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All Gold stocks are off today. A large sell order in the physical gold market has seen the gold price weaken by about 2.5%. Inevitably those who said that gold was a bubble to burst at $900 and at $1200 will be wheeled out again to blather on about bubbles and the end of the bull run. They are wrong but this is a good day to pick up a gold stock or two.
Why are they wrong? The gold bull against the paper currencies has lasted 41 years since we dropped the gold standard. Since then gold has gained 99% against Sterling and about 98% against the dollar. As our Central banks print more and more paper money the bull market of the past few years (caused by that Quantitative Easing) will accelerate. Most analysts see gold at well over $1800 in 2013 – I see it at $2000 plus. And so I remain a bull of both gold and well financed gold stocks. And that brings me to AIM listed Chaarat Gold (LSE: CGH) which at 20.875p is capitalised at £52 million ( call that $83 million).
Chaarat is not yet producing gold from its mine in the Kyrgyz Republic but it should be within a year. Until last week the only uncertainty was a slight shortfall in the cash it needs (it has c£50 million in the bank) to bring its mine into operation. The management had said that it would not issue shares at less than 50p but that it was looking at various non dilutive funding options.
To read my free tip of last week – another gold stock click here
Step forward the Chinese. First up, Shandong Gold Mineral Resources, the third largest gold producer in China said that it has secured Chinese regulatory approval to make an investment into Chaarat. Discussions are underway but there is of course no guarantee of a deal. Chaarat has publicly stated that it would not issue equity at less than 50p so my guess is that SGMR is negotiating to take a state in the underlying operating asset. The amount Chaarat needs is pretty small beer ($20 million) and so when the Directors state publically that they “intend that any agreement will enhance long-term value for Chaarat shareholders” – this means that it is in a strong enough position not to be legged over by the Chinese.
As an aside Chaarat also announced that it has signed an MOU China Gold International Resources Corp, the largest gold producer in China, and its 70% owned subsidiary, Kichi Chaarat, holder of a deposit adjacent to the Chaarat asset. This MOU relates to the joint construction and sharing of the cost of a power line from Chatkal, the entry point to Chaarat, to the national grid of the Kyrgyz Republic. This project is now underway.
This means a slightly higher initial capex for Chaarat but lower opex for the life of mine. The company states:
“Upon construction and commissioning of the power line, the projected cash cost of gold production at Chaarat is expected to decrease considerably. In addition, the need to transport large quantities of diesel by road will be eliminated. This will enable a more rapid development of the deposit overall. Chaarat’s management is considering a range of options, including vendor finance, for funding the cost of the power line, which falls outside the original budget of the Project.”
In other words this does not imply that additional equity needs to be raised. So what does this news mean for Chaarat?
In an article written on 9th October which you can read here, I included the following table:
| Year & Output | $1200 Gold | $1500 Gold | $1750 Gold | $2000 Gold | $2500 Gold |
| 2014 – 30,000 oz | $15m | $24m | $31.5m | $39m | $54m |
| 2015 – 70,000 oz | $35m | $56m | $73.5m | $91m | $124m |
| 2017 onwards 200,000 oz | $140m | $200m | $250m | $300m | $400m |
Now if you assume that opex is reduced by, perhaps $100 oz, you are adding free cashflow of $3million a year in 2014, $7 million in 2015 and $20 million from 2017 onwards. Those sort of maths mean that payback on the electricity project will be pretty rapid.
Now even if Chaarat ends up handing 10% of the mine over to a new Chinese partner the certainty of getting the mine, fully financed, into production de-risks this enterprise big time. But valuing the additional cashflows from the reduced power costs on a multiple of three more or less offsets that.
Valuing the project on a cashflow multiple of three is bloody harsh since it has a long life of Mine, five might be fairer but I shall be a prudent sort of fellow. On that basis with the power bonus and using a $1500 gold price you are looking at a 2017 valuation of $660 million. Discount that back at 5% and you are looking at a valuation of $537 million – that is a target price of 134p. Now I accept that there are political risks in the Kyrgyz Republic and that funding is not yet closed. But equally one might argue that a five times multiple is fairer or that a $1750 gold price is fairer. But at 20.75p the upside is clear.
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Libertarian investment writer Tom Winnifrith writes extensively for a number of US and UK financial websites. All of that material appears on his own blog, which also carries his extensive original non financial material, at TomWinnifrith.com – for alerts on all Tom’s writings (except for that free share tip) follow him on twitter at @tomwinnifrith
