated production of Molybdenum at Alumbrera.  As one analyst puts it, there is an "?ongoing strong investment appetite for molybdenum exposure."

3) Ongoing wave of consolidation. Given its size and proximity to Alumbrera, many see Agua Rica as strategic. In a recent note, BMO Capital Markets analyst Nawojka Wachowiak wrote, "We continue to believe that the most economic development scenario is the development of the project using the existing infrastructure at Alumbrera."

The company recently announced earnings for the first quarter of 2007 of US$0.06, when analysts were expecting around US$0.08. Lower copper recovery played a role, according to Salman Partners, as did a higher-than-anticipated royalty payment.

Looking ahead, Raymond James recently reiterated its C$6.50 target. Tom Meyer, mining analyst with the brokerage house, points out that the shares are undervalued when compared to Ivanhoe Mines Ltd. (NYSE: IVN). On a price to net-asset-value (NAV) basis, Ivanhoe trades at 1.10X, while Northern Orion trades at just 0.75. Salman Brothers has a target price of C$6.00, and BMO Capital Markets US$4.25.

And those targets will likely prove quite conservative should Agua Rica go into play. This looks all the more likely given the possibility for infrastructure being shared with Alumbrera. While it's never wise to invest solely in the hope of a take-over, analyst Tom Meyer of Raymond James wrote recently that "?we believe C$6.50 would be a fair 'starting point' under an acquisition scenario? ."

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