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Canadian Junior Gold Thriving

Canada's prolific Abitibi greenstone belt is one of the world's top jurisdictions for gold mining. And by far its most productive district is the famous Timmins district. Timmins has produced in the neighborhood of 70m ounces of gold over the course of its storied history. And with Lake Shore Gold's Timmins West mine now firing on all cylinders, this district is still going strong.

Lake Shore Gold is one of the few bright spots in the currently beaten-down gold-mining industry. On the production front its 2014 midpoint guidance of 170k ounces represents a year-over-year increase of 26%. And with cash operating costs guided at $725 per ounce, they'll come in lower than the previous year's.

Production growth and cost declines are certainly countertrend to what we've been seeing amongst Lake Shore's peers. And to make things even sweeter, Lake Shore has so far greatly outperformed its guidance measures. Through the first half of this year it has produced 96,900 ounces, at cash costs of only $600.

On an annualized basis this would lead to a 44% increase in year-over-year production volume, and a 22% drop in cash costs. And with H1's all-in sustaining costs estimated at only $890, Lake Shore's total costs are easily in the lower quartile of industry average. This has allowed it to generate net free cash flow, which has served to build up its treasury and aggressively pay down debt.

Lake Shore's superior operational performance has made it one of the best-performing gold stocks over the last year or so. And behind the scenes of this thriving Canadian junior gold producer is a great turnaround story.

As you can see in the chart below, things weren't always so rosy for Lake Shore Gold. Following its early-2011 highs, its stock cratered 70% to the end of the year, it fell another 41% in 2012, and then tanked another 76% from the onset of 2013 to its mid-year low. Provocatively this carnage was much worse than what its peers were experiencing. Lake Shore was in a world of hurt, and certainly had its work cut out for it to win back investors!

Unfortunately things got off to a rough start operationally in 2011, the first full year of commercial production at Lake Shore's Timmins West mine. It ended up processing much lower head grades than planned as it ran into broader zones of mineralization. And this naturally led to lower production and higher costs than expected. Production for the year was only 69% of original midpoint guidance (Lake Shore guided lower in July), at cash costs 41% higher than expected. Investors don't fancy misses this far off!

Things were a little better in 2012, but Lake Shore didn't instill much confidence in its mine-planning skills as it produced at the very low end of guidance at much higher costs than anticipated. Again the culprit was ore-grade issues, with grades 13% lower than planned. The nearly 86k ounces produced (64k ounces from Timmins West and 22k ounces from Lake Shore's smaller Bell Creek mine) was done so at cash costs 14% higher than midpoint guidance.

There's no denying that mine planning in deep underground mines is a challenge. Accurately modeling a vein system isn't an exact science. And indeed many miners are forced to alter their plans to some extent once they drive into the deposit and get their shovels and drills into the payable ore. Surface and even initial-stage underground drilling can only tell you so much.

Challenging geology is no excuse though. And Lake Shore Gold's initial lack of understanding of its mineralization and thus poor mine planning was no doubt frustrating for investors. But it worked tirelessly to right the ship and get its arms around its excellent deposit. And its diligence paid off with a blowout year in 2013.

With the support of a successful mill expansion and better grade control Lake Shore ended up producing nearly 135k ounces (107k ounces from Timmins West and 28k ounces from Bell Creek), near the high side of its guidance range and 57% more than the previous year. Its cash costs were also way down ($766), 21% lower than the previous year and well below the low end of its guidance range.

It was finally around the middle of 2013 that investors starting believing in Lake Shore Gold's turnaround story. And its operating performance so far this year has really convinced the markets that its Timmins district operations are everything they were originally made out to be.

In 2014 Lake Shore is targeting production of 140k ounces from its flagship Timmins West mine, a 31% year-over-year increase, and at least 30k ounces from its Bell Creek mine. And on the longevity front, both of these mines are expected to have their best years ahead of them.

Timmins West currently has 492k ounces of probable reserves, which is within Lake Shore's desired plan to maintain a 3- to 5-year reserve base. And it'll be able to renew reserves from 739k ounces in the other resource categories, as well as from what will likely be new discoveries on the periphery of its wide-open deposits. Lake Shore should also be able to pull from other targets in the greater Timmins West complex, including the nearby Gold River deposit which is host to 1.1m ounces.

Interestingly the small Bell Creek mine has turned out to be a pleasant surprise. Lake Shore originally acquired this mine as a secondary asset to the onsite mill that it would use to process Timmins West's ore. But thanks to a major discovery beneath Bell Creek's historic underground workings, this mine will be making a sizeable contribution to Lake Shore's output for years to come. With 1.5m ounces of total gold resources, Bell Creek has huge upside growth potential.

In addition to its producing assets, Lake Shore Gold owns an excellent advanced-stage exploration asset. Its Fenn-Gib project is located 60km east of the city of Timmins. And it is a former Barrick Gold project that holds 2.1m ounces of near-surface resources. Fenn-Gib currently waits on the sidelines, but Lake Shore sees huge potential for a low-cost open-pit mine down the road.

Investors finally like what they see with Lake Shore Gold. And they've recently been richly rewarded, with its stock up a whopping 483% from its 2013 low. But as you can see, LSG still has a long way to go before it comes close to returning to its 2011 levels.

Gold and LSG 2011-2014

In this chart I wanted to capture the action subsequent to LSG's 2011 high to see how it has performed relative to gold. And as is glaringly obvious, it has suffered with the metal over the last few years. This is no surprise, as the entire gold-stock patch has gotten hammered over this stretch. But as mentioned, Lake Shore's decline early on was on the extreme side in response to its operational struggles.

Unfortunately these struggles pushed LSG down well before gold reached its apex. LSG fell, and it fell hard for 8 months straight until the first of gold's four post-apex uplegs. And for investors it's a great litmus test to see how LSG has fared amidst these uplegs. Gold stocks obviously leverage gold to the downside given their inherent outsized risk compared to the metal. And to counteract this they must positively leverage on the upside, otherwise they're not worth owning.

LSG was certainly due for a bounce in early 2012 following the carnage the previous few quarters. And indeed it responded nicely to gold's first upleg. LSG was able to put together a 54% gain to gold's 15%, solid positive leverage of 3.5x. But when the metal started falling, it quickly followed suit.

Unfortunately LSG didn't respond as nicely to gold's second upleg later on in the year. It ended up only outpacing gold's 15% gain by 1.5x, a pitiful 22% gain over that same period. This was quite alarming considering its already low base and the fact that its peers were putting up much larger gains. And things got even uglier as it followed gold down into 2013.

Despite Lake Shore's operational turnaround, its stock was not immune to the infamous gold panic in the first half of 2013. LSG followed the entire gold-stock realm down, going as low as $0.18 before selling was exhausted. Gold finally bounced in late June. And after not responding in the previous upleg, the pressure was on LSG to perform.

And perform it did! Investors had not only bought into Lake Shore's turnaround story, they recognized how woefully undervalued its stock was. And they vigorously bid it higher, to the tune of +211%. With gold rising 18% in this third upleg, LSG delivered staggering positive leverage of 11.7x!

As you can see, gold ended up giving back the entirety of its gains over the next few months. LSG stayed strong though, consolidating sideways until its next launch higher. This surge occurred amidst gold's latest upleg, a three-month affair that peaked in March. And again LSG greatly outperformed the metal, soaring 112% to gold's 16% (6.9x leverage).

Despite the impressive gains over gold's last two uplegs, LSG should still have a lot of room to run. And investors are looking for any excuse to buy it as seen in the latest rally where it gained 80% to gold's 7.6% (10.5x leverage). This stock has a gorgeous upward trend since its mid-2013 low, and has been one of the top performers in all the markets!

Overall the gold-stock sector has yet to see any mainstream interest over the last several years. But with gold overdue for a major upleg, it's only a matter of time before investors return. And when they do, it'll be hard to miss Lake Shore Gold as one of the standout junior-level gold producers.

At Zeal we've spent the last six months researching gold-producer stocks in preparation for gold's next upleg. And although these mining companies have been the pariahs of the markets lately, we've found there to be an elite group of high-quality ones well-positioned to take advantage of any movement higher in their underlying metal.

In March we published a report profiling our favorite dozen mid-tier gold producers. And just in June we published another report profiling our favorite dozen junior gold producers. To get your hands on the detailed fundamental profiles of Lake Shore Gold and our other 23 favorite gold producers, buy your reports today!

We also recently added Lake Shore Gold to our trading books in both our weekly and monthly subscription newsletters, part of a campaign to layer in high-quality gold and silver stocks in preparation for gold's next big move higher. To get a look at our trade book and to gain a unique unparalleled contrarian perspective on the markets, subscribe today!

The bottom line is Lake Shore Gold is one of the few gold producers actually increasing output while lowering costs. This trend is a product of diligent work to better understand its high-quality Timmins-district assets. And it should lead to record production and profits in 2014.

Investors who've stayed on top of Lake Shore's turnaround have been greatly rewarded over the last year or so. LSG has been one of the top-performing gold stocks since gold's panic lows. And if it is to return to levels it was trading at in 2011, there is still a long ways left to go.


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