Unlearned lessons from the past
How soon we forget the lessons of the past. As little as three years ago, the investing world had written off precious metals entirely. I remember watching stocks; a week might go by and if a stock traded 400 shares, that was a big deal. Many stocks were selling for less than the cash they had on hand in the bank.
I went to a
gold show here in Miami along with maybe 14 other people. 13
of them had booths and one reprobate missed his turn, I suppose.
He was looking for a bridge to sleep under and lost his way.
He wasn't any more inclined to invest in precious metals stocks
than anyone else in the world.
I called a
top on April 2. I wrote the piece about 10 at night on the 1st
and Barbara begged off posting it until early in the morning. In the
I said that I was looking for a spike high in gold and silver
in the next few days. Well, between the time I wrote the piece
and when Barbara posted it, we got our spike. And as humble as
I am, I'll take credit for nailing the high. For as you see,
I am a true contrarian.
I love fear in the metals markets, it's the stuff bottoms are made of. There was one particular gold stock I was watching for signs of a bottom. It's a stock I've both owned and watched for the best part of two years. The difference in the company between two years ago and today is similar to that of chalk and cheese. On May 10th, that stock sold for less today in real terms than it did two years ago. So I called a bottom while blood was still pooling in the streets.
For a perfect example of how accurate true contrarian thinking is, here is a snippet from a Bill Fleckenstein piece of the same day. It, too, played a part in my thinking.
His call and mine nailed the bottom. And since I deal with contrary thinking, I can't possibly say how long this leg will last or to where it will travel. But until the dollar regains its long term intrinsic value, (hint:it ain't much) gold will remain in a long term bull market.
The stock I was watching was Desert Sun. To understand Desert Sun and how much the gold shares market has changed in the past three years, you need to read a little of the history of the Jacobina region of Brazil.
The town of
Jacobina lies about 150 miles northwest of Salvador in Brazil.
Salvador is the third largest city in Brazil behind Rio and Sao
Paulo. A massive gold belt runs through Jacobina. Desert Sun
has mapped and put claims on 110 KM of the belt. When the Portuguese
conquered Brazil they wanted two things, to convert the natives
to Catholicism and to find gold. You can guess which took top
place. Gold was found in great quantities around Jacobina area,
weathered from the quartz reefs. The area has been mined of gold
since the 17th Century and after taking a tour of Desert Sun's
property, I have little doubt there will be gold mining going
on long after I am gone.
William Resources couldn't have had worse timing, the Bre-X scandal blew up in 1996 and tossed the entire gold industry in the crapper. William tried to hang on but was forced by the abysmal price of gold to shut down the mine in 1998.
Eventually the price of gold did recover to the extent the project was once again possible. William Resources was faced with a tough decision to make. By this time, William Resources was up to about 400 million shares and the shares were trading in single digits. It's a choice all mining companies hate making when coming out of the bottom of a mining cycle, especially one as disastrous as the crash after Bre-X.
To advance projects, mining companies need to raise cash. When their stock is selling for pennies because they have so many shares outstanding, they are literally caught between a rock and a hard place. Their stock is low because they can't raise cash and they can't raise cash because the stock is low. In this case William Resources made what I believe is the right decision, they bit the bullet and started all over by selling an option on 51% of Jacobina to a new company named Desert Sun in May of 2002. William Resources did the mandatory rollback of shares and reemerged as Valencia with no project but at least some money in the bank.
In May of 2002, Desert Sun has a lot of energy in management and an interesting property at Jacobina which they could earn 51% of. Their stock was selling for about $.40 Canadian when the stock was a giant risk and gold was a miserly $320 an ounce. Investors who put their money on the table and rolled the dice were taking as much risk as you get in a gold junior.
Fast forward to 2004. Desert Sun now has $30 million in the bank, that's $.50 per share, more than enough to maintain operations for eighteen month without a cent of cash flow, is in the midst of a 40,000 meter aggressive drill program to increase reserves and resources, has claims on an incredible total of 110 Kilometers of strike length at Jacobina, has increased 43-101 resources to 1.36 million ounces in the measured and indicated categories and 2.47 million ounces of inferred resources. If you subtract the cash in the bank from the price of the stock on May 10, you could buy the stock for the grandiose sum of, get this, $.40 a share. Or the same price it was two years ago when conditions were far worse. And instead of having an option on 51%, Desert Sun now owns Jacobina entirely.
don't learn from their mistakes. I see so many people who want
to buy at the top and sell at the bottom and it's always someone
else's fault. Desert Sun now has management in place, 200 workers
getting the plant operational, they expect to begin production
of 100,000 ounces a year about nine months from now, Q2 of 2005.
They have money in the bank and 14 drills turning on the property
right now and investors want to pay what they did two years ago.
And they expect to be able to both mine and process 50% more
ore than under Anglo and William Resources.
I spent two days at Jocobina last week with Dr Bill Pearson, head geologist for Desert Sun. The town is a quaint little berg of 70,000 set in the foothills. My hotel was something right out of The Sound of Music. Since the town and local miners have been through the boom and bust cycle recently, everyone at all levels is eager to see the mine back into production. At full bore, they expect to employ over 300 workers.
Bill has 14 drill rigs working to expand the resources. He has a target for the year of 40,000 meters of drilling and hopes to expand the resource by 2 million ounces. I have seen the type of ore body. It's relatively low grade for underground mining but is in high angle reefs which is very easy and low cost to mine. Actually, anyone can look at the ore body and do a back-of-the-envelope calculation, their drilling isn't to find gold, it's to verify what they pretty much know they have.
At the same time, the COO of Desert Sun, Peter Tagliamonti, is driving his work force in restoring the $110 million dollar plant and equipment. That's how much Anglo invested, it easily could cost $150 million today to duplicate. That's worth about $2.50 a share and the market has it valued at zero. I like those odds. Peter and his group have studied how to improve the ore processing. They figured out that if they increased the leach time from 16 hours to 24 hours they could improve the gold recovery from 92% to about 96%. While a 4% increase in recovery doesn't sound like much, it all flows right to the bottom line and means about a 25% increase in profit. It might cost them $100,000 to put up the extra two leach tanks but they are already spending about $5 million to get the plant operational again.
Peter expects the plant to be fully operational and all permits in place by Q2 of next year. At that time, operational responsibility will turn over to Kurt Menchen who will be in charge of Brazilian operations. His experience with Jacobina goes back all the way to Anglo's first operations there in 1980.
in general are most profitable if you buy when no one wants them.
For all that Desert Sun and Jacobina have going for them, investors
don't value them very much more now than they did two years ago.
Investing at a profit is so simple that it passes over the heads
of most investors. You need to buy cheap and sell expensive.
Desert Sun is cheap. I just can't say enough about how impressed
I was with everyone at Jacobina including the drillers and drivers.
Everyone has this incredibly positive attitude. They are going
into production soon and they are going to be profitable. If
you like, you can wait to invest until they are in production
and the market is giving them a lot more value per ounce of resource
and production. But the price isn't going to be as cheap as it
Desert Sun has been an advertiser for two years. They are paying my expenses for the trip to Brazil but have not paid for this writeup. We do own shares in Desert Sun and obviously are as biased as we can possibly be.
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