Cejay Kim of Palisade Research - Thu, Jan 28, 2016

It's Time To Buy Uneconomic Gold Companies

Gold Bars pic

It may sound counterintuitive, but now is the time to buy companies where gold will remain in the ground for the foreseeable future. It is a strange phenomenon, but for companies that own mega-sized gold projects, the best thing to do is nothing!

No, this is not the worst investment strategy in the world; it is intended to fully take advantage of the power of optionality or buying assets for the price of gold today, and enjoying the extreme and leveraged upside when gold prices increase. A pure optionality play is characterized by low G&A costs and minimal project expenditures — hence companies where management is lean and doing nothing.

To put this into context, let's look at a simplified case study.

(TSXV:CKG; OTC:CHPGF) Chesapeake Gold Corp. is a company led by industry veteran and serially successful, Randy Reifel. Chesapeake Gold owns 100% of the Metates Gold-Silver project in Mexico. The project boasts ~20 million ounces of gold with a cash cost of $517 per ounce. Unfortunately, it also comes with a $4.3 billion price tag.

In light of current market conditions and with a current market cap of C$80 million, Chesapeake's project is not financeable. This is despite having an in-situ value of C$31 billion. During late 2011, Chesapeake Gold's market cap peaked at ~C$750 million with the same asset. Since 2011, Metates has progressed considerably, thus a rebound in gold prices can easily warrant a ten-fold increase in share price. At that time, financing will once again become accessible and the market will reward advancing the project towards production.

Looking at the top 30 mega-projects currently in development, there is in excess of over 1 billion ounces waiting to be extracted. Here is a list:

PropertyCompanyReserves & Resources
(Au Oz.)
PebbleNorthern Dynasty Minerals107,630,000
Potchefstroom GoldfieldSibanye Gold76,149,204
KSMSeabridge Gold75,282,000
Sukhoi LogGovernment of Russia61,729,000
BaimskayaMillhouse Capital49,834,000
DonlinNovagold Resources, Barrick Gold45,000,000
Reko DiqAntofagasta, Balochistan Dev. Authority, Barrick Gold41,373,000
KlerksdorpSibanye Gold39,671,492
ERPM ExtensionDRDGold39,112,207
NatalkaPolyus Gold36,800,000
SnowfieldPretium Resources35,097,000
La ColosaAngloGold Ashanti33,150,000
Cerro CasaleBarrick Gold, Kinross Gold32,607,000
Armgold/OrkneyBlack Economic Empowerment31,764,000
Oyu TolgoiTurquoise Hill Resources, Government of Mongolia30,126,300
EvanderPan African Resources 29,743,000
Tujuh BukitPrivate Interest, PT Indo Multi Niaga29,531,250
Wafi-GolpuNewcrest Mining, Harmony Gold Mining28,458,000
Las CristinasCrystallex De Venezuela27,061,000
CaspicheExeter Resource25,081,600
Lookout HillTurquoise Hill Resources, Entre Gold, Sandstorm Gold24,667,000
BuffelsfonteinVillage Main Reef23,156,000
Pascua LamaBarrick Gold, Silver Wheaton22,818,000
Frieda RiverGuangdong Rising Assets Manage, Highlands Pacific20,497,020
BougainvilleRio Tinto, Private Interest, Government of Papua New Guinea20,175,850
LivengoodInternational Tower Hill Mines20,147,087
MetatesChesapeake Gold19,827,900
Far SoutheastGold Fields, Lepanto Consolidated Mining19,800,000
Elang-DodoNewmont Mining, Sumitomo19,711,000
BarlevskySupatcha Resources, Local Interest19,700,000
Source: SNL Financial

Subscribers should be familiar with several names we zeroed in on when we first wrote about optionality back in November 2015 in an article titled The Power Of Optionality: (TSX:XRC; NYSE.MKT:XRA) Exeter Resources, (NYSE.MKT:THM; TSX:ITH) International Tower Hill Mines, and of course Chesapeake Gold. All companies that have felt the wrath of the bear market, but are not without prolific gold projects.

Obviously there is more due diligence to do here; however, we emphasize optionality speculation should be part of every investor's gold portfolio. The possibility of a ten to twenty-fold increase in just one position can negate several dogs, and given the current markets there will never be a better opportunity to take advantage of this. This has been a tried and tested investment strategy for the largest names in resources, including Rick Rule and Eric Sprott.

In an interview we conducted with Rick Rule on Palisade Radio, Rick listed the ingredients for a strong optionality play as a company with enough cash to weather the storm, a disciplined management team with low G&A, and lots of patience!

In resources, you are either a contrarian or a victim. Which will you be?

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