Overcoming the bandidos

SITE VISIT

SANTA ANA, MEXICO — They came from behind the mountains, from a swath of uninhabited high-plain desert marked only by rough outcrop-pings and dark patches of palo verde.

With guns in tow, they stormed the small gold room at Sierra Minerals’ (SIM-T) Cerro Colorado mine last summer, making off with three gold bars just hours before the armoured pick-up truck was due to arrive.

And just a little more than a month later, before the company had time to fully digest what had happened, another armed band descended on the project.

The second group of bandits mimicked the tactics of the first, forcing their way into the same gold room and making off with a similar haul.

In all, just over US$1 million in gold bars was stolen from the mine, and while none of Sierra’s staff were injured, the company’s bottom line took the hit as the gold was uninsured.

It’s now been seven months since the robberies and the high razor-wire fence along with the armed guard at the front gate speak to Sierra’s determination to avoid a three-peat.

Security consultants Wunderlich & Gladston were brought in last summer and their audit led Sierra to bring in a head of security with experience in Iraq, and to refortify the processing plant where the gold room lies. The company also managed to win government permission to have armed non-military personnel on site (no easy task in Mexico) and they arranged a random gold bar pick-up schedule so prospective thieves could not figure out when gold would be poured.

In all, Sierra’s chief executive and president Martin Walters says security cost increases for 2007 amounted to roughly US$360,000 dollars and that going forward, security costs will run at roughly US$30,000 a month.

Both Walters and Sierra chairman Keith Piggott are confident the measures have secured the site and put the robberies in the past, allowing Sierra to focus on the project at hand.

Cerro Colorado is an open-pit, heap-leach mine with a historical average head grade of 0.84 gram gold per tonne.

Notwithstanding the robberies, 2007 was a watershed year for the young mine, as production began to climb from roughly 14,000 oz. in 2006 to 17,400 oz. last year. The mine only began production in 2004.

And the financial statements for 2007 show that Sierra still managed to earn a profit. At the end of the third quarter of 2007 (the company’s most recent reported financial period) net income was $641,972, for earnings per share of 1. The company had $133,839 in cash as of Sept. 30,2007.

Those solid numbers under unusual circumstances show that Piggott and Walters’ plan is beginning to bear fruit. The corporate philosophy guiding Sierra is to provide investors with an alternative to the typical junior play. Instead offering the mere hope of seeing production five to 10 years out, Sierra is offering a producing mine from the get-go. And it’s a producing mine with positive cash flow that Sierra plans to use to not only ramp up exploration, but also to acquire other gold projects in Mexico.

The next step for the company, however, is to bulk up those cash flows by ramping up production at the mine.

Towards that end, the company announced in February plans to raise $3.2 million in an equity financing. Sierra will issue 8 million units at 40 apiece, with each unit composed of one common share and a warrant for another half share at a strike price of 70.

Piggott says the funds would be spent as follows: $1 million towards expanding the processing plant and leach pad, $1 million towards general machinery, workshop and parts and $1 million towards a new crushing system that could handle more ore inflows.

Piggott and Walters say those modifications will get Sierra to its target of 30,000 oz. gold per year by the end of 2008.

Last year, Sierra produced 17,400 oz. — slightly less than its 20,000 oz. target. Cash costs for the first nine months of 2007 came in at US$510 per oz. gold, which includes the cost of production lost in the robbery.

The company didn’t meet its production target because of a lapse in fourth-quarter production, which dropped by 26% from the previous quarter to 3,900 oz. gold. That drop was caused by a fall in carbon shipments. Carbon is a key ingredient in the extraction process but the timing of its shipments is irregular.

Still, fourth-quarter production was 18% higher than the 3,315 oz. gold produced in same quarter the year before, and by virtue of its being an unhedged producer, Sierra was able to secure an average price of US$775 per oz. in last year’s final quarter.

And if the company can get production up to the 30,000-oz.-per-year mark, it will reap benefits beyond the increased revenue that comes with gold’s soaring price.

“Fixed costs for this mine are high at around fifty per cent because of the relatively isolated location and the cost of putting up all of the infrastructure,” Piggott explains. “So the trick is to get the total ounces up.”

Put a slightly different way, with fixed costs taking up such a large portion of the total costs, increased production will reduce the average cost for each ounce produced.

As for the isolation that Piggott speaks of, while there isn’t much in the way of nearby communities — the nearest town, Trincheras, is 35 km away and has a population of just 5,000 — Cerro Colorado benefits from sitting only 140 km south of the U. S. border. What’s more, that distance is traversed by a smooth, paved highway all the way to Trincheras, after which a well-maintained gravel road carries vehicles to the site’s front gates.

Current Production

Even with new financing and experienced management at the helm — Walters has 12 years operational experience, the bulk of which has been with Aquiline Resources (AQI-T, AQLNF-O), while Piggott has been in the industry for 40 years and has had a part in building some 18 mines –a plan to ramp-up production still needs a compliant orebody.

Cerro Colorado appears to be willing to accommodate.

The mine takes its name — which translates to “coloured hill” — from the smallish mountain that hosts the ore. One side of the mountain has been cut off with a deep open pit widening at its base to reveal a near perfect cross-section of mineralization.

The faint pink hue of rhyolite can be distinctly seen, running in three well-delineated columns from near the top of the mountain and disappearing into the bottom of the pit. Those columns make up Sorpressa, Sorpressa Extension and Breccia Central. Other ore zones in the immediate area are Harris and Abejas –which sit in what is now the open pit– and Obra X, which is yet to be exploited.

Gold mineralization is found in rhyolite breccia, fractured rhyolites and porphyries and in fault breccias within the limestone. It’s theorized that the mineralization was formed by late-stage emplacement into the rhyolite and nearby sedimentary rocks, with the best gold concentrations forming near the intersections of deep open fractures through porous or reactive host rocks.

While Sierra doesn’t yet know how deep the rhyolite breccias extend, ongoing exploration drilling is providing promising results.

Assays released in March brought the best results yet from the site, as one hole drilled on the eastern extension Breccia Central intersected 90 metres grading 1.59 grams gold per tonne and 1.46 grams silver from 28 metres depth.

“The hope is that the zones will meet up at depth and we will be able to take the whole thing,” Piggott says as he gestures towards what is left of the mountain.

Resource in waiting

Cerro Colorado lacks a National Instrument 43-101-compliant resource estimate, something that the 20,000-metre drill programs Sierra is currently engaged in is aimed at correcting. Walters says a compliant resource should be finished by the end of the second quarter.

The project has, however, been subject to a few non-compliant
resource estimates in its past. Sierra considers the one completed by Laramide Resources (LAM-T, LMRXF-O) in 1996 to be the best.

Compiled from 20,905 metres of drilling, Laramide’s non-compliant indicated resource for the project came in at 4.3 million tonnes grading 1.36 grams gold per tonne. Sierra is using an estimated resource of 192,000 oz. gold with a mine life of seven years.

The prospect of expanding those numbers looks good.

Cerro Colorado sits within a historic mining district in the northwestern state of Sonora. Underground and placer mining produced an estimated 50,000 oz. in the late 1800s and early 1900s and companies such as Hecla Mining (HL-N), Kennecott and Placer Dome all had exploration operations in the area.

Sierra’s land package covers roughly 300 sq. km of the arid ground. While that represents a lot of possible exploration targets, the company is currently focused on keeping the drills turning close to known resources.

The decision is bearing fruit, as the recent discovery of a new mineralized zone between the Sorpresa and Breccia Central orebodies proved, and beyond the thick intersection on the eastern extension of Breccia Central already mentioned, recent drilling also returned highlight holes of 44 metres grading 0.9 gram gold and 9.61 grams silver and 50 metres grading 1.15 grams gold and 9.71 grams silver.

So far, Sierra has drilled 195 holes for 14,000 metres of the total 30,000 metres it plans. It says 154 of the already drilled holes were done for resource calculation — the remaining being exploration and ground sterilization drilling.

Sierra’s plan of using cash flows to increase production, increase exploration and acquire, is intimately tied up with Mexico itself.

Piggott reasoned years ago that in an environment of a falling U. S. dollar, a company would most benefit from rising gold prices in a country whose currency moved in sync with the greenback.

He set up shop here 12 years ago and has become an expert on its geology, geography, its people and most importantly, its gold mining potential.

“There’s been so many companies rushing in here to find silver, that many have neglected gold,” Piggott says, “and therein lies the opportunity.”