Great Investments

As we pointed out in our initial article on Copper Fox Metals (CUU in Canada, CPFXF in the U.S.) in August, Teck Cominco, one of the largest mining companies in the world, is a partner with Copper Fox on the Schaft Creek project, a neighbor to NovaGold's Galore Creek project. Today’s news of Teck Cominco partnering with NovaGold on Galore Creek is great news for Copper Fox. We believe Teck Cominco partnering with NovaGold on Galore Creek means they really like the area and are likely to buy out Copper Fox upon completion of the feasibility study, or at least exercise their option to buy out 75% of Schaft Creek by paying Copper Fox 4 times all prior expenditures and arranging production financing. Teck being involved in both projects also means that Schaft Creek should have an easier time piggybacking on the Galore Creek infrastructure (power, roads, etc.) to go to production, greatly reducing costs.

As this Metals Place article from earlier this year pointed out, Schaft Creek is arguably a better project than Galore Creek for a variety of reasons:

Another Galore Creek neighbor is the Schaft Creek project being developed by Copper Fox [CVE:CUU]. Schaft Creek is only 36km from Galore Creek, but it is on the BC side of the mountains, thus no tunnel or Alaskan environmentalists. The deposit is every bit as big as GC and they have a top notch CEO. The life of mine strip ratio is a much cleaner 0.7:1. The gold grades are higher and it also has molybdenum. The 2004 capital costs were $600MM. While the cost is sure to increase it will still be much less than GC. Copper Fox optioned the property from Teck Cominco in 2002, but Teck retained a back in right for up to 75%. Teck would have to contribute 4 times all prior expenditures and arrange financing after CUU delivers the feasibility study. A preliminary feasibility study and an updated resource estimate were ordered last month. At $2 copper and $500 gold the NPV is $1.2B discounted at 8%. So CUU has arguably a better project and a strong partner already in place. They will undoubtedly have to dilute shareholders to complete the FS, but then they get four times their expenditures to help pay for their 25% of capital costs. The entire market cap of Copper Fox is currently about $40MM. Twenty five percent of Galore Creek would run about $600MM.

Two weeks ago, Copper Fox shares rallied to a new all-time high of C$1.64 in anticipation of a resource estimate update. After the resource upgrade came out, a sell-the-news reaction in combination with a sector correction and the unlocking of shares from a private placement four months ago caused the stock to lose over 40% in a week. As Lawrence Roulston remarked about this selloff, "The fall-off in the share price after the announcement of the resource suggests that some investors don’t fully understand the figures... There is still considerable upside potential as the company advances toward a pre-feasibility study over the course of this year. An updated scoping study expected in the coming weeks should provide greater insight into the economic outlook for the project."

We believe today's news of Teck Cominco becoming the dominant player in the area means the risks for the Schaft Creek project have just been dramatically reduced, which, combined with the recent share weakness, has created a great investment opportunity for Copper Fox.

In December, we responded to readers’ questions about why the consistent drop in LME Zinc inventories had paused. Other than a one-day spike in June 2005, LME Zinc inventories had dropped nearly 90% in a very consistent pattern since April 2004, from 785,000 tonnes to a low of 84,825 tonnes, but that pattern appeared to have changed late last year.

From December through late March, a shallow uptrend developed, and media skeptics came out of the woodwork suggesting that the trend change in zinc LME inventories indicated a permanent shift in the supply/demand situation, as China became a “net exporter” of zinc. The truth was that a couple of short-term factors, delayed shipments from the world’s biggest zinc mine and a change in Chinese export tax law, had helped to create a short-term surge in refined zinc supply, causing a temporary pause in the downtrend.

Despite the media claims, China remained a huge net importer of zinc, as they imported more and more zinc in the form of zinc concentrate, which they then processed in their smelters to create refined zinc. Because they had dramatically increased their refining capacity via rampant smelter construction, China had decreased their refined zinc imports relative to their zinc concentrate imports, using their low-cost advantages to process the zinc raw materials from other countries to the extent that they were exporting more refined zinc than they imported. However, the huge consumption of zinc in China’s growing economy, far exceeding the capacity of their own mines, compelled them to remain huge net importers of zinc overall, importing enormous amounts of zinc concentrate from overseas mines. Conveniently, the media zinc skeptics never mentioned the fact that China was relying on other countries for much of the zinc concentrate they used to produce refined zinc, instead focusing only on the “net exporter” status for the refined zinc finished product.




We said in December that “We expect the zinc crisis to become very evident after the effects of the Red Dog shipment spike have dissipated by the end of Q1.” After the peak in LME Zinc inventories in late Q1, they have steadily declined to hit a new low, at 83,725 tonnes, below the December low of 84,825 tonnes, so we can see that the pause in the downtrend was only temporary. Since the current level represents only about 2 ½ days of inventory, there’s not a lot of room to move lower. There’s a “frictional level” of LME inventories required to maintain an orderly market. It will be interesting to see how the zinc price responds to lower levels of inventories, as at some point the price will have to move high enough to curtail the demand so that the LME inventories don’t get completely depleted.

In addition to the previously mentioned factors for the earlier surge in zinc supply, another factor may decrease future world zinc supply. China has taken actions to decrease their zinc production capacity, requiring new zinc mines to have at least an annual capacity of more than 30,000 tons and an operation life of 15 years, capping the country’s refined zinc production capacity, and reportedly removing the 5% tax rebate on exports of refined zinc. With the enforcement of these new regulations, China will likely need to rely even more on foreign sources of zinc concentrate, and other countries will need to step up their production of refined zinc to make up for China’s supply reduction.

Moving forward, we really like the fundamentals for the zinc market, as we explained in December: “After the short term surge in supply from these 2 temporary events is absorbed by the market, we expect zinc to remain very strong because of the dearth of sizable projects in the pipeline for the next few years combined with growing demand and depletion of reserves at existing mines. We believe the fears in the market that the recent short-term trend change in zinc LME inventories could indicate a permanent shift in the supply/demand situation are misguided, and we expect that to become apparent in coming months. If the downtrend resumes as we expect, we believe the only way the LME Zinc inventories will avoid complete depletion is with zinc prices increasing enough to curtail demand.”

The timing for strength in zinc mining companies is excellent. A year ago, one of the sharpest and most respected institutional commentators, Don Coxe, explained on a conference call that “there are 3 major movements in this metals bull market, and we're nearing the end of the first one. The second one will be a slowdown, where I expect the prices of commodities to correct after the initial big runup. The third one will be a dramatic move that lasts at least 5-7 years.” He specified that “the next 12 months would be 'great fun' but a very different game, and would provide the ‘last great opportunity’ for the next 5-7 years. The next economic cycle after that will be a giant.”

Over the past year, we’ve seen the second movement play out, with sharp corrections in the prices of commodities. Most zinc junior miners remain well off their highs of a year ago, and are poised to bounce back during the strong third movement. In his latest conference call, Coxe reiterated that he feels “as strongly as ever that the best is yet to come.” He also emphasized that although “because of compliance problems and the kinds of clients that we serve, we have to comment on the big cap stocks, that more money is made in any boom like this by buying small caps,” meaning “you’re better off if you can find small cap mining companies who have got reserves in the ground than you are buying big caps – the leverage is terrific, and you can also assume that they’re going to get taken out, if the stock market obstinately refused to bid them high enough.”

After the recent rallies in uranium, nickel, molybdenum, and copper mining stocks, we believe that it is now the zinc miners’ turn to shine. With arguably the best supply/demand fundamentals for at least the next few years, zinc is the only base metal whose price is still down on the year. We believe that laggard status will soon change as the zinc crisis becomes more evident, drowning out the media skeptics’ misguided claims. Quality small cap zinc miners may be the next group to shine in this bull market.

We’ve written about Metalline Mining (MMG) as an incredible long-term investment opportunity since the beginning of last year, doing extensive research and analysis of the company, the sector, the metals markets, and many other companies to verify that Metalline truly was an exceptional value. However, even that extensive due diligence didn’t prepare us for what we saw when we visited their Sierra Mojada mine site in Mexico last week.

There were 3 main takeaways we got from this trip:

1) There’s an incredible amount of infrastructure in place at Sierra Mojada. It’s very rare that a world-class deposit will have a rail line, electric power, water, paved road, and 2 local mining towns with many low-cost workers with mining experience eager to work there.

Anglo American’s Skorpion mine, the world-class (8th biggest zinc mine in the world), low-cost (lowest cost in the industry) zinc mine in Namibia, Africa, after which this zinc project has been modeled, had none of that infrastructure. Ken Hart, who had been the Project Geologist for Skorpion, and whose hiring for the feasibility study’s geological report was announced in the recent President’s Letter, was amazed at everything this project has that Skorpion didn’t (including much cleaner metallurgy). He told us that there was nothing there when he started working at Skorpion -- it was 160 km to paved road, 260 km to power, they had to pump water across 60 km and 800 meters up, and the project had to, by contract, use mostly Namibians, many of whom were just out of the bush without much education. Like many other preproduction projects, it was basically just a few holes in the ground in the middle of nowhere. They also had to drill the project entirely from the surface, as there was no underground access. Ken also commented to us that everything at the Sierra Mojada project was incredibly well organized, and he was really enjoying himself. Even with all those drawbacks vs. Metalline, Skorpion was able to go to profitable production at $.35 zinc. Zinc is currently over 5 times that price, at $1.77/pound.

In addition to all the infrastructure at Sierra Mojada above ground, there’s also a tremendous amount of underground workings already there. There are over 45 mine shafts that had been worked by various miners over the last century, though only using old technology and only selecting very high grade ore that could be direct shipped without milling to concentrate it. You can walk 6 kilometers underground across the district, on several different levels. You can even walk over 600 meters directly through the proven resource high-grade ore body, as we did.

2) The enormity of the property and the resource was something we really couldn’t appreciate until we had walked through just a small portion of it. We were in awe that even after our long underground hike through all that amazing mineralization, we hadn’t even gone half way through it, as the proven resource stretches 1.5 kilometers (about 20-100 meters high and about 50-100 meters wide). This zinc proven resource area was only a small portion of the district, as we were only under 3 of the 45+ mines, and the district covered about 6 kilometers by 1 kilometer.

As the President’s letter stated, “Polymetallic mineralization (silver, copper, zinc, lead) north of the Sierra Mojada fault occurs over an area of 6 km east-west and 1 km north- south. This mineralization occurs on the dumps of over 45 shafts that all produced high grade direct shipping silver ore and in the host rocks surrounding the high grade underground stopes in these mines.” The silver that was direct shipped was nearly all likely over 1 kilogram/tonne, which is incredibly high grade by today’s standards. In the old days, the workers had to carry 100 kilogram sacks on their backs climbing out of the mines, so only took the very highest grades – the low-hanging fruit. There’s a huge amount of silver still there, and the drill program Metalline is implementing will begin to prove out just how much there is. Metalline’s training more and more of the locals to do the drilling, which will save a huge amount of time and expense vs. trying to hire gringo drill contractors (the local drillers get paid about $40 a day, whereas it’s hard to get a gringo drill contractor for $40 an hour, and you have to wait months for them to be available).

In addition, similar geology continues on to the Northwest for about 14 kilometers. Metalline also has far more exploration area, totaling over 60 square miles, or over 2 ½ times the size of Manhattan. It’s just staggering to think that the world class zinc ore body we saw a portion of is just the tip of the iceberg.

3) The locals were incredibly supportive of the project. The 2 mining towns, Esmerelda and Sierra Mojada (total combined population about 3000), have families with generations of mining history. Many workers commute 3 hours to an iron ore mine, and would love to be able to give up that commute to work locally at Sierra Mojada. The climate at Sierra Mojada is very comfortable, with a nice breeze and high enough elevation to keep it relatively cool, and the location is beautiful. Metalline is already the biggest private sector employer there, with about 60 employees. The lead Mexican geologist, who had worked at several other projects in Mexico, proudly called this project a 10 on a scale of 1 to 10. A local contractor inquired about how to set up an American brokerage account so he could buy stock in the company. At the Sierra Mojada church, they even end service each week with a prayer for success at the mine site. This type of local support and excitement is a sharp contrast to the resistance other mining companies receive from locals and environmentalists at other projects.


These 3 features really distinguish MMG from the other zinc projects out there. Aside from the enormously discounted valuation based on their world class low-cost zinc proven resource, the incredible amount of infrastructure, the enormous growth potential, and the extraordinary local support make the company’s success a slam dunk in our minds. That combination is extremely rare to find in a junior miner at such a low valuation.


Here are some photographs from our trip:

Here’s the Sierra Mojada rail stop. It no longer is used for passenger traffic, but there’s a dolomite open pit mine next door operated by Penoles that uses the railroad, which has more than enough capacity for Metalline’s project.

Here are the site headquarters – about 7-8 buildings.

Other site buildings (for core storage, cleaning and processing samples, equipment maintenance and storage, etc.) with San Salvador mine shaft in the background.

A miner going down the San Salvador shaft, where we started the underground tour. Putting in a shaft like this would cost about $20-30 million today.

Underground drilling – this drilling was for the geotech analysis on the rock structure to determine pit wall steepness possibilities for potential open pit mining. The 3rd party geotech expert kept saying how solid the rock structure seemed.

Smithsonite mineralization underground – 40%+ zinc – was all around us.

LHD – Load haul dumper that replaced the old underground rail with more efficiency.

Iron Oxide zinc mineralization underground – 20%+ zinc – was all around us as we walked over 6 football fields through the ore body.

Encantada mine shaft – where we came up from the underground tour, with part of Penoles’ open pit dolomite mine in the background.

The Sierra Mojada town church where they pray for success at the mine site each week.

There are many more photographs of the mineralization and underground on slides 45-63 in the Metalline Mining corporate presentation. Those photos also show the mineral content of a lot of the rock samples. We were literally surrounded by this very high-grade rock for what seemed like miles, but was less than a kilometer. Slide 23 gives a good diagram of the ore bodies – we walked from the San Salvador mine to the Encantada mine area, so you can see it was just a small portion of the enormous resource.

On the weekly chart, one can see the triangle we highlighted in March is approaching its apex, meaning the stock is likely to break out from this formation within the next couple of months. The recovery from the financing related selloff has shown strong accumulation and sets the stock up well for a future breakout:

With the company now fully funded through feasibility and for an expanded drill program for the silver, there should be no more financing-related selloffs during the feasibility stage. The March financing had a relatively small number of shares, and those shares are restricted for a year.

With over $10 billion of zinc proven out (far more than producers like HudBay Minerals with many times MMG's market cap) and undergoing a feasibility study, and an enormous amount of zinc, silver, copper, etc. that isn’t yet proven out but we know is there because we've seen and touched it ourselves, MMG’s fully diluted market cap of about $175 million discounts way too much risk into the stock. With that deposit, that team (feasibility study led by Green Team International, who also did the feasibility study for Skorpion), that infrastructure, that local support, and the extremely strong economic advantages coming from their very low-cost processing all the way through to produce SHG refined zinc (not just concentrates sent to smelters, who take a huge cut of profits), we have no doubt that Sierra Mojada will be a world class producing zinc mine and that MMG will be much higher over the long term, even if zinc prices collapse. We also believe their high-grade silver that they’ll be focusing on developing next will provide a huge amount of upside that the market is not yet factoring in. The only real risks we see are short-term volatility that might cost the impatient shareholders who bail out on a dip and possible delays to get to production if the sector-wide shortages continue to affect them (they're bringing a lot of processes in house to avoid delays from 3rd parties). Patient investors who stay with Metalline Mining for the long term should be very handsomely rewarded.