November 23, 2009 - 5:13pm EST by
2009 2010
Price: 1.27 EPS $0.00 $0.00
Shares Out. (in M): 58 P/E n/a n/a
Market Cap (in $M): 74 P/FCF n/a n/a
Net Debt (in $M): 4 EBIT 0 0
TEV ($): 100 TEV/EBIT n/a n/a

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Gold Reserve, Inc. ("GRZ" or "the company") shares represent a compelling risk/reward opportunity with significant option-like upside and limited downside.

The quick story is that GRZ is an emerging mining company that owns a large gold mine located in southeastern Venezuela called Brisas.  Together with the adjacent Las Cristinas mine, this area represents one of the largest undeveloped gold mines in the world.  The Venezuelan government, after granting and then rescinding a production permit for the mine, recently expropriated the mine.  Gold Reserve has recently filed a claim against Venezuela through an international arbitration process based on the breach of a bilateral investment treaty between Canada and Venezuela to try and reclaim the costs of their existing investment (roughly $250 million) plus future profits (the lawsuit targets $5 billion).  The company appears to have sufficient cash to work through the arbitration process which could last several years.  Any reasonable settlement, even if just for reimbursement of expenses to date, would result in significant value creation for shareholders.

The value of the company's stock has declined significantly over the past few years due to the political uncertainty stemming from Venezuela's moves to nationalize valuable natural resources.  This situation is becoming somewhat common for investors in Venezuela as Chavez has nationalized companies in energy, telecom, steel and cement as well.

Gold Reserve is a Canadian company with executive offices in Spokane, WA, and the majority of its roughly 75 employees located in Venezuela at the site of the Brisas mine.  The company acquired the Brisas property in 1992 from its elderly owner for $2.5 million.  GRZ then spent roughly $250 million exploring and testing the mine in preparation for production, which was supposed to begin in 2010.  The Brisas property occupies a rectangular area of roughly 500 hectares (1,235 acres), and the company also owns roughly 4,950 hectares near the mine site for exploration and infrastructure purposes.  The Brisas project is a large-scale, conventional open-pit mine design, with simple metallurgy leading to easy extraction potential.  The mine is situated in a very good location for production, just 3 km from a well-maintained road and adjacent to a power plant. 

The potential for the company's gold and copper production is described in detail in a 2005 Feasibility Study conducted by Aker Kvaerner.  The 2005 study shows that the Brisas mine would have a 16 year life, with 486,500 ounces. of annual gold production and 63 million pounds of annual copper production (roughly $675 million of annual revenue at current gold and copper prices).

The production potential was further supported by a detailed Technical Report Update conducted in 2008 by mining consultants Pincock Allen & Holt ("PAH").  This report showed 10.4 million ounces of proven and probable gold reserves and 1.3 billion pounds of copper reserves.  It also estimated potential annual gold production of 456,000 ounces and annual copper production of 60 million pounds over an 18.5 year mine life.

If the mine were brought to production, GRZ would have a huge cost advantage over its peers.  Because of the very cheap energy costs in Argentina (e.g., diesel costs less than $1.00/gallon), GRZ has a strategic cost advantage relative to other global gold producers.  Company management estimates that they would realize savings of over $100/oz. vs. comparable gold producers in the U.S. or Canada.  The 2008 PAH Technical Study shows that GRZ could produce gold at a total cost of $277/oz. including all initial capital and operating costs.  For comparison, AngloGold Ashanti publishes total cash costs of $534/oz. and Agnico-Eagle Mines shows total cash costs of $340/oz.  For 2008, Barrick produced 7.7 million ounces of gold (the world's largest production) at cash costs of $443/oz.  Gold Reserve will have a huge competitive advantage due to cheaper energy costs if the mine reaches production.

Recent Actions:

On October 21, 2009, as a result of the inexplicable revocation of their production permit, Gold Reserve filed a Request for Arbitration through the International Center for Settlement of Investment Disputes ("ICSID"), an organization of the World Bank, against the Bolivarian republic of Venezuela.  The company seeks compensation for losses caused by Venezuela's violations of a bilateral investment treaty between Canada and Venezuela (the "Agreement between the Government of Canada and the Government of the Republic of Venezuela for the Promotion and Protection of Investments").  The company claims that their "investments were unlawfully and effectively taken from it as a result of the decisions and actions taken, directed, and supported by the administration of President Hugo Chavez."  The result of the unreasonable permitting delays, rescission of the March 2007 permit for the commencement phase of the Brisas project, and the governmental takeover of the property had the effect of denying GRZ its right to fair and equitable treatment as required by the Canada-Venezuela Treaty.

Gold Reserve believes that they have done everything possible to obey the law and even gathered support for production from local communities surrounding the mines.  The company has spent almost $250 million to date in exploration and development, and projects the losses from future profitability of their investments at roughly $5 billion.  While this $5 billion is subject to a significant amount of speculation, a settlement for just the $250 million of actual expenses would result in a tripling of the stock price.

On October 27, 2009, less than a week after filing the request for international arbitration, the Venezuelan government took physical possession of and seized control of the company's Brisas property. 

It is hard to predict what might happen during the arbitration process or how long the case would take, but there lies the opportunity.  There are currently several high-profile ICSID arbitration cases against Venezuela, including plaintiffs such as ExxonMobil, ConocoPhillips, Holcim, and CEMEX.  In previous high-profile cases involving Venezuela's seizure of assets belonging to ExxonMobil and ConocoPhillips, the oil companies sought compensation from Venezuela for the market value of the firms' assets ($2+ billion for ExxonMobil and $7 billion for ConocoPhillips).  Venezuela sought to settle the claims based on the book value of the reserves ($750 million for XOM and $4.5 billion for COP), a smaller but still meaningful value.  Providing some credence to ExxonMobil's case and international protection of investor rights, U.S., British, and Dutch courts agreed to seize assets from Venezuela.

Venezuela has settled with other oil companies over similar disputes related to projects in the Orinoco Oil Belt - in exchange for handing over majority ownership to the Venezuelan government, Total and Statoil-Hydro received $1.1 billion of remuneration.

Given the current uncertainty, Gold Reserve has drastically cut all further expenses related to development of the Brisas mine.  They will likely burn about $10 million/year in operating and legal expenses.  If the suit goes to arbitration, it could be drawn out for several years (most arbitration cases are settled over a 2 - 3 year period) and the company could incur significant legal expenses.  However, the company seems well capitalized to make it through the next few years while investors wait for an outcome.  The increasing value of the Brisas asset should incentivize Venezuela to reach some type of resolution or settlement.


Based on the proven and probable gold reserves at its Brisas mine, Gold Reserve is valued at a market cap/oz. value of roughly $7.50 and an enterprise value of roughly $10/oz, less than 1% of gold's current spot price.  For comparison, larger producing gold miners are currently valued at roughly $250 - $350/oz. of reserves.   Barrick, the world's largest gold producer, is valued at $311/oz. on a market cap basis.  Agnico-Eagle Mines is valued at $475/oz.  On the low end, AngloGold Ashanti is valued at $240/oz. of reserves.

The following table shows the tremendous upside in the case of an arbitration settlement with Venezuela (all values are in thousands except share price).

Arbitration Award: $0 $250,000 $500,000 $1,000,000
Cash and Current Assets: $89,000 $89,000  $89,000  $89,000
Property & Equipment: $59,000  $59,000  $59,000  $59,000

Less Debt (5.5% converts):

$(92,921)  $(92,921)  $(92,921)  $(92,921)
Less Other Liabilities: $(7,247)  $(7,247)  $(7,247)  $(7,247)
Less Legal and Operating: $0  $(20,000)  $(20,000)  $(20,000)
Equity Value: $47,832  $277,832 $527,832  $1,027,832 
Value Per Share: $0.82  $4.78 $7.34  $14.30 
Current Share Price: $1.25 $1.25 $1.25 $1.25
Upside/(Downside): -34% 282% 487% 1044%

Key assumptions:  This analysis assumes legal and other operating costs associated with a successful settlement of $20 million ($10 million/year for 2 years).  It also assumes that all bonds are converted to common shares at a stock price above $7.54.

In a worst-case liquidation, shareholders should receive $0.82/share, roughly a 30% decline from current prices.  The company has $89 million of cash and equivalents (as reported by the company on November 12, 2009), nearly equal to the value of the company's outstanding convertible bonds.  They also have nearly $60 million in property, plant and equipment which could be sold off as well.  While there is some potential downside in a liquidation at current share prices, the stock has traded down to as low as $0.50 as recently as August 2009, and may trade back down if people become frustrated with the possibility of a lengthy arbitration process further limiting downside if purchased at those lower levels.

For another comparison of value, Newmont Mining Corp. purchased Canadian explorer Miramar Mining Corp. in March 2008 for $1.53 billion.  Miramar owned an undeveloped project named Hope Bay which contained an indicated and inferred resource of 10.7 million ounces of gold, very similar to the size of GRZ's Brisas mine and also non-producing (and less well tested than Brisas).  The Hope Bay mine was arguably of lower quality given its remote location in far northern Canada, earlier stage (unpermitted and mostly unexplored), and higher extraction costs.  A similar valuation would put Gold Reserve at $21.25/share.

If GRZ successfully assumes control of the Brisas mine and pursues a strategy of production, the potential upside could get even greater.  In order to start production at the Brisas mine, PAH estimates that roughly $1 billion of capital would be required over the 18+ year mine life.  This results in a cash operating cost per gold ounce produced of $142, and $277 per ounce including all capital costs ("fully-loaded").  At current gold prices, this is a margin of over $700/ounce.  The PAH study, which was completed March 31, 2008, indicates that production at the Brisas project would yield an after-tax discounted cash flow rate of return of 15%, and an NPV of $767 million (5% discount rate) at a gold price of $600/oz., a silver price of $11.00/oz., and a copper price of $2.25/pound.  Total after-tax cash flow is $1.85 billion.  Current spot prices would increase these economics dramatically!

There is also a possibility that Venezuela initiates some type of joint venture to monetize the Brisas asset and ramp up production or acquire the assets outright.  In December 2008, Rusoro Mining, a Canadian mining company with significant ties to Russia, made an unsolicited all-stock offer to acquire Gold Reserve and gain control of the Brisas asset.  The bid was valued at $.88/share, more than twice the price of GRZ's stock at the time.  Chavez has apparently referred to a joint venture formed with Rusoro to co-develop and exploit the Brisas assets.  It is possible that Rusoro (with or without the Venezuelan government) could submit a more attractive offer for the assets.

Regardless of the ultimate outcome, there is clearly substantial value to the Brisas mine.  The question is who ends up with the asset and at what price?  If GRZ has any chance of retaining some ownership or receiving a settlement, then the stock is worth considerably more than its current value.


The most obvious near-term risk is that Venezuela does whatever they want and no settlement is reached.  There could also be unforeseen obstacles over the next few years while the arbitration process is underway, and the company could simply run out of cash while they wait for the arbitration process to conclude.  The case could also be found in Venezuela's favor.  Or, Venezuela could withdraw from ICSID Convention entirely as they threatened to do in early 2008.  However, this seems unlikely as Venezuela strives to become a global power and encourage domestic investment.

In addition, the stock is fairly illiquid, so acquiring a large position could be difficult.


Favorable arbitration settlement with Venezuela

Regain control of Brisas mine and begin production


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