Page 1 of 48 Institutional Research BUY Price (close) 12 Mar 2012: 78p 52 Week Range: 64p - 163p Price Target: 165p 3-year Target: 247p Vatukoula Gold Mines Profile Vatukoula Gold (AIM: VGM) is in the midst of ramping up production and modernising the historic Emperor Gold mine, situated on Fiji’s largest island, Viti Levu. Now known simply as Vatukoula, the orebody is a low sulphidation epithermal deposit that has been in virtually continuous operation for 80 years. To date, approximately 6.9Moz of gold and over 2Moz of silver has been extracted, with the current JORC compliant Resource standing at 4.3Moz Au, meaning that the mine has in-excess of three decades of production in front of it Share Price Performance Share Capital Shares outstanding (m) 88.6 Market Cap. (£m) 69.1 Free Float 81.3% Significant Shareholders Sprott Asset Management 17.9% Canadian Zinc Corp. 14.2% Zesiger Capital Group 9.1% Black Rock (UK) 4.8% Rex Harbour 3.9% Capital Research Global 3.6% HD Capital Partners LLP RESOURCE ANALYST Gaius LL King SALES/CORPORATE Philip Haydn-Slater/Paul Dudley +44 (0) 20 3551 4870 Vatukoula Gold Mines PLC Gold producer trading at 69% discount to our 3-year target BOE cannot QE Au Unhedged profitable producer sensitive to increases in gold price Scalar productive potential many times current rate Valuation at an after-tax NPV12% of 165p per share 3-year valuation of 247p per share It is increasingly probable that the BOE will find inflation an attractive tool to solve the problem of both public and private debt levels (for reasoning see page 41). The resultant inflation will distort the economy in favour of extreme consumption and the hoarding of real assets (e.g. property, oil, equities in perishables, such as Tesco, etc), but in particular, gold and bullion producers. The reality is that the current minority government in the UK will have to face the polls at least once in the midst of an austerity drive. It raises the question – does the UK public have the stomach for at least six years of egregious cuts and falling living standards, before even reaching budgetary equilibrium? We believe not. Unlike many of its gold producing peers, VGM does not suffer from a lack of Resources or exploration potential. In fact it may suffer the ignominy, in three to four years’ time, of having 8 to 10Moz Au in Resources, or in-excess of 100 years mine life at the current extraction rate. We believe our valuation of VGM is conservative, based entirely on projected cashflows from its key project, the Emperor/Vatukoula Gold mine. The non-linear financial model incorporates both fixed and variable components, as well as a Stage 2 expansion costing US$270m, large on-going annual underground capital development, and a five-year US$134m exploration programme. Given the enormity of out-going cashflows, we have expanded the number of shares on issue by 24%. Based on modelled cashflows and an issued capital base of 111.02m shares, we initiate with a BUY recommendation and value VGM at an after-tax NPV12% of 165p per share. Our 3-year valuation is based on after-tax cashflows from FY15 onwards, which results in 247p per share. We believe that this project has suffered historically from investor and analyst apathy. A non-mechanised underground operation, it is a form of mining that is increasingly rare, being replaced by open-pit, low-grade operations where metallurgy rather than mining is the key determinant. Despite this, we reiterate that the Vatukoula gold mine represents a large, multi-decade scalar and (we believe) a highly profitable proposition. It is, furthermore, highly sensitive to any increase in gold price (see p. 26). We believe VGM is ideal for the moderately risk tolerant and patient investor who, in time, will be richly rewarded.
Transcript
Page 1 of 48
Institutional Research
BUY
Price (close) 12 Mar 2012: 78p
52 Week Range: 64p - 163p
Price Target: 165p
3-year Target: 247p
Vatukoula Gold Mines Profile
Vatukoula Gold (AIM: VGM) is in the midst of ramping up production and modernising the historic Emperor Gold mine, situated on Fiji’s largest island, Viti Levu. Now known simply as Vatukoula, the orebody is a low sulphidation epithermal deposit that has been in virtually continuous operation for 80 years. To date, approximately 6.9Moz of gold and over 2Moz of silver has been extracted, with the current JORC compliant Resource standing at 4.3Moz Au, meaning that the mine has in-excess of three decades of production in front of it Share Price Performance
Sprott Asset Management 17.9% Canadian Zinc Corp. 14.2% Zesiger Capital Group 9.1% Black Rock (UK) 4.8% Rex Harbour 3.9% Capital Research Global 3.6% HD Capital Partners LLP
RESOURCE ANALYST Gaius LL King
SALES/CORPORATE Philip Haydn-Slater/Paul Dudley +44 (0) 20 3551 4870
Vatukoula Gold Mines PLC
Gold producer trading at 69% discount to our 3-year target
BOE cannot QE Au
Unhedged profitable producer sensitive to increases in gold price
Scalar productive potential many times current rate
Valuation at an after-tax NPV12% of 165p per share
3-year valuation of 247p per share
It is increasingly probable that the BOE will find inflation an attractive tool to solve
the problem of both public and private debt levels (for reasoning see page 41). The
resultant inflation will distort the economy in favour of extreme consumption
and the hoarding of real assets (e.g. property, oil, equities in perishables, such as
Tesco, etc), but in particular, gold and bullion producers. The reality is that the
current minority government in the UK will have to face the polls at least once in the
midst of an austerity drive. It raises the question – does the UK public have the
stomach for at least six years of egregious cuts and falling living standards, before
even reaching budgetary equilibrium? We believe not.
Unlike many of its gold producing peers, VGM does not suffer from a lack of
Resources or exploration potential. In fact it may suffer the ignominy, in three to
four years’ time, of having 8 to 10Moz Au in Resources, or in-excess of 100 years
mine life at the current extraction rate. We believe our valuation of VGM is
conservative, based entirely on projected cashflows from its key project, the
Emperor/Vatukoula Gold mine. The non-linear financial model incorporates both
fixed and variable components, as well as a Stage 2 expansion costing US$270m,
large on-going annual underground capital development, and a five-year US$134m
exploration programme. Given the enormity of out-going cashflows, we have
expanded the number of shares on issue by 24%. Based on modelled cashflows
and an issued capital base of 111.02m shares, we initiate with a BUY
recommendation and value VGM at an after-tax NPV12% of 165p per share. Our
3-year valuation is based on after-tax cashflows from FY15 onwards, which results
in 247p per share.
We believe that this project has suffered historically from investor and analyst
apathy. A non-mechanised underground operation, it is a form of mining that is
increasingly rare, being replaced by open-pit, low-grade operations where
metallurgy rather than mining is the key determinant. Despite this, we reiterate that
the Vatukoula gold mine represents a large, multi-decade scalar and (we believe) a
highly profitable proposition. It is, furthermore, highly sensitive to any increase in
gold price (see p. 26). We believe VGM is ideal for the moderately risk tolerant and
patient investor who, in time, will be richly rewarded.
Page 2 of 48
Institutional Research
Contents
Financials 3
SWOT Analysis 4
Ownership & Tenure 5
History of the Emperor (Vatukoula) Gold Mine 5
Regional Geology 6
Local Geology 7
Mining Method 8
Exploration, Geology & Mine Planning
Resources 10
In-mine Exploration 12
Near-mine Exploration 13
Indigenous Power Generation
Financial Impact of Reducing Power Costs 15
Proposed Construction of a Biogeneration Plant 15
Localised Geothermal Potential? 17
Mining Assumptions 19
Financial Forecast 21
Financial Valuation 25
Sensitivity Analysis 26
Appendix I – Country Transparency (Fiji)
Background 27
Country Transparency 27
Appendix II – Epithermal Gold Deposit Formation 29
Appendix IV – Company Directors 30
Appendix III – Effective Peak Gold?
Burgeoning Nouveau Riche Demand 30
Constrained Primary Supply Growth 32
Central Bank Demand Haphazard 34
Aftermath of Fiscal Profligacy 36
The Future of Gold 37
Thinking the Unthinkable 39
The British Pound and the Fallacy of Growth 41
Appendix IV – Company Directors 43
Glossary 44
Disclosures 48
Page 3 of 48
Profit & Loss (USD) 2012F 2013F 2014F
Operating Revenue 35.1 26.1 30.5
Royalties 3.0 3.0 3.3
Invest & other income 0.0 0.0 0.0
EBITDA 24.1 15.0 19.2
Depreciation/Amortisation (5.9) (7.1) 7.6
EBIT 18.3 7.9 26.7
Net Interest 0.5 0.7 1.0
Pre-tax profit 18.7 8.7 27.8
Tax expense 0.0 0.0 0.0
Minorities/Assoc./Prefs 0.0 0.0 0.0
NPAT 18.7 8.7 27.8
Non reoccurring items (5.2) 0.0 0.0
Reported Profit 13.5 8.7 27.8
NPAT add Goodwill & Pref 0.0 0.0 0.0
Adjusted profit 13.5 8.7 27.8
Cashflow Summary (USD) 2012F 2013F 2014F
EBITDA 24.1 15.0 19.2
Working capital changes (0.3) (0.1) (0.0)
Provisions 0.0 0.0 0.0
Other operating 0.0 0.0 0.0
Cashflow pre interest & tax 23.8 14.9 19.2
Net interest 0.5 0.7 1.0
Pref/con, dividends (debt) 0.0 0.0 0.0
Income tax paid 0.0 0.0 0.0
Operating Cashflow 24.3 15.7 20.2
Required capex (9.9) (9.9) (9.9)
Maintainable OCF 14.4 5.7 10.2
Dividends 0.0 0.0 0.0
Pref/con, dividends (equity) 0.0 0.0 0.0
Acquisitions/expansionary capex 0.0 0.0 0.0
Exploration cap./R&D (22.4) (22.4) (22.4)
Disposals 0.0 0.0 0.0
Free cashflow -8.0 -16.7 -12.2
Debt increase/(reduction) 0.0 0.0 0.0
Pref./Conv.Capital (Equity) 0.0 0.0 0.0
Pref./Conv.Capital (Debt) 0.0 0.0 0.0
Equity 0.0 0.0 0.0
Net cash flow -8.0 -16.7 -12.2
Balance Sheet (USD) 2012F 2013F 2014F
Cash & Deposits -2.4 -25.9 -42.3
Trade & other debtors 9.1 9.1 9.1
Inventories 4.1 4.3 4.9
Investments 0.0 0.0 0.0
Prepayments 3.8 3.8 3.8
Other 0.0 0.0 0.0
Total current assets 14.5 -8.6 -24.5
Trade & other debtors 0.0 0.0 0.0
Investments 0.0 0.0 0.0
Assoc. Co. Equity 0.0 0.0 0.0
Inventories 0.0 0.0 0.0
Total property, plant & equipment 22.7 28.4 14.1
Intangibles (Goodwill) 33.3 31.8 30.3
Intangibles (Exploration) 15.9 15.9 15.9
Tax Benefit 0.0 0.0 0.0
Other assets (Int in Gov Sec, Prepays etc) 0.0 0.0 0.0
Total non-current assets 71.8 76.1 60.2
Total Assets 86.4 67.5 35.8
Borrowings/pref. debt 0.0 0.0 0.0
Trade & other creditors 5.1 5.1 5.1
Provisions (excl. tax and divs) 1.8 1.8 1.8
Other Provisions (tax ) 0.0 0.0 0.0
Other 0.0 0.0 0.0
Total current liabilities 6.9 6.9 6.9
Borrowings 0.0 0.0 0.0
Preference (Debt Type) 0.1 0.1 0.1
Trade & other creditors 0.0 0.0 0.0
Provisions 1.9 1.9 1.9
Other 10.8 10.8 10.8
Total non-current liabilities 12.8 12.8 12.8
Total liabilities 19.7 19.7 19.7
Shareholder equity 66.7 47.8 16.1
Page 4 of 48
SWOT Analysis
Strengths
Weaknesses
Established infrastructure – existing processing plant,
hundreds of kilometres of underground development,
numerous shafts, exhaust fans, workshops, and operational
equipment. We estimate it would cost hundreds of millions of
dollars to replicate what the company already has.
Skilled workforce – experienced underground workforces are
now exceedingly rare, especially those with the ability to use
pneumatic air-legs, which takes years of training to gain
proficiency. Although not a modern mining technique, this tool
is a relatively cost-effective, selective extraction method, able
to mine at small widths that are impossible with current
mechanisation technology.
JORC compliant Resource – with over 4Moz’s in Resources,
there are decades of production at current extraction rates.
No hedging or debt.
Single commodity - gold. We believe, however, that the
downside will be mitigated by numerous countries engaging
in “beggar-thy-neighbour” policies.
High fixed-cost base – underground mines have large
costs that are incurred whether producing or not, including
ventilation, dewatering and basic maintenance. By their
very nature, underground mines produce substantially less
tonnage over any given period than their open pit
counterparts, so any costs incurred, spread over less
ounces produced, have the effect of compounding the cost
base.
Reliance on diesel power generation – ultimately a very
expensive source of power and, if our predictions are
correct, are to become increasingly more expensive in the
future as we enter a probable new bull market for oil.
Opportunities
Threats
Extensive exploration potential – following a recent site visit,
we were once again staggered at the amount of in-mine and
near-mine potential that exists. Despite the current JORC
Resource of >4moz Au, we believe that this figure will easily be
doubled in the next three to four years. In addition, we still
believe it likely that a near-surface ore-body will be discovered.
If and when this occurs, it could provide the impetus for the
company to develop it as a separate deposit via a decline, and
replace the current metallurgical plant with another, potentially
doubling current productive capacity.
Increasing underground production profile – the company
will have to organically increase the number of airleg miners
(significant investment and time to train). Given the thin
epithermal nature of the orebody, its variability, and the
relatively gently sloping orientation of the mineralised
flatmakes, it is a deposit that is virtually impossible to be
mechanised mining-wise, without adverse dilution.
Increasing in-house technical expertise - management is
slowly establishing a technical team to improve mine planning
functions.
Effective mine and stope design – although still mining from
the four main sections, management are consolidating
production from disparate regions (in a very large mine)
thereby reducing the substantial travel distances.
Management are establishing localised production centres
utilising a footwall methodology, with stope designs allowing
direct truck loading, thereby minimising double handling.
Renewable/co-generation power source – could
dramatically lower the cost of power to the company, affecting
its fixed cost base, either via cogeneration utilising sugar-cane
feedstock, or potentially using geothermal power from the
nearby caldera.
Nationalisation – despite a number of military coups,
social unrest, and economic difficulties, sovereign risk in
reality is minimal due to the underlying legal structure of the
operation and the critical importance of the Emperor Gold
mine to Fiji’s overall economy.
Loss of key staff – the company relies on a number of very
experienced expatriate staff who are critical to the future on-
going success of the venture, as well as establishing critical
mass where many currently contracted roles could be taken
in-house. Employees of this calibre would be very difficult
to replace in the current market.
Page 5 of 48
Ownership & Tenure
Vatukoula Gold began its life in August 2000 as River Diamonds, evaluating a number of
diamondiferous Kimberlite dyke systems in Sierra Leone as well as a number of gold
projects in the Para region of Brazil. During 2007, the company acquired a 19% indirect
interest in the Vatukoula Gold Mine for a total consideration of £4.25m. In November that
same year, a conditional agreement to acquire the remaining 81% of the Vatukoula Gold
Mine was entered into, and was consummated in April 2008. The company changed its
name to Vatukoula Gold Mines in August 2008. As at the end of August 2011 the mine
employed 1,150 people, both in Fiji and at its London headquarters.
Figure 1: Vatukoula Corporate Structure
Source: VGM, HD Capital
History of the Emperor (Vatukoula) Gold Mine
Gold was originally found via alluvial deposits within the Nasiv River in the late 19th
Century
in the Vatukoula region. Reputedly, the first recorded discovery of gold near the
Emperor/Vatukoula mine site was made by Baron A. B. de Este in 1872. However, the first
payable gold reef at Vatukoula wasn’t uncovered until November 1932, in the Lololevu
Creek, by William Bothwick, a prospector from Scotland. Following the initial gold rush in
1936, the deposit was held in separate titles by three companies, eventually consolidated in
1956 under Emperor Gold Mines Ltd. Under a number of owners, the mine operated
continuously until 2006, when it was put into care and maintenance. It was acquired by
VGM late in 2008 and reopened soon after. To-date the mine has produced approximately
6.9Moz of Au and 2Moz of Ag.
Vatukoula Gold Mines PLC
(England & Wales)
Viso Gero International Inc
(British Virgin Islands)
River Diamonds Limited (UK)
(England & Wales)
Vatukoula Gold Pty Ltd
(Australia)
Sao Carlos Mineracao Limitada
(Brazil)
Vatukoula Australia Pty Ltd
(Australia)
Vatukoula Finanace Pty Ltd
(Australia)
Koula Mining Company Ltd
(Fiji)
Vatukoula Gold Mines Ltd
(Fiji)
Vatukoula Mine Operations
Page 6 of 48
Regional Geology
The Fijian archipelago contains over 300 islands
and lies along the edge of the Pacific Ring of
Fire. The Ring of Fire is virtually a continuous
series of oceanic trenches and volcanic arcs/belts
defining the edges of continental plate
movements (see Figure 3), accounting for around
90% of the world’s earthquakes. A theory first
espoused by Alfred Wegener, plate tectonics
holds that the lithosphere (the hard outer layer
~100km thick) moves about on the earth’s
surface, resting on the fluid-like (visco-elastic
solid) asthenosphere, allowing these plates to
undergo motion in different directions. The
movement mechanism is thought to be related to
convection in the earth’s mantle (see Figure 5),
but is presently unproven.
This tectonically active region is defined by an
abundance of faulting, associated with numerous
volcanoes and intrusives, which are genetically
essential for the development of copper and gold
deposits, as well as a range of other metals. The
reason why there is an abundance of world-class
epithermal deposits is the fact that the Pacific
Ring of Fire region has a high geothermal
gradient, resulting from water bearing rock in the
form of subducting oceanic crust, being forced
beneath the adjacent continental crust. As the
oceanic crust decomposes and melts, it creates
hydromagmatic diapirs, releasing entrapped
fluids, allowing them to circulate in convection
cells, leaching metal ions out of the surrounding
rock. These diapirs effectively rise as isothermal
Newtonian fluids, until they reach isostatic
equilibrium. These associated fluids ultimately
cool and the metals that they carry are eventually
deposited in structural and stratigraphic traps.
Viti Levu, the largest Fijian island, is located in a
seismically active area within the Fiji Platform - a
remnant island arc that lies in a diffuse plate
boundary zone between the Pacific and
Australian tectonic plates in the southwest
Pacific. The regional Fijian geology is largely
defined by the collision and the subduction of the
Pacific plate underneath the Australian tectonic
plate (see Figure 2). This plate boundary hosts
major epithermal systems in northern and
eastern Papua New Guinea at Lihir, Porgera, Ok
Tedi and Misima; in the Solomon Islands, at Gold
Ridge; and at Emperor/Vatukoula and Mt Kasi in
Fiji; as well as several similar epithermal gold
deposits on the Coromandel Peninsula in New
Zealand's North Island and Bougainville.
Figure 2: The location and relative direction of movement of tectonic
plates. Fiji is on a diffuse plate boundary zone between the Pacific and
Australian tectonic plates.
Source: US Geological Survey, February 2006, HD Capital
Figure 3: The Pacific Ring of Fire, encompassing a 40,000km long
horseshoe region (high-lighted in red) is strongly coincident with epithermal
gold & copper porphyry styles of mineralisation.
Source: Simon Frazer University, March 2007, HD Capital
The Vatukoula1 gold deposit is situated in a collapsed caldera within an extinct volcano in
the north-western portion of Viti Levu. The caldera is semi-elliptical in shape with the long
axis trending north-easterly, covering about 23km2 of an undulating topographical basin.
The caldera formed when Tertiary basalts collapsed after prolonged explosions from a
central vent area. The ensuing subsidence (which appears to have been cyclic) was
accompanied by the deposition of andesitic volcanic material, rhythmic tuffs, breccias and
agglomerates, partly under lacustrine conditions. The peripheral basalts were shattered
during the stages of collapse forming a ring fault zone around the caldera.
Figures 4 & 5: In Fiji most of the earthquakes are located off-shore from the two major islands of Vitu Levu and Vanua Levu, with the risk of an earthquake on land being very low, comparable to many parts of Australia (left); and schematic cross section of subduction zone, demonstrating oceanic Australian plate subducting beneath the Pacific plate (right).
Source: Fiji Mineral Resources Department 2011; US Geological Survey, December 2005, HD Capital
The Emperor/Vatukoula2 mine is a low-sulphidation epithermal gold-vein deposit,
associated with alkaline type igneous rocks in a volcanic setting, typical of several other
major gold mines in the southwest Pacific region (e.g. Porgera and Lihir). An important
common genetic feature appears to be the post-caldera collapsing and, in particular, the
formation of a north-westerly shear system transecting the caldera, with flatly dipping
structures within the peripheral basalts resulting from tectonic resettling. Gold
mineralisation is thought to have formed between 3 and 7 million years ago, post-dating
magmatism by approximately 400,000 years. The Emperor/ Vatukoula gold mine is
currently the only significant producing gold operation in Fiji. The vast majority of the gold
mined at Vatukoula is mostly within a two square kilometre fractured basalt block, found
largely in the form of gold in arsenopyrite, with 10 to 50% of the gold in the form of precious
metal tellurides. Typically, the majority of gold mineralisation occurs within steeply dipping
dykes and shears, flat-dipping structures (<45°), known locally as “flatmakes”, resulting
from the intersection of two or more structures referred to as “shatter zones”. An estimated
6.9Moz (8.5Moz pre-mined resources assuming an 81% extraction rate) of gold has been
extracted since mining operations commenced in 1932.
1 Translates as “rock of gold”.
2 Its historical name is listed alongside its current name is being consistent to the fact that virtually all geological literature refers to the
project as the Emperor gold mine, not Vatukoula, which is a regional descriptive.
Vatukoula is located on the edge of a collapsed caldera/volcano.
Approximately 6.9Moz Au has been mined from the Emperor/ Vatukoula Gold deposit since operations commenced in 1932.
Page 8 of 48
Mining Method
The greatest challenge with most epithermal vein deposits is the fact that mineralisation is
thin and highly variable. At Vatukoula, a width typically varies between 10 and 50cm.
hydrothermal fluids interact and alter the surrounding host rock. As a result, fluids become both dilutive and neutralised,
precipitating silica within veins as quartz (left); and a 4 by 3.5 metre drive/drift developed along the ore zone near Smith
Shaft, with oxidised sulphide mineralisation dipping at a 25 degree angle from the top left into the right hand wall. The
dimensions of the mined stopes above and below the drive are developed by pneumatic airleg at a little over a 1.2metres
true-width, resulting in significantly less dilution than if done by other mining methods (right).
Source: HD Capital
Figures 8 & 9: Example of a “flatmake” bifurcating into two separate ore zones, illustrating the irregular nature of the
mineralisation over very short distances (left); and arsenopyrite-rich sulphide rich material, visible small relic voids known
as vugs (near red pencil), is a typical feature associated with epithermal deposits. Banding is the result of precipitating
silica from hydrothermal fluids associated with the caldera sealing the fissure closed, until the build-up of hydrostatic
pressure ruptures the seal. After time, passive conditions return with quartz precipitating and the seal closes again (right)
Source: HD Capital
Page 9 of 48
Being an underground operation, Vatukoula is accessed by a shaft at a
series of levels. Historically, each level was typically set 100 feet apart
continuing the entire depth extent of the ore-body(s). Levels are typically
developed in the footwall (often dependant on the most competent rock)
parallel to the orebody. At regular intervals, orthogonal adits are
developed to intersect the orebody, then drives (or “drifts” – see Figure
10) would be developed along strike of mineralisation on a specific level.
The workings on successive levels are then connected by raises and old
ore workings, which are critical for through-mine ventilation.
The dominant mining method employed at Vatukoula is a non-
mechanised long-wall method using a pneumatic airleg, a method
commonly utilised in South Africa mining in the Witwatersrand. Holes are
drilled into the rock at regular intervals in differing patterns dependent on
the mine design. The holes are loaded with ANFO (ammonium nitrate –
NH4NO3) using electric detonators and fired at specific and
predetermined times of the day. The residual broken material is scraped
out via an electric winch. This technique should allow a higher extraction
rate (aiming for in-excess of 80%) than the simple “room and pillar”
method, where a significant portion (often 50%) of the ore-body will be
left behind for ground support (in addition to wooden supports).
Previously, management were primarily concentrating on establishing
cashflows to maintain ramp-up of a new operation and recover from a
one-in-a-hundred year rainfall event in 2009, which flooded the mine to
the 15th
level. A major development since the author’s last site visit
several years ago, is the company’s single stope campaign.
Management is now establishing several large long-wall panels with draw points for loading
straight onto trucks. This will allow the miners to concentrate on several main working
stopes, one likely to be located near Philip’s Shaft, the other at Smith’s, rather than
disparate working faces throughout the mine. Not only should it result in higher
underground output, there will also be increased efficiencies associated with less materials
handling - possibly at the risk of having greater grade fluctuations due to less working
faces.
Figure 10: Simplified schematic for underground
entries and workings.
Source: McGraw-Hill (2005)
Parallels with Medusa Mining?
Unfortunately for Vatukoula, it has a method of mining operation that many investors (and analysts) are unfamiliar with As a result, we believe, many have shied away from this excellent investment story. It is our opinion that the Vatukoula mine cannot be mechanised (primarily due to the width and orientation of the orebody) because the resultant dilution would make the whole operation uneconomic. We believe that the company has significant parallels with Medusa Mining Ltd (ASX: MML) which has, since 2008, had a meteoric rise in its share price and public perception.
MML’s key asset is the Co-O mine, which is developed on a series of low sulphide, epithermal quartz veins, in Mindanao, the Philippines. Like the Vatukoula, the Co-O mine has a substantial history. It was originally developed by Musselbrook Energy and Mines, controlled by the late media tycoon, Kerry Packer. The plant was built by BHP in 1988, and ore was extracted via the use of mechanised jumbos. The machinery used was too large for the orebody dimensions, resulting in excessive dilution. After extracting only 60koz Au coupled with mounting losses, Packer abandoned the operation in 1992. When the mine re-opened, the majority of production was via hand-held methods (i.e. hammer and chisel), which made production slow and manually intensive. Massive hard veins composed primarily of quartz (often with grades greater than 30g/t) were avoided, being too difficult to extract. Like Vatukoula, ore production is now predominantly via pneumatic air-leg, which has considerably enhanced mining rates. In addition, scheduled refurbishments and
increases in mill capacity took significantly longer than management had originally predicted.
There are, of course, obvious fundamental differences. (a) Unlike the Co-O mine, Vatukoula, geologically speaking, is at least an order of magnitude greater in geological prospectivity. It has the very real prospect, in three to four years time, of having 8-10Moz in resources (and 100 years of production in front of it) without an obvious plan to increase production; and (b) because Vatukoula is also half the grade of the Co-O mine, it is also naturally a higher-cost producer. However, in both cases, any additional increase in underground productive capacity will have to be organic, likely via pneumatic air-leg, which is a skill that takes a number of years for a miner to master. It took a long time before the investment community woke up to MML’s promise; we believe that it will also take time to appreciate VGM’s potential.
Management intend to increase underground production at the expense of surface oxide material.
Page 10 of 48
Exploration, Geology & Mine Planning
Resources
Unlike many gold deposits, Vatukoula does not suffer a lack of resources or prospectivity.
In fact, the operation could suffer the ignominy in five years time of having 8-10Moz in
resources without an obvious plan to increase production. The largest bottle-neck to
increasing production at Vatukoula is the 650ktpa crushing capacity of the metallurgical
plant. Although working extremely well, the current mill is approaching the term of its
natural life, which could be extended almost indefinitely with maintenance. There is,
however, the opportunity to replace it with increased capacity plant, co-incident with
increased underground production. With the current mine resource standing at 4.3Moz
(see Table 1), given the aerial extent between the lowest developed level accessed by
Philip’s Shaft and the interpreted edge of the caldera (where the geothermal gradient would
be too hot to humanly work – although there are economic engineering solutions around
this, see p.17), we believe there to be substantial additional potential (conservatively 8 to
10Moz), meaning that the total mineralised system is therefore >20Moz3.
Table 2: Vatukoula JORC-compliant Mineral Resource estimate.
Source: VGM AR 2011, HD Capital
3 Current Resource of 4.3Moz, plus historical production of 6.9Moz (8.5Moz pre-mined resources assuming an 81% extraction rate).
Tonnes (Mt) Grade (g/t Au) Contained
Gold (Moz)
Tonnes (Mt) Grade (g/t Au) Contained
Gold (Moz)
Tonnes (Mt) Grade (g/t Au) Contained
Gold (Moz)
UNDERGROUND 7.4 6.0 1.4 4.4 8.8 1.3 4.6 9.7 1.5
TOTAL MINERAL RESOURCE 16.4 6.5 4.2
MEASURED INDICATED INFERRED
Figure 11: Pneumatic airleg allows miners to extract ore from narrow widths at a relatively flat orientation that would be
impossible via mechanisation. True width is approximately 1.1m. Extremely geotechnically stable, small excavations within
competent basalt displaying high uniaxial compressive strength, with additional timber ground support (see foreground).
Source: VGM, HD Capital
There was considerable prior underinvestment into the Vatukoula Gold mine for a substantial period of time which has to be rectified.
Page 11 of 48
Epithermal deposits, by their very nature, not only display highly irregular gold distribution
profiles, but gold bearing veins are also highly variable, ranging from 1cm to as much as
1.2m (averaging 20-30cm) in width over relatively short distances. This is evidenced by a
72% variation in annualised gold grades at the Emperor/Vatukoula Gold Mine (from just
5.5g/t to just under 9.5g/t Au – see Figure 24), despite largely identical mining methods.
Although the identification of mineralised zones is easily accomplished (and typically those
zones display good continuity), what is difficult is that any grade and thickness calculation
may not be representative, which cannot necessarily be resolved cost effectively by greater
drillhole density. This underlies one of the challenges at Vatukoula, accurately calculating
Reserves and Resources. Zones that were thought to be marginally economic have
proven to be substantially higher-grade, and vice versa. Despite management’s best
efforts, we believe they will inevitably resort to inadvertently absorbing good grade with the
poor; a problem unlikely to change, despite greater efforts by the company on detailed
short-term and long-term mine planning.
Figure 12: The Vatukoula orebody model consists of ten main discrete relatively flat-dipping planar structures (known
locally as “flatmakes”) overlapping each other; the Prince William, Dolphin Prince, Dolphin, 166N, TTN, R1, Matnagata,
Matnagata West, Matnagata East, and Matnagata Northeast.
Source: VGM, HD Capital
Due to global personnel shortages in the requisite fields, the company historically
outsourced many non day-to-day geological functions, costing in-excess of US$1.4m per
annum. Management have subsequently recruited several key personnel and will look to
internalise functions such as Reserve/Resource calculations, to reduce costs. More
importantly, once this intellectual capital is internalised, detailed mine planning functions
Epithermal deposits typically display substantial grade and thickness variations. However, given the extensive history of this deposit, it is unlikely that global mine characteristics will change dramatically going forward. The company is still in the midst of building its onsite team.
Page 12 of 48
can then take place. For example, at present mine engineers rely on annualised computer
tables, based on modelled Resource calculations detailing expected Reserve grades at
level and block intervals, while onsite management are unable to update forecasts
incorporating real-time information supplied by the mine geologists. Inevitably this will
change in time as additional people are incorporated into the technical team.
In-mine Exploration
Management have been aware for some considerable time that the previous two operators
(Durban Roodeport Deep & Western Mining Corp) of the Emperor/Vatukoula Gold mine
were “remiss” in their geological and capital-development investment, possibly due to the
prevalent low gold price. The lack of detailed geological information is a critical component
for management to make informed decisions.
Figure 13: Diagram demonstrating the change in orientation between the Prince William (Orange) and the Matnagata
surface (grey) overlain by underground drive development. Three footwall drillholes (white lines), to test ore-surface
replication, are planned before the development (in case the decline intersects additional orebodies) of a proposed
internal decline (white circular corkscrew), to access the down-dip continuation of mineralisation of the Dolphin, Prince
and Prince William surfaces.
Source: VGM, HD Capital
Although elsewhere universally adopted in all major new mining developments, it is only in
the past year the Vatukoula mine has been effectively modelled graphically. This is a
powerful tool for mine geologists, not only to be able to manipulate data, but also to plot
holes and their intersections in real-time. Historically, drillholes were plotted by drafts-
people on cross sections and then interpreted by the geologist. As well as being time
consuming, the successful interpretation of complex structural surfaces was often
dependent on the individual skill and competency of the geologist involved. The adoption
of this modern graphical technique virtually eliminates individual perception differences,
We believe that the pre-mine total gold mineralisation system at Vatukoula is considerably greater than 20Moz Au.
Page 13 of 48
with the enhanced ability to manipulate the image from any angle. We expect that as more
drill and mapping information is incorporated into this tool, it could be instrumental in
determining the existence of as yet overlooked ore surfaces. The economic benefits to in-
mine exploration include:
Increase in the number of ounces per vertical metre developed; and
Any resultant discovery would likely be close to existing infrastructure and ventilation,
meaning additional development would be minimal; and
Ore haulage distances will likely be substantially less, as will development
requirements.
To rectify the situation and update resources, during 1Q10 the company purchased an
additional four underground drill rigs, bringing the total number to nine. In time, with
surface and underground exploration programmes, we would expect regular discoveries
similar in nature to the recent Baron d’Este finding. Located approximately 300 and 700m
below surface (between levels 11 and 23), some 300m from existing workings, it is the first
discovery of a new high grade ore zone at Vatukoula since the discovery of the Prince
William ore zone in the 1980’s. The most significant composite intersections included
0.46m @ 125g/t Au and 2.86m @ 34g/t Au, part of up to four structures, three of which are
sub-vertical, and are open along strike and down dip.
Near-mine Exploration
We cannot emphasise enough what an incredibly promising prospect we believe Vatukoula
to be, especially for orebody extensions regionally. There are reputedly in excess of 4,500
drillholes outside the immediate mine environment. However, as Figure 14 demonstrates,
the vast majority of these holes are located in close proximity to existing mine workings.
Figures 14 & 15: Modelled Vatukoula gold mine with drill-hole traces. Note how little drilling exists for much of the Prince William orebody (left); and a simplified westerly x-section illustrating the geographical relationship between various orebodies. In addition, each of these surfaces is interconnect by steeply dipping dykes and shears, with the intersection of two or more structures referred to as “shatter zones” (right).
Source: VGM, HD Capital
There are good economic reasons to conduct in-mine exploration. Management are investing heavily into the long-term future of the mine, via underground and surface drilling, and substantial underground capital development. The exploration potential around the existing Emperor/Vatukoula Gold mine is enormous.
Page 14 of 48
In the late 1990’s the WMC4 board (then owners) commissioned an internal study on the
cost benefit analysis of exploration across all its divisions. Among other things, it found that
given the long lead times (sometimes decades) typically associated with getting a mine into
operation, exploration costs (although only between three and five percent of total
development costs in nominal terms) equated to between 15 and 17 percent of real costs,
once time value had been incorporated. Unfortunately, WMC upper management drew the
wrong conclusions from this cost benefit analysis, deciding to restrict general exploration
and development expenditure, in a vain attempt to develop a geological equivalent to the
modus operandi “just-in-time”. The unintended consequence of this strategy was the
continual inability of operations management to justify expenditure, meant that production
eventually caught up with capital development, resulting in production bottle-necks.
Given the large Resources base at Emperor Gold mine at any particular point in time,
coupled with the day-to-day production imperative to keeping the mill running at full
capacity, it would be very difficult to mount a geological argument for additional funds to
extend the resource base significantly, let alone funds for regional exploration. That if
something substantial were to be discovered, any cashflows would be so far into the future,
it would likely render any economic benefit to be almost negligible without considerable
expenditure.
Figure 16: Resource model in plan projection, overlain with mine grid. Each block is approximately
1km square. Blue = mined out regions and Measured Resources. Teal Green = Indicated
Resources. Yellow-Green = Inferred resource, see planned (blue trace lines) surface drill-holes to
the east and west, primarily targeting Inferred Resources. Red = unclassified resource (has some
drilling but not sufficient for a resource classification.
Source: VGM, HD Capital
4 After the resignation of geologist Roy Woodall, the international mining house Western Mining (WMC) did not have a single sitting
board member with any formal mining training (engineering or geological) or experience (they did have the token female biologist).
Mining by its very nature requires substantial and sustained upfront development. If neglected for a while, it will take a considerable period of time before rectified.
Page 15 of 48
Indigenous Power Generation
Financial Impact of Reducing Power Costs
Fiji has no indigenous source of fossil fuels for its power generation needs; hence, as a
country, it is heavily dependent on imported fossil fuels for its industrial, domestic, transport
and power generation. As a result of the relative remoteness of the Vatukoula operation,
power is obtained via on-site diesel generators, making up approximately 18 to 22
percent (depending on oil price and production levels) of C1 production costs. This, of
course, makes the operation particularly susceptible to future vagaries in the oil price, and
is why management are keen to diversify its generation source, potentially utilising a
biogeneration facility, which could halve the electricity tariff. This would increase
our NPV valuation by approximately 25% (see Sensitivity Analysis – p. 26) by reducing
cash-costs of US$880/oz (in real terms, post FY16) to around US$723/oz – a material
difference.
Proposed Construction of a Biogeneration Plant
According to recent media reports5, VGM has recently met with Fiji’s current Prime Minister
to discuss the construction of a new cogeneration plant at the Rarawai Sugar Mill. This
follows the signing of an MOU (Memorandum of Understanding) several years ago
between VGM and the Fijian Super Corporation (FSC) to purchase energy from the then
proposed Rarawai Mill Bagasse cogeneration project. Although FSC reputedly has
cashflow problems, recent discussions indicate that the project will get some level of
government support, with project capex estimated to be approximately US$90m (public
est.) to 120m (company est.).
Direct benefits to FSC will include reducing electricity costs, as well as providing an end
use for cane crushing waste. Sugar cane has one of the highest photosynthetic
bioconversion efficiencies in the plant kingdom, able (under optimal conditions) to fix
around 55 tonnes of dry matter per hectare of land annually (on a single crop basis). The
Fijian economy is heavily reliant on sugar as an export commodity, the processing of which,
results in the generation of a substantial amount of organic waste material (bagasse)6.
Bagasse is often used as a primary fuel source for sugar mills; when burned in high
quantities produces sufficient thermal energy to supply all the mill’s needs, typically with
substantial energy to spare. In a cogeneration plant, the use of a fuel source provides both
thermal energy (steam), which is utilised in the mill, and electricity, the excess of which is
typically sold on to the consumer via the regional electricity grid.
In addition to the obvious tariff advantages for VGM, other benefits for Fiji as a whole
regarding cogeneration include:
Renewable and indigenous energy source;
The relatively low capital-cost of the project;
CO2 emissions are equal to the amount of CO2 that the sugarcane plant absorbed
from the atmosphere during its growth phase. Effectively making the cogeneration
process entirely greenhouse gas neutral;
The ash can be used as a soil conditioner in landscaping work, or be returned to cane
farms to supplement fertilisers;
5 Fijilive, December 6
th, 2011 “PM shows support to VGM on expansion plans” (http://fijilive.com/news/2011/12/06/38478.Fijilive)
6 Despite high moisture contents (typically 40 to 50%), for electricity production bagasse is typically stored under moist conditions; with a
mild exothermic reaction from the degradation of residual sugars providing moderate drying.
Reduction in power costs could have a dramatic impact on the fixed-cost component of mine production costs. VGM are dealing directly with Fiji’s Prime Minister to forward the biogeneration option as renewable, low-risk, low capex solution. Cogeneration is a renewable indigenous energy source.
Cogeneration makes better use of waste biomass, which would otherwise be dumped
or burnt as waste; and
This appears to be a project with benefits for Fiji (balance of payments) and
Vatukoula.
Figures 17 & 18: One tonne of sugarcane produces approximately 250kg of wet waste plant material, known as bagasse (left); a 140MW facility in Florida utilises bagasse (brown stockpiles) and urban wood waste to generate enough electrical power and steam for its milling and refining operations, plus renewable electricity for 60,000 homes. Significant volumes of bagasse are stored at the end of the sugarcane grinding season, typically mid-October to mid-March (right).
Source: National Renewable Energy Laboratory (US), Florida Crystals Corp., HD Capital
Potential challenges for the project include:
Seasonality of the feedstock given there is only one cane growing season per annum
in Fiji. It is presently envisaged that sugar cane will provide approximately nine
months feedstock, with locally sourced tropical wood burnt providing the balance;
Timber plantation will have to be established, meaning there will be a lag time (>15
years) before it reaches full yield, meaning an alternate bio-source will have to be
found in the interim; and
This power cannot yet be transported to site, as 18km of power lines need to be
evaluated for upgrading or replacement.
A single cane growing season means that the bagasse will need to be supplemented for several months a year by another fuel source, most likely tropical wood.
Page 17 of 48
Localised Geothermal Potential?
Anyone who has had the privilege of going underground at Vatukoula will attest to how
indecently high the ambient temperature is. In-mine water temperatures of over 58
degrees Celsius have been recorded. The Vatukoula deposit lies on the edge of a
relatively recent (in geological time) thermally hot caldera. Historically, at various times,
working stopes (at the bottom of Philips Shaft) have crossed the caldera boundary7.
Because temperatures were too hot for continued human occupation, men would reputedly
work in 15 minute shifts in the stope then spend 15 minutes in a nearby fridge to lower the
body’s internal temperature, whilst a second crew would emerge to take their place, and
vice versa. It raises the question: is geothermal power a potential generation option at (or
nearby) Vatukoula?
Geothermal power uses the earth’s latent heat, by tapping regions of high temperatures to
generate electrical power. As a technique for power generation, it has been used since
1904 in Larderello, Italy, and is now utilised in over 24 countries around the world, five of
which use geothermal power to produce more than 15 percent of their total electricity power
generation. Total global installed geothermal power generation is now approaching
11,000MW, which is enough to meet the annual needs of over 110 million people.
Figures 19 & 20: Binary cycle power plants can accept fluid temperatures much lower than traditional systems, using either Organic Rankine, Kalina Cycle or Granex systems. Moderately hot geothermal water is passed by a secondary fluid with a much lower boiling point, resulting in the secondary fluid to flash vaporise, thus driving the turbines. Binary geothermal systems are the most common type of geothermal electricity plant being constructed today (left); and an example of a 192.5MW geothermal plant in the municipality of Valencia, Negros Oriental; situated in a similar topographic setting as Vatukoula (right).
Source: University of Queensland, Energy Development Corp, HD Capital
The dominant lithology hosting the gold mineralisation at Vatukoula is basalt, and underlies
the seven kilometre diameter caldera and somma, containing volcanic sediments
(pyroclastic flows and tuffs) which are, in turn, intruded by andesites and biotite-quartz with
andesites at its centre. Caldera sediments display monocline, inclining from the rim to the
7 Using the updated Resource/Reserve on Vatukoula by AMC Consultants Pty Ltd (“AMC”) in 2010, we note that the Resource
calculation used the interpreted edge of the caldera as a boundary, despite valid high-grade holes below. We assume that this was done on the simple basis that temperatures would be too high for extraction under current infrastructure provisions.
There appears to be significant regional geothermal prospectivity
Figures 25 & 26: Gross revenue (left); contrasting with operating revenue which reflects variation in cash-costs (right).
Source: HD Capital Assumed a long-term USD/GBP exchange rate of £0.60
Figures 27 & 28: EBITDA (left); and total metres of development (right). The dramatic rise in development compared to previous years is largely to rectify a significant period of time historically, when development and drilling were scaled back in order to lower costs during periods of depressed gold prices.
Source: HD Capital Assumed a long-term USD/GBP exchange rate of £0.60
Figures 29 & 30: Operating cash-flow per share (left); and earnings per share (right).
Source: HD Capital Assumed a long-term USD/GBP exchange rate of £0.60
Page 24 of 48
Figures 31 & 32: Cash-cost per tonne (left); and cash-cost per ounce (right). The variation between the two diagrams
reflects the fact that although mining and processing costs remain approximately the same despite increased tonnages, it
is the increase grade via improved mine scheduling, planning and improved extraction techniques that allow a lower cash-
cost per ounce.
Source: HD Capital Assumed a long-term USD/GBP exchange rate of £0.60
Page 25 of 48
The Inadequacy of NPV Valuation Method
The NPV financial calculation is based on production guidelines. However, we are cognisant that in this particular instance the calculation is an inadequate method in assessing a reasonable valuation, because after year-10 (due to the compounding nature of the applied discount), any additional revenue generated by the mine only has a collective minutiae effect on the final valuation.
We have chosen not to do peer-analysis, because it is our observation that it is regularly manipulated by the unscrupulous to imply valuations to stocks that are entirely unjustifiable, hence our preference for more quantitative methods.
Despite the deposit’s obvious shortcoming (the inability of the deposit to be mechanised) and the requirement to organically grow its work-force, we are extremely positive on the future of this project. We believe that the old Emperor Mine still has at least 58 years of production ahead of it – despite the fact that the NPV calculation fails to capture approximately 48 years of that future. It is a long-life and very valuable asset with enormous potential up-side. It is in this context that we remind readers of Medusa Mining (see insert on page 9), and the fact that no one (including this analyst) expected it to reach the heights it has. For the moderately risk tolerant and patient investor, this company VGM simply needs time, after which they will be richly rewarded.
Financial Valuation
The VGM valuation is based entirely on projected cashflows from the old Emperor Gold
mine. It is a non-linear financial model with fixed (labour, engineering, milling, mine
fixtures, capital development, power generation and administration) and variable (labour,
milling, mine consumables, smelting, refining and transport) components. The valuation
does include a conservative “Stage 2” expansion scenario, increasing production tonnage
by 53% from 650kt to 1Mtpa, reaching its designed production plateau in 1H20. Given the
size of the current resource, and the potential for its expansion, we think that this modest
increase in production is eminently achievable.
The financial model is entirely based in USD, with the exception of third party smelting,
refining and transport which is done in AUD, with the final valuation into GBP at the
conclusion of the process. The use of a discount rate of 12% is appropriate and is similar
to comparable mining stocks. It encapsulates a number of perceived investment risks in
either reaching Stage 1 (~101koz pa Au) or Stage 2 (~200koz pa Au). We have refrained
from calculating a WACC9, because we think it entirely inappropriate to be used for
companies at this end of the mining sector.
Our three-year target uses the same discount rate as the current valuation (see Table 7),
but begins to value cashflows from FY15 onwards. The effect of this technique is to
minimise the compounding effect of the DCF model during the period whereby the
company is establishing Stage 1, as well as more effectively valuing the additional
production emanating from Stage 2. This increases the valuation significantly (~50%) from
165p to 247p per share.
9 Weighted average cost of capital.
Table 7: Post-tax NPV matrix at varying discount rates, calculated over an expanded
shareholder base totalling 111.02m shares on issue.
Source: HD Capital
Discount rate After-tax NPV
(USD)
Three-year
NPV (USD)
Per Share
(USD)
Per Share
(£p)
3-year Target
(USD)
3-year Target
(£p)
0% 5,415 5,365 49 2,926 48 2,900
2% 2,643 2,867 24 1,428 26 1,550
4% 2,814 1,700 25 1,521 15 918
6% 1,422 1,105 13 769 10 597
8% 751 811 7 406 7 438
10% 450 596 4 243 5 322
12% 305 457 3 165 4 247
14% 224 365 2 121 3 197
16% 172 301 2 93 3 162
18% 137 253 1 74 2 137
20% 5.32 217 0 4 2 117
22% 0.88 188 0 1 2 102
24% (2.50) 165 (0) (2) 1 89
Page 26 of 48
Sensitivity Analysis
In the past decade (despite the gold price climbing five-fold) costs have typically kept pace
and is the main reason why, for instance, many lower-grade Orogenic gold deposits in the
Western Australian Goldfields have not re-opened. The Emperor Gold mine has a high
fixed cost base, using selective mining techniques. As previously mentioned, once fixed
costs are covered this project is highly leveraged to the gold price meaning, cēterīs paribus,
a 5% increase in the gold price results in a 41.9% increase in the company’s NPV (see
Table 8).
Table 8: Sensitivity of mining, metallurgical, commodity and currency assumptions
on the company’s NPV
Source: HD Capital
Additional points of interest include:
Gold-grade and metallurgical recoveries are also sensitive inputs, both being
associated with the revenue equation;
The financial model is far more sensitive to production from underground sources
than surficial oxide sources. Hence the reason why profitability does not suffer too
egregiously once oxide sources are no longer processed; and
Mine fixture and consumables have a large variable component and hence its impact
is more influenced by production output.
We would also point out that it is the quantum of change that is important as well. From the
sensitivity table above, it would appear that power generation costs are inconsequential.
However, as previously mentioned, management believe that when a cogeneration power-
plant is commissioned, electricity tariffs could effectively halve. Yet, the effect on this
model is very material, potentially increasing NPV and three-year target valuations by
approximately 25% to 206p and 309p, respectively (see Power Generation section).
Obviously, the converse is also true if oil prices increased by the same percentage
quantum.
Factor Factor Variation (%) Change in Company NPV (%)
Gold Price 5% 41.9%
Gold Grade 5% 17.9%
Silver Grade 5% 0.0%
Metallurgical Recoveries 5% 12.1%
Milling (Fixed and Variable) 5% (1.1%)
Underground Production 5% 12.0%
Oxide Production 5% 0.3%
Labour (Fixed and Variable) 5% (0.9%)
Power Generation Costs 5% (2.5%)
Engineering 5% (1.6%)
Mine Fixtures and Consumables (Fixed & Variable) 5% (7.2%)
Exploration Expenditure 5% (0.4%)
Administration 5% (0.2%)
Third party smelting, refining & transport 5% (0.1%)
Capex Costs 5% (1.2%)
Page 27 of 48
APPENDIX I - Fiji
Background
The first settlements in Fiji were
started by voyaging traders and
settlers from the west around
1500 BC. Europeans settled on
the islands permanently at the
beginning of the 19th century.
The British granted Fiji
independence in 1970.
Fiji has long suffered from ethnic
tension between the indigenous,
mostly Christian population and
a large minority of Hindu or
Muslim Indo–Fijians. Democratic
rule was interrupted by two
military coups in 1987 because
the government was perceived to
be dominated by the Indian
community. Free and peaceful
elections in 1999 resulted in a
government led by an Indo-
Fijian, but a civilian-led coup in
May 2000 ushered in a
prolonged period of political
turmoil. Parliamentary elections
held in August 2001 provided Fiji with a democratically elected government, which was re-
elected in May 2006, but was subsequently ousted in December 2006 by a military coup
led by Commodore Bainimarama. He initially appointed himself as president, before
becoming prime minister. Since taking office, he has effectively suspended democratic rule
and steadfastly refuses to hold elections.
Consequently, in September 2009, Fiji was suspended from the Commonwealth.
Sanctions have been imposed by Fiji’s main trading partners, including the European Union
and Australia, which has hurt vital agricultural, clothing, and fishing industries. In addition,
the coups and accompanying civil unrest have contributed to heavy Indian emigration, 70%
moving to either Australia, New Zealand or Canada. The population loss of mainly qualified
tertiary emigrants has caused compounding economic difficulties, but ultimately has
ensured that Melanesians have become the majority, thereby reducing political instability.
Country Transparency
According to the Index of Economic Freedom (2011)10
, Fiji’s score was 60.4, largely
unchanged from the previous year. Overall, it ranks the country as the 86th
best place to do
business globally, behind Burkina Faso but ahead of Italy. The top four places rated to do
business in order, are Hong Kong, Singapore, Australia and New Zealand. The United
States came 9th
, the United Kingdom 16th.
10
The Index of Economic Freedom is constructed through the analysis of 10 specific components of economic freedom, some of which
are themselves composites of additional quantifiable measures. Each of the 10 economic freedoms is graded on a scale from 0 to 100. The 10 component scores are equally weighted and averaged to get an overall economic freedom score for each economy.
Figure 33: General map of Fiji
Source: CIA World Factbook
Doing business in Fiji is equivalent to Italy or Burkina Faso.
Page 28 of 48
Fiji rates relatively well in several areas: in fiscal freedom, government spending and
monetary freedoms. The top income tax-rate is 31%, and the corporate tax rate has been
reduced to 28%. In the most recent year, overall tax revenue as a percentage of GDP fell
to 21.1%. Total government expenditures are steady at 25%, yet despite fiscal restraint,
the country recently ran a 3% deficit due to lower than expected receipts. Inflation has
increased, reaching 10.5% in April 2010 following a 20% devaluation of the Fiji dollar in
April 2009.
Although Fiji has not been ranked since 2005, Transparency International’s11
“Corruption
Perceptions Index” last had Fiji 55th out of 158 nations
12, which is higher than countries
such as Kuwait or South Africa, at equal 54, but lower than Malaysia, Namibia or Turkey at
56. Given Fiji’s relatively small population, personal relationships play a major role in
business. The protection of property rights and investment freedoms was ranked poorly.
All foreign investment has to be government approved, with investors having to meet
certain conditions before investing. Bureaucracy and regulation can be burdensome, and
the independence of the judiciary is sometimes questionable.
Fiji is currently attracting substantial foreign mining investment. The Namosi joint venture
(owned by Newcrest), located 30km west of the capital Suva, contains the Waisoi deposit
(as well as other copper-gold targets), and is ranked as one of the world’s largest
undeveloped copper-gold deposits, last estimated to contain total resources of 7.9Mt Cu
and 7.7Moz Au. According to the The Fiji Times13
, the country’s Prime Minister
Commodore Voreqe Bainimarama is overseeing talks and negotiations relating to Namosi,
including negotiations on the mine, whilst environmental assessment and economic impact
studies are still being concluded. The mine is expected to have an initial investment of
US$1Bn, with a similar annual turnover from 2015 onwards. Infrastructure development is
expected to commence in June this year.
11
Transparency International compiles surveys that ask businessmen and analysts, both in and outside the countries they are analysing,
their perceptions of how corrupt a country is. Data can vary widely depending on the public perception of a country, the completeness of the surveys and the methodology used. The second issue is that data cannot be compared from year to year because the organisation (Transparency International) uses different methodologies and samples every year. 12
New Zealand, Denmark and Singapore all share first place for being perceived as the least corrupt nations. 13
The mere existence of what we understand today as the gold standard was the result of
Spanish colonisation in Mexico and Peru during the 15th
and 16th
centuries that yielded so
much silver and gold that there was a major inflationary event throughout Europe the
following century. It affected all other commodities and ironically, in turn helped to ruin the
Spanish Empire, the global super-power of its time. It was this increase in supply that
allowed Britain (followed by other European nations) to go onto the “Gold Standard”14
in
1821. This meant that the British currency could be exchanged for gold on demand. From
that point onwards, the gold price in circulation was largely dependent on new supply from
mining operations. If there were new gold discoveries (e.g. Victoria, 1850; Klondike, 1896),
then the price of gold would drop. If economic activity grew faster than supply of gold, the
metal price would rise.
Figures 35 & 36: Although the gold price has risen against all currencies, in turn, some are more equal than others; as
demonstrated by the USD displaying substantially more weakness than the GBP (left); and nominal gold price versus
CPI indexed gold price. Despite the gold price reaching new highs in nominal-terms, it is in fact not dissimilar in real-
terms to that reached briefly in 1980 (right).
Source: World Gold Council 2011, HD Capital
Many equity markets around the world are trading nominally below what they were in the
year 2000; and in real-terms taking into account inflation, the majority have made no real
returns since 1996. Yet over that time, in a relatively benign inflation environment, the gold
price has risen in-excess of 500%, recently exceeding its previous peak (in real-terms) of
1980 (see Figure 36).
We believe that the main reason for this increase is that over the past decade, we have
witnessed the greatest bout of social, industrial and economic improvement that humanity
has ever seen. It is no coincidence that with the emergence of a large affluent middle-class
among BRIC nations, including China, India (see Figure 38) and Brazil gold has seen its
own meteoric rise, from its price low in 1999. Over time, all these countries have become
voracious consumers of the yellow metal, either for investment, Central Bank holdings or
jewellery. In addition, there is renewed investment via the use of Exchange-Traded Funds
(EFTs). Total EFT holdings exceed 2,450t, surpassing the gold holdings of Banque de
France, and being just short of Italy’s official reserves. On their own, ETFs now represent
14
In time, the gold standard was replaced by the Bretton-Woods system, which had hallmarks of the original gold standard, but was designed specifically as a system of international payments to be conducted without fear of sudden depreciation or wild fluctuations in exchange rates, which had been largely responsible for paralysing capitalism and global trade during the Great Depression.
The unabated rise in gold price since 1999 does not (as yet!) reflect the proliferation of fiat currencies. There has been a structural change in gold demand since 1999; primarily from large industrialising nations including China, Russia, and Brazil.
Historically, the gold price has been subject to the vagaries of demand and supply.
Page 31 of 48
the 5th largest holding of the yellow metal. In a perfectly competitive market when this
growth in demand is not reciprocated by an increase in supply, the price increases until the
opportunity cost equals the available inelastic-supply, and there is equilibrium.
Figure 37: Western World mineral exploration expenditures expressed as a percentage per
commodity class.
Source: MinEx, Nov 2011, HD Capital
Despite being increasingly difficult to discover, gold
is still a very attractive commodity to explore for.
Unlike base metals, gold deposits display a wide
diversity throughout geological time and
environments. The capital intensity is relatively low,
approximately one half to one third of that required for
a base metal project with the same sales revenue.
This allows quicker repayment of capital, thereby
lowering project risk. Other benefits include the
production of bullion on site, decreasing
transportation problems, which also allows mines to
be located in more remote areas. Processing is also
less energy intensive, with power often able to be
generated on-site.
With increasing demand from new middle-class
populaces from BRIC nations, coupled with
renewed interest from Western institutions, and
insufficient foreseeable supply, we believe gold
will suffer from a structural supply shortage into
the foreseeable future.
Figure 38: Emerging Asia’s share of global gold demand
Source: GMO, World Gold Council 2011, HD Capital
It may surprise many investors that gold is in fact the most sort-after metal globally – in terms of exploration expenditure.
Page 32 of 48
Constrained Primary Supply Growth
A remarkable thing about gold is that most of it ever mined still remains, estimated to
collectively total 175kt Au (or a cube 20.45m). Over 85% of the gold mined in history has
occurred since 1890, with two thirds extracted in the past 50 years. When discussing gold
supply, it is important to understand the nature of a non-renewable Resource:
The nature of depletion for a non-renewable resource dictates that exploitation of a
particular deposit will result in physical mineral depletion. If depletion continues
unchecked while other economic and technological conditions remain the same,
resource scarcity and the cost of mineral production will increase, causing real
mineral prices to rise; and
Discovery depletion, again, all things remaining equal, means the easier-to-find
deposits will be located first, with the more difficult deposits found later. The latter
deposits, as a rule, are usually of a poorer quality than initial operating mines, in that
their production costs per unit of output are higher (e.g. gold mines became deeper).
Despite the enormous growth in demand (reflected by a fivefold increase in price), unlike
many other commodities, primary supply (i.e. gold extracted from mining and processing
operations) has been entirely unable to react due to geological constraints (i.e. insufficient
gold is being discovered to match demand), meaning that the future supply of gold will
become increasingly more inelastic. This is evidenced by the general lack of success by
major gold mining houses to replace current production. For example, 2010 production by
Barrick Gold, Newmont Mining, AngloGold Ashanti, and Gold Fields was 21% (or 4.4Moz
Au) lower than that recorded in 2006. Global gold mine production peaked in 2001 at
2,645t Au, and recorded a year-on-year decline until 2010 with production reaching 2,686t
Au. Primary production is forecast to reach in-excess of 2,700t Au in 2011. Declining
South African, United States and Canadian production has been offset by increased
production from Australia, Latin America, China and Africa, with the total net difference
largely negligible (see Figure 40). Since 1990, global primary gold production has been
anemic, increasing on average 1.03% pa, and in the past decade production has largely
remained static.
Figures 39 & 40: Gold price in USD from 1990 to 2011 (left); and primary gold supply from mined sources (right).
Source: World Gold Council 2011, USGS 2011, ABARE 2010, ABARE, March 2011, HD Capital
The most important source of gold supply for the past century has been Witwatersrand15
. It
is estimated, that between 40 and 50% of the world’s gold bullion has been extracted from
15
"Ridge of white waters" in Afrikaans.
Nearly half of all the world’s gold has been sourced from a single orebody, the Witwatersrand, in South Africa. Almost without exception, major gold mining houses would be unable to replace their current production profiles without judicious corporate acquisitions.
Page 33 of 48
this single deposit. Discovered near Johannesburg in 1886, it is an ancient placer deposit,
hosted by conglomerates and sandstones, part of a sedimentary basin that stretches
through an arc of approximately 400km (covering 3.6m hectares) across the Free State,
North West and Gauteng Provinces, in South Africa. Some geoscientists estimate that
roughly one-third of the world's known gold resources remain unmined. However, after a
century of extraction, the Witwatersrand is now only a shadow of its former glory, with all of
its active mines operating underground, reaching depths of over 3.8km – with the Mponeng
gold mine the world's deepest. Peak production was reached in 1970 when over 1,000
tonnes (32.15Moz) Au was mined annually. As a result of declining ore grades (from
13.3g/t in 1970 to an average of around 6.0g/t currently), increased depth, personnel
problems, power interruptions and rising production costs, has seen output falling steadily
to around 200t (6.43Moz) Au pa presently.
Figure 41: Average global ore grade for all primary gold discoveries (>1Moz) versus the
average head-grade of ore mined. The diagram is somewhat misleading, because it appears
to indicate that gold grades are in perpetual free-fall. In-fact, the lower grade is in part due
to technological innovations, which can alleviate upward, or even reverse the pressure on
mineral costs over time. In particular, the lower grade over time demonstrates the
economies-of-scale involved in the processing of low-grade gold from large diffuse surficial
Orogenic gold deposits, often with processing a more important determinant than mining.
Source: MinEx, Nov 2011, HD Capital
Most are unaware of the historical importance of this single gold orebody (Witwatersrand16
)
meaning that for more than any other reason, it has singularly kept gold prices subdued for
the better part of the entire 20th
Century. However, as already stated regarding discovery
depletion, it is highly unlikely we will ever discover another Witwatersrand analogue. This
in turn implies, that (baring a technological breakthrough, on the scale of being able to
extract gold from seawater) structural demand for gold will most likely continually exceed
supply in the foreseeable future.
We conclude that the rise in the gold price is largely unrelated to the current credit
and sovereign debt crisis; but is the result of the inability of supply to keep up with
demand driven by global economic development.
16
Diamonds are also associated with the Witwatersrand reefs (some diamonds up to 8 carats were found), although a natural green colouration ranging from a nuance of green to bottle green and almost black was the result of the natural radiation caused with the association of uranium. Diamonds are no longer recovered from the Witwatersrand gold mines due to a change in the reduction procedure.
The Gold production profile from the Witwatersrand was so prolific that it more than any other reason, subdued the gold price for the entire 20
th Century.
No other Witwatersrand geological analogue exists on earth, for if it did, we would certainly have discovered it. This implies that supply demand dynamics now largely reflect forces more akin to those in the 19
th Century, than those more
recently observed throughout the 20
th Century.
Page 34 of 48
Central Bank Demand Haphazard
When discussing Central Bank gold reserves of any country, it is always important to put
into historical context how they were acquired. It was at the time the world’s largest
financial traction in history. In October 1939, part of Britain's gold reserves, bonds and
stock (then valued at US$7bn) were shipped to Canada in a light battle cruiser to pay for
raw materials, part of what Churchill referred to in February 1941, “Give us the tools and we
will finish the job”. Yet despite the hyperbole, the salient fact was that mercantilist America
would not give anything without payment. The Witwatersrand17
had, as part of her
colonies, allowed the UK to be by far the largest single holder of gold prior to WWII. Yet in
1941, after two years of war, Roosevelt had stripped Britain of all her assets globally,
including various leases in the West Indies, to the extent, that an American cruiser was
dispatched to the South African naval base of Simonstown, to pick up Britain's last
negotiable asset, £42m worth of gold bullion. It was these collective payments in physical
bullion that resulted in America at the close of WWII, being the single largest holder of gold
(see Figure 42).
Figures 42 & 43: Break-down of Central Reserves by region in 1951 totalling 30,821t Au (left); and break-down by region
of gold Reserves held by Central Banks in 2011, totalling 31,597t Au. Amazingly, despite a 60-year hiatus, there is only a
2.5% physical variation in the net amount held by all the Central Banks; disproving a common perception that it is net
Central Bank sales or purchases that largely affect demand or supply in the long-term (right).
Source: IMF, World Gold Council, HD Capital
In 1951, global gold reserves stood at 30,821t, 66% of which was held by the US (20,326t
Au - despite selling 1,356t from several years earlier). Sixty years later, in 2011, global
gold reserves stand at 31,567t Au, only a little over 2% more than previously. What is
surprising is that America’s current reserve (approximately 8,135t Au) equates to only 38%
of its gold holding of 60 years ago. In contrast, Europe’s post WWII gold holdings have
increased 122% (from a very low base following WWII) despite the UK selling 88% of its
gold from the post-war 1960/61 peak holdings.
Using a combination of World Gold Council and IMF data as well as our own calculations,
we estimate that Central Banks bought 237t over the first three quarters of 2011 (see Table
11). In addition we recognise (from other sources) that a significant portion of Central Bank
purchases (potentially 30 to 40%) could be undeclared in the IMF statistics. In the five
years from 2003 to 2008, China added 454t of gold to their reserves, reportedly amassing
17
Acquired following the Boer War in 1899. In 1871, diamonds were discovered in the Kimberley, prompting a diamond rush and a
massive influx of foreigners to the borders of the Orange Free State. Then the Witwatersrand was discovered within the South African Republic in 1886, making the Transvaal the richest and potentially the most powerful nation in southern Africa. Political interests, even military raids, propagated by one Cecil Rhodes, coupled with a massive influx of British workers, meant that war was largely inevitable.
WWII gifted America with the world’s largest gold Reserves (70% of the total at its peak) as the United Kingdom used its holdings to purchase raw materials for the war effort.
We assume that Central Bank sales or purchases have no net impact on supply or demand of gold. And this has been the case since WWII. Given that two thirds of the worlds gold supply has been extracted in the past 50 years (see p. 32), the impact of bank purchases or sales has dramatically diminished in importance over time.
Page 35 of 48
the gold via a government agency from domestic production using RMB, which was
subsequently handed over to the People’s Bank of China in 2008. Given their gold
holdings still only represent a tiny fraction (<1%) of their reserves (compared with >70% of
German, Italian and French reserves – see Table 12), intuitively it makes sense that the
Chinese would continue to use non-Central Bank agencies to increase their reserves. If
they stick to this policy, they should make their next holding announcement in mid 2013.
Table 10: Official Gold Holdings (tonnes), from 2004 to Sept. 2011
Source: World Gold Council 2011, IMF, HD Capital
Despite net Reserves having remained largely static over the past half-century, if 2010-
2011 Central Bank buying momentum is maintained going forward then purchases
should account for 13% of global primary production, which in turn would represent
a significant new source of gold demand.
Table 11: Official Gold Sector Net Purchases/Sales (tonnes), from 2004 to Sept. 2011
Source: World Gold Council 2011, IMF, HD Capital
2004 2005 2006 2007 2008 2009 2010 2011*
Africa 420 420 420 420 420 422 422 422
Asia 2,402 2,417 2,496 2,564 2,654 3,153 3,170 3,226
Australasia 80 80 80 80 80 80 81 81
Eastern Europe 930 933 949 941 1,015 1,142 1,283 1,347
Western Europe 14,051 13,529 13,207 12,707 12,436 12,300 12,294 12,294
Indian sub-continent 432 432 432 432 432 657 663 666
Latin & South America 571 571 571 573 576 586 599 714
Middle East 1,072 1,082 1,162 1,174 1,182 1,187 1,367 1,367
North America 8,140 8,140 8,138 8,138 8,138 8,138 8,138 8,138
Total (327.0) (501.1) (164.8) (461.3) (106.6) 531.3 351.5 236.9
Possibility of unofficial Chinese Bank gold purchases. For the first time in several decades, Central Banks (since 2009) have become net purchases of gold bullion.
Page 36 of 48
The Aftermath of Fiscal Profligacy
A continual sense of déjà vu has not disguised the fact that the credit (and ensuing
economic) crisis of 2007/2008, has morphed into the more serious current sovereign debt
crisis. With echoes of Generals always fighting the last war, nations have (without much
fore-thought) followed standard Keynesian dictum, bailing out the banks, and maintaining
public services in the face of declining tax receipts; having in addition increased public
project spending in a “vain” attempt to restore growth. Economic policy
responses by many Western Governments (already heavily shackled in
debt) have unwittingly made themselves victims.
According to a recent empirical study done by Reinhart and Rogoff (2009)18
,
financial (including sovereign debt) crises are typically severe and
protracted affairs, and more often than not, the aftermath has three
particular characteristics:
a) Asset market collapses are deep and prolonged. Real housing
price declines average 35%, stretched over a period of six years, with equity
markets collapsing on average 55% over a downturn of about three and a
half years;
b) The aftermath of banking crises is associated with profound
declines in output and employment. Unemployment typically rises by an
average of 7% over the down phase of the cycle, which lasts on average,
in-excess of four years. Output falls (from peak to trough) by an average of
over 9%, although the duration of the downturn (averaging roughly two
years) is considerably shorter than that observed for unemployment; and
c) The real value of government debt tends to explode, rising an
average of 86% during major post-World War II financial crisis episodes.
Interestingly, the main difference between the current sovereign debt crisis
and previous financial crises appears to be that the increase in Government
debt is not entirely related to the costs of bailing out and recapitalization of
the banking system, coupled with the inevitable collapse in tax revenues
that governments suffer in the wake of a deep and prolonged output
contraction. Rather, its severity will in part be due to the ambitious
(reckless?) countercyclical fiscal policies aimed at mitigating the downturn,
as evidenced in Japan following their property bubble in the 1990’s.
In conclusion, Reinhart and Rogoff suggest that we should expect sub-par global economic
growth for some considerable period of time. However, we believe that the length and
duration will be dependent on whether Central Banks pursue inflationary (printing money)
or deflationary (paying back the debt) policies.
18
Reinhart C.M. and Rogoff K.S. (2009) The Aftermath of Financial Crises. Presentation at the American Economic Association, San Francisco, Saturday, January 3, 2009 at 10:15 am. Session title: “International Aspects of Financial Market Imperfections.”
Figure 44: The fate of US$100 from 1965 to
today (Comparisons made on the 31st
December 2011). Despite paying no dividends,
it is remarkable that gold only under-
performed the S&P 500 by 27% over a 46 year
period. More importantly, it out-performed six
month US T-Bills by 233%; under-lining the
attraction of gold as a form of monetary
exchange against all fiat currencies, but in
particular, during sovereign debt crises.
Source: CNN, February 2012, HD Capital
Most western countries have followed Keynesian stimulus theory. Fiscal stimulus beyond a certain point could in fact exacerbate the current Sovereign debt crisis.
Page 37 of 48
The Future of Gold?
Given the amount of financial leverage undertaken in recent years, we believe that political
necessities (driven by the various national electorates) will exert enormous pressure on
various Central Banks to stimulate inflation as an attractive tool for solving public and
private debt problems. The effect of which, would be to wipe out the purchasing power of
both private and public savings, but ultimately be the elixir of the debtor. European nations
currently constrained by European monetary policy, such as Greece, Portugal and possibly
even Ireland are realistically, candidates for default and the reinstatement of their own
currencies. The danger with this strategy, however, is that excessive inflation distorts the
economy in favour of extreme consumption and the hoarding of real assets such as gold,
as well as making the affected country an anathema for investment (e.g. Zimbabwe). This
is what financial futurist and Wall Street pariah, James Dines has been predicting for a
considerable number of years: the inevitable “currency race to the bottom”.
Therefore, we believe it inevitable, particularly with export-oriented countries, that there will
be a series of competitive currency devaluations to regain/retain a competitive export
advantage. Recent examples include Japan, Iceland, Vietnam, Peru, and arguably the
United Kingdom and the United States. In particular, we look with interest to China’s
reaction given their slowing economy and deflating property sector. Students of Game
Theory will recognise that an “equivalent retaliation” (or tit for tat) strategy will invariably
ensue; ultimately all participants will have to participate or risk being left at a disadvantage.
Table 12: World gold holdings as a percentage of Reserves using November 2011 Au prices,
and total value of national Reserves at varying prices. Note that the United States,
Germany, France, the Netherlands and Italy all have very similar gold holdings (expressed
as a percentage of total Reserves). The anomaly is not so much how small developing
nations gold holdings are, but the small percentage of gold in relation to Switzerland’s
entire Reserve base; which gives an indication of the size of its national banking system.
Ironically, this contrasts with the common perception that the Swiss Franc is “safe”
because it is largely gold backed.
Source: World Gold Council 2011, IMF, HD Capital
It is in this context of massive sovereign defaults and the probable attempt by many others
to monetise debts via inflation that holding gold suddenly becomes a critical insurance plan
in an uncertain world. In Table 12 we list individual holdings of gold bullion, and express as
a percentage in the context of their respective countries total reserve holdings. Of
particular note, how these countries bullion holdings compare with outstanding liabilities.
Tonnes
% of
Reserves
Value at
US$1,500/oz
(US$Bn)
Value at
US$2,000/oz
(US$Bn)
Value at
US$2,500/oz
(US$Bn)
United States 8,133.5 75.5% 392,247 522,996 653,745
Germany 3,401.0 72.6% 164,017 218,689 273,362
International Monetary Fund (IMF) 2,814.0 N/A 135,708 180,944 226,181
Italy 2,451.8 72.2% 118,241 157,654 197,068
France 2,435.4 71.0% 117,450 156,600 195,750
China 1,051.1 1.7% 50,690 67,587 84,484
Switzerland 1,040.1 14.3% 50,160 66,880 83,600
Russia 851.5 8.6% 41,065 54,753 68,441
Japan 765.2 3.3% 36,903 49,204 61,504
Netherlands 612.5 61.0% 29,539 39,385 49,231
India 557.7 9.0% 26,896 35,861 44,826
European Central Bank (ECB) 502.1 35.0% 24,214 32,286 40,357
World 30,708.3 N/A
Euro Area (includ. ECB) 10,795.5 64.4%
Domestic political pressure will force many Central Banks globally to stimulate inflation as a solution to the excessive debt. If inflation were to reappear, it would be an attractive proposition to either hold physical bullion and/or gold mining producers.
Page 38 of 48
For example, the US has 8,133.5t of gold worth between US$392bn and US$523bn
(depending upon long-term gold assumption). However, given that its national debt19
is in-
excess of US$15.1tn, its gold holdings would only cover between 2.6% and 3.5% of total
outstanding liabilities. This is not unique, a similar picture exists for virtually every other
major Western nation with significant gold holdings. As hedge fund manager Kyle Bass
recently commented. it is inevitable that the world is heading for a hard default; given that
total world debt to GDP has historically only breached 200% when Governments were at
war. He then pointed out that the average Western Government debt is currently around
310%, with no sign of conflict (yet).
In summary:
a) We think it highly likely that in the medium to long-term politics of necessity will force
Governments of all political denominations, to push Central Banks to stimulate
inflation in order to solve public and private debt problems;
b) Domestic inflation will induce “beggar-thy-neighbour policies” (now alive in the
Euro zone20
, Japan and the US, with China publically touting the idea of devaluing the
Yuan), with actively deflating currencies, especially by exporter nations;
c) Central Bank gold holdings make up only a minuscule amount of outstanding total
debt. Given that Central Banks are now highly reluctant to sell their Reserves, this has
effectively put a floor21
under the gold price; and
d) Gold’s value is recognised globally (from the slums of Calcutta to Central Banks in
Europe). Part of the reason why Central Banks and private investors hold gold, is that
it is a liquid resource that can be used as collateral for borrowing. The opportunity cost
of gold is commonly compared with an insurance premium against a highly improbable
but damaging event, such as the recent credit crisis. And that it is the only
medium/currency that is not someone else’s liability (i.e. for any currency to be
acceptable as a valid medium, it has to be typically backed either by a Central Bank
and/or country).
19
http://www.usdebtclock.org/ 20
ECB’s balance sheet has expanded almost 50% in the last six months to €2.7 trillion, in addition the balance sheets of the 17
eurozone Central Banks have grown even faster and now add up to €1.7 trillion, creating a consolidated balance sheet in the European Central Banking system of €4.4 trillion, almost twice the size of the US Federal Reserve’s balance sheet. Jensen N.C. (2012) The Unlikely Bull Market. The Absolute Return Letter 10p. 21
Do we believe that gold is not susceptible to bubble-like tendencies? No, of course not! Gold’s last peak in 1980 (in relative terms,
see Figure 36) disproves the notion that gold is infallible. However, on balance, we believe it is in structural deficit and is less susceptible to Central Bank influence in the short to medium term than the equivalent fiat currencies, including the USD and Euro. If a major inflationary period is instigated collectively by the BOE, then gold will be an asset class (together with equities and property) that will provide a relative store of value in turbulent times.
In the grand scheme of things, Western Governments’ gold holdings only cover a small fraction of their liabilities. No Central Bank controls the price of gold. Its value is intrinsic and exists largely in a perfect market, subject to supply and demand.
The current sovereign debt crisis has been unique in many ways. It has proven the
limitations of current Keynesian economic theory, and the ability of monetary policy to
stabilise banking crises via fiscal stimulus to restore demand and growth. Rather, it has
reminded many market participants of the concept that economic parameters are intimately
tied to political reality. That economic policy is only relevant if the populace has the political
will to implement them (e.g. contrasting the Irish versus the Greeks to implementing
austerity measures). It has also called into question whether many Western technocrat
democratic governments and their intermediaries can effectively manage the economy in
the long-term. Particularly in the EU where temporary government stimulus typically
become permanent grafts, in time, expanding government into virtually all sectors,
ultimately leading to malinvestment on a large scale.
There are two main narratives underlying the current Euro crisis; the German version holds
that the fiscal irresponsibility of the Greeks induced the debt crisis, and now they want
(without preconditions) to be effectively bailed out. However, equally, there is another
narrative that suggests that only one country, Greece, lived beyond its means and that
every other European country largely lived within theirs until recently during this current
crisis (e.g. Spain and Ireland previously had solid surpluses) when the risk profiles
changed.
Table 13: Household, corporate and government debt as a percentage of nominal GDP -
demonstrates the rapid rise of leverage in the debt super-cycle. For the thirty-year period
from 1980 to 2010, Spain’s, United Kingdom’s, Italy’s and Greece’s total household,
corporate and government debts levels increased by 106%, 101%, 184% and 185%,
respectively.
Source: Bank of International Settlements Sept. 2011, HD Capital
As Table 13 demonstrates, on the face of it, it is the non-German narrative that appears to
have been be borne out. With the exception of Australia and Germany, Greece in fact has
substantially lower equivalent debt levels than some of its peers the United Kingdom (-
23%) or Japan (-74%), for example, which under-scores the political dimension of the
sovereign debt crisis. For instance, the majority of Japanese government debt is funded
via domestic bonds by the general populace who trusts the government to repay its debt.
The Japanese are perceived as hard working, collective, stoic and diligent. By contrast,
Greece has a long colourful history of defaulting on its debts. Until recently (due to the
‘arduous and perilous’ nature of their work), Greek pastry chefs, radio announcers,
hairdressers and masseurs in steam baths were among more than 600 professions allowed
1980 1990 2000 2010 2000-10 1980-2010
Japan 290 364 410 456 11% 57%
Portugal N/A N/A 251 366 46% N/A
Spain 172 187 258 355 38% 106%
Sweden 219 289 320 340 6% 55%
Norway N/A N/A 256 334 30% N/A
Netherlands 205 265 294 327 11% 60%
United Kingdom 160 203 223 322 44% 101%
France 160 198 243 321 32% 101%
Canada 236 278 293 313 7% 33%
Italy 109 180 252 310 23% 184%
Greece 92 139 195 262 34% 185%
Germany 136 137 226 241 7% 77%
Australia 128 174 185 235 27% 84%
Average 322 24% 95%
Std Deviation 57 15% 50%
Debt Levels Change
The political dream (The Euro) has been trumped by economic reality. Austerity by itself is contractive. Political perception often dictates whether an investor is likely to be repaid – or not.
Page 40 of 48
to retire at 5022
, with a state pension covering 95% of their last working year’s earnings.
Tax evasion is endemic, to the point that taxi drivers went on a national strike when it was
announced that meters were to be placed in their vehicles.
Figure 14: OECD government, corporate and household debt to GDP, 2010.
Source: Bank of International Settlements Sept. 2011, HD Capital
Although not readily recognised being difficult to quantify, it is this political perception that
influences markets when they set bond rates. For example, Spain’s 10-year bond rates
were recently in-excess of 7.1%, meaning that the country would have to willingly spend
approximately 9.2% of its GDP (see Table 14) to access market funds. By comparison,
Japan’s 10 year bond rate is approximately 1.1%, meaning that despite its total debt being
65% larger than Italy’s, its costs in terms of servicing accounts is 2.3% of GDP, some 75%
less than Italy’s!
22
Malone A. (2011) The Big Fat Greek Gravy Train: A special investigation into the EU-funded culture of greed, tax evasion and scandalous waste. http://www.dailymail.co.uk/news/article-2007949/The-Big-Fat-Greek-Gravy-Train-A-special-investigation-EU-funded-culture-greed-tax-evasion-scandalous-waste.html#ixzz1gDlii8ap
Total Government Corporate Household
Japan 456 213 161 82
Portugal 366 107 153 106
Spain 355 72 193 91
Sweden 340 58 196 87
Norway 334 65 174 94
Netherlands 327 76 121 130
United Kingdom 322 89 126 106
France 321 97 155 69
Canada 313 113 107 94
Italy 310 129 128 53
Greece 262 132 65 65
Germany 241 77 100 64
Australia 235 41 80 113
Average 98 135 89
Std Deviation 44 41 22
Political perceptions dictate whether existing debt levels are sustainable or not, and are prone to dramatic changes of view – as recently evidenced.
(3) Massive Default. 22% of the deleveraging paths, often with currency crises, where
debt decreases due to massive private and public sector defaults (e.g. U.S. (29-33);
Argentina (02-08); Mexico (82-92)).
(4) Growing out of debt. Only accounting for 3% of the deleveraging paths, associated
with unusual events such as an oil or war boom, where economies experience rapid
real GDP growth and debt/GDP decreases (e.g. U.S. (38-43); Nigeria (01- 05)).
We envisage option two as the only real alternative for many countries. That if one does
not pay down ones debt; the only other alternative (other than default) is to inflate it away.
23
McKinsey Global Institute (2012) Debt and deleveraging: Uneven progress on the path to growth. Updated Research. 16 p. 24
McKinsey Global Institute (2010) Debt and deleveraging: The global credit bubble and its economic consequences. 94 p.
Although not readily recognised by the market yet, the UK’s debt level is unsustainable even if gilt-yields rise only marginally.
Page 42 of 48
Most macro economic analysis regarding the symptoms of hyperinflation concentrate on
either (i) the rapid increase in money, and/or (ii) the increase in the velocity of money (rate
at which money circulates in an economy over a given period). Which comes first is a
matter of academic debate. As Milton Friedman said, “Inflation is always and everywhere a
monetary phenomenon”, but as Niall Ferguson points out in his recent book, The Ascent of
Money25
, “hyperinflation is always and everywhere a political phenomenon”.
Figure 45: Swedish economic deleveraging model suggests that the United States
could potentially complete its deleveraging by mid-2013. In the UK it appears that the
deleveraging process has only just begun, with the ratio of household debt to
disposable income not expected to return to trend for another decade. Spain has
fewer policy options (with the Euro) and consequently has a long road ahead.
Source: McKinsey Global Institute, January 2012, HD Capital
Given the enormous amount of financial leverage undertaken in recent years, we suspect
that stimulating inflation is increasingly becoming an attractive tool available to the Bank of
England (BOE) as a way of solving public and private debt problems. The effect of which
will be:
(a) To wipe out the purchasing power of both private and public savings;
(b) To be the elixir of the debtor by dramatically diminishing the amount they owe in real-
terms;
(c) That this in turn will make the United Kingdom an anathema for foreign and domestic
investment; and
(d) The resultant inflation will distort the economy in favour of extreme
consumption and the hoarding of real assets (e.g. property, oil, equities in
perishables, such as Tesco, Morrison’s, etc). But in particular, gold.
25
Ferguson N. (2008) The Ascent of Money: A Financial History of the World. The Penguin Press HC, 432 p.
The UK has only really just started the deleveraging process. It is only a matter of time before the BOE will stimulate a significant bout of inflation - which will mean that holding gold will be essential for all those whose main assets are denominated in GBP.
Page 43 of 48
APPENDIX III – Company Directors
David Karl Paxton: Managing Director
David is a Mining Engineer with over 35 years experience in the mining industry, with mine
production at Goldfields of South Africa, culminating with 24 years as a mining analyst for
both Goldfields and a number of Canadian and UK stockbrokers. He is a director of India
Minerals, Adit Investments, Sahara Mines, Ortac Resources, Far North Platinum, and
Mining and Dining Club.
Ian Colin Orr-Ewing: Executive Chairman
Ian has 35 years experience spanning both the oil and mining industries, having served as
a director of UK and Canadian oil companies, as well as Irish and Canadian mining
companies. He is currently an adviser to a fund management company on its natural
resources portfolios.
David Anthony Lenigas: Non-Executive Director
David is also a Mining Engineer, who between 1989 and 1991 was the Managing Director
of the joint venture company between Western Mining and Emperor Mines which ran the
Vatukoula Gold Mine. He is currently the executive chairman of Leni Gas & Oil Plc, Solo
Oil Plc, and Lonrho Mining Plc.
Kiran Caldas Morzaria: Finance Director
Kiran holds a Bachelor of Engineering (Industrial Geology) and has eight years experience
in the mineral resource industry covering gold and diamonds, spending his first four years
in exploration, mining and civil engineering. In 2004 he was appointed Finance Director of
Vatukoula Gold Mines Plc, and is also currently a non-executive director of Solo Oil Plc and
Hot Tuna.
John Ian Stalker: Non-Executive Director
John is a Chemical Engineer, and has worked in an engineering, mining, and metallurgical
consultancy company, at Lycopodium, as well as stints in Ashanti, Caledonia Mining,
Goldfields and Zambia Copper Mines. He was CEO of UraMin before it was acquired by
Areva.
John Francis Kearney: Non-Executive Director
John is a Lawyer with experience in corporate development and finance in mining ventures.
He is currently Chairman and President of Canadian Zinc.
John Arthur MacPherson: Non-Executive Director
A founding chairman of Canadian Zinc, he has been in corporate finance and development
for over 30 years, primarily in the fields of mining and oil and gas. Throughout his career he
has served as director of a number of public corporations listed on the Toronto Stock
Exchange, AMEX and LSE.
Page 44 of 48
Glossary
Agglomerates: Large, coarse, rock fragments associated with lava flow that are ejected
during explosive volcanic eruptions; essentially pyroclastic igneous rocks that consist
almost wholly of angular or rounded lava fragments of varying size and shape. Fragments
are usually poorly sorted in a tuffaceous matrix, or appear in lithified volcanic dust or ash.
Archipelago: A large number of scattered islands.
Alkaline rocks: Rocks in which the chemical content of the alkalies (potassium and
sodium oxides) is sufficient for alkaline minerals to form.
Andesite: A fine-grained volcanic extrusive rock associated with convergent plate
boundaries, grained, composed mainly of plagioclase with other minerals such as
hornblende, pyroxene and biotite.
Asthenosphere: A zone of the earth’s mantle that lies beneath the lithosphere and
consists of several hundred kilometres of deformable rock.
Arsenopyrite/Auriferous: Iron arsenic sulphide (FeAsS).
Basalt: The most common type of volcanic rock composed primarily of plagioclase
feldspar, pyroxene and olivine.
Basin: Large-scale structural formation of rock strata formed by tectonic warping of
previously flat lying strata.
Breccia: Rock composed of sharp-angled fragments embedded in a fine-grained matrix.
Caldera: A large crater formed by a volcanic explosion or by the collapse of a volcanic
cone.
Cēterīs paribus: A Latin phrase literally translated as "with other things the same," or "all
other things being equal;" and is often fundamental to the predictive purpose of scientific
inquiry, usually used to rule out factors that interfere with examining specific causal
relationships.
Conglomerate: Coarse-grained sedimentary rock consisting of rounded fragments of rock
embedded/cemented by hardened silt, clay, calcium carbonate or similar material.
Conjugate fault set: A cross-cutting set of fault planes which ideally intersect at angles of
60 and 120 degrees, and both have left-handed and right-handed shear sense. Maximum
principle of stress bisects the acute angle and the minimum principle of stress bisects the
obtuse angle.
Continental Drift/ Plate Tectonics: Continental Drift is a theory that the earth’s continents
move gradually over the surface of the planet on a substratum of magma, a theory which
has later been supplanted by plate tectonics, explaining the destruction, movement, and
interaction of the earth's lithospheric plates.
Convergent plate boundary: Also known as a destructive plate boundary (because of
subduction), is an actively deforming region where two or more tectonic plates or fragments
of lithosphere move toward one another and collide. As a result of pressure, friction and
plate material melting in the mantle, earthquakes and volcanoes are common near
convergent boundaries. An example of a continental-oceanic subduction zone is the area
along the west coast of South America, where the more dense Nazca plate is being
subducted beneath the relatively less dense continental South American plate.
Decrepitation: Breaking up mineral substances when exposed to heat, usually associated
with cracking noises.
Page 45 of 48
Glossary (cont.)
Divergent boundary: Also known as a constructive boundary, it is a linear feature that
exists between two tectonic plates that are moving away from each other. The most active
divergent plate boundaries are between oceanic plates and are often referred to as mid-
oceanic ridges. It appears that as a result of complex convection within the earth’s mantle,
material rises to the base of the lithosphere beneath the divergent plate boundary,
supplying vast melts from the asthenosphere, forming flood basalt lava flows, forcing the
two opposing plates away from each other.
Dyke: A tabular body of igneous rock that cuts across adjacent rocks.
Epithermal: Pertaining to mineral veins and ore deposits formed from warm waters at
shallow depth, at temperatures ranging from 80-200 degrees Celsius, and generally some
distance from the magmatic source.
Formation: A series of lithological units formed within a single depositional environment,
which may range from a metre to thousands of metres in thickness.
Geothermal: Refers to heat sources within the planet.
Geothermal gradient: The rate at which the earth’s temperature increases with depth,
which varies with location and is typically measured by determining bottom open-hole
temperature after drilling.
Hofstadter’s Law: it takes time for the people added to a project to become productive.
Hydrothermal: Of or relating to hot magmatic emanations rich in water, including rocks,
ore deposits, and springs produced by such emanations.
Igneous: Formed by solidification from a molten state.
Inelastic Supply: A market situation in which any increase or decrease in the price of
goods or services does not result in a corresponding increase or decrease in its supply.
Island arc: Arc shaped chain of islands, usually lying at the edge of a Benioff zone,
indicating volcanic activity, where oceanic lithosphere is descending into the earth’s interior.
Isostatic equilibrium: As huge plates of lithosphere “float” on denser, plastically flowing
rocks of the asthenosphere. The equilibrium, or balance between blocks of crust and the
underlying mantle, which is called isostasy.
Isothermal: A change in the system in which temperature remains constant.
Lacustrine: Of or relating to lakes.
Leached: Loss of soluble substances and colloids from the top layer of soil by percolating
precipitation. The lost materials are carried downward (eluviated) and are generally
redeposited (illuviated) in a lower layer. This transport results in a porous and open top
layer and a dense, compact lower layer. The rate of leaching increases with the amount of
rainfall, high temperatures, and the removal of protective vegetation.
Lithosphere: Brittle uppermost shell of the earth. The crust and mantle is separated by
the Mohorovicic discontinuity, its thickness varying between 1.6km at mid-ocean ridges,
and 300km in thickness beneath continental lithospheric plates.
Low-sulphidation: Distinction is based on the different sulphur to metal ratio within
sulphide minerals of each subtype.
Magmatic diapirs: A type of vertical intrusion along fractures or zones of structural
weakness, where molten material effectively rises through the lithosphere.
Mesothermal: A class of hydrothermal deposits by the deposition of a mineral mass from
hot mineralised aqueous solutions, usually under pressure forming at temperatures
between 200 to 300 degrees Celsius (compare with epithermal).
Page 46 of 48
Glossary (cont.)
Monocline: A set of rock layers that all slope downward from the horizontal in the same
direction.
Newtonian fluid: A fluid that continues to flow, regardless of the forces acting upon it, the
viscosity depending on temperature and pressure (and in certain cases, chemical
composition).
Oceanic trenches: A long, narrow, but very deep depression in the ocean floor where, at
the junction of two continental plates, one plate dives steeply beneath another thereby
penetrating the mantle.
pH: A measure of hydrogen ion concentration; a measure of the acidity or alkalinity of a
solution. Aqueous solutions at 25°C with a pH less than seven are acidic or reduced, while
those with a pH greater than seven are basic or alkaline. A pH level of 7.0 at 25°C is
defined as neutral because the concentration of H3O+ equals the concentration of OH
− in
pure water.
Plate tectonics: A theory first espoused by Alfred Wegener, it holds that the lithosphere,
the hard outer layer (~100km thick), moves about on the earth’s surface, resting on a lower
softer layer called the asthenosphere. The mechanism is thought to be related to
convection in the earth’s mantle, but is presently unproven.
Placer Deposit: An accumulation of valuable minerals formed by gravity separation during
sedimentary processes. Placer materials must be both dense and resistant to weathering
processes. To accumulate in placers, mineral particles must be significantly denser than
quartz (specific gravity = 2.65), which is usually the most common component of sand or
gravel.
Platform: A general term for a sequence of shallow water carbonate platforms that form
commonly along passive margins.
Pyroclastic: Composed chiefly of rock fragments of volcanic origin, and may be composed
of a large range of clast sizes, from the largest agglomerates, to very fine ashes and tuffs.
Seismic: Caused by an earthquake or earth vibration.
Sandstone: A sedimentary rock composed mainly of sand-sized minerals of quartz and/or
feldspar.
Sedimentary basin: Refers to a geographical feature exhibiting subsidence and
consequent infilling of sedimentation.
Shear: Is in response to rock deformation via compressive stress that forms particular
textures. It can be homogeneous or non-homogeneous, pure or simple, within a brittle or
brittle-ductile regime.
Silicic: Pertaining to silica or acids derived from it.
Somma: A somma volcano is a volcanic caldera that has been partially filled by a new
central cone.
Structure: A branch of geology concerned with the form, arrangement, and internal
structure of the rocks.
Subduction: A geological process in which one edge of one crustal plate is forced below
another.
Tectonic: Closely related to the field of structural geology, the primary difference between
the two is a matter of scale.
Tertiary: Geologic time spanning the interval between about 65.5 and 2.6 million years
ago.
Tellurides: A class of compounds formally derived from Te2−
.
Page 47 of 48
Glossary (cont.)
Tholeiite: Group of basalts composed principally of plagioclase, pyroxene and iron oxide
minerals formed as phenocrysts in a glassy groundmass.
Tuff: A rock composed of compacted volcanic ash varying in size from fine sand to coarse
gravel.
Vent: The channel, way or opening of a volcano through which magma ascends to the
surface; two general types are fissure and pipe like vents.
Visco-elastic: A property of materials that exhibit both viscous and elastic characteristics
when undergoing deformation and, as such, exhibit time dependent strain.
Volcanic arcs: Typically, an arc-shaped chain of volcanoes located on the margin of the
overriding plate at a convergent plate boundary.
Page 48 of 48
Institutional Research
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been constructed and released on Vatukoula Gold, the new recommendation supersedes this and therefore the recommendation
