Hyperinflation's  Instablog

Don't get me wrong, I think the likes El-Dorado Gold(EGO), RandGold(GOLD) and others provide great long term value for investors but in reality it comes down to opportunity cost in what is more or less an emerging industry (as it has just become profitable over the last couple of years). It is though I see the bullish case for the same group of emerging miners meanwhile those which will likely produce a higher rate of return over the next 3-5 years go largely ignored by the broader market. Case and Point is Jaguar Mining (Jag), which i believe has the best combination of valuation (DCF) , strong balance sheet with future projects and exploration that is fully funded, unparalleled long term growth profile, located in the mining rich and geopolitically friendly greenbelt of Brazil and has below industry capital requirements ( in other words, a  soon to be free cash flow machine). 

Yet this adds up to a mere 785 million market capitalization (or one sixth of El-Dorado and one seventh of Randgold). The aforementioned characteristics, most notably long term production growth potential come at much higher costs for Jaguars peers in the form of high capital requirements. For example, mines in China have proved to be plentiful but on average they have a tendency to have relatively small gold deposits. This requires more frequent capital outlays ( aka lower free cash flow) as world class mines such as those found in Brazil have for the most part longer lived mines as well as higher ore grades/recovery rates ( generally speaking of course).

Jaguar also lacks the substantial geo-political problems that could arise in the Congo ( the recent acquisition of Moto mines will be the key growth driver for randgold) as well as the capital requirements needed to commence production at the potentially world class mine. 

Jaguar has developed a reputation of bringing projects online rather quickly, thus their recent presentation given at the Denver Gold Show ( at which time the announced they were in the process of acquiring another Brazilian property with over 1.5 M+I) potentially provides the catalyst to move them up to the 1m oz production level by 2014-2015. For those who have paid attention to the meticulous nature of management, I would guess they have stumbled upon a possible future flagship mine (which may explain the lack of detail thus far). 

No matter how you make the case for EGO or GOLD, I just don't see how a valid justification regarding the markets current appraisal. A basic cash flow analysis published via google docs, which can be seen here, tells the same story as Jaguar is 1/3 undervalued while El-Dorado is slightly undervalued and RandGold is overvalued. Though this does not incorporate such things as added value places of proven reserves and the total reserve base, the degree to which it is skewed speaks for itself.

I think the recent developments out of Red Back Mining (RBIFF.PK) is another example of overlooked an valuation. One can argue that is just as risky as someone like RandGold, but Ghana and most of western Africa for that matter has become increasingly geo-politically and mining friendly compared to such countries as The Congo (though they say they are democratic) as the mess that is South Africa. Below is a rough estimation of Red Back’s growth profile, but this excludes the recent announcement of a 33% increase in reserves(in just six months) at their now world class Tasiast mine ( as 5m oz+ in the total resource base typically earns that title). That’s being said , the dynamics of Red Back’s growth profile should move them up to the 600k production level by 2012 assuming they are not successful in their publicly announced desire for accreditive growth via acquisitions, which they will remain aggressive in pursuing.

Should they fail to find the right acquisition target, there are several catalysts that can provide enormous upside potential. As previously mentioned Tasiast recently updated their reserve base to 3m oz and their resource base to over 5m oz. Here’s the kicker… The mine lies on 20km of a belt, only 8 of which has been drilled upon to date. At peak production, I think it wouldn't’t be overly optimistic to say Chirano will achieve 280-300k oz of production while Tasiast could produce anywhere from 300-400k per annum ( which is all dependent on future drilling results and expansion projects).

 When they report in the coming weeks, I expect them to have 175m+ in cash, no debt and access to credit facilities if need be. This will be more than enough to fund expansion projects at Tasiast and Chirano in addition to funding a mid-large acquisition as they aim to reach the 1m oz production mark.

Like Jaguar, Red Back Posses characteristics uncommon to the emerging junior miners such as high quality assets, good growth profile, low cash costs and capital requirements and perhaps the strongest balance sheet of all the companies mentioned in this article with no debt and 175m+ in cash and cash equivalents and many potential upside surprises in both production and reserve growth.

Valuation From Cash Flow Analysis – Rough Estimate

EGO - $15.23 - 26.72% Discount To Fair Value

JAG – 36.09 - 273% Discount To Fair Value

GOLD - $63.81 - 14.4% Premium To Fair Value

RBIFF.PK - $15.63 - 15.27% Discount To Fair Value

Disclosure: Long JAG, RBIFF.PK