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Another Free Call Option on Uranium

By Alf Field
January 11th, 2006

Compass Resources (code is CMR on the Australian Stock Exchange) will soon commence construction on its Brown’s Oxides copper/cobalt/nickel mine that by 2007 will be producing a cash flow sufficient to warrant a net present value (by any reasonable calculation) of at least double the company’s current market price. That means that all the company’s other assets – which include the potential to be Australia’s next uranium producer – come free. CMR can thus be regarded as a free call option on uranium.

Let me firstly declare my interest. I have been a shareholder of CMR for about a year now, which has been rewarding as the share price has risen from under A$0.50c to a peak of A$1.75 in September 2005 when the company raised A$15m in cash by issuing 12m new shares at A$1.25. A degree of profit-taking by these new shareholders resulted in the price declining initially to A$1.25 and them to A$1.00 in November. I added to my holdings at prices below A$1.25. I have no association with CMR, other than being a shareholder, and have not been paid nor received any other inducement to write this article.

What triggered my serious interest in CMR was the way the share price broke out upwards from a multi-year downtrend a year ago, as can be seen in the weekly chart below when the share price rose above the declining red line.

I have been studying the company’s assets and management for the past year and have become convinced that CMR is on its way to becoming a mid-tier mining company over the next 5 years and has a better than even chance of being the first, or one of the first few, new Australian uranium producers with a possible potential production of multi-million pounds of uranium per annum.

CMR plans to start mining its Browns Oxides section at a rate of 1m tons per annum, commencing in December 2006. Anticipated production and revenue at an exchange rate of US$0.735 to A$1.00, using current metal prices, is as follows:

Browns Oxides Production and Revenue Estimates

Copper 10,000 tpa (20m lbs) US$2.00 US$40m A$54.4m

Cobalt 1,000 tpa (2.0m lbs) US$15.00 US$30m A$40.8m

Nickel 700 tpa (1.4m lbs) US$6.00 US$ 8.4m A$11.4m

Total Revenue US$78.4m A$106.6m

Less Estimated costs -1.0m tpa x A$45 p/t US$33.0m A$ 45.0m

Pre-tax profits US$45.4m A$ 61.6m

Allowing for a 10% minority interest, the pre-tax profit attributable to CMR would be A$55m (US$40m) per annum. There is an important sensitivity to the A$/US$ exchange rate. A 10% rise in the A$ would reduce profits by A$10m (to A$45m) while a 10% decline from the 73.5 rate used would increase profits by A$10m (to$65m).

These profit estimates are significant relative to the capital cost of the Browns Oxide project of A$40m (A$33m still to be raised) implying a “pay-back” period of less than 12 months and also relative to CMR’s market capitalisation of A$120m or US$88m (80m shares fully diluted at the recent share price of A$1.50).

The Browns Oxides deposit sits directly above a much larger sulphides deposit. There are also considerable resources in CMR’s adjacent and nearby tenements. CMR’s announced JORC compliant base metal resources in this area of the Northern Territory have been disclosed at 84m tons containing 1.32 billion lbs of copper, 4.54 billion lbs of lead, 200 million lbs of cobalt and 192 million lbs of nickel. These code compliant resources will almost certainly increase when they are recalculated in the next few months to take account of the 2005 drilling results and the increase in metal prices.

The in situ value of these code compliant resources totals about A$14 billion (approx US$10 billion) split roughly 30% copper, 30% cobalt, 25% lead and 15% nickel, as calculated in the Chairman’s Year End Letter published on 19 December 2005. The company’s web site at www.compassnl.com.au is being redesigned and some of the latest announcements are not on the company’s web site, but they can be found on the ASX web site at:

Click Here

It is worth reading Chairman’s Year End Letter of 19 December 2005 as it provides a quick yet comprehensive summary of what CMR is all about. This letter can be found at the ASX web site detailed above. With 84m tons of resources, we can confidently predict that CMR will increase the amount of ore processed well above the 1.0m tons per annum for the initial Brown’s Oxide project. The Chairman has suggested that 4.0m tons per annum is a possibility, implying a 20+ year life.

Although the CMR Board has not yet given a formal go ahead decision on the Browns Oxide project, there seems to be little doubt that it will become a reality. The company has been buying good quality second hand plant for the project and immediately prior to Christmas announced the appointment of 3 new executives, one of whom will have the specific responsibility of bringing the project to a successful commissioning in December 2006. Final environmental and mining permits are expected soon and the A$33m funding still required should not be a problem given the robust financial projections for the project.

In the Broker’s Reports section of the www.compassnl.com.au web site are several valuations of CMR taking account of only the discounted net present value of the 1.0m tpa initial level of production. These valuations range from A$2.61 (Martin Place Securities) to above A$3.00 (Inter-Suisse and Ian Huntley). My own calculations verify that these numbers are reasonable. I stress that these valuations take no account of the value of the likely increase in production to an anticipated 4m tpa from 2010 onwards when the sulphides section will be mined. Nor is any value placed on the company’s uranium, gold and exploration assets.

These valuations are double the current share price of A$1.50. This is why I have been regarding CMR as a free call option on uranium. So let me get to the uranium story.

CMR’s Uranium Prospects:

The company’s official position on uranium at the moment is that they (quite correctly) do not wish to discuss this subject until they have produced a JORC code compliant resource estimate for their uranium assets. This calculation is being prepared and the Chairman has indicated that he hopes to have it completed by April 2006.

The market will only start to accord a value to CMR’s uranium potential once a definitive resource calculation has been presented, but there is a long list of reasons why a positive outcome may be anticipated. Firstly CMR’s tenements are a brown-fields uranium situation, having previously been mined and drilled extensively for uranium. It is not a green-field, grass roots exploration project.

CMR’s tenements include the Rum Jungle uranium mine that was in production in the late 1950’s to early 1960’s. The company was granted a “cost-plus” contract to produce 10m lbs of uranium for the Australian Atomic Energy Commission. These were the early days of nuclear power generation. Once this 10m lb contract had been filled (at grades in excess of 7 lbs per ton) the mine was closed, presumably for lack of customers and not because it had exhausted its reserves.

Considerable exploration drilling was undertaken in the adjacent area at that time (1950’s/1960’s) and CMR has all these old detailed records. Recent CMR drilling has been aimed at verifying the accuracy of the old drilling results, a fact that has recently been confirmed, and these old drilling results will be used in conjunction with more recent CMR drilling results to calculate the JORC compliant resources figure expected in April 2006.

There is a presentation by CMR on its uranium assets on its web site at:

Click here

This presentation includes location maps, historic drilling results, as well as the more recent CMR intercepts. A further uranium drilling program is scheduled for 2006.

An interesting note is that Malcolm Humphreys, the CEO of CMR, is an exploration geologist with plenty of uranium experience. In a previous life Malcolm was the chief exploration geologist for ESSO Australia and he says that at that time 50% of ESSO’s exploration budget was for uranium. ESSO were just 20 years too early!

The CMR web site is being redesigned so that uranium and base metals will be in separate sections and investors will be able to follow the area that interests them more easily. It is unlikely that management would go to this trouble unless they foresee an interesting uranium future for the company.

The final item on my list is located in the CMR Investor Presentation for the capital raising in September 2005 which can be found on the company’s web site at:

Click Here

Slide 13 of this presentation is headed “Browns Uranium – Overview” and the first statement is: “Inferred production ~ 4 million lbs/year based on conceptual exploration model”.

Given that CMR management consists of conservative mining people who are not prone to ramping the company’s share price, one must assume that they really believe that somewhere down the track CMR will be producing 4m lbs of uranium per annum.

These points taken together encourage me to the view that CMR will eventually produce a satisfactory JORC compliant mineable uranium resource. If this becomes a reality, then this “free call option on uranium” that I believe CMR represents, could prove to be extremely rewarding.

And CMR also has a Gold “kicker”:

CMR has farmed out its Wyoming gold discovery in New South Wales to Alkane Exploration in exchange for a substantial royalty. Alkane has recently announced a further good intercept (66 metres at 19.49 g/t) and will probably move to a bankable feasibility study this year. CMR has extensive gold exploration land holdings around the Wyoming discovery. CMR also has a 70% interest in the Nangali epithermal gold project in Peru, but does not plan further work on this project this year due to political unrest. Titles are being maintained.

ADDITIONAL INFORMATION:

Uranium:

The Potential Energy Crunch – Part 1

By Sol Palha and found at:

http://www.freebuck.com/articles/tactical/051229tactical.htm

According to Cambridge Energy Research Associates high energy prices are here to stay until 2008; we think if nothing is done to address the root cause of the problem that high-energy prices could plague Americans for at least another 9 years if not longer. Let’s look at some alternative energy sources

Wind Power - still not economical and needs huge subsidies

Coal - While cleaner technologies are being developed to process coal they are still not clean enough; it’s also very labour intensive.

Oil and Gas - these are non-renewable sources and no major discovery has been made for a long time.

Fuel Cells - while very promising it will still be years before anything truly promising has a chance to emerge from this field.

Hydroelectric power - the potential for more power from this source is limited as there are huge environmental concerns of creating new dams. In addition during times of drought power generation can drop to precipitous levels.

This leaves us unfortunately with only one option and that is nuclear energy; the problem is that everyone is now recognizing this at the same time. Nuclear reactors are powered only by uranium and there is only a finite amount of uranium available; to put it mildly at current production there is not going to be enough uranium to power all the new plants that are going to come online in the next few years. In fact we could hit a brick wall as early as 2007.

News Report on Uranium--January 4, 2006-- Canadian Analyst Forecasts 'Unbelievable Highs' Ahead For Nuclear Fuel As Utilities Scramble For Reliable Uranium Supply

Research analyst Kevin Bambrough for North America's top-ranked money management firm, Sprott Asset Management, predicts a major crisis ahead for U.S. utilities hoping to obtain fuel for their nuclear reactors, especially for those proposing new reactors. "The supply is just not there," warned Bambrough in a recently published interview appearing in StockInterview.com. "For people who want to bring on new facilities and contract for it (uranium), it's very difficult to do that," Bambrough advised utilities, "You have to go to mines that are not even there yet in order to try and contract supply."

Bambrough warns of a supply deficit peaking in 2015 that might hypothetically drive uranium prices to an "unsustainable" high "north of $500/pound." The U.S. EIA projects, during Bambrough's timeframe, 67% of the nuclear fuel required to power the 103 U.S. nuclear facilities has not yet been contracted. Under this scenario, Bambrough sees an investment opportunity with many of the junior uranium companies. He explained the Sprott team has invested in juniors that "acquired properties that were once owned and were actively being worked by majors at the end of the 1970's bull market."

Cobalt:

The market for cobalt is small, estimated to be about 52,000 tons in 2005. Much of the metal is produced as a by-product of nickel and to a lesser extent, copper. There are only about 30 producers world wide, so production is relatively easy to estimate, but demand and prices are shrouded in secrecy as refiners and middlemen attempt to protect their profitable markets.

CMR with an initial production of 1,000 tpa of cobalt, but rising to about 4,000 tpa when the mine expands, will be an important component of the cobalt market. The latter figure of 4,000 tpa is likely to be more than 6% of world production when CMR achieves that level of production, sometime after 2010. CMR’s future profitability will be sensitive to the price it receives for its cobalt. During 2004 the cobalt price declined from around $28 per lb to around $19 per lb at the end of 2004 as a feared shortage did not materialise. During 2005 the price declined further to about $14 in mid year and then started to rise again, reaching $17 per lb. In the profit calculations above for the Brown’s Oxide project, a price of $15 per lb was used which hopefully will prove to be conservative.

A useful web site dealing with the cobalt industry and supplying a great deal of background detail is the Cobalt Development Institute’s site at www.thecdi.com. One snippet that caught my eye was on the final page of the CDI’s October 2005 issue of “Cobalt News”, which is the following quote: “Examples of the beneficial uses of cobalt include – a range of catalysts for numerous environment protection applications such as the removal of pollutants from fuels. Latest research suggests that cobalt can be used as a catalytic converter in automobiles to substitute for costly precious metals” (My emphasis added.)

I have not investigated this item any further but with cobalt costing $1 per ounce compared to $1,000 per oz for platinum and $270 per oz for palladium, the economic advantages are obvious provided cobalt does the job as efficiently as the precious metals do. Approximately half the world’s platinum production (3.5m oz) goes into catalytic converters and a similar proportion of palladium production (4.0m oz).

There is no problem of sufficient cobalt supply – CMR’s initial production of cobalt will be 32m oz per annum, which alone would more than cover the motor industry’s requirements. The impact on platinum and palladium prices could, however, be very serious if this turns out to be a factual report.

Gold:

This is a very important chart. It is a 5 point/$5 reversal point and figure chart using only closing prices. That means that only moves of $25 or more are reflected in the chart. This eliminates most of the froth and “atmospherics” in the market and gives one a clear long term picture of what has happened. This chart of the gold price goes back to 1982 and depicts very clearly the massive quarter-century long base that has formed under the $500 level.

Recently the gold price broke out above the $500 level, then pulled back to test the breakout and is now steaming ahead. This huge base now becomes a launch pad for the market to move higher, substantially higher. The price objective from this base is well into 4 digit territory.

If anyone wanted confirmation that gold is in a new bull market, this chart supplies the evidence. Much has been written about gold being “over-bought”, with extreme highs in sentiment numbers. One should remember that these parameters were set during the 21 year bear market and during the white knuckle early phase of the new bull market. These old levels will be blown away as the new bull market gathers momentum. Old over-bought levels and sentiment parameters will be discredited and discarded. New bull market levels will be set.

Alf Field

9 January 2006

Comments to the author at: ajfield@attglobal.net

Disclosure and Disclaimer Statement: In the interest of full disclosure, the author advises that he is not a disinterested party in that he has a personal investment in Compass Resources Ltd shares. The author’s objective in writing this article is to interest potential investors in this company to the point where they are encouraged to conduct their own further diligent research. Neither the information nor the opinions expressed should be construed as a solicitation to buy or sell any stock, currency or commodity. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions. The author has neither been paid nor received any other inducement to write this article.