Fat Pitch: Gold Resource Corp (GORO.OB)

I consider Gold Resource Corp (GORO.OB) to be a hidden asset play. The hidden asset is high-grade gold-ore which has not passed the formalities needed to be considered NI43-101 resources or SEC Proven / Probable reserves. This makes it a speculative buy in my view. I classify it as a fat pitch because of the comparatively low risk and high reward of this opportunity.

The best introduction to Gold Resource Corp is the very-classy, narrated corporate presentation on their web site (click here). The four things that make Gold Resource Corp a compelling opportunity from my perspective is:

• High-Grade Gold Resource
• Proven, Stockholder Friendly Management
• Planned Production In Less Than A Year
• Valuation Compared To Benchmark Mid-Tier Producer

High-Grade Gold Resource

GORO has four high-grade properties whose ore can be processed by a single planned mill. The properties are in Mexico adjacent to 8 km mineralized trend that is conveniently located next to the Pan American highway.

GORO claims that this constitutes 773 oz of gold equivalent although this is mineralized ore rather than NI43-101 resources or SEC proven or probable reserves. The ore is such high-grade that bringing it to production is economically a slam-dunk and the GORO strategy is to skip the NI43-101 resource definition and feasibility phases and go straight to production on the strength of their management reputation and the quality of the drill results. These results, for the first project, the El Aguila open pit project, include several drill intercepts of 6 meters averaging over 10 grams/ton right next to the surface. GORO forecasts, given a silver by-product, that this mine will have a cash cost under $100 / oz Au.

Less than 2 km of the 8 km mineralized trend has been explored and drilling continues. The latest drill results are the best so far. I expect news results of continued drill results and increased mineralized ore estimates as the El Aguila mine progresses towards production.

Watch the presentation for more information on the high-grade gold properties.

Proven, Stockholder Friendly Management

Gold Resource Corporation was founded by Bill and David Reid. The Reids co-founded U.S. Gold Corporation (USGL), and ran the company since its inception in 1977 until August of 2005. During the 28 years USGL operated under the Reid's management, the company built or participated in 6 producing mines.

Bill and David Reid are the largest stockholders. As such, their interests are aligned with other share holders. This has a practical impact. Examples of how this helps other share holders include:

• Getting financing for the El Aguila open pit mine and mill with a private placement at current market price without warrants. The absence of warrants minimizes the share holder dilution and prevents the private placement price from being a major point of resistance to a rising stock price. In fact, this private placement took place at $4.00 a couple of months ago. The stock is now trading well below this level even though all the news since that time has been increasingly positive. The price of gold has been rising. A permit has been granted (see below). The ore body has been enlarged with increasingly higher grade drill results. This presents the rare situation of being able to buy at a price substantially below what "Smart Money" paid.
• An announced plan award to stockholders 1/3 of operating cash flow in dividends. How many Junior miners have announced a dividend policy like this?

A very well connected Mexican, Pepe Renoso, is the manager of Mexican operations and is responsible for the permitting process. His father was the head of the Mexican mining ministry. This should expedite the permitting process.

The management shows integrity. I had a 30 minute conversation with GORO's IR guy (Jason Reid, son of one of the founders) Friday. Jason was very clear at holding the line and providing only information that had been previously publicly announced. This is the first time I've had a pre-production Jr IR representative take this seriously. To me it is a positive sign of management integrity. After a couple of disappointing recent experiences with other promising Jr miners, I run at the first sign of a lack of management integrity. 

Planned Production In Less Than A Year

GORO has targeted production at the El Aguila open pit mine to commencing before the end of 2008. They are forecasting an initial production rate of 70K oz Au / year.

Progress towards this production is underway:

• The financing has been obtained (without issuing warrants, see above).
• The mill has been ordered.
• The approval of the Ejido (local government) as been received.
• The first of three federal permits, the permit for the road to the mill, has been approved.
• The second approval, the crucial one in my view, for the mill and tailing pond is off the critical path and is expected any day. This should be a major stock price catalyst. The third permit, for the open pit mine itself follows.

The fact that the final two permits are not in hand is another factor that makes GORO a speculative buy. My judgment is that the combination of:

• the management, with proven experience starting five mines,
• the well-connected in-country management,
• the approval of the local government (the Ejido),
• the grant of the first federal permit (granted by the same ministry responsible for the remaining two approvals)

leave the permit issue as a risk, but a managed, relatively low-level risk. The absence of permits also represents an opportunity as I have seen the stock prices of other advanced development Jr miners take off when the permits are actually finalized. 

Relative Valuation Compared To Benchmark Mid-Tier Gold Producer

GORO's presentation provides GORO's own view of how undervalued it will be compared to other gold producers as it progresses. I recommend studying it closely.

I compare Jr, pre-production gold Jr miners to Rangold (GOLD), a high-cost mid-tier gold producer with a relatively slow forecast growth rate.

Gold Resource forecasts a production of 100K oz during its second year of production and 1.3 million oz of resources. Compared to Randgold, and assuming GORO achieves this in the year 2010, I estimate that Gold Resource's price would have to advance by:

• 400% to match Randgold on a price to annual oz of production basis.
• 677% to match Randgold on a price to operating cash flow basis.
• 493% to match Randgold on a price to proved and probable reserves basis.

Gold Resource should be a low-cost producer while Randgold is a high-cost producer. As such, Gold Resource's price should advance even farther than this comparison indicates.

Overall, this is more than a big enough margin of error for me and makes Gold Resource sufficiently undervalued to be my favorite gold mining Jr.

Here's some additional items worth noting:

• Relations With Nearby Residents - It turns out that an economic calamity is looming for the vicinity immediately adjacent to Gold Resource's properties. This is the re-routing of the Pan American highway to a coast route. The result of this is that tourist traffic forming the main source of revenue for the nearby villages will be disappearing. This leaves nearby residents strongly supporting Gold Resource's mine startup as mining will be a major source of jobs and will help compensate for this loss of the tourism revenue.
• The recent stock price has been depressed by what appears to be an fund's forced selling, perhaps as a result of investor redemptions. This constitutes a major buying opportunity as conditions have improved since the "Smart Money" entrance price of 4$.
• The near-term stock price catalysts are continued drilling results and federal permit approvals.
• Gold Resource plans to focus entirely upon getting to production. Once in production, they expect to have all the information necessary (drill results, etc) to turn their mineralized ore into SEC-approved proven and probable reserves.
• I expect a move to AMEX exchange will take place around the time that production is underway and proven and probable reserves can be announced. This is yet another catalyst for a stock price advance.
  

Conclusion

In my view, Gold Resource (GORO.OB) constitutes a Fat Pitch. I have been cannabalizing other excellent Jrs to increase my position. Gold Resource has now grown to about 10% of my portfolio. If things go reasonably close to plan, Gold Resource will be in production 18 months from now with 1 MM oz of proven / probably reserves and the stock price should be trading at multiples of its current level. In my view, its an excellent risk/reward hidden asset situation. Of course, everyone should do their own due diligence and really understand an investing situation for themselves prior to actually committing any money.

Comments

[MontyHigh]

I'm not an expert, but I think that the permits will come in and that the stock will hop when they do. I believe that having the local community on your side is the critical item for getting the permits and that the road permit is a good indicator of the other two coming in. The mill and tailings pond is the tougher of the two remaining permits (FYI, this is what is holding up Crowflight in Canada). The mill and the tailings pond is where the toxic chemicals are involved. The open pit permit doesn't affect anything other than the appearence of the landscape (in my understanding).

Monty

[Patrick]

I've visited your blog several times over the past six months or so--very thorough analysis!! Metal stocks are outside my circle of competence, though, so I've always been reluctant to pick them up.. but this fat pitch seems extra delicious.

"The third permit, for the open pit mine itself follows."
Could you elaborate on the likelihood of securing this third permit?