How City banks and brokers stitched up local authorities with LOBO …

June 26th, 2014

By Rob Carver (guest blog)

First we had PPI. Then Libor. Then the misselling of interest rate swaps to SMEs. Now, ladies and gentlemen, I give you LOBO-gate: how banks ripped off local authorities and housing associations from someone who was there.

Cast your minds back to the early 2000s. Life was good. Both the public and private sector in the UK were doing well. But for treasurers of local authorities or housing associations, money was still tight on occasion. It was still necessary to borrow money.

One might have thought that local authorities could borrow very cheaply since in practise, if not legally, they are backed by the UK’s central government. Indeed, they are able to borrow from central government via the Public Works Loan Board (PWLB) at rates only slightly higher than the spread on UK government bonds. But, to a treasurer encouraged to make their department behave like a profit centre, even these rates were too high.

It would of course have made no sense for the local authority to approach a bank. Even in the halcyon days of the early 2000s, banks generally had worse credit ratings than the countries that hosted them, which meant they could only borrow money at higher rate than the sovereign nations; and that in order to make a profit, they had to lend out at a little more again.So, borrowing from a bank was inevitably going to be more costly than borrowing from the PWLB.

It would have made no sense at all…..and yet that is exactly what the local authorities did. And they were able to borrow more cheaply than from the PWLB. And the banks made huge profits, but not as much as some individuals working as money brokers did, for intermediary firms and brokerages such as ICAP and Tullet Prebon.

Welcome to the magic of the Local Authority Lender Option Borrower Option – otherwise known as LOBO loans. Surprisingly what little fuss has been made about these “too good to be true” deals to date has focused on their tenuous connection to Libor-gate. In fact this is a completely different scandal. Banks and brokers sold local authorities at least £7.63bn of such loans by 2014.

Financial alchemy

Let’s say I offer to lend you £40 on which I will charge you an interest rate of 3% over five years. Someone else comes along and offers you the same deal, but with the twist, that he wants to option to demand repayment in full whenever he chooses. You wouldn’t borrow money from him because he is clearly offering a worse deal.

Suppose he sticks to his guns but as a concession he will lend you the money at only 2.9% interest. Would you take that? What about 2.5%? 2%?

Essentially what I am asking you to do is to value the option of the lender wanting their money back. Why would the lender want their money back? There may be all kinds of reasons, but the most likely is that interest rates have risen to say 4%; and they would rather lend the money to some other person than have your 3% coming in.

Of course, as a borrower, having to suddenly repay the entire loan when interest rates rise is the worst possible thing for you. I assume you haven’t got the money to repay it. Unless you have hidden reserves, you’re going to have to repay the original lender and then borrow from someone else at 4%. Ouch.

There is nothing unethical or unusual about this (but don’t worry, the unethical bit is coming….).

In the LOBO deals, the lender has the right to ask for the loan to be repaid early. So they will charge less interest because they own a valuable option. The question still remains, how does the borrower value that option?

Enter the middlemen

To weigh up the merits of the mortgage option versus the repayable loan option you just need a Bermudan swap-tion pricer, to know the relevant volatility surface, some kind of interest rate model calibrated to the appropriate processes and the full forward and spot curve.

However it is unlikely that you have access to this kind of thing at home. 99.9% of people don’t. Which is why many of us use IFAs and mortgage brokers.

In the retail financial services market, the incentives were until recently skewed. Customers were reluctant to pay large upfront fees for advice, so advisers were paid through commission from the firms whose products they were recommending.

Likewise, in LOBO deals, the local authorities did not deal directly with banks, but were put together by middlemen known collectively as ‘money brokers’. The reason this was being done was supposedly to protect the local authorities…

Council mismanagement

Why keep the banks away from local authorities? Well, there was a landmark case in the early 1990s after the London Borough of Hammersmith and Fulham became embroiled with the trading of interest rate swaps (derivatives) in an attempt to reduce their funding costs (oh the irony!). It was decreed that they had exceeded their legal authority in signing these deals, and the judge concluded the deals were ultra vires (null and void). Local authorities were deemed to be too unsophisticated to trade these complex derivatives and were banned from doing so.

They were not allowed to trade swaps and certainly not Bermudan swap-tions, an even more fiendishly complex form of derivative. A Bermudan swaption is a right to cancel a swap… you can guess where this is going. Yes the kind of option embedded in a LOBO deal is a Bermudan swaption.

So what exactly is going on here? Is it okay for local authorities to take out cancellable loans (or cancellable fixed rate mortgages) which embeds a complex derivative, just as long as them directly?

Mechanics of a trade

Let’s examine a trade of which the author may or may not have had intimate knowledge whilst working on a bank’s derivatives trading desk in the early 2000s. (This is a ‘composite’ story with elements of things which really happened)

First, housing association B asked the broker to get them the best deal on a cancellable loan; say a 40-year loan, first cancellable in two years, and then every subsequent six months. Not many banks can do this kind of deal because the relevant derivatives market isn’t particularly liquid (because loans over 30 years are quite). The broker probably rang round three or four UK-based banks and at least one German bank.

Unable to do the deal themselves, the German bank called up one of the British banks to get a price for hedging the risk. This led to a situation where the relevant trading desk had requests for pricing an identical hedge from two different parts of the bank. The request made directly would have made the bank more money so the trader told the German sales guy not to mess around with letting the Germans try and undercut them and steal their business. One might imagine the Germans were given a quote that was sufficiently high to deter them from making a competitive offer to the broker. (This may border on cartel-like behaviour, but I’m not a competition lawyer so I don’t know.)

So the quotes come in from the banks. The broker chooses one.

I don’t know how he chooses the quote, I wasn’t there (I never even met the guy, all deals being done via bank salespeople). What I do know is that the quotes would have included a negotiated commission for the broker (remember the banks are paying him for arranging the loan). I know that the commissions on the deals we won (and we seemed to win quite a bit) were often very high compared to commissions on other brokered products.

Would the broker have chosen the best deal for the local authority or the best deal for himself? It might be harder to make the right decision if the commission was very large…

So, for example, most products brokered bank-to-bank had commissions of fractions of a basis point, or perhaps one basis point (1 basis point is 1/100 of a per cent). Whereas on some LOBO deals, the commissions could be approaching 1%. Although these deals are more unusual and complex than many other products, this is still a very large commission. In money terms we are talking £20m to £50 million dollar deals, on which six-figure brokerage commissions were not uncommon.

On this particular deal the commission was so large in percentage terms that it exceeded internal limits. Even the most rapacious traders on the trading desk were feeling pangs of…. well not guilt perhaps but fear their gouging of local authorities might one day be exposed. But the broker agreed to take half of the commission spread over subsequent deals, so that was okay.

The commission that the banks’ traders were personally earning on the deal would have been much lower than those the brokers were earning but, although not large in the grand scheme of things (billion dollar bond issues are not uncommon, though with much lower % profits), the deals were certainly making a healthy contribution to the derivatives trading desks profits.

This chart below, illustrating a £10 million Lobo loan taken out by the London Borough of Brent on 11 August 2009, should gives a taster of how local authorities got taken for a massive ride. The red line indicates the rate that at which the Royal Bank of Scotland told Brent it would be borrowing. The blue line is the Public Works Loan Board (PWLB) rate at which it could readily have borrowed. The green like is the actual LOBO rate that the London Borough of Brent is having to fork out  – to the massive detriment of its finances and the services it is able to offer its council tax payers.

Brent Council: Lobo; RBS pledged; PWLB interest rates. Source: Gary Kendall CDO2

Here is what Joel Benjamin of Move Your Money wrote about this particular LOBO loan following an FOI request in March 2014.

The recent FOIA disclosure of a 2009 loan agreement between RBS and Brent Council in London to Move Your Money has raised fresh questions of ICAP’s ‘market making’ activities, and the lack of regulatory oversight of UK local authority finance.

The loan agreement known as a ‘lender option borrower option’ or LOBO, is noteworthy for several reasons.

Firstly, the firm that advised Brent Council to take out the loan in 2009 was Butlers, a subsidiary firm of ICAP – noteable for losing half a billion of council cash in Iceland when the banks crashed in 2008.

The loan deal was executed by Garban International – another ICAP subsidiary, earning tidy profits for ICAP on both sides of the trade.

Finally, the structured loan signed in August 2009 features a fixed “teaser” rate, reverting to a floating interest rate which can be “called” higher by RBS at regular intervals, references not just the manipulated LIBOR rate, but the suspect ISDAfix rate as well.

How far does it go?

What I don’t personally know is the extent of this. It could just be a few isolated trades with one UK bank that I personally know about over a couple of years. I have absolutely no proof that this is a major problem. But I’d bet that it goes much further than this.

The immoral food chain

While none of this may been strictly speaking illegal, no-one comes out smelling of roses. The money brokers are the worst offenders; their behaviour was downright immoral and they personally benefited the most. It’s very easy to blame the bankers and they certainly should have behaved differently, but their incentives were to either pay the commissions or lose some very profitable business.

(What the bankers involved should have done was leave their jobs in disgust and go and work somewhere else more ethical. Then just when they had the moral high ground recaptured they should have spoiled it all by going to work for a hedge fund. It worked for me!).

But it isn’t just them. Just as naughty, I think, were the people who put pressure on the local authorities to trim their short term funding costs by a few fractions of a per cent, at any cost. The treasurers themselves. The well meaning people who through the law of unintended consequences prevented the local authorities from getting quotes directly from banks which could have improved things a bit. (This happens all the time. For example the use of financial advisors, investment and pension consultants to protect investors from being ripped off just adds layers of fees and in my opinion adds no value. But that’s a whole different story.)

This post is written by Rob Carver – visit his blog ‘Investment Idiocy’

Short URL: http://www.ianfraser.org/?p=10558

Source: www.ianfraser.org

Red Mountain Mining looks to early gold development at Lobo …

Wed 7:53 pm by Proactive Investors

– Red Mountain Mining (ASX:RMX) has completed an initial Scoping Study at its Batangas Gold Project in the Philippines that projects a total capital pay back of 14 months, and generates $40 million in free cash flow to the Company over the first 4.5 years of operation.

– That equates to an annualised free cash flow of $8.9 million, and values the project at >$26.7 million at a conservative 3 times cash flow.

– The project generates a high Internal Rate of Return of 70% on a light CAPEX of $16.7 million, and highlights the benefit of operating in a low cost and mine friendly jurisdiction.

– Red Mountain has identified JORC Resources of 408,000 ounces of gold at 2.2 g/t gold within the Batangas Gold Project. The development of high grade lodes along the South West Breccia Zone (Lobo Project) includes 45,000 ounces of gold at a grade of 7.2 g/t gold, and only constitutes ~3.3% of total strike lines that cover 15 kilometres.

– Recent drilling at the South West Breccia has delivered high grade gold, which importantly provides the company with an understanding at depth and indicate that it may be able to deepen the proposed pit design for the DFS.

– A resource upgrade is expected shortly.

– The Company is developing additional multiple high grade targets along the South West Breccia trend that have conceptual potential that is measured in the multi-hundreds of thousands of tonnes and are located along a 1.6 kilometre strike line. 

– Sampling, trenching and drilling are currently underway at Japanese Tunnel, Trench 13 and Signal, with high grade assays developing at all targets.

– Additional gold potential has been identified at Pica and Ulupong that are located on parallel strike lines.
 
– Red Mountain has commenced a Preliminary Feasibility Study and lodged mining plans for a 10 year mine life.

– Proactive Investors rates Red Mountain as a Speculative Buy with a 6-9 month price target of $0.017 – $0.025 per share (see Analysis and Valuation Guide) on currently defined resources. We believe that the gold potential at Lobo is significant and that gold resources will increase further in the near term and provide additional upside to our price forecast.

Recommendation: Speculative Buy
Share price target: $0.017 to $0.025   
ASX Code: RMX

Share Price: $0.011
52 Week High: $0.075, Low: $0.003
Ordinary Shares: 685.2M
Options: 278.3M

Cash (end of March): $3.1M
Market Cap: $7.5M
Enterprise Value: $4.4M

BACKGROUND

Red Mountain Mining Ltd listed on the ASX in September of 2011 as a gold explorer, developer and project acquisition company that is focused on the introduction of Australian mining methods and efficiencies to under-developed Asian gold and polymetallic resources. 

 

BATANGAS AND TAPIAN SAN FRANCISCO PROJECTS

On October 2012 Red Mountain completed the acquisition of its 100% interest in the Batangas Gold Project and 75% interest in the Tapian San Francisco copper and gold project (both located in the Philippines) from Mindoro (ASX: MDO) for a consideration of 100 million Red Mountain shares that were valued at a total of $10 million at the time of acquisition.

The Company maintains a strong board and highly skilled exploration and development team that has a track record of discovery and is currently focused on the fast track development of the flagship Batangas Project. 

BATANGAS FLAGSHIP PROJECT

The Batangas Project covers an area of 270 square kilometres that is located 120 kilometres south of Manila on the south coast of Luzon Island, and is within a regional province that is strongly endowed with major gold and copper and gold resources and mining projects. 

Mineralisation within Batangas consists of gold and copper-gold mineralised and pervasively altered andesitic volcanics, intruded by diorite and dacite intrusives, which are overlain in places by younger volcanic sequences. 

 

BATANGAS GOLD PROJECT 

The project area includes two key gold Mining Resource areas located on Mineral Production Sharing Agreements (Philippine equivalent of Mining Leases) at Archangel and Lobo, and copper and gold exploration areas on granted Exploration Permits at El Paso and Talahib. 

Gold mineralisation at Archangel is associated with extensive quartz stockwork veining and hydrothermal breccia’s hosted by shallow dipping andesitic volcanics, and gold mineralisation at Lobo is associated with a series of five parallel epithermal lode structures and breccias that have been mapped over a combined strike length of 15 kilometres.

Total Resources at Batangas (both Lobo and Kay Tanda) include:

– Inferred Resource of 3,020,000 tonnes at 2.1 g/t gold, for 200,000 ounces of gold, and 1.3 g/t silver for 125,000 ounces of silver.

– Indicated Resources of 2,760,000 tonnes at 2.3 g/t gold, for 208,000 ounces of gold, and 5.4 g/t silver for 481,000 ounces of silver.

– For a total of 5,780,000 tonnes at 2.2 g/t gold for 408,000 ounces of gold, and 3.3 g/t silver for 606,000 ounces of silver (at a cut-off grade of 0.85 g/t gold). 

RECENT HIGH GRADE DRILLING RESULTS LIKELY TO INCREASE RESOURCE

Red Mountain has recently been enjoying some high grade drilling success at South West Breccia, which included diamond drilling intersecting: (LB115) 5.35 metres at 8.18g/t gold from surface, including 1 metre at 18.5g/t gold.

The significance of hole LB115 is that it tested immediately below the recent Trench 27 intersection, which last month delivered: 19.4 metres at 8.24g/t gold, including 5.05 metres at 15.7g/t gold.

A deeper drill hole known as LB114 tested the southwest plunging depth extension to the SWB resource, delivering: 3.05 metres at 4.51g/t gold from a 69.6 metre downhole, including 1 metre at 9.5g/t gold.

These results earlier in June followed on from drilling success in May, which included: 6.7 metres at 11.6 g/t gold; and 18 metres at 6.85 g/t gold, including 6 metres at 11.5g/t gold.

These results are likely to increase the resource.

LOBO MPSA / MINING LEASE FOR HIGH GRADE OPEN PIT GOLD MINING 

The Lobo MPSA contains five parallel high grade epithermal gold structures that extend across the lease and include the Pica Trend, Calumpang-Balisong vein system, West Drift Trend, South West Breccia Trend and the Ulupong Trend. 

These high grade structures extend for a total of 15 kilometres, of which only a small part of this has been drilled along the South West Breccia Trend.

This 500 metre section of the South West Breccia Trend known as Lobo constitutes only 3.3% of the entire target area and currently hosts a JORC compliant:

– Inferred Resource of 16,000 tonnes at 5.3 g/t gold for 3,000 ounces of gold, and 1.7 g/t silver for 1,000 ounces of silver.

– Indicated Resource of 178,000 tonnes at 7.4 g/t gold for 42,000 ounces of gold, and 1.8 g/t silver for 10,000 ounces of silver.

– For a total of 194,000 tonnes at 7.2 g/t gold for 45,000 ounces of gold, and 1.8 g/t silver for 11,000 ounces of silver (at 0.85 g/t gold cut-off). 

Gold at Lobo is associated with a linear, steeply dipping epithermal lode with high grade shoots of mineralisation. Mineralisation remains open.

ARCHANGEL MPSA FOR ADDITIONAL RESOURCES OF OPEN PIT GOLD

JORC Compliant Resources at Archangel (Kay Tanda) include:

– Inferred Resource of 3,004,000 tonnes at a grade of 2.0 g/t gold for 197,000 ounces of gold, and 1.3 g/t silver for 124,000 ounces of silver.

– Indicated Resource of 2,582,000 tonnes at 2.0 g/t gold for 165,000 ounces of gold, and 5.7 g/t silver for 471,000 ounces of silver.

– For a total of 5,586,000 tonnes at 2.0 g/t gold for 363,000 ounces of gold and 3.3 g/t silver for 595,000 ounces of silver (at 0.85 g/t gold cut-off).

Gold at Kay Tanda is associated with a low to moderate grade stockwork gold deposit in andesitic volcanics.

SCOPING STUDY CONFIRMS LOW COST AND FAST PAYBACK OF CAPITAL

Red Mountain completed a Scoping Study in March of 2014 that confirmed resources at Lobo and Archangel could support an open pit mine life of 4.5 years to produce a total of 90,000 ounces of gold, and generate a free cash flow of $40 million to the Company at a gold price of A$1,500 per ounce.

The Study estimates a low cash cost of A$769 / US$690 per ounce, and a capital cost of A$16.7 million / US$15 million over a mine life of 4.5 years. Capital payback is estimated to take 1.2 years from commencement of mining operations. 

The process plant will be established 2 kilometres east of the seaside town of Lobo (population 37,000) and process open pit ore via a carbon in leach process.  

Average annualised production is estimated at 20,000 ounces of gold and 46,000 ounces of silver over the initial mine life of 4.5 years, and cash operating costs of A$769 per ounce include royalties, site taxes, refining charges and by-product silver credits. 

The 4.5 year process rate is estimated at 880,000 tonnes of ore with a head grade of 3.4 g/t gold, and 9.2 g/t silver for a gold equivalent grade of 3.6 g/t gold. This will produce o total of 90,000 ounces of gold and generate total Net Revenue of A$135 million / US$120 million for an Internal Rate of Return of 70%. 

Pre-production capital (with contingencies) is estimated at A$16.7 / US$15 million, and sustaining capital for 4.5 years is estimated at A$4.1 / US$3.7 million. 

Total free cash flow sensitivity to the gold price over 4.5 years is estimated at A$27 million at a gold price of A$1,350 per ounce, A$40 million at A$1,500 per ounce, A$53 million at A$1,650 per ounce, and A$74 million at A$1,800 per ounce.   

SOURCES OF FEEDSTOCK FOR THE INITIAL SCOPING STUDY

An open pit mining feedstock inventory was independently derived from the JORC Compliant Mineral Resource estimates by Dallas Cox of Crystal Sun Consulting, a Chartered Professional mining engineer contracted by the Company.

The mining inventory for the initial Scoping Study included 150,000 tonnes grading 6.4 g/t gold from the upper 80 metres of the South West Breccia Mineral Resource at Lobo This very high grade ore will be mined and processed within the first 18 months of production, and presents an opportunity for rapid pay back of capital. 

A further 730,000 tonnes grading 2.8 g/t  gold and 11 g/t silver, for a gold equivalent grade of 3 g/t gold will be extracted via shallow open pit from Kay Tanda West at Archangel. This ore will be mined and transported to Lobo by road then processed over the subsequent three years. 

Over 90% of the mining inventory for the Study is in the Indicated Mineral Resource category.  

Average mining cost is estimated at A$3.40 per tonne of mining feedstock and $2.60 per tonne of waste. Transportation of mining inventory from Kay Tanda West to the Lobo processing plant is estimated at A$7.20 per tonne. The total mining cost is estimated at A$37 per tonne of feedstock delivered to the process plant and includes all costs associated with mining all high grade, low grade feedstock and waste mining and transportation costs. 

Red Mountain is evaluating opportunities to extend high grade production through identifying further high grade resources at Lobo. There is also an opportunity to mine and process further lower grade resources from the Archangel project at higher gold prices, or based on lower on-site process costs.

METALLURGICAL RECOVERY AND PROCESS COSTS

The initial feedstock from the South West Breccia lode at Lobo will be processed at a rate of 12.5 tonnes per hour, for an estimated annualised rate of 100,000 tonnes, and average gold recovery rate of 95%. 

Ore from Kay Tanda West will be processed at a rate of 32.3 tonnes per hour for an estimated annualised rate of 258,000 tonnes, and average gold recovery rate of 90%.

This translates into an average life of mine annualised process rate of 196,000 tonnes for both ore types with average gold recovery of 92%, and silver recovery of 80%.    

The proposed process plant includes a preliminary circuit design that was produced by Sedgman Ltd a leading provider of mineral process plant. The design includes a two stage crushing circuit, ball mine, cyanide leach and carbon adsorption, carbon elution and regeneration.

The design includes a gold room along with electrowinning, cyanide detoxification, reagent mixing and distribution, power distribution and associated infrastructure. 

Process plant residues will be gravity fed to residue storage facility located close to the process plant. 

South West Breccia process cost for transition ore is estimated at A$44 per tonne, and at Kay Tanda West is A$22 per tonne for oxide ore, A$24 per tonne for transition ore, and A$23 per tonne for fresh ore.  Average process cost across all ore types is A427 per tonne.

The estimated capital cost of the process plant is A$10.7 million, made up of direct costs of A$8.6 million, and indirect costs of A$2.1 million for plant commissioning and contingencies.

Capital and operating costs are within + / – 30% which is typical for an initial Scoping Study.    

INFRASTRUCTURE AND ADMINISTRATION

Batangas will employ 232 personnel to handle mining, processing and other functions necessary to maintain the mine. This will include 144 local area personnel, 86 from other parts of the Philippines, and 2 senior expatriates. 

The workforce will be housed in the nearby Lobo town-ship and transported by bus to the two mine sites at Lobo (3 kilometres), Archangel (12 kilometres) and process plant outside of Lobo (2 kilometres).  

Site office and administration facilities will be maintained at the Lobo process plant. 

Permanent access roads to the Lobo and Archangel sites require 9 kilometres of newly laid road, and an additional 15 kilometres of existing road will be upgraded for access to all facilities.  

Power generation for all facilities will be generated via a leased diesel generating plant capable of outputting 1.3 megawatts at a cost of US$0.24 / A$0.27 per kilowatt hour. Red Mountain is also evaluating a hock-up to grid power that is available within 30 kilometres of the process plant site. 

A residue storage facility will be established close to the process plant and will initially handle 4.5 years of process waste. The facility will be lined and built to comply with required environmental and seismic standards. The facility will be capped and rehabilitated with vegetation on completion.  

PRE- PRODUCTION AND SUSTAINING CAPITAL EXPENDITURE

Pre-production capital expenditure is estimated at a total of A$16.7 million, and include land access $0.59 million, process plant with contingency $10.6 million, residue storage facility $1.0 million, earthworks $2.6 million, buildings with fit-out $0.37 million, vehicles and mobile equipment $0.67 million, power connection to diesel electric power plant $0.08 million, and Value Added Taxes and duties of $0.7 million.

Sustaining capital required during and on completion of mining is estimated at a total of A$4.124 million, and include land access A$0.468 million, residue storage facility $1.706 million, site earthworks $0.39 million, mine rehabilitation on completion of mining $1.519 million, and Value Added Taxes and duties of $0.041 million.

OPERATING EXPENDITURE OVER THE LIFE OF THE MINE

Total operating costs over the life of the mine are estimated on an Australian dollar basis and on a per tonne of feedstock ore processed, and include mining of ore and re-handling $37 per tonne, process plant costs $27 per tonne, and technical and administrative costs of $14 per tonne, for a total of $78 per tonne.

The same costs expressed on an Australian dollar basis per ounce of gold produced include mining of ore and re-handling $365 per ounce, process plant costs $365 per ounce, and technical and administrative costs of $139 per ounce for a total of $766 per ounce.

Refining costs including royalties, refining and net silver credits add an additional $3 per ounce to a total production cost of A$769/ US$690 per ounce.   
A financial cash-flow model for Batangas was prepared by consultants on behalf of Red Mountain and then independently verified and audited by Michael Conan-Davis FausIMM(CP), and adopts World Gold Council (C1-C3) guidance on cost reporting measures.

Total revenues from 4.5 year life of mine gold sales were estimated at A$1,500 per ounce for a total of A$133.707 million. Brake down of costs included on-site operating costs of $68.3 million, refining and smelting $0.295 million, by-product silver credits $5.021 million, and royalties and taxes of $4.989 million for a total C1 (World Gold Council) site operating cost of $68.564 million. This produced a C1 operating cash-flow of $65.143 million or A$731 / US$658 of free cash-flow per ounce of gold produced.

Additional costs include corporate tax $3.318 million, corporate administration $2.044 million, sustaining capital costs $4.124 million for a C2 sustaining cost of $78.049 million to produce a C2 sustaining cash-flow of $55.658 million or A$624 / US$562 per ounce.

Additional pre-production capital costs include $16.717 million, other payments and credits of -$0.935 million for a total C3 all in cost cash flow of $39.875 million to produce a C3 cash-flow of A$447 / US$403 per ounce of gold produced.

All estimates were completed at A$1,500 / US$1,350 per pounce of gold, A$24 /US$22 per ounce of silver, and A$ / US$ ratio of 0.90.

POSITIVE SCOPING STUDY LEADS TO COMMISSIONING OF DEFINITIVE FEASIBILITY STUDY

Red Mountain has now commissioned a Definitive Feasibility Study that will be completed in parallel with a recently submitted and expanded 10 year mining plan. This meets the requirements for Declaration of Mining Project Feasibility and related permit applications that have been submitted to the Philippines Government Mines and Geosciences Bureau of the Department of Environment and Natural Resources.

The estimate cost of the Definitive Study is estimated at $1.1 million and forecast completion date is December of 2014.  The Scoping Study contemplates commencement of construction (subject to financing) in the June quarter of 2015, and gold production to commence in the March quarter of 2016.

EXTENSION OF MINEABLE HIGH GRADE GOLD RESOURCES WITHIN LOBO MINING PERMIT

 

LOBO HIGH GRADE LODE SYSTEM – DEVELOPMENT IS NOW EXTENDING ACROSS MULTIPLE PARALLEL LODES

Red Mountain continues to advance sampling, trenching and drilling programs across the Lobo Mining Permit with particular emphasis on five areas known as South West Breccia shoot and its extension, Pica, Japanese Tunnel, West Drift and Ulupong.

 

FOCUS ON EXTENSION OF SOUTH WEST BRECCIA ZONE AND TARGETS WITHIN 500 METRES

Near term resource development focus is centered within exploration targets that extend for a distance of 500 metres to the southwest of the currently defined JORC Resource at the South West Breccia Zone.
 
Proactive Investors believes that the three exploration targets defined by the Company within this 500 metre strike line adds a conceptual tonnage target of at least 100,000 – 300,000 tonnes for evaluation and include:

– The extension of the South West Breccia Zone at depth, and small surface extension at surface;

– Exploration target along surface and at depth at the Japanese Tunnel; and

– A large target area that was identified by Trench 13 that extends under a shallow limestone cap. 

Red Mountain Mining collected surface float samples at the Signal Prospect which reported highlights of 72.6 g/t gold and 42.6 g/t gold and potentially extends the entire strike line from the south West Breccia to Signal by over 1,600 metres to the south west. Proactive Investors believes that this adds an additional conceptual tonnage target that is in the multi-hundreds of thousands of tonnes range.

Our conceptual tonnage estimates are attempting to define tonnages of rock for evaluation, and not gold resources. These estimates are meant to be indicative of the fact that the prospectivity of the entire 1.6 kilometre South West Breccia strike line has been significantly enhanced. This prospectivity will soon be defined by additional sampling, trenching and drilling.  

 

SURFACE TRENCHING OF THE “WEDGE” AT THE SOUTH WEST BRECCIA ZONE CONTINUES TO REPORT BONANZA GOLD GRADES AT TRENCHES 19 AND 21

Surface Trenching of the “wedge” at the southwest extension of the South West Breccia Zone continues to impress with Trench 21 reporting 6 metres at 31.2 g/t gold (including a bonanza grade of 1 metre at 122.6 g/t gold), and to the southwest at Trench 19 reporting 8.35 metres at 18.3 g/t au (including a bonanza grade of 0.5 metres at 136.9 g/t gold).

Drill-hole LB 92-14 completed within the same “wedge” intersected 1.5 metres at 8.1 g/t gold (including 0.5 metres at 12 g/t gold), and LB 98-14 intersected 1.2 metres at 4.65 g/t gold from surface to a depth of 1.2 metres, and 0.6 metres at 1.27 g/t gold at a depth of 23.65 metres.

Proactive Investors believes that Red Mountain will define additional mineralised tonnage at depth and at surface of the South West Breccia Zone.

The Japanese Tunnel prospect contains the Trench 21 vein with 6 metres at 31.2 g/t gold, and includes 1 metre at 122.6 g/t gold, and 3 metres at 59.5 g/t gold.

Drill hole LB 93 reported 3.9 metres at 4.6 g/t gold, and includes 0.75 metres at 15.7 g/t gold, and 0.5 metres at 7.16 g/t gold.  An additional 8 holes are planned to test near surface gold values within the Japanese Tunnel.

 

JAPANESE TUNNEL PROSPECT

Trench 7 is located at the southwestern end of the Japanese Tunnel prospect and reported 3 metres at 21.6 g/t gold. At least 8 additional holes are planned in this area to evaluate near surface gold values.

Trench 13 reported 2.6 metres at 28.6 g/t gold within a third target zone, and opens up a third mineralised area  that will be evaluated with four drill-holes. This third target zone is mostly covered with a shallow layer of limestone that may extend to the Signal prospect that will initially be evaluated with additional trenching and sampling.

The Pica prospect is located on a parallel lode system to the north of the South West Breccia zone, where early stage sampling at PC07 reported 2.5 metres at 9.2 g/t gold and included 1 metre at 14 g/t gold.

The Ulupong prospect is located on a parallel lode system to the south of the South West Breccia zone, where early stage sampling reported 19 metres at 9.77 g/t gold, and includes 7 metres at 23.6 g/t gold.

PHILIPPINES ECONOMIC BACKGROUND

The Philippines operates under a U.S. based system of democratic form of government that incorporates legislative, executive and judicial branches. The current President and head of state is Benigno Aquino III who was elected in June of 2010 for a six year term.

The islands of the Philippines were ceded to the United States in 1898 following the Spanish – American. In 1935 the country became a self-governing Commonwealth. 

The Philippines reported a high GDP growth rate of 6.8% in 2013, population of 107.7 million, and per capita GDP of US$4,400 for 2012. The International Monetary Fund projects an annualised GDP growth rate of 7% for the next five years.

The Mining sector is governed by the new Mining Policy Executive Order 79 of 2012 that demonstrates a commitment to the sector that includes a fast track for mining approvals and lifting of the moratorium for exploration permits, and is supported by a well-educated and English speaking workforce. 

The country has world class prospectivity for gold and copper gold resources that are being mined by Australian operators that include Medusa Mining (ASX: MML) at the Co-O mine, OceanaGold Corp (ASX: OGC) at the Didipio mine and the CGA Mining/B2Gold at the Masbate mine. 

CATALYSTS FOR 2014 – 2016

– Resource upgrade at Lobo pending.
– Results from sampling, trenching and drilling programs at Lobo released on an ongoing basis.
– Permits to mine at Batangas submitted to Philippines Government and grant of approval expected in late 2014.
– Definitive Feasibility Study for Batangas completed in December of 2014.
– Construction (subject to finance) to commence in June quarter of 2015.
– Gold production to commence in March quarter of 2016

ANALYSIS & VALUATION GUIDE

Red Mountain Mining is currently capitalised at $7.5 million, holds cash of $3.1 million and JORC resources of 408,000 ounces of gold at a grade of 2.2 g/t. This equates to an Enterprise Valuation of just $10.80 per gold resource ounce. 

A similar per ounce valuation range should be assigned to additional resource ounces that are developed during the current calendar year for additional upside.

Red Mountain is focussed on increasing mine life and high grade gold ounces within the Batangas project area, especially along the South west Breccia trend. Proactive Investors notes that potential for additional resources on new targets along this trend is conceptually at multi-hundreds of thousands of tonnes on targets that cover a 1.6 kilometre strike line. 

Capital costs for initial mine operations are low at $16.7 million, and generate a high Internal Rate Return of 70%, and confirm the low cost nature of operating in the Philippines.        

Based on the above, we find Red Mountain Mining to be undervalued.  Completion of the Definitive Feasibility Study should see a significant increase in resource ounces and total grades, along with an extension of mine life to at least 10 years. 

We rate Red Mountain as a Speculative Buy and assign a 6-9 month price target of $0.017 – $0.025 per share.

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