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Summary

  • Mexico has seen a massive increase in gold production over the last 10 years.
  • First movers like Alamos Gold have really benefited.
  • Alamos' Mulatos mine is one of Mexico's finest gold mines.
  • Alamos has an awesome growth pipeline.

Mexico has been a popular destination for mining companies seeking out their fortunes amidst gold's secular bull market. And considering the huge lack of modern exploration across its rich precious-metals belts, some of the first movers, like Alamos Gold (NYSE:AGI), have found smashing success.

Since 2003 Mexico's gold production has increased by a whopping 390%. This equates to a 2.5m+ ounce increase in annual output, which has vaulted this country to #8 in the global ranks. Alamos Gold's Mulatos mine has been a big contributor to this growth, with 1.2m+ ounces produced since 2005. And with total resources remaining of 4.9m ounces, it still has a long life ahead of it.

Mulatos is located in the east-central portion of Mexico's Sierra Madre Occidental, in an area that saw its first gold mining nearly 400 years ago. When Alamos acquired this project, it knew that the miners of yore had only scratched the surface. And it didn't take long to determine that there was a large complex of deposits that were amenable to profitable mining.

CEO John McCluskey, who was Alamos' original founder in 2003, had the support of rising metals prices and a spectacular team of mine builders. And Alamos methodically developed Mulatos into one of Mexico's finest gold mines. Mulatos is mainly an open-pit operation, although some underground mining is now taking place to tap the higher-grade ore. In both cases the ore is geologically incomplex. And with all-around fabulous logistics, Mulatos' gold is produced at operating costs in the lower quartile of industry average.

In 2014 Alamos is projecting midpoint production guidance of 160k ounces, at cash operating costs of $650/ounce. All-in sustaining costs will also be relatively low, at an estimated $980/ounce. And this will allow it to build on an already-strong balance sheet that includes $400m in cash and no debt. It will also allow Alamos to continue to pay its 2%+ dividend, a bonus for a sector that usually doesn't return much capital back to shareholders.

Looking forward, Mulatos has enough proven-and-probable reserves for a mining life of at least 10 years at the current production rate. But this is conservative considering 2.5m+ additional resource ounces available for upgrade as well as a whole lot of upside discovery potential from ongoing exploration.

Mulatos will long be the flagship asset for this mid-tier gold producer. But Alamos has its sights set on becoming a multi-mine producer in the near future as it develops its incredibly strong growth pipeline. Up next will be output from a set of standalone satellite deposits in the Mulatos district. And down the road will come production from advanced-stage projects elsewhere in Mexico, Turkey, and the U.S.

The Cerro Pelon and La Yaqui projects are located just southwest of Mulatos. These satellite deposits are amenable to conventional heap-leach processing, which will be performed at their respective mining sites. They'll add about 60k ounces of production per year at cash costs under $400/ounce. And if surface rights are acquired and permits are received in a timely manner, Alamos is targeting 2016 for the first gold pour.

Alamos acquired its Turkey assets from a joint-venture between Teck Resources (NYSE:TCK) and Fronteer Gold in 2010. The Kirazli and Agi Dagi projects are located about 16 miles apart, and are both great candidates for open-pit heap-leach processing. These projects have seen a number of technical studies, the latest being a joint prefeasibility study in which Kirazli/Agi Dagi would combine to produce an average of 166k ounces per year, at cash costs of $544/ounce, over a 9-year mine life.

Developing the Turkey projects is a slam dunk from an economic perspective. And Alamos is smartly looking at sequencing their construction (Kirazli first) so it can self-fund the entire buildout. If Alamos plays its cards right it shouldn't need outside funding, which is a huge boon in today's challenging capital-raising environment. Permitting is unfortunately taking longer than expected. But once things get sorted out, Alamos expects an 18-month construction period.

Elsewhere in Mexico is the excellent Esperanza project. Alamos acquired this beauty via its 2013 acquisition of Esperanza Resources. And it too has been subject to a series of economic studies that show great promise. Esperanza's ore is amenable to open-pit heap-leaching, and the latest assessment has it producing 100k ounces of gold per year, at cash costs of $500/ounce, over a 6-year mine life.

Even though Esperanza has low technical risk, Alamos will conduct more advanced feasibility work in order to incorporate a bigger chunk of this project's 1.3m ounces of resources into the mining plan. And if the Turkey projects continue to be delayed, Esperanza could end up moving up in the development queue.

Last but certainly not least of Alamos' advanced-stage projects is its Quartz Mountain project located in Oregon. Alamos scored this project via a 2013 option agreement with Seabridge Gold (NYSE:SA). And it only has modest financial obligations to gain full ownership. Quartz Mountain has had $60m invested into exploration since the 1980s, which has served to delineate 2.8m ounces of near-surface resources. This project is subservient from a capex perspective for now, but Alamos will progressively seek to prove up the resources and perform an economic assessment.

As you can see, Alamos Gold has a strong pipeline that if fully developed would make this company a multi-mine low-cost mid-tier powerhouse. And we can't discount the possibility of it making greenfields discoveries and/or using its financial strength to acquire its next producing mine.

Regardless of how its next mine comes about, Alamos' stock ought to be a great place for gold-stock investors to be once gold picks back up. AGI has demonstrated its ability to provide great positive leverage to the metal in the past. And a confluence of recent events is currently affording a tremendous buying opportunity.

Like most gold stocks, AGI (in blue) tends to trend in the same direction as gold (in red). Also like most gold stocks, AGI had a solid run-up in the years leading up to gold's 2011 all-time high. What I want to look at though is how AGI has performed since, amidst a period where gold consolidated and then plunged to the abysmal lows we saw last year.

Given their risk/reward paradigms, gold stocks tend to amplify their underlying metal's gains and losses. They are certainly no fun to own when gold is falling. But they can sure be a blast when gold is rising. Unfortunately gold has fallen on balance since 2011, but there have been four meaningful uplegs to test AGI's mettle.

The first two were in 2012, amidst what was essentially a healthy period of consolidation following gold's apex. Each time gold delivered 15% gains. And each time AGI responded with great positive leverage. With trough-to-peak gains of 30% and 44%, it leveraged gold's uplegs by 2.0x and 2.9x respectively.

Gold's next upleg emerged out of the depths of its Q2 2013 panic. It rose 18% in what we had hoped was the beginning of a prolonged run higher to bring it back to normalcy. But unfortunately it ended up being nothing more than a relief rally that eventually gave way to new cyclical lows. AGI did respond though, with a spectacular upleg gain of 57% (3.1x leverage).

In each of these first three uplegs, it was definitely worth investors' while to own AGI. But as you can see, it definitely wasn't worth it in upleg #4. While gold rose 16% from late December to its March 2014 high, AGI fell by nearly 5%. Not only did AGI not positively leverage gold, it didn't even pace it. And to actually lose ground against the metal was quite disconcerting.

The impetus for Alamos Gold's underperformance was the announcement of its 2014 guidance. Now in isolation its 160k ounces mined at cash costs of $650/ounce is excellent. These costs are easily in the lower quartile of industry average, and will make for another solid year. Comparatively though these figures were somewhat of a shock. And investors obviously didn't take too kindly to them.

Over the previous two years Mulatos' average production was 195k ounces at average cash costs of only $391/ounce. This obviously fostered high expectations for this mine going forward. So with 2014's outlook guiding production down by 18% and cash costs up by 66%, you can certainly understand investors' deep dismay.

Interestingly the reasoning for this outlook was actually not a big shocker for those who follow this company. On the production front a planned transition to mining different zones will push through a lower budgeted grade for the mill feed. Lower grades naturally lower output while adversely affecting costs. Also contributing to higher costs is a planned higher waste-to-ore ratio, a transition to contractor mining, and general higher mining costs that are associated with increased tonnage from underground mining.

Unfortunately this outlook shocker comes at a time when there is little tolerance for surprises. AGI did deserve to pull back a bit, but it didn't deserve to sell off as hard as it did. Even at 2014's guidance, it is still one of the best fundamental plays in the space. And I believe investors currently have one heck of a buying opportunity amidst these oversold conditions, which may never be seen again once gold continues its run higher.

The bottom line is Alamos Gold operates one of Mexico's finest gold mines. Since pouring its first gold in 2005, Mulatos has produced over 1.2m ounces while generating over $1b in revenue. Not bad for a project that was acquired for $10m and built for $70m. Mulatos also still has sizeable resources remaining, which means it is still in the early stages of its mining life.

Down the road Alamos targets the development of its strong growth pipeline. And in the process of becoming a multi-mine producer it ought to continue to perform well for investors. Alamos has historically offered excellent positive leverage to its underlying metal. And investors can take advantage of the one time it didn't by buying low at bargain-basement prices.

(Global gold production data courtesy of the U.S. Geological Survey. Alamos Gold data from latest available corporate presentations and financial statements)

Scott Wright

May 30, 2014

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Source: Alamos Gold - A Top Mexican Mid-Tier