Who has benefited from Gold at $ 1000

By Stephen Clayson
Who has benefited more out of the rise in the gold price from $650 an ounce this time last year to almost $1,000 now? Is it a company producing gold for $300 an ounce, or one producing for $500 an ounce?

The answer is the $500 producer, because he is now making good money whereas before he was only just breaking even.

The $300 producer was making good money before, and now he is doing even better, but he should already have been trading at a premium. His business has not been transformed.

Our $500 producer on the other hand has seen a transformational change. In fact, he suddenly looks a lot more interesting.

An example of just such a company is Mercator Gold [AIM:MCR]. Mercator has consolidated under single ownership for the first time the Meekatharra goldfield in Western Australia.

Meekatharra has supported historic production of in excess of 2 million ounces of gold, all extracted without going below 300 metres depth, which of course is not very deep by modern standards.

As an example of Meekatharra’s track record, the Paddy’s Flat line of lode, which contains the Prohibition and Vivian-Consols lodes, can boast historic productivity per vertical metre of 9,000 ounces – an impressive number.

Mercator commenced production from its Surprise open pit in October of last year, although it only managed to produce 9,479 ounces of gold by the end of December as it ploughed through low grade material left in the pit’s ramps and access ways by a previous operator.

However, Mercator produced almost 4,000 ounces of gold in January as it started processing newly mined ore from the Surprise pit, and what is notable is that the grade at Surprise improves significantly as the pit gets deeper, so later this year the company should see some +10,000 ounce months.

The Surprise pit will be exhausted later this year, and a second pit, Bluebird, will then support production into 2009 before underground mining of the Prohibition and Vivian-Consols lodes commences. Construction of a decline to access these lodes, which contain the bulk of Mercator’s reserves and its highest grade ounces, is planned to begin later this year, and this should allow the company to boost its production to 150,000-170,000 ounces of gold in 2010, up from the 80,000-100,000 ounces targeted for 2008.

Mercator is not a low cost producer. The company recently raised its life of mine cash cost estimate for the Surprise pit to A$570 an ounce, or slightly less (A$530 an ounce) if more ounces are produced from the pit than is assumed under Mercator’s model – which is a possibility as past data show that deposits at Meekatharra tend to outperform their models. At the time of writing, A$1 equals US$0.92.

Mercator has gotten itself into production without the need for debt finance, and remains debt free aside from an A$6 million working capital facility. This is largely down to the 2005 acquisition of a mill and carbon-in-leach (CIL) processing plant from St Barbara Mines [ASX:SBM], for A$21 million when the replacement value of the complex would be circa A$130 million. This also means that Mercator’s non-cash costs of production are very low.

Mercator has total probable reserves of 504,000 ounces and resources of 2.42 million ounces, with significant potential for increase, particularly once underground exploration becomes feasible from the planned decline.

The focus of Mercator’s surface based exploration is currently the Euro project, which has returned encouraging drill intersections. Drilling continues, and Euro may have the potential to become a low cost open pit, as it is hosted at reasonable depth in very soft oxide material.

The company’s feeling is that previous operators only scratched the surface of Meekatharra, and that the goldfield will reward its exploration and development efforts.


Australia

The flip side to Australia’s high labour costs is a rare degree of political stability and security of tenure, an accumulation of mining expertise and decent infrastructure.

There is also much untapped potential waiting to be taken advantage of in Australia, in contrast to its perception as a pretty fully explored country. The easy finds have been made for sure, but that is not to say that exploration cannot yield results, or that historic goldfields such as Meekatharra cannot be rejuvenated.

The Australian dollar though is a potential fly in the ointment. Australia’s booming, resource based economy means high interest rates and a strong Australian dollar, which causes problems for gold mining companies, who all have to deal with costs in Australian dollars and a gold price set in U.S. dollars.

ASX Listing

Mercator is currently preparing for a listing on the Australian Stock Exchange, which is scheduled by May. An associated equity fundraising will, it is hoped, bring in the necessary funding for the establishment of underground production from the Prohibition and Vivian-Consols lodes and for additional exploration.

Price Protection

Mercator has adopted a modest programme of price protection, selling calls over some 35,000 ounces at A$906 and securing puts over another 35,000 ounces at a similar price.

This might not have pleased all Mercator’s shareholders, some of whom may have been holding partly because of the company’s un-hedged status

But it isn’t just a fall in the gold price that Mercator is protecting itself from. There is also an additional risk factor in that the Australian dollar could continue to appreciate. If that were combined with a gold price fall, then Mercator could find itself with problems. It can also be said that committed deliveries stand at only around 7% of the company’s reserves.

Therefore it seems a prudent move for the company to have taken this level of protection.

Investment Outlook

As Mercator increases its annual production from this year’s expected 80-100,000 ounces to an anticipated 150,000-170,000 ounces in 2010, it should start getting noticed.

Whilst Mercator is not a low cost producer, if gold continues its rise or even just holds where it is, Mercator will make decent money. And a proportion of Mercator’s cash flow is protected against a fall in the price of gold.

Mercator should also benefit from its coming ASX listing, which might provide the retail shareholder interest and daily trading activity that all companies of this size (market capitalisation £50 million/US$100 million), and bigger, struggle to achieve on London’s AIM.

Courtesy: www.resourceinvestor.com