Consider Speculating in Aura Minerals

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While every investor knows the adage “buy low and sell high,” it astounds me how overvalued and how undervalued some assets can get, and how people justify this clearly irrational valuation. Over the past couple of years there have been and continue to be some extraordinarily mis-priced assets. Many of the undervalued stocks that I am familiar with are in mining companies.

With metal prices falling and production costs rising, there is no doubt that mining companies have lost intrinsic value over the past couple of years. But there is a point at which the value potential becomes too great. Nevertheless, investors continue to sell off the shares for no apparent reason other than that they fear additional weakness in the prices of these stocks. These situations make for incredible buying opportunities.

One such opportunity is in Aura Minerals (OTCMKTS:ARMZF). Aura Minerals traded at $10 per share at once point in 2008. It, too, suffered from falling metal prices and rising production costs, and it had the added burden of owning two gold mines in Brazil that are on the verge of shutting down either later this year or early next year. As a result, the company did lose intrinsic value — and a lot of it. But the market was ruthless in dragging the shares down to a September 30 low of just 7.5 cents per share, meaning that the shares fell more than 99 percent.

But while the company is priced for bankruptcy, this is hardly the case. It owns two valuable projects that are producing currently, as well as one development-stage project the company cannot afford to develop but which it can sell part of to a JV partner in order to extract value from it.

The company’s San Andres mine in Honduras can produce 70,000 ounces of gold per year, and while it has seen high production costs these costs have come down recently; the mine should be profitable at $1,320 per ounce gold. While investors are rightfully skeptical of investing in a mine in Honduras given the regulatory environment there, they should also keep in mind that some of this risk is offset by that country’s low corporate income tax rate of 25 percent. Ultimately, given the current gold price environment, this property has a fair value of at least $50 million, which is already more than Aura Minerals’ entire market capitalization of just $38 million.

Perhaps the most valuable property that the company owns is its Aranzazu copper and gold mine in Zacatecas.  This mine is currently a high-cost copper producer with costs exceeding $4 per pound. With copper trading at about $3.20 per pound, this mine is losing money. However, the company has an expansion plan that will enable it to lower costs substantially to less than the current copper price, which means that it will be profitable.

While the company doesn’t have the capital to expand the mine, it can fund this capital by selling a part of the project to a JV partner, selling part of its Serrote development-stage copper mine in Brazil to a JV partner, or selling some copper or gold production rights to a royalty or streaming company. The company already has a small royalty deal in place with Sandstorm Gold (AMEX:SAND) on its San Andres property, and so perhaps Sandstorm will step up.

Ultimately this is an incredibly valuable property that is worth at least the market cap of the company ($38 million). All Aura Minerals needs is a little help bringing this value out and the shares could explode higher.

Finally, the company owns a large but expensive copper mine in Brazil — Serrote. While it will be able to produce more than 60 million pounds of copper annually with low production costs, the company needs $400 million to develop it, which it simply doesn’t have. While this is a problem, if the company can find a JV partner, it will be able to realize a large amount of capital relative to its current valuation.

Thus there is no doubt that Aura minerals is a high-risk proposition, and we can certainly understand why the shares were bid down. But the downward price action was grossly exaggerated and this has created an excellent opportunity for speculators in the mining space.

While the shares last traded at 16.5 cents, more than twice the low of 7.5 cents, I think there is still a lot of opportunity left. From what I have said above, I think the shares could easily double. If the prices of copper and gold rise, this upside potential is much higher. Therefore I think investors interested in a speculative position in a high-risk, high-reward copper and gold miner should consider taking a position. Note that because this is a high-risk proposition that I would limit my position to a relatively small percentage of my portfolio and I would take profits should the shares spike.

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