- November 1st, 2007
- in Yachting
Nice 'Links! – Almost 3 years ago we started building our overweight position in gold and precious metals. Our thesis was (and is) that gold as an undervalued commodity – a commodity that hasn’t even kept pace with inflation over the last 20 years and has underperformed oil and the S & P 500 as well as many Blue Chip stocks – will rise in value. In addition, gold is a hedge against a decline in the US market and US dollar, which we felt was at risk due to the high level of debt and bubbly housing market. We have anchored our INTAC Global Hard Asset Portfolio with well diversified, top performing gold and precious metals asset managers from around the globe. In addition, we have added a select group of direct investments in individual Junior Mining Stocks.
Producing Junior Mining Stocks represent the biggest leveraged play on an increase in the price of gold. While our stodgy investment manager friend’s solitary gold investment of Tiffany cufflinks increases at a 1:1 ratio with the price of gold, Junior Mining Stocks have the benefit of operating leverage. That is to say, that any increase in the price of gold flows directly to the company’s bottom line as profits. In a well run, efficient, producing Junior Mining Company, the increase in net asset value relative to that of gold bullion can be exponential.
But aren’t they risky? Absolutely! But, like any investment you have to do your homework. The cheapest, most professionally run, producing, Junior Mining Company that we have found is Castle Gold Corporation (TSXV:CSG). CSG has low-grade, bulk heap leach gold production operations in Mexico and Guatemala. Below are some notes from our latest homework report sent to our clients:
“On August 17th 99% of the votes cast by Morgain Minerals Inc. (MGM), and 97% of Aurogin Resources Ltd. (AUQ) shareholders overwhelmingly approved the merger of the two companies into the newly named Castle Gold Corp. (CSG). MGM and AUQ shares were converted to CSG on a 2 for 1 share basis. This has reduced the number of outstanding shares and increased the stock price. This is a significant corporate event in two positions that we have been steadily building over the last 3 years in the INTAC GlobalPortfolios, as well as individual client Stock Accounts. INTAC, through Mark Plaxton’s efforts has championed this merger and been a driving force in the development of the new Investment Promotions strategy for the combined company. Management has approved a substantial budget to develop awareness in this undervalued stock using many avenues. The goal is to increase the stock price and bring on institutional investors and fund managers to support the stock both through open market buying and through participation in future financing. Like INTAC these managed funds must be long term investors that are willing to hold their position until CSG has appreciated significantly. Future financings may be used to:
- • Buy out the existing Joint Venture Partners that are currently receiving 50% of the cash flow being generated by the El Sastre mine in Guatemala.
- › They are currently mining at an annualized rate of 20,000 to 30,000 ounces
- › Process improvements over time may increase the annual output to 50,000 ounces
- › Drill program on surrounding El Sastre properties that we believe may be part of the same system and may substantially increase the reserve and resource base
- • Complete 43-101 compliant resource statement on the La Fortuna property (as little as two drill holes required).
- • Put the La Fortuna property into production creating additional free-cash flow.
- • Additional drilling of the 9,000 hectares of land purchased surrounding La Fortuna, which could substantially increase the resource base
- › The land surrounding La Fortuna is adjacent to an existing mine which is a property that Chester Millar (Chairman of CSG) is very familiar with having run the mining operations there
- • Buy equipment to reduce costs at the El Castillo mine in Mexico and El Sastre mine in Guatemala
- • Continue with an aggressive acquisition strategy when the market cap of CSG reaches or exceeds $200 million and as mineable properties have been put into production.
- We have been very bullish about the prospects for MGM, AUQ and now the combined CSG. The reasoning is two-fold. Firstly, this stock is greatly undervalued. We observe:
- • Total ounces 1,283,151 with 533,817 (going to 568,067) ounces of Proven and Probable Gold Reserves, 236,394 ounces of Measured & Indicated and 512,940 (going to 778,250) of Inferred Gold Resources between El Castillo Mine, El Sastre Mine, El Arenal zone, Bridge zone and Lupita zone. This does not include the 500,000 ounces of gold equivalent Resources at La Fortuna that should be 43-101 compliant by 2008Q1
- • Cash costs per ounce averaging $180 oz in El Sastre mine / Guatemala and $370 oz in El Castillo mine / Mexico for a combined average cash cost of $275 per ounce (note these costs should come down even further over time due to increased economies of scale and enhanced efficiencies)
- • Current Market Cap of $50.5 million
- • Using a conservative $575 gold price (gold is currently around $700 per ounce) the profit per ounce is $300 USD
- • The average value per ounce of Proven/Probable, and Measured & Indicated for junior gold producers is $230 so the fair market cap for CSG should be around $230 * (533,817 + 236,394) = $230 * 770,211 = $177,148,530. However, this does not include the 500,000 ounces of gold equivalent resources at La Fortuna that should be 43-101 compliant by 2008Q1 (this increases the market cap to $292,148,530) nor does this include possible increases to reserves and resources that would result from changes to the JV Agreement (this immediately increases the market cap to $300,026,030) and this also does not include any of the inferred resource and the potentially huge upside to reserves and resources that may result from aggressive exploration programs in Guatemala and La Fortuna / Mexico (which are planned for 2008)
- – Dividing the shares outstanding (70.2 million) into the fair market cap of ($177,148,530 to $300,026,030) the price should be: $2.52 to $4.27 per share (future cash flow not discounted)
- Currently trading around the $0.58 per share mark (all data as of September 10, 2007), we are able to buy a dollar’s worth of assets for 14 to 20 cents. Our estimates are conservative, as we have a high degree of confidence that the metallurgy is correct and that the price of gold will not drop below $275 an ounce (the break-even price), which gives us a lot of downside protection.
CSG is also cheap on a relative basis. CSG’s Current Market Cap to Proven and Probable / Measured and Indicated Reserves / Resources ratio is: $51.6 million / 1.42 million ounces or $36/ounce. It is trading below competitors like: Peak Gold Ltd. ($348/ounce), Wesdome Gold Mines Ltd. ($344/ounce), Claude Resources Inc. ($307/ounce), Uruguay Mineral Exploration Inc. ($159/ounce), Galantas Gold Corp. ($95/ounce), and others. All of these companies have similar (or lower) resources, and higher mining costs per ounce. This tells us that investors have an appetite for Junior Mining Companies and they are putting higher valuations on less profitable comp anies. We attribute this to the lack of investment promotion that has been done to date by CSG.
Secondly, the prospect of even greater upside in the surrounding property at both El Sastre and La Fortuna, make this stock particularly attractive because this potential upside is not priced into the stock – we are getting it for free! We also have the additional upside potential of gold remaining above $575 per ounce and/or climbing higher, which is a major factor influencing our decision to invest in this sector.
This trade echoes Mark Plaxton’s call to buy Russian Oil in the late 90’s when oil was trading at $9 per barrel and Russian oil was trading around $1 per barrel. However, we believe that an investment in CSG at this level will prove to be an even better trade, and with less volatility. It is our experience that trades like this only present themselves every 10 years. Analyzing a block of the outstanding warrants (4.81 million) and the selling of stock that will likely take place to capitalize on those warrants suggests that there will be some downward pressure on the stock before the Investment Promotions team creates awareness in this company. The management team has approved an early exercise incentive to 2.4 million warrant holders at the price of $0.58 up until October 19, 2007. Therefore, we anticipate that this may be the last great buying opportunity in this stock before awareness of this stock pushes the price up to the $1.25 to $1.50 level where we anticipate management would feel comfortable doing an equity financing.
INTAC, INTAC’s management team (Mark Plaxton, INTAC Trade Advisors and yours truly), INTAC’s clients, INTAC’s friends and family, and the cleaning lady at INTAC all own Castle Gold Stock. We may benefit as investors buy the stock – and all, or some of the INTAC related parties might sell their stock at any time. Junior Mining Stocks are the most risky, volatile, and illiquid of risky equity investments. Contents may be hot, handle with care, and do not mix with alcohol. While we feel CSG is a good investment, it should only be part of a robust, well-diversified portfolio such as the INTAC Global Hard Assets Portfolio and the exposure to the Hard Assets asset class should be part of an overall long term strategy that reflects your particular risk/reward profile, such as one of the 7 INTAC Investment Philosophies.