In my last article on Pure Gold Mining (OTCPK:LRTNF), I discussed a few near-term catalysts that could boost the company’s share price up. One of these catalysts was an incoming feasibility study (FS) for Madsen, Pure Gold’s flagship gold project located in the Red Lake gold camp in Ontario, Canada. On February 11, 2019, the company released the main figures disclosed in this study (a full report should be published later on). To my astonishment, the market reaction was totally negative, pushing Pure Gold share prices down more than 15% (two black arrows on the chart below):
Despite this negative reaction, Pure Gold still appears to be a very decent, long-term precious metals play. As the blue, up-sloping arrow on the upper panel of the chart shows, these shares have been outperforming the VanEck Vectors Junior Gold Miners ETF (GDXJ), a popular junior mining ETF. What's more, I think that Mr. Market is totally wrong about Pure Gold - as discussed below, the Madsen gold project is still one of the best in the entire industry. If I am correct, yesterday’s huge price drop looks like a classic buying opportunity.
Feasibility study vs. preliminary economic assessment
To remind my readers, in January 2018, Pure Gold released a preliminary economic assessment (PEA) for the Madsen gold project. Let me compare both studies:
(Source: Simple Digressions)
The rows marked in red depict an initial and sustaining CAPEX and an after-tax internal rate of return (IRR). I guess it is easy to spot that to build the mine, the company will have to spend more capital than initially planned (PEA):
- Initial CAPEX went up from C$50.9 million (PEA) to C$95.0 million (FS)
- Sustaining CAPEX increased from C$134.7 million (PEA) to C$232.0 million (FS)
As a result, although the company plans to shorten the life of the mine from 13.8 to 12.3 years (a shorter life has a positive impact on the project’s economics), the IRR was reduced from 47% (PEA) to 36% (FS). I guess that these figures (lower IRR and higher CAPEX) were the main factors standing behind a very nervous market reaction on February 11.
However, the main question is: is Madsen that bad? Well, in my opinion, not at all. What's more, as mentioned in the beginning of this article, in my opinion, it still one of the best projects in the entire industry. For example, at a gold price of US$1,100 per ounce, it should deliver an after-tax IRR of 23% (the blue rectangle below):
(Source: Pure Gold)
I think that is a very decent figure. For example, Madsen meets a very strict investment criterion established by Randgold Resources, a former gold producer (most recently it merged with Barrick Gold (GOLD)). To remind you, according to Randgold, a good project should generate an IRR of 20% (at least) at a gold price of US$1,000 per ounce. I think that Madsen, even assuming a higher CAPEX, meets this criterion.
What is more, the mine plan disclosed in the FS is based on the Madsen mineral reserves only. According to the latest estimate, the project’s mineral reserves amount to 1.0 million ounces of gold. However, the Madsen deposit contains 1.86 million ounces of gold classified as indicated resources (including reserves), so the additional upside potential is pretty large (0.85 million ounces of additional gold, roughly).
There are also three additional satellite deposits to be developed at later stages of the project’s life. These deposits (Fork, Russet South and Wedge) contain 431 thousand ounces of gold in indicated and inferred resources. For the time being, this material is not included into the current mine plan; however, according to the company, this month we should see a preliminary economic study on these three deposits:
“The Probable Mineral Reserves were based exclusively on Indicated mineral resources from the Madsen deposit. Mineral resources from Russet South, Fork and Wedge were not considered for the Feasibility Study, but will be considered in the forthcoming Preliminary Economic Assessment of these deposits, expected to be issued in February”
Well, I am pretty sure that a future mine will be much larger than that described in the FS.
Specific risk factors
Investment in Pure Gold shares carries a few specific risk factors:
- Pure Gold is an exploration company, and therefore, it does not generate any cash flow from operations. As a result, to build a mine, the company has to find external sources of capital (public offering, loan, streaming agreement etc.). If, due to various reasons, it's not able to raise the appropriate funds, the investment in Pure Gold shares may end with big losses.
- The company's shares are pretty illiquid. In the U.S., they are listed on the over-the-counter market, and the average daily trading volume has been around 99.5 thousand shares year to date. Hence, investors interested in Pure Gold shares should take this risk into account.
- Share dilution - It is a common risk when investing in explorers. Simply put, over time the net present value to be delivered by a gold/silver project is attributable to a higher number of shares (due to dilution), driving the share value down.
I think that Pure Gold shares still offer an interesting buying opportunity. Assuming a current price of gold of US$1,300 per ounce, the project should deliver an after-tax NPV of C$263 million (Graph 1). If that is the case, one share of Pure Gold is worth C$0.95, or US$0.71 (assuming a fully diluted share count of 289.3 million and cash of C$11.4 million at the end of September 2018). As discussed above, this calculation does not take into account the upside potential demonstrated by part of the Madsen deposit and the Fork, Russet South and Wedge deposits.
On February 11, 2019, Pure Gold shares closed the day at US$0.50 a share, so they are definitely undervalued.
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In December 2018 I launched the detailed coverage of royalty/streaming companies related to the precious metals sector (for example, Sandstorm, Metalla, Maverix, etc.). During a precious metals market meltdown these stocks perform much better than classic miners.
Disclosure: I am/we are long CEF, GDX, KL, SAND, ARREF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.