Thursday, 3 January 2013

Gold and Rare Earths in America

Elissa Resources: ELI.V/ELSRF
Current Price: $0.055
Target Price $1.60
Potential Gain: 2,809%
Shares Outstanding: 31,805,517
Market Capitalization: $1,749,303
Working Capital (as of September 30, 2012): $1,567,295

Click here to see Elissa's Investor Presentation

Jan 3, 2013 - With the fiscal cliff nonsense and the resulting increase in government debt from its temporary solution, it's no secret as to why some Americans and other investors are loading up on gold. The rare earths craze for lanthanum, neodymium, samarium along with over a dozen of other elements has also become apparent as they are needed for everything from high-tech gadgets like Smartphones to military equipment. Given the current political environment facing the United States, it is prudent for the country to secure its own domestic source of rare earth elements as China currently owns 95% of the world's supply.

In comes Molycorp (MCP). The company's stock price has been ravaged with high volatility thanks to balance sheet issues and the resulting dilution and issues with an SEC probe. Despite the struggles with their stock, increased awareness over the need for a domestic REE supply and announcement of the start up of heavy rare earth production on their Mountain Pass REE Mine in California a few months ago leaves the company in a very strong position for success going forward. The Mountain Pass project ensures that Molycorp is the largest domestic supplier of rare earths in the US. The stock shot up 10% to $10.39 on Wednesday after a Bloomberg article stating that Molycorp is a prime takeover target by a manufacturer such as Nissan, Siemens or someone else who would love to secure their supply of rare earths in their manufacturing process. 

The rise in price to over $10 represents a complete 180 degree turn for the company from its $6 lows in mid-November after the SEC probe news. An indiscretion by management in no way devalues the highly sought after resources in the ground at Mountain Pass. Rather, the beat up stock price gives a larger company an incredible opportunity to buy up Molycorp assets cheaply. Molycorp's current market cap of $1.43 billion is just slightly over what they paid for Neo Material Technologies just a few months ago

A possible takeover of Molycorp by a private firm would have huge implications for the REE industry. As mentioned above, the United States has a vested military interest in these rare earths and hundreds of US and multi-national corporations rely on them. Privatizing Molycorp, particularly into the hands of companies with no allegiance to the United States like Nissan or Siemens would not help alleviate their reliance on Chinese exports for REE. 

Great Western Minerals (TSXV:GWG, OTCBB:GWMGF) was also up strongly on Wednesday, building on their reversal from the last trading day of 2012. A buyout of Molycorp has implications for them as they have a processing plant in Michigan, hold several large REE exploration assets throughout US-friendly Canada and hold operations in the relatively West-friendly country of South Africa.  If Molycorp was to fall into private hands, Great Western Minerals would themselves become a prime buyout target. It would be of great interest to American and Canadian political interests to see GWG's business succeed so that the processing of these rare earths takes place.

While a Molycorp takeover has a very positive effect for shareholders of GWG as well as similar companies to a lesser extent like Stans Energy (TSXV:HRE) and Orbite Aluminae (TSX:ORT), both of them also up 10% on Wednesday, there is no company that would benefit more from a takeover of Molycorp than Elissa Resources (TSXV:ELI, OTCBB:ELSRF). ELI was up 38% on Wednesday on reaction to the Molycorp buyout news and looking at the map below you can understand why. Sitting just 16 miles away from MCP's Mountain Pass project is Elissa's Thor REE Project. The project is across state lines so its close proximity is often overlooked.

ELI was born out of the same Red Hill Energy transaction that eventually led to Prophecy Coal (TSX:PCY) and Prophecy Platinum (TSXV:NKL). ELI's shares raced over 60 cents in the summer of 2011 at the height of the rare earth craze and at the recommendation of Brien Lundin but now have dropped to 5.5 cents as their phase one drill results did not garner enough attention in a weak summer market for small cap commodity stocks and Molycorp. As a result ELI's market cap has dropped to just above their cash value, leaving very little downside left for investors who choose to get into the stock right now. In the face of this weak market, the company wisely decided to hold on to their cash resources and delay any further drilling until the market picked up.  

Elissa's closeness to Mountain Pass and Molycorp's recent purchases of AS Silmet and Neo Material Technologies makes them a prime buyout target for expansion of REE development in the area. MCP has taken the steps to secure the refining technology so that Mountain Pass will go from "Mine to Magnets" all under Molycorp's control when they bought NEM. The next step in evolving the company would be "More Mines to More Magnets" which means buying out adjacent lands to build an even larger site and benefit from economies of scale. Whether MCP is operating under their own name or ends up as a subsidiary of another company does not impact the attractiveness of ELI as a buyout target for their business. However, if a transaction on MCP were to take place, a speculative spike would be seen for all the rare earth plays - GWG, HRE, ORT etc - but the biggest spike would likely take place on the company with property just 16 miles down the road. 

Why would Molycorp target Elissa? Other than the close proximity, reading Elissa's November 15th, 2012 MD&A commentary of their Thor property shows:

"The mineralized intervals encountered in the Thor drilling are hosted by an apparently widespread biotite-rich granite/syenite unit. Ongoing independent studies of core samples from the drilling program by outside consultants and university researchers suggest the REE mineralization may have formed as part of the rock body itself. Petrographic studies (by Dr. Virginia Gillerman, Economic Geologist with experience in REE mineralization) indicate that the mineralization encountered in the drilling is associated with abundant biotite‑rich zones (or layers) within the alkali granite/syenite host unit and occurs as small, indistinct “veins” of apatite‑monazite (REE bearing phosphate minerals) that follow grain boundaries. There is little or no evidence of open-space fracture filling, and it is suggested that the REE minerals may have been emplaced from within the rock itself while the rock was still in a plastic, slightly molten state.

A new host rock/mineralization model for the Thor REE Project is being prepared. This new model will assist in a second pass drilling program planned to target a possible REE bearing rock system of significant size. Surface and geophysical work to date indicate the Lopez Trend and other untested targets on the Thor property remain widely open on strike and to depth. Elissa is supporting ongoing petrographic work and university research in an effort to advance an understanding of the REE mineralization. Elissa’s team of experienced consulting geologists now think that the known Lopez Trend represents part of the eastern limb of a very large, perhaps overturned, fold with the nose and similarly sized western limb of the fold, known as the Santos Trend, being concealed by shallow alluvial cover. If so, the total strike length of units equivalent to the REE bearing host exposed along the Lopez Trend could be 20,000 feet (6 km) or more."

As the size of the Lopez trend on Elissa's property could be over 6 kilometers, it would greatly contribute to the economic scale of Mountain Pass and add to it's longevity. This is an important consideration since Project Phoenix - the expansion and modernization project at Mountain Pass - will approach $1 billion in capital expenditures in addition to the over $1 billion spent on NEM. Any viable mine that's close by will be looked at as a potential expansion target.

MCP currently has a $1.43 billion market cap which was as high as $6 billion in the Spring of 2011 when investor interest in rare earths was at its peak. As rare earths are moving back into focus it's reasonable to believe that MCP can return to a $6B market cap level in the near future if they are not purchased before then. Assuming Elissa's Thor Property is valued at just 2% of Molycorp that would make the company worth $120 million from their REE mine alone during bullish times for rare earths. 

In addition to Thor, ELI has the St. Elmo Gold Project in Nevada. Located close to Newmont's Midas Mine, it has produced high-grade gold from the surface to a depth of at least 140 meters below surface in the past. From Elissa's MD&A:

"In 1990, Harrison Western Mining opened 70 m of new underground drift in the mine and extracted 1500 tons of material with an average reported gold grade of 11.3 g/t (0.33 oz/ton). A 360 kg bulk sample of this material sent to Hazen Research in Golden, Colorado, averaged 80.9 g/t (2.36 oz/ton) gold. Preliminary metallurgical test work returned 95% gold recoveries using standard gravity and flotation processing methods. The St. Elmo vein system was not examined by drilling until 1999, when 3 core holes were drilled under the St. Elmo workings, intersecting values of up to 16 g/t gold (0.466 oz/ton gold) over 2 m within a 16 m-wide zone of quartz breccia. In 2007, the property was further examined with 3 reverse circulation holes and in 2009 with 12 reverse circulation holes and 3 horizontal core holes, all of which were collared from only four separate permitted drill sites. Only selected sample intervals were chosen for assaying, a significant number of which returned anomalous to encouraging amounts of gold, including 3m of 16.8 g/t (0.49 oz/ton) gold."

Even when valuing the St. Elmo Gold property at zero, it is still reasonable to think that Elissa will capture the $120 million of value locked in Thor based on its close proximity to the now producing Molycorp mine. As Elissa further develops Thor they will receive capital for the project through exercise of the 30 cent warrants and through further private placements at prices much more favourable compared to today. It's reasonable to expect that the company will have about 75 million shares outstanding as they advance Thor. At a $120 million market cap that leads to a stock price of $1.60.

Many junior miners appear undervalued by as much as 10 times thanks to the current state of the market, but Elissa appears relatively undervalued even to them. In this investment climate it is prudent to put your money behind a company with a strong cash position that has a market cap close to that cash amount but also has very prospective properties that are in close proximity to a major player so there is the greatest potential upside with minimal downside. Add in the fact that Elissa is all about rare earth elements and gold in America and sits right beside one of the most ambitious companies in the REE mining sector and you are talking about a company that could explode in price as quickly as they did back in May 2011.