In this mass corporate dream the targeted gold acquisition “only” has to offer low cost production with exploration upside of a few million ounces. It should be located in a politically stable country with welcoming locals eager for the jobs a big hole in the ground will provide. A swimming pool and cold beer are also desirable attributes. Until this stealth opportunity arises, said new gold converts are cutting expenditures and shelving last year’s base metal projects until prices improve. You see, balance sheets alone cannot sustain a share price.

The problem we are all having is that quality economic gold deposits are few and far between. The most obvious confirmation of this claim is that world gold production has been steadily declining since it peaked in 2001 in spite of a nearly US$600 rise in the gold price (fig. 1 below). This goes against basic economic theory that rising prices should bring on more production and suggests a more fundamental problem in the gold industry. To wit, we are mining more gold than we are putting into production in spite of an estimated $US18 billion in gold exploration expenditure over the past five years (CIBC and Metals Economic Group).

Even more telling in the chart above is that production is declining in the historic major gold mining regions. These prolific regions: USA/Canada, Australia and South Africa have established and workable mining legislation, political stability, infrastructure, experienced mining personnel, access to capital and cold beer. For the most part it appears then that large new gold discoveries are going to come lacking at least one of the advantages just listed. This ultimately means that the deposits are going to have to offer significantly higher profit margins to compensate for the increased risks. It also means the timeline to production will more often than not be stretched over many years as political, bureaucratic and social issues are ironed out—or not. Needless to say, borrowing to build a billion dollar project in someplace like…say Angola, is going to be problematic even when the credit markets unfreeze. Net-net, gold production is unlikely to increase over the next several years at least.

There are more or less 30 major gold mining companies and untold junior companies that contribute to the roughly 74 million ounces of annual gold production. Many of the major mining companies are not keeping up with reserve replacement at their mines and are also showing declining production and reserve profiles. They have predominately been able to add ounces through acquisitions and by raising the gold price used in reserve calculations: essentially turning waste to ore. This increased gold price assumption directly translates into a lower average recovered grade and higher production costs. Margins are not expanding as one would expect due to the miners’ inability to add new high-grade reserves. CIBC World Markets calculates a four-year world recovered gold grade decline from 1.7g/t in 2004 to 1.4g/t in 2008. That’s about an $8.70 decline in the value of every tonne of ore blasted, hauled and processed.

On the acquisition side, much of the increased gold production and reserves has come by way of base metal production. When base metal prices were high, gold company production costs were lower and earnings strong due to the base metal credits. The collapse in base metal prices at the end of 2008 resulted in a remarkable 31% increase in gold production costs, according the World Gold Council figures. Lesson learned: henceforth, gold dominant deposits will command a premium.

Recognizing this lack of economic gold deposits there is a concerted effort afoot by the financial movers and shakers to cob a collection of smaller gold (and silver) producers together, creating larger producers. The idea is to tout these newly created mid-tier producers with increased “visibility” to a fresh and better-heeled audience (some might say suckers). Although this exercise will undoubtedly make money for the suits, brokers, and some shareholders, this can be more of a shell game than real wealth creation. The resultant new gold production is generally marginal at best and those buying into and financing said vehicles must make a conscious decision as to how many warts they are willing to overlook.

1.    On February 17, Canadian Superior (SNG-TSX) just had their $47 million loan called by the Western Canadian Bank. Canadian Superior along with partners including British Gas has made some very large offshore natural gas discoveries in the Caribbean Sea. But with the gas glut in North America, it is almost worthless for several years. Their stock has plummeted from $5 to 35 cents a share.

2.    On February 16, Bow Valley Petroleum (BVX-TSX) announced they are being bought by a UK oil firm, Dana Petroleum PLC, for 50 cents a share plus debt of $197 million. Bow Valley is a small oil producer whose big debts, taken on to develop assets in the North Sea, sunk the ship. BVX is a complimentary fit to Dana, which also has assets in the North Sea.

3.    Opti-Canada (OPC-TSX) has a promising oil sands project in Alberta just going into production, but on December 17 last year decided to sell a 15% working interest to partner Nexen (NXY-NYSE; NXY-TSX) for $735 million to reduce debt and increase working capital.

And with lower prices on the horizon for the next few months – especially for natural gas – these financial issues will get more press.

Peters & Co, an oil and gas securities firm out of Calgary, issued a brief research note showing that at US$30 oil/barrel and natural gas priced at CAD$4.63/mcf, intermediate-sized producers that they cover would have an average debt: cash flow ratio of 3.3:1. Junior producers would be an average 4.4:1. Lenders start to be aware of client companies when they have greater than 1:1 ratios. At more than 2:1 they are very aware. At US$40 oil and CAD$5.63 gas, intermediates are 2.5:1 and juniors are 2.7:1.

It’s a big issue in the oil patch these days. These debt levels are weighing on stocks. And unfortunately, in this business cycle trough, the banks’ balance sheets are not in great shape either.

Oil and gas prices fell so hard so fast last fall, and now, with almost no hedges in place, paying the debt back is a problem for both the producers and the lenders. It’s likely that the positive cash flow from these producers will be slim to none over the summer months. This means stock valuations will be under even more pressure as 2009 drags on, and equity could be harder to raise. Asset valuations are also declining along with commodity prices. But the debt doesn’t get any smaller.

So how do the bankers and producers go about working it all out? So how do bankers and energy producers deal with the large amount of debt that is on the balance sheet of almost ALL junior and intermediate producers on the Toronto Stock Exchange (TSX).

Both groups are realizing they could be in for a prolonged slump in energy prices, especially natural gas producers, meaning low to NO positive cash flow for most to even service debt, much less grow. (I mention two oil-weighted juniors with no debt at the end of this article.)

The bankers want to get paid.  And this time, their balance sheets aren’t great either.

Backing up one step, how did these companies get in this position?  In a rising price environment, debt is cheaper than equity – you can pay off debt and get rid of it, but once you issue equity it’s forever.

The Canadian management teams are truly excellent explorationists.  With modern technology and experienced people, many teams (or at least, the ones I follow) regularly ring out 80-90% success rate in their drilling exploration.

But what they do, and the bankers encourage it – they instantly lever up the newly found production with new debt – and purposefully kept their debt ratios high, to keep new equity issues low.  The idea is that one day they will issue shares to pay off the debt, but later when their production and stock price is much higher.  You just have to pay off the debt before the music stops (i.e. when commodity prices collapse).  Very few companies did that.

Lenders understand these price cycles always have troughs, it’s just that this could be longer and deeper than most.

So during these times, banks are liberal in their price decks, which means they run their financial cash flow models on prices like $6 gas and $50 oil – prices that are not “realistic” in this market.  If they do use realistic price decks, then two thirds of their oil and gas client base is under water, and somebody in the bank could say HEY! Call the loan or something.

Just like banks don’t give out full lending to these companies when oil is $140/barrel and gas is $8/mcf, they cut the companies some slack during low prices.  Banks also lend on reserves, not just cash flow, and because the price decks being used to calculate reserves are based on 2008, which are now VERY unrealistic, that helps the producers as well.

Banks normally run price decks every 6 months, and have reviews with management then as well.  That is now happening every quarter and if the company is on watch by the bank, even more often.

Calling the loan is a drastic last step that helps nobody.  In any vertical market, it serves the bank little purpose in bankrupting their client. And as soon as a bank takes over an asset, its value drops immediately.

A more realistic scenario is that the lender will send in a monitor to the company, and do a very thorough “audit” of the company – get an up-to-the-minute look at the financial situation.  In a good relationship, the company has been pro-active in dealing with their lenders.  But it still happens that management teams don’t do that, and then when the proverbial!@#$ hits the fan, they present the banker with a few ideas of which there is very little choice.

But most lenders have good relationships with their client energy companies.  The most likely action is the lender might reduce the loan facility for a company.  So if a company is fully maxed out on a $100 million debt facility, the bank might tell the management team that is now being reduced to say…$70 million.

So this team now has a few choices:

Raise equity. The good companies can still raise equity – Storm (SEO-TSX), Progress (PRQ-TSX), and Breaker Energy (WAV-TSX) are all natural gas companies who have (surprisingly, in my view) been able to raise equity in a declining commodity price environment.  Small companies – anything under 700 barrels per day equivalent let’s say (boe) – will likely NOT have this option.

Do a convertible debenture (CD – which is debt that can be converted into equity at a higher share prices sometime in the future).

Find some other subordinated debt.  A private lender might loan the company some money a short-term basis at very high rates – 20% + – that is interest only and secured by one particular asset

Sell assets, or partial interest in assets.  As I mentioned in my previous column, OPTI-Canada (OPC-TSX) sold 35% of their oil sands project to Nexen (NXY-NYSE; TSX) to get rid of debt and add working capital.

Ithaca Energy (IAE-TSXV) is a junior explorer, which took on huge debt to put its oil and gas discoveries in the North Sea into production.  They raised $75 million in equity last October at what was then a ridiculously low price of $1.50.  The stock was $4 just over a year ago.  Now it’s 35 cents.  They then sold a portion of their assets to another oil company active in the area, Dyas Exploration (listed in England) for $65 million, and got Dyas to take over the debt that Ithaca had with another bank, the Royal Bank of Scotland (RBS).

(RBS had some of their own financial problems this year, causing grief for their energy clients like Ithaca and Oilexco (OIL-TSX). Oilexco, a very high profile North Sea exploration company whose stock went from $5 to $30/share this year, was unable to restructure its debt and their operating subsidiary has since declared bankruptcy.)

But Ithaca has been creative – and successful – in handling their debt, and are likely survivors, as their first production comes on stream next month, in March 2009.  Too bad they turned down a $3.25 takeover offer in June 2008 (INVESTOR LESSON: ALWAYS sell a stock of a junior whose management team turns down a takeover – immediately! In my almost 20 years of investing I cannot think of a single time management has been able to create more value on their own afterwards)

Merge with another company with a better balance sheet.

Agree to be bought out by a larger company. See above investor lesson.

Reduce or stop drilling.

In Canada, the two largest lenders are the Alberta government, through the Alberta Treasury Branch (ATB), and National Bank (NA-TSX).  The ATB is not a lender of last resort, but they generally do experience an increase in business during the price cycle troughs we are now in.

A few companies have made the tough decisions already, but many have not.  I can smell the sentiment for the junior oils improving in the market, but most Canadian producers are heavily gas weighted.

Two oil weighted Canadian listed juniors with no debt are West Energy (WTL-TSX) and Painted Pony Exploration (PPY.A-TSXv)

Tom Mair, President and CEO said: “We are excited to have Scott join the Golden Star management team. His strong professional and technical skills and extensive experience in the international mining industry will be of great value to Golden Star, particularly during the Bogoso/Prestea and Wassa expansions we have undertaken in Ghana. We believe that Scott’s experience will be a strong complement to our current management team.”

Mr. Barr is a qualified metallurgical and chemical engineer with more than 30 years of international business experience in the natural resources industries. Prior to joining Golden Star, he was employed for 13 years by Newmont Mining Corporation in a number of key roles including Chief Technical Officer. His Newmont experience included involvement in projects and operations in Indonesia, South America, Australia, Ghana and North America. Prior to joining Newmont, Scott also worked in a number of roles with other mining companies that included 16 years experience in refractory gold operations in Nevada, along with development and operations experience in base metals and non-metallics.

COMPANY PROFILE

Golden Star holds a 90% equity interest in Golden Star (Bogoso/Prestea) Limited and Golden Star (Wassa) Limited, which respectively own the Bogoso/Prestea and Wassa open-pit gold mines and the Hwini-Butre and Benso properties in Ghana. In addition, Golden Star has an 81% interest in the currently inactive Prestea Underground mine in Ghana, as well as gold exploration interests elsewhere in Ghana, in other parts of West Africa and in the Guiana Shield of South America. Golden Star has approximately 236 million shares outstanding.

Like 2008, the first two quarters of silver production should be relatively flat year-on-year, as the new capital projects get underway. However, silver production should jump in the third and the fourth quarter of 2009, as the three new mines now under development at Guanacevi in Mexico are expected to enter into production this year.

At Guanacevi, after four years of rising production from the Porvenir mine, management plans to bring into production the Alex Breccia, Santa Cruz, and Porvenir Dos ore-bodies in 2009.

As a result of the 2008 capital programs and the depreciation of the Mexican peso relative to the US dollar, the cash cost of production fell to an estimated US$7.50 per oz in the fourth quarter of 2008.
Endeavour expects cash costs to average US$7.50-$8.00 per oz this year and to decline further as production ramps up by the end of 2009.

Assuming the average price of silver is US$12.50-$13.00 in 2009, Endeavour should generate US$12 – $16 million in mine operating cash-flow this year.

In 2009, Endeavour plans to invest up to US$16.8 million in capital projects, with the focus on Guanacevi, where US$14.9 million has been allocated. Approximately US$1.9 million is to be invested at Guanajuato to develop certain of the newly discovered mineralized zones and expand the plant to 600 tonnes per day.

Upon completion of the 2009 expansion projects, the Guanacevi mines production is scheduled to reach 1000 tpd, and the Guanajuato mines production to reach 600 tpd.

In January 1848, a work crew at John Sutter’s mill, near Sacramento, California, came across a few select nuggets of gold. Before long, a half-million prospectors arrived there seeking instant riches. The gold rush was on. Some 153 years later, another gold rush broke out at an old mine called Red Lake, in northwestern Ontario. This time, the fortune hunters wielded geological-modeling software and database mining tools rather than picks and shovels. The big winners were from Australia. And they had never even seen the mine.

Rob McEwen, chairman and CEO of Goldcorp Inc., based in Toronto, had triggered the gold rush by issuing an extraordinary challenge to the world’s geologists: We’ll show you all of our data on the Red Lake mine online if you tell us where we’re likely to find the next 6 million ounces of gold. The prize: a total of $575,000, with a top award of $105,000.

The mining community was flabbergasted. “We’ve seen very large data sets from government surveys online,” says Nick Archibald, managing director of Fractal Graphics, the winning organization from West Perth, Australia. “But for a company to post that information and say, ‘Here I am, warts and all,’ is quite unusual indeed.”

McEwen knew that the contest, which he called the Goldcorp Challenge, entailed big risks. For one thing, it exposed the company to a hostile-takeover bid. But the risks of continuing to do things the old way were even greater. “Mining is one of humanity’s oldest industrial pursuits,” McEwen says. “This is old old economy. But a mineral discovery is like a technological discovery. There’s the same rapid creation of wealth as rising expectations improve profitability. If we could find gold faster, we could really improve the value of the company.”

McEwen, a small, soft-spoken man with a neatly trimmed mustache and meticulous tailoring, had one big advantage over his slow-footed competitors: He wasn’t a miner, he didn’t think like a miner, and he wasn’t constrained by a miner’s conventional wisdom. As a young man, he went to work for Merrill Lynch, following his father into the investment business. But his father also had a fascination with gold, and McEwen grew up hearing tales of miners, prospectors, and grubstakes at the dinner table. Soon he was bitten by the gold bug too, and he hammered out a template of what he thought a 21st-century gold-mining company should look like. In 1989, he saw his chance. He stepped into a takeover battle as a white knight and emerged as majority owner of an old and underperforming mine in Ontario.

It was hardly a dream come true. The gold market was depressed. The mine’s operating costs were high. The miners went on strike. McEwen even got a death threat. But the new owner knew that the mine had potential. “The Red Lake gold district had 2 operating gold mines and 13 former mines that had produced more than 18 million ounces combined,” he says. “The mine next door had produced about 10 million ounces. Ours had produced only 3 million.”

McEwen believed that the high-grade ore that ran through the neighboring mine was present in parts of the 55,000-acre Red Lake stake — if only he could find it. His strategy began to take shape at a seminar at MIT in 1999. Company presidents from around the world had come there to learn about advances in information technology. Eventually, the group’s attention turned to the Linux operating system and the open-source revolution. “I said, ‘Open-source code! That’s what I want!’ ” McEwen recalls.

His reasoning: If he could attract the attention of world-class talent to the problem of finding more gold in Red Lake, just as Linux managed to attract world-class programmers to the cause of better software, he could tap into thousands of minds that he wouldn’t normally have access to. He could also speed up exploration and improve his odds of discovery.

At first, Goldcorp’s geologists were appalled at the idea of exposing their super-secret data to the world. “This is a very conservative, very private industry,” says Dr. James M. Franklin, former chief geoscientist for the Geological Survey of Canada and a judge in the Goldcorp Challenge. “Confidentiality and secrecy about reserves and exploration have been its watchwords. This was a totally unconventional thing to do.”

But in March 2000, at an industry meeting, McEwen unveiled the Goldcorp Challenge. The external response was immediate. More than 1,400 scientists, engineers, and geologists from 50 countries downloaded the company’s data and started their virtual exploration. When the entries started coming in, the panel of five judges was astonished by the creativity of the submissions. The top winner was a collaboration by two groups in Australia: Fractal Graphics, in West Perth, and Taylor Wall & Associates, in Queensland, which together had developed a powerful 3-D graphical depiction of the mine.

As a result of the current market conditions, the Board of Directors of Crosshair has determined that it is no longer in the best interest of Shareholders to spin-out the assets of Golden Promise, South Golden Promise and Victoria Lake into a separate publicly traded company to be known as Gemini. However, both Crosshair and Paragon remain committed to the Golden Promise Gold Project and believe that more value can be created from within Crosshair at this time.

We are excited to now control 60% of this great gold project, says Mark Morabito, CEO of Crosshair. Unfortunately, due to market conditions, transferring Golden Promise into a new company became impossible, but this agreement allows us to own 60% of the project outright, have operatorship and obtain the ability to increase our ownership to 70%.

Closing is expected to be completed no later than May 8, 2009. Closing is conditional upon both Paragon and Crosshair obtaining regulatory approval to the agreement.

Project Highlights

Five quartz vein zones characterized by coarse visible gold have been discovered on the Golden Promise Project. The Jaclyn Main Zone is the most advanced and has been intersected over a minimum strike length of 800 metres (m) and to a depth of 265 m. The zone remains open for expansion along strike and to depth. A preliminary independent National Instrument (NI) 43-101 compliant resource estimate has been completed at the Jaclyn Main Zone. The report estimates an inferred resource of 89,500 ounces of gold (921,000 tonnes averaging 3.02 grams per tonne gold) at a cut-off of 1 gram per tonne gold.

The next stage of exploration at Golden Promise will include additional diamond drilling to extend and further delineate the Jaclyn Main Zone with the objective of increasing the current NI 43-101 gold resource. Additional drilling will also be used to test the Jaclyn North and Jaclyn South Zones, both of which host locally abundant visible gold in quartz veins, but have seen limited drilling to date. The Jaclyn North and Jaclyn South Zones both remain open along strike.

Given the high-nugget gold effect at the Jaclyn Zones, Crosshair also plans to conduct a bulk sampling program on the Golden Promise Property in order to determine a more representative gold grade for the Jaclyn resource, since assay results from diamond drilling alone may not be an effective means of reliably determining grade in high-nugget effect gold systems. Studies of other high-nugget effect gold deposits, including deposits from the Bendigo Goldfield, indicate that assays from surface diamond drill holes may understate the actual in-situ gold grade in such deposits.

With that said, Rio Tinto, a 92.24 billion dollar mineral company based on its market cap, has positioned themselves the max amount in Northern Dynasty due to legal agreement threshold. Now, why would a company position themselves into a small mineral company like Northern Dynasty?

Well, I have two explanations behind this:

• Potential buy-out
• Stock is priced cheaper than its true value

For starters, Rio Tinto taking an approximately 20% stake into Northern Dynasty proves the validity behind Northern Dynasty exploration within the Pebbles region and the true value with their minerals.

Now, some may look at their balance sheet and say what is the underlying value? Their underlying value lies in the minerals that they own.

• 18.8 billion pounds of copper @ $0.05/lb (conservatively) = $94 million
• 31.3 million ounces of gold @ $80/oz (conservatively) = $2.5 billion
• 993 million pounds of molybdenum @ $0.02/lb (conservatively) = $19.86 million

The combined value of this is approximately $3.6 billion and the market cap is $1.39 billion value. Without even including the implied resources which has not been discovered as they are still exploring, the company is worth way more than their market value. With a $3.6 billion approximately true value / 99.3 million shares outstanding calculates into an approximate $39 dollar stock price. At the current price of about $15 dollars that is about a 160% increase if it is held long term. Now, let us say it is bought out at what people are speculating, $25. It still leaves you with a nifty profit.