Gammon Lake Resources: Another Mexican Treasure

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Trey Wasser (III-D Capital) submits: I recently wrote about the "Treasure of the Sierra Madre" focusing on the “bootstrap” mining methods being employed by some of the junior mining companies. Re-opening old mines with smaller mills and re-built infrastructure is proving profitable for many juniors. However, I do not want to leave readers with the impression that this is the only “treasure” being uncovered in the Mexican Mining Industry.

Mexico is very mining friendly. They have reasonable environmental laws and are consistent in their assessments and permitting. Mexico’s long history of mining has produced a large labor force that is very talented. Labor costs are reasonable and foreign ownership of Mexican Mines is widely accepted. Social programs are helping to cement local relations and stimulate the economy. Several junior companies have recently discovered and are developing some very productive and profitable mines in Mexico.

One of my favorites is Gammon Lake Resources (AMEX: GRS - News). Gammon Lake discovered a significant gold/silver deposit in the Ocampo District in 1998. Production at Ocampo began in 2006, and after a few problems with metallurgy, is now in full commercial production. What is especially impressive about GRS is that in only 8 years they went from initial discovery to becoming Mexico’s largest gold producer.

The Ocampo Mine is an excellent example of the extraordinary potential of newly developed mines in Mexico. Ocampo is located in the Northern Sierra Madres in the State of Chihuahua. Historically, Chihuahua is probably the most under-explored states in Mexico. What makes Ocampo particularly attractive is that it is actually two mines, an open pit heap leach operation and a very high grade underground mine with a mill and flotation system. Recovery rates at both mines are extremely high.

The open pit mine has high grade veins that average as much as 19.7 GOE per ton as well a low grade overburden. Even the overburden pays to be mined, so Ocampo has literally no waste rock. In addition, the highest grades from the pit are taken to the mill where recoveries are 96% for gold and 93% for silver. Conversely, the lower grades from the underground mine are taken to the leach pad. The Ocampo silver ore is a silver sulfide, which is cyanide-soluble. This results in extremely high recovery rates for silver. This efficient operation allows GRS to maintain cash costs at under $200 per gold equivalent ounce.

The feasibility study, released in 2004, indicated production for the first several years of 170,000 ounces of gold and 6MM ounces of silver. However, 2007 production is now estimated at 200,000 oz gold and 10MM oz silver. The underground mine currently is out-producing the mill. The stopes are much longer than originally estimated. Plus a second underground mine is already being added this year. By adding a filter press, for $2.4MM, 2008 production will grow to 240,000 oz gold and 12MM oz silver. Next year, they will add 3 new leach tanks and increase 2009 production to 280.000 oz gold and 15MM oz silver. Mine life has grown from 7 years in the Feasibility Study to over 13 years today. Resources continue to grow as GRS drills the property. Total resources are now 8MM ounces of gold and 400MM ounces of silver. While about half of these are inferred resources, they are already mining one vein of inferred mineralization and seeing grades averaging 11.5 GOE per ton. Only about 30% of the Ocampo District has been drilled.

The infrastructure at Ocampo is state of the art. They have their own power plant and a modern hotel for workers. Ocampo is already one of the largest and most profitable precious metal mines in Mexico. Steven Saville, of TSI, likens it to Goldcorp’s Redlake Mine which is considered the highest grade gold mine in the Americas.

Gammon Lakes also owns the El Cubo mine. El Cubo was acquired through the Mexgold merger last year. GRS has increased production by 100% since 2005 and more improvements are on the way. Recent drilling results indicate that the El Cubo complex will see significant resource increases and may validate an open pit operation. Production for 2007 should be 83,000 GOE growing to over 132,000 GOE by 2009.

Overall production is projected to grow, organically, about 50% from 420,000 GOE in 2007 to over 610,000 GOE in 2009.

GRS also has a very promising prospect at Guadalupe y Calvo. This is a historic mine where grades were so high that the Mexican government erected a mint right at the mine-site. The Company has really not focused on this project since the Mexgold merger as they have been concentrating most of their drilling dollars at Ocampo and El Cubo. But this very rich district has been underexplored and historic mining always stopped at the water table.

April 2007 was a very busy month for GRS. Early in the month, the Company announced the appointment of Richard Barwick as the the CEO. Barwick is a seasoned veteran with 33 years of experience. Most recently he was COO of Wheaton River-Goldcorp. This news was followed by the announcement of a $200MM secondary offering. The Company issued 10MM new shares at $20 (Canadian) with no warrants or other incentives. The funds will be used to payoff the Ocampo debt (about $132MM0 and speed up the improvements at Ocampo/El Cubo. This will accelerate production growth at least 6-8 months, according to the Company. This means that GRS could be producing close to 50,000 GOE per month by late 2008 or early 2009.

At today’s price of $16, Gammon Lakes is selling at 13 times 2007 earnings and 12 times cash flow. They were one of the companies I highlighted in my report titled “Gold Stocks Earnings to Shine in 2007”. While the majors struggle with declining production and skyrocketing costs, there are selected mid-tier producers, such as Gammon Lake Resources, that offer extraordinary fundamental value.

GRS is a solid core holding in my portfolio with a 12 month price target of $26 per share.

GRS 1-yr chart

GRS

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