Geologists rock: an integral approach to looking at resource stocks

By Jim Copland, Investment Director - 5 June 2012

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What happens when you ask three geologists their view? You’ll get four opinions! On the flipside geologists are amazed you can get a sensible answer out of an engineer without a slide rule! With resource stocks forming a significant part (approximately 34%) of the Australian Small Ordinaries Index, a technical background in resources is unquestionably a good starting point for assessing resource opportunities in the small caps space. Geologists, engineers, metallurgists and operators have a symbiotic relationship and enjoy a healthy rivalry in advancing mere resources to profitable outcomes, and as importantly, avoiding the underperformers. No one gets it right all the time but having a framework for evaluation anchored in reality at least maximises your chances.

At IFM we look at all stages in the conceptual value curve of a resource company from the early stages, even before an initial resource is released, to a producing asset. Identifying early stage exploration companies prior to delineation of a major deposit can be a significant source of return. After the initial surge in share price post discovery, a stock tends to retrace or move into a holding period while the company completes feasibility studies, secures approvals and arranges funding. Further market value appreciation occurs as cashflows are generated on initial production and ramp-up.

Avoca Resources, a gold explorer, is a fairly typical example where dramatic gains (eight-fold) were made in 2006– 2007 after initial discovery. Avoca’s principal asset was the Higginsville gold project, a structurally controlled orogenic gold deposit in the greenstone belt south of Kambalda, Western Australia (WA). As shown in Fig.2, the Avoca share price since listing in 2002 resembles the conceptual value curve, as it brought Higginsville from a mere prospect to a producing mine.

A combination of geologist and financial analyst skills can be advantageous in identifying potential winners, and also when to harvest those gains. Just holding a few of these small cap miners can add significantly to a portfolio’s returns. However, to spread the risk, IFM owns companies at various stages through the mine life-cycle and also companies that supply services to diversified mines.

 

Fig. 1 Source: From Pierre Lassonde’s The GoldBook, 1990

 

Fig. 2 Example of conceptual value curve: Avoca Resources (Source: Factset)

Geology matters!

Concentration of minerals, even within a single commodity, can be due to a variety of events. It is not just of academic interest – the way deposits are formed geologically has strong implications for the economics of mining and processing, and the type of company which may develop it. For example, different types of copper and gold mineralisation include, but are not limited to:

  • Porphyries: These are volcanic intrusive deposits with generally low-grade but pervasive concentrations of copper and often gold, which can be billions of tonnes in size. The world’s biggest copper mine, Escondida, in Chile is a porphyry. Other notable examples include Freeport’s extraordinary Grasberg deposit in Indonesia, Rio Tinto/Ivanhoe’s Oyu Tolgoi deposit in Mongolia and Newcrest’s Cadia Valley in NSW. They’re typically large-scale, relatively low-grade, bulk mining, open-pit and underground opportunities which require billionplus dollars to develop, and last for decades.

    Fig. 3 Cadia Valley, NSW

  • Iron oxide copper gold (IOCG deposits): Like porphyries, IOCGs are generally large-scale deposits. Their geological origins are more varied however, involving rich copper, gold and often uranium bearing fluids metasomatically enriching iron-rich host lithologies. Examples include Olympic Dam and Prominent Hill. Similarly, they tend to be a big boys’ game, although because IOCGs’ mineralisation is often more heterogeneous, and include other economic metals, they may present high-grade potential opportunities for bold juniors.
  • Structural or shear-hosted systems: Often mineralsrich hydrothermal fluids are structurally controlled, meaning their emplacement is related to movements along fault lines. These can be prolific and extensive systems for hundreds of kilometres along ‘strike’, but with highly variable grade, width and continuity. They can start life as open pits, subject to cover, before going underground. Grade and tonnage can be concentrated and therefore smaller players can make these opportunities work, requiring less capital, but they are scalable too for the large players. Discovery’s Bosetto mine in Botswana is an example of this in copper, or the granite/greenstone terranes of WA and West Africa are hugely prolific gold provinces.
  • Volcanogenic massive sulphide (VMS) deposits: VMS deposits have become fashionable with the success enjoyed by Sandfire’s extremely high-grade copper and gold mine in WA. They are formed from eruptions of sulphide minerals in marine floor environments and can occur in clusters. These tend to be smaller tonnage but very high-grade. They’re hard to find, and need to be drilled out on small centres. Generally polymetallic, the respective concentrations of copper, gold, zinc, lead and silver depend on how far from the source the mineralisation occurs. So while a rich VMS may indeed be an investor’s nirvana, beware; VMS deposits are not created equally, and expansions depend on binary rather than incremental drilling outcomes.
  • Supergene enrichment: Sometimes weathering processes can oxidise and concentrate grades of copper and gold near the surface. Because they are shallow and high-grade, they can often be lucrative sources of initial mill-feed in any project, which may enhance the economics of larger primary mineralisation projects, especially gold projects.

Processing matters too

It is traditional for geologists and engineers to blame metallurgists for not extracting all the metal that they deliver to the mill. For example oxidised and transitional material and refractory ore present challenges for metallurgists:

  • Oxidised and transitional material: Mineralogy associated with oxidation of any metal can be problematic when it comes to extracting the metal from the minerals as with transition ore, so-called because it forms the interface between deeper primary or fresh rock and the surface oxidised material. The amount of transition material and its behaviour, or misbehaviour, in processing can have a profound impact on metal recovered, and unit costs. This mineralisation is frequently different to the rest of the ore body that the mill process was built around and often the metal is unable to be recovered. Given that this is often encountered during the commissioning and early stage of a project, it is important to be aware of how a company is factoring this into its mine plan at the critical early stages when debt is at maximum drawdown and early cashflows are critical.
  • Refractory ore: In gold ores, sometimes the gold particle is physically encapsulated by associated sulphide minerals, which prevents cyanide from dissolving the gold into solution. Alternatively the presence of organic carbon in ore is problematic because it adsorbs the gold preferentially to the carbon-in-leach or carbon-in-pulp process. Sometimes it is both, like much of Barrick and Newmont’s Nevada mineralisation. While technology is available to treat these ores, such as autoclaves, roasters, ultra-fine grinding and bioleaching, they tend to add significantly to both capital and operating costs. It is therefore important to get an appreciation of the metallurgical characteristics of ore types quite early on.

Grade is king, sometimes

All things being equal, grade is king. Unfortunately, things are not ever equal, and there are other factors which can make or break a deposit. For instance, if a deposit is refractory, high grades may not be sufficient to offset the economic headwinds of extra processing.

Separately, in open pit mines, strip-ratio (the ratio of wasteto- ore tonnes that must be mined) and recovery rates (what percentage of metal can be extracted from the rock) are also what matter. By way of example, one of the biggest and best gold mines in the world in its day, Yanacocha at 4,700m altitude in the Andes in Peru mined by Buenaventura and Newmont from the mid 1990s, looked like a challenging proposition with grades of only ~1g/t. However, since it had an almost negligible strip-ratio, and recoveries of nearly 70% from heap leaching because of the porous nature of the material, Yanacocha at its peak was able to deliver ~3 million ounces of annual production at cash costs of only ~$100/oz.

Additionally, just because something is high-grade, does not mean it will necessarily be a winner. A reported bonanzagrade drill intercept is exciting, but mined grade will almost inevitably be less once you bulk out grades for mining. Many of the deposits described above are polymetallic. The economics of mines can be significantly enhanced by the presence of by-product metals, and these are conventionally reported as a credit to cash costs. For example, PanAust’s Phu Kham mine in Laos with a copper head grade of 0.7% reported C1 cash costs of US$1.01/lb last year, with the 54koz of by-product gold lowering that reported cost by $0.80/lb. Ultimately a drill-hole must form part of an interpretation that hangs together in three dimensions so that engineers can wrap a mine plan around it. It is tough for an underground mine to chase high grade stringers that do not actually connect.

Geology-speak!

Lithology: Gross physical character of rock.

Metasomatism: The process by which the chemical composition of a rock is changed by interactions with fluids; replacement of one mineral by another without melting.

Orogenic: From an orogenic belt, which is highly deformed rock developed while a continental plate is crumpled and thickened to form a mountain range due to the engagement of tectonic plates.

Strike: Direction of the line formed by the intersection of a fault, bed, or other planar feature and a horizontal plane. Strike indicates the attitude or position of linear structural features such as faults, beds, joints, and folds.

Stringers: A mineral veinlet or filament, usually one of a number, occurring in a discontinuous sub-parallel pattern in host rock.

Terranes (terrain): A general term for a piece of the earth’s crust that is usually smaller than a continent and bigger than an island. A fault-bounded area or region with a distinctive stratiagraphy, structure, and geological history.