Is Gold Resource Corp the next Agnico-Eagle?

I’ve been invested in Gold Resource Corporation (sym: GORO) since its IPO in 2006.  Gold Resource Corporation anticipates gold production by year end 2009.  Since day one, management has been positioning the company to be in the elite class of low cost gold producers.  Companies such as Agnico-Eagle (AEM), Yamana Gold (AUY), and Goldcorp (GG) operate in this group and trade at PE’s that are two-three-four fold higher than average cost gold producers.  The reason their gold cash costs are so low is that these companies not only produce gold but produce other by-products such as silver, copper, zinc, lead, etc that they sell and use as a credit against costs.  Several times Agnico-Eagle (AEM) actually had a negative gold cash cost due to by product sales being so high.   The pitch for low cost producers is simple:  The lower the cost, the higher the margin and EPS.  At $1,000+ gold, a company that can produce gold at a sub $200/oz level has almost Microsoft (MSFT) or Google (GOOG) margins.  Gold Resource Corporation anticipates producing 70,000 ounces of gold in Year one at a $100 cost in Year 1, 110,000 ounces at $0 cost in Year two, and 177,000 ounces at $0 cost in Year three.

If GORO is successful in being a low cost gold producer, the reward for investors is going to be very high.  Let’s look at Gold Resource Corp’s first year production dynamics (estimated grade, recovery rate, mill up time, etc) to see if they can produce gold sub-$200/oz.

Projected Cash Flow For Gold Resource Corp’s First Production Year

Any projection involves calculations that rely on certain assumptions.  The following assumptions are used to determine possible cash flows:

(1) The El Aguila open-pit ore will average 7.45g of gold a tonne.

(2) The El Aguila open-pit ore will average 63.0g of silver a tonne.

(3) Recovery rate for gold will be ~94%.

(4) Recovery rate for silver will be ~90%.

(5) Amount of recoverable gold a tonne is 0.94 X 7.45 = 7.003g

(6) Amount of recoverable silver a tonne is 0.90 X 63.0 = 56.700g

(7) The cost to excavate open-pit ore is $2 a tonne.

(8) The cost to mill a tonne of ore is $26. This cost is consistent with other Mexican miners processing ore through a mill.  Total cost (mining plus milling) is $28 a tonne.

(9) Mill commercial production capacity is 1,150 tonnes a day.

(10) Mill up-time will be ~90% or 328 days a year.

(11) There are ~31.1 grams to a Troy ounce.

(12) Use a gold price of $1,000 an ounce.

(13) Use a silver price of $17 an ounce.

Using these metrics, it is relatively easy to calculate the expected first production year cash flow once full commercial production is achieved.

Gold production should equal 1,150t/d X 7.003gAu = 8,053g a day.  Dividing by 31.1 to convert to ounces gives us 259 gold ounces a day.  Multiplying by 328, we get 84,937 gold ounces a year.  Dollar value of gold = 84,937 X $1,000 = $84,937,000.

Silver production should equal 1,150t/d X 56.7gAg = 65,205g a day. Dividing by 31.1 to convert to ounces gives us 2,097 silver ounces a day.  Multiplying by 328, we get 687,693 silver ounces a year.  Dollar value of silver = 687,693 X $17 = $11,690,781.

The combined value of gold and silver = $84,937,000 + $11,690,781 = $96,627,781.

The next step is to calculate and apply the cost to mine and mill the ore.

1,150t/d X $28/t X 328d/y = $10,561,600.  Subtracting this from the combined value of the extracted gold and silver:  $96,627,781 – $10,561,600 = $86,066,181 net.

An interesting fact is that the cost to mine and mill El Aguila ore ($10,561,600) is less than the value of the silver ($11,690,781) by $1,129,181.  Dividing the $1,129,181 surplus by the number of gold ounces produced (84,937) we get $13.29 per gold ounce.  In other words, if we apply silver as a credit against the cost of producing the gold, the silver should pay all mining and milling costs, and in addition, add $13.29 a gold ounce in profit.  Another way to view it is that gold would be produced at a negative cost of $13.29 an ounce.

In fact, even if El Aguila ore didn’t contain any silver at all, the cost would be $28/tonne X 4.44 tonnes = $124.32 an ounce to produce gold.  How is this possible?  Because 7g of recoverable gold per tonne is incredibly rich ore by industry standards and that’s especially true for open-pit operations.  The average ore grade for South Africa gold mines is 4.5g / tonne.

The assumption is that this gold and silver will be in the form of dore bars which will be sold to refiners at a discount of ~3% to the spot price of gold.  Correcting the net of $86,066,181 for the 3% discount, we have $86,066,181 X 0.97 = $83,484,196 in free cash flow.  Assuming a fully diluted issued share count of 50 million, the free cash flow per share would be $1.67.  Applying the 1/3 for taxes, 1/3 for exploration and development, and 1/3 for dividend that GRC has mentioned as a possibility, the dividend per share will be $0.55 a share.

Earnings would be 2/3 of $1.67, or approximately $1.11, which, if we assume a PE ratio of 20, would yield a possible share price of $22.

Please note that these calculations depend on GRC being able to supply high grade ore from the El Aguila open-pit mine for a full 12 months.  The recent new discovery at El Aguila of 904g (29 ounces) of gold per tonne of ore certainly increases the probability that there are 12 months of high grade ore supply at El Aguila.  GRC has said that they only anticipate that El Aguila would supply enough ore to produce 70,000 gold ounces.  If that proves to be the case, then running at a rate of 259 gold ounces a day, the ore would only last 270 days or about 9 months.

In conclusion, Gold Resource Corporation WILL be a low cost gold producer.  This peer group is currently trading at 20x forward EPS.  Gold Resource Corp and its shareholders look to have a very rewarding future.

Disclosure:  LONG GORO