Great Basin Gold Ltd.: Anticipating a shining future

Stephen Mauzy | Feb 01, 2008 6:20am EST | Comment

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Gold has been the most intoxicating of commodities dating back to antiquity: it has started wars, inspired exploration, exulted great love affairs and toppled regimes. It’s most revered application, though, has been as a store of value and exchange medium, especially during tumultuous times. In modernity, thanks to modern portfolio theory, that application has morphed into portfolio diversifier: gold and most stocks tend to be lowly correlated, so gold reduces a portfolio's volatility.

And, of course, gold is valued as a stand-alone investment, though one difficult to value. Any cash-generating asset, like a stock or a bond, is worth its expected future cash flows discounted to the present, but gold doesn't generate cash. On the contrary, gold is a cash consumer because of storage, insurance and opportunity costs; therefore, investors might consider a more liquid form of ownership, such as a gold-mining stock.

On that front, we like Vancouver-based Great Basin Gold Ltd. (AMEX: GBN), like most gold mining stocks, performs a dual role for investors, first as a gold proxy and second as equity investment.

Great Basin specializes in acquiring, exploring and developing gold and silver deposits, focusing on two primary projects: the Hollister Project on the Carlin Trend in Nevada, where an underground exploration and development program is underway on a portion of the property called the Hollister Development Block, and the Burnstone Gold Project in the Witwatersrand Basin in South Africa.

Great Basin is considered a “junior” exploration company (at least in industry patois) because it holds advanced development projects, but doesn't actually produce any substantive gold at the moment.

That will soon change; production from a resource of two million gold equivalent ounces at the Hollister property is expected in 2008. What's more, Hollister’s annual gold equivalent production is expected at 150,000 ounces at a grade of 1.01 ounces of gold per ton for the next six years. Production from the Burnstone Mine, which contains gold reserves in excess of seven million ounces, is expected to ramp up to an annual average rate of 254,000 ounces over 19 years once all gears start to mesh.

In the meantime, exploration consumes cash (production generates it), which is why Great Basin operates in the red. For the quarter ended Sept. 30, 2007, the company incurred a loss of $14.4 million compared to a loss of $3.7 million in the year ago quarter. Revenues were a paltry $1.1 million compared to an even paltrier nothing in 2006. According to projections offered by Deutsche Bank, Great Basin is expected to post revenue of $22 million for 2007, which will produce a loss of $15.9 million. The stock closed at $3.04 on Thursday, with shares ranging between $1.80 and $3.66 over the last 52 weeks.

But investing is about the future. Looking toward the horizon, Deutsche Bank analysts expect revenue and earnings to shine once 2008 production is underway. In fact, DB expects revenue to increase five-fold to $109.6 million and net income to burnish the bottom line at $38.8 million, producing EPS of $0.20 a share based on 190 million shares outstanding.

The analysts at Deutsche Bank quantified their prognostication on the Hollister mine moving toward a stated production rate of 150,000 ounces and an average gold price of $725 an ounce (roughly $200 an ounce below current market price) and an average production cost of $230 an ounce, increasing to $280 over time.

Potential revenue outpacing suspected costs at a three-to-one ratio would suggest a “buy” recommendation is in order, but Deutsche Bank has erred toward conservatism and rates Great Basin as a “hold.”

RBC Capital Markets is more optimistic, believing there is “significant value still to be unlocked in the company.” Specifically, RBC sees Great Basin's value approaching $4.40 a share based on the South African peer group average valuation multiples, which could rise as high a $10 a share based on its North American peer group multiples. Also erring on the side of conservatism, RBC has set a target price at $4.40 a share, a 50% premium from current levels, which translates to an “outperform” rating with average risk.

I also think the risk/reward matrix favors Great Basin. Gold prices are benefiting from the growing difficulty of finding new metal deposits. Meanwhile, Great Basin is developing mining assets in two of the world's richest gold environments — the Witwatersrand Basin of South Africa and the Carlin Trend of Nevada.

What's more, macroeconomic fundamentals around the world favor gold: Europe, because of its vast and sundry social programs, is always susceptible to bouts of inflation (which is why interest rates in the European Union and the United Kingdom are generally higher than in the United States). The Federal Reserve, meanwhile, is actively inflating the dollar to avoid a recession.

And let's not forget that as the standards of living in China, India, Russia and other emerging economies rise, gold ownership will increase. In fact, the long-term secular trend in gold prices is now driven to a greater degree by the level of world prosperity, whereas short-term volatility is driven by the U.S. dollar and economic and political uncertainty, all of which are in full bloom.

In short, the immediate outlook for gold in general and Great Basin (GBN) in particular, is, well, as bright as gold.