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Wednesday, May 07, 2008


Metalline Mining's Silver Lining

With the fears of global recession and the subprime-induced credit crunch, junior mining stocks have been clobbered in recent months. Investors have been liquidating whatever they can to get through this rough period, with even large producers taking big hits. As this article points out, "The juniors are in the midst of a fear-driven sentiment storm that is fierce and unforgiving... But eventually... those speculators positioned in the elite juniors should win legendary gains." Many investors have thrown in the towel on the sector, dropping some top-notch juniors to incredibly undervalued levels.

We believe the big money will be made by those investors who take advantage of rough periods like this to accumulate the junior mining stocks with the best long-term outlooks. As this article points out, "A temporary slowdown [was] predictable: Each decade has some sort of pause. What will follow this one will be, we believe, an even greater boom - that will last for many, many years... For miners, the best is yet to come."

Metalline Mining's Oxide Zinc Project Progress

In our last update, we mentioned Metalline Mining's (MMG) "best of both worlds" status with a world-class low-cost zinc project as well as an aggressive silver exploration program. Since then, Metalline has updated their oxide zinc feasibility study progress, including the announcement of plans to drive the production decline to the center of the resource and test mining to back up the information in the paper feasibility study. In the current environment where many projects that hadn't done test mining (and a good number that hadn't even done a feasibility study) have encountered unexpected difficulties going to production, we believe this test mining will significantly reduce the risk of the project and make it much more attractive for financing and/or potential acquisition. Driving the production decline before the completion of the feasibility study will give the project a head start on the move to production, saving significant mine construction time later. It also will provide much better information on both the oxide zinc and the north side silver/copper/zinc/lead mineralization.

The zinc feasibility study progress update also introduced an economic model involving selling their concentrate to existing refineries rather than building their own, which would eliminate the vast majority of the project's capex costs and accelerate the move to production. If the evaluation of this option proves fruitful, the economics would be extremely attractive in an environment of tighter credit. The operating costs would be higher with this approach, but still likely much lower than other zinc miners.

On Monday, Metalline announced the hiring of a large international engineering team (which had worked on the Skorpion zinc project) to complete work on the concentrator plant studies by September in order to accelerate completion of the feasibility study, expected to be completed by the end of the year. In an environment where many mining projects endure repeated delays because of a shortage of qualified personnel, this news shows that management is aggressively moving toward timely completion of the oxide zinc feasibility study.

Zinc bottom

In November, in an update explaining Why Zinc has Underperformed This Year, we mentioned that "We believe zinc is near a bottom and won't go much lower." Zinc was testing the $1/pound level then, and it's still testing that level now, nearly 6 months later. The fact that LME zinc inventories have increased over 50% in those 6 months (still historically very low and down well over 80% from the 2003 peak), yet the price of zinc hasn't dropped lower, indicates the worst may already be priced in. As we explained, "The surge in new supply is only temporary, and doesn't provide the consistent growth in supply needed to meet the growing world zinc demand and offset depleting reserves at existing mines."

As this article points out, there will be an "extremely large" shortage of zinc in coming years because of slow mine supply growth, leading to much higher zinc prices. In addition to lower mine supply growth, a number of the largest zinc mines in the world will start shutting down because of depleted reserves soon, including Teck Cominco's Lennard Shelf mine, scheduled for closure next year, and Xstrata's Brunswick mine, the world's fourth largest, scheduled for closure in 2010. We don't believe there will be enough new supply to overcome the loss of production as well as meet the increasing demand from emerging economies and infrastructure rebuilding in developed countries, resulting in the predicted "extremely large" zinc shortage.

We saw last year during zinc's big drop while LME inventories decreased significantly that the market was already looking forward to a recession and the bounce back in inventories caused by a short-term surge in supply during the last 6 months. We believe it's only a matter of time before the forward-looking market starts to recognize the coming shortages and starts to move zinc much higher.

The Silver Lining in the Oxide Zinc Project

On the silver front, the aforementioned oxide zinc feasibility study progress update also indicated that metallurgical studies on the oxide zinc materials showed "better than 80% recovery of the contained silver." Previously, we had not been expecting any silver by-product in the oxide zinc project. If further work confirms the feasible recovery of this by-product silver, that could have big ramifications for the financing of the move to production.

Last week, a deal was announced between Silver Wheaton and Augusta Resources where Augusta will sell to Silver Wheaton 45% of the payable silver from its mine, or about 1.2 million ounces per year for 18 years, starting in 2011, for a total upfront cash payment of $165 million. As explained on their web sites, companies like Silver Wheaton and Silverstone Resources have a business model of growth by pursuing such silver by-product stream deals. With good silver projects becoming more and more scarce, these companies are actively in the hunt for silver by-product streams

If MMG could do a deal like this with one of these companies for the oxide zinc project's by-product silver, they might be able to finance the move to production without any dilution, especially if they choose the option of outsourcing the zinc refining (at least initially). Perhaps the biggest worry investors have about late stage mine developers like MMG is about financing the move to production during a credit crunch. If MMG can do a deal that allows them to finance the move to production without dilution, while still keeping significant silver upside for shareholders from the north side, it would be an ideal scenario for current shareholders, and the stock would be worth a heck of a lot more.

The beauty of MMG's zinc project is that they may be able to finance the move to production with little or no equity dilution either with the very low capex option of outsourcing the refining, which most zinc miners do (MMG has a big cost advantage because of their huge amount of existing infrastructure and the cheap processing of oxide zinc), or with a silver stream deal on the project's silver by-product, or both. That would be a very unusual situation for a world-class zinc project, and would give current shareholders tremendous upside.

The Big Silver Upside

Since our last update, in addition to some promising drill results, the announcement of ramping up to 4 drills working 2 shifts, and the implementation of an on-site assay lab to guide operations, MMG also completed a 3D evaluation of the silver and copper content of an initial block of mineralization on the north side based on the drilling compiled to date. This evaluation indicated that there are approximately 30 million ounces of silver and 30 million pounds of copper in this block for a rough total of over $600 million of gross value using current prices. There also is significant zinc and lead in this block, but the evaluation of that content is still in progress. The 3D evaluation also showed in Powerpoint images that the block is a nearly flat-lying, wide and thick body, which would be amenable to low-cost bulk tonnage mining.

This initial block is just a small portion of their prospective property. It covers only 600 meters east-west within the 1,100 meters east-west they've been drilling, within the 3,100 meters east-west they've been sampling, within the over 5,000 meters east-west of the historic mining district. In addition, they have 14,000 more meters west of the district that has similar geology, as well as other prospective areas. So this 600 meters east-west is less than 1/8th of the east-west length of the historic mining district, and less than 1/30th of the east-west length of highly prospective geology. It's really the proverbial "tip of the iceberg," with 2 shifts working "4 diamond drills, 3 percussion drills, channel sampling and geologic mapping," all guided by an on-site assay lab to efficiently prove up the rest of the iceberg.

Given MMG's market cap under $80 million, this initial $600 million+ of gross metal value, which will be added to when the zinc/lead evaluation of the block is completed, is a great start to the evaluation of the north side mineralization, especially when combined with the several billion dollars of zinc in the oxide zinc project.

With MMG considered to be just a zinc junior, with a world-class zinc project on the south side of the property, this huge amount of silver on the north side just in this initial block indicates that MMG is well on their way to establishing themselves as a huge silver miner, too. Since silver juniors get valued much higher than zinc juniors, MMG should be getting a very nice revaluation as the market recognizes the transformation of the company. Watch for far more drill results and more evaluations in coming months as this aggressive transformation progresses.

Unique Value

With a world class zinc project being run by the same team that put the similar world class Skorpion zinc project into production a few years ago at historic low zinc prices (about 1/3 current prices), MMG clearly has enormous upside. Skorpion was valued much higher than MMG's current market cap when it got bought out by Anglo American upon completion of the feasibility study 8 years ago, at the trough of the metals bear market -- and they didn't have any silver. The oxide zinc project's silver by-product has the potential to allow MMG to finance the move to production without significant equity dilution, which would be a huge positive for current shareholders, especially during a credit crunch.

Separately, MMG's big silver upside from their north side mineralization that they're very aggressively working to prove up could end up being worth many times MMG's current market cap. The aggressive work being done to prove the silver value has already shown significant value, and will likely prove up much more value in coming months.

There's still much work remaining to be done on both projects, but it's clear that the work being done in coming months should add enormous value for MMG's shareholders. With the junior mining sector potentially recovering strongly from its doldrums in coming months, with zinc likely to start rebounding soon as the market begins to recognize the looming shortages, and with silver likely rebounding from its correction soon, the timing for MMG completing all this work to transform themselves into a near-term zinc producer and significant silver miner could be excellent.

Best Time to Invest

Some of the best returns in the stock market are made by investing in out-of-favor stocks during slumps in long-term bull markets, especially those that are improving their fundamentals by transforming themselves to increase shareholder value. The recent sector weakness has been a difficult period for junior mining investors, but we continue to believe that long-term investors in quality junior miners will be very well rewarded for their patience.

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