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There appears to be
an enhanced investment opportunity for long-term value
investors in emerging producers selling near cost of investment or book
value. We see the mining sector gaining in interest for value investors as
they screen for companies selling at 52-week lows, below book value, and with
potential to expand margins and earnings. Wholesale redemptions by investors,
along with tax loss selling in both the U.S. and Canada, are creating
opportunities for value investors looking to acquire companies with both real
assets and the potential for increasing production.
Reduced
global lending and investment, which caused a shortage of liquidity, has
resulted in a deflationary environment unfavorable to commodities, including
precious and base metal prices. Recent actions by governments and central
banks are largely inflationary, which should lead to higher gold and silver
prices as banks begin to lend and invest. A reduction in credit risk should
spur a resumption of global growth, increasing demand for commodities and
leading to higher base metal prices. While this cycle appears inevitable to
long-term investors, this scenario may be delayed by credit markets or
anti-growth policies including protectionism, higher taxes, and increased
regulation.
It
follows that deflation in the near term should be favorable for companies
that have cash or the ability to operate profitably at current metal prices. Clearly,
the inflationary environment in the mining industry in 2007 has reversed and
costs of labor, materials and supplies are moderating or declining. Recent
declines in the price of fuel lifts a burden on both operating profits and
the barrier to resumption of economic growth. As this situation persists,
should metal prices rebound, margins will also expand, leading to potentially
significant appreciation for emerging producers above current levels.
China continues to be
important for sustained economic growth through wealth accumulation and
investment in infrastructure. Despite concerns over declining rates of
growth, China still maintains near double-digit annual growth rates. The
ongoing demand for precious metals as a store of value, and base metals for
the production of goods and infrastructure, remains immense. China’s 1.3 billion people consumed $1.2 trillion last year, while America’s 300 million
consumed $9.7 trillion. While China is criticized for a lack of domestic
markets, this situation may be revered as financed by its central
bank’s reserves, largely composed of U.S. treasuries.
NovaGold’s market cap is significantly less than
the sum of the book value of its three major projects:
NovaGold
Resources Inc.’s (NG) market cap is
currently about $317 million, which is only slightly higher than the book
value of its Rock Creek gold mine including property, plant, and equipment, plus
development costs. This would imply that the market is currently attributing
no value for NovaGold’s share of its 50% ownership in its two
world-class projects, the partnership with Barrick Gold Corporation (ABX) on the Donlin Creek
gold project and with Teck Cominco Ltd. (TCK) on the Galore Creek
copper-gold project. NovaGold’s share of the total investment in
property, plant, and equipment plus development costs at Donlin Creek is $238
million, with $360 million on the Galore Creek project, for a total of $868
million on these three main assets. NovaGold’s market capitalization is
about one third of its share of the capitalized investment in these projects.
NovaGold Gold Pour, Rock Creek Mine, Nome, Alaska
Source: NovaGold
We
understand that Barrick is working toward completion of a Feasibility Study
on Donlin Creek by 1Q09. This would mean that a majority of NovaGold’s
50% ownership of this gold resource of 31.7 million Measured and Indicated
ounces should move into the reserve category and allow for the start of the
permit process. In addition, Teck Cominco is anticipated to provide an update
on a new design plan for the Galore Creek project, which would be the basis
for an updated Feasibility Study and initiation of permitting. Continued
development by Barrick and Teck Cominco should assure markets, leading to
NovaGold’s market cap appreciating toward total book value.
NovaGold
is in the process of commissioning its Rock Creek gold mine in Nome, Alaska , and has recently completed its first gold pour. NovaGold is scheduled to
produce 100,000 ounces annually, generating an estimated $25-$35 million in
2009, at an average cash cost of $500 per ounce. NovaGold is working to
increase the resource to extend the mine life to ten years. Management
estimates that production from the Rock Creek mine, plus cash on hand and
proceeds of other non-core assets, should provide funds for planned
activities for the next twelve months. NovaGold remains a viable company with
significantly undervalued and unrecognized assets.
Etruscan’s market cap is less than the book value
of its Youga gold mine which does not include the development potential of
projects in West Africa:
Etruscan
Resources Inc.’s (ETRUF.PK) market cap is currently about $73 million, which is
less than its investment in property, plant, and equipment, plus development
costs for the Youga Gold project of about $109 million. The Youga Gold Mine
produced 7,450 ounces of gold in October; this was about 14% above September
production of 6,572 ounces of gold, and 11% above estimated average monthly
production. We suspect that with further optimization, production may
continue to exceed published scheduled production, important to build its
treasury to fund further development. Cash costs should improve through
project stabilization to an estimated $450 per ounce for the life of the
mine. The project includes a program to limit price exposure of the gold
price on the downside to $629 per ounce.
The
current market cap does not appear to reflect Etruscan’s other assets. Etruscan
may have the largest land position of any mining company in West Africa. We
are looking for additional reports on their Bitou project about 35 kilometers from the Youga Gold Mine and new discoveries in southwest Ghana. We are also quite keen
on further developments on its recently announced rare earth deposit in Namibia. As the market cap of the company is now less than the construction cost or book
value of the Youga Gold Mine, value investors have the upside to increasing
gold prices, as well as exploration in West Africa, Namibia, and its diamond assets in South Africa.
Minefinders’ market cap is close to book value and
half base case economic study of Dolores mine:
Minefinders
Corporation Ltd. (MFN) has a market cap of
about $250 million, slightly above the book value of its Dolores gold-silver
mine in Chihuahua, Mexico. Current book value of the Dolores mine, including
property, plant, and equipment plus development costs, totaled $203 million
as of the end of June 2008. The total budget for the project is $191 million,
which includes about $10 million for contingency, with available cash and
credit to complete construction. Incidentally, Minefinders recently
negotiated an additional $10 million in credit for additional working
capital.
Minefinders
recently began leaching ore, a major milestone, and anticipates its first
gold and silver production in the next few weeks. Previously they had
targeted producing 10,000 ounces of gold and 350,000 ounces of silver in the remainder of 2008. They report crushing at a rate of 15,000 tpd,
close to the design capacity of 18,000 tpd. Estimated operating cost for gold
equivalent during ramp up may range from $400 to $450 per gold equivalent
ounce, declining to $297 per gold equivalent ounce over the average life of
the mine, scheduled for 15 years.
The
Dolores open pit mine currently has 99.3 million tonnes of Proven and
Probable reserves, containing 2.44 million ounces gold and 126.6 million
ounces of silver. The most recent economic study estimated an NPV at a
discount rate of 3% to be $563 million (metal assumptions of $675 gold and
$13 silver). The study did not include the potential benefit of adding a
3,000 tpd flotation circuit to increase recoveries of gold and silver in the
pit, or located in a high-grade gold-silver resource below and parallel to
the identified reserve. As Minefinder’s market capitalization is close
to the book value of its investment, and less than one half of its base case
economic study, we also consider the company to be significantly undervalued
and of interest to value investors.
Mercator’s market cap is less than almost half
book value and profitable at significantly lower metal prices:
Mercator
Minerals Ltd.’s (MLKKF.PK) market cap is currently about $72 million. As of June
30, 2008 the book value of its Mineral Park mine near Kingman, Arizona, including property, plant, and equipment and development costs was over $141
million. The original budget for both phases of the 50,000 tpd facility ($128
million for stage one and $62 million for stage two) is about $200 million. Mercator
is completing commissioning and anticipates production in the near term and
has completed and paid for about 40% of stage two.
The
first stage of the Mineral Park mine was financed by debt. The balance of the
second phase will be paid out of cash flow from the first phase, remaining
cathode copper production, and cash from the sale of its silver stream to
Silver Wheaton Corp. (SLW). The mine has an
estimated life of 25 years, and with a strip ratio of only 0.18, the project
has good economics. Cost of production, assuming a 50-50 split for production
of copper and molybdenum (net silver credits from Silver Wheaton), is
estimated at $1.28 per pound and $6.49 per pound, respectively.
Their
pre-feasibility study, assuming metal prices of $1.53 copper, $10.16
molybdenum, and $7.50 silver (prior to the sale to Silver Wheaton), estimated
an after-tax IRR of 51% and NPV of $426 million with a 1.8 year payback of
capital. As Mercator’s market capitalization is about one-quarter the
estimated value of the pre-feasibility study and one-half the book value of
the Mineral Park mine, the company should be of interest to risk averse value
investors.
Acadian’s market cap is less than Scotia mine book value and replacement value not including significant gold assets:
Acadian
Mining Corporation’s (ADGLF.PK) market cap is about $14 million. This is less than
one-half book value of their Scotia Mine operation in Nova Scotia, including
property, plant, and equipment plus development costs of approximately C$30
million. This includes the cost to acquire the mothballed Scotia Mine and
bring it into production. Management estimates the replacement cost of the
Scotia Mine to be about C$100 million.
Acadian
brought the operation into production in 2007 on time but faced challenges in
early 2008 due to difficult weather conditions. This was followed by
declining zinc and lead prices. Management estimates an operating breakeven
rate of $0.55 per pound zinc-lead, and overall company breakeven of $0.59 per
pound zinc-lead. This was prior to the decline in the Canadian Dollar to the
U.S. Dollar, which benefited Acadian, as their costs are in Canadian Dollars.
Prior to declining metal prices, management implemented an aggressive cost
reduction program, with plans to resume development of its gold assets in
2009.
Acadian
has a gold resource in Nova Scotia of about 1.6 million ounces. When Acadian
acquired the Scotia Mine it was expected to centrally process gold resources.
Record zinc and lead prices accommodated restart of the mine as previously
designed. Should base metals stabilize at lower levels, we expect management
to revisit the original concept of processing gold ore. We estimate this
could be accomplished in six to eight months at a cost of C$5 to C$10
million.
Disclosure: The author is long
NG, ETRUF.PK, MFN, and ADAIF.PK. An affiliate of the author's employer
provides corporate advisory services to NG, ETRUF.PK, MFN, MLKKF.PK and ADAIF.PK.
Mike Niehuser
Beacon Rock
Research.com
Mike Niehuser is the founder of Beacon Rock Research,
LLC which produces research for an institutional audience and focuses on
precious, base and industrial metals, and substitutes, oil and gas,
alternative energy, as well as communications and human resources. Mr.
Niehuser was nominated to BrainstormNW magazine's list of the region's top
financial professionals in 2007.
Mr. Niehuser was previously a
senior equity analyst with the Robins Group where he was a generalist and
focused on special situations. Previously he was an equity analyst with The
RedChip Review where he initially followed bank stocks but expanded to a
diverse industry range from heavy industry to Internet and technology
companies.
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