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America's neighbor to the south has been famous for its silver mines, but has emerged in the past few years as the world's tenth largest producer of gold. As rising gold prices have driven industry majors into increasingly risky countries, it is only logical that North American producers would ramp up their efforts in Mexico, an emerging economy with a long tradition of natural resource commerce with the U.S. and Canada. Fortunately, the deposits therein have proven sufficient to justify the increased exploration activity. Just under two years ago, an experienced exploration and management team that had been on the forefront of this development started a new venture in the state of Guerrero.

The company, called Newstrike Capital (OTCPK:NWSKF), has generated considerable buzz from analysts, even before its maiden resource statement, due by year end. When CEO Richard Whittall wistfully described the first year of the project in a phone interview last week, he almost sounded like someone describing how once he eked out rent checks for his first apartment. It is hard to believe he was describing a situation just 23 months ago, when the company started out with $500,000 in the bank, about 40% short of its payables. Using these scant resources to back a risky exploratory drilling in October of 2010, Newstrike now sits on $34 million cash and its shares trade at an aggregate market value of $281 million dollars.

Those not familiar with industry protocols might scratch their heads. As you might expect, the company has a long way to go before producing any gold. How could a company be valued so highly, when it is years away from earnings? Furthermore, as Whittall explained, "we will not be the team that leads Ana Paula into production." Why not? In sum, the cost of building on-site processing facilities is almost prohibitively expensive for all but the biggest gold mining companies. Exploration outfits like Newstrike buy mineral claims over thousands of hectares and use their geological expertise to find high-grade deposits, which attract attention from industry majors once drill results show significant potential. At this point, the exploration outfit forms a joint venture with one of the majors or sells the property outright. Properties developed with such intentions are sometimes referred to as turnkey mines.

Newstrike's team is as familiar with this process as it is with the state of Guerrero, where some of its members have been operating for eighteen years. Whittall was formerly a director at Miranda Mining, which was one of the first Mexican gold miners to list its shares on the TSX. In that capacity, he saw the potential of Ana Paula firsthand, which Miranda once owned. VP of Exploration Gillian Kearvell, while leading exploration efforts by Teck Resources (NYSE:TCK), discovered the nearby Morelos mine, now owned by the $850 million cap Torex Gold Resources Inc. (OTCPK:TORXF). It is one of her three major discoveries, to complement the five made by Field Operations Consultant and fellow Mexican mining veteran Craig Gibson.

According to Whittall, he got a call from Kearvell noting the geological similarities between Goldcorp's (NYSE:GG) nearby Los Filos Mine and Ana Paula and decided essentially to hinge the company's future to the latter. In spite of the risks, this strategy made sense given the runaway success of Los Filos. While Goldcorp liked the potential of the property, they generally prefer to develop later stage projects, opening the door for an exploration play.

Since that time, Ana Paula has done anything but disappoint. They have found significant mineralization of gold at 104 out of 108 drill sites, an astounding hit rate. The most recent drill results include a 76 meter intersection of 10.57 g/t grade gold, the highest grade currently seen in the Guerrero Gold Belt. According to Whittall, echoing statements made by Kearvell at the Precious Metals Summit in Colorado, the key takeaway from these results is not only the grade mineralization but the unusual proximity to the surface of such high quality deposits.

Ana Paula was originally purchased for the potential of multi-million ounce reserves of low-grade gold as found in Los Filos, but Newstrike discovered an unexpected quantity of high-grade gold on its first set of assays. In addition to the potential low-grade deposits that exist, a junction of two structural controls trapped a highly mineralized concentration of gold in an open pittable deposit, rendering extraction far more efficient and profitable. In layman's terms, as Richard Whitall put it, "You can actually go down and kick the high-grade deposits with your boot."

In addition to the fortuitous drill results, the Ana Paula Project has a number of other advantages. With easy access to water, power, infrastructure and roads, the capital expenditures of the project are on track to be lower than the industry average. Transport to the nearby port of Acapulco, also in the state of Guerrero, is very easy. And, as the company's massive influx of cash indicates, they have a very low cost of capital. All this combines to make it a very attractive takeover target.

Now it should be noted that the company has not yet filed a verified NI 43-101 resource statement. The consensus among analysts seems to be that Ana Paula will have somewhere in the neighborhood of 3 million ounces of easily extractable gold. There have been junior miners in the past that built up high expectations only to disappoint investors once qualified independent geologists made their official report. However, it should be noted that Newstrike has made a significant effort to put all available information out to the public (http://newstrikecapital.com/projects/ana-paula-drill-status/). Investors should do their own due diligence on all companies, and Newstrike's transparency puts it significantly apart from the juniors that have burned speculative investors in the past.

In addition, it is encouraging to note that a sizeable stake in the company is held by billionaire natural resource investor Lukas Lundin, through his various holding companies and family trusts. He owns at least 20% of the company (with some saying it could be in the 30-40% range), which should help keep the company's share price stable for the time being. Anyone who notices the volatility in exploratory miners' stocks can glean not only the risky nature of the drilling process, but also the presence of speculative investors looking to cash in and out on early drill results. Lundin's presence has not eliminated this feature of the market, but certainly dampens it to a degree. Those not familiar with his track record need only do a small amount of research to see how many mining and oil/gas ventures he's successfully backed.

Another key factor in the valuation of Newstrike is the risk premium of operating in Mexico. The picture many Americans have of Mexico is bleaker than the reality at least in economic terms. An upper middle income country by IMF standards, Mexico has achieved impressive growth over the last two decades. A brief hiccup during the US financial crisis notwithstanding, the country has come a long way since NAFTA was signed. Mexico has long been a key natural-resource trading partner for the US, and that is unlikely to change anytime soon. It should also be noted that Newstrike Capital has good relations with the local communities, has developed strong knowledge of the area over the past 18 years, and has not seen any security or political challenges since drilling began.

Such a context is that while the Anglos and Newmonts of the world are sitting on a good deal of cash at this point, the enthusiasm for mega-projects has waned. As Barrick CEO Jamie Sokalsky has assured his shareholders, "Returns will drive production, production will not drive returns." Many are content simply to find efficient projects that will keep their margins down, as cash costs for big miners have exploded over the past two years in anticipation of sustained increases in the price of gold.

This is what really matters to industry majors. They are looking for low-cost high-grade projects. Gold prices are so high that companies are drilling wherever the grade and project economics are appropriate. But they are not high enough that companies can continue to absorb high capital expenditures and snap up any project with potential.

In conclusion, Newstrike represents significant upside. The risks inherent in the industry should be noted, but anyone able to jump in before the maiden resource statement and the ensuing analyst coverage stands to benefit considerably. For those outside the speculative quick-trade genre of mining investors, the long-term upside should prove reasonable considering the upward trend in gold mining stocks, long-term prospects of gold and the preponderance of projects in the Guerrero Gold Belt. Even if future drill results wane slightly, somebody with an ancillary processing facility will eventually snap it up.

Source: Newstrike Capital And The Mexican Gold Boom