Shares digital

China Goldmines (CGM:AIM) – 119.5p, stop loss 96p

SHARES SUMMARY

Revamping eight producing gold mines in China where low operating costs equal potentially high profit margins. High expectations over exploration offer upside potential to the share price.

Business:

Junior gold producer with assets in China

Vital stats:

Market value: £57.9 million

Historic PE 2007: n/a

Prospective PE 2008: n/a

Prospective PE 2008: n/a

Sector PE (next 12 months):

1-month relative strength: -19%

1-year relative strength: 44.2%

Yield 2007: n/a

NMS: 2,000

Spread: 7.3%

With gold holding strong above $900 per ounce, unhedged producers of the precious metal should be making healthy profit margins, even after accounting for rising operating costs.

China Goldmines is the latest Aim-quoted company to join the ranks of gold producers, having produced its first bullion since completing a deal on a portfolio of mines in the Hunan Province late last year. It has an estimated 1.8 million ounces of gold and reckons its licence area could support another 55 years of mining.

On paper, it’s a simple story. Eight mines will be connected underground over a 6.5 kilometre stretch to form a single deposit that will produce 150,000 ounces per year from 2011. A new ventilation system and central treatment plant will cost $6 million, easily funded from its current $30 million cash position.

Having secured full ownership of the mines last November, China Goldmines shut down production for a month while it carried out basic refurbishment. As a test, it restarted production to produce 142 ounces of gold last month with a second run of 670 ounces set for mid February.

Commercial production will recommence on 1 April with the aim of producing 25,000 ounces of gold this year, rising to 35,000 ounces in 2009. Operating costs should only be $200 per ounce, reflecting cheap labour in China.

The previous owner was already producing at 25,000 ounces per year but could not sustain this output level, according to chief executive Frank Vanspeybroeck. ‘They had just about exhausted the easy mining. Production levels were actually declining because of ventilation problems.’

Although China Goldmines faces the immediate task of deeper mining, beating previous production levels shouldn’t be a problem. Vanspeybroeck claims workers under the old management stole 70% of the gold and that the 25,000 ounce annual output grossly understated actual production levels. ‘Most of the gold is recoverable through a simple gravity process due to the nature of the ore. We believe the former owners only declared the 30% that came out as concentrate or tailings.’

China’s mining industry has an appalling reputation for health and safety. China Goldmines says it is a priority to introduce Western standards, improving structural supports for underground operations and adapting a rail system to bring ore safely up to ground level. ‘The old miners used to drag the ore back up in wheel barrows up 300 metres of small steps. It was impractical and extremely dangerous,’ says Vanspeybroeck.

A regional exploration programme starts in April. It has commissioned a portable drill rig to test a zone parallel to the main mines. Results will be published in June. Exploration also continues on the core deposits, with two drills working underground and two above ground.

The company is among the most attractive of current junior gold investments. As such, it is not surprising to see limited availability in the shares. That isn’t to say the stock is completely illiquid, as there is steady trading. You will just have to work harder than normal at picking up a decent size holding.

It plans to dual list in China at some point in the future, in hope of getting a better valuation.

House broker Brewin Dolphin believes China Goldmines will become profitable in 2010, earning $15 million before tax and interest and rising to $69.8 million in 2012.

The company’s shares enjoyed a short-lived spike last July when the price rose over 50% to 167p after a consultancy report suggested there could be ten times more gold in the Hunan licence area than expected. There is a small buzz on China Goldmines among keen followers of the mining sector. In wider investment world, it remains relatively unknown but this should soon change.

by: Dan Coatsworth