Gustavo Larrea, the Ecuadorian government minister and confidante of President Rafael Correa, was reported as saying on Thursday evening that miners would be hit with a tax regime so strict that it would take away 70% to 80% of revenues. Or did he?
Larrea in fact told news agency Agence France Press that (translated) “in the new contracts with petroleum companies, the percentage (of revenues) left for the private company will vary between 20% and 30%, and 70% or 80% for the state”. He then went on to say that “these are the rules in Brazil, Colombia, Mexico and in Venezuela…and they will also be in Ecuador, same as for the mines issue.”
Textually correct, as one would expect from a quality newswire service such as AFP. Larrea was clearly talking about raising taxes on the petroleum industry and clearly not talking about slapping 80% burdens on miners operating in Ecuador. The reference to miners was fair comment about having the same playing field for resource extraction businesses in Ecuador as already exists in the other countries mentioned. Does anybody seriously believe that an 80% mining tax burden is the same situation as in Brazil? Or in Mexico? If so, they have bad news for Newmont, (NEM), Barrick (ABX), Freeport (FCX), Goldcorp (GG), Penoles (OTCPK:IPOAF), Southern Copper (PCU), CVRD (RIO) and hundreds of other large and small mining companies operating in LatAm.
Lost in Translation Again?
However, business media service Stratfor decided to report the story in the following way:
“May 24, 2007 21:31 GMT. Ecuador's upcoming Constitutional Assembly will be presented with proposed reforms to laws regarding foreign investment in the country so the state will be able to assume 70 percent to 80 percent of the earnings from the oil and mining sectors, Agence France-Presse reported May 24, citing Government Minister Gustavo Larrea.”
For those who are unaware, Stratfor likes being known as “the shadow CIA” of news intelligence services. We also note in passing that Stratfor, operating since 1996, is a mere puppy when compared to AFP founded in 1865.
“It’s socialism, Jim, but not as we know it”
The Ecuador government led by President Correa is undoubtedly left-leaning, but on the issue of mining it is clearly trying to foster a good working relationship with local companies. Only last month, Dynasty Metals (DMM.v) were awarded the last of the permits they needed to ramp their Zaruma project in southern Ecuador. At that time Dynasty CEO Robert Washer said that “… it clearly demonstrates the intention of the new government to support the development of the Ecuadorian mining industry”. He has also said that “it’s no more difficult for me to work in Ecuador than it was to work in Australia”. This from a man who has lived and worked for 14 years in Ecuador, which is longer than Stratfor has been in business.
Also LatAm expert Stephen Bailey of Frontier Strategy Group, leaders in emerging market risk analysis, recently said, “Certainly Correa is not an ideal pick for foreign investors, but I think that he’s taking more of a measured approached (than Venezuelan President Chávez).”
The Usual Suspects, The Usual Result
So opinion from those on the ground and looking closely at Ecuador clearly points to it being a mining-friendly environment. However, when it comes to today’s South America the world prefers a good shock story than measured analysis, case histories or even listening to what ministers actually say. The result of the Stratfor newswire was unfortunately predictable; stocks of miners with Ecuador exposure fell sharply in Friday’s trade, with IAMGOLD Corp (IAG), Corriente Resources Inc (ETQ), Dynasty Metals and Mining Inc (OTCQX:DMMIF) Lateegra Gold Corp [LRG.V] as a few examples of large and small miners hit hard in intraday trading. ETQ, DMM.v and IAG managed to claw back most of the lost ground once word began to get round that the story was not all it was cracked up to be, but LRG.v lost 8% on 4X normal volumes traded and couldn’t recover.
However the eye of the storm was Aurelian Resources Inc. (OTC:AUREF) [ARU.to]. Aurelian began the day at CAD$33.10 and dropped a full 20% to trade intraday at CAD$26.40. The company wisely released a PR casting doubt on the newswire story and it recovered somewhat to finish 5% down at CAD$31.40 on volume of 5.7m shares traded, a whopping 14X average daily volumes.
The Blessing In Disguise
By way of a little background on the company for those not familiar with the story, Aurelian Resources Inc. is a Canadian gold, silver, and base metals exploration company that controls over 234,000 acres of concessions at their ‘Condor’ property in southeastern Ecuador. The property has 38 concessions and has already identified dozens of gold and copper targets on site. ARU.to has very solid looking financials with around U$79m cash at bank, no debt and 35.5m shares fully diluted, giving a total market cap of just over U$1Bn. Insiders and institutions together hold 55% of stock.
ARU.to has so far concentrated its efforts on one site, the Fruta del Norte [FDN] gold discovery. Without the slightest exaggeration, the results so far from the FDN drilling program have been spectacular. One particular hole reported March 27th 2007 graded an incredible 35g/t gold over 820 feet, later described by a leading analyst as “the best drill hole that has ever been drilled in a gold project”. One 10ft long part of that drill core showed over 1kg of gold contained per tonne of rock. With a kilo of gold selling at around U$21,000 today, if ARU.to doesn’t impress you we suggest you find another sector in which to invest your money. The photo below shows a close-up photo of the FDN drill core with clearly visible gold.
The company is due to publish a resource estimate for the FDN central core in mid 2007, and there has been a lot of speculation as to the size of the resource estimate that will be announced. Guesses range between 6 million and 14 million ounces of gold at FDN without taking into account the silver credits. If at the higher end of the resource guesstimate scale as we ourselves suspect, the underground gold would be priced at U$73 per ounce as a ratio to Aurelian’s market cap and therefore on FDN alone ARU.to is extremely good value at its present stock price. On top of this, only 1.2km of the FDN strike has been examined so far, and there is every reason to believe the same strike continues for a full 3km. And heaped on top of this, FDN is only the first of 31 targeted sites contained inside “El Condor” that has been drilled. The company is currently drilling at their “El Tigre” target, with results expect in a few weeks’ time.
Whatever the new drilling results bring, the future certainly looks bright for ARU.to and we consider it a real bargain. Upside is difficult to accurately predict as the company is still in early stage explorations, but our modeling suggests a CAD$48 price tag would be very reachable in 2007, representing a targeted upside of 53% to Friday’s close.
Separately, we have also heard some background talk of ARU.to as a buyout target. If so we would expect the stock to at least double before the company goes to the highest bidder, but we stress that buyout scenarios are more likely once Aurelian has solid measured and indicated resource figures to show the world, something that would probably come no earlier than FY08.
When it comes to LatAm, don’t believe everything you read, especially when reading in English. We have witnessed a growing tendency towards sensationalism in regional reporting recently, and as such advise any investor with LatAm exposure to check and re-check stories before rushing to trade and having to repent at thy leisure. On the other hand, we reiterate that the smart and nimble investor can take advantage of a situation with suitable background knowledge at hand.
Friday’s trading on “news” has given investors a golden opportunity to buy Aurelian on the cheap. We are applying the same proven formula to Ecuador as we have done with Venezuela this year. The knee-jerk reaction of investors once again allows us to take a position in a financially excellent company trading at a short-term discount. We recommend a long position in ARU.to at CAD$31.40 with a target of CAD$48 for end 2007.