Geologist Merrill McHenry Keeps His Eye on the Guerrero Gold Belt

The Gold Report: Merrill, speaking as a geologist, what makes the Guerrero Gold Belt in Mexico so highly prospective for gold and silver mineralization?

Merrill McHenry: Two words: plate tectonics. Two tectonic events in that area of sufficient scale to create an entire region filled with gold mineralization.

In more detailed terms, the Chortis plate, which was about the size of Colorado, impacted the western side of southern Mexico. The first event, about 140 million years ago, created "laramide" north-south extensional faults. That was followed, about 70 million years later, by a strike-slip to the southeast. As the strike-slip slipped and subducted under the southern portionwhat is today Guerrero Stateit rotated many of those north-south transitional faults and shear zones into roughly 40-degree and other angles, creating a chimney effect, which brought the mineralization, in liquid form, much closer to the surface. In geological terms, this is called a metasomatic transfer. The strike-slip also created various low-angle extensional faulting allowing laterally displaced mineralization and improving strike-length potential.

TGR: How does the creation and mineralization of the Guerrero Gold Belt compare to the Carlin Trend in Nevada?

MMcH: Both had tectonic events that liquefied the subterranean minerals and resulted in events that could transport the minerals to the surface. The Carlin Trend, which is older, was formed underwater. On Carlin, hydrothermal channels were created and bubbled up for long periods. In the Guerrero Gold Belt, the minerals were liquefied and brought up as structurally controlled magmatic events along various intrusive zones.

"Two tectonic events in that area of sufficient scale to create an entire region filled with gold mineralization."

Typically, economic mineralization is highest along these intrusion zones. (The structural control is a key to creating and allowing for higher-grade mineralization.) These systems are most fully developed either at (e.g., El Limon-Guajes) or below (e.g., Los Filos-Bermejal) the contact of the local Mezcala formation (shales and sandstones) with the underlying Morelos formation (carbonates).

In addition, the strike-slip and subduction that created the Guerrero Gold Belt arguably covered a larger area. To date the Carlin Trend is roughly 4060 kilometers (km) long; mineralization in the Guerrero Gold Belt has been found along a 60km-plus range.

Another difference is that the Carlin Trend has been mined and prospected for well over 100 years, with the first large mineCarlinopening nearly 50 years ago. The first major mine in the Guerrero Gold Belt went into production in 2008 and most of the exploration remains to be done. So far, two companiesGoldcorp Inc. (G:TSX; GG:NYSE) and Torex Gold Resources Inc. (TXG:TSX)have reported 16 million ounces (Moz) of NI 43-101 gold resources in the Guerrero Gold Belt. I expect Newstrike Capital Inc.'s (NES:TSX.V) Ana Paula project will report near 3 Moz of NI-43-101-compliant in-pit gold mineralization, and roughly 4.5 Moz in global resources, mostly to be included in subsequent pits, by the end of 2012. Ana Paula has some breccia pipe areas of spectacular grade and width.

TGR: What can you tell us about the kind of precious metals deposits discovered in the Guerrero Gold Belt so far?

MMcH: Because it is a long, intrusion-hosted system, much of the gold mineralization is at or near the surface. You can find the intrusionsan orange-red oxidized ore (retrograded calc-silicate skarn)at the surface. Gold mineralization in the district tends to be in the most oxidized alkaline significantly reduced iron and magnesium host rock that conversely hosts increasingly higher gold values.

Essentially, you want heavily magnetite/hematite (iron) initial fluid flows, but later during the retrograde (cooling) phase, you want the magnetite to precipitate out and become more oxidized Calc-alkaline potasically altered and biotite rich. That is where the highest gold mineralization occurs.

"So far, two companies have reported 16 Moz of NI 43-101 gold resources in the Guerrero Gold Belt."

Gold occurs either in chlorine complexes or in a variety of high-sulfidation complexes that are stable at lower temperatures, which tend to drop out at lower near-surface temperatures, usually because of some event that changes the oxidation state. Therefore, you can get multiple economic mineralization in the same hydrothermal systemhigher temperatures and less fluid mixing at depth giving you gold, copper, and silver; and lower temps and magmatic/meteoric mixing as you move higher in the system, giving you gold with much less silver and copper.

TGR: Is there a company working on one of those polymetallic deposits?

MMcH: Torex is working on the Media Luna project, to the south of the Balsas River, where the mineralization tends to be deeper. To date, Media Luna is 300 to 600 meters deep and looks to be polymetallic, not predominantly a gold project.

TGR: It is rare for a polymetallic deposit to get developed at depth, given the expense of bringing the minerals up.

MMcH: Yes. Before Torex released its feasibility study, I had moved it from a Buy to a Hold and changed the price target to $2/share. The stock has hung in there around $1.901.95/share because it is a show-me situation. Pending further Morelos gold project development, the market needs to see that Media Luna has enough mineralization and thick intercepts that can be accessed, ideally through an adit, to make the project economically viable.

TGR: It was exploration of the Carlin that led to the discovery of the Cortez Trend, where Barrick Gold Corp. (ABX:TSX; ABX:NYSE) now operates its massive Cortez gold mine. Have similar high-grade trends been found in the Guerrero?

MMcH: Yes, that is one of the Guerrero's calling cards. When it opens several years from now, Torex's Morelos project, at 3.14 grams per ton (g/t) Measured and Indicated, will be one of the highest-grade open-pit mines in the world.

Newstrike's Ana Paula project has some phenomenal drill results. To give you an idea, just one hole at Ana Paula had 174m of 5.4 g/t gold that included a 76m interval of more than 10.57 g/t gold and 15 g/t silver.

TGR: Are there advantages to mining the Guerrero over the Carlin?

MMcH: Many projects in the Carlin Trend are destroyed limestoneblack rock formed by the hot springs upwelling mineralization while deforming the host rockso you cannot distinguish what is gold mineralized. That makes finding the ore bodies difficult visually; in most respects, you are drilling blind without geophysical signatures other than the generalized trend to guide you. The intrusion-hosted mineralization in the Guerrero tends to be quite visible so you can see where you are likely to have potential gold intercepts.

Also, a fair amount of the ore in the Carlin Trend is refractory ore and a lot of that has to go through an autoclave. That process is expensive, and a lot of the cost of an autoclave is capital expense, not processing.

TGR: Mexico is now on the list of the top 10 gold-producing countries. What are some mines that helped it crack that list?

MMcH: Mexico also had the fastest growth of any gold-producing country last year, and the Guerrero had a lot to do with both accomplishments. Last year, Goldcorp's Los Filos project produced 336,500 oz, with cash costs roughly $463/oz. The company estimates production of 345,000 oz gold in 2012.

Mexico is a very fertile country for gold production. In central Mexico, you have the volcanic trends for mineralization, which tend to be vein swarms and silver-oriented projects. Then, you have the unique mineralization of the Guerrero.

TGR: All of the mineralization created in the past is good news, but present-day Mexico has its troubles. What issuessecurity, nationalization, rising costsmight make Mexico a riskier jurisdiction?

MMcH: Mexico had its nationalization experiment with PEMEX, its national oil company. PEMEX was a jobs machine, but its production growth has been flat to declining because it is not operated efficiently or effectively.

"As long as QE in is play and economies remain stagnant, gold will continue to do well."

There can be security concerns when a project is just starting up. For example, five trucks were stolen from Torex at gunpoint last year. So, the company built its own security force. Other companies have taken a different route. Number one, they employ a lot of local Mexicans. Number two, they work on community relations, support the community and fund social projects. Number three, they just lay low and try not to attract attention.

TGR: What recent discoveries might add to Mexico's gold and silver production?

MMcH: As I mentioned, I expect Newstrike to have 3 Moz in pit resource by year-end. The most logical efficient outcome is to tie Ana Paula in with Torex's planned mill and use a conveyer belt to deliver it to Torex for processing.

Bear in mind that Newstrike has the largest land holding in the region. I believe it will have other successes. Newstrike has already extended and increased the width of the high-grade breccia zone; it is currently pending an "in-pit" NI 43-101 resource. It also has land to the northwest and southwest of the Ana Paula region, where I expect additional resources to be found.

TGR: Has Newstrike done any metallurgical studies to determine the amount of recoverable gold?

MMcH: Yes, it is expected to be in the mid-80s percentage range, similar to Torex.

TGR: Is either Torex or Newstrike likely to be bought out?

MMcH: Richard Whittall, CEO of Newstrike, is a very credible and capable operator who does things on a very conservative basis. My take from him, and he has clarified this for the Street, is that Newstrike does not plan to develop Ana Paula.

TGR: Torex issued a feasibility study on its Morelos project Oct. 1. What stood out to you in that study?

MMcH: First, the costs continued to increase in an environment where that does not go down well. Notably, although necessary to grow and develop, general and administrative costs per ton of expected production had roughly tripled in three months to a level where I wonder if the final project tally will rise excessively.

Second, when a company does financing and it is working on project development, it is in a dead zone for catalysts. Most of what happens is delays and cost increases in this periodunless the company can prove up additional resources. In time, I believe it may. Until the company can actually say, "We started the mill earlier than expected and at a lower cost," it gets no credit in the market; it just gets skepticism.

TGR: Have you visited Morelos?

MMcH: Yes, it is a great-looking project. The destroyed magnetite oxidized Calc-alkaline potasically altered mineralization tends to host very good mineralization. Torex will use an innovative "RopeCon" conveyer belt system developed by the Austrian firm Doppelmayr. RopeCon is an innovative, green derivation of ski lift technology. It produces electricity as the weight of the ore going downhill generates electricity, as well as saving on trucking and diesel costs.

One challenge is that because of the angles, the company will have to relocate two small villages. Unfortunately, it will take time, in some ways delaying project development.

Broadly speaking, Newstrike, Torex and Goldcorp have blazed a trail. The next exciting thing will be juniors starting to drill on intrusive zones that are similar to what you see on Torex or Goldcorp's projects. These junior companies could really pop.

TGR: What are some of the early stage discoveries that our readers might be unaware of?

MMcH: I am extremely excited about Cayden Resources Inc.'s (CYD:TSX.V) projects. It is currently drilling on Magnetita East. The company is fully funded and has more than $5 million (M) in the till. Preliminary trench results on Magnetita have been significant, such as 5m of 11.65 g/t.

Magnetita East has northwest to southeast faulting structures, where intrusions come up and the destroyed magnetite rock looks exactly the same as the rocks at Torex's project or at Los Filos. Magnetita East has the rocks and the ground sampling. It also has a rapid transition from magnetic to non-magnetic zones in what is called RTP airborne magnetics, which can indicate destroyed magnetization during the retrograde phase. That is when the rock basically sucks in the gold when it drops out the iron. You can have gold mineralization without that; but in the Guerrero, the highest gold grades have a measure of replacement of iron during the retrograde (cooling) phase.

TGR: Speaking of Los Filos, some of the waste rock Goldcorp has been dumping from Los Filos has made its way onto Cayden's property. How will that be resolved?

MMcH: In addition to already having dumped waste ore there, Goldcorp wants to expand its leach pads. Most likely, Goldcorp will have to buy the easternmost portion of Cayden's property, given that Cayden can definitely say Goldcorp is violating the integrity of Cayden's Morelos Sur portion of the concession.

TGR: That could be an interesting story to follow. Are there other early-stage discoveries that you want to talk about?

MMcH: I am super-excited about Minaurum Gold Inc. (MGG:TSX.V). Late this year it will probably start drilling on its Vuelcos del Destino project, just southeast of Goldcorp's Los Filos project.

I visited Vuelcos and you can see the intrusive zones as plain as day. The project also has large areas of intrusives and jasperitehallmarks of good prospectivitycomplemented by interesting airborne geophysics.

Vuelcos is a high-impact, high-risk, high-reward situation. Minaurum has only $7M or so in market cap, but it has about five projects now. I expect the company will joint venture its Santa Marta projecta former producing mine with significant copper mineralization at surface.

Minaurum's most immediate way to unlock value is to drill Vuelcos in the Guerrero. In my opinion, there is very likely gold there. The question is how long a strike and how much gold. The surface and intriguing airborne geophysics are great, but not definitive.

One of the best things you get with Minaurum is board member Dave Jones, a noted geologist. He found Los Filos. To have his expertise guiding the drill program in such a fertile region is a strong indicator that you are looking at some very interesting projects that you would not normally find in a small-cap company.

TGR: Any other names to share?

MMcH: Oroco Resource Corp. (OCO:TSX.V) has a small, 193-hectare project, the first mine discovered in the Guerrero. Its questions are: Is it economic? Is it enough? I expect Oroco will do some funding and drilling in the near term, so time will tell.

TGR: Developing the Guerrero will depend on sustained high prices for gold and silver.

MMcH: Although not necessarily any more dependent than other gold regions in the world. Keep in mind Mexico has the lowest cash costs of any country, $325 versus $649 world average, according to Thomson Reuters.

TGR: What market signals do you think point to higher gold prices over the long term?

MMcH: Both the U.S. and the EU have been printing money and doing quantitative easing (QE). As long as QE is in play and economies remain stagnant, gold will continue to do well. If you lag global money supply by three to six months, you see a significant correlation with the gold price. Recently a World Gold Council study indicated a U.S. money supply to gold correlation of 90%.

I would also point out though that Q4 has the strongest by far gold seasonal of the year, finishing strong after typically having an October correction. Though rallies may be capital markets constrained, I would think from now until the end of the year the wind is at your back for gold exploration and gold development companies.

TGR: What wisdom can you offer our readers when it comes to playing precious metals companies?

MMcH: The more exploration companies you have, the more diversified your portfolio should be because there is no second guessing what is underground until the company actually drills.

That diversification can be within one company. Minaurum, for instance, has multiple projects, any of which could hit. Cayden is in the thick of it with several projects on Magnetita. Oroco is a two-trick pony.

TGR: Merrill, thank you for your time and insights.

Merrill W. McHenry, MBA, CFA, has been in the investment business for over 28 years. Early in his career, as a portfolio manager he managed over US$1.5 billion in three U.S. mutual funds, and set up an international mining merchant bank visiting mine project sites on multiple continents. As a mining analyst, he has worked both the buy and the sell sides, providing research for Tier 1 and Tier 2 Investment Dealers, as well as prominent global investors. A couple years ago, he led special projects modeling at BMO Capital Markets for the Global Mining Research Group that was top ranked in Canada by Brendan Wood during his tenure. Currently McHenry is a private mine industry consultant and is a member of the CFA Institute and the Toronto Society of Financial Analysts.

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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp Inc. and Newstrike Capital Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Merrill McHenry: I personally and/or my family own shares of the following companies mentioned in this interview: Cayden Resources Inc. and Minaurum Gold Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

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