Article on Nearby Madsen Mine (see map on RLG web site)Pure Gold - A New Gold Producer In The Making Dec. 28, 2017 Simple Digressions Summary Pure Gold owns a very interesting mining project located in the Red Lake gold camp, Ontario, Canada. Despite a few risks discussed in the article, the company's shares seem to be undervalued. The Madsen deposit, a core asset owned by Pure Gold, is a well-explored gold project; for example, its drilling holes database is one of the largest in the entire industry. This idea was discussed in more depth with members of my private investing community, Unorthodox Mining Investing. Pure Gold (OTCPK:LRTNF) is a gold exploration company developing its Madsen project in Ontario, Canada. In my opinion, Pure Gold is well positioned to become an operating mine within next two three years. The main features supporting this thesis are as follows: Gold project located in a prolific gold camp Huge drilling database Experienced management Relatively small CAPEX, definitely within the reach of the company What is more, the company is well-perceived by investors a recent bought deal financing was upsized from C$12.0M to C$18.3M. Introduction - Red Lake gold camp The Red Lake gold camp, located in western Ontario, is one the most prolific gold districts in Canada: Source: West Red Lake Gold Mines Since the 1930s this region has delivered around 30 million ounces of gold. Today there is only one large gold producer in the Red Lake district (Goldcorp) - this huge gold mining company operates the Red Lake high-grade, underground gold mine (I discuss this operation below). Apart from that, there are a few exploration companies holding gold projects at various stages of development. In my opinion, Pure Gold is the most interesting developer. Rubicon Minerals case I am pretty sure that many precious metals investors remember the Rubicon Minerals case. To remind, Rubicon Minerals (OTCQX:RBYCF) is a development company owning the Phoenix gold project located in the Red Lake district. In 2015 Rubicon tried to put this project online but very shortly the company failed. Well, failures happen but this case overshadows other projects located in the Red Lake district, Madsen included. Therefore, when discussing the Madsen project, I very often refer to the Phoenix case. Madsen project In September 2017 Pure Gold released a preliminary economic assessment for the Madsen god project. Let me discuss this document. A little bit of history Mining operations at Madsen were started in 1938 and continued until 1974. During this period as many as 2.4 million ounces of gold were produced at an average grade of 9.91 grams of gold per ton of ore. Then the deposit was explored by a number of mining companies as, for example, Goldcorp (GG) or Claude Resources. In 2014 the property was acquired by Pure Gold. Since that time the company conducted a few drilling programs and released two preliminary economic assessments. This month it commenced a definitive feasibility study that should be published in the third quarter of 2018. Deposit According to the latest preliminary economic assessment (the PEA), Madsen is a host to 5,785 thousand tons of ore grading 8.86 grams of gold per ton of ore, classified as indicated resources (1,648 thousand ounces of gold, in total). Apart from that, there are 587 thousand tons of ore grading 9.42 g/t, classified as inferred resources (178 thousand ounces of gold). However, the mine plan is limited to 2.9 million tons of ore, attributable to 911 thousand ounces of gold. Now, according to the PEA, there are five mineralized zones at Madsen where the future mining operations are planned: Austin, South Austin, McVeigh, A3 and 8 Zone. The first four are relatively shallow (they start at 100 meters below the surface) and the fifth one (8 Zone) lies beneath them (hence, it is not marked on the graph below): Source: Pure Gold's presentation and Simple Digressions (the green contour) According to the mine plan, the majority of the ore is to originate from the Austin, South Austin and McVeigh zones. Drill spacing and the number of drill holes According to Pure Gold (the PEA, page 115): The overall average drill spacing is 6.3 m in the high-grade zones and 9.5 m in the low-grade zones, while the overall median drill spacing is 5.9 m in the high-grade zones and 6.8 m in the low-grade zones. These results indicate a very tight drill spacing in the area of interest Why am I touching this issue? As a rule, the tighter the spacing between the drill holes the more reliable resource estimate. And the 6.3-meter spacing should be considered as a very tight one. What is more, the latest estimate is based on the database comprised of 14,627 drill holes (1.1 million meters drilled), of which 355 holes (114.5 thousand meters) were drilled by Pure Gold itself. In my opinion, the Madsen database is sufficiently large to construct a reliable resource model. Projects economics First of all, the Madsen gold project is a relatively small operation. According to the PEA, it should produce 65.9 thousand ounces of gold per year, on average. For example, since 2007 the Red Lake mine, operated by Goldcorp, has been delivering 539 thousand ounces of gold in annual production, on average. It means that it is highly unlikely that Madsen could be acquired by any major gold company. Simply put, it is too small. However, Madsen being an operating mine is a viable idea for me. Let me list a few basic features of this project: Source: Simple Digressions and Pure Gold Firstly, due to the fact that Pure Gold intends to build the mine using the previous infrastructure (shaft, mill etc.), the CAPEX is relatively small. To build the mine the company plans to spend C$50.9M (US$40.7M), which is within the reach of the company (for example, in November Pure Gold closed a bought deal financing for gross proceeds of C$19.2M). Now, using the price of gold of US$1,275 per ounce and a discount rate of 5%, the project should generate the after-tax net present value of C$258M (US$206M). An after-tax internal rate of return (IRR) stands at 47%, which is one of the best figures in the entire industry (at current gold prices). The mine should operate for nearly 14 years and deliver the gold at an average operating cost of production of C$226 per ton of ore. Let me digress a little bit at this point. Between 2007 and 2016 the neighboring Red Lake mine was producing its gold at an operating cost of production of C$245 C$414 per ton of ore so the cost assumed by Pure Gold seems to be under-estimated. Well, it may be the case so as long as this cost is not confirmed by a definitive feasibility study, investors should perceive this figure as a risk factor. By the way, Rubicon Minerals in its 2014 economic study for the Phoenix project assumed an operating cost of C$151 per ton of ore. Indeed, this cost was far too low Risk factors Apart from an operating cost of production (discussed above) there a few additional risk factors: Free cash flow profile Contrary to many mining projects, over the first four years of production Madsen is going to deliver relatively small free cash flows (C$16.5M per year, on average): Source: Simple Digressions Simply put, it will take the company four years to reach the zones where high grade parts of the deposit are located. In my opinion, it is a feature differentiating this project from the industrys average where the highest free cash flows are delivered in initial years of production. At Madsen the first serious free cash flow should appear in the fifth year of operations (the red rectangle on the chart above), relatively lately. I hope that the definitive economic study will show a better profile Gold grades I am a little bit skeptical about the grades disclosed in the mine plan. According to the PEA, the average grade reported at the Madsen mine should stand at 10.2 grams of gold per ton of ore. However, the average grade disclosed in the resource statement stands at 8.86 g/t: Source: Simple Digressions and Pure Gold In other words, it looks like the company is going to mine gold at much higher grades than those disclosed in the mine plan. Well, it is possible (statistically) butlook at these assumptions. According to the company, the main deposits where the gold is going to be mined are: Austin, South Austin and McVeigh (marked in grey in the table above). Interestingly, the average gold grade at these zones (8.01 g/t) is even lower than the average grade reported in the mine plan (8.86 g/t). Fortunately, those deposits consist of a few sub-deposits and a few of them report higher-than-average grades so, as I have noted above, it is statistically possible that the mine plan is correct. However, I would like to see a detailed statement indicating where the ore included in the mine plan comes from. The current PEA does not provide this data and, in my opinion, it should be considered as a risk factor. No reserves It is a standard risk - mineral resources are too speculative to be considered as an economically viable mineral material. Hence, we have to wait until the reserve estimate is published. To remind my readers, the Phoenix project was based on the mineral resource statement only. Despite this fact, Rubicon started the construction of the mine and the results were very poor. Catalysts Definitive feasibility study This month Pure Gold commenced a definitive feasibility study for Madsen. It is another step to de-risk the Madsen project. According to the Canadian Institute of Mining: A Feasibility Study is a comprehensive technical and economic study of the selected development option for a mineral project that includes appropriately detailed assessments of applicable Modifying Factors together with any other relevant operational factors and detailed financial analysis that are necessary to demonstrate, at the time of reporting, that extraction is reasonably justified (economically mineable). The results of the study may reasonably serve as the basis for a final decision by a proponent or financial institution to proceed with, or finance, the development of the project. The confidence level of the study will be higher than that of a Pre-Feasibility Study The last sentence is particularly important a definitive feasibility study should provide the more detailed data than the current study (the PEA). What is more, when the feasibility study is published (Q3 2018) the company should make a final production decision. Mill capacity According to the PEA, the Madsen mine should process 600 tons of ore per day. However, the current mill capacity is well above 1,000 tons a day so the company can very easily increase its throughput. Expansion potential Apart from the mineralized zones comprised in the mine plan, there is a number of exploration targets that can be converted into future mining operations. The two most important targets are: Starrat and Fork Starrat is another former operation, very similar to Madsen. Between 1948 and 1956 this mine delivered 164 thousand ounces of gold. Russet South this deposit is similar to the 8 Zone at Madsen, which is an ultra-high-grade gold deposit. Source: Pure Gold's presentation Valuation As discussed above, the net present value of the Madsen project is C$258M. According to my simplified calculations, now the company should hold cash of C$22.2M (taking into account the latest bought deal financing and cash held as of September 30, 2017) and no debt. It means that the equity value is C$280.2M (the Madsen net present value plus cash) or C$1.25 a share (assuming the current share count of 223.3 million). Today Pure Gold stocks are trading at C$0.55 a share so they are theoretically undervalued. PGM data by YCharts Summary In my opinion, Pure Gold shares present an interesting buying opportunity. First of all, Madsen seems to be a well-explored gold mining project the database of drilling results is huge and the drill spacing seems to be very tight. What is more, Madsen is a former producing mine, which increases its chances to become a successful operating mine once again (note that the Phoenix project has never been a producing mine). Further, the company seems to be doing the right things at the right time. Shortly after publishing a preliminary economic assessment it commenced the definitive feasibility study. Apart from that, it conducts a few exploration programs at the deposits included in the current mine plan and a few additional exploration targets which may become the future mines. In November Pure Gold closed a big bought deal financing. The company raised around C$19M so now it has cash to operate for another 3 4 quarters. The CAPEX disclosed in the PEA is relatively small (C$51M). In my opinion, it is within the reach of the company, which is another factor supporting my thesis that Pure Gold may become a producer in the not so distant future. Finally, Pure Gold is run by Darin Labrenz, a former chief geologist at the Campbell mine located in the Red Lake district. I think that it is a crucial factor enhancing Pure Gold chances to put Madsen online. Last but not least there are a few risk factors that should be cleared out in the definitive economic study. In my opinion, the most important risk factor, which is not well covered in the current study, are high grades projected for a future operation (refer to the section Risk factors).