| |
Tracker 2010-04
April 28, 2010
Chesapeake Gold Corp (CKG-V: $8.78)
Metates PEA reveals substantial upside leverage for Chesapeake to price of gold
Synopsis: Chesapeake Gold Corp was originally recommended a Good Relative Spec Value Buy at $6.88 on February 8, 2007 as part of the transition from my earlier recommendation of American Gold Capital Corp which was taken over by Chesapeake. Since that recommendation gold has marched from $656 to $1,212.50 while Chesapeake first dropped to $1.89 on October 24, 2008 during the 2008 Crash and more recently traded at a high of $10 on March 2, 2010. The rationale for the recommendation was that Chesapeake's 100% owned Metates deposit hosted in excess of 15 million ounces gold plus silver and zinc which were subeconomic below $800, but if gold ever made a substantial move, the price of Chesapeake would go up sharply. Well, gold has nearly doubled and Chesapeake has only delivered a 28% gain at the current price. Two key reasons are responsible for this under-performance. One is that the cost structure of developing and operating a gold mine has increased significantly during the past few years so that much of gold's gain has been offset by cost inflation. The other reason is that the development challenges faced by Metates proved very difficult, and it has taken considerable work on Chesapeake's part during the last couple years to come up with a plausible mining scenario that does not blow capital and operating costs to the moon. On April 21, 2010 Chesapeake published a preliminary economic assessment for a mining scenario that had never been considered by previous operators. The PEA is capital cost intensive and makes it clear that with a $3.2 billion price tag Metates is a big company mine development story. The PEA also indicates that at $1,150 gold Metates should be developed and that a buyout price target of $20-$30 for Chesapeake is plausible. During the next 12-15 months Chesapeake will conduct a prefeasibility study which will firm up the PEA numbers. Cash flow sensitivity modeling of Metates in a constant cost scenario shows that the price of Chesapeake is very well leveraged to respond to significant increases in the real price of gold. For example, if gold were to jump to $2,000 the per share after tax NPV at 5% would soar to $156. What this means is that if gold breaks out and starts to make new highs in a context that does not involve a collapsing US dollar exchange rate or soaring inflation, the price of Chesapeake will move higher very swiftly. On the premise that closer scrutiny of the technical report when it is filed in late May will not cause the PEA cost assumptions to fall apart, and that Chesapeake has done its homework with regard to the permittability of the proposed mining scenario, I am closing out the old recommendation and issuing a new Good Absolute Spec Value Buy at $8.78 with a $10 buy limit and a 12-24 month target in the $20-$30 range.
Chesapeake Gold Corp achieved a major milestone on April 21, 2010 when it published a preliminary economic assessment (PEA) by M3 Engineering for its 100% owned Metates project in Mexico's Durango state. The formal technical report will be filed on SEDAR by late May. The PEA is based on a 90,000 tpd open pit mining operation with a 27 year mine life that has a capital cost of $3.2 billion. The flow-sheet involves crushing and high pressure grinding followed by sulphide flotation that will produce a slurry concentrate representing 11% of the ore's original weight. The concentrate will be transported downhill along a 140 km 18 inch slurry pipeline to a site near ample limestone deposits in Sinaloa state where it will be treated in a pressure oxidation autoclave to drive off the sulphur. The resulting oxide concentrate will be subjected to cyanidation and Merrill-Crowe recovery of gold-silver dore. Zinc sulphide will be stripped separately out of the autoclave for shipping to a smelter. The low grade sulfuric acid generated by the autoclave will be neutralized with limestone from a nearby quarry. The mill feed will consist of higher grade ore during the first 7 years shifting to somewhat lower grade ore as the waste to ore strip rate goes from 0.83:1 to a high of 2.96:1 with an average of 1.75:1 for the life of the mine. Recoveries are expected to be 84.7% for gold and silver, and 85% for zinc. The mineable resource of 852 million tonnes would produce 14.8 million ounces gold, 391 million ounces silver, and 2.44 billion lbs of zinc. At base case prices of $900 gold, $14 silver and $1 zinc the PEA generates a pre-tax net present value of $2.5 billion at a 5% discount rate.
In order to understand the leverage Metates offers to the price of gold in a scenario where the cost structure remains constant, that is, in my speculative scenario where gold makes a real price increase during the next six years as high as $2,000, I have constructed a simplified discounted cash flow model for Metates using the PEA's deposit, operating and cost parameters. The after tax NPV at $1,150 gold using a 5% discount rate works out to $56.63 per share, which can be knocked back 25% to $42.26 to reflect the six years between now and year one during which the $3.2 billion capital cost is assumed to be spent. At the base case gold price of $900 the value per share drops to $27.13, with breakeven occurring at a $670 gold price. Where the outlook gets really interesting is at gold prices of $1,500 and $2,000 where the stock value jumps to $97.70 and $156.61 respectively.
Cash Flow Metal Price Sensitivity Analysis
| Chesapeake Gold Corp | Metates | Durango - Mexico |
|---|
| Parameter Source: | Chesapeake PEA Apr 2010 | Scenario Author: | JK | Primary Metal: | Gold |
| Other Metals: $14/oz Ag, $1.00/lb Zn | Breakeven | Current | Pessimistic | Base Case | Optimistic | Fantasy |
|---|
| Metal Price $/oz : | $670 | $1,150 | $800 | $900 | $1,500 | $2,000 |
| Rock Value $/t: | $19.04 | $27.15 | $21.24 | $22.93 | $33.06 | $41.50 |
| Pre Tax NPV: | $640,877,014 | $4,393,577,197 | $1,660,080,706 | $2,441,079,704 | $7,127,073,689 | $11,032,068,676 |
| After Tax Cdn Price/Share: | $0.01 | $56.53 | $15.36 | $27.13 | $97.70 | $156.51 |
| Internal Rate of Return: | 0.1% | 10.6% | 3.4% | 5.6% | 16.7% | 24.6% |
| Payback (years): | 13 | 7 | 10 | 9 | 5 | 4 |
 |
| Mine Parameters | Cost Parameters | Other Parameters |
|---|
| Tonnage | 852,000,000 | Capital Cost | $3,194,000,000 | Fully Diluted | 45,150,008 |
| Grade | 0.64 | Annual Sustaining Cost | $27,115,385 | Net Interest | 100.0% |
| Primary Metal | Gold | Net Smelter Royalty | 1.5% | CAPEX Funding | 100% Equity |
| Primary Recovery | 85% | Marketing Cost | 0.0% | Years to Startup | 365 | | Primary Production | 572,528 oz |
Mining Cost $/t | $0.90 | Mine Life | 26 |
| Mining Method | Open-Pit | Processing Cost $/t | $8.70 | CAD:USD Exchange Rate | 1.00 |
| Processing Method | Milling | Transportation Cost $/t | $0.00 | Discount Rate | 5% |
| Milling Rate tpd | 90,000 | Smelting Cost $/t conc | $0.00 | Tax Rate | 32% |
| Operating Days | 365 | G&A Cost $/t | $0.40 | Payback Tax Holiday | No |
| Ore Mined Annually (t) | 32,850,000 | Reclamation Cost $/t | $0.00 | Cost Inflator | 0% |
| Waste to ore Ratio | 1.75 | Miscellaneous Cost $/t | $0.00 |
|
|
| Concentrate | 0.0% | Total Operating Cost $/t | $11.58 | Currency | USD |
| Other Assumptions: During first 7 years of production grades of 0.69 g/t Au, 25 g/t Ag and 0.24% Zn were used, afterwards 0.62 g/t Au, 13.9 g/t Ag amd 0.13% Zn. Life of mine average is 0.64 g/t Au, 16.9 g/t Ag and 0.16% Zn. Reclamation cost was treated as $75 million in each of the last 4 years of mine life. All costs were held constant as were the base case prices of $14/oz Ag and $1/lb Zn. A 30% smelter retention rate was used for zinc of which 15% was the standard smelter holdback and 15% was an estimate of treatment and concentrate transportation charges. Taxes were applied each year after deducting depreciation of capital costs on a straightline basis over the mine life. Capital cost was incurred during the year prior to production start. |
The PEA follows two years of work during which Chesapeake tackled some serious challenges that included a remote location, steep topography, refractory ore and acid drainage none of which were overly conducive for the heap leaching scenarios Cambior had studied. Chesapeake acquired the deposit in 2007 when it merged with American Gold Capital Corp, which in turn had acquired the deposit in 2004 from Luismin and Glamis as an option on higher gold prices. The Metates deposit had no mining history until the sixties when a private party attempted a 25 tpd mining operation. Serious work was not undertaken until 1993 when Cambior optioned the property and spent $14 million on a feasibility study which concluded in 1997 that the deposit was sub-economic below $556 gold. No further work was done until 2008 when Chesapeake conducted a twin drilling program and started to review development options which doubled to 60,000 tpd or higher the production scale Cambior had considered. In the process of twinning Cambior's holes Chesapeake discovered that due to a systematic bias which arose through a Cambior assay protocol change the gold grade had been over-stated by 10%. The 43-101 resource estimate below reflects the revised numbers.
| Project Resource Estimate - Metates |
| Apr 21, 2010 | NI 43-101 | Independent Mining Consultants | Cutoff: |
| Resource Category | Tonnage | Total
Rock Value | Metal | Grade | Recovery | Contained Metal | % of GMV |
| Measured Resource | 216,199,000 | $39/t | Gold | 0.67 g/t | 100.0% | 4,657,214 oz | 64% |
| Silver | 16.5 g/t | 100.0% | 114,692,586 oz | 25% |
Zinc | 0.190% | 100.0% | 905,595,459 lb | 12% |
| Indicated Resources | 729,938,000 | $33/t | Gold | 0.54 g/t | 100.0% | 12,672,942 oz | 61% |
| Silver | 15.2 g/t | 100.0% | 356,719,853 oz | 27% |
Zinc | 0.160% | 100.0% | 2,574,737,213 lb | 12% |
| Inferred Mineral Resources | 135,315,000 | $34/t | Gold | 0.6 g/t | 100.0% | 2,610,327 oz | 66% |
| Silver | 14.3 g/t | 100.0% | 62,212,793 oz | 25% |
Zinc | 0.120% | 100.0% | 357,976,190 lb | 9% |
| All Categories Spot | 1,081,452,000 | $34/t | Gold | 0.57 g/t |
| 19,940,483 oz | 62% |
|---|
| Silver | 15.35 g/t |
| 533,625,232 oz | 26% |
|---|
Zinc | 0.161% |
| 3,838,308,862 lb | 11% |
| Spot Gross Metal Value | Market Cap as % of Net GMV | Spot Prices Used |
| $36,958,684,477 | 1.1% | Gold $1,154.50/oz, Silver $18.35/oz, Zinc $1.08/lb |
The deposit consists of two zones of similar size and grade, the intrusive hosted Main Zone and the sediment hosted North Zone. Mineralization occurs as disseminated or veinlet controlled pyrite that encapsulates microscopic grains of gold and silver, making ore refractory to conventional cyanidation recovery. The sediment hosted zone contains considerable organic carbon exceeding 1% locally which makes it "preg-robbing" which had led Cambior to focus on the intrusive hosted zone because carbon was present to a lesser degree. The problem with a "preg-robbing" character is that once gold and silver has been extracted by cyanide leaching it gets tied up with the carbon from which it cannot be readily recovered. Cambior's efforts to come up with a heap leaching solution collided with another challenge, the steep topography which offers limited space for heap leach pads. The acid generating nature of the waste and ore represented an additional challenge.
Rather than focus on only a portion of the resource and settle for low recoveries, Chesapeake decided to tackle Metates as a large scale resource that would be mined in its entirety with maximum recovery. What had been a limiting factor for the heap leach scenario, namely the near absence of an oxidation profile for the Metates deposit, proved to be a virtue for a milling and flotation approach which benefits from a consistent feed of sulphide ore. The flotation process has the added benefit that the tailings are not acid generating, though Chesapeake will still have to deal with waste rock which contains sulphides. Coming up with an acceptable plan to keep the waste rock dumps from generating acid drainage will be a major task for a feasibility study and the permitting process. The next obstacle was to overcome the refractory nature of the sulphides, and to that effect Chesapeake explored roasting and pressure oxidation, both of which have high energy inputs. As it turned out pressure oxidation produced the highest and fastest recovery, so the flow-sheet includes an autoclave. Bringing power to the Metates site would be expensive and the shortage of flat areas suitable for site infrastructure was also major problem. But not every card dealt the Metates deposit was unlucky. Instead of bringing power to the site, how about bringing the concentrate to the power, possibly through a slurry pipeline? Chesapeake was able to identify a 140 km downhill corridor to a site in Sinaloa state which is not only well located for regional transportation infrastructure, but also has a limestone deposit that can be used to neutralize the sulfuric acid generated by pressure oxidation. Finding this corridor and establishing its feasibility was a key breakthrough during the past two years.
For long lived projects such as Metates a key issue is the control of input costs. Novagold's Donlin Creek is an even larger undeveloped gold resource than Metates with similar problems in terms of refractory ore and remote location. So far the development scenarios for Donlin Creek have not come up with an energy source alternative to diesel, which closely ties the profitability of Donlin Creek to the future price of oil. Mexico's electricity power plants were mainly fueled by oil until 2000 when the feedstock shifted to natural gas which now dominates electricity generation. However, Mexico is now a net importer of natural gas which would expose Metates to natural gas price variability. In order to stabilize its energy costs Chesapeake developed a scenario where it would build a dedicated coal fired power plant with a long term supply contract involving coal from Colombia. The Sinaloa location close to a port and rail would facilitate fuel transportation and connection of the power plant to the regional grid to supply surplus electricity, a scenario bound to attract political support for the development of Metates as a major mine. Although the power plant scenario adds substantially to the capital cost, it does help fix the long term operating cost, and that is critical for Chesapeake's exit strategy.
Chesapeake has no intention building a mine. It's plan from day one was to hold Metates as a speculative option on a higher real gold price. At one time it thought the threshold would be $800 gold, but during the last five years capital and operating costs have kept pace with the price of gold, not in a smooth linear pattern, but in stops and starts. How little gold has gained in real terms during the past three decades is evident in my long term chart plotting the actual price of gold since 1980 along with $400 gold in 1980 adjusted annually for the average US inflation rate. Chesapeake's gamble is that gold will undergo a dramatic real price increase during the next decade similar to what it did during the seventies where it increased to a 20 fold peak before stabilizing at a level ten times higher. From 1970 to 1980 the $35 starting gold price adjusted annually for inflation would have ended up at $77 in 1980, which means that during this period the real price of gold increased about 5 times. In the 30 years since then $400 gold inflation adjusted should be just over $1,000, which means that the current $1,150 price represents a 12% real increase. It is the view of many people including myself that gold after a 30 year bear market hiatus is on the threshold of making significant new gains in real price terms. Chesapeake's Randy Reifel has a similar outlook which is why he has let Chesapeake spend the last two years working out a plausible development plan so that when the day comes where major gold producers are confident in a higher real gold price, they will make a buyout offer for Chesapeake and its Metates project.
Chesapeake is ready to begin a prefeasibility study expected to last 12-15 months and cost just $3 million because only a small amount of geotechnical drilling is still required while the rest involves engineering work. A realistic timeline for production startup would be 5-6 years, but a buyout could occur during the next 12-24 months. Chesapeake had $6.2 million working capital as of September 30, 2009 and is sufficiently funded to complete the next milestone in the development cycle. Fully diluted Chesapeake has 45,150,098 shares out which include 4,510,301 warrants exercisable at $8 until February 23, 2010. At the current $8.78 stock price the Metates project has an implied value of $396 million. This does not assign any value to the Talapoosa gold deposit and other resource projects which on March 4, 2010 Chesapeake proposed to transfer to Christopher James Gold Corp (CJG: $0.07 halted) in an RTO transaction that would give Chesapeake 75% control of Christopher James. Under this deal Christopher James will conduct a 10:1 rollback to reduce its fully diluted to 6,161,975 shares, issue 18,845,924 shares to Chesapeake, and change its name to Gunpoint Exploration Ltd. Gunpoint would have 25,007,899 shares fully diluted. In the event that Chesapeake receives a friendly takeover bid from a major it is likely that the company will distribute its Gunpoint shares to its shareholders on a pro-rata basis. Completion of the RTO has been delayed because of tax complications, but the RTO remains on track. Christopher James, which was recommended an extreme risk bottom-fish buy below $0.10 on December 24, 2008, will remain halted until completion of the RTO. Although the stock is suffering a 10:1 rollback, the structure of the resulting company and the nature of its assets makes be confident that bottom-fishers will with time achieve the 500% plus gains we seek for bottom-fish recommendations.
Conclusion: I adopted Chesapeake Gold Corp as a Good Relative Spec Value Buy at $6.88 on February 8, 2007 when my earlier recommendation, American Gold Capital Corp, was acquired by Chesapeake in a complex transaction involving stock, a warrant and a gold price linked right. Since then Chesapeake has been as high as $10 on March 2, 2010 and as low as $1.89 on October 24, 2008, the bottom for advanced gold stocks during the 2008 Crash. Chesapeake has not been a particularly good spec value hunter pick during this period even though gold has risen from $656 to its current level of $1,150. However, much of the uncertainty surrounding the mechanics of developing Metates has since then been removed, and the new PEA provides a fresh basis for assigning a concrete price target range. Mainstream gold analysts have noticed the Metates PEA and are waiting for the technical report to be filed in late May so that they can slam it with their sledgehammers to see where the PEA model breaks. If the detailed PEA numbers prove solid, we can expect Chesapeake to start moving toward a target range of $20-$30 which would price the project at $900 million to $1.4 billion. That would leave plenty of valuation upside for a potential buyer if gold stays at $1,150 level, and offers lots more upside if gold does march towards $2,000 in an environment of stable cost structures. For this reason I am closing out the old 2007 Spec Value recommendation at $8.78 to wrap up a 28% gain, and issuing a new Good Absolute Spec Value buy at $8.78 with $10 as an accumulation limit, and $20-$30 as a buyout target during the next 12-24 months. The bonus for Chesapeake is that if gold breaks out past its recent London high of $1,212.50 made on December 2, 2009, and shows every sign of moving significantly higher, Chesapeake's stock price has the potential to move very rapidly toward the $20 target.
|
