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Gold Looks Bullish in Medium to Longer Term

Nolan Watson, president & CEO, Sandstorm Gold Ltd., talked briefly about world gold mining industry, associated risk and future prospects while interviewed by Debajit Saha. Excerpts…


1) Tell us briefly how a gold streaming company operates.

Sandstorm Gold looks for companies that have advanced staged development projects and need funding to advance those projects into production. The funding is provided in the form of an upfront payment, in exchange for the right to purchase a portion of the commodity produced from the mine, at a fixed price. What the business model allows us to do is expose our investors to the typical upside that you would get in a mining investment, while mitigated a lot of the downside risks.


2) When investing in a gold mine, what risk factors does Sandstorm take into consideration?

The main risk factors that we face are the quality of the asset, the quality of the management (and of course we try to invest only in companies with good management teams and although we don’t have a perfect record with respect to that, we continue to focus on it going forward) and the overall financial health of the company. We have a multi-pronged due diligence approach that focuses on analyzing all of the technical aspects of the asset including metallurgy, mining method and processing method as well as community/sustainability issues, corporate social responsibility issues, political risk, permitting risk; so we have a comprehensive due diligence process.


We also spend a lot of time focusing on the actual financial health of the mining companies. We ask questions like, is the company over levered? How much cash do they have? How well capitalized are they? Are they able to raise more money? We try to understand those risks before investing.


3) What's your opinion broadly on how the gold mining sector will perform in the next three to five years?

There is a difference between how the actual gold mining sector will perform versus the price of gold. I think that over the next three to five years the price of gold is going to continue to be volatile and it will have periods where it goes a bit lower than $1,300 (which is where it is today) and it will spend periods of time above the current price. I think five years from now the price of gold will be reasonably higher than where it is today but that obviously depends on a number of macroeconomic factors that have not been decided yet. On the whole I would describe myself as medium to longer term bullish on the price of gold.


If you translate that into the gold mining sector itself, one of the things that you have to focus on is the grades that are being mined at each mine and understand how that affects the costs of operations. Right now one of the focuses of the gold mining sector is to mine higher grades and ignore lower grades. That has the benefit of making it look like your cost of production is lower but the actual costs of running the mine per year are the same, there are just increased ounces because of higher grades, making it appear that costs are lower. The problem is, eventually you run out of high grade material and eventually the mines either have to shut off or you have to go process the lower grades later, and costs per ounce go through the roof when you process the lower grade material.


So, right now the gold mining industry appears to be recovering and seems to be doing okay but the future doesn’t look very bright unless the gold price goes up. It is going to be very tough for companies to make money five years from now if they spend the next five years high-grading their assets. I think the price of gold will need to continue to rise to provide a reasonable risk-adjusted rate of return that incentivizes mining companies to keep investing in future mines.  


4) At a $1,200 priceof gold per ounce, how profitable is it for Sandstorm to invest in the gold mining sector?

The benefit that Sandstorm has is that the average cost of the ounces that we are buying from mines that are now up and running and in commercial production under the existing contracts that we have is only $400 per ounce. So even at $1,200 an ounce, our margin is $800 an ounce on average and so we are still highly profitable as a company and are continuing to accumulate cash to make future acquisitions.


Right now there are not a lot of mines being built because the rates of returns that the actual mining companies can get are not high enough to make sense for them to build mines. Because very few companies are building mines, there will be fewer deals that Sandstorm is doing unless the gold price either goes up enough, or the cost of capital comes down enough, such that mining companies start building more mines. Having said that, you can be assured that it is Sandstorm’s goal to invest in streams that we will get a good rate of return; otherwise we are not going to invest.


5) Gold refiners are coming to India. Can they source primary raw material from you? If yes, what is the procedure and if not, why so?

No. We buy refined gold from our partners under all of our contracts. It is their obligation to extract the ore, process that ore, and then send it to a refiner before delivering it to us. We purchase the gold after it has been refined by the refiners.



 6) At last, can you give us a broad perspective on the worldwide mining industry and how that relates to bullion?

There are two prevailing themes in the worldwide mining industry. One is costs of mining which appear to be going down, but in actuality the costs are not going down because of the grade issue that I talked about earlier. The second theme is the cost of capital issue. There has been a tremendous amount of capital that has fled from the mining industry and it has driven up the cost of capital of all of the mining companies. What that means is that company hurdle rates become higher and they become less likely to find projects that are worth investing in (that exceed the hurdle rate), so they stop building projects for the most part and they scale back expansion plans.

From a worldwide mining industry perspective, I think there will still continue to be a strong demand for metals but you are going to see that demand met by existing mines and there won’t be many expansions to their mines or new mines built. I think you are actually going to see a similar effect as it relates to bullion. The demand for bullion remains strong and it is going to continue to go up. As ETFs stop liquidating gold in North America, the demand from various parts of Asia and the Middle East and India will continue to drive the gold price higher and eventually gold mining companies will do okay. But in the mean time, the cost of capital is so high that it does not make sense to build many gold mines. It is going to be volatile next five years for the mining industry and it is going to be a challenging five years to make profits, but if gold companies do the right things they will be poised to make money once the prices return to higher levels. 

Nolan Watson is the President & CEO of Sandstorm Gold Ltd., a company he co-founded in 2008 and has since acquired a portfolio of 8 gold streams and 27 gold royalties. Prior to Sandstorm, Mr. Watson served as the CFO of Silver Wheaton Corp. where he helped develop the silver streaming business model and raise over US$1 billion in debt and equity to fund Silver Wheaton's growth. Mr. Watson has won numerous awards for his professional achievements including the Canada's Top 40 Under 40 award, CEO of the Year by Business In Vancouver and the Queen's Diamond Jubilee Medal.

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