A golden wager on Azumah

Azumah Resources’ share price, like the rest of the gold sector, has been clobbered. Since 24 Jan 12 (Speculative Buy - $0.40), the share price is down 43%. Even by the standards of risky explorers, it’s a harrowing drop.

But it shouldn’t be a huge concern. Azumah is one giant wager. If the company is successful in getting its Wa gold project in northern Ghana into production, it should be producing at least 70,000 ounces of gold per annum by 2014 and will be worth far more than it is today. If Wa fails, Azumah will be worthless. To say this is the very essence of speculation is not to understate the matter.

The reason we’ve embarked on such a gamble is because there are good reasons to believe that Wa will eventually produce gold; the geology is simple; the metallurgy is excellent; and the prospects for resource expansion are high.

For new gold mines, simplicity can be more important than size. Easy geology makes early cashflow more likely, which can pay for resource expansion at a later stage. Happily, Azumah’s deposits present no unusual difficulties.

Standard deposit

This is as standard a gold deposit as you’ll find. Grades are higher than average without being sensational. Open pit production keeps operating costs low and geology is enticing enough to promise further discoveries.

Identifying gold is the easy part. Metallurgy, or processing ore into gold, is often where new mines falter. Rock that is harder than expected, the presence of other metals, or simply crushing rocks too coarsely or too finely can all play havoc with processing plans.

In this case, metallurgical testing shows high recoveries of gold—over 92%, which is considered very positive. Encouragingly, about a third of all gold is recovered from simply gravity separation, a low-cost technique not unlike panning for gold on a larger scale. Azumah scores well on the technical front but two areas still threaten the venture—politics and finance.

Politics and money

The ‘Africa discount’ is warranted in many parts of the continent. Zimbabwe, Congo and others have long been no-go areas. Recent political strife in South Africa, Mali and The Ivory Coast, all formerly bastions of stability, suggests crisis can never be ruled out. Political risk is serious, even in Ghana, home to one of the largest gold industries in Africa. Yet Azumah makes a case for caution rather than African exclusion. A cheap share price is preferable to ignoring the continent altogether.

Of more concern is the financing of the endeavour. Costs for new mines continue to rise and Azumah is seeking to establish its mine in northern Ghana, an entirely new gold province without a production history. Capital costs, before an ounce is even produced, will amount to about $150m.

Funding for a project of this size is easy enough in times of cheap credit and rising gold prices. Amid fear and a falling gold price, banks lurch from being promiscuous to picky. There are many examples of excellent projects failing to access funding and failing. It’s impossible to say whether this hurdle will be overcome or not but having Macquarie Bank as a 12% shareholder can't hurt.

No one can accuse Azumah of timidity. This year $20m will be spent on exploration. Five drill rigs, 18 geologists and 100 technicians are hunting for more gold. The company, in a move that reeks of hungry ambition, has even set up its own lab to process drill results faster.

Resource upgrade

And the drilling is paying off. Azumah has announced that measured and indicated resources increased 57% to over 1m ounces of gold. Total resources stand at 1.7m ounces and, with a little more drilling, this can easily rise to over 2m ounces of gold. Wa is growing into a significant resource.

One concern is that Azumah has lowered the cut-off grade it uses to measure resources, from 1 gram a tonne to 0.5 grams a tonne. This cheeky change means higher gold price assumptions and positive metallurgical tests, rather than exploration alone, have helped expand the resource base. The previous cut-off grade was conservative, roughly double the cut-off used by neighbouring mines, so bringing it in line with peers isn't a huge surprise. But it’s still a detail worth watching. Lower cut-offs from here won't be welcome. 

Having expanded the resource, the next step is to outline a reserve, expected later this year. The figure will be crucial, an indication of how much of the resource Azumah can realistically expect to mine. It’s a vital step towards funding and the realisation of our investment thesis.

Stocks at this end of the market will always be volatile but, with patience and some luck, today’s speculators have a good shot at success. Azumah remains a SPECULATIVE BUY but note the strict portfolio limit of 1%.