Description

Report on Bolivar Gold Corp (BGC) and Gold Fields (GF), El Callao, Venezuela


1. Personnel / Management team quality
The team on the ground in Venezuela is nothing short of impressive. The company has collected a team of guys from around the world to come work on this project, with them came a vast amount of contacts for let’s call them non-traditional suppliers – the jeeps come from Russia as a cost of $8,000 a piece, the huge pumps used throughout the mine are from South Africa, exploration drills are used equipment from Canada, impeller blades from Brazil, dump trucks from Scotland, etc. For each and every piece of equipment there was an analysis which determining which equipment should be new, which should be slightly used, and which should be purchased used and then refurbished. This has kept the costs low. The construction was managed by two Brits, a Canadian and an American. The mine manager is Russian, and had 20 yrs of experience in some of the huge Siberian mines out there. The plant manger/engineer is Chilean. The General Manager of the operation is Chilean as well, with 25 years experience in some of the larger South American mines in the world, and a graduate degree in mining management from the UK. A couple of geologists are Canadian, helped by an Australian couple at Gold Fields (GF). All have extensive experience in their home countries, and have come to El Callao because they believe it is an exceptional opportunity, based on my conversations with them, and based on my seeing El Callao (there is no reason anyone would move there beyond exceptional opportunity, as it is a village 3 hours drive from the nearest “city”, Puerto Ordaz, which itself is not much of a city).

2. Plant and expansion assessment
The plant consists of two 2,750 hp ball mills, which can process over 5,000 t a day of raw ore (the largest in Venezuela and probably in Northern South America). After the ore is crushed into a fine powder it goes into a series of tanks where, mixed with cyanide, gold is extracted. The ore slurry resides in the tanks for a minimum of about 24 hours. After the slurry reaches the final tank, it is sent to a catalytic unit which extracts the gold. The process is one of the more advanced ones available, and is economic at ore grades of as little as ~1%. For September, the plant has been operating at above 90%, as most of the kinks have now been worked out of the system. Several gold sales have already taken place, under tight security and by helicopter, at London’s 2nd fix to a Swiss refining company (under long-term contract). The ingots have proven to be exceptionally pure, at about 96% gold, with the balance being silver, iron, and platinum (<0.5%). The plant manager, a Chilean with 25 years of experience running various plants around Latin America, is optimistic that they will pour at least 5,500 ounces this month. He personally toured the operation with me and was exceptionally knowledgeable (I was a mechanical engineer in a former life, so I am fairly knowledgeable about these things).
Most of the plant equipment was purchased from an Idaho division of Hecla that barely used the equipment. When Hecla ceased using it, it was disassembled and stored in a hanger at about 8,000 ft of altitude, where corrosion is less of a problem. As a result, most of the equipment was in fine working order, and where needed, the equipment has been either refurbished or replaced. Most of the new equipment consists of ore handling conveyors, sorting and sifting machinery, and pumps. The mills, crushers, and processing tanks are all from Idaho. As you will see in below, the main problem for mine operations in remote areas, energy, is not an issue because of the mine’s fortuitous location. The problem is that while the plant was being built, exploration activities were moving forward, and at this point, it has become clear that the plant will no longer be sufficient to mine out the reserves in a timely fashion (reserves at the current rate of processing will likely be about 30 yrs by year’s end).
The company is on the lookout for another used mill to bring the plant capacity up to 10,000 tons/day. Talks with a mothballed mill in northern Quebec were delayed as the reserve keeps growing rapidly and engineers are therefore still debating what size plant will be needed. There should be an announcement on the decision within the next few months.

3. Political risks / Corporacion Venezolana de Guyana (CVG)

All required environmental, mining and gold-selling permits are in place. BGC management has strong ties with the CVG and the Venezuelan Gold Mining industry in general as a couple of BGC officers have held posts in those organizations at high levels. Furthermore, the pact signed with Canada has been done in great fanfare by Chavez himself, and so is under less of a risk relative to other deals that his predecessors might have signed, which he often accuses of giving away Venezuelan assets. Finally, as Chavez has sought to minimize the influence of US companies in Venezuela, he only has a limited choice of alternative partners that historically have invested there and therefore might provide significant FDI rapidly, Canada being one of those. Chavez has made a lot of noise about signing deals with the Chinese of late, and indeed Ciudad Guyana was full of Chinese businessmen making deals with the local steel and aluminum companies. Nonetheless, keeping Canadians, major investors in Venezuela, as well as generous donors, happy, should definitely be one of Chavez’ priorities if he wants his non-US strategy to succeed.

In general, while in Venezuela, I found the situation a lot less worrisome than I originally anticipated. People were friendly and most of them well-educated. No beggars roaming in the streets. I felt safe the whole time I was there, though I avoided walking around outside at night too far from any well-lit area. Definitely a lot safer than for example Mexico City. Pretty much anyone with a respectable job (Taxi driver, hotel check-in clerks, restaurant waiters, etc) very publicly made fun of Chavez and derided him, which in my mind means that there is a large group of sensible people that have not bought into all his populist babble. Venezuela has enjoyed the strongest growth of all of Latin America for the last two years (15+%) and is slated to continue on that track next year which only bolsters the argument that a lot of his talk is just that – talk and not much else.




History and opinion
The Corporacion Venezolana de Guyana (CVG) was established to help develop the poorer south of Venezuela that borders with Brazil. The region has many natural resources, including iron ore, bauxite, steel and aluminum smelters, several large rivers powering a number of hydro dams (with power exports to Brazil). It also has a gold mining district that was active in the early 1900s, but because of the high water table and the lack of adequate pump technology available in those times, the industry never really took off.

The current situation stems from a relative lack of investment in Venezuela’s sizeable mineral deposits, especially gold. A bit of history helps place the current situation in context.

In 1992 Venezuela passed landmark mining laws that allows the government’s mining ministry to allocate concessions to private companies to develop the country’s resources. One of the early takers of a number of mining concession in the south was the CVG, which supposedly at one point controlled about 50% of the concessions in the area. The CVG, not having enough capital to fund the massive exploration efforts needed to explore this large swath of land, started transferring those concessions to third parties, including foreign companies, in exchange for some stake in the resulting venture. The concessions were granted to 3rd parties with approval of the mining ministry. An early foreign entrant into the area was a now defunct Canadian junior that paid something like $40M for a concession on a completely unexplored piece of land, which caused a huge land rush as local businessmen snapped up whatever concession they could find in hopes of eventually unloading it on a miner/foreigner for a quick buck. The Canadian company however, never went far, but the land rush it caused meant that most land was already locked up in the hands of hopeful flippers who never had the intention nor the ability from either a capital or technical perspective to invest in explore their concessions. And so the concessions remain literally untouched to this day, and Miguel de la Campa (President & COO of BGC) estimates that more than 90% of the land out there has yet to even have preliminary exploration work done on it. The original BGC concession was itself picked up by a Venezuelan cement company as a speculative play, and when that company was bought up by the Mexican giant Cemex, the concession was sold off as an obviously non-core part of the Venezuelan operation.

By the mid 90s, a power struggle between the CVG and the ministry led to the ministry revoking CVG’s right to acquire additional concessions. The CVG, however, in cahoots with the regional government (the current governor of the province for example, is a former CVG president and supposedly has the ear of Chavez), shifted strategies, unilaterally allocating mining contracts to 3rd parties without the government’s approval. One such contract was granted to Placer Dome in the 90s for the Las Christinas area [approx. 2 hours’ drive from the El Callo district], one of the historically interesting areas in terms of gold mining. Placer Dome did some exploration work, increased the proved reserves of the area, but then decided not to invest further for various corporate reasons (did not want to spend the capital, gold prices tanked, etc). The government then planned to organize an auction for the license, got several multinationals involved, but at the last minute the sale was stopped and Crystallex received the license under shady circumstances for an approximately $15M payment (ridiculously low for the amount of gold in the ground). The legal counsel of BGC suspects this was a case of high level bribery, and refused to represent Crystallex in their negotiations with the government on the basis that the original contract was itself of dubious nature, not to mention the circumstances of the sale just described.

Shortly after Chavez came into power, he launched a “comprehensive review” of the mining contracts and concessions that had been issued, in an effort to get the ball rolling on the mining industry. BGC had no problems on that review, and they expect no problems this time around, as they have been diligent about meticulously implementing all rules relative to operating in Venezuela from environmental regs to mining permits and so on. They have invested a large amount of capital and have created about 500 jobs directly and indirectly in the local economy, so one would have trouble arguing that the concession is dormant and that the company is not benefiting Venezuela.

Miguel de la Campa told me of his life as an emigrant to Venezuela after his family lost everything in Cuba, and one could plainly see that he is strong-willed and determined to not let his life’s work escape him, and he felt strongly that there was no chance of nationalization or expropriation of BGC (expropriation is supposedly done with appropriate compensation while nationalization offers no compensation). When I challenged him and said that I expected at a minimum that there would be a re-negotiation of the existing concession, he pointed out the following:

1. There is no precedent for a nationalization or expropriation in the recent history of Venezuela.
2. The current concession contract was negotiated with the Chavez government including the current minister of MIBAN, and the CVG.
3. The level of taxes and royalties on BGC are similar to other Venezuelan gold companies so that it could not be argued that they are receiving an unfair benefit from the government. Furthermore, BGC taxes and royalties are broadly in line with what goes on elsewhere in Latin America.
4. BGC have been meticulous in respecting the law and government regulations.
5. BGC has excellent contacts and relations at all levels of government.
6. The heavy oil taxes that have been featured in the press of late were not the result of the government re-negotiating contracts it had in place. The tax increases were stipulated in the contract, fair and square. The legal counsel confirmed this fact.
7. The Canadian ambassador has met with Mr. de la Campa and told him she sees BGC as one of Canada’s biggest interests in Venezuela.
8. Historically, Venezuela has had good relations with Canada which exports both capital and expertise throughout Latin America, and if Chavez were to burn that bridge, then he would turn his back on the last friendly North American government he has, as well as the main investor in the mining industry in Latin America.

My take:
The government will launch a review of the contracts that are currently outstanding and will most likely seize the concessions on which no work has been done, as should be done. The government might also seek some renegotiation of contracts, though if it does so, BGC’s contractual arrangement would likely be the last to be changed/challenged as it has just been renegotiated with the current powers that be.

The impending government visit to Las Christinas will likely cause more noise and negative press for Chavez, but given the very different situation for Crystallex from a legal and development perspective, that situation should have no real bearing on BGC’s activities in the area. I am certain that the visit will provide journalists with ample opportunities to quote Chavez out of context, giving one of his grandiose populistic statements that rarely translate into anything really tangible beyond a wild stock market ride. If nothing else, this should provide for phenomenal buying opportunities.

Congressional elections in December will be more interesting to watch, as Chavez is just a few percent short of a 2/3 majority, but the opposition has grouped itself into one party to maximize its anti-Chavez potential. And international monitors last time around declared the elections to be clean, so we should not expect meddling in the results. Even if Chavez does get the 2/3 majority, he has already changed the constitution to his benefit, so it is not clear what additional power that would bring to him beyond giving him extra confidence in his actions.

4. Union issues
There have been a couple of run-ins with the local unions, but these have all been with the construction unions, which bring workers from all over to work on these projects. The entire union system is corrupt, and current construction workers are paying one month’s wages to the union leader to get a job. For every new piece of machinery, every different ditch to dig, etc the union needs to give approval – and this is what had caused the delays in the construction of the plant, along with the traditional “month off” construction workers get at Christmas to go home. Thankfully, for the mine workers themselves, this is not a problem, as BGC has created its own union and appointed someone they know to run it. Apparently this has been done with success at the other mines and they have even been able to run at full capacity on Christmas day in the past.

5. Energy issues
Energy is always a big issue for mining as it usually represents a major cost of production, and a potential risk in developing countries where supplies are sometimes at risk. This particular situation has two advantages which make it very favorable for BGC.
a. Venezuela always has sold fuel at ridiculously low costs as a social gesture, and it is deeply ingrained in the psyche of the locals that the price should be that low – every single taxi driver told me that Venezuela was anywhere from the largest to the 4th largest oil producer in the world, which is why gas was so cheap (they are actually 10th, but no matter). Current super unleaded prices are approximately 16.7 US cents / gallon (97 Bolivars/liter), and the fleet manager at the mine told me they were buying diesel at 66 Bolivars a liter, or approximately 11.4 US cents / gallon.
b. Perhaps more importantly, a reliable source of power is critical for the plant, as gold processing requires ore dissolved in water to be pumped throughout the plant, and in the final processing step, must be constantly agitated in the deposition tanks. Again BGC is in a good position here. The Guyana region is endowed with several large rapid rivers, over which the government has built a system of 5 large hydro electric dams, producing much more power than the region needs. As a result, the government has signed a long-term supply contract for neighboring Brazil, which guarantees a 99.4% availability. That availability has always been met. The Choco 10 plant is approximately 2 miles from that main transmission line, and its substation is directly fed from that line. As a result they have 25 MW of highly reliable capacity, enough for a small city, and about 4x what is required when the plant runs at full capacity.

Put all of this together, and what one obtains is a total cost / oz of gold of approximately $159. And note that the traditional gradual devaluation of the Bolivar (happens once every 1-2 yrs) will only make this number better vis-à-vis gold sales which are always conducted in US dollars.


6. The Gold Reserves
Choco 10, where the current mine and plant are located, is 100% owned and operated by BGC. From the latest geology reports, it seems that what were 3 different pits are actually turning into one giant mineral deposit. Rosika, Coacia (RoCo) and Pisolita, now have approximately 2.5M ounces of Measured and Indicated reserves, and it is only a matter of time for an independent geologist to approve the results and for the mine engineers to lay out a mining plan for them to become proved reserves (most likely by January). Furthermore, BGC is starting an extensive drilling and exploration program on another pit in Choco 10, Villa Balazo-Karolina (VBK). The geologists are highly confident that VBK will have at least 1.7M oz of proved reserves in 12 months or less (depending on how fast they can finish the drilling etc). BGC now has an in-house lab so the sample testing is going a lot faster than before. A geologist told me, “we are looking at a 5 million ounce resource, easy, before the end of next year”. And note that is excluding all the work that Gold Fields is carrying out in the area – while the GF work has not found any deposit that is the magnitude of RoCo, it is becoming clear there are a couple 1 million oz deposits that are in the works (which on their own would be interesting to mine). So the bottom line is that there is a lot of gold to be mined…

7. Gold Fields Joint Venture
GF has dispatched two Australian geologists for a two-year assignment at El Callao, working on the other blocks that are joint-ventured with BGC (Choco 1, 2, 4, 6, 9, 12 and 13, GF must do all the exploration work to earn-in its share). The two worked in a mine that was run by an Australian junior before it was bought out by GF, which had very similar geology to the El Callo district. As a result, the two have rapidly built up an exploration operation of some 25 people, and they are methodically exploring the JV concessions. Most of the area has never been explored with modern tools, though artisanal miners have had small operations in various spots. To date, GF have completed initial soil tests on Choco 1, 2, 12 and 13 with samples on a grid of 400m x 40 m. That has allowed them to generate a list of priority targets for costlier core drilling. But they asserted to me that the geology was full of promising areas and that the major geological feature of neighboring mines goes straight through Choco 1 and 2. Furthermore, some artisanal miners were recently expelled from Choco 1 & 2, and they typically only mine in areas with extremely high gold content as they do not have advanced processing available to them that can exploit lower quality ores. This in itself is a major indicator of potential, as a couple of other large finds in the area were under the spots where artisanal miners were working.
The current two Australians’ goal is to identify and complete the financial planning for at least one significant gold find. The idea is to find enough gold to support another plant. The team seemed extremely motivated, and no doubt partially because they wanted to leave El Callao at the end of the 2006 when their initial assignment is done. Without a solid find they probably would have to stay on longer, and they privately admitted to me that they were working 12 hour days because there really was not much more to do in El Callao.

They also told me that they were in the process of negotiating with the CVG to acquire 3 more concessions, Gloria 2, 3 and 4.

Overall, I would say that there is significant upside potential in the JV, and since BGC is a lot smaller than GF, BGC stock would be more levered to such good news. Given that the markets seem to completely ignore this facet of BGC, the upside here is a freebie.


8. Valuation computation

Using somewhat overly conservative assumptions, namely:
- 10% CVG share of operation (vs current 5%)
- Gold price average of $400/oz (vs current pricing of ~$470)
- Total output from Choco 10 of 4.5M oz (10% less than what geologists predict)
- 1 year delay in plant expansion (2009)
- Zero value to GF JV
- 10% discount rate (which is high given that in mining there is a relatively little uncertainty as to the amount of value in the ground and the time it takes to bring it to market).
- I figure the company is undervalued by 2.1x. Price target is ~$4.00 Canadian. The Venezuela risk seems small, and there is still significant potential value in the GF JV. This is as cheap as they come, folks.

Catalyst

BGC should post some very good results in the near future that will reassure investors that it is a real, highly-profitable operation that is not under any kind of significant risk from Chavez' government.