Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement.
Imagine that a highly respected geologist tells you about an astonishing yet little-known gold discovery. The deposit is 5 per cent yellow metal (typical mine-quality grades are a minuscule fraction of that). The metallurgy is top-rate, meaning the gold is really easy to get out of the rock. The deposit is about 100,000 tonnes, meaning 5,000 tonnes of gold, and all of these figures have all been independently verified by third parties. At today’s value, the gold is worth about $450-million. The best part? The company that owns the deposit has a market cap of $10-million.
By this point, you’d be dying to know the ticker. But to buy this stock would be a grave mistake, because it could well be massively overvalued.
Don’t get me wrong: There are deals to be found in the battered junior resources sector today and now is a good time to start selectively hunting for them. Many companies are trading for less than net asset value, some less than cash. Another positive sign is the hostile takeover offers we’re starting to see, which tend to happen just as the sector gets cheap.
But before you start, you have to know what to look for. A fine ore body like the one in our example above is not nearly enough. Most promoters, and small investors, get carried away with the grades – the percentage of mineral in the ore rock. But grades can be totally irrelevant compared to other factors – the most important being jurisdiction.
If you learned that our fictitious ore body was on an Indian reserve, bordering a national park or near a suburb in Ontario, you should have grave doubts about investing because it’s not likely to ever get a permit.
Even if it does, it would take years, and the cost of compensating all parties involved could easily ruin the economics of the project that appeared so good when looking at only the grade.
And even if it does get permitted, there are other monumental hurdles – which brings us to another critical element in junior resource investing: infrastructure. It takes roads, railways, water and electricity to build a mine. The farther you are from these services, the more it will cost to start producing. When you consider that it can cost $1-million per kilometre to build a road in the wilderness, you understand why so many promising ore bodies never see the light of day.
Mining promoters rarely talk about infrastructure or jurisdiction. And although resource extraction built this country, it’s getting harder and harder to get things done in Canada, notwithstanding an established legal system that makes it unlikely a deposit will be seized by the government, as happens in places like Latin America.
For example, Alberta-based Athabasca Minerals applied more than a year ago for a permit to scoop a small amount of frac sand, a crucial ingredient used in the hydraulic fracturing process, from a desolate patch of land near Fort McMurray. The company, whose main business is to supply aggregates to the oil sands, still hasn’t had an answer from the province, which likes to hold itself out as business-friendly. And that’s just sand at surface.
The truth is that some of the best jurisdictions for mining these days are south of the border. Nevada has a good reputation for being friendly to mines. I own a few shares of Klondex Mines, an aspiring gold producer with a deposit in the state. The stock price is up 50 per cent in the past year even while most gold producers are getting crushed, and I guarantee you that jurisdiction is one of the unheralded reasons for the performance. Investors expect the mine to be built.
Alabama is also emerging as a business-friendly place to mine. I spoke to a geologist about his experience trying to get a permit for a mining project there and he laughed as he described how apologetic the government official was when he broke the news that it would take a couple of weeks to get a permit. “But y’all can start anyway because you’re gonna get it for sure.”
All of this isn’t to suggest that grades and tonnage aren’t important. But as you start to pick through the rubble of junior exploration in search of value, it pays to remember that they simply aren’t the most important factors. If you can’t extract it, it’s worth nothing.