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Caledonia Mining: Three exciting investments in one

With Caledonia Mining (LON:CMCL, TSE:CAL) you get three different investment propositions for the price of one in a company that’s generating cash and is essentially debt free.

There’s an interesting and profitable gold production play, plenty of gold exploration upside and an exciting copper story which, if it fulfils its potential, could completely transform the company.

The backdrop to this investment is Zimbabwe, where the tectonic plates of politics shift daily and thorny issues such as indigenisation make it a complicated place to do business.

What you need to know, however, is that Caledonia isn’t simply a one-way bet on this troubled and perplexing part of Africa.

A revival of Zimbabwe’s fortunes will help the company enormously, but it is not the be all and end all as we’ll see later.

Caledonia owns and operates the Blanket Gold Mine in the Gwanda greenstone belt. 

Acquired from Kinross in 2006 (before that it was owned by Falconbridge), output was approximately 18,000 ounces last year rising to a target of 40,000 ounces of the precious metal for this year. 

With cash costs falling and on target to go below US$550 an ounce this year, the current management, led by Stefan Hayden, is sweating the assets more efficiently than the mine’s two previous owners. 

Gold recoveries have improved markedly from around 80 per cent on acquisition to the present sustained gold recovery level of 92 per cent. Now management’s ambition is to further increase Blanket’s output – to a target of around 100,000 ounces by 2015.

Before it can do this it needs to increase its reserves and resources, which at the current production rate of 40,000 ounces per year gives Blanket at least a 13-year mine life.

It is currently sinking one new shaft and rehabilitating three others on two of its highly prospective brown-field satellite zones – GG, which is seven kilometres from Blanket’s metallurgical plant, and the Mascot Project Area, which is 42 kilometres away.

Caledonia also isn’t ignoring the potential of the Blanket Mine footprint itself. 

It is developing the 22-Level Haulage, which is essentially a horizontal tunnel 750m below surface that will provide access for further exploration of the up-dip and down-dip extensions of the mine’s known main ore bodies above and below this depth. 

This is a much faster and cheaper approach to exploration than drilling all the way from surface.

The 22-Level haulage itself will then be over 3 kilometres long and will provide immediate mining access to these resources from the recently upgraded number four shaft and automated ore loading system.

Blanket has already installed substantial excess capacity in its crushing, milling and CIL circuits, which can handle 2,400, 1,800 and 3,800 tonnes per day respectively.   Daily throughput at a production rate of 40,000 ounces of gold per annum is roughly equivalent to a plant throughput of 1,000 tonnes per day. This means that Blanket can immediately treat 80 per cent more additional ore with little or no requirement for new investment in the processing plant.

The only increased costs would be the mining, transport and consumable costs related to the additional tonnage, and the result would be a significant decrease in the cost per gold ounce produced as the fixed costs are amortised over the increased production.

This busy round of resource development activity will produce an updated 43-101 reserves and resource statement by mid-2011 with a further updated reserve and resource statement a year later.

Hayden has set aside US$4 million for exploration this year and early next. 

“We are playing catch up,” he admits. “But exploration funds have previously not been available in Zimbabwe due to the economic climate there.  

“We have been forced to restrict our exploration activities to the amount of free cash we have generated after our on-going expenditure on essential capital equipment for the mine’s surface and underground operations.”

“But over the next two years we confidently expect to come up with a compelling growth story driven by exploration results.”

If Zimbabwean iIndigenisation rules are enforced, under the existing legislation, Caledonia would be obliged to sell a 51 per cent shareholding to black Zimbabweans over the next four to five years.

Caledonia had been hoping for a compromise deal, which seems unlikely ahead of the general election later this year as the issue of indigenisation in the mining sector has turned into a political football. 

“The political temperature has gone up and there are lots of aggressive comments coming out indicating it will be 51 per cent,” says Mark Learmonth, the company’s head of Corporate Development.

“We can do a partial leveraged buyout of our own assets and use the proceeds to invest elsewhere.  We are not ambivalent about the situation, but the cash we would then receive from a forced sale does sweeten what would otherwise be a bitter pill.”

But there is, as I said earlier, more to Caledonia than meets the eye. 

Specifically here I’m talking about the company’s Nama mining licences in Zambia’s Copperbelt.

Caledonia has four large scale, long term, contiguous mining licences covering more than 800 square kilometres in one of the world premier locations for conventional copper-belt type mineralisation. 

“If this was London then the address would be Park Lane,” say Learmonth.

In fact one of those mining licence areas borders onto the world class Konkola copper property being developed jointly by Brazilian giant Vale and African Rainbow Minerals, a South African mining company currently capitalised at around US$4billion. 

They are currently investing a massive US$400 million in Konkola and expect to be in production by 2013.

Caledonia’s immediate plans are more modest by comparison. It is initially drilling four holes, each about 800m deep. on its Konkola East Target at a cost of just over US$1m.  

Subject to the drilling results and board approval, further drilling this year will either be focused on defining the this target to a 43-101 compliant stage. 

That, or an initial programme of holes may be drilled on its second copper belt target, Kafwira, which lies about 20 kilometres northwest of the Konkola East target.

The drilling programme has just started, and the initial results are expected this summer.

Should the drilling yield encouragingly positive results, then management wants to pull the trigger on a much more ambitious drilling programme.

However the company won’t be drawn any further on this aggressive exploration plan until the results of these holes are known. 

“We will consider all of the various funding opportunities that are open to us once we have a better appreciation of the copper opportunity at Nama and the size and timing of the costs for further work,.” Learmonth says. 

Were the Blanket Mine anywhere else other than Zimbabwe, then Caledonia’s valuation would be far higher than it is today, particularly with its potential to more than double production to 100,000 ounces in the next five years.

Copper doesn’t even figure in anyone’s calculations yet, although it has the potential to completely transform the company and its risk profile.

“People say we have this bit of copper on the side. Well, if we find what we are looking for, we could end up with a project that is multiples bigger than Blanket,” Learmonth says.