Choice Spot, Tough Decision For Geologix

SITE VISIT

Durango, Mexico — Geologix Explorations (GIX-T, GXEXF-o) is positioned on top of what could be Mexico’s next great polymetallic mine.

Just an 85-km drive along a paved highway from the city of Durango, the San Agustin project hosts a gold, silver, lead and zinc deposit that, even at this relatively early stage in exploration, hosts indicated resources of 1.61 million oz. gold, 48.3 million oz. silver, 161 million lbs. lead and 1.3 billion lbs. zinc.

But while Geologix is itching to drill more and push the robust deposit towards production, it has to first make sure that its position atop San Agustin is secure.

The company still has to pay a yet to be determined purchase price to Silver Standard Resources (SSO-T, SSRI-q) before it can call the project its own. To make things more

interesting, that purchase sum — estimated to be between US$42 and US$54 million — has to be paid within four months, at the most, of delivering a resource estimate to Silver Standard in December (Silver Standard can take up to 30 days to audit the estimate, and Geologix has three months from the time a successful audit is finished to hand over the money).

And it is that uncertainty around both the final sum it will have to pay and how it will pay it — the company currently has $7 million on hand that is earmarked for exploration work — combined with a slumping commodities market that has weighed so heavily on the company’s share price.

Shares in Geologix began the year trading in the $2.50-range, but have fallen since to around 35.

And while a significantly lower market cap is hardly reflective of the value in the ground at San Agustin, it does point to how high the stakes are in the deal with Silver Standard.

That’s because if Geologix can’t raise the necessary funds to make the payment, it will lose the project outright.

Under the arrangement between the two companies, made back in 2006, Geologix agreed to issue 1 million shares to Silver Standard and spend US$2 million at the site, including 15,000 metres of drilling in the first two years. Geologix has met those obligations — and well surpassed them on the drilling front — leaving only the final cash settlement between it and the deposit.

That price is set according to a sliding scale on mineral prices, with Geologix paying US$20 per oz. gold to Silver Standard if the gold price is above US$750 per oz. at the time it delivers the resource estimate. If the gold price is below that mark, it pays US$15 per oz. It also pays US$1 per oz. silver in the estimate, rising to US$1.50 in the unlikely event that silver works its way up to US$20 per oz. by Dec. 14 — the day on which the resource estimate is to be submitted.

“We will figure out a way to make that payment,” says Sig Weidner, Geologix’s vice-president of exploration. “It’s not a question of if, it’s a question of how.”

While only a short time ago, financiers and underwriters alike would have been lining up to offer funds for such a project, the twist in the plot came when markets took a turn for the worse.

“Our top choice is to own the project free and clear,” Geologix president and chief executive Dunham Craig said during a recent conference call. “One way to do that would be through an equity financing, however, that requires it to be a beautiful world out there and we know that right now it’s a bit of a tough slog.”

In lieu of equity financing, the company is considering five other options.

Its first preference would be to lure private capital into taking a stake. That would create a scenario where the company would have a “sound partner that would stand by while we did the work,” Craig says.

If that doesn’t materialize, Geologix will consider a merger. For that option to be viable though, Craig says the math would have to be magical.

“One plus one would have to be equal to three,” he says, explaining that the joining of two management teams would have to result in an even stronger team at the top of the new company.

Next on the list is forging a joint venture with a larger miner. The company has had talks with both majors and mid-tiers towards that end with several companies making the hike out to the project to kick the tires.

Moving down its list of options, Geologix could sell metal offtakes to smelters. That option is only slightly more desirable to it than the last option — one that is down low on most juniors’ lists these days given the skyrocketing cost of capital — a debt financing.

Outside of those choices, there’s always the option of coming to some new set of terms with the counter-party to the deal.

“We’re in discussion with Silver Standard,” Craig says. “We’re offering them a variety of alternatives that would be a win-win for both companies.”

And if Geologix needed any more motivation to grab hold of the funds it needs to secure a project it says has a net present value (NPV) of US$1.7 billion dollars, it would come in the form of the huge mineral potential the project still has.

Its most recent resource estimate from November — just five months after a previous estimate completed in June — managed to up indicated resources by 100%.

And still, the company has only drilled 20% of the project area, with the deposit remaining open at depth and in three directions.

It all has Weidner seeing San Agustin emerging as one of the larger-scale mineral projects anywhere in the Americas.

It was, in fact, that huge potential that led to Weidner joining the company to oversee it. Weidner has extensive experience with elephants, having spent 18 years total with Rio Algom, Billiton, and finally BHP Billiton (BHP-N, BLT-l)–following the series of takeovers and mergers.

During that time, he won the PDAC’s Prospector of the Year award for the co-discovery of the Spence porphyry copper deposit, in Chile.

Further fuelling both Weidner and Craig’s bullishness on the project is the fact that the extra ounces outlined in the most recent re-source update don’t add to the price Geologix must pay Silver Standard for it.

As per the agreement, Geologix only pays for gold and silver ounces that lie within a defined area. While the resource estimate for that area has not yet been released, it will be a subset of the June resource estimate that outlined 2.6 million gold-equivalent oz. in the indicated category and 2.5 million inferred gold-equivalent oz.

As for the updated resource, it drew largely from the area around the perimeter of the section defined in the agreement.

Zinc and lead — which do not affect the project’s purchase price — as well as all four minerals lying outside the delineated area, do carry a 2.5% net smelter return royalty payable to Silver Standard, however.

Beyond the large tonnage already outlined and waiting to be tapped, the project also boasts resilient metrics.

The project’s US$1.7-billion NPV (which was calculated with a 0% discount rate — it falls to US$1.23 billion when a 5% discount rate is applied) was calculated using prices of US$630 per oz. gold, US$11 per oz. silver, US78 per lb. lead and US$1.11 per lb. zinc. But Craig says if gold stays within the US$725-$800 range, the price of zinc can go down to around US86 without affecting the economics of the project by more that 3%.

And while zinc is currently trading in the US55-per-lb. range, Craig contends that with zinc projects closing down at a price of around US80-90 per lb. zinc, a supply crunch will bring prices back up to at least those levels.

The backstory

The story of San Agustin began with Monarch Resources, which explored the ground from 1996-97. The project was left idle until Silver Standard picked it up and began its own exploration program in 2003. A year later, it released an inferred resource estimate of 11.22 million tonnes grading 0.96 gram gold for 356,000 oz. gold and 4.6 million oz. silver.

And while those numbers were promising for such an early stage exploration project, the company determined the deposit to be primarily a gold property and thus a non-core asset for a silver company.

That left San Agustin as a ripe target for drills under Geologix’s guidance.

The most recent resource update doubled resources in the indicated category to 122 million tonnes grading 0.41 gram gold for 1.61 million oz., 12.3 grams silver for 48.3 million oz., 0.06% lead for 161 million lbs., and 0.49% zinc for 1,320 lbs. zinc.

Roughly 21.7 million tonnes of the total lie in the oxide zone, while the remaining 100.3 million tonnes sit in the sulphide.

For oxide ores — which would go to the heap-leach pad — recoveries are expected to be 68% for gold and 40% for silver. Sulphide recoveries are estimated at 72% for gold, 74% for silver, 50% for lead and 62% for zinc.

As for inferred resources, grades are similar to those in the indicated category — the notable exception being gold, where the average grade drops to 0.36 gram per tonne. The project hosts 1.08 million oz. gold, 37.3 million oz. silver, 143 million lbs. lead and 983 lbs. zinc in the inferred category — for a 74% increase over the last resource estimate.

In all, the estimate was composed of 240 drill holes, for roughly 50,000 metres.

Of the total, 91 of the holes were historic, while the rest were drilled by Geologix.

The company describes the deposit as a multiphase porphyritic dacite dome complex intruding siltstones that occur as wedges or roof pendants in the dacite dome complex.

Gold and silver are hosted in a sericite-pyrite altered, locally brecciated, massive to flow-banded dome with some quartz and extensive alunite veining.

Limonites, hematite and pyrite veinlets with lesser sphalerite and alunite veinlets are the main ore-bearing minerals with higher-grade mineralization structurally controlled and centred on the alunite veining.

With a firm grasp on both the geology and the economics of the project, and enough cash in hand to continue to drill at the site through 2009, Geologix is poised to follow the expected gains in gold prices in the coming year.

All it needs now is the cash, or partners, to make the project its own.