Gold and Silver miners (Jr and Exploration)

[Edge83]

Pretium Resources: The GDXJ Portfolio Rebalancing + Fear Of The Nugget Effect = A Buying Opportunity

Jun. 12, 2017 9:28 PM ET|9 comments| About: Pretium Resources Inc (PVG), Includes: GDXJ
Peter Arendas

Summary

Pretium Resources is down by more than 20% since early February.

The Brucejack mine commissioning is underway.

If the commissioning goes well and the resource model holds, Pretium has a more than 100% upside potential at the current gold price.

If there are no negative surprises, Pretium's share price should reach $15 by the end of 2017 and attack the $20 level by the end of 2018.

Back in early February, when I wrote my last article about Pretium Resources (NYSE:PVG), I concluded that the re-rating of Pretium from a developer to a producer is almost complete and the further share price growth potential will be driven mainly by the gold price. But the situation has changed. While the gold price has increased by $50, Pretium's share price declined by $2.68 or by 22%. Pretium declined along with its peers as the VanEck Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) portfolio rebalancing weighs on the whole segment of junior gold miners. The rebalancing should be over soon and another event will start to set the tone. The commissioning of the Brucejack mine has started and the first production results will be known in the coming months. If everything goes well, the share price will grow by several tens of percent relatively quickly.

Valley of the Kings deposit and the Nugget Effect

Back in November 2013, Strathcona Mineral Services that was involved in Pretium's bulk sample program resigned from the project. The problem was that Strathcona believed that the right way to evaluate the bulk sample was to take a small amount of material and to analyse it. On the other hand, Pretium as well as another consultant, Snowden Mining Industry Consultants, believed that the best option was to process the whole 10,000 tonnes bulk sample and to evaluate how much gold was produced. This situation unnerved Pretium's investors and Pretium's share price tanked.

In my opinion, Pretium's methodology was right. This opinion was confirmed also by Orion Mine Finance Group, Blackstone Tactical Opportunities or Zijin Mining (OTCPK:ZIJMF) which helped to finance the Brucejack mine construction. Given the very essence of the nugget effect, evaluating the whole bulk sample (as proposed by Pretium and Snowden) seems to be much more logical compared to processing only a small part of it (as proposed by Strathcona).

The nugget effect means that the gold is distributed very unevenly in the deposit. It means that there are some relatively small areas of mineralisation with extremely high gold grades and the space between these high-grade areas is filled by material with mediocre or low gold grades. As a result, it is very difficult to make a relatively accurate resource estimate. Before continuing, I would like to say that I'm not a geologist and I use only a very simplified example, as I don't intend to describe here a precise methodology of resource estimations.

The resource estimates are based on drill results. The gold content of the mineralisation between two drill holes is calculated using the grades in the two drill holes. In a common type of deposit, the gold is distributed relatively evenly. Simply said, if one drill hole intersects mineralisation of 1 g/t gold and another drill hole intersects 0.95 g/t gold 20 meters away, the resource estimate assumes that the first 10 meters of the interval between the two drill holes contain 1 g/t gold and the other 10 meters contain 0.95 g/t gold.

Let's say that a gold explorer identified an area of mineralisation with dimensions of 5x5x60 meters. Three drill holes, with spacing of 20 meters, were drilled. Drill hole A intersected 5 meters grading 1 g/t gold, drill hole B intersected 5 meters grading 1.2 g/t gold and drill hole C intersected 5 meters grading 0.9 g/t gold. Using rock density of 3 tonnes/m3, the resulting resource estimate for this area will equal 149.52 toz gold ((5x5x20x3x1.0 + 5x5x20x3x1.2 + 5x5x20x3x0.9)/31.1). As the mineralisation is consistent and the grades are similar, this estimate should match the reality quite well.


Now, let's assume that drill hole B intersected a small high-grade vein that boosts the grade significantly to 5 meters grading 980 g/t gold. Due to this small high-grade vein, the model wrongly assumes that the whole middle section contains mineralisation of 980 g/t gold. As a result, the resource estimate would lead to 47,358.5 toz gold ((5x5x20x3x1.0 + 5x5x20x3x980 + 5x5x20x3x0.9)/31.1).

This problem can be solved only by setting an upper limit for the gold grades taken into the calculations, drilling much higher number of drill holes with much closer spacing and by testing much bigger samples than only the small drill cores. And this is exactly what Pretium did. And it did it pretty successfully.

Pretium drilled a lot of drill holes in order to come to a more reliable resource model. What is more important, the bulk sample program was a huge success. Pretium was able to produce 5,865 toz gold, which is 47% more than the projected volume of 4,000 toz gold. It means that the resource model not only seems to be working, it even seems to be conservative. It is hard to expect that the overall production will be 47% higher compared to the projections of the feasibility study. But given the extent of the Brucejack mine project, if the deposit turns out to have only 10% higher gold grade than expected, the annual production should be higher by approximately 50,000 toz gold that is almost costless (given that there are no additional mining costs and only limited processing costs attributed to them). At the current gold price, it means an additional profit of more than $50 million.

The valuation of Pretium Resources

Pretium Resources has a market capitalisation of $1.65 billion right now. The Brucejack mine is expected to produce 504,000 toz gold per year, at an AISC of $445/toz, over the first 8 years of production. At the current gold price of $1,270/toz, the after-tax NPV (5%) is approximately $2 billion.

If the current gold price of $1,270/toz prevails, Pretium should generate revenues of $640 million during the first year of full production (hopefully 2018). To make the estimate more conservative, let's assume that the AISC will be $500/toz instead of $445/toz. The interest payments should be around $30 million and the gold and silver stream deliveries are going to start only in 2020. As the company should be able to optimize its tax obligations notably over the first years of production, it is possible to expect earnings of more than $300 million and EPS of more than $1.6. Using a conservative P/E value of 10, a share price of $16 should be expected. Even assuming that Pretium won't be able to decrease its tax base, the earnings should be over $250 million, using the British Columbia 26% tax rate. In this case, the EPS should climb approximately to $1.4, which leads to a price target of $14.

However, given the safe jurisdiction, high-grade nature of the project and significant exploration potential, Pretium will probably command a higher P/E ratio. At a P/E ratio of 15, the estimated share price climbs up to $24 or $21, respectively.

It is also important to note that the above-mentioned calculations attribute no value to the giant Snowfield project that contains measured, indicated and inferred resources of 35 million toz gold, 127 million toz silver, 4.08 billion lb copper, 386 million lb molybdenum and 34 million toz of rhenium. The problem of Snowfield is that it is a low-grade deposit with a gold equivalent grade below 0.7 g/t.

Conclusion

The GDXJ portfolio rebalancing dragged Pretium down along with its peers. Moreover, the commissioning of the Brucejack mine has already begun and some of the investors may remember the old controversies related to the Valley of the Kings deposit and the nugget effect. This is why the coming months will be crucial for the future of the company. It's going to be a binary situation. If everything goes well, the ramp-up process progresses smoothly and the production numbers confirm the accuracy of the resource estimate, Pretium's share price should attack the $15 level by the end of this year. It may be pushed even higher if the gold price grows or if the resource estimate turns out to be too conservative, as indicated by the results of the bulk sampling. If there are no negative surprises, there is quite a high probability that the $20 level will be broken by the end of 2018. On the other hand, if there are any problems with the ore or with the ramp-up process, other support levels are at $7 and in the $4.5-5 range. The upside is much higher than the downside. Moreover, the positive outcome seems to be more probable.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PV over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

https://seekingalpha.com/article/4080949-pretium-resources-gdxj-portfolio-rebalancing-fear-nugget-effect-buying-opportunity