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How to identify a future gold mine

EMANUEL DATT

Datt Capital

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Towards the start of the 2019 calendar year, we identified a strong investment thematic in junior gold companies driven by the confluence of 3 primary ideas:

• A potential rise in gold prices based on geopolitical factors
• A weakening of the Australian Dollar based on macroeconomic factors
• A resource and mine life deficit amongst mid-tier Australian gold producers

This led us to the identification and subsequent investment in Echo Resources, which was consequently taken over by Northern Star for a return over 100% in less than 12 months.

We believe this thematic is still strong and in this wire, we discuss a number of qualitative factors that help assist us in identifying high-quality gold opportunities and outline 2 names that tick our boxes.

Generating our own ideas

While it is very difficult to quantitatively screen companies due to the early-stage nature and non-financial characteristics of these companies, there are a number of different methods of discovering companies in this space. The most common of these are: sell-side (broker) research, industry comparisons and independent project assessors (typically covering later stage companies).

However, we tend to rely heavily on our own proprietary research library of almost 1000 primary research pieces to generate ideas and identify broad brush investment thematics.

We largely avoid secondary research, but do find it useful on occasions to confirm and question the veracity of our own primary research efforts.

Geological factors

1: Depth and scale

These factors are very important in determining whether a deposit may be economic. A general rule of thumb is that the deeper a deposit, the higher grade it needs to be economic – this is a function of higher mining costs at depth. This should be looked at in conjunction with the scale of a deposit, as generally the larger the scale the lower the cost.

2: Geometry and mineralisation style

The shape of a deposit is an important indicator of potential mining cost for example, a gently dipping equidimensional (spread consistently in all directions) shaped deposit will almost always be cheaper to mine than a steeply dipping, planar deposit. Disseminated (spread uniformly) style mineralisation deposits are preferable to vein or reef hosted mineralisation from our perspective, again due to lower processing costs.

3: Historical context and potential exploration upside

We have a preference towards ‘time capsule’ projects where little modern exploration has been conducted. This could be for a number of reasons including areas where mining exploration has been banned, or where exploration was not conducted due to a low commodity price environment. We consider that exploration upside is generally considerably larger with these particular projects, given the historical context.

Corporate factors

1: Location/jurisdiction:

This is important from an economic and strategic perspective. Government royalty rates can vary significantly between jurisdictions, along with the general legal and social environments. A resource situated near infrastructure will generally hold an advantage over a similar more isolated deposit. Being close to other producing mines allows optionality in terms of commercial outcomes for example, a smaller deposit that may not be large enough to support its own processing plant could potentially utilise a neighbouring mine’s processing plant for a fee.

2: Management team and corporate strategy

Pursuing a prudent strategy can expedite the time needed to bring a deposit into production, and add considerable value to a project whilst mitigating risk. One common mistake we see is rushing into production too soon for marginal or higher-cost projects. Mineral production has its own skill set quite different from mineral exploration.

3: Overall economic evaluation

To be robust and minimise downside, any economic studies on the deposit should use conservative assumptions and incorporate all costs. In the gold sector, a commonly used metric ‘AISC’ (all-in sustaining cost) is one of the most misquoted with each producing company using their own poetic licence to their quoted metric. Investors should perform their own calculations instead of relying on company provided AISC figures. In addition, we have a bias to project with relatively low capital intensity which usually results in a higher project IRR. Higher metallurgical recoveries are positive.

4: Ability to build relationships with credible larger counterparties:

This is an important factor especially when considering commercial terms could be negotiated for production or exploration. A management team that can attract large partners to the company or its projects, adds credibility from our perspective.

5: Catalyst/s to rerate the stock:

This is one of the more important elements in our process and can be either external, internal or multi-faceted. One must remember that the company cannot change the physical resources that may or may not lie within their ground and accordingly be very selective when investing in this space, taking a ‘resource first’ approach.

A good read........