first majestic silver

A Peek at Smaller Golds


October 6, 1999

In "A Peek at Smaller Golds" (Part I) I presented a group of successful advanced stage exploration companies that should offer substantial upside gains in a gold bull market. It is my belief that the bull market is now at hand and that we have just scratched (or mined) the surface in terms of the money to be made in smaller golds. Allow me to review where we have come from since Part I was presented in July in Gold Eagle.

If you had bought as a group the seven explorers (Pangea, St. Jude, Birim, Nevsun, Greystar, Golden Reserve, Battlefield) highlighted in Part I you would now be showing gains of about 60%. In reviewing an even broader list of smaller golds, 60% gains (some more, some less) seems to be about the norm. Despite the 60% gain it is my contention that the move in gold from $250-260 to $300-$310 has made the enterprise value of smaller gold companies with actual deposits even more compelling than it was before. The reason for this is the tremendous leverage a $50 move in POG has on the economics of the deposit.

Frankly I am surprised that this has been lost in the heated recent discussion on gold, as the concept is pretty straightforward. If we were to take an average, the mining costs for most of these deposits is around $200. In the previous $250 (and threatening lower) gold environment, a $200 cost deposit was not very attractive to a major. The reason was obvious: other than surface mining the lowest cost ore, the long term investment required to mine the remaining higher cost ore can be substantial and take some time (1 to 2 years) to engineer. Therefore the time value of that development capital combined with an uncertain and rather modest $50 an ounce profit on mined gold made the proposition problematic.

As a result major miners were in a dilemma. Their commonly stated strategy pre-breakout was to 1. "search for low cost (under $150), million plus ounce deposits", or 2. cherry pick higher cost deposits by scrapping off a couple hundred thousand ounces of the easy to get oxidized surface gold. The problem for the majors is that they have been going through low cost deposits like shit through a goose. The second problem is the finite number of low cost deposits (remember that exploration in the last couple years has dried up). Further given that they have already hedged (sold at fixed prices) their gold deliveries for years to come, they need to consider finding sources that will allow them to fully participate (unhedged and open ended) if POG really continues to take off. Therefore if POG can hold over $300 or move higher over the next couple months, the likely outcome for the majors is to rethink their development strategies. I believe this will manifest itself initially in a flurry of mining JV's and takeovers of advanced staged explorers.

At $300 POG these explorers, even with higher cost deposits are worth exponentially more than at $250. Obviously at $200 cost, the profit at $300 POG is $100 versus $50 before. What appears to be lost on the market is the fact that with the modest 60% gain in the shares, the gold resources (relative to market capitalization) of the average explorer has gone from a mere $2 to $5 an ounce to only $3 to $7 an ounce, despite the fact that mined ore would bring in an additional $50 an ounce.

Thus even after the explosive rally, the stock prices prices seem to be reflecting the notion that $300 POG won't stick. From a risk-reward perspective the prospect that it will stick is not even modestly priced in to the stocks, and the notion that even higher POG is possible is non-existent. Well as the saying goes, " youse pays your money and youse takes your chances" on any investment, but this looks like a excellent proposition to me.

A updated review of advanced staged exploration golds is very much necessary. A caveat emptor is in order first: these stocks trade funny, they always have and they always will. Given their small market capitalizations, a modest seller or some broker churning his clients for commissions somewhere can hold up or depress the stock price for as long as a week or two. Also most investors are showing losses (often substantial) in these stocks. As the bids start to materialize you may see year end tax loss selling holding things at bay. My advise is take advantage of it, and employ the bull market strategy of buying dips. If you can't handle the weird little 20% side moves, or the fact that individual stocks might just sit there while POG is on the move, don't torture yourself by getting involved. I read chat lines on many smaller gold stocks and it seems most of the energy there is spent on whining and agonizing. If you don't have the conviction, spare yourself !

I won't go into the selection criteria again here as it was spelled out in detail in "A Peek At Smaller Golds" (part 1) on July 30th. The initial details on each recommendation was also presented then. The overall approach of concentrating primarily on advanced stage companies (in elephant hunting territory not US or Canada) rather than early stage explorers still stands. What follows is the update.

Pangea (PGD.TO): recommended at $1.75 CDN, now at $3.40. The increase in net net (mkt cap after subtracting working capital) to $47 million US does not reflect the resources already discovered and likely to be discovered as results are announced from this year's $11 million exploration projects. More positive results from Tulawaka just came out. Stock is still a buy, aggressively on any dips.

St. Jude (SJD.V): Company's lack of promotion and difficulty of getting information (no web site, but CEO typically available by phone) hurts the stock price. Still at the 65 cent level of the pre-breakout. Nevertheless good news has been forthcoming as this seasons drilling results have linked the Father Brown and Adoikrom zones at the Hwini-Butre concession in Ghana. SJD has a valuable deposit and what's more about $8 million US in cash. With the mkt cap still at $6.5 million you are being paid to buy a very good deposit. A classic net net situation that is likely to draw someone's attention in the form of a raid, buyout or brokerage sponsorship.

Birim: (BGI.TO): recommended at 20 cents, now at 28 cents. A lot of very positive news has come out of BGI since July. The action started pre-breakout with an unsolicited and rather modest buyout (40 to 50 cent stock swap) offer from Golden Star. The company wisely used that to negotiate a good royalty and cash infusion deal with Ashanti on it's most advance project, Mampon, Ghana. The deal gives BGI upfront payment of $4.75 million US for the first 175,000 ounces of recoverable oxide gold, plus a $30/oz royalty on any additional ore mined out (plus 20% of the uplift over $300 POG). BGI gets another $500K US selling 2,500,000 shares to ASL (10.5% of BGI) and another $500 K in convertible debentures, and cash of another $500K.

The end result is a good illustration of how inefficiently the small cap golds trade. At 28 cents BGI has become a net net (market cap less than working cap on hand) : 23.7 mil shares out after deal X 28 cents CDN= $4.5 mil. plus $0.5 debt= $5.0 US mkt cap. BGI owns $6.5 mil cash (includes a little still in the treasury pre-deal), excellent future participation in Mampon, a new partnership with ASL, the high potential Bui concession and the rest of Dunkwa. Further, there is the potential of receiving $2 million next year from Dominion on a concession called Akrokeri should that company exercise it's purchase option. Not a bad proposition! Outstanding buy!

Nevsun (NSU.TO): recommended at 38 cents, now at 83 cents. Again represents a modest mark up of the resources they own. No where near a sell and still a decent buy.

Greystar (GSL.TO): Still trading around the pre-breakout price of 75 to 85 cents. This is odd given the enormous and growing deposit they own at Angostura, Columbia. Further, management has openly stated that their goal now is to sell the deposit (at a reasonable price) to a major. Kinross owns 21% but has stated that GSL's 10 million ounces might be too big for them to handle. Angostura will require a substantial investment (estimated at $88 million), but it will also produce fairly low cost gold ($154). The political risk in Columbia might be a factor for other majors as well. Still GSL's mkt cap of $25 mil (net 18 mil subtracting it's substantial cash hoard) values it's resources at a mere $2 an ounce even after the move in POG. At some point it seems likely that the great enterprise value here will be unlocked. An outstanding buy!

Golden Reserve (GLDR-Nasdaq): recommended at 90 cents, now trading at $1.38. This is a play on the expected change in the development strategy of the majors. GLDR's 5.6 million oz gold and 659 million oz copper Brisas project is located next to Placer Dome's (PDG) Las Cristinas in Venezuela's KM 88. PDG has taken a very cautious, conservative stance of late on it's development projects. A change in PDG's philosophy (such as proceeding with Las Cristinas) will be very strong signal to the whole advanced stage exploration sector that a huge mark up is at hand. GLDR is one of the most direct ways to play this. With $18 million in cash and a total mkt cap of$30 million= net net $12 million or $2 an ounce for it's deposit, the risk-reward is very favorable for gold bulls. El Callao (ECM.V) @ 16 cents (Bema is major shareholder) is a similar play on KM 88 gold.

Battlefield (BFM.V); recommended at 5 cents, now 10 cents. Story is the same as before, no new news to report. Excellent speculation with upside if company can cut the right deal. Prospects are improved for that with $300 POG.


Madison Enterprises (MNP.V): 36.3 mil shares out @ 1.00= $25 mil US + 1.75 note-4.5 cash= 22 1/4 million US net. Owns 90% of Mt. Kare, Papua New Guinea located 15 km from Placer Dome's 28 million oz deposit Porgera mine. Mt. Kare has 4.5 million oz. defined resources and a new estimate (based on this seasons drilling) is coming out in the fourth quarter and should push that well over 5 million. Given the prolific nature of the region there is plenty of future additional potential (new drilling at Pinuni Creek 1 km east). That values Madison's Mt. Kare at only $4 to $5 an ounce.

By comparison PDG increased it's share of Porgera last year to the tune of $65 an ounce. Metallurgical testing on recovery rates at Mt. Kare came in at 90% versus 75% at Porgera indicating that the cost per ounce at Mt. Kare will be low. MNP management pedigree is solid, as the top brass were the developers of Eskay Creek (Homestake) and Hemlo (HM, Hemlo). They are developers not miners, so this project will be sold (to HM if not PDG?) when the true enterprise value ($5.00 to $7.00 per share?) can be realized.

A gold nugget can be worth three to four times the value of the gold it contains because they are so rare.
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