The importance of the drill test for junior Gold Mining investors...
WHEN IT comes to investing in the high-risk junior resource sector, 95% of the companies investors might choose will fail to hit paydirt.
Exploration Insights Editor Brent Cook has some advice for those looking to pick winners from the remaining 5%.
In this interview with The Gold Report, conducted during the 2011 New Orleans Investment Conference, Brent Cook makes the case that selecting juniors whose properties are most likely to pass the drill test also gives investors an ideal, built-in exit strategy.
The Gold Report: Could you tell us the premise behind your statement at the New Orleans Investment Conference about why so many exploration and mining companies fail?
Brent Cook: Mining is a tough business—a very tough business. So many things can go wrong even if the company did everything right. On the exploration side, probably 95% of the junior companies whose share prices start moving up the discovery curve finish down at the bottom of that chart. Very few actually end up with something of any real economic significance.
The main reason is that exploration is a very inexact science. In geology and exploration, we deal with a limited amount of data at the earth's surface and then use geologic models to try and understand what is happening at depth. So we are doing a lot of guessing and projecting based on a very limited data set. In fact, exploration geology is as much art as science because so much of what a geologist thinks is subjective and based on experience.
So, in the end, that fuzzy science is being applied to test some sort of geochemical or geophysical anomaly near the earth's surface. It could be slightly elevated gold or arsenic in the soil or a magnetic body of rock at depth. You have to bear in mind that an anomaly is really little more than a difference in the background values of something like soil or rock or density or magnetism.
Whatever it is, the world is full of anomalies and they are not all deposits. Nature has scattered billions of geochemical anomalies all around the world, so chasing anomalies is just the nature of the game; that's what keeps us all employed in the exploration business. And failure has to be the overwhelming result when you are looking for that rare place in the earth that everything came together to form an economic deposit.
Still, all of that chasing has been very profitable to the Vancouver stock market scene; a lot of money is raised and made chasing anomalies.
TGR: So even for trained geologists like you, geology is an inexact science and you cannot know what you have until you start drilling.
Brent Cook: Basically, that's right. Drilling is a scientific tool. That's when you test your hypothesis. You hypothesize that a vein of gold, for instance, formed at 200 meters of depth under the right circumstances. More often than not, you test your thesis, get your data back, reassess the data and adjust your thesis to fit the data. That's another reason it takes so long to actually make a discovery. Putting widely scattered pieces of data together takes time.
TGR: If 95% of what appear to be good geographic anomalies fail the drill test, why does so much money chase the junior mining sector?
Brent Cook: Because if you are successful, your stock goes from $0.25 to $2.50, $10, $20. And even without an economic discovery the rewards can be enormous if you know when to get out. As I say, a lot of these stocks start up that price-appreciation curve. At some point, an investor who is well-enough informed and understands the drill results can sell that stock at a profit before the rest of the world realizes that this is a bust. So a lot of money is made on that upcurve.
TGR: That sounds like making money based on hype and not on value.
Brent Cook: A lot of hype goes on in this sector for sure, which is facilitated by the inexact nature of the science, but savvy investors really base decisions on interpreting the results as they come in. When the data start indicating that the hypothesis was wrong, they probably decide it is time to start thinking about getting out. To make money, speculators just have to recognize it before the crowd does.
TGR: Few investors really know how to interpret the data and test the thesis, as you say. How can they realistically play in that junior mining game?
Brent Cook: My honest answer is to get good advice. Rick Rule, who emceed the mining panel at the conference, runs Global Resource Investments, a brokerage firm that actually employs geologists and mining engineers as brokers. That's one good place to get advice. A good investment newsletter is another; I like mine.
Of course, a good adviser has to interpret the data correctly and say, "Look, the results from this drilling program from this project up in the Yukon aren't looking so good right now. The results are telling me we have less chance of finding something, so it's probably time to sell." Or it could be the opposite: "This is really looking interesting. Let's buy some more."
TGR: In your New Orleans presentation, you advised junior exploration sector investors to know their exit strategy. Can you expand on that in light of what you've just explained?
Brent Cook: Always buy a junior with some idea of who will buy it from you and why. My exit strategy ultimately is to invest in juniors that find deposits good enough to interest the majors. In other words, my exit strategy is to sell to someone somewhat smarter than I am—a major that knows its stuff, does its due diligence and decides to buy one of these companies. I also like to get in early on a project with the idea that as the company derisks it with drilling, metallurgy or whatever, the project fits the profile of a fund manager or someone looking for less risk and more quantifiable upside.
But I think the exit strategy for most people who get into this game is to sell to someone dumber than they are, hoping the fools come in and pay more for a stock than they did. That works in a raging bull market, but not in this market. In essence, with a sound exit strategy you know 1) what the deposit the company is looking for actually looks like, 2) what it is going to take in both money and exploration to realize the deposit goal and 3) what it might be worth if all goes well—and then sell when it gets to that point.
TGR: So 95% of the time you sell to someone not so smart, and 5% of the time you hit it and sell to someone smarter.
Brent Cook: Theoretically, yes, but that assumes you buy all the stocks that start up the discovery curve and that you are right and that there is an infinite supply of dopes. It's such an inexact science, though, that even expert opinions differ. If you get five geologists in this room with me and we start talking about a property, you will hear six different opinions as to what's going on down at depth or who makes the best beer. I'm certainly not right all the time—no one in this business can be. You have to go with your interpretation of the data at hand and stick with it.
TGR: And the 5% that prove out are fabulous. Does some knowledge base allow a geologist to winnow that 95% down so that geologists have a somewhat lower risk than non-geologists?
Brent Cook: I think so, although on the whole geologists are dreamers, so keep that in mind. You can, however, improve the odds quickly by not getting into projects that don't really have a chance of significant success. I would say half the junior companies in this industry are chasing prospects that are not worth very much even if they're successful.
TGR: You are also an investor. Do you prefer prospect generators because, in essence, they have multiple projects and thus spread the risk more than explorers? Or does your knowledge as a geologist enable you to pick and choose on a very educated, selective basis?
Brent Cook: I think it's both. The prospect generator model is a very intelligent way to go about investing, and I certainly think that any investors in this sector should have at least some portion of their high-risk investment in some carefully selected prospect generators. With the companies I know that follow this model, the people running them recognize the low odds of success and incorporate that into their business approach. You want intelligent people running the company to begin with—as opposed to those who think they will drill a glory hole, hit it the first time, and strike it rich. That is not a realistic approach to the business.
TGR: Could a lay investor infer that a prospect generator's project has a higher percentage of hitting if it is joint ventured with a major that knows this stuff and has probably done a fair amount of analysis?
Brent Cook: That's a good point. It's fantastic when a prospect generator is involved with a major. Its in-house experts are doing the due diligence and selecting the properties the company thinks have a chance of making its hurdle and meeting its big company criteria. A prospect generator in those circumstances has access to the big company's geophysical, geological and engineering experts. There is no way small companies can afford that depth of knowledge on their own.
TGR: Where do you think the next really big precious metals discovery will be?
Brent Cook: If I could go anywhere in the world regardless of politics, I'd be in Iran, second is probably Afghanistan. After that it's a tough call.
TGR: Would you like to add anything else, Brent?
Brent Cook: I'd like people reading this to come to my website and click on the Discovery Process video link to a property tour I did in the Yukon; it's also on youtube. I think it's worth seeing the reality of a property visit and the sorts of things you can't get reading a press release.
TGR: Thanks for fielding our questions today, Brent. And for the link. Another one our readers may want to check out is an article you wrote.
Looking to buy physical Gold Bullion?...