Research Report: Capstone Gold Corporation - written by Mike Kachanovsky  

August 30, 2004.

Capstone Gold Corporation has negotiated the option to acquire six late-stage exploration and former producing properties in Mexico.  Two of these properties come complete with infrastructure on site for milling and processing of ore deposits, and have the potential for rapid resumption of operations.  All of the properties have tremendous discovery potential to increase the resource through the application of modern exploration activity.

 

I believe that Capstone Gold has been virtually overlooked by the market, and the company is grossly undervalued at current prices.  A resumption in production will provide the company with the cash flow necessary to fund ongoing exploration commitments in order to complete the terms of the acquisition.  Because the share structure is tightly held, the company is leveraged for rapid appreciation in share values if they are successful in advancing the business plan.  I own shares of Capstone Gold.  -  Mike Kachanovsky 

Overview

In an effort to increase mining activity several years ago, Mexico encouraged the development of mineral deposits through a series of grants and incentives.  This resulted in the start-up of many smaller operations during the 1990s, working high-grade silver/gold deposits scattered throughout the prolific Sierra Madre Occidental belt. The smaller nature of these companies, many of them family owned, dictated that limited funding was available for exploration activity to fully exploit the contained resources, and in some cases only the highest grade ore was processed.  Many of these operations shut down as declining commodity prices resulted in an inability for the mines to earn a profit.  During this current bull market for precious metals, these mines are now re-appearing on the market as a new wave of junior explorers are taking advantage of revised Mexican mining laws, allowing well funded, foreign owned companies to acquire former producing properties and bring them back into production.

 

Capstone Gold signed a joint venture agreement with a subsidiary of Wheaton River Minerals in April 2003 to earn a 70% interest in a former past producing silver/gold mine, the Ventanas Project.  Subsequently they then announced an option agreement through their Mexican partner Compania Minera Bacis, for a 90% interest in 5 former producing properties.  The combined effect of these deals has positioned Capstone to rapidly advance to become a mid-tier silver-gold producing junior.  Several of the properties controlled by Capstone also contain significant resources of copper, lead and zinc.

 

Through an over-subscribed private placement offering completed in January 2004, the company was able to raise $9.1 million to fund operations and allow for aggressive exploration of the suite of properties.

 

The management team of Capstone is comprised of a balanced mix of hands-on geologists responsible for the exploration and development of dozens of projects throughout Central America, and capable financial and institutional specialists with the skills to secure access to markets and capital, and maintain compliance with regulatory issues.

 

Office Address:  401 – 750 West Pender Street, Vancouver, Canada, V6C 2T8

 

Telephone:  604-684-8894

 

Exchange Listing Symbol (TSX):  CSG

Website:  http://www.capstonegold.com

 

Share Structure:                        Issued and Outstanding:            26,302,788

                                                Options and Warrants:              16,347,534

                                                Fully Diluted:                            42,650,322

 

Market Capitalization:   $13.7 million

Projects  

The flagship property for the company is the Cozamin Copper-Gold Project, located in Zacatecas State.  The property includes a 750-ton per day milling facility.  Mining activity on the property has occurred intermittently since the arrival of the Spanish in the 1500s, and it is estimated that over 750 million ounces of silver have been produced in the prolific mining district where Cozamin is located.  Significant ore reserves remain to be exploited on the property, and additional exploration has revealed further zones of mineralization.  An initial drilling program was completed on the property in June 2004, comprising 20 drill cores for a total of 5000m, to verify data from previous exploration and target new prospective zones.  The first 7 cores were assayed and revealed the presence of additional high-grade ore both below and further along strike from the existing mine workings.  Also the results suggested the grades of the gold and silver resources increased with depth.  Due to the encouraging initial results Capstone then increased the diamond drilling program to 7,500m and later secured an additional drilling team and announced a further 5,000m of drilling.  Results are pending from the ongoing exploration work.

 

The objective of the program is to identify a reserve sufficient to provide feed-stock to resume operations at the mill.  An estimated $660,000 USD will be required to restart the milling operations, and a further investment of $1.4 million USD will increase the capacity of the mill to 1,200 tpd.  The facility is ultimately capable of processing 2,000 tpd with additional capital investment. The project benefits from superb infrastructure and access, located less than 4 kilometres via paved highway from the city of Zacatecas.

 

The Copala Silver-Gold Project in Sinaloa State also comes complete with a small milling facility with a capacity of 175 tons per day, and existing mine infrastructure.  Previous sampling and drilling activity has confirmed a vein system extending for more than 6 kilometres across the property.  A large deposit has been identified adjacent to the historic underground mine workings, and can be accessed by extending existing mine drifts further into the ore body.

 

Through the option with Minera Bacis, the company also controls the Claudia, Montoros, and Promontorio Projects.  All of these properties are past producers and are considered advanced stage exploration projects with measured and indicated resources identified through past exploration activity.  The resources do not meet the requirements for reporting as defined by NI43-101, but estimates for the 5 projects total resource total 90,792 oz Au measured & indicated, and 2,282,472 oz Au inferred, plus 8,723,963 oz Ag measure & indicated, and 106,770,065 oz Ag inferred. 

 

The Ventanas Silver-Gold Project in Durango is another past producer.  Extensive previous drilling efforts and several levels of drifting have been completed on the property prior to the JV deal with Wheaton River Minerals.  Recent mapping and surface sampling completed by Capstone have yielded encouraging results, and a drilling program has commenced with the objective to establish possible bulk tonnage targets.  The current resource estimate for the property is 18,958 oz Au and 1,636,602 oz Ag measured & indicated, and 7,753 oz Au and 979,328 oz Ag inferred

Outlook

Capstone Gold is a development stage company and as such does not have current earnings. The shares of the company appear undervalued with respect to the peer group of junior precious metals exploration companies, when considering other metrics for valuation.  For example, using a 60:1 silver-gold ratio, the total resource estimates equate to 4,386,475 gold equivalent ounces.  Expressed as a ratio to market cap using an exchange rate of 73 cents CDN, an investor in Capstone Gold today acquires an ounce of gold for each $2.20 of market cap, an exceptionally low ratio.  Due to the lack of current data supported by NI 43-101 compliant reporting, there is some doubt as to the accuracy of the resource estimates, and this may account for some of the discounted value the market has assigned to Capstone.  The current round of exploration activity focused on the various properties is designed not only to confirm the resource estimates and bring them into compliance with NI 43-101 reporting standards, but also has the potential to reveal new discoveries and further increase the already impressive numbers.  One would expect then that significant upside appreciation in the share price would result just from the company continuing with the exploration commitments necessary to earn their interests in the various projects.

 

The very low capital expenditure requirement of only $660,000 USD to bring the Cozamin Project into production represents a minor investment in comparison to the potential cash flow the project is capable of generating.  With the pace of ongoing exploration on the property, the high-grade nature of the results to date, and the well-funded status of the treasury, in addition to the strong outlook for commodity pricing, it is reasonable to assume the company will be able to successfully resume operations.  Further development of Cozamin is well within the capital resources of the company, and the management capabilities to execute.  It should be noted that the historic data for the tonnage of the deposit estimates a resource of 5.8 million tons (not compliant within the standards of NI 43-101 reporting), and this figure does not include the recent drilling data that in all probability will result in the discovery on new zones that will increase the tonnage further.

 

That the management team at Capstone succeeded in negotiating an excellent agreement to acquire the properties can be underscored by considering the intrinsic value of the milling infrastructure included with the properties.  In recent years mining companies that purchased used milling facilities and equipment in Mexico have paid about $10,000 per ton of capacity.  This would represent a market value of $7.5 million USD just for the existing mill at Cozamin.  The mine workings remain well maintained and could support new activity with a minimum level of refurbishment.  The capital investment requirement to bring a similar property to the status of the Cozamin Project would doubtless exceed several million dollars and a year or more in construction time. 

 

As the company does not have any exposure to commodity hedging it remains fully leveraged to rising spot prices that can be expected as the bull market in precious metals continues.  However, several of the properties controlled by Capstone have demonstrated the potential to become very profitable producers even in the event that commodity prices remain within a trading range close to the current levels.  By advancing their Cozamin project to production, CSG will generate profitability that will create added value for shareholders.

 

Companies in the junior exploration sector are very much leveraged to news flow, and the aggressive exploration commitments that Capstone Gold has agreed to will ensure a steady stream of reports to maintain investor interest.  The majority of outstanding warrants were issued in the private placement completed in 2004 and have an exercise price of $1.00 in the first year.  These will not result in a flood of cheap paper sold off into the market below that level, suggesting CSG has the potential to at least double from current prices with limited upside resistance as the company advances their business plan.  The full conversion of the warrants would result in the addition of a further $6-7.5 million to the working capital of the company.

 

The current share price for Capstone Gold is a product of the overly bearish sentiment in the sector, and is better regarded as an opportunity for patient investors to establish a position cheaply and wait for the inevitable recovery.  The usual risks and volatility of the junior sector very much apply to CSG, so an investment here is only suitable for those risk tolerant, sophisticated investors that can sustain large swings in share value.  However, taken in the context of the strong financial position of the company, the high quality suite of properties controlled, and the potential gains in share price as the company works towards their production goals, the risk in this case appears very much justified by the rewards

Disclaimer:  I have made my research and opinions available to the public as a resource to provide investors and the public with basic information.  My comments and opinions should not be interpreted as a recommendation or investment advice, which I am not qualified to provide.   While I have made every effort to maintain accuracy in the information I provide, it is possible that there are some errors or omissions in my coverage and the accuracy cannot be guaranteed.  It remains the responsibility of each individual investor to confirm if the subject of my analysis is appropriate for their investment objectives, and to conduct their own research and due diligence, and retain the services of a qualified advisor on to provide this service on their behalf.  I accept no responsibility for the performance of the companies that I feature in my coverage.  Junior mining and exploration companies are a risky market sector and investment in these companies can result in loss of capital.  Past performance is no guarantee of future success.  From time to time I may purchase stocks in the companies I feature in my reports, and I may sell some or all of my holdings.  I will disclose personal ownership in those companies that I refer to at the time of my first coverage, or after follow up reports.  I do not accept compensation from companies as payment to provide positive coverage or opinions.