If you want to protect your wealth, buy gold, not miners

Last April, I wrote about Jinshan Gold (CA:JIN), a Canadian gold miner operating in China. A number of you have asked for an update on the company.

You may remember that China's largest state-owned gold miner, China Gold, had just bought a 42% stake in Jinshan from Ivanhoe Mines. Jinshan suddenly had access to a lot of capital, it was set to make some serious acquisitions and rapidly become a major player in Asian gold mining.

But unfortunately, things didn't quite work out. What went wrong?

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Where it all went wrong for Jinshan

Jinshan's Chang Shan Hao mine had reserves of almost four million ounces of gold in the ground. The group was just ramping up production and aimed to produce some 120,000 ounces per year at a cost of $350-$400 per ounce. The company had a market cap of around C$450 million with a share price just over $2.60. China Gold paid $3.11 a share a nice premium.

I interviewed the company's then-president Jay Chmelauskas. What was the strategy going forward? It seemed that China Gold was tremendously impressed with Jinshan's management and with the Canadian mining expertise they brought with them. China is the largest gold producer in the world. The country has hundreds of mines, but, astonishingly, Jinshan's modest 100,000-150,000 ounce producer would be one of the biggest. The Jinshan team felt that China's many gold mines were underexplored and underdeveloped, operating at as little as 10% of their full potential. With China Gold's funding and Canadian mining techniques this could rapidly change. A listing in Hong Kong was mooted for 2009, which would have marked the company as a serious player. It all looked very rosy.

But then the gremlins got involved. The Chang Shan Hao mine encountered production problems. Even now, many months later, despite its estimated cash cost of $350-$400 and a gold price of $900 an ounce, it is still barely operating at breakeven. In fact, Jinshan had to raise further funds in the autumn.

In June and July the company's share price started to slide, despite the rally in gold, going from just below $3 to $2. China Gold had made it clear that it was buying its strategic stake in the company because it liked the management and wanted to use it and the offshore listing to build a world class mining company. The Chinese even specifically mentioned Jay Chmelauskas' name in the press release which accompanied the purchase and went on a global road show with him soon after the purchase.

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But then, as the shares dropped in the summer, they fired him. Panic may have influenced the decision, but the trouble was, the charismatic Chmelauskas was a key reason why many shareholders had bought in. Since he left, the shares have more than halved again, with the global stock market collapse hardly helping matters. Over the winter the remaining senior Westerners have left the company, the last being Roger Walsh, last month.

You do have to wonder - what is the point in buying a company for its management and then letting them go? Jinshan is now a Canadian-listed company with no Canadians on board, which will surely make it rather an enigma to the Canadian markets, while the Hong Kong listing is on hold.

There is some good news

It's not all bad news. China Gold has been true to its word on helping Jinshan on the financing front, making it possible for the company to borrow at low cost through Chinese banks, and it seems to have been working hard on sorting out the production problems. Mr. Sun, who heads China Gold, is now the President of Jinshan. He is a powerful man in China and is thus unlikely to let it fail.

China Gold's continued support on the financing side will be important going forward, as Jinshan is not making vast amounts of money and will need to invest in a crusher sometime in 2009. This investment should solve a lot of the issues they have had with production, which has been hampered by poor recoveries, but the original plan had been to finance this investment from cashflow. Now it will have to be from debt or dilutive equity.

I do not see Jinshan as a short from here. It has fallen too far already and I don't believe management will let it go under. They may well remedy the production problems at Chang Shan Hao, but this will take time and money. It may be that they start making some serious acquisitions, but I see no indication of that happening so far.

The chart looks to have found a bottom just below 50c and yesterday began a nice rally with good volume somebody is buying. But I do not see it regaining its former highs any time soon.

Why you should buy gold, not miners

This whole episode demonstrates once again some of the risks inherent in junior mining there's so much that can go wrong. When Ivanhoe sold its stake to China Gold, many felt the group was making a mistake. It now looks like one of the trades of the year.

And it also demonstrates the fact that owning the metal itself is a very different ball game to speculating in juniors. Yes the strong gold price is great news for gold miners, and it's little wonder that the sector as a whole has been rallying well in recent months. But if you want protection from the financial upheaval that we're seeing around the world just now, stick to the metal. Certainly, some junior miners will do very well out of rising demand for gold, but as with any small stocks they are no place to invest money that you can't afford to lose.

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