A Mother Lode for Pennies on the Dollar
by Sean Brodrick

Dear Subscriber,

What if I told you that there was a producing silver miner, sitting on nearly half a billion ounces of silver equivalent, that you could buy for under a buck a share. Would you be interested?

You'd probably have more questions. I had a lot of them when I had a chance to sit down this week with Stephen Altmann, President of ECU Silver (symbol ECU on the TSX in Canada; ECUXF on the pink sheets in the United States). ECU is a Canadian miner hard at work in mineral-rich Durango State in Mexico.

Let me tell you what I like about this stock. Then I'll tell you what bothers me about it. You can draw your own conclusions.

ECU can currently mine from 5 different areas within its Velardeña District Properties. The properties contain a measured and indicated mineral resource of 40 million silver-equivalent ounces and an inferred mineral resource of 391 million silver-equivalent ounces.

"We took this resource from 25 million ounces to 431 million ounces in less than four years," Stephen told me proudly.

Here's a piece of the company's technical report from January ...

The resource estimate is based on 46 veins and includes the sum of mineral resources from the main Velardeña Property, the Chicago Property and 50% of the San Diego Property, which is a joint venture with Golden Tag Resources (GOG on the TSX-V).

Stephen thinks there's a lot more silver to be found. The technical report also outlines a further mineral potential of another 570 million to 930 million silver-equivalent ounces. If it works out, this could eventually take ECU's resource to more than 1 billion ounces.

However, there is already a big difference between "inferred" and "measured and indicated" — we'd really be pushing the envelope to consider "mineral potential." So let's use the 391 million-ounce resource number, which is still very good.

And ECU is sitting on more than precious metals. About two-thirds of ECU's mineral resource is gold and silver (gold is nearly half of the precious metals resource). The rest is lead and zinc. The base metals credits should lower ECU's mining costs for gold and silver dramatically.

ECU recently celebrated its first gold/silver pour at its mill. And the pour was a success. Assays confirm that the 20 doré bars contain about 140 ounces of gold and 7,250 ounces of silver.

"The original doré bars came from low-grade material and development muck — the rock we go through to get to the mineralized zones," Stephen told me. "This is typical in any mine start-up as you don't want to find any start-up problems with your higher-grade mineralized material."

Going into production is an important milestone for ECU, and more importantly, gives it cash flow when mining companies without cash flow are being ground into dust.

The speed with which ECU brought its Velardeña oxide mill online surprised the industry because ECU had acquired the plant just six weeks earlier. Normally, it would take months to get a mill up and running.

But Stephen said that ECU had an inside edge. "We built that mill," he explained. "Then ECU sold it to Hecla Mining 10 years ago when we needed money."

When Hecla's silver in the area ran out, they put the mill on care and maintenance — lifting the big ball crusher up off its cradle and shrink-wrapping all the motors in plastic. But ECU was able to buy the mill and quickly put it back into production.

The company is operating the mill at 400 tonnes per day, and it has a capacity of 500 tonnes per day. ECU has to build a new water line for the mill, Stephen says, but the mill can operate with the old water line for now.

Let's Crunch Some Numbers

If a lot of numbers make your eyes roll back in your head, you can skip this next part. But I think this is where it gets interesting ...

The oxide grade resource that ECU is working with has 2.95 grams per tonne (g/t) of gold and 162 g/t of silver. That's about 5.25 g/t of gold equivalent or 370 g/t of silver equivalent.

If the mill can process 400 tonnes a day, with 2.95 grams per tonne of gold and 162 grams per tonne of silver, at $700 a troy ounce for gold and $10 a troy ounce for silver (I'm being very conservative here), the company should have revenue of $47,450 a day from the mill, or a little more than $1.4 million a month.

Of course, costs have to be deducted from that.

"Our mining costs will be between $45 to $50 per tonne," Stephen told me. "This translates to about $3.80 to $4.20 per silver-equivalent ounce using the resource grade."

So, that means the company should make between $5.80 and $6.20 per ounce of silver in the rock ... or cash flow of between $27,422 and $32,096 per day based on $10 silver.

Now here are a couple potential boosters ...

• The mineral grades in the area that ECU is currently mining could be higher. "The grades we expect in this certain area will be closer to 4 grams per tonne gold and 180 g/t silver," Stephen told me. "That's about 6.6 g/t gold equivalent or 460 g/t silver equivalent."
  
  
• ECU should have that mill operating at 500 tonnes per day in six to nine months. That raises cash flow potential to a range between $34,277 and $40,120 per day at full capacity.

And the company has a second plant it is already operating — a flotation sulphide mill with a capacity of 320 tonnes per day. However, the company is concentrating its efforts on feeding the oxide mill.

Not All Mills Are Created Equal

The difference is that the oxide mill turns material from ECU's oxide resource into a gold/silver doré bar that is shipped directly to a refinery. There are no base metals produced from the oxide material.

The sulphide mill produces three concentrates — a lead/silver concentrate, a zinc concentrate and a gold/pyrite concentrate. The lead/silver and zinc concentrate must then go to a smelter for further treatment.

As you probably know, lead and zinc prices plunged last year while smelter charges have remained high, which made the sulphide operation unprofitable. And the third product — the gold/pyrite concentrate — also needs more treatment beyond the smelters.

The good news is that when base metals start to recover, that should give ECU's share price some extra oomph.

Certainly, the insiders think ECU's stock is cheap. Records show they've been buying, not selling the stock recently.

So What Don't I Like About The Stock?

The company had to file a restatement of its Dec. 31, 2007, and Sept. 30, 2008, financial statements. You never like to see that. But Stephen explained: "The reason we had to re-state our financials is because the regulators wanted us to report as an exploration and development company and not as a producer until after we completed a pre-feasibility study. So in essence we could not report revenues and instead had to report revenues as a reduction in our deferred expenses. The deferred expense being those that relate to mining activity."

A bigger problem is that ECU has 278.6 million shares outstanding, and fully diluted shares, figuring in options and warrants, rise to 339.1 million shares. That's a huge float.

"We do have a large number of shares, but about 125 million are tightly held within five groups," Stephen told me.

The company increased the number of shares recently when convertible notes (debt) converted to shares of stock. The company did a bought-deal financing to raise the U.S.$8 million it needed to buy the mill.

"We raised C$17.5 million in our last financing for the purchase of the mill and for working capital," Stephen explained. "We have U.S.$15 million of debt."

Some investors won't like that debt hanging over the company, but the money was used to get ECU to production and give it a cash cushion.

Another potential problem was raised in the Management Discussion & Analysis that Golden Tag Resources — ECU's joint venture partner on the San Diego property — released on Wednesday. In the MD&A, Golden Tag's management wrote:

"Subsequent to the year-end the company became aware that its joint venture agreement (JVA) partner on the San Diego property is in breach of several covenants and representations made by it in the JVA. The matters are not in material dispute and the other party has advised the Company (Golden Tag) that it believes it will have these breaches rectified."

I asked Stephen about this, too. He replied: "The breach in the JV agreement is that our lenders have our mineral assets as collateral. There was some confusion as to whether this claim included GOG's 50% interest. We are working with the lenders to sort it out. And they have told us that it would be no problem to sort it out."

Stephen added that the lender, IIG Capital, has worked with ECU for the past 10 years and is very accommodating.

The final thing I don't like is that even with the first mill running at 500 tonnes per day, it really needs more capacity.

And that's where ECU's 3-phase plan comes in.

The Three-Phase Plan

In Phase 1, the company will expand the operations that feed its 500-tonne-per-day mill to capacity. That should be done in 6 to 9 months, with a maximum production of more than 1 million ounces of silver equivalent per year.

In Phase 2, the company will construct a 1,500-tonne-per-day sulphide operation. This would raise the company's production to more than 3 million ounces of silver equivalent per year. This would require a big expansion of the existing sulphide plant or a new mill.

In Phase 3, ECU plans to expand the sulphide operation to 5,000 tonnes per day, raising its production to more than 10 million ounces per year.

ECU may look for a partner to complete phase 2 and phase 3. And as its production increases, especially if its existing resource expands, there is more and more potential that the company will be snapped up by a bigger player.

Is This Stock Cheap?

Recently, an analysis of junior producing silver miners showed they were valued at about U.S.$0.58 per ounce of silver resource. Using that metric, ECU should have a valuation of about U.S.$249 million. The stock recently had a market cap of around U.S.$150 million.

By this metric, ECU is very undervalued and could rise by at least 60 percent. And if a big miner starts sniffing around, its value could really go up.

• This is a high-grade producing mine with the lower grades proven at 2.8 grams per tonne of gold and more than 100 grams per tonne of silver.
  
  
• They already have a large resource. More drilling could expand that resource.
  
  
• They have leases in place on vast tracts of land, where they can do more exploration.
  
  
• ECU is already mining from 5 different areas within its properties.

Bottom line: As I said, you can draw your own conclusions. Mine is that ECU's problems are road bumps, not road blocks. This stock is undervalued, and looks to go higher. The stock is up about 43% from its closing low on March 31 — investors liked the news about the first gold pour — so you could wait for a pullback before adding it.

The question is when ECU will really start to rally. As I said, the company needs to expand its production capacity. I think even before ECU finishes phase 2, it will already be taking off.

Stephen told me that he wants the stock's value to grow prudently — he doesn't want a moon-shot stock with flipside risk of crashing and burning. So far, the company seems to be making the right moves.

Nothing is guaranteed, and small miners like this are much riskier than big, established miners. But as I think I've shown you here today, with the risk comes the potential for big reward, as long as you have some patience.

You'll have to make your own decision whether to invest in ECU. Consult your investment advisor, and never invest more than you can afford to lose.

Oh, and you also may be worried about Swine Flu, since this miner is operating in Mexico. If you've been reading my blog, you know that while I don't mean to minimize any personal tragedies, I think that, at this time, there is more hysteria than necessary to the Swine Flu scare. And ECU's operations are nowhere near Mexico City.

Yours for trading profits,

Sean

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