 If it looks
too good to be true...
Bob Moriarty
Archives
Feb 9, 2010
...it probably is. But you knew I was
going to say that.
Everyone knows that if something looks
too good to be true, it probably is. But the key word, the driving
force, is the word probably. Notice that I didn't say
anything about definitely. Never trust any wisdom that
"everyone knows." Everything that "everyone
knows" is certainly nonsense.
I went to Peru to visit a mining project
last week. I flew to Lima, spent the night at a hotel right at
the airport and got up early to fly to Trujillo in the north
of Peru to visit the La Arena gold/copper project of Rio Alto
Mining. (RIO-V) And my conclusion after a very short visit was
it literally looks too good to be true. That's why the company
is selling for maybe 25% of what it should be selling for. It
looks so good no one wants to believe their lying eyes. But it
is just as good as it looks and it's for certain not too good
to be true. It's the real deal.
Let me give you a little background so
you can put it into context. Cambior discovered the project in
1994 and began to advance it. They spent $30 million to complete
a 60,000-meter drill program outlining a 4 million ounce gold
resource and an additional 2.9 billion pound copper resource.
Cambior was taken over by Iamgold in September of 2006.
To be technically correct, La Arena is
more precisely defined as a gold-rich copper porphyry containing
about $13 billion dollars of minerals at their gross metal value.
That's a fairly meaningless number because they won't mine that
much and they won't recover that much but you can use it to compare
one project to another. Any $13 billion dollar project is pretty
big. Actually any 4 million ounce gold project is pretty big.
Any 2.9 billion pound copper project is pretty big as well.
After developing the project to the feasibility
stage, Iamgold decided they should sell the project. Iamgold
is a $5 billion dollar company. Believe it or not, this is a
small project for them from a gold perspective. And they don't
want to be in the copper business. Too small for them, in the
wrong area, just right for someone else. The project went through
a bidding process and by December of 2007 Iamgold agreed to sell
La Arena to the then private Rio Alto for the princely sum of
$47.55 million.
Things were going just fine until the
Global Mining Crisis hit in September of 2008. Like many other
companies in mining that were project rich and cash poor, Rio
Alto suddenly found themselves without cash even though they
had been promised financing for the $47.55 million and $30 million
for an open pit, heap leach operation. With their backs against
the walls, they did a sort of friendly merger with cash-rich
but project-poor, Mexican Silver Mines. The merged company ended
up with about 75 million shares outstanding, $5.5 million cash
to move forward with the project and management shared across
what had been two companies.
Before the merger with Mexican Silver,
Rio Alto sat down with Iamgold to renegotiate the deal. The original
deal called for all cash terms. Iamgold settled for an option
on the project with a $1 million dollar payment in Rio shares,
a $30 million dollar work commitment to earn 38.7% and a final
payment of $47.55 million US to be paid by December of 2012.
A key issue in the renegotiated deal was that Rio Alto was able
to get Iamgold to agree to allow Rio access to 100% of the cash
flow from production from the gold oxide project. In other words,
you build the mine and pay for it out of 100% of the cash flow
from production.
That's a deal, that's a hell of a deal.
Or course Rio Alto wants to spend the $30 million to earn in
38.7% of the project as soon as possible. They envision a cost
of $30 million to have the open pit oxide gold being stacked
and leached by Q4 of 2010 at a rate of 10,000 tons per day. First
year production will be 50,000 ounces at a grade of about .7
gpt Au advancing to 24,000 TPD in 12 months with annual production
of about 100,000 ounces of gold a year for 5-6 more years.
The copper has been leached out of the
oxide ore so there will be no copper production until Rio has
finished with the 540,000 ounces of gold production from the
oxide portion of the mine. By then Rio will have generated enough
cash flow to be able to finance a plant doing 10 million tons
per year at a grade of .4% Cu and .3 gpt Au. The mill will use
a conventional crushing circuit and ball mills combined with
a flotation plant to produce a copper/gold/moly concentrate.
Rio anticipates production of about 100 million pounds of copper
and 60,000 ounces of gold over a 15-year mine life.
Rio Alto's General Manager Jaime Soldi
met me in my hotel. We flew up to Trujillo and drove about 4
hours to the project. It's a porphyry project, looking at the
core doesn't tell you much but we went over the maps and their
plans. The oxide portion of the deposit sits on top of a hill,
there will be a low strip ratio and gravity will help save money,
as the leach pads are a short distance down the hill in a small
valley.
Porphyries are typically very large but
low grade. With a starter pit grade of about 1 g/t gold,
this is a fairly high-grade system. We would go over the numbers
once we got back to Lima the next day. But there are six mines
totaling over 20 million ounces of gold within 30 km of La Arena.
Barrick's giant Lagunas Norte gold mine producing some one million
ounces of gold a year is located only 18 km to the west.
The project has a lot of blue sky. Cambior
wanted to define enough gold to make a production decision and
they would have but they were taken over by Iamgold who didn't
need the project. It's perfect for a junior who has mid-tier
expectations.
The project is located at 3,400 meters
elevation and since we didn't need the headaches and lack of
sleep that accompanies a quick visit to higher altitudes we promptly
returned to Trujillo in the late afternoon, had an early dinner
and got a good night's sleep. The next day we returned to Lima.
Jaime took me to the office of Rio Alto for a technical brief
by the consultants working on the project design.
Their figures show a cash cost of production
per ton of gold oxide ore of about $4 a ton for the first year,
decreasing to $3.50 a ton once production levels of 24,000 tpd
are achieved. That's a lot lower than I expect to hear from even
a heap leach scenario so I questioned the number. I'm more comfortable
thinking in the $6-$8 a ton range.
To save startup costs and management
issues, Rio Alto is taking the approach of using contract miners
and Peruvian consultants for technical design of the project.
They have passed the project numbers by five contracting groups,
some of whom are working in the immediate area. The number of
$4 a ton is rock solid. Peru has an efficient and inexpensive
power grid and they will be buying power for about $.05 a kilowatt-hour.
Metallurgical tests show that Run of
Mine (ROM) ore will deliver about 70% recovery over 120 days
of cyanide leaching and 76% over the Life of Mine. (LOM) The
gold is located in the fractures of the rock so crushing to a
smaller size isn't required. That saves energy and capital.
Back of the envelope calculations by
yours truly show a gross metal value at today's gold price of
about $35 a gram of $24 a ton gold and net revenue of $16.75
at a recovery of 70%. There isn't a business in the world or
a mine in the world that wouldn't think a 75% margin is just
great. Rio can produce gold with costs of $4 a ton and revenue
of $16.75. They think they can produce gold at a total cash cost
of about $420 an ounce over the 5-6 year life of the gold oxide
project.
If La Arena was the first project in
this area, I'd seriously question the numbers. But with production
of over a million ounces of gold a year nearby with the same
ore and the same issues, I'd call Rio's plan a slam-dunk. They
aren't reinventing the wheel; they are using a cookie cutter
to do exactly what everyone else in the neighborhood is doing.
All of the issues they expect to run into have already been sorted
out by others. All they have to do is execute a plan that has
been tried and proven.
After the technical briefing I visited
with Alex Black, COO and Director so I could sort out all the
questions I had. Alex, who lives in Peru with his gorgeous wife,
had been President and CEO of the original Rio Alto prior to
the merger with Mexican Silver. He was the driving force who
was responsible for identifying and picking up the La Arena project.
Rio has done a lot of things really right.
While top management is Canadian and Australian, it's a Peruvian
run project. Many Canadian juniors come to Central and South
America without understanding local issues. From the gitgo, this
has been a Peruvian project. They are using experienced contract
mining and contract technical people.
They understand they don't need to create
an empire, just need to get a simple project into production
cheaply. I looked at their G&A figures as part of the cash
costs and realized I wasn't dealing with the typical Canadian
junior trying to do a stock promotion and surrounding themselves
with a highly paid staff of dozens. These guys are miners and
they intend to get this into production cheaply and earlier than
promised at a lower cost than promised.
Unlike many of the other Canadian juniors
operating in Peru, Rio understood the value of listing on the
Lima Stock Exchange. That's a really smart move. They were able
to do a $6.1 million PP in late 2009 easily on the exchange.
It's a good move others would be wise to emulate. The Lima exchange
has in the past given a higher value to silver and lead projects
than Vancouver. Right now Vancouver is setting the price for
Rio Alto shares but I suspect that in the future, Lima will be
the market maker and Vancouver will follow. I believe companies
who list in Lima will have higher market values than those who
don't.
So after much rambling on my part, we
get back to the central issue. Rio Alto looks too good to be
true. For an investment of about $80 million total, they will
own a mine with an equivalent of 10 million ounces of gold or
5 billion pounds of copper equivalent. That's $8 an ounce. That's
like stealing. And it almost is. Because when they have invested
the $30 million necessary to put the oxide gold portion of the
mine into an open pit heap leach production, they can use 100%
of the cash flow to pay off Iamgold. That does seem too good
to be true.
But you have to look at it from Iamgold's
point of view. They own 8.67% of the shares of Rio and stand
to receive about $47.55 million more for a project they want
to get rid of. They would be thrilled to get paid out of cash
flow. If you use Desert Sun's Jacobina project as a model, 105,000
ounces of gold production a year was worth $700 million. If Rio
Alto falls on their face and totally fails, Iamgold gets the
project back. If they put it into production, Iamgold makes a
lot of money. That's a good deal for everyone.
Including Rio Alto shareholders.
There is an issue I do want to cover
because I have my own point of view on the subject. I hate shareholder
dilution. Rio has several options to choose from in financing
the project to production. They are well cashed up now with about
$6 million in the bank. They need another $25 million by May
when the big expenses start as they build the gold oxide mine.
They finance by issuing shares or by borrowing against the project
or they can do a gold loan and forward sell some or all of their
gold.
The stock is absurdly cheap by any model.
With a market cap of only $35 million Canadian they are getting
less then $3.25 an ounce US for their gold. That's absurd. They
already have 93 million shares outstanding. At some point, when
you have issued hundreds of millions of shares, the shareholders
get no value out of production. I would not like to see them
do an equity financing. Likewise, borrowing money seems foolish
if it was even possible. Any lender would demand and get harsh
terms sweetened by a boatload of shares issued far too cheaply.
But they could do a gold loan where they
presell gold for delivery in the future at a set price. They
get the money now and deliver the gold in the future. They know
what their costs are so can work out just how much they need
to sell to raise the $25 million. That's what I would like to
see. I don't want to see a lot more dilution; it will kill the
future of the stock for shareholders.
If you look at the comparables, the other
similar juniors at a pre-production stage, they get between $21
and $206 an ounce for their gold ounces. I suspect that the convoluted
deal they had to cut with Iamgold confuses the issue but it's
a pretty simple deal once you understand the history and motives
of both Iamgold and Rio. It's a good deal for both of them. It's
an exceptional deal for shareholders, far better than the original
deal. It's just a deal that looks too good to be true and all
that's going to take is someone to come along who can explain
it in a simple way.
Regular readers of 321gold are well aware
that I have a bias for production stories, especially gold production
stories. The world's financial system is coming unglued as you
read. In the end we will go back to a gold backed currency because
there is no other choice as every country in the world defaults
on their massive debts. When that happens, you want to own shares
in a gold mine because they will have turned into, well, into
a gold mine, literally.
Rio Alto has brilliant management. They
understand Peru, they understand La Arena and they have a plan
that is excellent for shareholders. They will be in production
this year. This is the sweet spot where most of the risk has
been taken out of the deal. I don't even want to spend any more
time discussing how silly a price of $3.50 an ounce for gold
is. It's absurd and won't last for long.
I am going to buy some shares. I like
the story. I am not paid to write this piece, they are not yet
advertisers but I would be shocked if they don't feel like shouting
out their story from the highest hilltop. I am biased but in
a good way.
As always, we don't share in your profit
so we don't share in your losses. I'd encourage you to go to
their website and follow the story. Please take some responsibility
for your own life and finances and do your own due diligence.
Rio Alto Mining
RIO-V $.44 (Feb 8, 2010)
RIOAF-OTCBB 93.0 million shares
Rio Alto website
Bob Moriarty
President: 321gold
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