With the growth of gold production in places like Peru and Ghana, investing in, and lending directly to, miners has become a real opportunity. How does one watch for the pitfalls?
First, why is this happening? With the explosion in gold prices over the last 15 years, Peru has experienced a meteoric rise in gold mining. This has taken them from one of the poorest countries in the world with a poverty rate that exceeded 50% to one of the fastest growing countries in the world with a poverty rate that is much less than 25%. Along the way, people have been slapping up low quality, low performance gold ore processing facilities that are environmental nightmares. The ore quality is so high; they can still make tremendous profits while removing only 35% to 55% of the available gold. More recently, the government has begun cracking down. These same low quality processing plants are run without government registration, payment of taxes nor knowledge that their gold ore suppliers are registered gold miners paying taxes. The government now realizes that about 40% of all gold exported by Peru came from companies that are not paying their taxes. They are now demanding that ore processing companies and miners: register with SUNAT, the country’s tax authorities, and adhere to all safety and environmental laws. Within the last few months (Mar 2014), they have been destroying the ore processing equipment of companies that are not compliant. This has resulted in large demonstrations and a huge windfall for legitimate gold ore processing companies. For most of these companies, the race is to grow as quickly as possible.
Similarly, in Ghana, they had a problem with miners from China that were also operating in a similar style, not following environmental regulations, work rules, avoiding taxes, as well as not working well with locals and claim jumping. Recently, the Ghana government reacted in a similar manner as the Peruvian authorities, but with a twist. They simply revoked all the Chinese visas in their country. Suddenly, thousands of claims have now been returned to the Ministry of Mining. The resulting small, legal gold mining companies are now growing at unheard of rates.
For both of these countries, the limitation is cash and management. If a company has a CEO and management team that knows how to take a company through high growth, cash is the only limiting factor.
People are how these companies grow fast.
Examining these firms is not a whole lot different than examining any other resource firm. First, one must understand that they are producing gold at all and they are not a scam. This typically involves discussions with organizations and investors that are currently recipients of their production. Speaking with these investors and understanding their backgrounds and experience in the field is key. Also, one needs to understand management and their backgrounds and experience. Have they been involved in design and development of production operations? Is it credible that this management team could produce gold?
The next question is: are they producing the gold legally? This requires careful legal review of permits and permissions and also a review of their tax status to understand that they are paying their taxes. Tax receipts and documentation from the tax authorities helps assure that the gold you’re buying is legal and documented by the country it was mined in.
Next, one needs to understand the reserves. How much gold do they have to produce? Is it enough to produce for the duration of your investment? Discussions about both the depth and extent of their claims and discussions about the amount of claims available to them are also important. For many of the firms, it’s not necessarily the number and extent of current claims as it is the ability to acquire more as they go. For example, currently in Peru, there are millions of tons of gold ore that have 0.5 oz/ton of gold in them. A small firm could not even begin to be ore limited for at least the next 10 years.
How much do they produce? One needs to know the miners are producing at least 250 ounces a month. How much of the production is committed to discounting? Typically, one doesn’t want to see them discounting more than about 50% of their production. Of course, at the same time, once the company is producing over roughly 6,000 ounces per month, rarely will they be interested in offering more discounted gold.
Will they be able to continue to produce? Do they have the management team to support them technically? Administratively? Financially? and with appropriate information technology support? This requires more questioning. The management team needs to have both a minimum set of capabilities as well as a plan for growth and the experience and skill sets to pull it off. This is typically the weakest part of every team we review. Inevitably, they begin to work with us, or others, to make sure their management gaps and capabilities are filled.
Do they have the management and labor available to do the work? This is not only the management, but also the direct labor. Do they have relationships with the local people? Do they have connections to tribes or small nearby communities? These relationships are critical to building a sustained business that can thrive with the full support of the community. Much like the town you live in, one has to have a vibrant connection with the local community or they’ll ask you to leave. Also, the local community has to have the available work force to support a high growth effort. Without adequate labor supply, high growth can’t work.
Do they have good logistics and administration for delivery of the gold? If they do produce the gold, can they deliver and administrate the delivery? Does their refiner offer a global bullion mark? Is the refinery expense appropriate and reasonable?
Sometimes, it is best to review their documentation and actually do a site visit. We routinely visit our potential gold teams and meet with their lawyers, their labor and labor suppliers and review all of their documentation and tax receipts. It’s not unusual for me to go out personally and work with the CEO, at no expense, to better understand the business and help him to understand clearly the challenges he faces. I typically build financials, build chemical and engineering analyses and design schedules. This has sometimes resulted in some very abrupt realizations for all involved. This is a good thing. From the point of realizing the reality of the situation, people can then begin to work on how to move ahead in a prudent way towards a sustainable business that can succeed and earn investors the returns they’re aiming for.
Investing in emerging market gold mining is a great opportunity. With the right due diligence support, one can add some good risk adjusted returns to a private equity portfolio that then results in outstanding returns to supplement a fully diversified set of investments.
Larry Ortega is the CEO of logi Gold, a gold miner, and a gold explorer that has wandered with his team throughout the US and the world exploring for and finding gold and reviewing gold operations from early exploration to gold refining. His team at logi Gold has been extensively involved in Gold mining explorations and operations in the US, Peru and Ghana in the last 3 years. Check out his blog at blog.logigold.com. To find out more, check out www.logigold.com.