Every mineral deposit’s value comes down to one underlying factor: Feasibility. If the deposit cannot be mined profitably, it is worthless. In reality though, every deposit has some small value based on future potential, either:
- additional resources not known to be present, or
- economic conditions changing so the current resources become economic.
From the day that the first drills turn on the site, junior resource companies can be classified based on a timeline toward feasibility. The further a company is on this timeline, the higher the stock price.
- Drill Results
- Resource Estimate
- Pre-feasibility Study
- Feasibility Study
Before any drills have turned on a property, it is considered “greenfield.” There is very little an investor can deduce from properties in this stage. Every property has to have some reason for exploring it. The primary ones are:
- Some sort of surface outcrop, or visible gold.
- A known gold deposit on trend or in the area.
Neither of these are reasons to think that this company has found the motherlode before any drill results have been found. I have seen many properties with visible gold turn up empty (or not enough to justify anything), and of course every known deposit has many people exploring around it. Wherever there is expectation, there is an elevated share price and therefore a risk that the expectations are not met.
When a company has drill results on a property, investors can only speculate what the odds of it being economic are. The best you can do is to be familiar with the grades required to be economic, but this is a moving target too. The minimum grade is around 0.4 – 0.5 g/t gold equivalent (i.e. including all metals). Below that number, the deposit is likely to be a write off, but in that range it might be just barely economic if the deposit is big, i.e. at least 2 billion tonnes (800 million cubic metres). On the other end of the scale, if the drill results are reporting a very rich 100 g/t you probably need at least 100,000 tonnes (40,000 cubic metres). So you can think of less than 40,000 cubic meters of anything as uneconomic.
The drill results will be reported as a grade in g/t over a length in meters so you will be able to do some quick math in your head to put your deposit within those two extremes.
The first time an engineer looks at the deposit will be a resource estimate. This launches the company into a stage where they can report reserves and resources to the public. Before this they aren’t allowed to give you any back of the napkin numbers (see NI 43-101 Explained ) so don’t expect them to.
As you might be able to imagine, estimating a resource is a complex exercise. Drill holes are not usually parallel to each other, and the grade varies tremendously throughout each one, so a computer model of the drill holes is produced which can interpolate between them. The resource will be classified into regions of confidence, usually divided into three categories:
- Inferred: The drill spacing is too far apart for engineers to have the statistical confidence to say the deposit exists between them. As an engineer myself, I understand the scientific basis for this, but as an investor, I can safely say that most of the time the deposit is there between the drill holes. As long as the two holes were side by side holes targeting the same structure rather than widely spaced shots into the open, you can probably expect that inferred resources are probably there, even if the engineer isn’t allowed to certify it.
- Measured and Indicated: Although these are two different categories, they are usually reported together. They represent resources with drill spacing close enough for an engineer to certify that the deposit exists, but is not necessarily economic.
- Proven and Probable: This represents resources whose economics have been proven to be positive. The engineers have gone through a basic mine plan, estimated the costs, assumed metal prices (usually very conservative), and everything else necessary to determine the economics of a deposit. Upgrading resources to this category is expensive, usually 5-7% of mine construction costs, and you will not see many juniors with proven and probably reserves.
A resource estimate will give investors a concrete deposit size, but nothing more. Although I wanted to show all three categories together, Proven and Probable reserves cannot be determined by a resource estimate. It requires a “Pre-feasibility Study” or greater.
Pre-feasibility Study (aka Scoping Study)
The resource estimate will identify the size of a deposit, and the pre-feasibility study will run through the economics. At this stage, the company can report reserves, which is defined by NI 43-101 as that which is contained in the Proven and Probable category. As long as the engineer can produce a positive Internal Rate of Return (IRR) and Net Present Value (NPV), a portion of the Measured and Indicated resources will be upgraded to Proven and Probable reserves.
The reality is that market influences are paramount at this stage. The pre-feasibility study must assume metal prices, and we all know how volatile they can be. Therefore, one of the biggest factors in any pre-feasibility study is the sensitivity analysis, which is usually buried near the back but I believe this is what the investor should immediately look for. The deposit is only worth what someone will pay for it, therefore I believe it is important for investors to think like major mining companies.
If I was the CEO of a major mining company I’d let my own engineers loose to analyze everything that could go wrong, and one of the biggest factors would be the payback period. Building a mine is a one-shot, all or nothing deal where you don’t get a penny of your investment back until the whole thing is built. Who knows what could happen in the meantime that could endanger the entire investment?
The full feasibility study costs usually around 5 – 7% of the mine construction cost. By the time this study is out, everything is out in the open. There isn’t a significant functional difference between a pre-feasibility and a full feasibility study, except for the level of accuracy. A full feasibility study shoots to be within 10% of all costs, and is meant to be a basis for a mining decision. But in reality, mining decisions are made at any time in the process. I’ve seen companies with mere drill results bought out by majors for billions; Obviously they anticipate the deposit to be economic and the feasibility study is instead called “engineering design.”
The important numbers in a feasibility study are:
- Net Present Value (NPV): If you take all of the expenditures, and revenue, over the life of the mine and convert them each to today’s dollars, accounting for inflation, you get Net Present Value. It is a good comparison to today’s share price, or the purchase price of a deposit.
- Internal Rate of Return (IRR): The rate of return of capital invested. It is easily compared to a companies target investment returns, or returns generated in the past by a major mining company.
- Payback Period: The time required for the initial investment to be returned. It gives a good representation of the attractiveness of a deposit, since you have to spend the entire investment before seeing any of it back.
Companies often go back to a previous step to firm things up, for example, once a pre-feasibility study comes out they might want to drill to upgrade more resources into reserves.
the Junior Gold blog