There's an impressive start to Gemfields' (GEM:AIM) life as a bonafide rubies producer. Its maiden auction has yielded $33.5 million revenue, nearly covering the entire amount of money spent on buying the asset in Mozambique and subsequent costs of production to date (a combined $34 million). Yet as ever, the market has already priced in a positive result, hence why the share price has been on a strong rally since the start of May. Today's news takes the stock up a further 2.9% to 53.75p.

Strategically this is an important result for Gemfields. There is opaque pricing in the rubies market because there's so few players. In a sense Gemfields hopes to actually establish a market by becoming a big producer and attempting to influence the global marketing of products, in the way it has already done with emeralds from its Kagem mine in Zambia.

Investors must appreciate this is still very early days with Gemfields' ruby operation. It is unlikely you'll see a repeat of the 2 million carats put up for auction on a regular basis in the near future. Today's auction results come from material derived from a very large bulk sample. It has mined 8 million carats to date, although Numis Securities points out that we don't know the quality of the remaining inventory.

gemfield ruby

The miner's key challenge is to now improve its mining fleet, as it is inadequate to fill the existing plant (which can process up to 150 tonnes per hour). Gemfields will no doubt first analyse the results of the auction to see where the best value material lies, and work that into a new mine plan.

This is still very early stage, project wise. There's no Jorc-compliant resource statement; no scoping study; no guidance on potential annual production. Gemfields didn't provide any public expectation on selling prices (although we understand that an $18.43 average value per carat achieved in the auction smashed internal expectations).

The Mozambique project is very rich in rubies and large in scale. That presents both opportunities and challenges. It needs to deal with illegal mining on the project and work out which areas are best to mine first. But it also needs to work out how much material it can bring to market without causing over-supply versus demand.

gemfields chart

Nonetheless, it is clearly a great start for Gemfields and it will be interesting to see if today's auctions provide enough detail for analysts to rework their valuation models. Most of the City number crunchers had attributed minimal value to the project, awaiting auction results to have a more accurate idea of potential selling prices. This might explain why circa 40p price targets were out of kilter with the trading price which has shot up from 20p last July to 51.5p last night.

FinnCap is the first to upgrade its price target on the back of today's news, now seeking 60p. Canaccord follows with a new price target of 62p.

Regular Shares readers should have been aware of the re-rating opportunity many months ago, given that we've highlighted the importance of the ruby auction as a share price catalyst to Gemfields on many occasions. Recent articles can be found here (from March), and here (from last August).

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Issue Date: 18 Jun 2014