Moving into Production - Talking Gold and Silver with Archipelago Resources

Archipelago Resources (LON:AR.) is an AIM listed mining company with licences to explore and produce gold in Indonesia, Vietnam and the Phillipines.  Their flagship Toka Tindung project in Indonesia is set to move into first production in March 2011.  It has been a long road for Archipelago since their flotation back in 2003 and we spoke with Colin Loosemore, CEO, last week to talk about the company's journey to date, the bull market in gold and their hopes for 2011 and beyond.

Could you introduce us to the background and history of Archipelago Resources and the gold mining projects you have in Indonesia, Vietnam and the Philippines?

The Company was formed in 2002 and we listed on AIM in September 2003.  Our flagship project is the Toka Tindung Gold Project in North Sulawesi, Indonesia, but we also have some other exploration activities in northern Vietnam and also, to a lesser extent, the Philippines.  

Our focus over the last few years has been developing Toka Tindung and we’re within a few months of getting that into production - we’re targeting first production by the end of March 2011.  We will produce at an annual average rate for the first six years of the project life of 150,000 ounces per annum gold plus 250,000 ounces per annum silver.  Mining started some months ago and the construction is near complete and so we look forward to changing from developer status to producer status early in 2011.

The open pit mining operation is straightforward and the processing operation simple carbon in leach (CIL), a very stock standard process and so we don’t see any risk attached to either the mining or the processing.   Other than silver we don’t have any significant metal impurities to deal with in the process flow sheet.

 

Our production cost of US$442/oz is about one third of the current gold price and well below that of world average producers.  By historical mining standards, that leaves a high surplus margin and makes for a very financially robust project. We are going to commit some of our surplus revenues to exploration with a view to maintaining and extending the mine life and a drilling programme has already commenced.

Will you be devoting the resulting cashflow primarily to your projects in the Indonesian area or will you parcel that off between Vietnam and the Philippines?

Firstly it will go to service and repay the US$55m loan which the Company proposes to borrow to complete the project and reach production.  Secondly, it will go towards the exploration programme and thirdly, I would like to think that the Company may be in a position to consider a dividend, possibly even as early as the end of calendar year 2011, but that will be subject to a number of things including of course a decision by the Board, but it’s certainly an objective that our strong cash flow be used to pay a dividend as soon as possible.

Yes, we will be looking to reinvest some of that money in Vietnam and the Philippines and if appropriate, contemplating acquisitions and perhaps down the track a corporate merger if we were convinced it that it will increase rather than dilute value.

Can you elaborate further on the history of Toka Tindung?

Toka Tindung was discovered by its previous owners in the early to mid 1990’s.  There was a hiatus period through the mid to late ‘90s when a lot of work was done including about 157 kilometres of drilling.  They produced a number of feasibility studies through to 1999. However, while they were trying to get the project into production, the gold price was falling thanks in large part to Gordon Brown announcing to the world that he was going to sell Britain’s gold reserves and in so doing forced the price down to US$255 an ounce, at which price Toka Tindung along with most other gold producers wasn’t viable.  As a result the project was put on care and maintenance for a couple of years before being put up for sale when I together with a colleague and another company put in bids to acquire the project.  Eventually, after the other company’s higher bid failed to materialise we acquired the project in February 2002 when the gold price was about $280 an ounce.  We then put it into Archipelago and floated it on the AIM market in September 2003.

Since then we’ve lost about three years due to various delays getting to where we are today.  While we’ve always obtained our permits and approvals, we haven’t always had the provincial political support necessary to allow financing.  The main reason for getting Indonesian group Rajawali on board was that they brought a lot of credibility which has been very positive for the Company and the project and accordingly with their financial and political strength we’re now on the final run with a high degree of confidence.

At what price did it become economic and why have there been delays?

When we originally acquired the project we thought that it might be economically viable at $350 an ounce but with hindsight and inflation we needed a much higher price.

Our focus was to get into production rather than explore and so we purchased a processing plant from Barrick Gold (NYSE:ABX) in Chile, or at least the larger components of it.  We then had to redesign the plant, the pits and amend the development plan.  

Initially we were going to use submarine tailings, which was a very logical way to go at this location because we’re very close to the coast. The continental shelf is only 3.5 kilometres wide and there is a 2 kilometre deep trough just offshore. The intention was to pipe the tailings to the edge of the continental shelf and then deposit them into the trough.  It was a technically very sound and well researched proposal and I think it would have probably been one of the best submarine tailing systems in the world. Unfortunately, submarine tailings has negative perceptions not dissimilar to nuclear power.  Anti mining groups peddle the view that you’re contaminating the world’s oceans, whereas in fact all you’re doing is replicating in a controlled way the geological ‘cycle of life’.  Nature pushes up mountains, erodes them down and utilises rivers to transport the resulting sediment to the ocean.  

However, there was an incident involving Newmont Mining (NYSE:NEM) , some 100 kilometres away from Toka Tindung, where on closure they were accused by local anti-mining groups of polluting the ocean.  Newmont was subsequently exonerated but it took years to achieve through the court process and basically became a political hot potato based on fiction rather than fact.  So the Indonesian authorities asked us to consider an alternative form of tailings.  There is only one realistic alternative form of tailings storage and that’s on land, in our case a very small catchment area in the head waters of a small river upstream of our open pit, where they are placed behind a waste dump for long term stability.  As we are in a seismically active area we need a very stable structure and so there will be an impervious clay wall to ensure permanent separation of waste from tailings, which prior to deposition will undergo detoxification to ensure no residues from the gold extraction process.

While there is some extra cost in hauling waste and pumping tailings uphill, the long term benefits are that if there’s any erosion in centuries to come from the waste dump, it will end up back in the pit that it came out of and can never go down the river system to the coast.  So we’ve designed the operation, as you should, with closure in mind to ensure that we end up with a very long term sound environmental outcome.

 

With Newmont now gone, which other miners are in the area?

The only other operation close by (100 kilometres away), is Avocet Mining (LON:AVM) ’s heap leach operation at Lanut.

Do you have the financing to take the project into full production?

No we don’t and are currently in the process of raising $55m by way of a loan facility.  We have received proposals from two banks, one of which is credit approved.  We expect to select one of the proposals in December.  In addition, we’re also contemplating a $10m gold offtake facility.  To address working capital requirements we are in addition raising approximately US$45m by way of a placement.

One of the obligations of the bank loan will be hedging.  Both banks have agreed that the hedging will be by way of put options.  We propose financing those by committing to sell a small number of ounces of gold.  That will leave us with no committed hedging and therefore fully exposed to movements in the gold price apart from the partial floor provided by the put options.

Could you comment on the grades?

Our grades are around 3 grams per ton gold which is pretty high for open pit mines today.  My first experience in the gold mining industry was in the 1980s in Western Australia where we were mining similar grades.  However much lower grades are normal for open pit operations today.

You now have Rajawali on board and it seems that you have the right local partners. How do you feel about the political stability in Indonesia that surrounds your projects?

We’ve always enjoyed the support of central government authorities, but haven’t always enjoyed similar support at Provincial level, however bringing Rajawali on board as a shareholder has greatly helped to turn that situation around.  We have always enjoyed support at the local level particularly the local communities as the area had high unemployment.  We currently employ 1500 people with the majority from the local villages.  So we’re very comfortable with the support that we’re getting, however we understand the importance of maintaining support at all levels to ensure continued ‘social licence’ to operate.  Accordingly we have quite a large number of programmes assisting with health, education and water supply as well as a number of sustainable development projects including farming and fishing projects.  So yes, we’re very comfortable with our local relationships, but having a strong local shareholder has helped greatly.

Could we move on to talk about the gold price, which is at the top of everybody’s list these days. What do you have as your own in house projections for it and what you see as the key drivers of the current move?

These views are purely personal and not a Company view and I have to confess to being a ‘dyed in the wool’ gold bull.  I’ve been in the mining industry for 40 years with 30 of those years in gold and you wouldn’t have stayed that long if you’re not a gold bull, so I would preface any comments with that background.

I think there is a distinct similarity between what we’re seeing today and what we saw in the 1970s.  We are seeing another great gold bull run and my view is that it’s going to end in a ‘blowout top’ very similar to what we saw in 1980.  The question is whether we’re talking months or years to achieve that, but certainly I think the kind of corrections we’re seeing now in the gold price on a regular basis are very healthy.  Accordingly I think that there is likely to be a lot of upside yet in the gold price, but when I see it going up hundreds of dollars a week with no sign of corrections then I will be concerned that we’re probably looking at a rerun of 1980.  Having said that, if you look at what happened in the early ‘80s, the gold price did come back with a crash, but never to the levels that it was in the early ‘1970s.  Rather it settled at new and much higher levels and that could well happen this time around.  

I certainly don’t profess to be an expert in economics but I think there is a fundamental rule of supply and demand and at the moment there’s a lot less gold and metals generally than there are bits of paper being printed by governments.  Inevitably I think that will result in inflation and that is what you’re seeing in the price of metals.  You’re not seeing it yet in the High Street but I think that’s simply a function of the recession environment with no corresponding shortage of goods and labour.

So yes, I’m very bullish but nothing goes up forever, there will come a point where it’ll overshoot, but that may be a lot higher yet.

What do you think has been driving that demand since the days of $250/oz - people’s fear of fiat money devaluation or the growing availability of gold as an investment class via new instruments such as ETFs?

I think it’s a combination of those two.  Basically there is a fear of devaluation as we risk a currency war where countries seek to beggar their neighbours.  The availability of EFT’s is making it easier for more people to invest in gold than was the case in the past.

Could you talk a little about your comparables, and give some further colour to your comments on M&A; are there companies that you’re looking at in the geographic areas you work in or do you think you may be a target to the more acquisitive majors?

Well big companies, by the very nature of the risk and the time involved in exploration, have to acquire, they just can’t discover millions of ounces every year to replace production, so acquisition is the only option for many of those bigger companies.  

In terms of our peers companies that we are following in the footsteps of, the obvious ones are Avocet Mining (LON:AVM) and Medusa Mining (LON:MML), both companies which like us have had their challenges in the past but have very successfully steered their way through to be recognised producers, so we look forward to joining that club in the not too distance future.  There are a number of others, without naming any in particular, who like we were, are still trying to get traction and overcome adversity.  Many of those companies probably recognise that there could be benefit in combining operations to be a larger producer.  However two and two don’t always make 5 as always hoped for; you have to match your resources and management.  I’m not saying anything new there, I think most companies recognise that and while there is a push for marriages they have to be matched and managed well to be successful.

One of the key drivers of share prices in gold companies over the last decade has been reserve upgrades once mining actually started.  Could you comment on the possibilities for reserve upgrades at Toka Tindung?

We are just embarking on a major exploration programme.  We will be spending nearly $30m over the next couple of years, which is a very large amount.  We’ve spent almost nothing on exploration for the last decade and that’s purely because of our limited finances and focus on production.  I think that the ground that we’ve got is very prospective.  I’m talking specifically here about Toka Tindung where we have a high probability of adding substantially to resource and reserves.  If you look at the results of the little exploration work that we have done, there is one drill hole referred to in the recent Ambrian report, which intersected 12 metres at 10 grams per tonne gold at only 100m below surface.  Now that’s underground mining grade but it’s only 10’s of meters from the base of our currently planned final open pit.  So that’s something we have to follow up which I think indicates the potential.  About 4 kilometres to the north of Toka Tindung we have another prospective area where we have surface float up to 2 ounces of gold to the ton.  Again, that’s not been followed up for a decade so all of these things are priority targets for early testing.

Can you qualify the implications of surface float for our readers?

It means we’re picking up pieces of gold mineralised quartz in the soil, detached from its source rock but likely not far removed.  The quantity of float suggests that the source is quite close by and the prospect is only 4 kilometres from Toka Tindung and the processing plant.  We would like to think that this float may be the tip if you like of an ore body perhaps lying very close to surface there.

Could you comment on valuation at all and your broker’s projections?

There are several methods used to value gold proposals.  The most simple way is to focus just on production but it gives no indication of project quality.  My preference is to focus on profitability, because if you’re making $100 per ounce versus $10 per ounce profit, only then is production important to determine total revenue.  You can then determine EBITDA and in turn the price earnings ratio. So in our case we have at today’s gold price, an average annual EBITDA for the next six years of about 17p per share, giving us a P/E of circa 2.4 at today’s 40p share price.

Now you might say ‘Why is that figure so low compared to other producers?’  The answer to that is quite simple, we’re not producing and the others are! and obviously there is still some risk attached to us getting to that stage.  So I think investors will watch our performance very closely over the next 6 months to see if we can deliver what we say we can deliver.  As we move closer to production I would expect a significant re-rating of the share price to occur.

Ambrian’s broker report, which has just been released, has put an indicative price on the Company of 55p today, and a price of 70p a share by the time we’re in production at the end of the first quarter 2011.  My personal view is that it’s not unrealistic for us to be aiming for £1 a share by the end of 2011.

Our focus is very much on getting into production first and foremost, however in parallel with that we have a very exciting exploration story over the next couple of years.  We’ve also got opportunities in other countries but at least initially we will stick to our knitting at Toka Tindung.

Thanks for speaking with us today.

 

John Colin Loosemore (Managing Director)
B.Sc.Hons (Geology), M.Sc., DIC. (Mineral Exploration)
Mr Loosemore (Age 62) is a geologist with over 36 years experience including multi-commodity exploration and management within Australia and overseas, having graduated from London University in 1970 and the Royal School of Mines in 1977.  Mr Loosemore is a Fellow of the Australasian Institute of Mining and Metallurgy.  Mr Loosemore was previously a Director of AIM listed Brancote Holdings Plc, the first mining company to list on AIM and Managing Director of ASX listed Carr Boyd Minerals Ltd and Hill Minerals N.L.