On Tuesday, Sandstorm Gold (NYSEMKT:SAND) and SilverCrest Mines (NYSEMKT:SVLC) announced that the former company is paying the latter company $10 million in exchange for an extension of a streaming agreement on SilverCrest’s Santa Elena mine in Sonora Mexico.
The original agreement dates back to 2009 when Sandstorm Gold first bought a streaming deal on the Santa Elema mine that entitled it to purchase 20 percent of the gold it produced for $350/ounce. Part of the agreement limited this to only the gold that was produced on the surface. At the time, SilverCrest was fairly certain that it would be able to expand the mine so that it produced underground ore, although the company only recently released an economic assessment that estimates the amount of gold that will be produced, the cost of producing this gold, and the cost of expanding the mine.
Since there was uncertainty regarding the underground resources back in 2009, the streaming agreement between Sandstorm Gold and SilverCrest Mines included a clause that gave Sandstorm Gold the right — but not the obligation — to fund 20 percent of the construction of the underground mine in exchange for the right to purchase 20 percent of the gold produced at $450/ounce.
The $10 million that Sandstorm Gold is paying to SilverCrest Mines is going to go toward the development of the underground mine at Santa Elena. This means that the streaming agreement will be extended, and starting later this year, SilverCrest will be selling gold to Sandstorm Gold at $450/ounce from its newly producing underground mine.
For Sandstorm Gold acting up on the aforementioned option was a no-brainer decision. As per the 2013-released economic assessment, SilverCrest Mines is going to be producing an average of 30,000 – 35,000 ounces of gold annually as well as some silver. This means that Sanstorm Gold is going to be able to buy 7,000 ounces a year at $450/ounce. At $1,330/ounce gold, this means that it will be generating annual cash flow of over $6 million before taxes for eight years.
Thus, except in an extremely weak gold price environment, $10 million is a low price to pay in order to continue the 2009 streaming agreement. Furthermore, Sandstorm Gold is entitled to purchase 20 percent of any gold that SilverCrest Mines produces underground at Santa Elena. So, if the company does some exploration and finds more gold, Sandstorm will be entitled to purchase 20 percent of this new gold at $450/ounce regardless of how much SilverCrest finds and produces.
The deal is good for SilverCrest as well. True, it will be losing cash flow from its underground Santa Elena mine, but at the same time, it will be saving $10 million at a time when it is preparing to develop the first stage of what shareholders hope will be the company’s flagship mine, La Joya. Last year, the company released an economic assessment in which it demonstrated that it can build an initial “starter pit” at its La Joya mine that will be profitable even with metal prices depressed.
However, it is going to need $124 million in order to develop this starter pit. Unfortunately, as of the end of September, the company had only $24 million in cash and equivalents and $30 million in working capital, which means that unless the prices of gold and silver rise dramatically it is going to need to raise most of the capital it needs. With the Sandstorm deal, it needs to raise $10 million less, and in an environment in which mining companies are struggling to raise capital, every bit helps.
Ultimately, this new deal is good for both companies. Sandstorm Gold will benefit from additional cash flow, and SilverCrest will benefit by getting additional capital to develop its underground mine at Santa Elena and is La Joya project down the road. Furthermore, the fact that Sandstorm Gold’s management acted upon the agreement expansion clause shows that they have faith in SilverCrests’ management and in the quality of the project.
Investors interested in these two companies might want to wait for a pullback in the shares of both. Sandstorm Gold shares have been weak as of late, but a lot of this is due to the fact that its streaming deal with Colossus Minerals (OTCMKTS:COLUF) on its Serra Pelada mine fell apart when that company went bankrupt. While the company has a lot of solid streaming agreements in place as well as growth potential, I think investors are still somewhat optimistic, and I would consider buying at lower prices.
On the other hand, SilverCrest shares have been on fire, having risen 37 percent for the year already, despite a recent pullback from $2.75/share to $2.30/share. I still think the shares can pull back more, but this is a great company with valuable projects in Mexico with large resources and low production cost estimates.
While I prefer SilverCrest, I think more risk-averse investors will prefer the low and steady cost structure of a streaming company, and so they should consider owning Sandstorm Gold shares on a pullback to $4.50 – $4.75.