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Timberline Resources: The Best Risk/Reward Junior Gold Mining Stock in the Market

|Includes:Timberline Resources Corporation (TLR)

Timberline closed today at .79 with just a tad over a $50MM enterprise value. We are coming to the end of the summer doldrums season for mining stocks, which typically concludes in September, before the strongest seasonal trends kick into gear. We felt it imperative to give our views on this ridiculously cheap and undiscovered junior gold mining company prior to this season and the launch of the Gold Investment Letter. We'll give a brief overview of the company and then focus on the details which drive our investment thesis.

Timberline is a soon to be gold producer and active exploration company with a 100% owned diamond drilling division. The company recently reported a profitable quarter driven by 50% top line growth at the drilling division, which should produce close to $30MM in revenues in 2011. This is significant because the drilling division will throw off enough cash to fund exploration activities that normally are cause for frequent dilution to the capital structure. Some institutions don't like businesses like this that distract and muddle the "pure play" theme of focusing on the companies primary business.....finding gold. However, I like it for a number of reasons: It's a growth business that is profitable-It is a strategic benefit that ensures drill availability (this will be a problem for companies as the bull market matures) and reduced exploration costs-did I mention it throws off cash to explore? At the end of the day, Timberline will make too much money from gold production for those same folks to care!

Which brings us to their lynchpin project: The Butte Highlands deposit just south of Butte, Montana. Timberline teamed up with the premier underground mining and development company in North America, Small Mine Development (SMD), to operate the mine. The deal is that SMD carries ALL costs of starting up the mine, SMD gets an 80/20 carry on revenues until costs are repaid, then it flips to 50/50 from there. This wise "farm out" is another reason TLR has been able to keep a tight capital structure and not raise endless funds. They project 50,000-70,000 ounces of annual production, commencing in the first quarter 2012 (less than 6 months away!). Let's use up to date general numbers and say they 'only' produce the 50k ounces(recent bonanza grade drill results has been expanding the discovery and ensuring longevity and resource expansion. At a $1500 gold price, we're looking at $75,000,000 in revenues from production next year. The estimates are for a total mine development cost of $24 Million. Let's use $30 Million and say TLR gets zero until paying this off (even though they get 20%). That's $22,500,000 coming into TLR next year in cash flow. With 60MM shares outstanding, that's 37 cents in net income from this project, which will be more profitable on an annualized basis once the initial capital costs are knocked out.

The company also has several exciting exploration properties currently being drilled. Including South Eureka, which is one of the largest undeveloped gold exploration properties in Nevada(23 square miles). Lookout Mountain, which looks like an M&I resource that will grow up to a million ounces in the first half of 2012 fairly easily is the flagship propert. This project is rapidly moving toward a production decision and is amenable to low-cost, run-of-mine, heap leach processing with modest capital expense(30,000 feet of drilling to be completed by year end). There are other earlier stage areas being drilled aggressively that could act as exploration catalysts(don't discount White Rock in NE Nevada, which has tremendous potential and initial drill results should be released soon).

In the near term, drill results from the summer program could ignite the shares. And, the Butte Highlands operating permit certainly will wake up the market and jolt investors into the reality that large profits in 2012 are rapidly approaching. Assuming the drilling division stays profitable in 2012, the companies significat cash flow from Butte, along with very exciting exploration projects, could take the stock up to the $2-2.50 level within 12 months.

Disclosure: I am long TLR.

Stocks: TLR