Financing growth the key

Red Back Mining (TSX: RBI) is an emerging gold company with a focus on gold producing assets in West Africa. The company's two key projects are the Chirano gold mine in Ghana and the Tasiast gold mine in Mauritania. In addition, Red Back holds an extensive exploration portfolio both in Ghana and Mauritania.

As shown in the accompanying map, the Chirano Mine is situated in southwestern Ghana, 100 kilometres southwest of Kumasi, Ghana's second largest city. The Chirano Gold Mine achieved its first gold pour in October, 2005 after commissioning of the process facilities in September, 2005. Current production is from open pit deposits however many of the deposits have underground potential.

Drilling at the Akwaaba deposit has established a high grade underground resource called Akwaaba Deeps. Here, an underground mine is being developed which will use Sub-level Caving ("SLC") to produce ore.

In order to accommodate the expected increase in production from the underground mine, the Chirano mill, with a current capacity of 2.1 Mt per annum, is currently undergoing an expansion to a throughput capacity of 3.5 mtpa.

Similarly, the Tasiast gold mine in Mauritania is undergoing expansion, where new plant capacity is on schedule for completion and commissioning in mid-2009. The Tasiast mine is a conventional open pit mining operation with significant exploration potential, as the deposit is within an extensive gold system that is largely under-explored.

Before we discuss these expansion plans, let’s look at the company’s third quarter operating results. Chirano produced 25,752 ounces of gold at a cash operating cost of $C596 per ounce in the three months to 30 September. This compares to Chirano’s average per ounce costs of C$472 in the first 9 months of the year.

There were a number of reasons behind the cost increase. Ghana’s government increased the cost of electricity by more than 100% from 1 July following the (previously) large increase in global oil prices. Also, the hardness of the Chirano ore is causing an increase in costs. This will cease, however, once a new crushing facility is completed in late 2008. Lastly, a pit wall failure at one of the deposits resulted in lower than expected grade being mined.

As a result of these issues, 2008 operating cash costs will be higher than originally expected at C$495/oz. The 2008 production forecast has also been reduced to 120,000oz from 130,000oz previously.

At Tasiest, third quarter production came in at 34,251oz at a cash operating cost of C$403/oz. The commissioning of a power plant in the current quarter is expected to lower the mine’s cost profile. Offsetting the weakness at Chirano, Tasiest is expected to produce 135,000oz in 2008, 25,000oz more than originally forecast.

Moving onto the company’s expansion plans, Chirano remains on track to support the increased production to come from Akwaaba Deeps. Commissioning of the expanded plant remains on track to commence in the first quarter of 2009.

Similarly, expansion of the Tasiest operations is expected to commence commissioning in early 2009. Once the expansion is complete, the operations are forecast to produce 250,000oz of gold by 2010.

In normal market conditions, expansion plans are welcomed by investors. However, in a world where the banking system is seriously impaired, growth prospects are best accompanied by a solid cash balance.

In order to progress the increased production profile of the two mines, Red Back will spend an additional $23.2 million in 2008. Based on an end of quarter cash balance of $15.2 million, the company should be able to meet it capital commitments for this year (factoring in operational cashflow) however further expenditures in 2009 may not be met from cashflow. Red Back is in talks regarding the establishment of a banking facility but in these credit constrained times, there are no guarantees so in the near term we remain cautious.

In addition to general market volatility, this concern over future funding has obviously been impacting sentiment towards the stock. From a charting perspective, volatility remains a key feature of Red Back Mining. As evident on the daily chart, we have seen the stock correct heavily over the past four months since reaching a high of C$9.25 in July.

More recently, prices have traded between a low of C$3.28 and a high of C$6.11 over the past month alone. With the stock now retesting the lower end of this range, we need to see support in the C$3.50 to C$3.25 region hold to improve the near term outlook.

Over the longer-term, we expect the high volatility will eventually subside, allowing prices to consolidate and form a base. Once this occurs, and given our bullish long term views on gold, there is potential for a revival in longer-term upward momentum.

The issues facing Red Back Mining currently are emblematic of the issues facing many capital hungry gold producers. Continued rising costs around the world, and a ‘mysteriously’ weak US dollar gold price is hurting profit margins. We don’t expect this situation to persist but in the short term, growth companies like Red Back will remain under pressure.

While buying at current levels could prove to be an astute move, we would rather gain comfort around the financing of the growth projects before recommending additional buys. Until then, Red Back Mining will remain held in the Fat Prophets Portfolio.