2 Mining Companies With Operations In Eritrea Are Undervalued

Part of my strategy for investing in the coming boom in mining/resource stocks is to focus on areas that I believe will be particularly prosperous. Such areas are characterized by favorable geology (i.e. an abundance of valuable minerals, and faults in the earth that make mineral extraction cost-efficient) sufficient infrastructure (roads, power plants), and a jurisdiction that is sufficiently pro-mining and with enough geopolitical allies to allow for opportunities via imports and exports. Ideally, we also want to see a sufficiently developed value network that allows for specialization -- whereby some companies can focus on drilling, others on the prospector model, setting the stage for M&A opportunities.

From this perspective, I believe Eritrea is increasingly well-positioned. And when we consider that Eritrea is still not on the map and disliked, irrationally in my opinion, by many investors because of UN sanctions, I think the story becomes even more compelling -- and thus one I plan to invest in and incorporate in my portfolio.

To understand the opportunity in Eritrea, I'd like to focus on the two publicly listed companies operating primarily out of there at the moment: Nevsun Resources (NSU) and Sunridge Gold (SGCNF.PK).

I've already blogged about Nevsun Resources before, although that was before its recent 30%+ sell-off (which still may be underway, as we have not had a upday since the sell-off started). I view Nevsun as a success story that is breaking the market open; they are already in production, complete with positive earnings and dividends. They did have to revise their production estimates down by 50% this year, which some analysts regard as an unforgivable error and one that will cast doubts on the company's ability in the future.

While I agree this is a rather large mistake, I don't think it changes what we've seen out of the Bisha mine, which has been Nevsun's main focus, thus far. It has historically yielded very low cash cost per ounce and is a mine with multiple layers of mineralization that suggest the best is yet to come. The most critical thing I can say about downward revision is that the future of the mine seems more about base metals, rather than gold -- and so this downward revision in gold production is especially unfortunate for those who are focused on gold and are not interested in base metals. I sympathize largely with that perspective and have a strong bias towards operations that are focused on gold, although I do believe that base metals and all "stuff in the ground" in general are in secular bull markets where the best is yet to come.

Moreover, while I previously found Nevsun to be a bit overpriced prior to its sell-off, I think it's a great buy now -- and will get better if prices fall. Its P/E ratio is below 9 at the time of this writing, and moreover, the company has announced it will most likely not cut dividends in spite of the downward production revision. I believe this is an attempt to retain shareholder trust and allay fears that they will have cash problems, and if they live up to the promise and keep dividends intact, I think it is a smart move that will reward shareholders in the long run.

Now let's move on to another emerging player in Eritrea, one that I believe will benefit from the work that Nevsun has done in helping to open up the market: Sunridge Gold Corp. Sunridge has some projects in the works that I think will be especially favorable low-cost opportunities. Specifically, there is a DSO Zone in the firm's Debarwa Deposit that yields gold, copper, and zinc. DSO is an acronym for "direct shipping ore", and it means the ore can be shipped directly to smelter. For shareholders, this means revenue comes in faster at a lower cost.

The resource estimate on Debarwa suggests 180,000 ounces of gold at 3.0 grams per tonne, as well as 200 million ounces of copper. In terms of price, it's currently trading at 0.60 with a 52 week range of 0.30 - 1.32. About 75% of shares are outstanding. The company had 14 million in the bank as of October and its market cap is about 70 million. The company also has members of B2Gold and Lundin Mining as members of its board of directors. I recommend checking out the investor presentation for those looking for a deeper look, but at this point, I like what I see very much, and think Sunridge is well-positioned to be an acquisition target.

Of course, there is one main reason why I believe both these stocks are underpriced: They're in Eritrea. As noted earlier in this article, the country has been sanctioned by the UN, and so there is fear that it is economically cut off from the world at large. But, I believe these fears are unfounded; China is a major supporter of Eritrea, and so I think from a geopolitical perspective, Eritrea is part of the value network that China runs. As I've noted numerous times in my Seeking Alpha articles, I believe China is the smart money of the global economy at large, and particularly the resource sector; it is China who corners 97% of rare earth production, who is aggressively buying gold, who is striking uranium import deals with Canada, farmland in Africa, and basically playing the resource game to the max. Accordingly, it is particularly important to note the following:

1. The current Eriterian president, Isaias Afewerki, received military training in China

2. China has provided much in the form of economic support to Eritrea, including debt cancellations

3. China has spoke out against the sanctions placed on Eritrea and even continued to provide Eritrea with arms

To put it simply: the major customer, China, likes buying from Eritrea. So, I think many of these geopolitical fears are unfounded, and that there is value opportunity created by irrational sentiment. That's a particularly strong buy sign for me.

Of course, nationalization risk is always a concern -- particularly if you are an emerging economy and are deeply influenced by China -- but as Nevsun is proving, Eritrea is creating some opportunities for mining firms to prosper and to help the country as a whole enjoy prosperity.

For these reasons, these two are some of my favorite buys -- especially now, as both of them are well off their 52 week highs. They are higher up on the watch list.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NSU, SGCNF.PK over the next 72 hours.