Portfolio News - NCM, SAR 13 Oct 10

Sell half SAR and NCM

Saracen – Sell Half

Saracen has gained almost 50% since our initial buy recommendation back in June. We continue to think the miner’s exploration tenements will yield further success and underpin future production growth.

However, given the rapid pace of gains, the potential for near term weakness in the gold price and the inherent risks associated to a mining junior, we recommend remove some profits from the table and sell half of Saracen.

Saracen established itself as a producer during its fourth quarter, delivering a maiden production of 25,036 ounces of gold. Commencement of production has come on the back of a successful exploration program at Carosue Dam. Production at Carosue Dam should continue to ramp up and further exploration success is likely as Saracen moves into full exploration of its other tenements.

Members may recall Sons of Gwalia owned these tenements but was unable to undertake further exploration or development work due to financial constraints. The tenements and plant were placed into care and maintenance, prior to being sold to St Barbara, who then sold the assets to Saracen in October 2005 for A$19.4 million.

Saracen expected cash costs to be in the range A$550 and A$750 per ounce and achieved this at A$654 (excludes royalties of A$52).

We would anticipate mine cash costs to fall marginally as the Carosue plant is ramped-up to a full capacity of 2.4 million tonnes per annum. Costs will also improve as the low grade legacy ore trails off and is replaced with the higher grade ores from Saracen’s other operations. Saracen is forecasting gold production of 30,000 ounces at a cash cost of A$640 per ounce exclusive of royalties for its opening 2011 quarter.

Saracen’s hedging programme remains in place, setting a selling price of A$1,250 per ounce over approximately 10 percent of current ore reserves. The position is a reducing monthly hedge which will expire in December 2011. There is now an opportunity cost in the hedge because the market price of gold is currently at a higher level. Although with its expiration due in a little over a year, this will not do much damage over the longer term.

At Red October Saracen is in the midst of a major drilling programme. Management hopes to significantly increase reserves, targeting a resource containing 204,000 ounces of gold (750,000 tonnes grading 8.4g/t) and delineating expansion of the resource at depth and along strike.

Development of the Karari open pit has been given the go ahead, with pre-stripping expected to commence in January 2011. Karari contains a gold resource of 544,000 ounces, with probable ore reserves comprising 223,000 ounces graded at 1.4g/t.

The potential for further exploration success remains high, as both Red October and Karari remain open at depth. Saracen’s other mine, Whirling may also continue to deliver exploration surprises as the deposit is also open at depth.

We recommend Members sell half of Saracen around $0.64.

Newcrest – Sell Half NCM

Newcrest is now one of the world’s largest goldminers following the Lihir merger. Its size now makes it a cornerstone holding in many more portfolios, than potentially just gold focussed portfolios in the past. Indeed, the addition of Newcrest to more institutional portfolios has been a factor in its more than 25% rise since our buy recommendation earlier this year.

The major driving force of Newcrest’s stock price has of course been gold’s meteoric rise through first US$1,200 then more recently US$1,300. Our conviction that gold still has much further to go before its historic bull market comes to an end has not loosened one bit.

Nevertheless, gold typically corrects and consolidates each major move, which is a perfectly healthy feature of any bull market. In light of the potential for this and given the strong gains to date, we recommend that Members reduce their exposure to Newcrest by half.

Newcrest will release its September quarter production report on October 21 and this will be the first report including the merged Lihir assets. We will of course provide a discussion of the report following its release. In the meantime though, Newcrest recently directed investor intention to one of its other key assets, the huge Telfer project in Western Australia.

Telfer remains very significant to post-merger Newcrest, contributing around 20% of production and accounting for 28% of the miner’s gold reserves at 13.2 million ounces. Telfer also contains copper reserves of 0.65 million tonnes, the sale of which assists in lowering the cash cost of gold production.

Australia is awash with gold mines, but very few of Telfer’s size. The mine is in fact Australia’s second largest open pit gold mine, second only to the Superpit Barrick/Newmont JV near Kalgoorlie, Western Australia. Telfer also produces gold and copper from an underground operation.

Telfer was originally opened in the 1970s, but mining was suspended due to rising costs in 2000. Mining operations recommenced in 2003 from the open pit and 2006 underground. The reborn mine’s early years were far from impressive, marred as they were by cost and schedule over-runs, in addition to a generally poor operational performance. Telfer hit its low point in 2007 when management was forced to downgrade its gold resource by 4 million ounces due to a previous over-estimation.

Management launched the Telfer turnaround strategy in 2008 and the mine has become a very different beast since then. Telfer produced 689,000 ounces of gold last year at a cash cost of A$499 per ounce. This is within management’s guidance for sustainable annual gold production of 650,000 to 700,000 ounces per annum.

Telfer’s feed grades are low, at 1.1 grams per tonne last year. But mill utilisation has improved to 92.9% with gold recovery of 88.1%, which are levels we would expect to see for a project of Telfer’s geology. Site costs have also been brought down, in part by reducing headcount through natural attrition and improving efficiency. Labour costs are an area of pressure, partly due to the fact that Telfer is in “iron-ore country” and competition for skilled workers is that much more intense.

Nevertheless, labour price inflation is an issue across the Australian resources industry and Telfer does have a major ace up its sleeve in the form of its by-product copper credits.

We will provide a more detailed review of the company following its forthcoming production report. In the meantime though, we recommend that Members lock in some of the healthy gains to date by selling half of Newcrest.


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