This article appeared in the November 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Understand the junior explorers' road and you might find riches, and plenty of risk.
By Adam Bold, investor and geologist
The appeal of junior mining stocks is their high leverage to success, albeit with high risk. They put together an idea, skills and a modest amount of cash to find an unrecognised resource, or develop a method of economically treating ores previously neglected. Junior miner success with exploration, development or resource exploitation operations has the potential to trigger a dramatic share-price rise.
Junior explorers generally focus on a specific commodity or suite of commodities and, if the commodity's outlook changes, the company's pricing may follow the commodity price lead. Such companies generally have a small team, and successful teams often start up a new company with investors following the trail of success.
In short, get on to the right junior resource companies and you may experience the thrill of explosive capital growth. But you need to understand the value drivers of junior resource companies. More than 1000 mining and oils shares are traded on ASX, but only 30 are represented in the top 300. However, an investor without training in the art of resource company analysis can develop the keys to understanding this complex sector.
(Editor's note: Small exploration companies that are yet to earn revenue typically offer higher potential returns and higher risks for investors, than established, profitable industrial companies that pay dividends. Be sure to understand the risks involved, before investing in this part of the market.)
The selection process
Here are some questions you should be asking when assessing a junior miner:
- an explorer, a resource developer or a miner?
- listed or about to list via an IPO?
- a single commodity play or a portfolio of commodities
- operating in a specific part of the world or a specific region
- exploring well-explored terrain (brown field) or virgin areas (greenfield)
- operating in a specific region.
A long-range project
Advancing an exploration idea to an operating mine takes a lot of effort and time, with 10 years not being uncommon. Progression to (hopefully) being a miner is often accompanied by an appreciating share price, which can be in steps rather than gradual.
The investor who understands what triggers price change can take a position before steep increases. Equally, the patient investor with faith in the project and company management can profit from price rises over time. Of course, prices can fall upon exploration failing to find enough of value, economic conditions may deteriorate, or the political environment may change and the company is not permitted to develop the discovery.
Clearly, a successful resource junior will go through several significant changes as it develops ideas, tests its prospects, proves up resources, confirms recovery processes, arranges financing, and builds a mine and processing plant. Sometimes the greatest price increase comes when the operating mine finally proves itself an economic success.
A resource company may start just from the germ of an idea about mineralisation:
- that may not have been previously recognised in a well-explored area
- that may benefit from new exploration techniques
- which, when subjected to new technology, becomes economic
- where market demand increases a mineral's price, so the economics of extraction become positive
- a particular parcel of land may become available where the idea is present.
Developing an exploration idea includes scouring geological maps to locate the right rocks, geophysical surveys and old reports of previous explorers. With geology, geophysical indicators or historic work supporting the premise, resource title maps are reviewed. These show if land covering the possible mineralisation is free to be secured under an exploration licence.
Alternatively, if the land of interest is already held, a deal may be done with the title holder to secure an interest. Among the states, land titles have myriad names and it is rare to find conformity between state-based titles and attendant conditions. There are different titles for exploration, retention and extractive operations. There may be requirements for bonds and commitment to do specific work during title tenure. These costs are often funded by the team putting the title package together or by other investors, often referred to as seed capital.
Raising the money
When all is ready, the original seed capital may allow an immediate start to work, but most likely the company will have to raise more cash, generally through an initial public offering (IPO) of shares and seek an ASX listing.
An IPO must meet strict requirements of Australian securities laws and listing rules. It is the prime information source for investors, providing the company's intentions, assets, land titles, management track record, and where it is in terms of exploration. The IPO will seek capital for at least two years of operations. It may list at a premium to the issue price. An investor should review the assets, commodity focus, management, and technology to be deployed, against the present market conditions, to help make a judicious decision.
Up close or from the bottom of an open pit, a mine looks huge. Seen from a distance, most mines look like the veritable needle in the haystack. A run-of-the-mill, open-cut gold mine containing, say, 300,000 ounces would, at an unremarkable grade of 3 grams per tonne, require about 3 million tonnes of ore. This could fit into a body of rock 500 metres long by 15 metres wide and 150 metres deep.
If exploration companies want to find anything other than outcropping ore, they need to work smarter to improve their chances of finding masked or poorly exposed mineralisation.
Exploration titles' conditions oblige the holder to report activities and results. Where new ideas are formed, a review of these reports can provide a wealth of information, including an indication of potential problems. Where drilling is recorded, historic reports and the new model may suggest that cores need to be re-examined and re assayed (a form of geological test). The cheapest discovery can be from work conducted by someone else, so literature research is a great start to an exploration program.
Also, to the experienced geologist's eye, satellite images, Google maps or low-level aerial photographs can reveal a wealth of information: particular outcropping strata can be seen to continue under covering rocks; textures of possible mineralising events may be indicated; faults, fractures and dislocation of geology can be recognised.
But ultimately, a geologist needs to head out to the field to test assumptions and interpretations by direct observation. On-ground geological mapping will start to directly measure and sample surface rocks to confirm their prospectivity, extent and structure. Understanding the surface geology is the start to interpreting what lies below.
Finding the halo
Mineralisation is a concentration of valuable minerals in natural rocks; with enough concentration the mineralisation becomes profitable to mine. Mineralised rocks' chemistry differs from their host (country rock) and mineralisation is often surrounded by a more extensive halo of chemically altered rocks. Find the halo and you may be closer to zeroing in on mineralisation. As rocks decay and erode away, both the mineralisation and halo chemistry are liberated and dispersed.
Explorers will sample soil, stream sediments and rock outcrops for both the element sought and a range of indicator elements. Plotting results identifies hot spots where high values are concentrated, trends which may indicate underlying geology or dislocation structures. Even if the element sought is not detected, elements from a halo may support further work.
Mineralisation and individual rock units differ in many physical characteristics, including density, magnetic susceptibility, response to electrical stimulation, and radiometric content. Geophysical surveys have the benefit of effectively seeing below ground surface, a great assistance in areas where mineralised regions are covered by sediments, where surface rocks are deeply weathered to a brown mush, or where mineralisation does not outcrop.
Geophysical surveys are generated from the air and ground. An explorer can chose from a range of geophysical surveys, with some being specific to a particular target. It is not uncommon for several different types of surveys to be carried out on the one prospect. The output, generally a coloured contour map showing intensity of the measured response, can show areas of geological dislocation, buried prospective strata or areas which may be prospective to host mineralisation.
It is important to understand that a geophysical anomaly is not an indictor of a mine; it is an indication that the rocks in that area have a contrasting geophysical response.
Assessing the data
The work explained above could take up to two years or more. The overall aim is to locate areas where the geology is consistent with the model, where mineralisation or its indicators are present, where geological structures are confirmed, and where the expected geophysical response is present and geochemical signature suggest mineralisation.
At this stage there may be enough information to form a view of whether the prospect can support the conceptual size sought. Alternatively, the information may demand a change to the model. If the work confirms the exploration model, it is time for drilling.
The drilling process
Drilling is expensive, but it's a lot cheaper than an uneconomic mining exercise. Drilling is arbitrary; it does not selectively pick out the shiny bits of an outcrop. Drilling can be managed to get regular, planned intersections and samples of mineralisation. The aim of a drilling program is to collect enough samples, at a sample density that allows an average grade and volume of a mineralised mass of rock. With enough drill intercepts, a mineral resource may be calculated.
Drill samples are used to develop a process to separate the valuable minerals to a saleable product, to confirm the product specifications, and to assess the rock strength to guide mine planning and engineering. With enough drill intercepts, an economic treatment process determined and an overall positive economic outcome indicated, an ore reserve can be defined.
There are two main drilling methods - percussion (producing rock chips) and diamond (producing a core). Regardless of which technique is used, once a drilling program is started, both cross-section and long-section maps are prepared. Whereas maps so far are plan views, a long-section is a vertical slice view of the prospect along the mineralisation plane; a cross-section is at right angles to the long-section view. The cross-section, a view showing drill hole trace(s), where the mineralised intervals align with surface mapping, historic mine openings and other drill intersections.
As plans and sections are updated, the explorer starts to get an idea of the mineralistation's continuity, grade and thickness. The aim is to define a mineral resource, part of which will be an ore reserve. Depending on the resource and reserve character, the company will seek financing for building and equipping a mine and treatment facility.
Lead times and value change
Earlier we looked at the step changes to share value, so let's consider these in context of the company's life outlined so far.
Seed capital funds a company's pre-listing activity of putting together the exploration ideas and preliminary requirements. There is no certainty that seed capital will be rewarded with the company completing listing requirements, there is no liquidity and financial survival may be perilous.
After market listing, a company can be valued by comparison with its peers. The market may judge the IPO prospectus favourably. A fully underwritten IPO or the presence of reputable, successful investors and institutions may add credibility and support a strong market upon listing.
Mines take up to a decade to find and develop. This is plenty of time for a change in the demand and price of the commodity the junior explorer has been working on for years. For example, consider your awareness five years ago of rare earths and how topical they are today.
Where mapping and sampling confirm the exploration idea and the prospect's potential, the share price may change positively. Companies release the results soon after they are determined, but it can take several days for the market to appreciate the impact. This is the diligent investor's opportunity.
Using integrated information
When a number of surveys are completed, particular locations may be highlighted by multiple exploration methods showing coincident anomalies. Mapping may confirm that a known prospective rock strata extends to our lease; a number of small occurrences of mineralisation are confirmed by assay; a broad geochemical anomaly is demonstrated and geophysics show anomalies similar to known mines that are located on structure observed on aerial photographs.
Companies present their activities at many public events, or roadshows, where investors can meet and question management. Market rules prevent companies releasing material not already in the public domain, but you can assess management enthusiasm, particularly in answers to questions. Indeed many companies welcome direct contact with their investors.
Using funds to increase value
A junior company's aim is that as cash is spent, its prospects' value increases and the market recognises the change. At some stage the company will need to raise additional money or introduce a partner. Additional cash being raised indicates the company's confidence in its assets and may drive further share price increase. A new partner funding further work may be seen as a vote of confidence in the company and propel the share price.
As noted previously, drilling is expensive, and a commitment to spending is indicative of the company's management enthusiasm for the exploration area.
Listed companies, including juniors, keep investors informed of their intention to conduct these activities as well as the results. Company announcements can be accessed from ASX or online brokers' websites, as well as company websites. Investors should look for these reports, make a judgment as to their impact, and invest accordingly.
About the author
Adam Bold is a qualified geologist and has explored for many minerals. He worked for Westpac's online broking business for 11 years until recently and has held senior positions with several financial services companies. Adam is an active researcher and investor in junior resource companies.
Dozens of ASX-listed companies have signed up for ASX's new Corporate Profile series, which provides a short video interview to help companies inform investors. Many of these profiles are for small and medium-size resource companies.
Each three-minute video usually features a chief executive who explains their background and experience, and gives an overview of their company's business and growth plans. This helps investors put a "face" to companies and learn more about those running the company on a day-to-day basis, in a simple, user-friendly format.
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