TGR: That is going to place greater importance on exploration.
AK: Exploration is an important aspect of regeneration in mining. Consolidation is really a short-term way for these companies to get out of their current predicament. If we take a longer-term view, exploration has been key to companies reinvigorating existing mines by expanding reserve bases over time. We're not seeing exploration at the level we think it needs to be to replenish reserves in today's market. That's why we think consolidation in the short term has the potential to take hold. And that's constructive from an investor standpoint.
This sector needs to go through a consolidation to create stronger mining companies—and consolidation allows companies to grow their reserve bases and operational flexibility. Then we can look toward a future where investors will want to begin investing in exploration companies again for the prospect that they might make impactful discoveries.
TGR: What is consolidation going to look like in 2015?
AK: Consolidation makes for an interesting discussion. For example, David Haughton, our senior precious metals analyst, says that many of the senior producers he covers are not in a position to acquire and that only a handful have a mandate for acquisition. Our view is that we're not really going to see the large mining companies participate in a round of acquisition. Mergers and acquisitions will mostly be the domain of the small to intermediate gold and silver producers.
TGR: Will consolidation come in the form of cash-and-share deals?
AK: Cash is scarce in this sector. If a company is going to make an acquisition, it is going to make an acquisition primarily with shares. One of the biggest questions for junior companies right now is cash. There is an ongoing debate among exploration company management teams: Are shareholders better off in a larger entity that has the means to develop its assets or are shareholders better off sticking it out in the current environment and hoping for better days?
TGR: In other interviews you have suggested that investors should stick to outliers in the gold space. Please describe an Andrew Kaip outlier.
AK: Outliers are those companies that we believe are well run. They have quality assets that can generate cash at current metal prices or lower. They have management teams that are well regarded, are technically strong and make decisions in the best interest of shareholders. Often those management teams are significant investors in their companies, too. That's the combination we're moving toward.
TGR: What are some examples?
AK: We view Franco-Nevada Corp., a royalty company, as an outlier. In the silver sector, we look toward Tahoe Resources Inc. as an outlier given its strong management team, high-quality assets and significant management ownership of the company. These are the leaders of our industry.
TGR: Franco Chairman Pierre Lassonde says his company is very much undervalued. Is he correct?
AK: David Haughton, our senior analyst who covers Franco-Nevada and who has covered royalty companies for a long time, noted recently that over the last couple of years valuations of royalty companies have come down significantly relative to those of precious metals producers. In that context, Pierre is absolutely correct.
TGR: Tahoe was among three "flight to quality" recommendations in a recent BMO report on the silver sector. The other two names were Fresnillo Plc and Silver Wheaton Corp. Why did Tahoe make your short list?
AK: Tahoe made the short list because it has asset quality that's comparable to Fresnillo, a London-listed silver company with operations in Mexico. Fresnillo is a high-quality operating company with first-quartile cash operating cost mines that are run with a conservative approach toward execution—good execution. Tahoe doesn't have the depth of assets that Fresnillo has, but it certainly has a primary asset that will be the company cornerstone for many years to come.
I put Silver Wheaton in that group because Silver Wheaton is a precious metals streaming company, a naturally defensive name. Any royalty company carries some operational risk from the standpoint of production from its underlying streams or royalties, but royalty companies don't deal with the capital or operating cost escalations that mining companies incur. All three companies, in the context of value relative to their peers, are more attractively priced.