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China's Golden Age
Bob Moriarty
Archives
October 25, 2004
"Always arrive first to the empty battlefield to await the enemy
at your leisure. After the battlefield is occupied and you hurry to it, fighting
is more difficult."
-So said Sun Tzu.
I returned recently from a two week trip to China. While there I visited several gold
projects for two different Canadian juniors. While different in style and business model,
each of them realizes a fundamental precept of both war and business. The best time to
occupy a hill is before anyone else realizes it's even there.
This was my first trip to China and boy was it an eye opener. 'New countries' isn't any big
deal for me. For fifteen years I delivered US-built airplanes all over the world. So a visa
from another country is just another visa. But China was different and special.
I flew into Beijing in the evening so couldn't see anything on the 30 minute drive to the
hotel. But the service was nothing short of incredible. The hotel had a greeter meet me,
literally, as I walked off the plane. And she took me straight through the lines of
officialdom and had me in a limo 20 minutes after I got off the plane. Throughout my
visit, I would find the service prompt, efficient, and courteous.
When I woke the next morning I pulled the curtains back to see what I
could see of Beijing. From my 18th floor window, in a hotel matching or
exceeding any in New York or Vancouver or San Francisco (but a lot
cheaper,) I saw a clear China morning with a flock of China's new national
bird, the building crane. Without straining my neck, I could see 20 cranes, all working
like busy little beavers.
China can only be under described. The pace, the energy, the hustle and bustle of the
people is unmatched and I lack the words to fully describe what I saw. Words don't
suffice. China is on the move.
In the next two weeks, I would see architecture which would rival the best
Chicago ever dreamed of; hotels and shops as grand as any in New York or
London; construction on a scale unparalleled in history.
I've underestimated the impact of China on demand for raw materials. In ten
short years, China has moved from a net exporter of commodities to a net
importer. And Chinese demand is going to continue for the next fifty years.
Fortune magazine just did a special on China and came up with some interesting
numbers. In the next 25 years, China plans on moving 400 million people from farms
into urban areas, this is the largest mass migration in history.
Without question, China faces problems. The primary limit on demand in China today is
energy. China has increased oil imports by 39% in the first eight months of this year yet
most areas in China face increasing shortages of electricity. Experts suggest the Chinese
banking system is your garden variety disaster area yet demand continues to increase
and growth goes on. They will face problems but I suggest they will overcome them. If
the 20th Century belonged to the United States, the 21st Century is going to be Chinese.
Americans tend to wear blinders which prevent them from seeing what is going on in the
rest of the world. The average cab driver in London or Rome has more of a clue as to
world economics than does the average college graduate in the US. Our ignorance knows
no limits and we soon shall pay a giant price as a result.
And all the kids are learning English. Everywhere I went in China, when I came across a
4-5 year old child, he/she would run up and smile shyly before saying in perfect English,
"Hello, how are you." I guess hairy barbarians give them the opportunity to try out their
English.
I suspect that somewhere in every school is a document asking the teachers to tell their
young students to practice their English on every foreigner they see.
They also are fascinated by arm hair. The little critters would reach up and pluck a few
hairs from your arm just to see if we really are hairy barbarians.
China is your typical garden variety 800 pound gorilla. And we all know where an 800
pound gorilla sleeps. But China is an 800 pound gorilla chimp. With lots of growth yet
coming. We aren't prepared, the world isn't prepared and there will be constant supply
dislocations for many years to come.
The key to commodity prices is no longer going to be American demand. It's going to be
Chinese demand. We had best learn to live with far higher prices for commodities,
especially oil, because the sleeping giant has awakened.
Dynasty Gold
A year ago I came across a gold company starting operations in China: Dynasty Gold
[DYG-V $.465 Canadian 28 million shares outstanding, 38 million fully diluted. Website].
Dynasty had a compelling story. Basically they were in the process of acquiring
Terrawest Minerals which had a joint venture with Xinjiang NonFerrous Metals Co. which
is one of China's leading mining companies.
Dynasy's deal requires exploration commitments of $12.1 million US over a three year
period to earn a 70% interest in the JV. The joint venture properties included 1600
square kilometers in the Hatu Gold Belt, 600 square kilometers in the Baogutu Mineral
Belt and an additional 300 square kilometers in the Hami Gold Belt.
Some of the top analysts in the mining business participated in the Dynasty Gold tour.
We began by flying to Urumqi in Xinjiang province in far northwest China and then
driving 5 hours to Karamay. In each stop, I was amazed at the level of the activity and
the volume of construction.
Dynasty didn't provide us with briefing books and I suspect that was a
mistake. On most of the tours I've been on, the company provides a
briefing book with a general statement of their goals, maps of all the
properties and a detailed brief of how they are proceeding to meet their
goals.
When I get back from a trip, I think about what I saw for a few days and then do a
thorough review of their website and materials provided to produce what I write.
Basically, the company provides the story and writers do a critique. Not having a briefing
book complicated my job. I don't create stories, I just report them.
When I talked to Dynasty management a year ago, their theory was that prior Chinese
mining had concentrated on mining narrow, high grade structures. Dynasty believed
prior mining had ignored lower grade but far higher tonnage formations. The Chinese
only mined underground which means they missed a lot of lower grade ore not economic
in underground mining. And they simply failed to even sample anything but the vein
structure.
Dynasty brings a western approach to exploration. Dynasty wants to consider the
economics of open pit bulk mining which allows for a much lower cutoff grade for ore.
Drill results to date tend to prove their theory. Dynasty released the results from eight
holes in September including a 64.7 meter intersection of 5.1 gram gold. The market
snored at the news and the stock did nothing. But if that near-surface intersection
represented a cube of the same grade and dimensions, a 65 meter cube of 5.1 grams is
about 45,000 ounces of gold. And that's better than a read-hot stick in the left eyeball.
A few more holes like that and Dynasty will be well on the way to proving their theory.
On the first day of the mine tour, we saw Dynasty's work at Baobei. As
with most projects, the early work consists of a lot of trenching and soil
samples. They had done some drilling to follow up on tentative drill
targets but have been so far disappointed. While it's not covered on their
website in any detail at all, the Baobei project was not part of the deal
with Terrawest, it was a hole in their property which was privately owned and operated.
In late spring, the opportunity came up to bid on the project and Dynasty signed an
option. To date they have committed and spent about $440,000 Canadian. Some soil
samples looked promising but they have not yet been able to confirm ore grade through
drilling.
I will make one interesting point here. Since they were taking over a Chinese
project, they took over the tools the Chinese were forced to drill with. And in
the case of drilling, the Chinese used these 50 year old Russian designed drill
rigs which could only drill vertical holes. So they could angle at 10 degrees
from the vertical, but they couldn't do the 45 and 60 degree holes Canadian
juniors are far more comfortable with. Dynasty made it a major project to
bring in an angle drill so they could better locate vertically aligned structures. It makes a
world of difference. With a vertical drill, you could miss a 1000 meter structure by two
inches for the entire length and might never know it.
We saw a bit of drill core from Baobei and it didn't look very juicy. One of the
alternatives Dynasty has is to not complete their option on the property. I got the feeling
that unless they came up with a lot better drill results than they had gotten to date, they
might walk away from that particular project. It probably was a necessary move on their
part to at least consider the project. The worst thing possible would be for that part of
the structure to end up in the hands of another mining company. Dynasty did what they
had to do.
Qi2 is another story. It is part and parcel of the first Hatu Area project and drill results
have been very encouraging. Qi2 was a mine in the past, the area has been mined for
200 years. It surprised me that Dynasty hadn't sampled the dumps to get a feel for the
background level of gold but until we visited Qi2, they hadn't sampled the dumps, it
didn't occur to them.
We did see drill core from several holes, some split and some not. We
compared the drill core with the 5.1 gram gold and if looks aren't
deceiving, they should be announcing very good results shortly. The drill
core I saw a lot of was identical in appearance to the very positive drill
core of the 64.7 meter, 5.1 gram per tonne intersection.
More results will be out any day and should they meet or exceed the 64 meter
intersection, I would expect the market to respond in a far more positive way. While the
senior mining companies are making new highs, the juniors are still snoozing. One day
soon they will wake up and when they do, you want to have your dance card filled out.
I do want to add one minor bit of trivia. My best friend in Miami happens to be the
grandson of the world famous Colonel Sanders. He's not rich, the old story of
shirtsleeves to shirtsleeves in three generations is accurate. But eating in China, let me
say simply, was a challenge. Trig Adams would have enjoyed one of our meals...
We were honored guests everywhere we went and the Chinese wanted to
serve us the very best and most expensive food possible. I went through
7 straight 40-course meals. A lot of the food you didn't even want to
identify, much less consider eating. At least I didn't. But
on our last day at Karamay, when we were in the midst of
sorting through the core shed for goodies, Dynasty rewarded us with
lukewarm Kentucky Fried Chicken which their driver had driven 40 miles
to pick up. The 20 or so of us doing the work leaped into the greasy boxes
to scarf up the chicken. It was pure heaven.
We had a short brief of the the second major property in the Dynasty stable, that called
the Red Valley Project in Qinghai Province. Dynasty has yet another JV covering a 1000
square KM region. They received their business license in April and have to date spent
about $110,000 US in trenching, soil samples and mapping. An area next to where they
are testing was the home of 5,000 placer miners for the past 15 years. Anything which
would support 5,000 placer miners for 15 years is a pretty good indication that the
mother lode is around. The gold came from somewhere.
Dynasty's third major project, Wildhorse, is located in Gansu Province and totals about
3000 square KM. Dynasty expects the business license soon, exploration won't begin
until spring of next year. Dynasty must spend $1 million US on exploration in the first
year.
Dynasty isn't a slam dunk. They have one of the largest land positions in China and are
running, not walking, in their quest to be the biggest and best foreign junior in China.
They have made deals which require a lot of money over the next three years and that
means they are under the gun. They need results now. But even with few holes already
announced, they have shown the validity of their theory. They will either succeed grandly
or fail grandly, this isn't your average mining company with two full time geos and a
secretary with a three line phone system.
Dynasty is acting like a big mining company and that can be a little dangerous. What I
saw seemed to reflect a lack of control, a lot of simple things like taking samples of the
dump, even as simple as splitting core, were running behind. Dynasty needs to get
management under control. They were on the edge of chaos in a lot of ways. That's
good, the best work is always done on the edge of chaos. But it's dangerous to become
long-time comfortable with chaos.
China is beginning a golden age. Those foreign companies who offer technical help and
access to investment capital will be welcomed. I cannot fully explain how impressed I
was with China. Dynasty saw the opportunity early and has a two-year head start over
most Canadian juniors. They are completing a drilling season when most companies are
only just thinking about drill targets. If they can get management coordinated and
everyone working in the right direction, I think they will become one of the leading
juniors.
Dynasty will be announcing drill results for the next two months and expects to release a
43-101 resource during the winter. 1-2 million ounces would not be impossible and that
makes the stock pretty cheap at $.465.
Goldrea Resources
The last part of my trip to China was a visit - along with my favorite
traveling companian, Rick Langer of Canaccord - to Rushan City in
Shandong Province to look at a gold project of Goldrea Resources [GOR-T
$.215 Canadian, 19.5 million shares, 25.5 million fully diluted. Website].
Goldrea has entered into a JV with China Rushan Gold to earn a 74% interest in a 650
square KM property near Rushan City in eastern China. Shandong province produces
26% of all the gold produced in China today.
Chairman Larry Reaugh of Goldrea has pulled a near slam dunk. He
negotiated the contract in Canadian Dollars, a first as far as I know.
Which should also give viewers an idea of what the Chinese think of the
US Dollar.
The contract calls for Goldrea to invest $2 million Canadian over a four year period for
74% of a 650 square KM region. The package comes with a Chinese resource of 707,000
ounces (not 43-101 compliant) which won't mean anything until Goldrea reviews the
data and brings it up to 43-101 standards. But China Rushan operates a 65,000 ounce
per year mill and has granted an option to Goldrea to buy the existing
mine and mill based on a mutually-agreed appraisal price.
The Daye Gold Mine, currently in operation with 4 years of reserves,
operates the 2,300 TPD capacity mill at a rate of 1750 TPD so there is
excess milling capacity available immediately. Also once Goldrea takes
over the mill, it would be dead easy to expand production capacity.
We walked some of the area covered by the JV. One major deposit already identified lies
beneath a small village. In most areas of the world, that would be a killer to at least that
portion of the deposit. But China intends to build new living facilities for 400 million
people over the next 25 years and it's not all that difficult to build new homes over an
area with no gold.
It's fairly unusual to find sulfide ores at the surface but this project
contains a sulfide ore at the surface. It has gold associated with pyrites
and chalcopyrite. When we visited the existing pit and looked at the
mining going on, it was easy to pick out the ore grade rock visually. When
we walked around the village, you could pick up the identical rock type.
Developing a 43-101 resource of some quantity isn't going to be difficult. The rock being
mined today grades between 3-5 grams per tonne. The ore bodies are near surface and
that makes for cheap drilling. This is not a greenfields project where some scatterbrained
geo thinks there may be some gold. There is an existing mine, there is a producing mill
with up-to-date equipment, there is a resource which at least the Chinese believed and
there are trained and qualified workers available at once.
The Daye Gold Mine does both open pit and underground mining. The
existing pit doesn't have much expansion capability until they move the
pit wall back and it's right next to a highway. They report about 3.5 grams
from the underground mining which wouldn't be much by western
standards in most mines but works for the Chinese. Larry Reaugh wants
to explore the idea of finding a larger but low grade bulk mineable resource at the
surface.
There is a lot of work already done by the Daye Gold people. If I had to guess, I'd say
the Chinese showed us maps and drill results which would have cost a lot more than $2
million Canadian.
There will be problems, there are with any new project. Management of
any company is in the business of solving problems. The first problem is
that the most accessible gold is right under a village. That may be an
easy problem to solve.
The JV has the rights to the gold under the existing pit and that may require moving the
road. A high priority will be developing a reserve quickly and coming to an agreement on
purchase of the existing mill. The mill had equipment with a replacement value of $25
million which will be worthless once the existing mine runs through its reserves in 4 short
years.
I hate picking numbers on gold potential, it is like walking through a minefield with a
blindfold. But I also think I owe it to our readers to give them as honest an appraisal as
possible.
At $.20 a share, the company has a market cap of about $4 million Canadian. Goldrea
has just completed a placement. They wanted to raise $600,000 which would have
gotten them through the next year and were overwhelmed with demand and increased
the placement to $1.2 million which will give them a lot of operating space.
There aren't many companies out there with an agreement of this value who are priced
at such a low market cap. Goldrea is cheap. Shandong is in a reasonable moderate
climate and I know Larry Reaugh will be arranging for a drill rig as I write. He's going to
hit the ground running and the company could easily have a 1-2 million ounce 43-101
resource by late summer of 2005. They know where the gold zones are, all they have to
do is drill.
Ounces in the ground vary all over the place. On the low side, $10 an ounce is really
cheap for an operating junior. The average I saw on a recent report was $68. You can
work out the math, I won't bother. But this is about as low risk, high potential as you will
ever come across.
Especially if you like either China or the future of gold. I like both.
These two companies represent two totally different approaches to mining gold in what is
a new frontier. There is risk in China but there is risk walking across the street. You can
get run over walking across the street but you can't get rich.
Investing in new frontiers can make you rich. I believe the
future - the next 50 years at least - will belong to China.
While I recognize there is a very real risk of a Boom-Bust in
their banking and construction industry, the Chinese have
built enormous production capacity over the last ten years
and at the end of the day what we produce is what we are. And, on a side note, the
Chinese recycle everything.
Dynasty is batting for home runs. They have the largest and in my so humble opinion,
one of the best land positions of any gold junior in China. They were one of the first five
in the country and I suspect they will all be rewarded for their vision. But Dynasty has
some giant financial commitments which almost certainly will require substantial dilution
of their stock. It's going to take a major management effort to succeed and I'd like to
see them shore up management. It wasn't the most organized company I've ever had
dealings with. But should they succeed, they will succeed grandly.
Goldrea on the other hand is going to be hard to screw up. Larry Reaugh
has negotiated an excellent package and price. I fully expect him to
exercise the option to buy the mill as soon as reasonable. He will have a
resource next year and it will be worth reading. My meeting with his
Chinese partners was memorable if for no other reason than the fried
bumble bees, silkworm larva, jellyfish and sea slug dinner. The Chinese can not only
mine gold and build buildings at a rapid rate, they drink like fish and smoke like
chimneys.
Both companies are advertisers. We own stock in both companies. I am biased. I like
them and I like the opportunities I saw in China. We try our hardest to be both balanced
and complete but everyone is biased. I wouldn't have bought the shares in the first place
if I wasn't biased.
I suspect the Chinese will go to a gold backed currency, certainly articles over the past
month have seemed to me to indicate they have a realistic view of the future of the US
dollar. If and when China goes to a gold backed currency, every country in the world who
intends to compete on the world market will be forced to do the same or see their
currency turn to something with the rough value of used toilet paper.
Owning a piece of a gold mine, especially in China, might be real handy about that point
in time.
And FYI there are gold shops everywhere. I bought Barb a small gold bar
and a 24kt miniature sword for her 60th Birthday, that I missed because I
was on this trip. Gold is sold by the gram and costs about $15 per gram.
That reflects about a 10% premium over the value of the gold which as
good a price as I've found anywhere in the world.
Note: On Wed October 27th I am packing my bags once again, and leaving
for Kazakhstan via Frankfurt. I will be back on Tues. November 2nd, so PLEASE don't
send me email.
October 24, 2004
Bob Moriarty
President: 321gold Inc
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