Gold News

The Intricate Science of Gold Mining

The money guys often don't understand the science guys – and vice-versa...
 
IN TODAY'S fast-paced market, investors sometimes forget that Gold Mining is an intricate and time-consuming science experiment. Those who can stomach the risk and the wait are generally the ones who profit the most. Brent Cook, editor of Exploration Insights newsletter, and Quinton Hennigh, a geologist and contributor to the newsletter, believe that investments in prospect generators have yielded some of their best investments, plodding along slowly to unearth some often spectacular projects.
 
In this interview with The Gold Report, Cook and Hennigh discuss why prospect generators are worth the wait. 
 
The Gold Report: Brent, Quinton recently joined Exploration Insights. What does Quinton bring to the publication? 
 
Brent Cook: Quinton is a geologist who can see the big picture. He focuses on how a mineral deposit forms and assesses if it is economic. His contributions allow us to cover a lot more ground in the same time and our discussions often refine and improve the final investment decisions. It's a whole aspect to the business that's going to help me make Exploration Insights better. Given the state of the junior mining sector, this is the time to be picking up the deposits and companies that are undervalued or that show potential value based on a real economic evaluation. 
 
Quinton came out of Newmont Mining Corp. and Newcrest Mining Ltd. He knows how the big companies work and what their investment criteria are. Ultimately, our goal at Exploration Insights is to identify deposits that are going to have high enough margins and be large enough to attract a buyout or purchase from a major mining company. Quinton did that at Newmont. 
 
TGR: Do you have a target rate of return when you invest in companies?
 
Brent Cook: In a sense we do. It all comes down to what a company is looking for, what that mineral deposit really looks like and, if it's successful, what it's worth. How much is it going to take to turn this rock into money? That takes into account the development costs, capital expenditures, and process and infrastructure costs. It all goes into determining what we need to see on a property. It's on a property-by-property, country-by-country basis. That's how we get a sense of what our target price might be. Then we follow the news as it goes along and judge if we should stay in it, buy more or sell.
 
Because this is such a high-risk game, we're mostly looking for homeruns. We do own a number of prospect generators that just plod along and go up and down a little bit with the market, but that's a different business model. I think we still have a chance for a tenbagger in those, but it's a long-term investment.
 
TGR: Quinton, one of the things that you're going to talk about at the workshop is red flags in mining company press releases. Give us some specifics that make you raise your eyebrows.
 
Quinton Hennigh: Let's say there's a news release that comes out. It mentions a killer hole—a long interval for a potentially good grade. But the company doesn't list a cross section, making it very difficult to interpret. That's always a little suspect. Why isn't it showing us the full picture here? 
 
Grade smearing is a chronic problem. Grade smearing is where a company takes a high-grade interval or two and transposes that into a much longer interval of lower grades in order to make it look like a bulk intercept.
 
Then there is drilling where there was a previous campaign. Maybe a major had a property and did some drilling. It got some results. Now a junior is coming back in and drilling basically on top of that and reporting results as if it's a new discovery. The company isn't showing the historic information and allowing investors to gauge what it actually has in its proper context.
 
TGR: The difference between true width and apparent drill width in drill results is also on the agenda. Why do investors need to know the difference between those two things?
 
Quinton Hennigh: There's a lot that goes into interpreting the geometry of a deposit. Drill intercepts are never a simple line. We have a one-dimensional line of data. Deposits are not one-dimensional. They're three-dimensional. We need multiple holes to see what's going on. You can't say much about geometry until you have multiple intercepts. 
 
True width is the width of an intersection or a vein that gives us one of the three dimensions we need to determine the tons of a deposit or a system. We need true width versus apparent width or drill width, which can give us an exaggerated width. 
 
TGR: Brent, you've said in other interviews that a 1 gram per ton gold (g/t) deposit could be economic in Nevada whereas a 2 g/t gold deposit might be uneconomic elsewhere. Other than the fact that you have walked over most of it, why are you partial to Nevada?
 
Brent Cook: The real point of that statement is that you cannot judge a deposit or a drill intersection based on the grade. It has to be viewed in the context of what it costs to get the gold out of the rock. There are certain types of deposits that average 1 g/t in Nevada that you can make tons of money on because they're so cheap to process and recover the gold. There are other deposits of 1 g/t that would not be economic anywhere; it's all about the costs of turning that rock into money. 
 
The advantage of Nevada is that all the infrastructure is there. A 1 g/t deposit makes money in Nevada, but the same deposit out in the middle of Burkina Faso will have infrastructure costs that are much higher. Then add in processing costs that are going to be more, plus energy costs and a host of other issues and it is clear we are not dealing with the same base case scenario. Jurisdiction and location relative to infrastructure are also key components of determining what a deposit is actual going to be worth.
 
TGR: There's been a lot of development in Nevada over the years, but it seems most of these projects are proximate to other producing assets. Is that part of your investment thesis?
 
Brent Cook: Most of these deposits in Nevada line up along clear trends. These trends represent deep structures into the earth's crust that are the conduit to mineralization. That's where you go to look. We certainly want our investment thesis to make sense in the context of the basement geology throughout Nevada, or anywhere around the world for that matter.
 
TGR: You stay with a small number of companies for the newsletter. You have a very specific thesis. But in a recent edition, you said you were going to get into some other types of plays.
 
Brent Cook: Given the current currency debasement from quantitative easing, the speculative money is going to jump back into these sorts of plays very selectively. We decided it was time to get a bit more aggressive in early-stage exploration. Having said that, we bought a big company that Quinton identified but nixed two other much smaller companies that we initially had high hopes for being worthy of our clients' money. Although we want to get aggressive, we're not getting careless. I still feel the market is not going to buy your mistakes.
 
Our thesis is the same, though. I still want to keep it to 20 companies or fewer. A few stocks in the EI portfolio really don't count as exploration stocks. Prospect generators are a different business philosophy and risk profile, for instance. If I bring something in, I want to be able to throw something out as well. That allows me to continually upgrade the portfolio. But exploration takes a bit of time. It's a process. I'm not going to throw out a company until I've seen it follow through with the process and our original investment thesis has been tested. However, I am looking to upgrade the portfolio as quickly as possible. 
 
TGR: You just have these 20 companies. How do your readers feel about that? 
 
Brent Cook: They seem to be pretty happy with that. 
 
TGR: You've said that the odds of a geochemical anomaly becoming an economic deposit are roughly 10,000 to 1. Nonetheless, hundreds of millions of dollars are raised each year with those odds in place. Is the system broken? Or are enough people making money on the way up that it doesn't matter what happens on the way down?
 
Brent Cook: It's not broken, but it's certainly inefficient. The scientific side of exploration often doesn't understand the money side and the money side doesn't usually understand the scientific process. A lot of money gets wasted through unrealistic expectations on both sides. It's much easier to raise money on an old property, as Quinton mentioned, that's got an old drill hole in it from years ago. They say, "Look, they drilled this hole. It was 100 meters at 2 g/t. We can repeat this. Maybe it gets bigger?" And, a money guy can say, "Yeah, I can see where we can repeat this hole. We get some excitement. I get off my paper in four months and I can move on." A lot of money gets wasted with that thinking and more often than not retail investors get stuck, if they haven't done their due diligence. 
 
TGR: Is that wasted money coming home to roost now? The brokerage community is struggling in general.
 
Brent Cook: Most definitely. A lot of hedge funds that bought into these two years ago didn't understand the long odds of success and how to evaluate early-stage concepts or the people behind them. Now they're stuck with some stock that's down by half, or more in some cases, with no liquidity. It's a real problem. It's very difficult to raise new money on anything but the very highest quality drill holes or prospects right now. I believe that's going to last through this year at least.
 
TGR: The TSX Venture Exchange recently changed its regulations to allow companies to finance at less than $0.05 a share. What are your thoughts on that, Quinton?
 
Quinton Hennigh: It's like a stimulus for juniors. It's going to amount to an excessive amount of paper being issued. Junior companies are going to have to issue a lot of it to raise anything meaningful. A first-class drill program can cost $1.5–3 million (M) in a reasonable location. That's a lot of nickels. We're going to be like Australian companies with a few billion shares out pretty quickly.
 
Brent Cook: The prospect generator model is a business model employed by some juniors that recognize the long and poor odds of success. It focuses on generating good conceptual ideas that can then be brought to another company with more money to spend to test the exploration thesis. It's a very intelligent way to efficiently explore and make money, but it's slower and not as exciting as the big go-for-broke drill hole play. 
 
The bottom line is that we're investing in ideas, the intellectual capital of the people in the company. If I'm an investor in a company's intellectual capital, I want to keep my percentage of that as high as possible and dilute my interest at the project level, which is the drilling level. That way I get many more shots at potential discovery over time without excessive share dilution.
 
TGR: Have you ever done any quantitative analysis between prospect generator companies and the typical capital pool company method? 
 
Brent Cook: No, but my experience has been that the prospect generators are less volatile and they last longer. Ultimately, I've made more money off of those than the occasional homerun because they go through a number of projects—10, 15, 20 of their projects drilled by partners that eventually fail—that is the reality of exploration. Eventually, however, they seem to come up with a project that they recognize as being special. They know that because the more work they do, the better it gets. Many of them will keep that project for themselves. Then we own a company that has 100% of a project that is recognized as special and we have not been diluted out of the discovery by previous failed exploration efforts. We've got something that really works. 
 
TGR: Do you have anything to add to that, Quinton?
 
Quinton Hennigh: Project generators tend to be run by people who have a prospecting mentality. These are good geologists who can see the big picture. They can recognize the potential of a region. They can go in and pick up areas that are clearly geologically important. A lot of people that we know in the companies that Brent just mentioned know what they're doing and know the areas that work and pick up that land. That alone tells you that they're a pretty good bet.
 
TGR: The projects are longer-term investments, right? You have to be willing to hold these for a while.
 
Brent Cook: Exploration is really a long-term scientific process where we test a thesis, go back to the drawing board, test it again. It's a process. Companies don't just go out there, drill a hole, and say, "Bang! That was easy. Let's go out and drill another one!"
 
TGR: Are you recommending to your readers that they should stay out of most of the names in the junior mining business until tax-loss selling season is over?
 
Brent Cook: There's going to be a lot of pressure on these juniors coming into the end of the year. It's been going for quite a while; we've seen a reprieve, but there are a lot of funds that have to get liquid and get rid of this stuff before the end of the year so they can start new and work on their bonuses for the next year. There's going to be a lot of pressure. There's no urgency to chase things up unless there's an obvious drill-hole discovery in the making. 
 
TGR: Quinton, do you have anything that you want to add?
 
Quinton Hennigh: Things do seem to be picking up, but we're going to see continued volatility. Looking back on the past two years, one thing that stands out in my memory is that companies were issuing paper in a big way when things were riding high. There's a lot of overhang from that period. There are warrants out there. Funds are looking to liquidate certain positions just to get out of them. We're not out of the woods yet.
 
TGR: Thanks for your time, gentlemen.

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