When it Comes to Gold Deposits ‘It’s not Grade; it’s Margin’

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When it Comes to Gold Deposits It’s not Grade- it’s Margin, says Brent Cook, author and publisher of Exploration Insights.

Brent Cook, author and publisher of Exploration Insights, a newsletter targeting the small-cap mining space, says that mid-tier and senior gold producers are becoming more selective about the gold deposits they are willing to buy to replace their reserves. These predator companies, Cook says, want high-margin deposits that will generate robust cash flow and some may be willing to pay a premium for them. He expounds upon his thesis and offers some potential targets in this SmallCapPower.com exclusive.

SmallCapPower.com: Brent, you recently told The Northern Miner that investors should sell everything in their portfolios that they remain uncertain about. Could you elaborate on your reasons for that course of action?

Brent Cook: This is something I have been saying for a year now in Exploration Insights. A lot of speculators buy junior stocks for whatever reason – their broker tells them about it, they read about it in a newsletter or someone gives them a tip – and then they tend to forget why they own some of them, especially when those stocks keep going down and down. With junior stocks it’s really, really important to track what a company’s news releases are telling you. Those releases are either reinforcing the investment thesis or disproving it. So I think investors should frequently go through their portfolios and get rid of whatever they don’t understand, take the tax loss, and redeploy that money into something that has better odds of success. The market has changed done an about face over the past year. A few years ago everything was booming and today virtually nothing is booming. You have to look at speculations differently now.

SmallCapPower.com: Where should investors redeploy that money?

Brent Cook: In Exploration Insights we’re more and more focused on deposits that are large enough and offer a high enough margin to interest mid-tier or major mining companies. My overall thesis is that regardless of the market, these majors and mid-tier companies need to replace their production, their reserves. And the more aggressive companies amongst them are going to buy cheap deposits. There are some cheap deposits out there and I would be focusing on those deposits that offer a good margin. That’s really important: It’s not grade; it’s margin and internal rate of return (IRR).

SmallCapPower.com: What’s a high-margin deposit?

Brent Cook: In the gold mining business cash costs average between US$700-US$800/oz an ounce, and that’s just the direct cash costs. But what I see in research reports from some of the big firms, CIBC and RBC in particular, is that the total cash costs of production, including everything, is between US$1,200-US$1,300/oz. So these gold mining companies are only making US$200, US$300/oz on average. Now,if I can indentify a deposit that’s going to produce gold for under US$800/oz, and preferably under US$600/oz, then that’s a deposit that larger mining companies will look at because that’s what they are really after. I also think a mining company will pay a premium if they can see good exploration upside and/or they are comfortable with the jurisdiction.

SmallCapPower.com: Yes, but you’re not a proponent of large, low-grade bulk-tonnage deposits. Yet those projects are going to have so many more ounces than most deposits that even if you’re clearing only US$100/oz, you’re going to generate a profit because of the economies of scale.

Brent Cook: That’s very true but is that margin realistic? The capital needed to build these mines starts around US$600 million and can reach a few billion dollars. And a lot of the assumptions being used in the resource estimates, preliminary assessments and prefeasibility studies that I’m seeing are somewhat generous or even flawed. For instance, I recently looked at one company that has a big, low-grade deposit. The problem was that a lot of the assays used to calculate the resource came from reverse-circulation holes or churn holes below the water table where some contamination of the assays had been documented previously but ignored in this report. I would consider that dubious drill information. If that’s the case, when you go to mine these things, the grade is not going to be there.

Barry Cooper at CIBC recently noted that a 0.1 gram per tonne drop in grade equates to a US$60/oz per increase in cash costs for Osisko’s Marlartic deposit in Quebec and, a $1 per tonne increase in the mine cost adds about $30 to the cash costs. Think about it, slight changes in grade because the estimator pushed gold into an area where there was none can kill a project. Add to that a few percentage point decrease in recovery or a minor increase in fuel costs and you can see why these large low grade, high capex deposits are falling out of favor, for me at least.

Another problem is that most of these large, disseminated deposits, particularly in Canadian Archean greenstone belts, are really made up of a number of narrow, high-grade veins that are erratically distributed. If a deposit like that is mined as an open-pit, and many are, it creates problems at the mill. A mill in that kind of operation needs to receive a consistent grade. If the grade (in the mill feed) jumps all over the place, it’s difficult to make money.

In fact, Barrick Gold Corp. (TSX:ABX) just mothballed two of its large, low-grade deposits: Donlin Creek (in Alaska) and Cerro Casale (Chile). That’s 37 million ounces (Moz) of their resources that they no longer considerable viable. Wow, do that a few more times and there is a serious supply problem going forward.

SmallCapPower.com: Tell us about more about milling the ore from an open-pit deposit with a number of high-grade veins interspersed over a large area. How does that create problems for a mining company?

Brent Cook: To better explain it, here is an excerpt from a recent Exploration Insights report by my associate, Quinton Hennigh:

At the end of the day, a mine must make money. Once all the drilling, mine planning, and construction are done, it all boils down to whether each Haulpak coming out of the pit takes its load to the mill or to the waste pile. At this point, it is about things like grade, recovery, and the price of the metal. If a tonne of rock can generate enough value to pay for its processing and G/A (general and administrative costs), it goes into the crusher. If not, onto the waste pile.

Continuity and consistency of mineralization are very important. Deposits with grades that are relatively uniform and predictable and, even better, that display mineralization that connects well from one drill hole to the next are preferred. In such deposits, there is usually very little internal waste within the mineralized envelope.

Another good quality is when the ratio between the average grade of the deposit and the cut-off grade being applied is high, say better than 3-to-1 (e.g. average grade 0.9 g/t and economic cutoff grade of 0.3g/t). Good resolution between ore and waste implies the deposit has relatively sharp boundaries and it should be easy to differentiate rock that will make money from that that won’t. Favourable continuity and consistency mean that there will likely be a much higher certainty of the tonnages and grades being produced once the deposit becomes a mine. Basically, the mine manager knows what he will be getting because the deposit is so uniform. Many of today’s bulk tonnage projects are geometrically complex and display poor continuity and erratic grade distribution. As mentioned above, mine dilution is typically high in deposits that are complex. Grades that are "smeared" during exploration become reality once in a pit. It is not funny when one has to mine questionably marginal material for a month or two to get to that one or two days’ worth of higher grade rock. It is even less funny when one discovers that much of that “marginal” material is found to be sub-economic, having been misinterpreted by resource estimators who used faulty methods or poor reasoning when modeling the resource.

Some bulk tonnage resources being published lately display a ratio of grade to cutoff grade of 2-to-1 or less (e.g. average grade of 0.7g/t and economic cutoff grade of 0.4g/t). This implies the boundaries of such deposits are ill-defined, and when it comes time to mine them, it will be challenging to discern ore from waste. Even more concerning, the size of a resource can be subject to broad errors when one cannot confidently put one's finger on the boundary of the deposit.

SmallCapPower.com: You often question the numbers in preliminary economic assessments (PEAs), prefeasibility studies and even feasibility studies on various mining projects. Do you think it’s a case of scurrilous behaviour or is it that there are not enough skilled people out there to properly do these studies?

Brent Cook: I was just talking about this with someone who evaluates mining projects for a living. He says there’s too much work being pushed on the engineers conducting these studies and that there’s a lot of pressure on them to get a positive result. To make matters worse, there’s not enough people in the industry that have the experience to know what it takes to build a mine. It’s one thing to put the assay results into a spreadsheet and start calculating a resource – what my friend calls a “faith-based” resource – but it’s another thing altogether to understand the geologic controls behind those resources and put the ounces where they really are. You need to understand where the data came from, how it was collected and where the issues could be. A fair amount of that information isn’t being plugged into the PEAs that I’m seeing. So you’re getting sloppy work but I don’t think it’s intentional or fraudulent. It’s just sloppy and that gives investors or potential investors the idea that projects are more economic than they actually are. I think that’s the reason we are seeing a number of these deposits enter commercial production with costs way higher than the initial estimates.

SmallCapPower.com: Why do the gold companies have people who can properly crunch the numbers on development stage projects while geological consulting firms do not?

Brent Cook: I’m not making a blanket statement, I’m just seeing more slop in these early studies for the reasons we talked about. There are many engineering firms with very competent people doing good work. The advantage a mining company has over investors is that they have the ability to take all the data and redo it themselves. Once the mining companies run the numbers through their mining engineers and their mining programs, the result often doesn’t look as good as it does in the PEA we see. Remember, they’ve got their in-house guys that are actually mining guys that have built mines and have seen all the problems with mines; their jobs are on the line. They do a much more thorough job on the whole than someone that just puts out a PEA for “XYZ” junior company. I think that’s one reason why acquisitions aren’t happening as quickly as we expected.

SmallCapPower.com: That’s certainly an interesting theory. Are you more likely to look more closely at a study from Engineering Company A than Engineering Company B?

Brent Cook: To some degree, yes. It’s just experience. I have an idea of which firms I trust more than others, but I’m certainly not going to tell you which ones.

SmallCapPower.com: OK. But how does that get fixed?

Brent Cook: I don’t think it does. There is a major gap in the mining industry in experience between, say, 35-year-olds and 50-year-olds. Not many people came into the mining during the last bust in the cycle, so we’ve got an experience gap and the industry doesn’t currently have enough experienced people to do all the work that needs to be done.

SmallCapPower.com: We’re in the throes of a 16-month downturn in gold stocks. How much longer is this bear market for gold equities going to last?

Brent Cook: To me, this looks like it’s going to last a long time. I don’t see where the new money is going to come from to dig out the mining sector, particularly the junior sector. We’re in a phase where it’s going to be all about legitimate discoveries and legitimate profit margins for these companies. And that’s really good because the people who are able to identify those two things will make money in the long run. Demand for new ore is still strong.

SmallCapPower.com: What are some companies that are developing these high-margin deposits you’re targeting?

Brent Cook: Two that we own and I’m willing to talk about are Belo Sun Mining Corp. (TSX:BSX), and Lydian International Ltd. (TSX:LYD).

SmallCapPower.com: Let’s start with Belo Sun. Chairman Peter Tagliamonte has been involved with other management teams that have developed and sold assets like the Jacobina gold mine in Brazil. Where is Belo Sun’s Volta Grande gold project, which is also in Brazil, in terms of development?

Brent Cook: Belo Sun should be putting out a prefeasibility study fairly soon and have the feasibility completed next year. Belo Sun has almost 5 Moz (1,887 Moz measured; 966,000 oz indicated; 1,966 inferred) in all categories. Volta Grande is a nice deposit and I think it’s large enough and offers a high enough margin that somebody ought to buy it.

SmallCapPower.com: And Lydian is developing the Amulsar gold deposit in Armenia. Would a major be looking at a large capex to put that into production?

Brent Cook: No, the infrastructure is good there. It’s near a highway, there’s power, there’s a few small towns nearby. It’s on top of a hill so your strip ratio is low. And it’s totally oxidized, which means the cost of extracting the gold is lower. Your capital cost to build a mine there is at least half what a comparable milling operation would cost in a lot of other jurisdictions.

SmallCapPower.com: Is there a grade threshold you prefer to see?

Brent Cook: No, not at all. Lydian’s Amulsar deposit averages 0.9 grams gold per tonne and I reckon that its cash costs are going to be around US$600, whereas I could point you to a deposit that grades 30 grams gold per tonne and it’s just barely breaking even. Grade is not what’s key; it’s what it takes to get the gold out.

SmallCapPower.com: So the idea that “grade is king” is a myth?

Brent Cook: To some degree, yes. It’s really all about what it costs to turn that rock into money or cost per tonne of ore mined.

SmallCapPower.com: If we do begin to see more M&A activity, what situations are the majors looking for?

Brent Cook: That’s a good question. In the newsletter we are doing a three-part series where we look at the majors and their needs; the mid-tiers and their appetites; and, finally, we’re going to go through the deposits and point out the ones that we think are likely to be sold.

It’s key to figure out the corporate growth strategies of ompanies like Iamgold Corp. (TSX:IMG) or AngloGold Ashanti Ltd. (NYSE:AU). I think it’s clear that Anglo wants to reduce its exposure to South Africa and get into more stable jurisdictions, whether it’s Brazil or maybe even Canada. Iamgold is active in West Africa and maybe it wants to add to its West African portfolio. Those are the kinds of questions we’re asking right now.

SmallCapPower.com: In June, Barrick Gold fired its CEO. And in early August Kinross Gold Inc. (TSX:K) did the same. Both of those firings, if you connect the dots, can be traced, at least in part, to problematic acquisitions. In Barrick’s case it was Equinox Minerals Ltd. and for Kinross it was probably the $7-billion it paid for Red Back Mining Inc. Are those failed takeovers likely to make the majors more cautious?

Brent Cook: I think so, although it’s interesting that you mentioned Barrick. It just shelved 37 Moz million ounces at Donlin Creek but I believe that if the company saw an opportunity to acquire 10 Moz with good margin, Barrick would jump on it.

SmallCapPower.com: What sort of impact has this downturn had on your newsletter subscriptions?

Brent Cook: This year I’ve actually added more than I’ve lost. I have a very good subscriber base and people tend to stick with me a long time. We recently added Quinton Hennigh so we now have two seasoned economic geologists running around the world looking at deposits. It’s just a matter of finding the few deposits or discoveries that are actually going to work. No one’s going to buy our mistakes.

SmallCapPower.com: Quinton used to be with Newmont Mining Corp. (TSX:NMC) and now he’s a director with several companies. What does he bring to the table?

Brent Cook: Having worked with larger companies, he’s got a better perspective on what they’re looking for. More recently he’s been working with Evolving Gold Corp. (TSX:EVG), EurOmax Resources Ltd. (TSX.V:EOX), and Gold Canyon Resources Inc. (TSX.V:GCU), as well as interacting with the majors in terms of deals and acquisitions. That’s a big help. Plus he’s got a very good geologic mind. He sees things from a different angle.

SmallCapPower.com: Are there any other small-cap companies our readers should look into?

Brent Cook: I’m still a big fan of Almaden.

SmallCapPower.com: Almaden uses the prospect generator model.

Brent Cook: Yes, except for one project it’s drilling on its own: Ixtaca, in Mexico, which has what I like to see in a mineralized system. It’s really big and Almaden has pulled some very good holes. It’s just a matter of finding the sweet spot. And I think they will.

SmallCapPower.com: What’s the next catalyst for Almaden?

Brent Cook: It has four rigs working on Ixtaca and I’m just watching the drill results come in as the geology gets put together. Most of the deposit is under cover of volcanic ash so we can’t see what’s beneath there except through drilling. It’s a very complicated system but with each drill hole we get a bit more information and can start to project where it’s leading us. I want to find out where the centre of that system is.

SmallCapPower.com: Perhaps one more prospect generator for our readers?

Brent Cook: Renaissance Gold Inc. (TSX:REN), which was spun out of AuEx Ventures when it was bought by Fronteer Gold Inc., which was later bought by Newmont Mining Corp. (TSX:NMC). Renaissance has about 30 projects, most of which are in Nevada, but there are others in Spain and Argentina. Renaissance is going to see more than 40,000 meters drilled on its projects by its partners. And while the stock has come down quite a bit, the company still has plenty of cash.

SmallCapPower.com: I was once told that a good prospect generator should have more money at the end of the exploration season than at the beginning.

Brent Cook: Yes, that’s generally the case. Two that fall into that category are Riverside Resources Inc. (TSX.V:RRI), which seems to make money generating projects, and Eurasian Minerals Inc. (TSX.V:EMX), which is probably the top prospect generator out there in terms of partners and how much money gets spent versus how much Eurasian puts in. I would certainly look at those two.

SmallCapPower.com: Do you have any parting thoughts for retail investors?

Brent Cook: I want to reiterate that it’s really important to understand what a larger company is looking for when it comes to deposits. Know what the deposit looks like and then evaluate the drill results as they come in, the context of what those deposits should look like. About 95% of the companies that go up the curve eventually end up back down at the bottom of the curve. It’s really important to find that fatal flaw before the rest of the market figures it out. And to do that you have to know your company and what it is doing better than most of the people out there. To me, you can’t use a shotgun approach. You want to be a sharpshooter and know more about these companies than anybody else.

SmallCapPower.com: But how is the average retail investor supposed to learn about geology? Obviously, subscribing to your newsletter is one way to learn more about that kind of thing but are there other ways?

Brent Cook: This is a very specialized field. On www.explorationinsights.com I’ve got a tab under “Geo Insights” where I’ve posted a number of my geologic discussions for anyone who wants to learn what oxidized mineralization versus sulphide mineralization means or any number of other topics. But to be honest, it’s really tough. It’s best to get advice from someone that knows the industry and that you trust.

SmallCapPower.com: Thank you for talking with us today, Brent.

Interview Disclosure: Brent Cook owns shares in Almaden Minerals Ltd., Belo Sun Mining Corp., Eurasian Minerals Inc., Lydian International Ltd., Renaissance Gold Inc. and Riverside Resources Inc. but none of the other companies mentioned in this interview.

Disclosure

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