Red 5 Ltd - emerging gold producer (buy)

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I first came across Red 5 Ltd (RED.ASX) about 4 years ago. I was quite excited by this stock at the time because I saw alot of potential in its gold deposits in the Philippines. There were 2 targets then:

1. The Siana pit & UG potential

2. The Mapawa area along strike

3. The porphyry copper - volcanic intrusive potential

Notwithstanding the potential of the Siana pit and depths with its historic production of 5 grams/tonne, I was more interested in the bulk tonnage, low grade porphyry deposit at the time. Why? Because there was a similar structure up the road that hosts a multi-billion dollar mine deposit. As far as I was concerned, everything hinged on the first deep drill hole. The results were sold as a 'plus' but 500m of 0.2g/t is not commercial. The distribution of the gold suggests you would have to go very deep to find commercial gold, and that becomes costly. There is still however the prospect of remobilised gold along faults (like Siana), but as far as I am concerned the porphyry potential has been disproven. Well it was a punt worth taking. The stock at the time rose from 5c (from where I started accumulating) to 25c.

For the last few years efforts have focused on defining a 2Moz gold resource at Siana. They have identified a 3 year open-pit deposit, plus a 7yr underrground mine. This has taken some time because they have had trouble getting mining consultants to complete work. But here we are at feasibility study time. The next stages are:

1. Capital raising - Red will requiring $60mil up front for the plant & open-pit, followed by another $8mil in 2 years (which could come from earnings) for the development of the UG. Of the $60mil, they appear to be modelling $25mil of equity, plus $35mil of debt. I suspect this project is robust enough to secure a debenture issue, though maybe underwriters were worried by the way Lafayette Mining was treated by the Philippines government after a mine spill. So we might expect a placement to institutions and Anglogold (13% shareholder) plus an entitlement for other shareholders (say 1:5 issue), with maybe Anglogold & a broker underwriting the shortfall. Thats a positive outcome because Anglogold will have a vested interest in guaranteeing project revenues (as a shareholder), which means no hedging will be required. Many good projects hav been ruined by hedging. We dont want it because we want the upside exposure to a higher gold price. Altrnatively Anglogold could just buy a stake. That would suit Red shareholders. Anglogold's intent I suggest is to ensure it retains ownership of the processing plant after Red's reserves are depleted, as it can use any surplus ore processing capacity for its much larger, longer life mine, as well as grabbing equity in Red's prospective tenure.

2. Plant construction, tailings dam construction, pre-strip - this will take about a year

3. Operation: So we are looking at the commencement of mining in early 2009.

I have prepared a financial model for the project based on the limited data available. I have used my forward estimates for the gold price, which are bullish by others standards, but I think they will be revising their numbers up as inflation picks up. I have factored in a very strong $A ($US1.25 in 2013) because of $US weakness, and expected tight commodity supplies. I have not allowed for any increase in underground resources, or Mapawa pit contributing in later years. The area has excellent potential for further discoveries, and since Anglogold is about to embark on an exploration program in Red areas, we might have exploration upside in 6-8mths. The UG I believe has the potential to be substantive resource too. So its a pretty conservative model....but the intent is to be realistic. Actually I think gold will perform much better.

Based on these numbers I have Red showing very volatile earnings mostly because of its production profile and a rising gold price. My NPV places a value of around $150mil on the company's Siana project after accounting for the $8mil in Year 2. Red offers the following sensitivity analysis for gold price, but I suggest they are not factoring in a much stronger $A.

Now given that Red is now trading at 10.5c, we can expect the company to be attempting to keep the price there prior to announcing the raising of $25mil at I guess 10c per share (as I assumed above). This gives a NPV per share of 29c, but on a yield basis we might give them a value of 18c in 2009, 22c in 2010, and thereafter it really depends on exploration, the gold price and retained earnings. These numbers fit with the chart below. So post issue I can see Red rising to 17-19c level. They will be major resistance levels, and where I would be taking profits. That might not seem like much upside, but dont forget the exploration. This is an evolving story, and this financial model does not really assess the long term possibilities of this project.

- Andrew Sheldon www.sheldonthinks.com

Technology stocks

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The focus of my investments have always been mining, however because of my interest in science I have always had an interest in technology and its commercialisation. In recent years I have recommended a number of technology stocks which have done fairly well. The ones that come to mind are:

1. Papyrus Australia (PPY): I originally saw the story of this new paper fibre on ABC's Landline program around 6 years ago, then around 3 years ago I noticed a ASX report announcement by 'Papyrus' and I knew instantly it had been listed, and followed it conscientiously. Missed out on the price action however for lack of patience, as a Japanese paper company took a stake.

2. ZBB Power Systems (ZBB): This company is developing a new battery suited to commercial power storage for back up supplies and load shifting to benefit from the high cost of emergency supplies (diesel gensets) and time-of-day pricing. The batteries can be used to charge at night (off-peak) and discharge during peak periods. It will have an important implication for the shape of the 24hr power demand curve. The concern I have with these battery devices is that if we ever move to overnight car battery charging, the disparity between on & off-peak will be reduced...even inverted. But there is a demand for the next 10-15 years, and the future is hard to pick.

3. Living Cell Technologies (LCT): I started watching this stock after a report was released about 1-2mths ago, though I never acted on it. They have recently rallied on good news. Cant recall why they appealed to me..yet the rally made me take another look at this sector.

Biotron Limited (BIT.ASX)

Well to some extent these are the stories that got away, but I have recently found another stock that has alot of appeal. The stock is close to running stage 2 clinical trials on a HIV drug that attacks a protein that is the source of the HIV viruses capacity to replicate itself. Other HIV drugs have had limited success in destroying the HIV virus because they dont attack the body reservoir. Biotron's inhibitor-type drug shows 100% success in preliminary trials with these other drugs. I dont get the sense that this drug will work alone, or at least the results are not evident, however it seems encouraging, and the company is taking a similar tact on the hepatitis virus, though development of an antiviral drug for hepatitis is less advanced. The results of the Phase 2 clinical trials are due in mid-2008, though I expect the stock to improve before then in anticipation. In the short term, the company has just $1.3mil in cash, so I'm expecting an issue to raise around $5mil in the next month or two, so stay clear of that, but it should offer some buying opportunities before Xmas. The following chart suggests 12-13c is a good entry point. They are currently trading arounf 19c.

- Andrew Sheldon www.sheldonthinks.com

Quick trade opportunity in gold spec

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Every commodities boom is littered by bad decisions. There are several that come to mind:
1. Projects where ore resources (or grades) are overstated, either because of poor ore zone definition or nuggetty effects on grade estimation (Bendigo Gold).
2. Projects where the project development costs are understated (Batavia Mining, Gleneagle Gold, Perseverence Mining)
3. Pojects where the operating costs are understated (Gleneagle Gold)
4. Projects that were financed at low prices (Highlands Gold, Lafaytte Mining)
5. Projects that locked in low prices to secure funding (by hedging) and subsequently were forced to buy back metal in the spot market to meet their hedge commitments. eg. Lafayette Mining, Highlands Gold

Austindo Resources (ARX.ASX) is another Australian mine developer whom falls into this category. Poor selection of consultants and contractors, or more precisely work presures caused by a persistent commodities boom resulted in the company under-estimating capital costs, and its project engineers cutting back on underground decline support. The delays cost in excess of $35mil. The project debt has blown out forcing the company to raise equity finance. Whilst existing shareholders are being diluted it offers a compelling opportunity for investing. Why?
1. The stock has been oversold on its problems
2. All the problems are out on the table, so its mostly upside from here
3. The gold price has rallied to $US750 an ounce since the problems besieged the company

The company has partially completed the gold project so they are not totally out of the woods, but I think a second consultant is more likely to perform better correcting the errors in another's work. The project resource upside remains to be seen, but the project offers upside there, as well as from a stronger gold price.

The company has already offered renounceable (tradable) rights at 0.1c trading as ARXR until 18th October 2007 - thats just a few more days, thereafter you have just until 25th October to send in the application money (thats 1c per share) to exercise. It is a buyers market in the rights - no doubt because alot of small shareholders burnt on the share price are unwilling to risk more. This is poor trading psychology as history is no measure of future performance. I bought 500,000 ARXR (rights) today for 0.1c with the intent of paying 1c in the next week to take up the rights. That will give me 500,000 shares in ARX at a total entry price of 1.1c - when they are currently trading at 1.4c. Thats 25% market premium is bait however to take up the rights. I can assure you that once the rights expire the ARX share price will fall. Really that stock price manipulation at the 'market' price margin is what brokers earn huge fees for. eg. Austock is underwriting this issue, and since they are raising $12.4mil - they will earn more from commissions than they loose from supporting the stock. Better still is that they can recommend to their clients to buy the stock...though they might tell their best clients to sell for a 'stag profit'. Of course the better clients will be offered other opportunties like that.
The other positive of the issue is that ARX are offering a free 2012 option exrciseable for 1.5c by June 2012. Thats another compelling reason to buy. So I will get 50,000 options which will be worth 0.3c upon listing based on the current price. Now because I only get 10% offer they have a value of 0.03c. Anyway given their leverage they are probably better to hold for any upside.

- Andrew Sheldon www.sheldonthinks.com

Matrix Metals does not disappoint!

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Matrix Metals is so far up 11% today and I suspct it will go much higher. The annual report was released 15minutes ago and it does not disappoint. Here is a basic summary of the points made:

1. There are 550 mining companies listed on the ASX but just 10% of them are in production. Of those 10% Matrix is now one of them.
2. Matrix started copper cathode production from its Cloncurry heap leach operations in June'07
3. Matrix is currently producing 360tonnes of copper per month, and is ahead of schedul ramping production up to 420 tonnes per month
4. Matrix has 4300km2 of tenure around the existing operations. The Mt Isa Inlier - a geological window into older Paleozoic rocks is very prospective for copper and other minerals
5. Copper prices are testing record prices. Back in 2001 copper prices were languishing at 80c/lb, but today they are $3.70/lb. Whilst copper prices are up 380% the benefits of higher $US prices are somewhat offset by a 40% increase in the $A and the higher capital & operating costs of commissioning a mine.
6. Matrix has exploration JVs with Deep Yellow Ltd (where Deep Yellow has increased its JV commitment to uranium exploration) and Xstrata (looking for deeper sulphide ores at McCabe).
7. Matrix expects the current strong copper prices to remain so it remains unhedged exposure to copper
8. The company is considering an expansion from 5500tpa to 11,000tonnes - but this is tentative

The upside in productive capacity will tend to counter any concerns of softer revenues from softer copper prices, as will any fall in the $A (in response to softer commodity prices).

If you want further information on Matrix have a look at their website at http://www.matrixmetals.com.au/.

- Andrew Sheldon www.sheldonthinks.com

Gippsland - worth another look

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For several years I have been following the fortunes of Gippsland Ltd, an Australian listed company developing a tantalum, tin, feldspar deposit in Egypt. Just today I was carrying out a price review and I came across the tantalum price - see http://metalsplace.com/prices/?a=14&grt=6. A few years ago the tantalum price rose to over $200/lb, but then collapsed as a result of over-supply. The demand was prompted by the PDA, cellphone, laptop demand for resistors. As you can see tantalum prices are recovering so it seems likely that over-supply has been absorbed.

Logic would suggesr new mine capacity is required, and Gippslands tantalum project must be a contender given that its a world class deposit capable of supplying 8% of the world's demand. I guess however there are several problems:

1. The International Finance Corp (World Bank affiliate) walked away from financing the project. Why?

2. The government has a 50% free carried interest

3. Country risk - Egypt is perceived to be a high risk

The outlook for tin is good as well. I dont place much value on the gold/copper exploration they are doing. Anyway, you can see the latest (Aug'07) broker report at www.gippslandltd.com/i_broker_reports.asp. I new financial advisor was appointed 6mths ago, but there are no visible signs of progress. Its quite possible this project will be overlooked in favour of others. I think banks are unlikely to accept the financial terms, and it seems unlikely that the government will alter the law for one project, although perhaps the foreign investment regulations are under review anyway. So thats worth following up. There are a number of tantalum projects in Africa looking to develop, and in this industry manufacturers have been an important source of finance....so perhaps this company poses an unacceptable risk at this time.

- Andrew Sheldon www.sheldonthinks.com

Gryphon Minerals (ASX.GRY)

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Gryphon Minerals is another very attractive gold explorer in West Africa. Th attraction of this company is that they are outlining a multitude of ore zones, and drilling results to date have been high grades over commercial zones. With a multitude of targets to test, it has scope to be a significant gold mining operation. Exploration over the next 12mths should demonstrate this, and with the gold price proving its meddle, there should be a substantial re-rating in this company from $50mil to $150mil.

I have actually been following this stock for some time, though it fell off my radar. Looking at the chart we can see consolidation at this level - I think this will turn out to be a flag structure. The implication is that I can see a move to 80-85c pretty soon. But we should wait to see if that flag structure is confirmed by consolidation at current levels. And weakness below 55c would be a sign of a fall back to lower support, and present an even better entry (if you can get it).

- Andrew Sheldon www.sheldonthinks.com

Gold Aura (ASX-GOA)

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I love grassroots exploration because its the opportunity to see value before everyone else can see it. Several months ago I bought GOA at 9c in anticipation of attractive drilling results from its Anomaly A & B drilling program in the Carpentaria region of North Qld. This region of course hosts some VERY significant resources with a value of $100+billion - so its a good place to find elephant-size deposits. There are the Mt Isa Cu-Ag-Zn deposits, the Cloncurry Cu-Au deposits and the Cannington Zn-Ag deposit.

GOA is targeting a geophysical anomaly and is discovering zones of multiple veinlets running 2-4% zinc and 60-140g/t silver. For preliminary drilling these results strike me as highly significant. Ok the negative is that the minralised zones are being struck at 300-400m depth. The upside might be a Mt Isa size underground deposit. So when you consider this company is capitalised at just $9.3 million, its quite possible this company has huge upside. Its still early days but the tenure of the grades and widespread occurrence of mineralisation I think point to a future mine. The question is whether there is something more significant at 800m depth. Ultimately we are not going to know for another 6months - by which time they should be looking at drilling some much deeper drill holes. In the interim they will be drilling shallow holes to determine the structural controls. But with gold & silver about to go very high over the next few years, the market is going to find very few prospective silver stocks. There is just Macmin (MMN) offering significant silver exposure, so I see this as an opportunity to get in early. Nevertheless I've never been one to buy and hold. So try to avoid those capital raisings. That is hard as capital raisings tend to be paired with drilling results.

- Andrew Sheldon www.sheldonthinks.com

BC Iron Ltd (ASX.BCI)

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I learned about this stock in the process of researching Alkane Exploration (ALK). ALK has a 16% stake in BCI, and whilst I like ALK, I dont see it as a buy for another year or two, since its attractive zirconia and gold projects still need some work.

The attraction of BCI is that they have a large iron ore exploration area just north of one of the front-runners in the iron ore game - Fortescue Metals (FMG). Already Fortescue have tied up marketing agreements with a Chinese buyer, and its likely that FMG will emerge as a large (iron ore) mining house. So why not buy FMG you say? Well thats not a bad idea, its just that the returns are likely to be better on BCI, but FMG might be considered a lower risk investment by many. I dont think so...but it seems to be convention that bigger stocks are safer.

BCI's project has had little work done on it, but preliminary investigations suggest there are areas of good iron ore content. The project areas are 70km from the Fortescue loadout facilities, but of course its likely that the rail line would be extended to the mine in cas of production.

In case you are wondering why FMG-BCI, you need to understand that iron ore consumers have a vested interest in negotiating supply agreements with smaller companies like FMG. For the last 20 years, Rio Tinto, BHP Billiton and CRVD (Brazil) have been consolidating control over iron ore production worldwide, and have lead in price negotiations. The Chinese, Indians and other consumers have a vested interest in breaking that 'cartel' by offering purchasing agreements and finance to alternative suppliers.

FMG has already negotiated access to the BHP rail infrastructure and are building a new loading port on the WA coast. By tying up with FMG, BCI will gain access to FMG's infrastructure. For a $60mil -odd company thats alot of leverage. Its possible that FMG will eventually takeover BCI. It seems likely.

Mind you - there are alot of iron ore projects....so expect future price weakness. But given the cost of establishing a new mine & supporting infrastructure, as well as the current shortage of mine services, it seems likely that over-supply is likely 5 years away. I see significant price weakness then because:

1. A plethora of new iron ore mines

2. A fall in iron ore (steel) demand because of rising interest rates globally.

Anyway, you should have fun in the next few years on commodity stocks. Looking at the technical analysis for this stock, its apparent that we ae looking at an ascending wedge with 2 plausible growth paths. The $2.10-2.20 levels are going to prove to be tough resistance levels, so I would advocate taking profits at these levels. The stock price is currently $1.45 - so that doesn't leave much upside. The reality is - I cant see any short term break out (above $2.20) because they still have alot of work to do. But given the tie-up with FMG I might be proven wrong on this. The reality is that it really depends on how much supply FMG can contract and whether FMG can service that ore from its own leases. It would be prudent for it to defer BCI developmenr until its ore deposits reach a mature phase of development. Given that risk, I see this stock as a speculative BUY, and FMG as the safer entry. But having said that....I prefer gold and silver.

- Andrew Sheldon www.sheldonthinks.com

Gold stocks - Sept 07

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Well as posted on my Commodities Trading blog I have a renewed interest in gold as previous resistance appears to be falling and gold seems destined to rise, and after testing $720-730/oz, rise even further. The question is - where does the best value lie in gold stocks.

When you review the market you realise that there is surprisingly little exposure. We can look at 2 types of company:
1. Established producers: I like emerging small producers that are cashed up, debt-free, unhedged, offer significant leverage as well as having significant resource upside.
2. Advanced projects: There are a host of companies that have no production interests but will have them within 12-18months. The benefit of these companies is that they will receive a re-rating at a time when gold prices are much higher, and the technical risks have fallen somewhat. We need to appreciate that most funds are run by accountants or actuaries that are 'conceptually blind'. You cant convince them of the value of a 'concept' - they need a feasibility study at the least, and even then they might be sceptical until those forecasts are converted into earnings. The added benefit of these companies is that they are often take over targets (if their resources are significant - say PRU) and they are able to lock in much higher gold prices to finance their project.

In Australia, I like the following companies listed on the ASX:
1. Bendigo Mining (BDG): BDG has one of the largest gold inventories in Australia, and its project lies in one of the most proliferate gold producing provinces in the world. At its peak of activity in the 1850s this gold province produced 40% of the world's gold. BDG has proven that the ribbon-type reef structures extend over a wide area, and even though the grades (and thus resources) were downgraded, they are still compelling value. The company has a 600,000tpa plant and is unhedged with $70mil in cash reserves. The newly appointed MD has not disappointed either. At 31c the company is valued at $158mil. With $70mil in cash, that places just a $88mil value on its project which has the capacity to produce 600,000tpa x 10g/t of gold = 200,000 oz per annum of gold. Thats amazing! Fund managers might however be a little slow crawling back into this one given the losses they incurred on the issue a year ago. But that has not stopped the State Teachers Union Super Fund of Ohio (USA of all places) from increasing its holding in the last week.
2. Sub Sahara Resources (SBS): SBS has a huge tenure holding in Africa - including JV interests in Tanzania, Eritrea and Ghana with a number of companies including Barrack Mines. Its Zara & Koka projects are the most advanced, however it has a number of other advanced projects with a focus on gold. The compelling value of this company was highlighted when Anvil Mining took a 10% equity stake in the company several months ago. I think this company will do very well as it has a huge portfolio of interests to trade with, and a diverse exposure that could yield some attractive discoveries. The intention with companies this size is to expose oneself to exploration upside. Capitalised at $40mil (at 8.7c), we can say a significant discovery in itself would double the value of the company.
3. Alloy Resources (AYR): I jumped on this one at 11c, its now 13-15c. They are an explorer, but I like that they are a mouse of a company hunting elephants along strike from some significant deposits held by the heavyweights Oxiana Resources and Pan Australian Resources (PNA). I will be hoping for greater gold content as opposed to copper, but I wont complain. The company should be close to releasing some drilling results, so I see that lifting the market.

These are not gold, but I still have MRX and MKY:
4. Matrix Metals (MRX): I still like this company even if its copper. I cant see copper prices coming off too much given that China is still growing so fast. Their project in West Qld is a cash producer, and I still see benefits from expanded output, not to mention the exploration upside. Current price 13c.
5. MKY: They had some attractive uranium soil sampling results 6mths ago and are currently drilling them. Uranium spot prices have come off but they are still high, so I'm expected a phenomenable rally if drilling results are good because the anomaly is quite large. Current price 4.2c

Tentative trading in MRX - Aug'07

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Hi all, I am trading aggressively just two stocks at the moment and keeping a sizeable amount of cash on the side. Why? Because I believe this market is going lower. I believe there is a lot more bad news to come, and fears might escalate if the credit rating agencies are called into question.

Most of the stock I am retaining is Matrix Metals (MRX.ASX), plus an explorer Alloy Resources (AYR.ASX). The reason being is that both companies were oversold and are expecting drilling results. Matrix is a low cost copper producer aggressively expanding output. It is ripe for a takeover by Xstrata if they find anything big. They recently entered production at are probably trading at a PER of 3x, and they have alot of upside besides. More importantly the chart is signalling to me a technical breakout.

The other stock Alloy Resources (AYR) is drilling a copper-gold target along the same geological trend as Pan Australian Resources (PNA.ASX). For this reason I am holding out for some excellent results which might just be the basis for a company-making mine. PNA have had some impressive results on this trend, so I'm hopeful for AYR despite the long development lead time.

- Andrew Sheldon www.sheldonthinks.com

Are you ready for the forthcoming gold boom?

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The global resources sector has had a bonanza period over the last 3 years, though the bulk of the fortunes made to date have been in the bulk materials (bauxite, manganese & iron ore), energy (uranium, oil, conventional gas, coal seam methane) and base metals (Copper, nickel, zinc, lead) sectors. The lagged has been the gold industry – particularly in the major commodity producing countries like Australia, South Africa and Canada.
Metal price Comparison
Looking at the returns of base metals, copper price was $0.80/lb in 1999 and now its around $US3.50/lb. Copper producers have never had it so good. Now consider the situation in the Australian gold mining sector. Despite a 70% increase in the gold price from $390 to $665 an ounce in the last 3 years in US terms, the 22% rise in the $AUD over the same period meant that the gold price in Australian dollar terms increased by just 40% from $555 to $775 an ounce.

Japanese gold producers have done far better given that the 7% depreciation in the yen over the same period means gold prices over the same period increased by 82%.
The fortunes of the gold industry
Currently the bulk of Australia's gold producers are facing difficult operating conditions, whether its staff or material shortages, rapid increases in mining costs or poor grade reconciliation. While their base metals peers have been raking in the profits, several gold miners have gone into administration, including BMA Gold, Croesus Mining and Gleneagle Gold. Others such as Batavia Mining and A1 Minerals have been forced to delay their projects rather than undermine the viability of their projects.
Consider that Barrick Gold's cash production costs rose 38% between 2005 to 2006 for its Australian and Papua New Guinean operations, whilst Newmont's costs rose 18% in Australia and NZ over a later 1 year period. More broadly, global gold cash costs have nearly doubled since 2001. Some producers have faired better than others, eg. Barrick has hedged much of its exposure to the Australian dollar at lower rates.
Gold outlook
Whilst the global economy becomes de-leveraged by falling asset prices and rising inflation, the gold sector is likely to benefit on both fronts because:
1. The value of gold to the total size of the global economy still has gold under-priced. Gold as we have already indicated has not risen like other commodities
2. Divestiture of other assets leads people into the safety of bonds, but gold for high returns. But gold is a very small market so expect volatility and significant price advances .

The paradox is that gold miners will benefit from the next leg of the gold boom for several reasons:
1. Gold was the laggard in the 2nd stage of the commodities cycle - but not this time - it will rise greatly whilst other metals fall off.
2. Gold (and other metals) will benefit from a weaker $AUD

Gold investment strategy
There is no question that gold miners offer superior exposure to rising gold prices than gold metal (coins or exchange traded funds), but you need to be selective. Consider the following:
1. Location: Seek gold miners located in non-resource based economies, or economies in which mining represents a small portion of the global economy (China, USA), as these countries will not experience stronger currencies as gold prices increase. There are a number of miners in Africa (Resolute Gold, Sub-Sahara Resources), Thailand (Kingsgate Cons), as well as explorers. Eg. Azumah Res, Castle Minerals in Africa.
2. Gold resources: Look for gold stocks that have a large inventory of gold resources because they offer a longer mine life. We are looking for a life of 15+ years. We are more impressed by miners that have large gold inventories because they are more likely to be taken over.
3. Low cost production: Look for miners with lower cash production costs, whether because they have higher grades than normal, significant credits for associated metals, or very favourable ore characteristics, eg. Large, tabular, shallow ore bodies suitable to cheap bulk extraction.
4. Low capital costs: Look for miners with low capital costs, whether because it’s a simple gravity separation process only, a cheap heap leach operation, or they have conscripted a third party plant for toll treatment.
5. No hedging: We don’t want to see gold price hedging, or if they have hedging, it should be for a small proportion of production or will be paid out soon. We should reflect favourably on producers that hedged their currency at lower rates, but any fresh currency hedging now would be a negative factor. We want maximum exposure to the gold price increase.
6. Scalability: We should look favourably upon gold producers who have the capacity to scale up production from existing plant through minor modifications or resource upside.
7. Discounts: We would prefer stocks trading at a discount to market parities. Particularly projects which have low gold grades, so they have the greatest upside from higher prices.
8. Options: We are particularly interested in stocks that have low-priced options because they offer low-cost entry into promising stocks.

A lot of Australian companies are looking outside Australia to find larger ore bodies, as well as to reduce mine costs. Sino Gold's open pit mining costs are one-third the Australian costs, while the salary of a skilled mining operator is about one-fifth of the equivalent Australian labour. This shift in exploration overseas and lost prospectivity has taken its toll on Australian gold production, since it has fallen to its lowest level in 15 years, whilst China had overtaken Australia as the world's third-largest producer. But the other reason gold exploration has floundered is because gold prices have lagged, so more money has gone into uranium, iron ore and base metals. The number of new IPOs for these metals has way surpassed new gold floats. But the major miners still like Australia and see it as part of a global portfolio with lower political risks helping to offset the higher costs.

- Andrew Sheldon www.sheldonthinks.com

Universal Resources (ASX.URL)

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In the process of doing some research for the copper stocks listed in my previous posting, I came across a comparison of copper stocks in a Exco Resources presentation. It is a table which computes the value of insitu (in-ground) copper resources in terms of stock market capitalisation (ie. $A market cap /tonnes of insitu copper). You might wonder why the discrepancy in values. For the most part its because of:

1. Stage of development - the stocks ranking over $1000 are in production, the stocks in the $300-500 range are still developing resources. They have not prepared a feasibility study so the project sponsor can't give you an accurate picture of realistic cashflows from the mine scheduling for ore block extraction. Without that info there is greater risk attached to the project.

2. Recoverable grade - Its apparent that most of the projects have a recoverable grade of around 1% copper. The exception is URL - with a grade of 0.73% Cu. That has to impact on mine profitability...but there are other issues - the big ones being economies of scale, strategic objectives and our forward-looking price assumptions.

So why is URL so low?

Before we get excited there are several things we need to know about URL. The company controls alot of copper - 933,000 tonnes of it, worth billions. These resources are spread among 10 pits, so there is even more upside in exploration potential around the mine planned pit margins and even underground potential below the pits.

The marginal grade of the ore has a big impact on mine value. The forecast cash cost of the mine is $1.10/lb compared to likely $0.60-0.80/lb for the other projects, which have higher grades and less onerous capital expenditure demands. URL need to raise $340mil compared to their much lower market capitalisation of just $25mil. Consider that if we assume an unreasonably high (current) copper price of $3.50/lb, the project has a NPV of $960mil. But if we assume a capital cost of $2/lb, the project has a NPV of $140mil. Thats a huge difference.

But consider the strategic value of a centrally located copper processing facility in one of the most important copper provinces in the world. Xstrata has recognised the potential of these resources since it has contracted to earn a 51% stake in the underground potential (below 200m depth) by spending $15mil. Really $15mil figures means nothing since they can withdrawal after a lesser commitment. In fact the company has screwed up because Xstrata - one of the world's largest copper miners, gets a strategic stake in a huge mine for little outlay, and effectively locks out the competition from dealing with URL. Companies like Teck Corp of Canada. Clearly these copper deposits and and any centrally-located processing plant associated with these deposits has a strategic value. The value its greatest for Xstrata since it already has significant capital invested at Mt Isa Mines (having taken over MIM several years ago). Clearly the deal is sweeter for Xstrata if it can:

1. Find higher grade copper ore through exploration

2. Take over other explorers with higher grade ores in the area

The URL clearly did not see the strategic importance of this project. I would argue that they should have got a firmer commitment on capital expenditures for the testing of the UG potential (the SEET project), or raised more capital to test the UG potential themselves...if only with a few deep holes.

Going forward, URL is a company with a $25mil market capitalisation (292mil shares at 8.8c) and $7mil in cash. Aside from some uranium exposure, the attributed value of their project is $18mil. That seems very low considering the exploration potential of its ground, the outlook for copper prices and established resources. For this reason I bought a stake, in the hope that:

1. Xstrata will make a takeover offer for URL after it has:

a) Proven that higher grade ore exists below the existing pits

b) Found higher grade ores in the area through its only exploration efforts

c) Taken over other companies in the area, or negotiated control over additional high grade ore

Any of these steps would justify Xstrata taking over URL. Given the lack of competition that URL management have effectively excluded, its likely that Xstrata will be able to purchase the company for about double its current value.

So this is a hard stock to pick because Xstrata need not be in a hurry...they have until 2010 to expend $15mil to earn their 51% stake. But in case you are thinking that copper prices might sink to $0.8/lb like they did in the late 1990s, think again...we are in the midst of a commodities boom driven by China, India and other countries. We are not likely to see copper prices under $2.00/lb for some time, and I think $2.50-2.80/lb is a more likely average price. So I see the URL project NPV around $300-500mil. But I dont expect shareholders to see much of that. Xstrata will play hard ball, just as they did over the Windimurra Vanadium project. It seems Xstrata is very good at extracting value from small company managers that under-value the value of their assets. The problem is a lack of commercial/strategic skills in our small mining companies. Take a look at the URL and you see geologists (scientists) and mining engineers (operations). You dont see commericial/strategic thinkers. Thats a problem...because thats a huge source of revenue/value.

I'm sure you are familar with the notion of Australia 'selling the farm' at extraordinarily low prices. Well its not just us, its foreigners as well, as its a global phenomena. Its a lack of capacity for conceptual thinking and the general knowledge required to support it.

Anyway I bought some URL because it offers value from:

1. Further exploration success - by URL or Xstrata

2. Prospect of a URL or neighbour takeover (Exco Res, Copperco)

3. Xstrata (SEET project) drilling success

Haven't decided if it will be a short term trade or a longer term investment. Lets see how the drilling results unfold. At 8.8c its unclear to me whether they will fall to 8c support or even lower.

- Andrew Sheldon www.sheldonthinks.com

Copper stocks - Aug'07

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You could be forgiven for thinking that the world is about to end, that the continents are about to slide into the sea...given the recent equity market slide. This is not totally unwarranted that stocks took a slide over recent weaks, but the rationale seems somewhat dubious. Personally I think its more about profit-taking than fundamentals. Or is the market worried about inflation? Well in any respect there seems little justification for the recent slide in small copper mining stocks in recent weeks - an average fall of 30% according to the Sydney Morning Herald. Gold stocks didnt fair as badly, perhaps suggesting that gold is deemed to have more upside.

Well we should be accustomed to mining stocks falling with the general malaise of the stock market, and we are accustomed to the spec-end of the market being punished more than the blue chips, despite some very favourable fundamentals. As www.basemetals.com/Copper has suggested copper prices have risen 22% this year to $US8,0000/tonne on the basis of tight stockpiles. London Metals Exchange (LME) stockpiles have fallen 42% this year, and more tightness is expected. Interestingly copper prices are still short of their previous high of $4.04/pound reachd in May 2006, but the market seems to be pricing in a fall based on the calamity in th sub-prime market. Might equity investors be seeing a fall before the metals market?

As we can see from the attached charts, copper stocks have fallen on average 30% to their support levels on the basis of a 4.8% fall in copper prices in recent days related to the sub-prime loan issue. Despite the uncertainties in the stock market, the downgrading of copper stocks appears excessive, and the attached stocks offer some good buying opportunities. My apologies this is not a very clear chart - the stocks are:
1. Matrix Metals (ASX.MRX) -at 13.5c
2. Exco Resources (ASX.EXS) - at 30c
3. Copperco Ltd (ASX.CUO) - at 87c
4. Redbank Mines (ASX.RBM) at 12c
Some pundits are expecting the Federal Reserve Board to respond to the weakness in the US housing market with an interest rate cut. I however dont expect as much....I think the Fed will hold the current line. I dont believe the Fed would want to signal easier monetary policy at times of higher commodity prices and tight labour markets, even if 'junk loan' end of the property market and a few funs managers and investors are feeling the pinch. There has been no collapse in earnings, and no significant reduction in credit outstanding....so there remains alot of money sloshing around the global economy, so expect markets to resume their climb. I am expecting copper prices to recover to their previous high of $4.04/pound reachd in May 2006.
It can be said that I have a suspicious nature, but when you consider that one of the reasons that copper prices are strong (supply is tight) is that workers at several very large mines in Mexico and Chile are on strike. That being the case, you'd have to wonder whether price manipulation is going on. Given that the market is driven by such short term factors....it would seem to 'profitable' for several senior mining executives at the major producers to conspire to hold off on pay rises in conditions of very high inflation in the mining districts to push metal prices higher. Why would they do that? Well - because its easy and profitable. Consider what it takes:
1. Several senior mining executives at a metals conference to get together for dinner and talk about metal markets....understand producers are largely price takers....with many producers and few refiners.
2. Only a few executives need to conspire to hold the status quo on wages, to cause strikes, to prompt a temporary supply shortage
3. After copper prices have risen by a significant degree, producers lock in the higher prices in the derivatives market
4. The executives then seek a deal with the miners which results in a concessional increase in wages, and they commence the resumed delivery of copper concentrates into the market by selling into those derivative (futures, options) contractual commitments

This is not an outlandish proposition.....its a small community among the major mining companies. They are constantly talking about prices given the dominance of these players and the benefits of holding the line. They are not really competitors since on prices but volumes. And when there are tight volumes, it makes sense to hold back some for higher prices. I am reminded of Amcor, a paper producer that was involved in price fixing years ago. I think that was a rare occasion that a groups of executives were discovered to be engaging in price fixing. I think its more prevalent than we know. Makes you wonder whether Osama Bin Laden is playing the futures market from some bunker as he blows up US Iraqis?
The only way we can determine if this is happening is:
1. Correlating price movements with strikes and derivative contractual commitments
2. Correlate spot and derivative copper prices to see if the derivatives market is questioning the soundness of copper prices

Disclosure: The author holds Metrix Metal stock.
- Andrew Sheldon www.sheldonthinks.com

Gold stocks - Aug 2007

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Gold stocks are one of the most compelling sectors of the equities market for several reasons.

1. Inflation is emerging

2. Gold is technically close to a breakout. You might be thinking that gold has already risen a great deal, but it has not kept up with the other commodities. See my posting on my Commodities blog.

The next question then is how do we position ourselves for this phenomena. We already have the major stocks trading at huge multiples, so its worth looking at some of the smaller stocks.

Listed on the Australian Stock Exchange (ASX) we have:

1. Bendigo Mining: This company has recently fallen off considerably after it revised its gold resource estimation model that culminated in a significant downgrading of its resource inventory. Since the downgrade the company has found new ore resources in new vein systems.
2. Resolute Gold: Resolute has an operating gold mine in Ghana, Africa and is developing several others.

Stay tuned for more info.

- Andrew Sheldon www.sheldonthinks.com

Specs in Platinoid Group Metals (PGMs)

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Few would be aware that there is a platinum boom going on. The reason is that the media does not cover the platinum market. Why? Its a relatively small market that is unlikely to sell newspapers. Rest assured a great many investors are benefiting. I have already updated an article on the Fundamentals of PGMs - see http://hot-metals.blogspot.com highlighting the price outlook for platinum and palladium - the 2 main PGM metals. So its now appropriate to look at the best entries into that market. Since platinum prices are already high, it makes sense to restrict our research to the following company specs:

1. Low capitalisation: We are looking for stocks offering maximum capital gain.
2. Advanced projects: We are looking at companies with a PGM project that has had a high level of exploration activity, so that its commercial potential is demonstrable. We also want them to reach production whilst prices are high or peaking.
3. Metal ratio: We prefer PGM projects with a high palladium ratio because they are likely to be discounted.
4. Location: We prefer projects located outside of South Africa because high PGM prices is likely to lift the currency, driving Rand revenues down as the currency rises against $US (as the PGM prices rise).

From previous research and current market analysis, I am already aware of some stocks:

1. Goldstream Mining (GDM.ASX): Goldstream is a diversified explorer, however its company-making project is a nickel-cobalt-PGM project in Tanzania, in which its joint venture partner Lonmin is earning a 50% stake by spending through to feasibility. As a result GDM has retained a considerable amount of cash to undertake other exploration projects.
2. North American Palladium (PDL.TSX): This company operates a PGM mine in the USA. See their website at http://www.napalladium.com.
3. AIM Resources (AIM.ASX): AIM is an emerging PGM producer situated on South Africa's Bushveld Complex. The problem with this compant is that it will be penalised by a higher Rand and any labour issues.
4. Aquarius Platinum (AQP.ASX): Aquarius was the first company to capitalise on rising PGM prices in 2000. It has since commissioned 3 mines as it moves towards PGM production of 600,000 oz per annum. It has acquired Zimplats, thus diversifying its PGM holdings outside of RSA. But it is still exposed considerably to a higher Rand.

- Andrew Sheldon www.sheldonthinks.com

Favourite gold stocks

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At this stage of the gold boom the majors have already realised alot of the price gains, so we can expect the greatest price gains in the small & emerging producers. There are several qualities we should be looking for:

Small & Established Producers

1. Low hedging exposure - preferebly only hedged from a higher or lower $A. I see the $A stable in the short term (1-3mths), rising in the medium term(3-12mths), falling in the longer term (1-3yrs)
2. Long life reserves - most analysts assess gold producers in terms of their revenue security, which can be assessed only if they have a resource within a mining plan (feasibility study). We therefore want to see in excess of 10yrs mine life.
3. Mine costs: We prefer established miners with the higher cost output because they have the greatest leverage to an increase in the gold price.
4. Location of mines: We prefer miners with projects in western markets, but better still if their projects are outside established gold-producing countries like Australia, South Africa, Chile, since a stronger currency will undermine mine revenues. Eventually the revenues have to be paid back.
5. Debt burden: Preferably the miner will have no or low debt, so they will be in a position to finance dividends or expansion.
6. Management: Preferably they will have management with commercial acumen so they are always looking to acquire under-valued projects.
7. Low cost capital expansion: Its preferable to buy companies that can implement low-cost capacity expansion. We want to avoid being diluted by capital raisings.

The companies with these characteristics in order of preferences are:

1. Emperor Mines (EMP): Its a high cost producer of 130,000oz per annum, so it has the most to gain from higher gold prices. Its based in Fiji, though the $Fiji follows the $A. Unfortunately it has diversified its assets by taking over other DRD assets in PNG, and its got shit South African management, which causes tensions with Fiji workers. Too risky.
2. Dragon Mine (DRA): Its established a new operation in Sweden, and plans a 2nd. It has exploration interests in Eritrea. I dont like the capital outlays required to get these small, scattered projects into production, and the incessant need for hedging. It will rise, but a disappointment in the making.
3. Resolute Mining (RSG): It operates several gold mines in Africa (Tanzania & Namibia), and Ravenswood, Qld. I dont know enough about this company.
4. Perseverence Mining (PSV): They operate a bio-leach gold mine in Victoria producing 130,000oz per annum. Hedging is a problem.
5. Gallery Gold (GGN): They produce gold in Africa. Know little about this company.

The companies I don't like on these terms are Dioro Exploration (DIO) as it moves underground.

Emerging Gold Producers

The risk with emerging gold producers is that they the gold price action supporting the market might be over by the time they commence production. The qualities we look for are:

1. Reserves: Looking for the maximum ounces, even if they are not currently in the mine plan because of the current price of gold.
2. Capital cost: Looking for miners that can establish a production capacity for the lowest possible cost. If a company needs to finance plant, they are likely to need gold loans (hedging) to finance it. This means they are limited in their upside exposure to higher gold prices. It also means it will be longer before they can pay dividends. The best producers are those close to several treatment plants (for toll treating) or have had the forsight to purchase a 2nd hand plant.
3. Cash reserves: We are looking for project sponsors with sufficient cash for the next year (preferably over $1.5mil) because we don't want to be diluted by a share issue, nor have those new shareholders dumping their stock in the market.
4. Mine costs: Looking for projects with low unit mining costs to ensure that we are supporting a project with a high Net Present Value (NPV).
5. Upside: Some type of upside in the company, whether investments, other projects or adjoining exploration targets.

By these stakes the best emerging gold companies are:

1. Gleneagle Gold (GLN.ASX): They have a strategically located treatment plant in WA and a significant resource which can quickly be commissioned using their established gold treatment plant. Very quickly they can go from an explorer to a producer. They have alot of exploration upside. Currently 28c - target 70c.
2. A1 Minerals (AAM.ASX): They have a very attractive gold project in WA close to the old Sons of Gwalia gold plant. They have high grade gold close to the surface. They have alot of exploration upside. They are promising because they might not need to purchase a treatment plant to get into production. Currently 26c - target 75c.
3. Great Basin Gold (GBG.TSX): This Canadian-listed company is developing 2 exciting projects. The most attractive is a 1Moz resource on the Carlin Trend in Nevada, which is currently being developed by a JV partner. They have alot of exploration upside. I recommended them at 90c, now $2.30. Target? No longer follow this stock.
4. Red 5 Ltd (RED.ASX): They have 1.7mil oz of resources and a relationship with Anglogold which will help to finance the project. They have alot of exploration upside. This company is under-performing because it contracted out mine services, as a result the project is behind schedule. The IRR was not great either. But alot of exploration upside. Will they need to hedge forward gold output? Risk?

These are the best gold stocks I can recommend. They stocks will multiple in value over the next year by about 300-500%.

Factors for assessing mining & exploration stocks

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The factors pertinent for assessing resource stocks varies depending on the nature of the business. There are basically 3 stages in the evolution of a mining company. Most companies tend to be reconstructed, liquidated, recapitalised or taken over by other companies before they have a chance to mature. The 3 stages are:

1. Exploration company: These are small teams of geologists & mining engineers searching for minerals. They will tend to be pursuing grassroots 'conceptual' targets or attempting to expand or re-test an old target, whether demonstrated minerals exist, indicator minerals, proven ore zones, or perhaps have acquired an old treatment plant hoping to find more resources. These companies typically have less than $3mil in cash and tend to disappear when a boom collapses.
2. Mining juniors: These are companies that have managed to discover, delineate, develop and commission a mining operation. Solely relying on cashflows from a single mine, these companies often have a limited life unless the discovery proves to be a 'company maker'. Bonanza discoveries are rare - except at the top of the resources boom when alot more money is being spent on exploration.
3. Middle rank miners: These companies emerge through the successful developement of several mines or the merger of several mining companies.
4. Multinational miners: These companies tend to arise from the merger of even larger companies. They tend to have their origins in important mineral centres like Broken Hill (BHP Billiton), Mt Isa (MIM) and Nevada (Newmont).

These 4 stages have some relevance to the share price performance of the company. Exploration companies are listed on the stock exchange in the middle to late stages of a boom when capital is readily available. Over time the quality of such listings deteriorates as good projects become scarce. Brokers are only too willing to place their clients money at risk to support a capital raising since they are earning commission on the listingg. If the broker is getting more than 5% commission, or offers free options, its usually a dog, or difficult market conditions. The level of over-subscriptions is also important, and such listings will usually enter the market at a 100-200% premium. New listings are attracting maximum exposure, and tend to fall from then on, unless they are able to maintain the momentum with successful drilling programs. Eventually these companies fall victim to investor impatience. It takes anywhere from 2-5 years to get a mining project into production. In that time there is alot of money to spend, and considerable potential for surprises. Eg. Samples could be tampered with, the orebody could be faulted, the metallurgy could be difficult, metal prices might collapse.

Successive drilling programs see the share price of the best stocks go sideways, and the less compelling stories go down. Generally they are not worth touching until the results of the Bankable Feasibility Study (BFS) are released since that is the point the project can be financed - as long as the Internal Rate of Return is over 24% (before tax, equity basis). Ensure that the sponsors are using conservative parameters for currency & metal prices. The release of the report is a good selling opportunity. If its a bad report, hold off selling because metal markets might move in your favour, and often the project can be re-engineered to reduce costs. eg. Using 2nd hand plant, production of a concentrate rather than a finished product, etc.

After the BFS is completed, its not worth investing until the mine is close to production. Even then the company is often a long way from paying dividends because most have to carry alot of debt. The upside on metal prices is restricted by hedging metal prices and the Forex rate. Many companies also have further capital commitments if they have to go underground.

Since there are a multitude of opportunities to invest in the mining sector, we are looking for the most attractive companies and projects. Small companies have attractive features (like capital gain), but large companies offer diversification and have regular cashflows and dividends. Small companies tend to be more cyclical, but in absolute terms the large companies have more to loose, and the small companies more upside. Each investor needs to consider their risk-reward exposure.

Assessment of these 4 stages of a mining company are very different, but are highlighted below.

Exploration Companies

The factors pertinent to assessing the merits of an exploration company are:

1. Capital structure: Its preferable that they have a low market capitalisation. The lower the better. Any discovery will result in a larger gain in the share price.
2. Cash: You don't want an exploration company to be under-capitalised (less than $1mil cash) or over-capitalised (>$4mil cash) because this exposures you to dilution, or reduces the upside. Established investors would prefer new shareholders buy in at higher prices to lock in a share premium.
3. Management: Its preferable that they have experienced & ambitious management. They should have an applied background rather than an academic one. The CEO should be a geologist with commercial skills not an analyst or accountant. He should be well connected and competent.
4. Targets: The quality of a company's exploration interests can say alot about the quality of the management.
5. Focus: The commodities upon which they are focused should be of interest to the market NOW - not in 5 years. Otherwise you should buy later. But ultimately the investment decision depends on the value of the project. A great project will be valuable at the depths of the commodity cycle, and likely worth waiting for. Use charts to pick an entry point.

Most exploration companies target low grade haloes to old mines, the depth extensions to them, or they might seek virgin 'grassroots' exploration areas. Given that most developed countries are over-explored by comparison to South America, Asia & Africa, a great many companies are exploring in these areas. This is a benefit to shareholders because the exploration impediments are often lower, and the areas are more prospective for larger discoveries. Thats not to say Australia is depleted - far from it. Large discoveries are sometimes made after a multitude of explorers passed an area off, and there is still potential at depth as more sensitive instrumentation and improved software allow better detection of 'concealed' orebodies with only a geophysical expression.

Minerals are usually discovered in established areas, though every so often an explorer will make a fresh discovery, often based on a conceptual target established by a mineral province elsewhere, which suggests a mode of formation applicable to other areas. Other explorers peg claims in similar or nearby areas hoping to identify repetitions. Mineral deposits with a lithological or structural control pointing the way. Many companies will target grassroots targets offering several prospective models for mineral accumulation.

Once a mineral deposit is identified we are concerned with the following issues. The less we know the more the risk, and the greater discount we apply to the discovery. Net sum we consider:

1. Potential size & grade of the mineral deposit to determine the in-situ mineral content
2. The distribution of the ore zones to determine if they will readily fit into a mine plan, as well as impacting on the scale and cost (selectivity) of mining. Is the orebody offset by faults?
3. The geometry & depth of the deposit to determine the cost of accessing the minerals. Deeper deposits are more costly to drill define, acess with development drives and expensive to operate. Very deep mines require underground air cooling systems. eg. Fiji volcanic zone
4. The metallurgy of the ore to determine how much can be recovered and a rough idea of the costs of mining, processing & transporting the ore to customers.
5. Vested interests that pose a threat to the project, eg. environmental, land rights, export licenses, royalties, sovereign risk (political stability).
6. Market prices for the contained metals to determine the value of the ore and the availability of customers
7. The likely scale of mining to determine the life and scale of production (cost of mining).
8. The political stability of the country so we can be assured of the security of the company's title.

Most of this information will come over time. The initial focus is on the distribution of minerals and the strategic importance of the mineral deposit. A new discovery does not always sit in isolation. The commercial viability of a mineral deposit is much improved by the availability of a nearby processing plant. If a small project sponsor can commission a mine without building a new processing plant - it can pose a huge saving. W need to consider the location of each drill hole, the grades and their distribution downhole. We would prefer to see homogenous ore zones for easy mass-mining rather than multiple ore zones surrounded by barren material. This would require more costly selective mining. We would prefer little overburden and flat tabular deposits so the overburden ratio is minimal. We would like to see a higher grade zone near the surface to offer a rapid cashflow - perhaps to finance expansion or pay off debt quickly. We hope their will be alot of ore amenable to Open Cut (OC) mining, so we can delay underground (UG) development. If there is UG development better that the project is in the mountains where we might be fortunate to get horizontal access to the ore zone quickly.

Junior Miners

Junior miners trade at a premium to explorers because they have an established cashflow which can be used to finance new projects or expansions. This means shareholders are free of issues diluting their equity, but they are somewhat exposed to 'technical' and 'market' surprises like falling commodity prices, or disappointing drilling results. Better if there are a number of projects so the companies interests are diversified if the shareholder is not. The focus on these companies are of a more commercial nature, as the risks shift from technical to earnings-yield concerns since the technical risk has been diversified. Consider the following:

1. Cash costs: After they have paid off the debt their cashflow is basically profit after exploration, amortisation, depreciation, administrative, royality and expansion costs
2. Hedging: Investors want exposure to the upside. Unfortunately companies with few assets need to hedge a portion (50%) of their reserves to secure project funding. Typically all the debt will be repaid in 3-5 years. As a consequence unhedged producers are more attractive in rising prices, and hedged produces more valued when metal prices are falling. Some companies like Sons of Gwalia have gone backrupt because of dubious hedging programs.
3. Forex rate: Its an unfortunate fact that when commodity producing countries like Australia, Canada and RSA benefit from higher commodity prices, local investors don't benefit as much because the higher commodity prices are neutralised by a rising local currency. For this reason miners situated in non-traditional commodity producing markets like Thailand (Kingsgate Consolidated) or Sweden (Dragon Mining) offer an added attraction. In contrast, gold miners in South Africa were going broke on recent high metal prices because the Rand rose too high.
4. Metal prices: A 10% rise in metal prices might well have a 30% impact on project earnings since profit margins rise faster. The impact is even greater on large-scale miners with high costs, eg. Emperor Mines in Fiji.
5. Mine Life: Investors, particularly fund managers, are very concerned about the stability of earnings. The biggest factor affecting mine earnings is mine closures, so its important that a company is able to expand its earnings and replace diminishing production capacity, either with new projects or expanding reserve inventories. This means that companies have to drill up areas years before they will be mined. For mine planning reasons, this is sensible anyway. Those mines with high capacity & long life are vert appealing takeover targets for the multinationals too.

Multinational Miners

These companies include Rio Tinto (RIO) and BHP Billiton (BHP). Such companies tend to be listed on a multitude of exchanges and have a highly diversified geographic presence. These companies have a very different strategy to the others - focused on the right strategic asset mix and assemblage of the right assets. The share the following characteristics:

1. Acquisition focus: They are less interested in maintaining exploration teams, preferring to finance small companies which operate on smaller operating budgets. Instead they will retain generous buy-in rights if the exploration area yields a resource of sufficient size to meet their criteria, eg. strategic asset, long life (20+ years), lowest cost quartile, profits over $30mil a year potential.
2. Metal mix: They are interested in having exposure to a diversified suite of minerals, in a broad range of areas. This allows them a stronger price negotiating position, as well as offering them the opportunity to reduce transport costs.
3. Sovereign risks: They have little sovereign risk
4. Value adding: They are interested in downstream processing opportunities like ferroalloys, powdered metals if that comes within their area of core expertise.

Because of the more secure earnings stream from these companies, they are more highly valued by institutional investors, particularly since there are very few resource companies which offer the stock liquidity to attract sizeable investments - apart from the oil industry. eg. Exxon, Chevron, British Petroleum and Shell.

- Andrew Sheldon www.sheldonthinks.com

Finding the best speculative stocks

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There is no single way to make money - rather each of us has to adopt a strategy that suits their skills, experience and character - not to mention lifestyle criteria. By default, I became a trader. Working as a mining analyst I was exposed to unethical practices, and was being turned away from opportunities because another wanted to 'monopolise the deal'. All this wore on my morale, and I realised I could make more money trading my own. I made $A55,000 that year, plus another $35,o00 trading my own money. Whilst I support 'insider trading' laws that unfairly prosecute people from benefiting from others knowledge, I dont think I should be prevented from benefiting from my personal knowledge.....just because there is a possibility that I might know something. The 'insider trading' problem is really a disclosure problem. Directors should be required to release information when it becomes available, and directors should be prosecuted only - not investors, so they get caught easily when something goes wrong.

Anyway the basis for my most profitable trading system is the following. Unfortunately few of you are in a position to benefit from it because it requires technical knowledge, as well as a bit of mining history. I have been doing this since I was 11yo (25years ago), when I started going to the Dept of Mines and stock exchange. Mining research was cheap back then, you could borrow reports for each company under the letter 'A' for $1.50. Most people researched a single share - I did them all - every report - every letter. That taught me what a good company looked like...often without reading the report. ...Just because of the way it was written.

There are several characteristics that made a good stock:

1. Potential of some kind, whether a large world-class resource whose time had not come, or an exploration target that showed great promise. Maybe its 'nothing', but such companies at some time become something.
2. Small market capitalisation, whether the company had a few shares at a high price, or 1billion shares at 0.1c, it mattered little if they were capitalised at less than $4million - even better if they had a few options since it gave me leverage. Not too many options that would potentially dilute the value of the company. You don't want stocks with partially paid shares or preference shares. Certainly not stocks with directors have control.
3. Attractive management, whether competent or just well-connected. When you have read as many reports as me, you know who are the better connected and competent mining executives are. Sometimes the company association is better than the name because there are so many executives with the same name, eg. Tim Carter. But some of them are guilty by association since badly run companies tend to attract bad people who will take any association. A well-connected mining engineer or geologist will always find a project. eg. Vulcan Resources is a case in pointt. Bought this thinly capitalised company's option at 5-8c, 3mths later I sold for 15-20c before results on its Russian project were released. The company shares fell from 50c to 14c, but my brother who retained them for tax reasons, sold them despite my advise. They will turn a new project again, better to retain them. Be careful of retiring executives wanting a company to 'play with' part time. You want young, aggressive management.
4. Cash in the bank: The target company should have some cash, at least $1mil, to give you a year so you don't have to worry about being diluted by new stock at a discount. And they should not be spending it quickly. They will also need cash for a new project, eg. to buy an option.

A listed company is a priced possession, particularly during a boom. It doesn't have to be a mining company. It might be a small company with a tangible asset that can be sold off, it might be a medical centre franchise easily sold off. The bigger question is whether the management can be bought out. That question often depends on the willingness of directors & major shareholders. You dont want the old directors staying around. Most will go. But its better to go with a mining executive with a history as a deal maker than an entrenched board sitting on a shell (or cash box) company. The reason is that they are still there because they are dug in, and no one wants to touch them.

When I bought Vulcan Resources opts (VCNO) back in 2003, no one was interested in mining stocks. After announcing that they had acquired a Ukrainan gold project with over 7km of development, I was amazed that others did not jump on it. No one was interested in a gold explorer which could be producing within 10mths. I jumped on. In the current mineral boom, I wouldn't get a chance. They would go into 'pre-open' and would open 50% higher, and might end 100% up. Its harder to trade such positions. It might open at their highs. Some go beyond fundamentals - others never get there. For this reason its critical to identify those companies offering potential before the deal occurs, or before the opportunity arises.

The opportunities appear in various forms, though the following styles are the most common. All of these opportunities are essentially contrarian positions - buying when no one else is interested. There are various schemes - but there is a common scheme - an unloved company abandoned by disillusioned shareholders.

1. Stalled by legalities: Some companies are abandoned by shareholders because they are in a legal straightjacket. For example, years ago Xstrata sold its Windamurra vanadium project to Xstrata in exchange for a royalty interest. Xstrata closed the mine to allow it to realise higher prices from its African vanadium mine. Xstrata over the next 10 years offered to buy out Precious Metals Aust, but they resisted. Only now with Vanadium prices high is that stock able to move, in anticipation of Xstrata restarting production.
2. Low commodity prices: Amazing opportunities are presented because stockmarket analysts are not interested in certain sectors of the market. In a cyclical downturn, mining analysts can't find work because there is no exploration, no need for mining finance. But in this environment I found a gem a few years ago. I bought Minotaur Res at 14c, opts at 5c because they were about to drill a huge geophysical anomaly 100km from the $US6billion Olympic Dam mine. The company was valued at $2mil, so little downside. The upside was spectacular. They eventually went to $2.80, opts to $2.60. Would have made me a millionaire. But I sold it because no news, and I thought I needed the money for a NZ holiday. That $2mil company became $200-300mil in 3mths.
3. Political stocks : There are stocks like Anvil Mining which are unloved because their mining interests are in a country experiencing civil war or destabilised government. I bought AVM at 12c, at a time when the UN peace keepers had come in to monitor the election proceedings. I got impatient with this one, after waiting a year, I sold out. Despite being in production, it still only valued at 1x earnings. Actually technically, I sold when I should have been buying. A channel breakout resulted - It went to 70c (600% gain).
4. Misunderstood commodities: The ascension of Australia as a financial centre is relatively new because this was not a sophisticated market 15 years ago. Things have improved. Analysts have more depth to monitor a broader variety of markets, and Australians are working in Asia too. But sometimes analysts just dont understand a market, and the stock is thus heavily discounted. eg. I made 3200% on Aquarius Platinum opts over 3years because Aust analysts did not understand platinum, and Sth Africans did not understand Open cut mining. It was not until the stock was listed in London that it got the attention it deserved.
5. Corporate shells: There are listed companies in Australia, Canada & RSA that are doing nothing, perhaps have some cash, but more importantly ambitious management who are project-hungry. Suddenly these unloved companies go from $2mil market cap to $20mil when they find a great project. They are targeted because they are an easy entry into equity markets, without the sponsors having to prepare a detailed prospectus for investors. Eg. Vulcan Minerals (VCN) - I made 300% on this one in several months. It was an easy pick because the company had announced it was looking at projects in Eastern Europe.

Such opportunities don't just pertain to resources. I often find such opportunities in the technology sector - my other favourite sector. But I can't expect to understand this sector as well because I've not grown up with them. But often I find these stocks flying. Often I'm not patient enough, and thus I've found technical analysis a great tool for timing stock entries. Trading psychology has proved to be my greatest obstacle.

The other aspect of trading such stocks is when to sell. I offer the following suggestions:

1. Cash backing: When cash reserves get too low ($400K) its time to sell - otherwise you risk dilution.
2. Technical exit: Charts provide a useful tool for determining when to exit a stock. The unfortunate aspect of using them for entries is that they might rise 100% in a day on a good announcement, so you miss out.
3. Fundamentals: Sometimes fundamentals give a good exit point. I assessed the value of VCN shares at 50c before I sold out. I got it.
4. Critical news: You should sell out before news that bears risk as you might be disappointed, eg. Don't wait for drilling results to prove you right. I've seen miners fall 70% in value overnight. VCN for instance when Russian drilling proved unreliable.
5. Lethargy: I waited a year for Anvil Mining to go up, but missed out. I was worried about the lack of disclosure. I sat on Aquarius because they always exceeded my expectations and offered great disclosure. This is a personal decision.

This trading strategy is a high risk strategy for those with little knowledge of mining, but very lucrative for those with such knowledge.

- Andrew Sheldon www.sheldonthinks.com