05-18-14 exploration

Source: John Timmer: Building a better way to Understanding Science, 2009. Link.

For a virtual letter titled Exploration Insights, we seem to devote an inordinate amount of text to mining, metallurgy, infrastructure, discounted cash flows, social license, permitting and, working capital.

Not today. Today we want to consider minerals exploration, a scientific process that is largely intuitive and that is being degraded by an over reliance on snappy technology and the blind rush to make an easy buck. John Timmer’s diagram above provides some insights into the complexity and iterative processes behind true exploration and discovery.

Minerals exploration is essentially the scientific method applied to a particular field of science (geology) in which many of the underlying observations, assumptions, and facts are subject to variable interpretations, because:

1)    More often than not the subject of scientific inquiry is under a pile of rocks, swamp, or jungle. Hard data is extremely limited.

2)    The “control group”, meaning the deposit type on which you are basing the research, is generally out of control. Each mineral deposit is the result of multiple geologic events imposed on differing rock types over a considerable period of time, therefore no two deposits are exactly the same. It is not uncommon for even the actual genesis of a deposit type to be in contention amongst the experts. Battles still rage over how two of the most important gold deposit types, Carlin and Witwatersrand, formed.

One of the byproducts of the inherent uncertainty associated with minerals exploration is an entire industry based out of Vancouver that survives, nay, profits, from the hunt for hidden treasures that very few really understand. The lack of both scientific consensus and explicitly defined parameters for success means the average speculator in this industry believes (hopes) that the discovery process is little more than punching a hole or two into a target that was presented with sexy colored maps by a hotshot geo-promoter.

But, you may ask, how hard could it be to find a gold deposit?

Actually, really hard. An in-house study by Newmont Mining determined that, in round numbers on a yearly basis, 1 in 1,000 prospects turn up an economic deposit and 1 in 10,000 become a major gold deposit of over 4 million ounces. Many of the reasons behind such a poor success rate have been posted on the EI website and covered in our letters, namely geology, metallurgy, deposit depth, infrastructure, social realities and politics, ad infinitum. The disconnect between the scientific method and speculators’, and all too often mining companies’, desire (need) for immediate gratification is another major reason for the statistically poor rate of discovery. For the most part, the two goals are fundamentally incompatible. One side wants to turn a quick buck or submit a positive quarterly report, while the other gets bogged down in esoteric geologic discussions that have very little relevance to turning a profit.

Exploration is a process during which concepts are tested, using someone’s money, in the search for economically viable mineralization. The process needs time to play out, for ideas to ferment and be revised based on the interpretation of new data. It takes years, not months, to understand what Earth did to a deposit during and after its formation. Success requires:

1)    The ability to conceptualize a legitimate target that offers the possibility of a meaningful economic deposit.

2)    Teamwork and open minds to revise and adjust the exploration target concept based on new data.

3)    Money, plus an investor base that is willing to let the exploration process play out.

4)    The ability to rapidly recognize and accept failure and walk away from a project that once held great potential.

To me, item number 4 is probably the single most important skill any exploration team can possess, and is the determining factor in buying into an exploration company. We know the odds are long, money is tight, and exploration costly, so it is critical to cut bait ASAP. However, all too many geologists and companies either view their work as a science experiment and treasure hunt, or don't have the experience or courage to tell their shareholders, “We struck out”. They persist in literally throwing money down a worthless hole.

That, my friends, is not the way to make serious money in exploration.

Although there are over 1,000 publicly traded junior exploration companies, I’ve found that very few possess the four qualities listed above. Additionally, because most speculators don't have the technical background to differentiate a prospect with legitimate, world class potential from worthless moose pasture, hard earned money goes almost indiscriminately to these 1,000 or so junior exploration companies—at least in a bull market.

The net result is that good money is wasted on improbable geologic concepts and properties that, even if “successful”, aren’t worth much. We know this to be a fact, the statistics bear it out. In my consulting years, maybe 70% of the projects I was sent to evaluate were obvious dogs that needed little more than a day on the ground to reject. The fatal flaws were either overlooked by all too enthusiastic geologists, or ignored by fast talking, highly incentivized, promoters.

This is how we make money. . .

We also know (and have expounded upon many times in past EI issues) that the gold mining industry is not replacing what it mines with new economic deposits (Fig. 2 below). Exploration budgets have been decimated, and fewer and fewer junior companies have the technical and financial resources to afford the time it takes to make a discovery. The pipeline of new deposits is shutting down-- to the point where, eventually, the few companies left standing in this Dust Bowl of a market will be valuable in their own right. If they can find something of economic importance, all the better.

world gold discovery trends
(Gold discoveries 1991 to 2013. Source: Blackrock Natural Resource Team and Bloomberg. Note there is a lag in discoveries and time, so it is not quite this bad)

Today, and probably through at least the end of 2014, the junior mining and exploration markets are in real financial trouble. The gold price is down, profits almost nonexistent, exploration and development expenditures severely curtailed, and new money extremely hard to come by. The macro questions that investors into this sector need to answer are: 1) Will metal demand increase over the next few decades? 2) Will mining companies need new deposits to replace what is being mined? 3) Will discoveries keep up with production?

If the answers to those questions are yes, yes, and no, then, it seems obvious to me that all one has to do to make serious money is to accumulate shares in the best deposits and most competent explorers, and wait. The mining sector has always been cyclical; when we come out of the market bottom, the pressures and issues we have covered above tell me it is going to come out hard and strong.

That’s the way I see it.

Brent Cook
Economic Geologist and Author Exploration Insights.


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Exploration Insights
by Brent Cook