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Friday, August 10, 2007


Babies being thrown out with the bathwater

During the recent stock market weakness, many quality mining stocks, particularly the smaller ones, or "juniors," have taken huge hits in the market, as investors panic sell out of a sector that was already severely undervalued and we believe will be very strong in coming years. Liquidations in the market have caused some proverbial babies to be thrown out with the bathwater as nervous investors move to cash either voluntarily or under forced sales caused by margin calls or liquidity needs.

There have been articles predicting the doom of base metals because China’s strong economic expansion is sure to slow down to reduce demand. However, even if China’s economic growth drops in half from the 10%+ rate it’s had over the past 3 decades, their economy will still be significantly larger each year than the previous year and will still demand far more base metals. China has a very long way to go to get to anywhere near half the per capita GDP of western nations. This recent article does a good job addressing the bearish view on base metals.

Metalline Mining

As far as the proverbial babies being thrown out, we’ve repeatedly written about the incredible long term outlook for Metalline Mining (MMG) over the past year and a half, and it remains our favorite risk/reward investment in the stock market, with its world class, low cost zinc project approaching the end of its feasibility study and its huge amount of silver in their 45+ former silver mines, all with mind-boggling infrastructure already in place and other unique advantages:

MMG’s currently valued at less than what the similar world class Skorpion zinc mine in Namibia was bought out for back in 1999 upon completion of their feasibility study, when zinc prices were a small fraction of the current price, and Skorpion didn’t have the infrastructure or the silver that MMG has. Skorpion also was attempting unprecedented high tonnage processing of oxide zinc via a technology that hadn’t been proven with zinc before.

Now, that oxide zinc processing is proven at the very successful Skorpion Mine, and MMG has hired the same team, Green Team International (GTI -- note their listing of MMG’s Sierra Mojada zinc project along with the Skorpion zinc project on their web site:, that did the Skorpion feasibility study and put them into profitable production at a time of record low zinc prices. Meanwhile, LME zinc inventories are hitting record lows, there’s a dearth of world class zinc projects in the pipeline for coming years, and the major mining companies are awash with cash and buying out smaller mining companies at a rapid and accelerating pace.

Despite the worldwide shortage of zinc and record low inventories, the market is expecting the surge in zinc supply from earlier this year (we previously discussed 2 temporary factors that caused that surge) to not only be sustainable, but to grow at a similar rate in future years. When that expected increased supply doesn’t come on the market as expected, we believe the price of zinc will strengthen significantly.

Metalline Mining should complete the mine plan portion of the zinc feasibility study soon, and that will show the world class size of their zinc project, which should put Metalline on the map for many institutions and major mining companies that have only considered them to be a zinc explorer in the past. Whereas most mining projects end their feasibility studies after the mine plan is completed, Metalline will also be doing a refinery plan in coming months, and the refinery they build will save them a huge amount vs. other miners who give up a huge chunk of their profits to smelters.

Besides the zinc, Metalline has been ramping up the drilling and proving out of their silver mineralization in an aggressive exploration program. This drill program will add to the drill results from their previous years of silver exploration, allowing Metalline to begin to estimate the size of the silver mineralization. Considering their 45 former producing silver mines never even had a mill to concentrate the ore, and only direct shipped the very high grade silver, we believe Metalline has an enormous amount of silver at Sierra Mojada, probably more than enough to justify the current market cap without consideration of the zinc. The upcoming silver estimates should begin to get Metalline credit in the market for their silver as well as their zinc.

RBC put out a report last month saying that mid-tier and larger zinc producers were pricing in $2.13 zinc for the long term (while copper producers were only pricing in $1.80 copper), and were priced at 7x cash flow. Using those numbers, if valuations for zinc producers stay around the same level, MMG's market cap should be over 20 times higher when they're in production with their first zinc deposit. Add in the silver potential and the upside is phenomenal for the long term. Factor in dilution for production financing and possibly lower valuations in the future, and MMG still has at least 10 times upside potential. If they can finance production with minimal dilution and if zinc producer valuations go higher, the upside increases even more.

We continue to believe that MMG is headed much higher over the long term, and because of its unique position in the market place, they will likely receive multiple takeover bids after they complete their feasibility study next year. We view short-term weakness due to market conditions as an excellent buying opportunity for the long term.

Victory Nickel

Another baby being thrown out in this market selloff is Victory Nickel (NI in Canada, or VNCKF in the U.S.). Victory Nickel is a fairly new nickel junior, having been spun off from Nuinsco Resources earlier this year. With a market cap of under $100 million , they have 3 promising projects, the main one being the Minago project in Manitoba, which, based on a recent scoping study, has an NPV@8% (Net Present Value using an 8% discount rate), assuming $7.43 nickel, of $334 million. They also have frac sand overburden at Minago with an NPV@8% of that resource of $32 million. Minago has excellent infrastructure, with a nearby paved highway, port, rail, and low power rates.

Victory also has the Mel project, with 83 million lbs of Measured and Indicated contained nickel, and the Lac Rocher project in Quebec with 25 million lbs of Measured and Indicated contained nickel (including a phase one section with 50,000 tonnes of 4.06% nickel, which can go to production with minimal capex).

Victory plans to get all 3 projects in production by 2009 or early 2010, using the early cash flow from the Minago frac sand and Lac Rocher's phase one to minimize the dilutive financing required to get the huge Minago project (one of the largest nickel projects in Canada) into production.

While we don’t like the outlook for nickel nearly as much as we do zinc and silver, if Victory can get to production with these projects as planned and nickel doesn't completely collapse below $6/lb (currently around $12/lb), the stock should move much higher in the next couple of years. With the recent weakness in the sector, market, and nickel price, the stock has dropped back to all-time lows (currently $0.53, less than half the high of 2 months ago, which was less than the stock's first day close of $1.21 in February), which we believe is a great buying opportunity for risk-tolerant long term investors looking for near-term production of sulphide nickel.

You can see more details on Victory nickel in this recent presentation.

Pediment Exploration

One baby that has bucked the trend among junior miners and moved up strongly recently is Pediment Exploration (PEZ in Canada, PEZFF in the U.S.). Pediment is an early stage gold explorer with 10 highly prospective properties in Mexico. We normally don’t like the risks of early stage explorers, but we like the risk/reward ratio for Pediment because the upside potential is so high if they continue to be successful with their drilling.

We became interested in Pediment in the spring after a site visit by Greg McCoach, Luke Burgess , and Bob Moriarty. That interest was rewarded last week when the stock moved up strongly upon the announcement of excellent drill results showing 84.12 meters of 3.79 g/t gold. More drill results are due soon, and if they continue to be successful, the stock could move much higher.

As Moriarty concluded in a recent article, “Pediment has done everything right at Las Colinas and the drill results are brilliant. Gary Freeman did a wonderful job of communicating the very real accomplishments of Mel Herdrick. Expect more and better results soon. The stock is a screaming buy even at these prices. It will be millions of ounces of gold. The company has a $45 million dollar market cap and that's tiny."

Others not previously covered

Crowflight Minerals (CML in Canada or CMLGF) is another baby being thrown out in this market selloff. Crowflight is a near-term nickel producer which should be in production next year with a nickel project that has a NPV at $8 nickel far higher than their current market cap. At just $0.65, the stock has now corrected to less than half its high in May. As long as nickel stays above about $6/lb. and they make it to production as planned, Crowflight should go much higher next year.

Metanor Resources (MTO in Canada or MEAOF in the U.S.) is a near-term gold producer which has lost nearly half its value since its February high. The did a recent dilutive financing at .80 to finance their move to production, yet the stock is currently trading below that price on this market selloff. If they get to production as planned later this year, the stock should move much higher. Metanor’s an excellent investment for leverage on gold and near-term production.

Mantle Resources (MTS in Canada or MTSZF) is an early stage zinc explorer that Lundin Mining (LMC) has bought a just under 10% stake in at prices up to $1.25 during the current ongoing financing. Though they have no proven resources and are many years from production, they have a lot of potential to define a world-class high grade zinc deposit, and Lundin may end up buying them out if their drilling is successful. Lawrence Roulston initiated positive coverage on Mantle in May at $1.35.

There are a number of other junior mining stocks that have sold off hard recently and represent great buying opportunities, including the ones we’ve covered here before. From our analysis, we see Metalline Mining and Victory Nickel as two of the best, and Pediment Exploration one of the best early stage gold explorers, with Crowflight, Metanor, and Mantle Resources aso great options.


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