Gold Reserve GRZ
August 28, 2004 - 7:50pm EST by
2004 2005
Price: 3.68 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 103 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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  • Mining
  • Gold


Aptly-named Gold Reserve Inc. is a Canadian/American gold mining and exploration company with significant proven but undeveloped copper and gold reserves in southeastern Venezuela. Despite extensive independent geological audits of proven reserves, an experienced management team, and a pristine balance sheet, GRZ appears exceptionally underpriced in comparison to the value of its mineral resource, and could become a very attractive takeover target for larger firms once its final feasability study is completed later this year.

An updated August 2004 survey by independent geology firm Pincock Allen & Holt assessed proven and probable reserves of the company's principal Brisas deposit at 9.1 million ounces of gold and 1.15 billion pounds of copper, adding that they believe there is further "upside for additional reserves" at the Brisas site. Based on a current market capitalization of slightly over $100 million, the GRZ gold reserve is being valued at approximately $11 per ounce, far lower than almost any other development-stage company, and strikingly below the current industry average valuation of $143 per proven and probable reserve ounce reported in the Mineweb database of global gold stock valuations:

More importantly as a direct comparison, the nearby Las Cristinas claim of US gold exploration firm Crystallex (NYSE: KRY) is valued at $56 per ounce of proven reserves -- still a huge discount to the $143 gold industry average, but more than five times the valuation of GRZ. (In fact, KRY itself also appears quite undervalued, and was the subject of a previous VIC writeup by omar810 which is well worth a read.) Even assigning an extremely large margin of safety for the deposit's undeveloped state and for any political uncertainties specific to Venezuela, GRZ appears to carry a generous further discount to this directly comparable peer. As Omar points out in his writeup, gold acquisitions have recently been taking place around and above $100 per P&P reserve ounce (sometimes significantly more, depending on the perceived potential for further exploration.) KRY and GRZ could possibly be even more interesting as a dual acquisition for a much larger mining firm, as the two reserves could potentially be exploited more efficiently with a central ore processing operation.

Another way of valuing reserve gold assets is via a replacement cost approach. In a May 2004 address to the Global Mining Forum, industry analyst Trevor Steel noted that 348 million ounces of gold reserves have been discovered since 1990 at an exploration cost of $22 billion, or $63 per ounce discovered. Although this replacement cost is below the price per ounce at which the average gold firm is currently valued, it is significantly above the $11 per ounce valuation of already discovered reserves at GRZ.

Intriguingly, the 348 million ounces of new reserves found since 1990 fell far short of the nearly 1.1 billion ounces mined and sold worldwide during the same period of time. Although I am not a "gold bug" and have no firm opinions either way on the likely direction of gold prices, these figures do point out that reserves are being depleted faster than they have been replenished by new discovery, and the cost to firms of exploring for new resources is significantly greater than that of acquiring an already well-characterized deposit through the Gold Reserve property. If six birds in the hand are worth anything close to one in the bush, GRZ would appear to be a reasonable buy.

Gold Reserve has zero debt and a cash balance of US $16.8 million; adjusting for this $0.52/shr net cash position, reserve valuations look even more attractive. GRZ also has an additional $14 million in tax assets not included on the balance sheet under a valuation reserve. A total of over $70 million has been invested in analysis and preparation of the Brisas deposit during its development.

As a relatively low-density deposit including large additional amounts of copper, operating profits at the Brisas mine will be leveraged to change in gold or copper prices. Current reserve calculations are based on the assumption of $350/oz gold and $0.90/pound copper (actual current prices being $406 and $1.29). Inflation, dollar weakness, or any further rally by either metal (or simply remaining anywhere near current spot and futures prices) would do wonders for profit margins and enable further ores not presently included in the reserve to be extracted profitably. In the bear case, Brisas could probably operate profitably down to about $280/oz gold. Favorable infrastructure and labor and energy costs at the Brisas site could give the future mine some additional long-term benefits -- with easy access by road and river to nearby ports, unusually low fuel costs due to Venezuela's status as the region's key oil exporter (according to management, diesel prices within the country are currently as low as $0.15 per gallon), and an inexpensive source of hydroelectric power already on site from a large regional dam, the Brisas mine could have a particular advantage in an enivronment where gold prices and energy costs were both high. I view GRZ shares as creating an option on an interesting inflationary hedge in addition to a straightforward value investment opportunity.

Much of GRZ's extreme reserve discount to its peers is likely due to perceptions of political instability in Venezuela itself. Hugo Chavez, the left-leaning Venezuelan president, is rarely at a loss for anti-Bush-administration rhetoric; however, it should be pointed out that the current government has never made any move to interfere with the many foreign mining firms operating in Venezuela and playing crucial roles in the economy of its mineral-rich regions. Exploration and open-pit mining by major firms such as Glamis and Gold Fields have continued without disruption, and state mining authorities continue to be cooperative with ongoing extraction and new construction. A national referendum confirming Chavez for the remainder of his presidential term has recently been held without incident, and the resulting reduction in uncertainty should begin to remove some of what I view as a very excessive discount given the actual situation in the country.

Geological and engineering firms Aker Kvaerner, Vector Colorado, and Pincock Allen & Holt are currently preparing a "bankable feasibility study" verifying the mine's economics and establishing an optimal design for the excavation and processing plant. This study, the final step in years of geological analysis, should be complete by late 2004, and could provide an important catalyst for recognition of reserve value by the overall market or an outside acquirer. Construction of a large-scale mine with processing plant would likely require a $300 to $400 million capital investment -- completion of a feasibility study generally enables firms to obtain bank financing for 50% or more of total development costs. GRZ would probably be much better off selling the claim for a reasonable price to a firm with more resources, but could potentially raise additional equity and debt financing on its own at the cost of some significant dilution. Even assuming a very dilutive offering at below current prices, GRZ would still rank among the very cheapest gold stocks per reserve ounce.

In addition to the Brisas reserves, the company has recently begun exploration of its separate "Choco 5" prospect, located in the historically gold-rich El Callao mining district and immediately adjacent to several proven deposits and producing mines. Initial geophysical studies and inference from the surrounding deposits have given promising indications; exploration is still at an early stage, but any further reserves discovered here would only add to the attractiveness of the current valuation.


Completion of bankable feasibility study on Brisas deposit by year-end 2004; possible sale of the company.
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