"Investing" in junior mining?

[ItsAValueTrap]

The Canadian junior mining stocks strike me as an incredible trap. 

 

I see a lot of value investors not realizing that NI 43-101 reports can be manipulated and that they are all almost overly optimistic.  I agree with Parsad that there is too much scum on the TSX Venture (and TSE).

 

Examples:

- Barkerville gold.  They came out with a press release claiming that Barkerville had a Bre-X sized deposit.  The stock is currently halted.  The author of the report, Peter George, is a disgrace to his profession.

- Canada Lithium.  Before they were named Canada Lithium, they hired Peter George to write a technical report on their gold deposit.  Black Pearl announced a deposit of around a million ounces of gold.  Then they raised capital.  In the next quarter, they wrote down their gold property to almost 0 (the property was pretty much worthless).

- Canada Lithium.  Currently, they are being sued because they had to restate their resource estimate.  And it's not the first time Michelle Stone wrote an aggressive technical report.

- Bear Lake Gold.  The geologist decided to commit outright fraud and enter in some assay results higher than what they actually were.  An independent technical report did not catch this, though the author of the technical report didn't seem to be bothered by the fact that all his QC checks came in 20% too low.

-Many juniors do not disclose title issues with their properties (Bre-X, East Asia Minerals, etc.).

 

Is there some way of investing in these companies without getting burned?  It seems to me that the odds are heavily, heavily stacked against the retail investor.  Other investors kind of have access to inside information.  Analyst/site visits and face-to-face talks can be an unfair advantage over retail investors.  And it's almost always the case that juniors fail to release critical information (e.g. title issues, full assay results for deleterious elements, etc.).

 

Parsad has a great post on similar issues:

Hi Moore,

 

No worries on the debate.  I enjoy that aspect as do many others.  You have to tear down ideas to find out if they have value or not.

 

I was just asking because your handle has Moore Capital on it.  I was just going to make a point that if that was where you worked, your institution has numerous internal controls in place to prevent fraud, illegal trading, etc.  Yet, even then you can have fraud or unethical behavior occur there, such as the case with Christopher Pia who was fined $1M there for illegal trading activities.

 

You'd be surprised by who we work with.  In regards to 43-101 certification, all you need is five years exploration or mine development experience, and be registered as a member with any professional geology organization.  About the same as a CGA or CFA in terms of depth of study.  I know and have seen a number of geologists go through the process. 

 

In terms of auditors, I've seen every auditor in Vancouver, from small ones to the big 4, certify financials for some crappy companies.  There are a couple of firms where all they do is certify financials for shell companies and new exploration companies for large promoters.  Even the large audit firms use CA students and senior managers to do the testing, while partners review the financials, MD&A and results of testing.  There is plenty of room from the drilling stage, to the certification process, and finally the operations side for fraud to occur.  All auditors and internal control specialists can do is establish enough key controls to reduce the amount of fraud and allow it to be detected more easily.  We can't stop it.

 

My off the cuff remark about geologists, executives, etc, was a generalization, but the amount of fraud is rampant.  And that is partially due to the incestuous relationship between officers of companies, the geologists, board of directors, investment banks and promoters.  The incentives are completely misaligned, enforcement is lacklustre, and the majority (I would guess 80% or better) get the shaft. 

 

You must be relatively young, because David Baines has been covering more OTCBB companies in the last few years primarily because alot of West Coast promoters have gotten their hands more heavily involved on there.  He used to write only on TSX Venture, or what used to be the VSE, for pretty much most of his career.  He still does write regularly on TSX and TSX Venture companies, but more time is spent on OTCBB's.

 

Anyway, I've spent considerable time examining the space from the interior and the exterior, including reading plenty of 43-101 reports.  I've viewed the business from on-site drilling and exploration to the company's head office and boardroom.  I've interviewed executives, directors, geologists and administrative staff.  Examined ledgers, continuity schedules, treasury orders, inventory, asset valuations, payrolls, etc. 

 

The handful of companies you mentioned sprouted from thousands and thousands of companies that failed...partly due to unsuccessful projects, and often due to unethical conduct, incompetence and mismanagement.  Often I've seen companies that have raised financing, simply find a garbage property so they can continue to work, receive salary and options, and feed off the retail investor trough.  Are there legitimate companies...sure, plenty.  But they are outnumbered by the rubbish.  Cheers!   

 

*Disclosure:  I own juniors.  Maybe I shouldn't.  Northfield Capital, Altius Minerals (they own Alderon), Noront, KWG Resources are my big positions.  EDIT: Queenston Mining too.

[beerbaron]

Yes, invest in originators that know what they are doing (Altius for example). In the junior miner sector it's a mess that I would not invest directly unless I wanted to lose my money.

 

BeerBaron

[moore_capital54]

Hehe.. anybody that had any experience reading 43-101's not only knew Barkerville was a scam but shorted the stock (As we did).

 

Just as in every business and every area of life, one has to study and learn how to analyze a 43-101. To say they are all manipulated and or scummy is a weak generalization.

 

The purpose of a 43-101 resource estimate is to methodically document a resource envelope. The investor then has to take that information and arrive at various DCF estimates based on their analysis.

 

Everyone knew BGM was a fraud and that was why the BCSC rejected that report immediately. The biggest hurdle for a value investor dabbling in juniors should be that the ultimate arbiter of value and price is not the fundamentals as they relate to cash flows because there are none. Instead these things should be viewed as highly levered options on the respective commodity. An investor should look for exposure in their target commodity and then try to find a situation where they are getting a lot of that commodity in the ground at a large enough discount to the spot price which results in very high option value.

 

 

[ItsAValueTrap]

1- Maybe this is getting a little off topic, but I don't understand why the regulators allow companies to issue press releases for a technical report before filing the technical report.  In the case of Barkerville, the stock popped up when it issued the PR and some retail investors are probably going to get hurt.  Would it not make more sense that these companies can only issue a PR after the technical report has been released?

 

2- Some of the flaws with 43-101 reports are very difficult to spot.

 

With Canada Lithium I read the technical report.  I didn't catch on that the resource estimate was inflated.  Actually now I think it's a scam because if you look at Talison Lithium's mine, Talison has over twice the grade and the scale of Talison's operations is far greater than what Canada Lithium proposes.  Yet CL claims that its cash costs will be slightly lower than Talison's.  That doesn't strike me as likely.  And their technical report doesn't show the assay results of their metallurgical testwork... this seems to me to be a HUGE omission.  The purity of the final product will affect its price.

 

2b- I'm not sure how to spot title issues that aren't disclosed. 

 

----------------------

Ok instead of ranting about juniors let's try to be more constructive.

 

So far, this is what I know to look for in technical reports (and in mining in general):

 

a- Some authors I just don't trust.  Peter George, Michelle Stone, and Behre Dolbear.  Companies like BBA are better, but I know that BBA's technical reports can be way off (e.g. look at Cliffs operating costs for Bloom Lake versus the BBA reports for Consolidated Thompson/Bloom Lake).

 

b- Check the commodity price assumption.  Is it reasonable?  Some technical reports cherry pick between the spot price and 3-yr average.  Some reports assume inflation (!!!).  If they use something other than the 3-yr trailing average (which is the standard), then pay attention.

*If it's gold or iron ore, many technical reports will actually use something more conservative than the 3-yr trailing average.  I believe this is because they are pandering to the banking analysts, who have incredibly bearish outlooks on future gold and iron ore prices.  So what you do is to deflate your opex/cash costs (aggressive) and deflate your commodity price assumption (conservative).  NPV will stay about the same.  But the analysts will be "happy" because they blindly plug numbers into their models and they see reasonable NPVs even with their bearish commodity price outlooks.

 

c- For many commodities, the purity of the shipping product affects its price.  Hopefully they provide assay results for the shipping product and for the ore.  You can be pretty sure that they assay for everything that matters because assays are cheap.  If they do not release assay results for deleterious elements, this may be an intentional omission.

 

d- Read the section on QA/QC.  Do the assay results match exactly?  If not... do more research.

 

e- Look carefully at the search radius that they are using.  An extremely high search radius is a method for inflating indicated/inferred resources.

 

f- Geological Interpretation / use of wireframes.  If you are dealing with complex geometries such as gold veins (or veins of anything), then you often aren't sure which intersections in one drill hole correspond to which intersections in another drill hole (sometimes they do not connect).  There is room here to make aggressive assumptions in this regard.

Companies will perform infill drilling to figure this out.

 

g- Metallurgical risk.  Some ores are really expensive to process, e.g. anything labelled as refractory, sulfide gold, etc.  You just have to know something about the commonly-used recovery processes (e.g. where heap leaching works well and doesn't).

 

h- Metallurgical risk.  If the company proposes some new technique that is not tried and proven, you need to be very very careful.  You don't know how much it will actually cost until you build the thing as full commercial/production scale.  Our scientific models aren't perfect.  Before they go build the processing plant, you want to see them build a pilot plant that is at least 1/10th-1/100th of the scale of the production plant.  And even then, **** can happen.  The Goro nickel project for example has had many delays and accidents.  Baja Mining and Starfield Resources proposed novel recovery techniques and will likely never make it to production.

 

i- In general, anything novel such as placer deposits and underwater mining should probably be avoided.  These things usually have a terrible history.

 

j- Cost of infrastructure.  You have to know something about infrastructure as costs can vary wildly.  If it is close to existing infrastructure (e.g. close to a highway, site of an old mine) then this usually isn't a big risk.

 

k- Cost of mining.  You have to know something about mining as costs vary wildly depending on a number of factors.  Veins that are thin (e.g. 1 meter wide) are really expensive to mine.  Deposits with phenomenal grades but thin veins are probably a trap.  Deposits with thin(-ish) veins don't benefit from the cost savings of mechanization... so the economics also depend on labour costs in a particular country.

 

l- The problem with the stock market is adverse selection.  Private investors are much savvier than the public markets and do much more research than institutional and retail investors.  Freeport Mcmoran didn't get completely burned by the Bre-X fraud while many institutional investors did because Freeport actually did their due diligence.  Freeport would have assayed splits from the drill core if Bre-X didn't destroy their drill core (maybe this is a red flag that institutional investors should have picked up on... it was known at the time that Bre-X wasn't saving any drill core).  So Freeport did their own drilling and drilling is not cheap.

 

m- Mines shut down because they aren't economic.  If a public company wants to restart a mine that was shut down in the past few years... this is a red flag.  e.g. Yukon Nevada Gold did a mine restart and lost a lot of money.  (Um... public markets are stupid.  There are also a lot of bullish writeups on YNG on valueinvestorsclub.com and on value investing blogs.)

 

n- Areas with commercial mining a long time ago are good places to look for ore.  So are areas close to existing deposits and existing operating mines.  I'm not telling you to stay away from mine closures... I'm telling you to be careful with mine restart projects.

 

o- Political risk.  You have to know something about political risks in that particular country.  Things are simpler if you stick to only US/Canada/Australia, though there are First Nations issues, NIMBY, and environmental NGOs to watch out for.  Many major projects have been delayed due to these issues.

 

p- Some deposits may be the "tip of the iceberg".  This mainly applies to high-margin deposits only.  The existing deposit may extend further with follow-up drilling.  The surrounding area may also host similar deposits.  High-margin discoveries often lead to mines that operate well beyond their original mine life and to other mines in the surrounding area because they keep finding more economic ore.

If the deposit is low-grade, then it's no use if the deposit extends deeper since mining deeper usually costs more money and therefore this ore may not be economic.

 

q- Interpolation method.  One way to inflate resources slightly is to cherry pick between nearest neighbor, ID2 (inverse distance squared), ID3, ID5, ordinary kriging (OK), etc.  If the technical report lists the results with many of these methods, then usually it is a good sign because it shows that the author isn't trying to cherry pick.

 

r- Read insider trading reports on canadianinsider.com (*don't use your real email for financial sites because you may get pump and dump spam) and sedi.ca.

 

s- Many juniors don't spend that much money on actual exploration and mine development.  A lot of them spend money on stock promotion... they advertise on websites, pay for spammers, pay for shills, etc.  If you Google the name of the company plus the word "sponsor" you may be able to find these activities.  Insider salaries for the (part-time) CEO is usually high... this is disclosed in the information circulars filed on SEDAR.  You can look at the company's historic G&A spending versus their exploration spending.

 

t- Check if the management team has experience in bringing mines into production.  (Because often they don't...)

 

u- Some investors like Rick Rule will avoid most of the stocks out there and only stick with the superstar management teams with good track records.  Many geologists will never find a mine in their entire professional careers.  A few of them consistently find mines... the skilled geologists will be lucky more often than their peers.

A few mine developers (promoters) are much better at promotion than their peers.  Robert Friedland for example is a very good salesman.  I'm not sure about these guys' ability to create value.  But because they are successful, they attract those who are able to create value. 

Guys like Lassonde, Schulich, Dalton are very smart because they bought land when it was really cheap.

 

v- According to Rick Rule: Junior exploration is a huge destroyer of capital.  Senior gold miners are usually overvalued and they made far less money than they should have.  Be a contrarian or be a victim- buy the dips, sell the rallies.  Clearly right now is the time to buy.  see http://sprott.com/news-centre/why-i%27m-excited-about-this-market/

[BargainValueHunter]

Have the juniors EVER been this cheap on a "cost to mine/ price of gold" basis?

[ItsAValueTrap]

Cash costs/ounce have steadily gone up over the past decade.  In aggregate, the gold industry has had very poor performance over the past decade.  The price of gold has skyrocketed but the industry's production has been flat.

 

In aggregate, junior explorers are NEVER cheap because the "industry" in aggregate is a destroyer of capital.  They spend too much money on things that don't create value... corporate overhead, stock promotion costs (sometimes outright paying for shills), dumb drilling campaigns (to get results to promote the stock), underwriting fees and costs associated with raising capital, excessive salaries for the part-time CEO and other insiders, etc. etc.

And it's common to lie about reserves and the economics of their deposits.  This is extremely common in technical reports.  Technically it's very difficult to prove that they are lying or committing fraud because these things are uncertain and are estimates.

 

2- There are some things that are selling below liquidation value... some of the closed end publicly-traded funds, Pinetree, Aberdeen, and Northfield Capital.  These things are easy to analyze because almost all of their assets are in stocks (with the exception of Aberdeen, which has private companies with questionable valuations).  Only Northfield doesn't have "corporate governance issues"... insider compensation is very tame.

[Liberty]

http://www.bloomberg.com/news/2013-02-27/gold-miners-come-clean-on-costs-after-lost-6-years-commodities.html

[Guest ajc]

Dundee’s real-time data innovations are as good as gold

 

"You would think an iPhone would be an utterly useless gadget in Dundee Precious Metals Inc.’s Bulgarian gold mine for the simple reason that the mine lies nearly a half kilometre below impenetrable rock.

 

But the underground reception is working well and that makes Mark Gelsomini, information technology director for the Toronto-listed company, smile like he has just tripped over a gold nugget the size of a golf ball. About 400 metres underground, his e-mails arrive without a glitch. Phones are static free.

 

“You’re coming in clear,” Mr. Gelsomini tells Dundee CEO Rick Howes, who is also deep underground in a dark tunnel that connects the mine’s various operations.

 

The free-flowing communication at Dundee’s Chelopech mine is thanks to a fully enabled underground WiFi network – a technological leap is attracting international attention.

 

One of the mine’s visitors this week was Mark Cutifani, CEO of Anglo American PLC, one of the world’s biggest mining companies. He was there to learn whether Anglo could adopt some of Dundee’s communications and data systems for its own operations, perhaps in partnership with the little Canadian gold player. He says he was impressed by what he saw: “This is where the innovations are, in the smaller mines.”

 

Installing a data network in the mine puts Dundee at the forefront of the industry’s next phase – treating mines as if they were just-in-time manufacturing sites. That means every activity, from the number of scoops of ore delivered to the crushing machine to the number of metres drilled into the rock face, is recorded and displayed in real time..."

 

http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/dundees-real-time-data-innovations-are-as-good-as-gold/article15708530/