Special Report — The San Francisco Mine, Sonora State, Mexico

Mexican Gold Explorer Poised for Production

I recently went through a part of Mexico where the streets are literally paved with gold. And it's thanks to the San Francisco Gold Mine, which was the subject of my visit.

The San Francisco Mine is owned by Timmins Gold Corp (TMM on the TSX-Venture Exchange) and is located in Sonora State Mexico, about 2 hours outside of Sonora's capital city of Hermosillo. There are excellent roads leading to the mine (I can attest to the fact that they can be driven at speeds in excess of 80 miles per hour in darkest night), the mine is on the local electric grid and it has plenty of water.

The San Francisco Mine in located along the Mojave Sonora Mega Shear. This is an area of rich mineralization that runs through the area.

The San Francisco Mine first operated from 1996 to 2001, producing between 300,000 to 400,000 ounces. But in 2001, the gold price crashed to $250, and the mine closed. Left behind is an old and large pile of crushed rock from the mine, with an average grade of 0.5 grams of gold per tonne, which is currently being used for road gravel.

Now, years after the mine closed down, it's being brought back into production by a new company, Timmins.

The San Francisco Mine is an open-pit, heap leach operation. Here, you can see me next to Timmins CEO Bruce Bragagnolo as we stand in front of the main San Francisco pit. The next shot is me down in the pit by ore that has been graded as having 9.78 grams of gold per tonne of rock. In fact, Timmins has found a higher-grade section in the pit and management is now deciding if they want to drive a shaft in that area right into the pit wall.

Heap leaching is the least costly, most effective way to get gold out of ore, and is optimal for a low-grade operation like the San Francisco. Heap leaching involves placing crushed mine ore (from the open pit operation) in a pile built upon an impervious liner. Cyanide solution is distributed across the top of the pile and the solution percolates down through the pile and leaches out the gold. The gold laden solution drains out from the bottom of the pile and runs through a treatment plant where the gold is precipitated out. The barren solution is then recycled to the pile.

Cyanide is highly poisonous, but this method has been around since the 1970s and its risks are well-known and manageable. The dry desert in Sonora isn't prone to the kind of rainfall that could overtop a tailings containment pond. Also, free cyanide breaks down rapidly when exposed to sunlight, although the less toxic compounds such as cyanates and thiocyanates may hang around for some years. And the left-over crushed gravel from the last time the San Francisco was operating is clean enough that the local government has no problem using it to build roads.

And the pits themselves are very clean. I'm told that there are fish — bass — living in the pond at the bottom of the main pit. The water is very clear; if slightly green due to some copper content. Timmins has all its environmental permits — indeed, permits of all kinds that it needs to start production.

The old heap leach pile is actually a potential resource for Timmins. Thanks to improved, modern recovery methods, the company can probably recover another 120,000 ounces of gold out of the old pile at a very low cost (after all, the ore has already been mined). But that's not where Timmins is concentrating its initial efforts.

Instead, the company is focusing on the existing 611,000 ounces in reserves that it has already located. At current prices the resource (which includes the reserve) would be in excess of 1 million ounces — see table below.

The company is of the view that 200,000 ounces of that resource can probably be added to the reserve with more drilling.

And Timmins has spent $12 million to refurbish the existing gold plant, installing a new primary crusher as well as secondary and tertiary crushers. The new heap leach pads are being constructed, and after tests are done in February, the plant will be ready to pour gold. The new crushers have the capacity to crush 3,500,000 tons of ore per year, with a resulting planned production of 80,000 ounces of gold per year.

My next photo shows you the beehive of activity that takes place at the Timmins Gold camp, as crews work to install the new crushers. At right is the mouth of the primary crusher, waiting for rock to be dumped into it.

Timmins has a good team in place at the San Francisco Mine. I can tell you from my experiences at other mines that Mexican miners are some of the best, hardest workers you can find. I spent a lot of time talking to CEO Bruce Bragagnolo, and Frank Cordova, a director of the company and a point man on community relations. Bruce and Arturo Bonillas, President of Timmins, have worked to establish good relations not only with the local community but also with the political power structure in Sonora. That's important because in Mexico, it's not enough to have the law on your side; you need the politicians as well. The phrase "all politics is local" was probably coined with Mexico in mind.

There are plenty of potential gold resources in the immediate area of the San Francisco mine. Timmins has identified at least nine interesting targets, with more to the North. If they can find just two or three more deposits like San Francisco ... and that's certainly possible ... the company believes it could have a resource of 3 million ounces or more.

Over the next year, Timmins will undertake a 25,000-meter drilling program to start filling in along the zone of mineralization. The company has set a target of finding at least 200,000 ounces of gold a year to replace what they mine and add to the resource base.

Timmins' projected operating cost per ounce is $420. That is less than a lot of miners I could name. If the price of gold rises to double or more Timmins' operating cost, that should be very beneficial for the stock's share price.

Here are five things I really like about this company ...

1. Great Team. The team can be the most important thing about any miner. Bruce, Frank and Arturo know what they're doing and should be able to shepherd their company into production.

2. Right place — right time. Timmins is going into production at a time when other new projects have been delayed or canceled. If gold heads higher — and I think it's going to trend higher — Timmins' timing could be excellent.

3. Discovery potential. The company has large areas yet to be drilled on the 42,000 hectares of property they own around the San Francisco Mine. They also have other projects in the works — the Tequila Project in Jalisco State; Trincheras and Patricia, two claims to the west of San Francisco; Cocula, a Jalisco project that shows real potential, and more.

   Timmins Factbox

   Main project: San Francisco Gold Mine, Sonora State, Mexico Production time target: March 2009 Production rate target: 80,000 ounces a year Known Reserves: 611,000 ounce reserve Projected cost: $420 per ounce Market cap: $17.7 million Common shares: 76,555,454 (including special warrants convertible to shares) Managers & insiders: 21% Institutional holdings: 33%

4. Great plant and set-up for operations. The company has 100% of the equipment it needs to restart an open-pit, heap-leach mine. It has spent $12 million on new plant and equipment (including installation). One of the keys to the operation is new crushers that are specifically designed to deal with the hard rock of the area. Bruce says it costs more in the beginning but will save Timmins a lot of money down the road, as the plant will operate more efficiently. All the equipment should be in place and tested by the end of February, and then Timmins will start doing tests in March. And Timmins even has potentially another 120,000 ounces of recoverable gold in the old heap-leach pad from the last time the mine was operating.

5. Potential for growth. The interesting thing to watch is what happens in the next couple years. Will Timmins use their cash flow from the current mine to put together deals on other projects? I think they could make money, and what they do with that money will be interesting.

Indeed, I think that Timmins will leverage cash flow from San Francisco into other projects. So while Timmins may be very small now, it could get bigger over the next few years.

3 Caution Flags

I've told you some of the things I like. Now, let's look at the things that raise caution flags...

The need for funding. Timmins looks poised to go into production, and while it has no debt other than $3.5 million that comes due in 2010, the company will have to raise cash — about $25 million — to keep things running until cash flow from the mine starts to come through.

The company could go into debt for the $25 million — CEO Bruce Bragagnolo says he has offers on the table to do just that. But that would be a large amount of debt considering that the market cap of Timmins was recently just $17.7 million.

So, Timmins would prefer to raise the cash through a mix of a line of credit and issuing equity (using a private placement). But the market has been brutal for junior gold explorers recently, making an equity issuance unpalatable at present prices.

I'm pretty sure the company will be able to raise the cash through a combination of debt and equity. But we could see downward pressure on the stock until the financing comes through.

Violence: The Mexican government is waging an all-out war against drug cartels that operate in Sonora and elsewhere in the country. The good news is that weapons and drugs have been seized and key members of drug cartels have been arrested. The government has disrupted the cartels' operations in meaningful ways.

But there is also bad news. The security situation in Mexico continues to deteriorate. The total number of drug-related homicides is increasing while the violence has spread to include high-level assassinations, beheadings, and the indiscriminate killing of civilians.

In short, the local criminals are growing more desperate. This does affect the gold mines. Last year, Sierra Minerals reported that bandits stole gold from its Cerro Colorado Mine in Sonora — twice!

Good community relations can go a long way toward inoculating a mine against bandits. But the risk is still there.

Global recession/market weakness. The world is in a severe recession and credit crunch, and both have the potential to get worse. We are seeing plenty of great stocks punished in this brutal environment and that goes doubly so for junior miners. Indeed, I think Timmins, a company that is on the cusp of bringing a gold mine into production, would already be trading at much higher levels if the bears weren't chewing up the markets.

As a result, if the markets go lower, Timmins could slump, even if it makes all the right moves. Looking at a weekly chart, you can see that Timmins is way off its highs. It has been punished along with the rest of the junior miner/explorer stocks. It is close to oversold, so we could see a bounce soon.

To these three caution flags I'll also add that Timmins has no cash flow now, which can be problematic in a severely restricted credit environment. On the other hand, if and when the mine starts up production in March, cash flow should be around the corner. So Timmins' current lack of cash flow is probably just a temporary situation.

My Recommendation: Watch this stock with interest. Due to the trio of caution flags I talked about, I'm not in any rush to buy Timmins. We may be missing a ground-floor opportunity — the stock may catapult higher once its financing is worked out, especially if gold continues to trend higher and the markets remain resilient, AND Timmins is the only new gold mine coming into production at the time. But it's also clear that Timmins has yet to pass many milestones. There will be opportunities to pick it up again along the way. I look forward with interest to seeing what develops with this company over the next year.

For now, I recommend sticking with the large- and mid-cap miners like I recommended in my recent gold report, "Your Golden Parachute for 2009." They've been beaten down and have tremendous snap-back potential. Indeed, as of this writing, the stocks in the "Golden Parachute" report were all in positive territory from my recommended entry points. I'll let you know when things change and I think it's time to snap up juniors like Timmins.

Yours for trading profits,

Sean