Malcolm Bucholtz B.Sc, MBA Analyst Trading Note Cobalt – This High Tech Metal is Starting to Shine Cobalt has been around for years, but up until recently it has been largely ignored by traders and investors who apparently did not stop to consider that Cobalt has a myriad of applications in things like high temperature magnets, rechargeable batteries in hybrid cars, high strength steels, carbides, catalysts for petroleum refining and gas-to-liquid technology, catalysts for automotive exhaust systems and of course super alloys. It is this latter category that requires the vast majority of Cobalt. The next time you are on a plane taxiing down the runway, stop for a moment and think that the turbine blades in a typical jet engine require up to 130 pounds of Cobalt.(1) But, focus is now starting to shift to this high tech metal as the markets figure out that it is vital to so many applications. And what caused this shift? The DRC – that’s what. As South Africa is to Gold and Platinum and as Chile is to Copper, so too is the Democratic Republic of the Congo (DRC) to Cobalt. In 2007, the DRC accounted for nearly 40% of 64,000 t global Cobalt supply. But the DRC is a political mess to put it bluntly. Years of civil war have seen the Cobalt mining industry fall behind as investment capital to develop new resources went to safer locales around the world and into other metals. Now to add to the DRC woes, the Deputy Minister of Mines has launched an investigation of all mining contracts in the country. Chances are that many will be revoked. As well, legislation has now been passed in Katanga Province that says Cobalt can only be exported in its refined form. This has dealt a severe blow to countries such as China, India, Norway, Finland and Belgium that have all been relying on unrefined concentrate from the DRC to feed their Cobalt refineries. There is one refining plant in Katanga Province (Gecamines facility) that in theory could be refurbished at a capex cost of $60 million. But, given the political uncertainties, what investment banking syndicate in their right minds would consider placing capital at risk in the DRC? Even if Gecamines did get refurbished, its output capacity is probably not enough to meet global demand which would then dictate that other plants would have to be built. The risk and time frame again would prove to be major obstacles in sourcing capex funding. Bottom line – the DRC can no longer be relied on as a source of Cobalt. Sad, but true.(2) As a result of events in the DRC, the global Cobalt market experienced a deficit in 2007 and it now appears that this deficit will continue for the next several years. As the following chart shows, this has driven a huge increase in price. Spot Cobalt right now is trading at about $49/pound up from $30/pound in late 2007. Enter – Geovic Mining and Cameroon Geovic Mining is a Grand Junction, Colorado based company that has not only taken due note of the situation in the global Cobalt market but has moved quickly to take action as well. Geovic has established itself in the African nation of Cameroon with a 60% ownership stake in Geovic Cameroon plc (Geocam). Geocam’s Mine Permit covers 1,250 sq. kilometers in Cameroon and provides exclusive production rights to seven large cobalt-nickel-manganese deposits. The project area is located 640 kms by road from the seaport of Douala. The closest town is Lomie, some 26 kms away. Access to the project area is by a well maintained highway from capital city Yaounde – an eight hour drive away. Southeastern Cameroon was subject to sedimentary deposition some 1.8 billion years ago. This sedimentation was subsequently metamorphosed into schists and quartzites. A fracturing event hundreds of thousands of years later brought ultramafic rock up from the depths and it is this rock that contains the Cobalt and Nickel mineralization. Intense tropical weathering over the centuries that followed has created large residual laterite deposits which comprise much of Geocam’s permit area. Geocam has been focused for many months now on the first of these deposits (Nkamouna deposit) and all the hard work is now starting to bear fruit. Consulting firm Pincock Allen & Holt has compiled a substantial amount of engineering work on the Nkamouna deposit. Nkamouna’s proven and probable ore reserves are 54.7 million tonnes grading 0.25% Cobalt, 0.69% Nickel and 1.33% Manganese. The 43-101 Technical Report released back in January, further noted that this tonnage at Nkamouna contains 299 million pounds Cobalt and 829 million pounds Nickel. The report also went on to say that the mineralization at Nkamouna “averages about 15 meters thick and will be relatively simple to mine with straightforward metallurgy”. Mining will be by the open pit method at a rate of 8.5 million tonnes of ore per year for 19 years at a stripping ratio of 1.87:1. Metallurgical testing has been carried out by several firms in the US. What has emerged from this work is the notion that the Cobalt mineralization is contained in a unique mineral structure called asbolane. Recovery of Cobalt and Nickel will be by way of a Metals Recovery Plant with a 2000 t/day throughput which will employ a leaching and solvent extraction methodology to produce 4000 t/year of Nickel oxide and 5700 t/year of Cobalt oxide concentrate (9% of 2007 output). Electrical power to service the planned mining operation will come from generation units fired with locally harvested wood products – in other words bio-mass. Adequate water resources appear to be available from the nearby Edje floodplain and so it is fair to conclude that there are no infrastructure issues that could derail this project. With several projects (ie Galore Creek in Canada) having been derailed by lack of infrastructure, the fact that Geovic has no such issues is a major positive factor. Project Economics – Very Compelling Initial capex to get Nkamouna up and producing is pegged at $397 million and the construction period is estimated at 24 months. Using a base case of $20/lb Cobalt and $11/lb Nickel shows that Nkamouna will generate an after tax NPV of $577 million at a 10% discount rate and $704 million at an 8% discount rate. These figures assume a capex funding structure of 40% equity and 60% debt. Using these base case prices, capex payback will occur in 2 years. Geovic’s share of this NPV is of course 60% given its 60% ownership position in Geocam. Taking 60% of these figures yields a 10% NPV of $346.2 million and an 8% NPV of $422.4 million. All in all, Nkamouna is a very compelling mining story. And – it is only one of seven such lateritic deposits. No doubt the other deposits will have varying degrees of economic value, but all should be sufficient to significantly add serious additional value to an already attractive looking project. Geovic – Do the Math Geovic at present has a basic share structure of 101.68 million shares outstanding and a fully diluted structure of 137.1 million when options and warrants are included. There are of course many ways to value a pre-production type story such as Geovic. With the NPV data having been estimated, we see can divide the NPV by the share structure to arrive at a rough estimate of per share value. I am going to use just the basic share structure in these calculations as many of the warrants are currently out of the money. Using the $346.2 million NPV figure and the basic share structure we arrive at a valuation of $3.40 per share. Using the $422.4 million NPV figure we arrive at $4.15 per share. Quite a stretch from current share prices which speaks to the notion of just how badly beaten down the resource sector is right now. At The Market Traders we often resort to a more crude methodology which involves assigning a nominal value to contained in-situ mineralization and then taking into account metallurgical recoveries. As noted above, the contained mineralization was pegged at 299 million pounds Cobalt and 829 million pounds Nickel. Using a nominal Cobalt value of $3 per pound (10% of what I perceive to be an average price over the past 3 or so years) and a recovery rate (as determined by Pincock Allen & Holt) of 58% along with a nominal Nickel value of $0.80/lb (10% of what I perceive to be an average price over the past 3 or so years) and a recovery of 16% we arrive at a valuation of $626 M. Taking Geovic’s 60% share of this and dividing by the basic share structure yields a valuation of $3.70 per share. So, at this juncture, it is fair to conclude that Geovic is currently trading at a level that does not properly come close to reflecting the true value of what it is sitting on in Cameroon. Accumulate Geovic (TSX: GMC) with a $4.00 Target Price Geovic President William Buckovic and his team at Geovic have done a substantial amount of work and have positioned Geovic for success in Cameroon. With events in the DRC causing a material and perhaps long term change to the Cobalt market dynamics, Geovic with its Nkamouna project which will be in production late in 2010 appears set to enjoy considerable financial success. Valuation calculations suggest that Geovic should come to eventually be trading at closer to $4. At the Market Traders, we will be watching the Geovic story with great interest. We are initiating coverage of Geovic with an “accumulate” rating on the stock. Use the current market volatility and any short term market weakness to build a position in Geovic. Geovic trades on the Toronto Stock Exchange under the ticker GMC. Company management is now also seeking to obtain a listing on the OTC BB market. For further information, be sure to visit the Geovic website at www.geovic.net or call Andrew Hoffman – VP Investor Relations at Geovic at 720-350-4130.