Dubai buys into top Australian gold junior

Posted on 23 September 2008 with no comments from readers

This morning I read with some satisfaction that the Dubai Group has bought an 18 per cent stake in the Australian junior gold producer Citigold in a $29.4 million deal which makes Dubai Government its biggest shareholder. Earlier this year I wrote the article below for MoneyWorks magazine recommending Citigold as a buy – all of the arguments still hold true, only more so with the backing of the Dubai Government for this stock…

By any yardstick the Australian gold mining companies are less highly rated than their compatriots in Canada or the USA, and could consequently be due for a re-rating because there seems little to justify this anomaly aside from a shortage of investors in Australia. Amid this undervaluation Dubai Financial Exchange quoted Citigold stands out as particularly cheap, and perhaps the cheapest stock of the lot.

One recent private study compared Australian gold companies on several parameters. Citigold had the lowest cost per ounce of gold produced at around $500 – against management claims of a very impressive $320 per ounce – and the lowest percentage of enterprise value as a percentage of reserves. Operating costs as a percentage of reserves were also lowest among the quoted Australian gold producers, while net financial assets were above the average level. Gold production is un-hedged, a major advantage in a bull market for the yellow metal.

Yet technical analysts can not get very excited about the recent performance of Citigold, which has tended not to deliver on its obvious promise, and this puts some investors off the company. But expect this to change as the gold price lifts off again, and attention becomes focused on where best to invest for leverage against a rising gold price. Australia is the land of the most undervalued gold companies, and Citigold is the most undervalued of that pack.

However, Citigold is an easy and straightforward investment story. The company’s flagship ‘Charters Towers’ project comprises five gold concessions covering 220 miles located right underneath the city of Charters Towers in Queensland, population 8,500. So unlike many Australian gold mines nobody has to live isolated in the outback and staff can go home to their families at night, and in an industry chronically short of labor this helps in staff and management retention.

There is also the benefit of a stable electricity supply, water, good roads, a railway and an airport. The lack of such basic amenities can make production expensive for many Australian gold companies. Citigold does not have this same deadweight of costs, and that is reflected in its low cost of production per ounce.

Gold mining stopped completely in Charters Towers in the 1917 after 40 years of production when rising costs made it uneconomic. But the surging gold price of the 2000s has made exploitation a highly economic prospect again, and gold production from the first ‘Warrior’ reef restarted in early 2007.

The latest research from Kareg Corporation cites a production target of an annualized 100,000 ounces by the end of this year, and 250,000 ounces by 2011. With gold at $880 at the time of writing that would deliver revenues of $88 million rising to $220 million. Gold veins are said to be ‘very predictable from 40 years of mining data allowing for an efficient operation’.

In its glory days Charters Towers was probably Australia’s richest major gold field and produced more than 200 tons of gold and holds the grade record for an Australian gold field. In truth this property can be characterized as a ‘proven giant’ field, and the management believes a recoverable 50 million ounces of gold remain underground worth $50 billion at the March 2008 gold price.

The original discovery of the Chartered Towers gold field is the stuff of Australian legend. A 12- year old boy went looking for some lost horses in December 1871 and happened to notice a glimmer of gold in a nearby stream. A prospectus for the original company to exploit the field raised 60,000 pounds from a share issue in London, and some 30,000 people migrated from Europe to work in Chartered Towers which produced 6.6 million ounces before closing in 1917 during the First World War.

The modern history of the company dates from as far back as 1969 when the father of the current chief executive officer, James ‘Jim’ Lynch started a 15 year personal campaign to restart mining operations under Chartered Towers. But it was not until 2004 that one company controlled this vast oil field for the first time, and the advance in the gold price made restarting a viable commercial proposition.

It is remarkable that the recent stock market capitalization of Citigold is just $200 million, a huge discount to net asset value. For unless you believe that the gold price is likely to sink back below $500 an ounce then Citigold must have a very profitable future, and super-profits are in the pipeline if the gold price really takes off over the next couple of years as the US dollar collapses and inflation roars ahead. In any case buying the lowest cost producer is a good insurance policy against less dramatic gold price progress.

The management team is also well respected and highly experienced. The chief executive officer Mark J. Lynch is the son of the founder and has 28 years experience in the business. His chief operating officer Christopher Towsey is a senior geologist of 30 years experience; and engineering general manager Gerry Foord is a first class mine manager of 24 years. The geological team is also highly regarded.

An A$5 million drilling program is presently underway. This exploration program is the reason for the management’s optimism that the present resource base of 10 million ounces of gold could be extended to as high as 50 million. In the past most gold was produced from a five kilometer reef at 700 metres down. But drilling has indicated that gold is present down to 1,280 metres and could extend to 3,000 metres.

This is far more solid evidence for the likely extension of reserves than the drill studies offered by many exploration companies. And it has to be said that exploring for gold next to a proven giant field is generally the most predictable and successful place to look. There are also the past exploration results from the 40 years that Chartered Towers produced gold which give the company an excellent guide to the geology of the region, again enhancing the chances of successful exploration.

From a share price perspective the reason for the undervaluation relative to other Australian companies is hard to fathom. There have been some problems in ramping up production levels and increased costs but nothing material. Finances remain strong with A$8m raised in fiscal 2007 and A$4.5 million in cash by mid-2007.

The general undervaluation of Australian gold shares is less of a mystery: the pool of local investors is smaller in Australia that in the US and Canada where local taxes are not so high, and this has tended to cause these smaller market cap companies to be overlooked as they are presently too small to interest institutions. Clearly that may well change if the gold price advances significantly and smaller gold companies come on to the radar of the major funds.

The share price chart is off putting for many investors. Citigold stock spiked to 34 cents in late 2003 as excitement about the consolidation of the gold field mounted but then slumped to 10 cents for the following two years. Then it recovered in 2006 and spiked to 55 cents, remaining range bound above 38 cents until early this year when the gold sell-off dragged the share price down to just 28 cents.

Many gold junior producers and explorers have similar charts. Indeed, the ratio of the gold price to this sector is presently at a historic low, according to research by www.golddrivers.com. Part of the explanation appears to be that hedge funds are currently long on major gold producers but have been shorting the juniors. Gold industry rumor has it that this may even be a deliberate strategy by a much larger ‘consolidator’ who is trying to force the share prices of junior gold companies down and down, breaking investor confidence and enabling a quick consolidation of the sector at super cheap prices.

Indeed, with the gold price now probably close to the bottom of its correction from this May’s new all-time high of $1,030, there will likely never be a better time to buy junior gold shares as once the gold price recovers, so will this sub-sector. Many gold experts predict prices could reach $1,200 an ounce before the end of the year, and $1,650 is a two-year projection for the end of 2011 assuming the US dollar continues to weaken and the US slowdown proves to be more than an average recession, which is what you might anticipate after a major financial crisis – three years is typical for recovery from such a crisis.

What you want to find in such a market is a leveraged play on the gold price. Spotting the most undervalued pure junior exploration stock will likely claim this prize but it is a risky and almost impossible task. But next up ought to be an undervalued Australian gold company whose shares have been overlooked to date, and Citigold looks the most depressed of this depressed group of stocks. Financial crises like the one we are living through can throw up some amazing opportunities and Citigold could be one such investment over the next couple of years.

Kareg Corporation put an 18 month price target of $1 on Citigold which would be a very good return on the 28 cent share price as this article was written. But this could be rather conservative in view of the triple re-rating that should be in prospect for the company: first for the gold price, second for Australian gold miners and finally its own intrinsic undervaluation.