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"A gold mine is a hole in the ground with a liar at top and a fool at the bottom"
Mark Twain
1.0 INTRODUCTION
The majority of readers to these pages will be familiar with the language of the
Technical Analyst or Economists. However, the language of the Mining Industry is,
more often than not, unfamiliar territory for investors in gold mining stocks. Failure to
appreciate fundamentals allows investors to be sucked in by "Market Hype" as
happened in the much reported on BRE - X fiasco, that did much to damage the
reputation of the entire industry. This short paper attempts to address these
fundamental issues and highlight the key facts that the investor in gold stocks should
be aware of.
In view of the much predicted gold bull by economists and technical analysts writing
on these pages, it is crucially important for the investor to keep his head and to exert
at least a measure of control over the markets principal driving forces; i.e., greed and
fear (panic). Remember the oft-quoted brokers adage, which will always remain a
truism "Investment in gold stocks is not for the feint of heart". This small brief
attempts to assist the lay investor to see through the fog of some company's reports
and press releases and enable them to get a feel for a company's style of reporting
and to what extent they are looking to "Ramp" a stock.
2.0 RISKS
As most investors are aware, there are several types of risk in undertaking any
business, namely:
Business Risk
This is evaluated in Financial Pages as a company's Beta, which relates to the business
segment the company operates in. The gold mining industry has a high - risk beta,
near the top of the range. However, to minimize the recurrence of BRE - X type frauds,
the major Stock Markets and Governments in co - operation with leading mining
industry professionals have introduced increasingly stringent reporting requirements
for Stock Exchange releases. For example, the AUSTRALIAN INSTITUTION OF MINING
AND METALLURGY (hereinafter Aus, I.M.M.) has introduced its J.O.R.C. Standard (Joint
Ore Reserves Committee). This standard is rapidly gaining approval as a benchmark in
the world's stock exchanges; Public statements to the Stock Exchange or Press
Releases are based on Ore Resource estimates or Ore Reserve calculations.
The reader is referred to the Aus.I.M.M website to read the full text of JORC and for
any recent updates. However, the writer has quoted some key sections of the JORC
text verbatim below from which the reader can get the main thrust of the
requirements. Some mining companies still abuse these requirements. Any investor
should be aware of these requirements, and is strongly recommended to go to the
Aus.I.M.M. Website to read the full text.
JORC requires that any statement on Mineral Resources that goes public; for example,
to the Stock Exchange, Press or Financial Institutions etc., must be prepared by a
"Competent Person or Persons".
Statements by mining companies refer to both a Mineral or Ore Resource and Ore
Reserves. The Aus. I.M.M. "J.O.R.C" definition of a "Mineral Resource" is as follows:
J.O.R.C then goes on to define the three main Mineral Resource categories as follows:
with each showing a greater degree of confidence in the Resource Estimated:
"Inferred Resource"
"An 'Inferred Mineral Resource' is that part of a Mineral Resource for which tonnage,
grade and mineral content can be estimated with a low level of confidence. It is
inferred from geological evidence and assumed but not verified geological and/or
grade continuity. It is based on information gathered through appropriate techniques
from locations such as outcrops, trenches, pits, workings and drill holes which may be
limited or of uncertain quality and reliability".
"Indicated Resource"
An 'Indicated Mineral Resource' is that part of a Mineral Resource for which tonnage,
densities, shape, physical characteristics, grade and mineral content can be estimated
with a reasonable level of confidence. It is based on exploration, sampling and testing
information gathered through appropriate techniques from locations such as outcrops,
trenches, pits, workings and drill holes. The locations are too widely or inappropriately
spaced to confirm geological and/or grade continuity but are spaced closely enough for
continuity to be assumed.
"Measured Resource"
A 'Measured Mineral Resource' is that part of a Mineral Resource for which tonnage,
densities, shape, physical characteristics, grade and mineral content can be estimated
with a high level of confidence. It is based on detailed and reliable exploration,
sampling and testing information gathered through appropriate techniques from
locations such as outcrops, trenches, pits, workings and drill holes. The locations are
spaced closely enough to confirm geological and/or grade continuity.
The following rider put in by J.O.R.C for the definition of "Mineral Resources" is worth
quoting:
"Mineral Resource estimates are not precise calculations, being dependent on the
interpretation of limited information on the location, shape and continuity of the
occurrence and on the available sampling results. Reporting of tonnage and grade
figures should reflect the order of accuracy of the estimate by rounding off to
appropriately significant figures and, in the case of Inferred Mineral Resources, by
qualification with terms such as 'approximately'.
NB: Writers underlining.
In addition the investor should be aware of the following, also quoted from JORC:
The words 'ore' and 'reserves' must not be used in stating Mineral Resource estimates
as the terms imply technical feasibility and economic viability and are only appropriate
when all relevant technical, economic, marketing, legal, environmental, social and
governmental factors have been considered. Reports and statements should continue
to refer to the appropriate category or categories of Mineral Resources until technical
feasibility and economic viability have been established. If re-evaluation indicates that
the Ore Reserves are no longer viable, the Ore Reserves must be reclassified as
Mineral Resources or removed from Mineral Resource/Ore Reserve statements.
"An 'Ore Reserve' is the economically mineable part of a Measured or Indicated Mineral
Resource. It includes diluting materials and allowances for losses, which may occur
when the material is mined. Appropriate assessments, which may include feasibility
studies, have been carried out, and include consideration of and modification by
realistically assumed mining, metallurgical, economic, marketing, legal, environmental,
social and governmental factors. These assessments demonstrate at the time of
reporting that extraction could reasonably be justified. Ore Reserves are sub-divided in
order of increasing confidence into Probable Ore Reserves D30 and Proved Ore
Reserves"
NOTE: "Ore Reserves are those portions of Mineral Resources which, after the
application of all mining factors, result in an estimated tonnage and grade which, in
the opinion of the Competent Person or Persons making the estimates, can be the
basis of a viable project after taking account of all relevant metallurgical, economic,
marketing, legal, environmental, social and governmental factors. Ore Reserves are
inclusive of diluting material, which will be mined in conjunction with the Ore Reserves
and delivered to the treatment plant or equivalent.
The term 'economic' implies that extraction of the Ore Reserve has been established or
analytically demonstrated to be viable and justifiable under reasonable investment
assumptions. The term 'Ore Reserve' need not necessarily signify that extraction
facilities are in place or operative or that all governmental approvals have been
received. It does signify that there are reasonable expectations of such approvals.
It should be noted that the Code does not imply that an economic operation must have
Proved Ore Reserves. Situations arise where Probable Ore Reserves alone may be
sufficient to justify extraction, as for example with some alluvial tin or gold deposits.
Some countries use the term 'Mineral Reserve' instead of 'Ore Reserve'. The Joint Ore
Reserves Committee has retained the term 'Ore Reserve' because it assists in
maintaining a clear distinction between a 'Mineral Resource' and an 'Ore Reserve', a
distinction which might be less clear if 'Mineral Reserve' was substituted"
Under JORC there are two ore reserve categories: "Probable" and "Proven". Obviously
"Proven" is the highest category of reserve and both are defined below:
"PROBABLE RESERVE"
"PROVEN RESERVE"
"A 'Proved Ore Reserve' is the economically mineable part of a Measured Mineral
Resource. It includes diluting materials and allowances for losses which may occur
when the material is mined. Appropriate assessments, which may include feasibility
studies, have been carried out, and include consideration of and modification by
realistically assumed mining, metallurgical, economic, marketing, legal, environmental,
social and governmental factors. These assessments demonstrate at the time of
reporting that extraction could reasonably be justified."
Many smaller companies now are obliged to get their ore reserves verified
independently by an international firm of consultants. Indeed, some companies utilize
an independent firm of consultants to undertake all aspects of the "Evaluation
Program", and even the entire "Feasibility Study", once a project has been identified in
exploration. This minimizes, or, hopefully, eliminates the possibility of tampering with
samples taken during the evaluation program, as the consulting company would be
sued for extensive damages resulting from fraud.
Whilst technical risks resulting from fraud or simple incompetence may be minimized,
business risks still remain that are much less controllable, particularly if the company
is operating in countries that do not rank as "mature democracies" such as: U.S.A,
Canada, Australia, New Zealand, EEC and South Africa. The latter countries are rated
"triple A" in terms of their business risk. However, countries such as Vietnam,
Philippines, Indonesia, Laos and Myanmar (Burma), for example, have very different
Sovereign Risks and Business Risks. Companies operating in these countries incur an
increased risk penalty dependent on the scale of the risk, Factors to consider here are:
The personality and "track history" of the CEO is of fundamental importance to the
future of the company. The old adage that "success breeds success" is particularly true
in the world mining industry. A CEO who has a documented record of bringing mining
projects into successful production, and understands the twists and turns and complex
problems of the mining industry, is clearly more likely to do so than the untried
outsider brought in, for example, because he is a good corporate accountant or lawyer
and can talk to the financial institutions. . The Internet enables background research to
be done by the Investor on corporate CEO's. Also, if the Investor is an old hand and
has many contacts in the industry, there's the "Industry grapevine" to rely on!
The "make up" and character of the "Board of Directors" of any given
company is also interesting to read and investigate. Working on the
geological maxim that "the past is the key to the present …… and future".
Individual track records of "Board" members can make interesting reading for
the investor.
The following are useful to know and can be acquired from corporate websites or
calculated, in particular, from the company's statement of accounts:
Remember that the Cash Operating Cost may vary with gold price, hedged gold
program, mine stripping ratio, mill operating costs and ore grade. It is important to
examine the company's projections over "Life of Mine".
4.2 Ownership and Title
4.3 Exploration
Such statements as " the company is pleased to report that a program of rock outcrop
sampling at Prospect X encountered an average of 15 grams per tonne gold over 100
meters of strike" or " a sample from the YZ prospect returned 80 grams per tonne gold
and 3,000 grams per tonne silver equivalent 110 grams per tonne gold equivalent"
should be regarded as interesting BUT utterly unrepresentative of the likely grade or
potential gold - silver resource. Many such fabulous grades have no continuity
whatsoever. The investor should look for exploration reports that put assay results in
their context. Remember the old adage, " If it sounds to good to be true then it most
probably isn't".
• A scaled prospect map showing: location of old workings, drill holes, prospect
trenches and channel samples. The map should be simple, clear and suitably
annotated so that a layman investor can easily understand the basic picture
• All rock chip and channel sampling should be accurately described with grades
quoted over sample widths. Spot sample grades from rock chips are indicative
only and cannot be extrapolated under any circumstances with any degree of
confidence
• Sampling procedures, in particular a company's check sampling and assaying
procedure should be accurately described. Check assay laboratories named
and independent consultants verification will provide greater investor
confidence in results.
• Drill intersection angle with ore zones should be given, where possible, in
diamond drill core, and the core diameter drilled. Larger diameter core will
generally provide more representative and reproducible mineralized grades,
because one can cut a much bigger sample. All cores should be split, and half
retained for future reference, and, where necessary, further check assaying. In
the BRE - X fiasco, one of the first alarm bells to ring with the mining fraternity
was that the company assayed the entire core!!
This is the key exploration phase, taking the prospect from discovery to mine
feasibility study. Therefore, the way in which the data is collected will have a
fundamental impact on the success or failure of the project.
In the case of Bre - X, the samples were skillfully salted in a "sample preparation"
facility at the Busang prospect. Supervision of the evaluation program by a geologist
who is a member of an internationally recognized professional geologic body, such as
the Australian Institution of Mining and Metallurgy, is an essential. Nonetheless, this is
no absolute guarantee against fraud. Independent audit of the program by an
internationally recognized firm of geological and mining engineering consultants is the
only sure guarantee against fraud. Unfortunately the BRE - X fiasco was "a disaster
waiting to happen", to an overly complacent industry, hyped up to an obscene level of
greed.
All gold projects are basically evaluated in the same way. This involved a combination
of:
Each of these phases increases the degree of confidence in the calculated ore reserves.
For most deposits, a combination of RC and DDH drilling will suffice to bring the ore
resource into the "measured" category. However, RC drilling, although a very good
sampling tool, does not return drill core for accurate geologic analysis. Fundamental
geologic data is lost - primarily structural geologic data that determines the confidence
level a geologist may have in the correlation of ore intercepts. Ore Resources based
entirely on RC drilling should be treated with a substantial degree of skepticism.
Unless, of course, the deposit is a laterite or alluvial deposit, where geologic features
are of less significance.
Gold deposits are normally drilled to ore reserve status on either a 25 m x 25 m grid or
20 m x 20 m grid. This is the drilling density generally required to calculate an ore
reserve in the "measured" category. Furthermore, if the program has been largely
drilled RC, at least 10% to 20% of the "key holes" which comprise the resource should
be twinned with diamond drill holes.
Significant issues to look at in entirely "diamond drilled" resources are, the core
diameter and percentage core recovery in the ore zones. The larger the core diameter
(HQ being optimum - 68 mm) the better the confidence levels in the assay grades. Any
mention of an entire drill core being assayed as routine should ring immediate alarm
bells! Resources based on drill core recording significant core loss in the ore zone may
have to be RC drilled, before a meaningful resource can be delivered.
The key assumptions used in the Feasibility Study include, inter alia, those concerning
the gold price. A project sensitivity analysis should have been undertaken to review
the impact of a significantly lower gold price, where a forward hedged price can not
been built in.
In third world countries, there will be the added costs of higher cost utilities and
services where these have to be used. In particular, the higher costs of transportation
of materials and supplies to the operation will impact on overall project economics.
The CAPEX (Capital Expenditure) required to build the Mine and its associated
infrastructure. In hilly or mountainous, heavily forested, third world countries, such as
the Philippines, the infrastructural costs can amount to a significant percentage of the
total CAPEX. Therefore, to support such a project the mining company will have to
benefit from some advantages to overcome these additional capital costs such as:
• Exploration tax write - downs against future profits from the operation
• Tax holidays
• Accelerated depreciation
• Low Cash Costs of Production per fine ounce of gold
• A project which allows a rapid payback in years 1 - 4
• Government assistance with infrastructure costs, such as building bridges and
roads to the project site
Other issues of importance relate to Project Financing. The structure of the Financing
Package for the project development should be examined, together with the track
record of the Project Financiers.
4.6 Mining Operations
For the Investor in Mining Stocks, the key investment parameters are as follows:
• Cash Operating Cost per ounce of fine gold produced. This should be given on
a quarterly basis and a projection of Cash Operating Costs over "life of mine" is
also very useful
• Annual gold production in ounces with the gold grade, recovery and tonnes
milled
• Ore Reserves given in the "measured", "indicated" and "inferred" categories
• Waste / ore stripping ratio's over life of mine for open pit operations
• Underground development programs and costs for underground gold
operations, and how these are being financed
• Details of the company's gold hedging or dehedging programs
Major gold funds have analysts doing this type of analysis, to produce league tables of
mining companies to invest in. Many of them are very successful, however, some are
not. Remember, "When the wind blows even turkeys fly". However, the astute private
investor can cut out the "middle - man", and can compile his own league table on a
spreadsheet, and call up company CEO's to ask the hard questions. After all, he is
looking to invest his / her money in the CEO's company!
NHM
03/07/2003