Great Investments

State of the Zinc Market

As we mentioned 3 months ago, there’s a worldwide zinc crisis. As you can see from the zinc production and consumption statistics for the first half of 2006 from the ILZSG (International Lead and Zinc Study Group), zinc consumption is far outpacing zinc production, led by strong and consistent growth in demand in Asia. China’s zinc demand is forecasted to increase by 56% by 2010 , exasperating the current supply crisis. This article from early this year does a good job outlining the case for zinc and zinc stocks.

The below charts of zinc consumption by continent and LME zinc inventories over the last few years help illustrate this current situation:

Zinc consumption has continued to grow so much despite the meteoric rise in the price of zinc, with most of that growth coming from Asia. The average price of zinc for the first half of 06 was more than double the price for the first half of 05, yet Asian consumption still grew 5% during that period. With China building the equivalent of a city the size of Philadelphia every month, with its standard of living still nowhere near that of the West, and with the enormous savings they have, it's hard to imagine Asian consumption slowing for more than a blip on their long-term growth path.

Worldwide consumption exceeded worldwide mine production by 5.44% in H1 06. Asian consumption exceeded Asian mine production by 42.23%, as China become a net importer of zinc in 2004. This excess of consumption over production is reflected in the precipitous decline in LME zinc inventories since 2004. At the current rate of decline, the LME will be out of zinc within months, escalating the severity of the crisis.


Largest Zinc Projects in the World

Metalline Mining's (MMGG's) Sierra Mojada could be the second biggest new zinc project in the world for years to come. Sierra Mojada's similar in size to Apex Silver's San Cristobal in Bolivia on this list of big zinc projects:


The biggest zinc project (by far) is Mehdiabad in Iran. They're currently trying to get financing now for their $1.6 billion in capital expenditures, during this time of political crisis there. If that huge project fails to get to production, that's 6% of the expected world supply of zinc that won't be coming, which would be extremely bullish for zinc and MMGG. Given the enormous Asian demand and the quickly declining zinc inventories, it’s hard to imagine a zinc supply surplus over demand in coming years even if there’s a severe worldwide slowdown.

With many zinc mines scheduled to cease production in coming years, zinc miners with multi-billion dollar deposits in safe areas of the world coming into production during that time should do extremely well, as they help fill the zinc supply gap:

It’s no wonder zinc producers are on the hunt for world class zinc deposits.


What Makes Metalline Mining’s Sierra Mojada Zinc Project Unique

Anglo American plc’s Skorpion mine in Namibia, Africa, is the lowest-cost zinc producer in the world, producing zinc at a cost of about 25 cents/pound. The Skorpion mine is the first and only mine in the world using the solvent extraction electrowinning process for extracting Super High Grade zinc (SHG zinc is 99.995% zinc) from oxide zinc ore. Green Team International (GTI) completed the feasibility study for Skorpion and then designed, supervised the construction and operated the mine and extraction plant through initial production and until they were at 90% of capacity, at which point they turned over operations to Anglo American.

Metalline Mining has hired GTI to do the feasibility study at Sierra Mojada in Mexico, as their experience with the unique process should make going to production almost a “turnkey” process. Using a proven team to implement a proven process that yields the lowest-cost zinc in the world, in one of the largest zinc projects in the world, in a safe area of the world, makes Sierra Mojada a one-of-a-kind project that’s extremely attractive to larger mining companies.


The Potential Bidders

In January, we explained why we think Anglo American, the second largest mining company in the world, will try to buy MMGG's zinc deposit. As the Mining industry continues to consolidate, we believe several other bidders for Metalline’s Sierra Mojada zinc project will emerge after completion of the feasibility study next year.

Other mining majors are likely to bid as their coffers fill up with incredible sums of cash while their reserves and resources decline. Rather than investing heavily in exploration, decreasing reported profits and making them look less attractive to the financial community, large mining companies are buying other companies with large mineral deposits.

Xstrata, which will become the 5th-biggest mining company in the world after completion of their recent acquisition of Falconbridge, is not done with their acquisition spree. After they beat out Inco and Phelps Dodge in the bidding war for Falconbridge, CEO Mick Davis said, “We are always thinking about the next deal.”

Teck Cominco, the world’s largest zinc miner, just lost out in the bidding war for Inco last week, withdrawing their C$17.8 billion bid. CEO Don Linsay said Teck “will now pursue other acquisitions.”

Australian miner Ziniflex, the world’s second largest zinc producer, just announced a more than 4-fold increase in annual profit and a willingness to participate in acquisition opportunities in the global zinc market. CEO Greig Gailey said, “We still think there are opportunities in consolidation, and we would be willing to participate.”

EuroZinc Mining and Lundin Mining, two mid-cap zinc producers, recently announced a merger. The new company, to be called Lundin Mining, will have an interest in 4 of the top 15 zinc mines in the world, and will be looking for more huge zinc deposits. Colin K. Benner, Vice-Chairman and Chief Executive Officer of EuroZinc, stated: "The combined financial strength and collective expertise of our talented personnel will allow the new company to pursue global growth opportunities." Karl-Axel Waplan, President and Chief Executive Officer of Lundin Mining, added: "The combined strengths of Lundin Mining and EuroZinc will allow an acceleration of both companies' aggressive growth strategies… we intend to both maximize our existing assets and also continue to pursue other world-class opportunities..." On the merger conference call, the CEO’s stated that they would be looking to acquire “world-class pre-production base metals deposits wherever they are in the world.”

The bigger zinc producers are on the lookout for world class zinc deposits to extend their cash flow beyond the reserve life of their existing production. With MMGG’s Sierra Mojada likely to be one of the 3 largest zinc projects in the world coming to production in the next few years, and the other 2 largest being in politically risky Iran and Bolivia (and already owned by bigger mining companies), we’d be very surprised if MMGG doesn’t get multiple bidders when they complete the feasibility study next year.


Junior Mining Sector Bloodbath Creates Opportunity

Like other junior mining stocks, MMGG has dropped over 50% from its May high. However, as a recent article pointed out, the sector is prepared to rebound, as it historically does in fall following a summer slowdown.

Despite a recent technical buy signal, MMGG has pulled back to retest the support area in the mid-2’s. A big seller has been pressuring the stock, keeping a lid on it in the relatively low volume trading environment, just like a few weeks ago when a big seller was pressuring Copper Fox (CUU). We mentioned the significant seller of CUU when we first highlighted Copper Fox in early August. Now that its big seller’s gone, CUU has doubled in less than a month. Notice how similar CUU’s chart through the end of July looks to MMGG’s current chart:



Once the big seller who’s been holding MMGG back on low volume is gone, we expect the stock to rebound in a similar manner to how Copper Fox has rebounded. When it breaks the downtrend from May, it will establish a new uptrend and should also trigger a positive divergence MACD buy signal, with a higher low on MACD at a lower low in price.

Any way you look at it, MMGG's valuation is ridiculous at about 1% of the value of the metal in the ground. The late Julian Baring used a rule of thumb for valuing metal shares:
"Buy up to 10% of the in situ value of a deposit using current metal prices, hold up to 40% and sell above 40% taking no prisoners!!!!"

If Metalline Mining can prove up their silver and other zinc deposits, they'll be worth even more.

At the end of last month, in our last update on MMGG, we listed 6 events in coming months that should help the stock move higher. Each of those 6 events are a few weeks closer to fruition, and should start moving the stock up toward a more appropriate valuation.


Conclusion

Once the feasibility study on the Sierra Mojada zinc deposit is done, we think the takeover bidders will come out of the woodwork. However, barring a frenzied bidding war, the best path for shareholders would probably be to move into production alone.

Given the zinc crisis situation that will likely get much worse in coming years due to Asia’s insatiable demand and a lack of new projects to fill the supply gap, we believe that Metalline Mining, with the biggest zinc project in the world that’s in a secure area, will be in the driver’s seat at the right place at the right time.