November 28, 2010
Spanish Mountain Gold Ltd (SPA-V: $0.60)
Spanish Mountain PEA confirms project as leveraged bet on gold
Synopsis: Spanish Mountain Gold Ltd published the results of a preliminary economic assessment (PEA) on November 23, 2010 for the Spanish Mountain pyritic shale hosted Spanish Mountain gold deposit in central British Columbia and the market was not particularly happy about the outcome. On October 8, 2010 following a property visit I published a Bottom-Fish Comment (Speculative DCF Valuation indicates good leverage to price of gold for Spanish Mountain) in which I applied guidance provided by management to generate a speculative DCF analysis which portrayed the project's sensitivity to the gold price. At the time gold was at $1,350 per ounce which level suggested the stock could be worth $1.50 per share using a 10% discount rate if the deposit went into production at 30,000 tpd and dilution beyond the existing 170 million shares could be kept at a minimum. The negative conclusion was that if gold dropped below $1,000 per ounce Spanish Mountain was dead in the water, a conclusion that did not sit well with the market but which was pretty much in line with the expectations of Ian Watson and his UK group who have been the financial backers of Spanish Mountain since Q4 of 2009. I concur fully with Ian Watson's view that Spanish Mountain is a leveraged bet on higher real gold prices, or at least the preservation of current prices as the long term status quo. The PEA, which envisions a 40,000 tpd open pit mining and milling operation, confirms my outlook, and on that basis I am issuing a Good Relative Spec Value Buy at $0.60 with a $0.75 buy limit and a 12 month target of $1.50 premised on gold staying at the current level of about $1,350 or higher without the development of inflation beyond the current 1%-2% level. Should gold approach $2,000 in a context where American inflation remains muted and a real gain in the price of gold is underpinned by a global investment trend to hedge against a long term shift of the balance of economic and geopolitical power from West to East, then we are looking at a price target of about $5. As far as bottom-fishers are concerned, I am maintaining my Spec Cycle Hold 100% recommendation from the original $0.20-$0.29 bottom-fish buy recommendation. The recommendation is "relative" rather than "absolute" because of the following contingencies: 1) Spanish Mountain must secure a memorandum of understanding (MOU) with the two aboriginal groups in whose jurisdiction the project falls, which social license CEO Brian Groves expects to have in hand by the end of December 2010, 2) both the gold bears and "fiat currency" based gold bugs must prove wrong in their gold price expectations, 3) whatever political party that ends up in charge of British Columbia will not revert to the anti-mining policies of the earlier New Democratic Party which imagined that tourists would spend lots of money to stare at stands of beetle devastated pine trees, and, 4) Ian Watson's group will find the will to exercise their warrants to raise the $5-$6 million Spanish Mountain needs to deliver a prefeasibility study (PFS) over the next 12 months rather than resorting to additional dilutionary equity issues. I have suggested that Spanish Mountain is a good substitute for my top "gold ounce in the ground" bottom-fish and spec value hunter pick Brett Resources Inc, whose Hammond Reef gold project attracted a successful takeover bid from Osisko Mining Corp this year at $4.78, but I do need to emphasize that Spanish Mountain is a less than perfect substitute for Brett, while also pointing out that for speculators seeking leverage to a higher real price in gold there are not a lot of alternative choices which are not bogged down by serious structural risks. My assessment is that Spanish Mountain will secure a "win-win" social license from the relevant aboriginal groups, my disdain for gold bears and apocalyptic gold bugs is something readers will simply have to disagree with at their own peril, British Columbian voters and politicians are not so stupid as to still believe that cowering in the shadow of America works well no matter where you are in the political spectrum, and, Ian Watson is not ignorant of the reality that for now Spanish Mountain and his group's stake in it lives or dies based on what he decides to do next.
Spanish Mountain's PEA displeased the market for a number of reasons, some of which reflect a somewhat clumsily worded news release whose confusing aspects I was only able to sort out after a lengthy conversation with Brian Groves. The most obvious problem was that although the new group creating the 43-101 resource estimate, AGP Mining Consultants of Barrie, Ontario, used a lower 0.2 g/t cutoff grade than the 0.3 g/t used by Gary Giroux in his March 19, 2009 estimate, AGP came up with a measured + indicated + inferred resource of 1,983,200 ounces gold compared to 4.4 million by Giroux at roughly the same grade for the same combined resource categories. To make matters worse, the news release mumbles about a 0.6 g/t grade being used to "constrain" the pit shell, which causes a brain seizure among normal people who associate a cutoff grade with a pit shell and cannot understand why the average grade of the deposit defined by a pit shell works out to 0.53 g/t when the "constraining" grade is 0.6 g/t. Well, apparently this makes perfect sense to the geo-statisticians who create resource estimates and has something to do with connecting the dots within the block model. The rule of thumb in the mining industry among executives who also do not understand this stuff is that if number-crunching results in a smaller number than was started out with, the smaller number is most likely closer to the truth.
To be fair, during my property visit Brian Groves pointed out that when a resource undergoes conversion to a reserve, the reserve typically yields ounces in the ground about 60% of the resource amount. This is not the same for disseminated deposits such as the porphyry gold-copper system of Dunham Craig's Tepal project in southern Mexico which is also the focus of a KBFO recommendation and which did not suffer a significant resource chop when Geologix Explorations Inc published its PEA. Brian Groves has pointed out that the reason Spanish Mountain underwent such a large "ounces in the ground" drop was that unlike a project such as Tepal, where the mineralization occurs as a dissemination across all lithological boundaries, Spanish Mountain has two styles of mineralization, namely a disseminated form hosted by a pyritic shale horizon, and a higher grade form associated with quartz veins which cross-cut the lithology. When a more conservative deposit modeling groups undertakes the conversion of a resource estimate into a mineral inventory, the mortality rate for gold ounces goes through the roof. In the case of Spanish Mountain there is an added complication in that the purpose of the PEA was to focus on a "mineable" resource, a mandate that AGP followed in terms of the PEA, but because of drill density reasons was not able to convert the resources into proven and probable reserves. The good news is that when the Spanish Mountain resource is formally converted to a proven and probable reserve, it is unlikely to undergo any additional shrinkage.
|Project Resource Estimate - Spanish Mtn|
|Nov 23, 2010||NI 43-101||Gordon Zurowski & Michael Waldegger, AGP Mining Consultants, Barrie, ON||Cutoff: 0.2 g/t Au |
|Note: Although this estimate uses the categories associated with a resource, the numbers reflect the rules applied to produce a reserve estimate prior to applying recovery, estimated at 90%.|
|Metal||Grade||Recovery||Contained Metal||% of GMV|
|Measured Resource||4,875,900||$46/t||Gold||1.05 g/t||100.0%||164,605 oz||100%|
|Indicated Resources||72,498,800||$23/t||Gold||0.52 g/t||100.0%||1,212,082 oz||100%|
|Inferred Mineral Resources||39,531,300||$21/t||Gold||0.48 g/t||100.0%||610,071 oz||100%|
|All Categories Spot||116,906,000||$23/t||Gold||0.53 g/t||1,986,757 oz||100%|
|All Categories LTA||116,906,000||$17/t||Gold||0.53 g/t||1,986,757 oz||100%|
|Spot Gross Metal Value||Market Cap as % of Net GMV||Spot Prices Used|
|LTA Gross Metal Value||Market Cap as % of Net GMV||LTA Prices Used|
|$1,968,120,965||5.2%||3 Year Average: Gold $990.62/oz|
Because the purpose of a PEA is to home in on a mineable as opposed to a "conceptual" resource that is only good for befuddling those who look at dollar per ounce in the ground statistics, Spanish Mountain ended up with a lower gold resource despite a lower cutoff grade. One can argue that this is a story about the subjectivity that goes into a resource estimate versus a reserve estimate, but the reality is that we are dealing with NI 43-101 definitions at whose expense Spanish Mountain has emerged as roadkill. Keeping in mind that I lack the technical expertise to make any judgement on this topic, the upshot is that the lower resource created by AGP is almost equivalent to a mineral reserve but because the drill density does not quite meet the requirement to call this a proven and probable reserve, it ends up being a smaller measured, indicated and inferred resource Spanish Mountain loosely describes as a "mineralized inventory". Nevertheless, until AGP converts the resource into a proven and probable reserve with minimal loss bottom-fishers or spec value hunters need to appreciate that there appears to exist a major disagreement between Gary Giroux and AGP about what Spanish Mountain is all about.
The table below shows what happens to Spanish Mountain at a 5% discount rate when different gold prices are applied to a constant cost scenario. Management believes that its metallurgical studies are already at a PFS level and believes that its main focus during 2011 will be to establish the engineering associated with the mining plan and to upgrade the resource to a properly qualified proven and probable reserve. The company chose to pursue a 40,000 tpd operation in part to pass the 150,000 oz per year hurdle many investors perceive as important, and because it believes that infill and expansion drilling will deliver the ounces needed to support a mining operation well beyond the 9-10 years implied by the current resource. About a third of the proposed 2011 $6 million program is devoted to converting the AGP resource into a reserve with minimal loss, while the rest is devoted to exploring on the edges of the deposit to beef up mining parameters (ie geotechnical drilling) and perhaps to recover laterally or at depth the ounces that AGP was forced to discard when it applied its resource estimation rules to Spanish Mountain.
Cash Flow Metal Price Sensitivity Analysis
|Spanish Mountain Gold Corp||Spanish Mountain||BC - Canada|
|Parameter Source:||Spanish Mtn PEA Nov 2010||Scenario Author:||JK||Primary Metal:||Gold|
|Metal Price $/oz :||$1,044||$1,378||$1,050||$1,100||$1,600||$2,000|
|Rock Value $/t:||$15.41||$20.34||$15.50||$16.23||$23.61||$29.51|
|Pre Tax NPV:||$36,147,535||$471,803,158||$43,332,261||$108,647,946||$761,804,801||$1,284,330,285|
|Pre Tax NPV:||$36,147,535||$471,803,158||$43,332,261||$108,647,946||$761,804,801||$1,284,330,285|
|After Tax NPV:||$980||$292,236,539||$4,976,160||$49,538,468||$483,070,377||$825,019,956|
|After Tax Cdn Price/Share:||$0.00||$1.72||$0.03||$0.29||$2.84||$4.85|
|Internal Rate of Return:||5.0%||21.5%||5.3%||7.9%||31.2%||47.3%|
|Mine Parameters||Cost Parameters||Other Parameters|
|Tonnage||116,906,000||Capital Cost||$447,000,000||Fully Diluted||169,986,433|
|Grade||0.51||Annual Sustaining Cost||$0||Net Interest||100.0%|
|Primary Metal||Gold||Net Smelter Royalty||0.8%||CAPEX Funding||100% Equity|
|Primary Recovery||90%||Marketing Cost||0.0%||Years to Startup||1|
|Primary Production||206,604 oz
||Mining Cost $/t||$1.54||Mine Life||9|
|Mining Method||Open-Pit||Processing Cost $/t||$5.12||CAD:USD Exchange Rate||1.00|
|Processing Method||Milling||Transportation Cost $/t||$0.00||Discount Rate||5%|
|Milling Rate tpd||40,000||Smelting Cost $/t conc||$0.00||Tax Rate||35%|
|Operating Days||350||G&A Cost $/t||$0.38||Payback Tax Holiday||Yes|
|Ore Mined Annually (t)||14,000,000||Reclamation Cost $/t||$0.00||Cost Inflator||0%|
|Waste to ore Ratio||2.00||Miscellaneous Cost $/t||$0.00|
|Concentrate||0.0%||Total Operating Cost $/t||$10.12||Currency||USD|
Conclusion: Spanish Mountain has put a lot of effort into demonstrating that what was once viewed as a quirky quartz vein controlled gold system is in fact part of an overall sediment hosted bulk tonnage gold system which lends itself to economies of scale when open pit mining is brought to bear. The PEA makes clear that Spanish Mountain is not an overlooked jewel that should have been brought into production during the past 30 years. It does, however, show that if the trend toward a higher real price for gold is not only real but sustainable, Spanish Mountain will deserve to be put into production.
*JK owns shares of Spanish Mountain