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Investor Exposure to Molybdenum

There is no commodities futures market in molybdenum. Yes, there are many more moly traders than trading companies buying and selling uranium. But, it is a small market. Because molybdenum mining is majorly a byproduct of copper mining, investments in Phelps Dodge is mainly a bet on the rise of copper. A July 24th report that a worker’s strike at Escondida in northern Chile, the world’s largest copper operation, was imminent should probably give molybdenum prices a boost. “Whether it’s a long strike or a short one remains to be seen,” Magyar told us, during a phone call to his USGS office in Reston, Virginia.

He pointed out U.S. molybdenum production, the largest in the world, had reached 58,000 metric tons in 2005, up a whopping 37 percent from 2004. “Increases for 2006 will be incremental,” he said. “Through May, production is up 2500 tons.” In January, Magyar wrote in his monthly update, “China continued its high level of steel production and consumption, thus providing strong demand for molybdenum.” There appeared to be no signs of China slowing down. Perhaps it is time to look at molybdenum companies.

We turned to Maria Smirnova for what Sprott Asset Management favors as molybdenum investments. Surprisingly, the money managers have avoided investments in several molybdenum juniors.

Smirnova told us, “Both Blue Pearl and Roca are good ways for an investor to gain exposure to molybdenum.” She referred to Blue Pearl Mining and Roca Mines, both of which trade on the Toronto Venture Exchange. “They are both in a stable political environment, Canada, and are run by competent managers.” (As a matter of disclosure, Sprott Asset Management has investments in both companies within its various funds.)

Smirnova commented on both companies.

“Blue Pearl is advancing their Davidson project near Smithers in British Columbia. We consider Blue Pearl to be cheap on a contained metal value basis and on a potential earnings basis. The company’s market cap is approximately C$110 million. Using a 0.10 percent MoS2 cutoff grade, the deposit contains an NI 43-101 compliant resource of 588 million pounds Mo. That means investors are paying 19 cents for something that trades at around US$25 per pound. Currently, Blue Pearl is awaiting the results of a feasibility study on mining the deposit’s high-grade core, which would accelerate the payback for the project. We do not expect the mine to be in production until at least the end of 2007.”

“Roca Mines is planning to begin production from their MAX project in the fall of this year utilizing their small mines permit. The company plans to produce approximately 1.5 million pounds of moly per year from a high-grade zone grading 1.95 percent MoS2. The great news is that the small mining permit is already in place and the company has purchased the mill components. As well, Roca just announced an off-take agreement for 100 percent of their concentrate production in 2006 and 2007. Roca is trading at 2x potential cash flow at current moly prices.”

We were curious about Roca Mines, which late Monday announced an agreement with United Kingdom-based Derek Raphael to purchase all of the company’s molybdenum concentrates produced through 2007. The British metals trader is a member of the Minor Metals Trade Association, based in Gloucestershire. According to an industry website, “Molybdenum, in all its forms, is the principal product of the company.” Our curiosity grew because the Blue Pearl website announced it was “Developing Canada’s Next Molybdenum Mine.” We heard otherwise so we passed this one by.

We talked with Scott Broughton, Chief Executive of Roca Mines, to get some background on his company. From whence came the MAX molybdenum property? Having acquired the property in 2004, Broughton told us, “It’s a deposit that was explored extensively by big companies, Newmont and Esso Minerals, back in the late 1970’s and early 1980s.” He mentioned, “They lost control of the key claims, but held control of the other surrounding ground and all of the original exploration and engineering data. It took us the rest of 2004 to negotiate a deal with Newmont, whereby we acquired the rights to their remaining property and, importantly for us, all of that engineering data in its original form.”

What did Broughton get for his money? “Drill data bases and lots of metallurgical work was done on this site,” he told us. “Newmont spent about $15 million dollars (in 1980 dollars), developed an exploration adit, or tunnel, that goes right to the heart of the deposit.” Roca also got a good deal of the baseline study and environmental work as part of the package. “We have bought a very comprehensive engineering, mine, metallurgical, environmental, and baseline data set, as well as the property, from Newmont,” Broughton explained.

“We have about 43 million tonnes of molybdenite,” Broughton told us. Molybdenite is the naturally occurring molybdenum sulfide mineral. “That is not an outstandingly large deposit.” But, it is a primary molybdenum deposit. There aren’t any other economic values in the rock other than moly. “What we now know from our own drilling is that there are very continuous and substantial zones of high grade,” Broughton suggested. “That presents an opportunity for us to go back to the classic way to develop a mine.”

So what is Roca Mines doing? “We’re focusing on small scale, small capital cost project,” he answered. That reduces the risk. “We got it permitted at the end of last year, and we always felt that starting small and starting high grade was the way to go.” Broughton believes this is the classic way to build a mine.

How small is small? “What we have permitted now can produce about three million pounds of contained molybdenum, starting at the end of this year, through to the same period in 2007,” Broughton told us. At $24/pound, that’s $72 million in roughly about 14 months. What’s the cost to produce this moly? “We know this operation has a break even cost of $5/pound,” he responded.

But it never works out that perfectly in the real world. How did Broughton answer that challenge? “I am an engineer. We have got major contingencies built into all our operating costs, but it’s also why we’ve focused on reducing our capital cost. It’s why were are starting with a small, super high grade plant here.”

And what about expansion plans? Broughton didn’t bat an eye, “When we expand from our initial mine, we can steadily produce three million pounds per year for onwards of 10 years. That’s when we expand to a 1000-ton-per-day scenario. We intend to do that by 2008.” So, small means 500 tons per day.

Is that the whole story? On the face of it, this is a good story of mining production and consistent cash flow. While molybdenum prices may have some risk at these levels, our research confirms the next year’s price levels should remain well above production costs. A review of the National Instrument 43-101 remarks made about the moly deposit were encouraging: 42, 940,000 tonnes grading 0.2 percent MOS2 multiplied by 0.59 (the molybdenum equivalent) equals 111,368,000 pounds. According to the document filed with Canadian regulators, the gross value of the molybdenum deposit is valued at more than $2.7 billion (using $25/pound moly prices).

Of course, any veteran natural resource investor knows better than to buy that at face value. First, there are capital costs and operating costs. Then, no resource will be mined entirely. At best, the company might recover perhaps 90 percent. That would only come about should the moly remain high grade and if the metal’s price sustains above $10/pound. Most U.S. molybdenum is produced as a byproduct at little cost to the mining company.

But, there are some bright sides to this. The world’s greatest concentration of molybdenum occurs in the Western Cordillera – the mountains along the eastern half of the geological Pacific Rim of Fire, from the tip of North America to South America. The world’s largest molybdenum reserves are in the United States (about 40 percent). Roca Mines has the right geological setting (as does Blue Pearl Mining). Another aspect of the company’s security filing on their property’s geological estimates boiled down to the individual who prepared the technical report. Terry MacCauley who provided the estimate for Roca Mines had been the exploration manager for Newmont between 1976 and 1982. He had also done the initial geological mapping and geochemical survey in 1975. We readily accept MacCauley’s resource estimate in light of one who is versed in the property’s potential.

Which brings us back to the big question: where does Roca Mines go after it has begun mining moly? “We have a very interesting exploration model in the Henderson mine,” Broughton told us. “The Henderson was a deposit that was explored by Amax. They basically had an upper deposit, in a mountainside that from a physical point of view is almost an identical twin to what we have at MAX.”

Broughton continued his comparison, “It’s called Urad. It has similar size, similar tons, and similar grades to what we have. Amax observed there was multiphase mineralization. There was such a high grade in some of these zones within the deposit that they suspected a very large mineralizing source at depth.” So began the success of one of the world’s largest molybdenum-producing mines. The geologists went deeper to find the source, which was about 700 million tons of ore.

“They went from something that is around the size of a MAX project,” said Broughton. Does he believe he will repeat Amax’s success at Henderson, “I think the model is very well founded, and we’re actually assembling an advisory board to help us focus on that exploration model,” he concluded. “Once we’re in production and cash-flowing, we want to do some more exploration and to drill at depth.”

For the time being, Roca Mines will have Canada’s newest molybdenum mine, possibly as early as this year. Shares outstanding and fully diluted, even with a financing announced before the summer correction arrived, would be less than 100 million shares. If the company honors its promise and produces 300,000 pounds of molybdenum concentrate monthly at its MAX project, starting before the end of this year, and continues into 2007, then Roca will have plenty of cash flow from which to explore the depths of its molybdenum deposit to discover whether or not its “Henderson model” materializes.

Roca Mines and Blue Pearl may indeed become two vehicles for investors to play the molybdenum side of this energy bull market.

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