Hallgarten & Company

• The mining corporate scene continues to strengthen with more companies moving into the “fundable” category (including some that are deeply unworthy of life after death). At best this gives investors trapped underwater in some stories that are no longer convincing a second chance to exit gracefully

• The rise in base metals has ruined chances of Chinese bargain-hunting so now they shall have to settle for relative bargains and move down the food chain to the levels where their overtures will receive a better reception.

• Precious metals have stabilised with the effect that investors have started searching out left behind sub-sectors in the mining space. The moves in the base metals have not taken them back to previous highs but some, copper in particular, have not been brought back to levels broadly above production costs.

In looking for the “next big thing” the moly and uranium spaces seem the obvious candidates The “last big thing” that strikes us as a flash in the pan is hard-rock lithium It is worth repeating our comment of last month that “Chinese dabbling in the markets may

retreat (and they may even attack prices to create a bear-trap for speculators that followed them in) however base metals could stay around their current levels as destocking has left manufacturers with low inventories and massive capacity shutdowns in zinc and nickel (and to a lesser extent copper) have reinforced the perception that the longer term supply deficit in most metals has not gone away and has probably been exacerbated”.

The Month that Was

The past month was not one of the more exciting in recent mining history. The first flush of gold was a long while ago now. The base metals have gone into a consolidation phase at their new higher levels despite negative talk about the Chinese “having finished” their buying spree. The metals have not staged an appreciable retreat as one would expect with all the negativism on what the Chinese will do next. Maybe they have realized they shot themselves in the foot at Rio Tinto and elsewhere by their buying of metals “ with the ears pinned back”. Too late for regrets there but they definitely would be unwise to force metal prices higher as Rio getting away now mens they will have to make acquisitions lower down the food chain and mining/explorer managements are becoming more empowered by the day and we are sure the Chinese are hearing “No!” all over the place as they make their discrete enquiries over their next targets.

Some of the moves have been quite stunning and this prompted to take profits on some longs and some shorts during the month. Despite the aforementioned pacific nature in the base metals of late, some of the second tier producers and producer wannabes got walloped, probably on the fear that the mini-rally in metals was over. Curiously stocks like Quaterra and Dynasty got beaten down while Lundin, a big zinc producer staged a big upward move. We also did well with IAMGold for reasons discussed later.

US Gold was our Short that did not work out as the Great Unwashed piled in to get part of the action (if there is any). Most likely is the long-denied move on Minera Andes (which we hold as a Long). That stock moved up even as the traditional management was ousted to make way for McEwen men. Believe us.. we will be gone from the stock the second they announce the all-stock offer for MAI, as we do not want to be Long US Gold when we can be Short!

Relatively Active – for a long-term portfolio

The past month’s transaction were:

‹ Established a Long Position in Mercator Minerals (ML.to). Purchased 84,933 shares at CAD$1.35

(6:31 AM Jul 1^st)

‹ Established a Short Position in Vale (VALE). Sold 8408 ADRs at US$17.84 (10:01 AM Jun 29^th)

‹ Closed our Short position in African Copper (ACU.L). Purchased 3,446 shares at GBP 6 (3:37 PM Jun 24^th)

‹ Closed our Short position in Gabriel Resources. Purchased 46,964 shares at CAD$1.68 each

(3:35 PM Jun 24^th)

‹ Added a Long position in Cardero Resources to the corporate actions section of the model portfolio. Purchased 98039 CDY at USD1.02 (10:58 AM Jun 11^th)

‹ Closed our Long position in OZ Minerals in the model mining portfolio. Sold 262535 shares OZL.ax at AUD0.89 (10:47 AM Jun 11^th)

‹ Added a Long in the West African gold producer SEMAFO. Purchased 150,000 SMF.to at CAD2.23 (8:57 AM Jun 3^rd)

‹ Closing our Long in Mirabela Nickel. Sold 145529 shares at CAD2.68 (5.26 AM June 3^rd)

Raisons d’être

Our move on the model portfolio since last publication was to close out the highly successful Long in the Brazilian nickel near-producer Mirabela (which has ASX and TSX listings). Our gain was just too large to leave ion the table in light of the rise in the Australian dollar and the enhancement in the stock price since we instituted the position.

To replace Mirabela we chose the Quebec based gold producer SEMAFO that operates the Mana mine in Burkina Faso. It also explores in Guinea and Niger (for uranium in the latter). Production runs at around 30,000 ozs of gold per quarter. We had recently met with the company at the NYSSA mining conference and were suitably impressed both with the company’s own merits and its attractiveness as a takeover target for IAMGold or Randgold. While the latter steers clear of acquisitions (and is a stock we admire a lot) its very high valuation makes it stock into a great currency to do all stock takeovers and SEMAFO looks like the largest bite sized producer in the general vicinity. We might also have hoped that IAMGold might make a move and that might yet happen. SEMAFO itself would have been a good buyer for Oromin OLE.to) which we also hold as a Long but IAMGold (surprise, surprise) snapped up 17% of OLE in a placing during the past month, putting it in a prime position to swallow the whole as the resource of Oromin in Senegal gets more proved up. Oromin, up XX% for the month was not as big a move as one would have hoped considering it has moved into the IAG orbit. Maybe just goes to show that companies that sell strategic stakes at a discount end up removing themselves form the target range of other predators and forestall a bidding war either now or in the future. It is shareholders that end up shortchanged by this trend.

Our position in SEMAFO at 150,000 shares was significantly larger than our previous limit ($100,000 for initial positions) for stocks in the mid-cap category. SEMAFO’s market cap is around $300mn.

We added a Long position in Cardero Resources (CDY) as per the rational in our recent note on that company.

We closed the Short position in the London-listed African Copper (ACU.L) when, as predicted, reality set in that the holders of the remnant 6% would not be able to call the shots. This was a tidy 30% gain for a few weeks of waiting.

We closed the Short position on the Romanian gold producer wannabe, Gabriel Resources (GBU.to). The stock had gone into free fall and the profits were too tempting to pass by.

To replace these two shorts we instituted a Short position in the Brazil iron-ore (and nickel) giant Vale (VALE). We have been less than impressed over recent years at the undiscriminating pursuit of this company by emerging market fuind managers and hedge fund managers who regard it as a 1) Brazil proxy, 2) iron ore proxy 3) BRIC exposure 4) steel industry proxy. While the company has shown flashes of genius it has also done some extremely dumb transactions. The INCO purchase was right at the top of the nickel bubble which promptly deflated. Then the company launched its ultimately unsuccessful bid for Xstrata. Investors have given little thought to the “what if” scenario when they rhapsodize over the management of Roger Agnelli at Vale. As they won’t, we shall. The Xstrata bid had a massive debt component (estimated at one point to have been $60bn). Considering Xstrata’s own debt stress post-crash of 2008, a successful bid for Xstrata would have put Vale into an even worse position than Rio Tinto found istlef after its Alcan binge. Agnelli only escaped this fate by failing in his bid. Now Anglo American is being mooted as a target for Vale’s attentions.. Ye Gods.. what will it take to damp down Agnelli’s ambitions?

Meanwhile nickel has managed to get out of the hole it fell in. The current price of $7,000 per ton is a far cry from the nearly $25,000 that it peaked at in recent years. Even zinc has not experienced such a disastrous fall. When nickel was $10,000 per ton, it was regarded as an inauspicious price so the current level is only good for Vale in that it is forcing less resourced competitors to shut up shop, some for good.

The worst news is yet to come for Vale though for in recent iron ore negotiations with Asian steel mills the contract price for iron ore is adjusting down by 25% of more. We note the company made around 33 cts per share in the first quarter and that analysts are forecasting $1.33 for the full year. We find it very hard to see how this seemingly blatant annualisation of a quarter, which enjoyed legacy high contract prices for iron ore, can be extrapolated for a full year in which Vale is exposed to the ONLY metal that is still adjusting down. What’s more Vale will be stuck with the low prices from current negotiations for much longer than those players in basic metals mining that are subject to the vagaries of LME pricing. The opaqueness and negotiation “by appointment” are coming back to haunt Vale. Thus we suspect the company might find its share price ground between the competing millstones of emerging markets (read Brazil sentiment), hedge fund hot money flows, a torpid nickel price, a falling iron ore price, a rising Brazilian Real and the danger of Agnelli launching an “adventure” after Anglo-American or even Xstrata again. That sounds like more than enough reasons to us to go short the name..

As a parting shot we note from the chart below that Vale has outperformed the Bovespa in its stellar recovery from the depths of last year. How much longer can a stock with so much potentially going wrong beat a market representing an economy that has shown itself to be meriting credit for dodging the bullet of the international economic slump? Vale does not represent the Brazilian economy. Its almost enough

lil irs trade with the Vale Short!

We closed our Long position in OZ Minerals (OZL.ax) after Minmetals announced that its bid had been successful for a handsome gain. Now the Chinese are talking of reconstituting the new acquisition as a partly listed entity in the Australian markets. That won’t save having to spin off Prominent Hill. We are not too sure that investors will have a great time riding in the backseat of a vehicle that is overwhelmingly under Chinese control. Better them than us… We shall happily take our gains and redeploy elsewhere.

To position the portfolio for the inevitable upturn in molybdenum we decided to opt for a hybrid stock that is a copper, moly and silver producer, in the form of Mercator Minerals (ML.to). The sizeable new production facilities of Mercator came into operation in late 2008. The timing could have been much better but the result was a plunge in the value of the company to around 10% of its recent highs and this provided an excellent buying opportunity for a stock that has a production cost which is now “in the money” on all its metals (something that could not be said at reigning prices at its nadir six months ago).

The company’s main asset is the Mineral Park mine, an open pit copper-molybdenum mine located in northwestern Arizona, approximately 74 miles southeast of Las Vegas, Nevada. The mine produces approximately 12 million pounds of copper per year from the leach operation, and currently has an estimated 25-year mine life based on the proven and probable mineral reserves. The current plan is to increase average annual production to 56.4 million lbs of copper per year, adding 10.3 million lbs of molybdenum and 600,000 ounces of silver per year over the first 10 years of the 25-year mine life. Despite this, it is no surprise that the stock got beaten up in the copper/moly price meltdown. However with the mine being profitable (at life of mine base case) metals prices of US$1.53 per lb of copper, US$10.16 per lb of molybdenum and US$7.50 per oz Ag, the mine’s period on the “dark side” in late 2008 and early 2009 was mercifully brief. Our twelve-month target price for this new position is $2.50.

Conclusion

The metals prices led the mining stocks out of the doldrums by a few months. Now the metals have gone into a holding pattern for their own diverse reasons the precious metals focused companies are flat to retreating while selective base metals miners are still gaining upward momentum. Some are wary of overshoot but considering that copper, for instance, fell by a bit over 60% and now is 40% off its mid-2008 highs it is understandable that miners that fell 90% should continue to rise, particularly as they are now back in territory where they are cashflow positive, which wasn’t the case at $1.50 per lb.

The key to precious metals is the state of the world economy along the deflation-inflation continuum. In most views the main economies are perched in the middle with the possibility of going either way. Hence the torpor in the gold price. To our amusement though the silver bugs out there are slowly coming to the horrible realization that the gold-silver ratio of early 2008 (when gold was just over $1000 and silver was $22) was likely an aberration and they shall have to content themselves with 60 or 70 to one.

The base metals are suffering from the China Syndrome. This is not a meltdown but a controlled melt-up. The Chinese are now scrambling to correct their error in reviving prices “too soon” and sabotaging their various asset accumulation stratagems around the globe. Their recent attempts to talk down the market have singularly failed. They have become the boy that cried wolf in the LME warehouse. They will be wary not to push prices higher. If they haven’t secured the “means of production” (to throw some Marxist dialectic back in their face) then they need to keep the output running at a level that is cheap enough for them to stockpile but high enough to keep mines in production and a pipeline of new projects on a low-boil. Mine closures are not in the Chinese interest.

So in an environment of relative stasis in metals prices, what can move? We suspect the old chestnut of “the next big thing” is the place to look for capital gains. The obvious candidates for the next move are uranium stocks and molybdenum stories. In both cases producers are way more attractive than wannabes. In the uranium universe two thirds of the existing “plays” need to be recycled as vehicles for other metals. The U-space is just too crowded with zombie stocks for them all to come back to life. That said, we were almost tempted last week to put a Short position on in the temporarily overhyped UEC, but it feel so fast in the throes of a Toronto-inspired “pump and dump” that if you blinked you missed the perfect moment to play the story. We shall keep it in the corner of our eye though for future signs of manipulation.

Moly has some great producers that are still in the price dumpster. The steel sector appears to be flat on its back and yet spot purchases of iron ore by the Chinese are soaring. Whether the steel story is true or not or yet another head fake, moly looks like the next mover. Our opting for Mercator gives us a foot in both copper and moly in preference to the pure plays like Thompson Creek and General Moly.

And finally, speaking of over-hyping and next movers, there is the hard-rock lithium barrow-pushing competition. Some of those stories are already starting to lose their wheel. A wheelbarrow without its one wheel is a total non-mover..

Important disclosures

I, Christopher Ecclestone, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

Hallgarten’s Equity Research rating system consists of LONG, SHORT and NEUTRAL recommendations. LONG suggests capital appreciation to our target price during the next twelve months, while SHORT suggests capital depreciation to our target price during the next twelve months. NEUTRAL denotes a stock that is not likely to provide outstanding performance in either direction during the next twelve months, or it is a stock that we do not wish to place a rating on at the present time. Information contained herein is based on sources that we believe to be reliable, but we do not guarantee their accuracy. Prices and opinions concerning the composition of market sectors included in this report reflect the judgments of this date and are subject to change without notice. This report is for information puposes only and is not intended as an offer to sell or as a solicitation to buy securities.

Hallgarten & Company or persons associated do not own securities of the securities described herein and may not make purchases or sales within one month, before or after, the publication of this report. Hallgarten policy does not permit any analyst to own shares in any company that he/she covers. Additional information is available upon request.

© 2009 Hallgarten & Company, LLC. All rights reserved.

Reprints of Hallgarten reports are prohibited without permission.

Web access at:

Research: www.hallgartenco.com

60 Madison Ave, 6th Floor, New York, NY, 10010

Christopher Ecclestone - Portfolio Manager: since 2003 has been a principal at Hallgarten & Company where he has had the roles of equity strategist, analyst and asset manager. Prior to that he was the head of research at an economic think-tank in New Jersey which he had joined in 2001. He was the head of research at the esteemed Argentine equity research house, Buenos Aires Trust Company, from 1991 until 2001. This latter firm pioneered in-depth locally-generated investment analysis in this hitherto undiscovered market. The reputation of the firm spread through fund management circles and the firm became allied with Banamex, the leading bank in Latin America in 1993 and eventually Buenos Aires Trust Co formed an alliance with Interacciones Global in 1994. As part of the IGI structure he assembled the London sales team of the firm and built up the analytical team in Peru, Chile and Brazil. By 1997, IGI was the leading independent broking firm serving institutions investing Latin America. Prior to his arrival in Argentina, he worked in London beginning in 1985 as a corporate finance and equities analyst and later as a freelance consultant on the restructuring of the securities industry. He is a native of Melbourne, Australia. He graduated in 1981 from the Royal Melbourne Institute of Technology and is fluent in English and Spanish.  Most recently he has been engaged on behalf of Hallgarten in conducting due diligence and deal sourcing for two mining investment bank boutiques in New York.