A free call option on the Dubbo Zirconia Project (rare earths)
Alkane is below the radar of some investors. The company has two gold projects and a rare earth deposit, all located in Central New South Wales. The company’s current market capitalisation is justifiable on the company’s share of gold resources with the Dubbo Zirconia Project thrown in for free. At the end of 2Q10 the company had A$8.9 million in cash with three feasibility studies in train as potential catalysts to re-rate the company’s share price.
For most of the past 12 months Alkane has mostly underperformed the ASX 200 Index. For the first time since September 2009 turnover has moved sharply higher and the stock strongly outperformed the broad market in August. Since the start of August, two things happened to make investors refocus attention on the stock.
The first catalyst has been the increase in the price of gold and the second catalyst was China’s announcement to cut exports of rare earth oxides. China’s announcement re-focused investor interest on Alkane’s Dubbo Zirconia Project which is a play on rare earth elements.
WHAT ARE RARE EARTHS?
There are 15 rare earth elements (REEs) in the Periodic Table; but scandium and yttrium are also included in the rare earth basket, taking the total to 17. The atomic numbers of the rare earths are 57 to 71. The rare earth elements are: lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium and lutetium.
The rare earths are subdivided into Light and Heavy REEs (LREEs & HREEs). The light REEs end at neodymium, which is the most common rare earth element used to make magnets, and commonly used in electric cars. Rare earth magnets produce intense magnetic fields that are ideal for making a small highly efficient electric motor. LREEs are relatively abundant but as the elements get heavier, that is as the atomic number increases, the elements become rarer in economic concentrations.
Two of the elements that are of particular interest are terbium and dysprosium. When these two elements are added to make magnets using neodymium, the magnets can be used at high temperatures and they also allow the magnet to maintain its strength. HREEs are rarer and thus more expensive to buy than LREEs, they are indispensable in many applications because there are no substitutes. The high temperature magnets require concentrations of 4-5% of terbium and dysprosium.
The actual amounts of these metals used in applications is small, in as much that the set of magnets in a Toyota Prius weighs around 600 grams, requiring 200 grams of neodymium and perhaps 30 grams of dysprosium. The problem is that almost 100% of the dysprosium is produced in China, and China is going to cut back on its exports of rare earths. This is a worry for makers of electric cars in South Korea and Japan.
China controls around 97% of the world’s production of rare earth oxides. The military uses REEs in smart bombs, night-vision goggles and radar applications. The manufacturers of military equipment in the U.S. are tied to Chinese suppliers which is surely an uncomfortable situation. Chinese internal consumption of REEs is rising fast and a secure supply train to the U.S. is a topic of hot debate.
The rare earths have a wide range of other uses; production of modern electrical devices, hybrid vehicles, liquid crystal displays and low-energy home appliances. Cerium for instance is used as an abrasive in liquid crystal television manufacturing and its price has soared almost 10 times this year.
REEs are also used in wind turbines, catalysts in cars, oil refineries, lasers, fibre optics, and for polishing glass.
The biggest producer of rare earths is Baotou Steel and Rare Earth Company in Inner Mongolia, China. By 2014, China is expected to supply around 80% of rare earth alloys from total demand of around 205,000 tonnes.
In terms of reserves the U.S. Geological Survey lists China as having the largest reserve of 36 million tonnes or 36.5% of world total. The U.S. has 13.2% of reserves followed by Australia with 5.5%, and India 3.1%.
Demand for REEs is rising at around 10% per annum or doubling every seven years. At a time when growth in demand is strong, China is cutting back exports but probably not production. Japan is believed to have adequate stocks of rare earths at this point in time but looking ahead will have to consider manufacturing in China or alternatively seek suppliers in other countries.
Security of supply is going to become an increasingly important issue, and this is where Alkane might fit in because the Dubbo Zirconium Project would produce a range of products including HREEs.
SHARE PRICE CHARTS AND COMMENTS:
Turning to the charts, Alkane Resources is in a strong uptrend since touching a low of 23 cents in early July. The latest advance encountered resistance at the 54 cents level. A corrective pullback has resulted, finding support at the 61.8% Fibonacci retracement level at 42 cents. Short term consolidation is currently the theme, which allows buyers and sellers to square off.
The weekly chart reveals the strength of the almost vertical upward move. We would expect solid support around the 38.5 – 40 cents region, should the retracement continue. Once this pause in trend is complete, we would anticipate another upward move to test the 54 cents high. The bullish moving average cross, coupled with the positive weekly MACD, bodes well for a continued move higher over the broader term.
In 1996 Alkane commenced mining at the Peak Hill gold deposit north of Parkes. Mining finished in the main pit in 2001 and continued for longer in two satellite pits. The company intensified its regional exploration effort that led to the discovery of the Wyoming deposit at Tomingley, just north of Peak Hill on the western side of the highway which separates the Wyoming deposits from the Caloma deposit.
Wyoming One has the potential for underground mining with 690,000 tonnes grading 5.0 g/t gold. Details of the Tomingley project are shown in the following figure taken from a recent company presentation, as are the other figures that follow in this review.
The company is targeting a 10 year mine life at Tomingley. Tomingley is expected to be a moderate to high cost operation with a cash cost of around A$900 per ounce. The production target over a 10 year life is around 550,000 ounces generating a free cash flow of nearly A$300 million.
There is good potential to increase the open pit resource at Caloma to one million tonnes. Mineralisation has also been intercepted below the level of the planned Caloma pit; so there is also potential for an underground resource.
The other advanced gold project is the Orange District JV with Newmont where the focus of exploration has been on the McPhillamys gold-copper discovery. This deposit is located in a north trending volcanics to the east of Newcrest’s Cadia Valley operations which includes the Ridgeway mine. Like the Cadia mine, McPhillamys has a copper credit.
Newmont has already earned 51% in the Orange JV; when Newmont has completed a bankable final feasibility study it will own 75% of the JV. The geological environment is ripe for the discovery of another large porphyry copper-gold deposit.
Preliminary metallurgical tests have been very encouraging with gold recovery better than 90%. The conceptual mine studies are for an open pit or a block cave underground mine. Block cave mining is the lowest cost underground mining method but it has a disadvantage in that all the mine development costs are bought forward.
There are multiple targets around McPhillamys and drilling has intercepted broad zones of low grade gold mineralisation. At Kings Plain a drill hole intercepted 78 metres at 1.04 g/t gold.
The total strike length of mineralisation extends for at least 6 kilometres, and might continue for 10 kilometres. The exploration potential with the Orange JV is still very high and known mineralisation is open at depth.
Zirconia and Rare Earths: Dubbo Zirconia Project
This project should be attracting a lot more attention because there is essentially an embedded call option on the project in the company’s share price; and a free option at that.
A new rare earth circuit has been added to the Demonstration Pilot Plant (DPP) which is in operation at the Australian Nuclear Science and Technology Organisation (ANSTO) facility at Lucas Heights. ANSTO is a statutory body of the Australian government; it was formed in 1987 when it replaced the Australian Atomic Energy Commission.
It should be pointed out that the deposit contains 23 million pounds of uranium. The deposit is not classified as radioactive but under current state legislation, no uranium can be produced in New South Wales. This is not a problem but it does represent an opportunity cost to increase revenue and the return on investment. What will happen is that the uranium will be returned with the tailings to an impoundment pond. Hopefully the state government will relax the legislation so the uranium can be recovered.
A major attraction of this project is the potential to recover HREEs. To this end the company has added an yttrium-heavy rare earth circuit to the DPP and Alkane has started large scale production of yttrium and HREE concentrate.
The Dubbo deposit is unusual because yttrium and heavy rare earth elements account for 25% of the total REEs. The usual distribution is for the LREEs to account for 95% of REEs. The higher concentration of HREEs will ensure a more robust project with a higher average return for the rare earth product.
Yttrium and HREEs are expected to account for over 40% of revenues from the project.
The DPP has been operating since 2008 and has produced substantial quantities of zirconium and niobium products, samples of which have been sent to potential customers around the world.
This is a very advanced project and the DPP was designed to confirm the proposed flow sheet to a high level of engineering and to recover a suite of zirconium chemicals, zirconia, a niobium-tantalum concentrate, a LREE concentrate, and yttrium-HREE concentrate.
Samples of the yttrium-HREE concentrate produced from a 6-day trial period will be used to advance the marketing program. A second 6-day trial period is scheduled before mid-September.
A LREE recovery circuit will be added to the DPP in 4Q10. HREE has taken precedence because of the change in global supply dynamics because China is reducing exports.
China is also concerned about the supply and rising price of zircon. The Government of China has removed a 5% VAT refund on zirconia exports. This move will be supportive for the prices of zircon and zirconium chemicals. Mineral sand producer Iluka will also benefit from this decision.
The supply of zircon is becoming tight. Although China dominates the downstream zirconium chemicals industry, China does not produce a lot of zircon and has to rely on imports.
A very positive outlook for the price of zircon is another highlight for the Dubbo Zirconia Project. Strong revenue growth looks assured for this project.
The Dubbo Zirconia Project will have a very long project life. Using the Base Case assumption of 400,000 tonnes of annual production, the current resource will support a 175-year life. This means among other things that there is plenty of scope to keep increasing production to meet demand and still have a decent project life.
The influence that China’s decision to lower exports of rare earth oxides is shown in the following table.
Alkane has a significant project development pipeline that will require project financing of over $250 million. This will represent a challenge for the company but not a major one. The price of gold looks like it will move higher and the market is seeking new gold investments. The company has a target to be back producing gold from Tomingley in 2012.
The Definitive Feasibility Study (DFS) for Dubbo Zirconia is scheduled to be finished within the next 5-6 months.
Alkane has excellent management that will not over promise and under deliver. Management is conservative and in the case of Dubbo Zirconia will not make any estimates on the project economics until the DFS has been completed. We anticipate a favourable outcome and the DFS will be a major catalyst to re-rate the company’s share price.
STATE OF PLAY
Our current starting point for gold equivalent resource ounces has risen over the past couple of weeks to US$114 per ounce. Just as a reminder, this value is the average of over 70 companies with over 750 million gold equivalent ounces in resources. Note that these are global resource ounces and not recoverable ounces.
Returning to Alkane’s resource position the company has around 800,000 ounces at Tomingley, of which 659,835 ounces are in resources being considered for development.
After Newmont has finished the feasibility study to develop the Mc Phillamys gold deposit, Alkane’s interest in the project will fall to 25%. The current resource is 3 million ounces with potential for another million ounces.
Alkane’s share of resource ounces is at least 1.5 million ounces. Both gold deposits are near regional centres with good infrastructure, Orange, Parkes or Dubbo. The current market valuation of around A$128 per resource ounce would put a value of A$190 million on the company. With a market capitalisation of A$113 million it seems that the company is undervalued.
The Definitive Feasibility Study (DFS) for the company’s Dubbo rare earth project will probably be finished within the next 5-6 months. Alkane will not be releasing any of the financial metrics on the project until the DFS becomes available. Based on the average valuation of gold resource ounces it can be argued that there is zero value being placed on the rare earth project.
There are not many small resource companies with three feasibility studies in progress. Each of these will be a catalyst to re-rate the company’s share price. Recent news from China concerning the control over the export of rare earth minerals is having a positive impact on prices.
Demand for heavy rare earth elements is set to increase a pace and there is the potential for shortages to occur. In any event, users of rare earths will seek alternative suppliers other than the Chinese. The outlook for rare earths has been greatly improved through China’s action.
A good time to buy speculative explorers is before they get too many runs on the board and the share price races away. Such is the time to consider Alkane Resources Limited. There will of course have to be an issue of new shares to fund project development, and holders of the stock should anticipate a placement and/or rights issue in 1H11.
The stock is a highly speculative in nature but with gold and rare earth projects the company is set to get a lot more attention from investors. On a risk to reward basis Alkane stacks up very favourably.
Alkane is recommended as a SPECULATIVE BUY for all Members.
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