published by Resource Intelligence
Minerals exploration is a scientific process of generating ideas and testing those ideas through a trial and error methodology that refines, validates, or negates those ideas. While the goal is the discovery of an economic mineral deposit that enriches shareholders, the odds of success are poor. For both junior exploration companies and speculators it is critical to shift the odds ever so slightly in your favor while keeping the costs at a minimum. Speculators can do this by knowing more about a company and its property than the crowd and then acting on that knowledge ahead of the crowd. That means understanding management’s strengths, weaknesses and loyalties. It also means knowing what the company’s mineral target actually looks like from both a geologic and economic perspective.
For a junior exploration company, it often comes down to understanding the actual odds of success and utilizing that knowledge for the benefit of your company and shareholders. The following discussion focuses on one business strategy, the “Prospect Generator Model” that shifts the high risk and cost of exploration to a third party. Although this exploration model is certainly not the only way to succeed or make money, it is a model that accommodates the realities and odds of minerals exploration success.
Understanding the odds
The discovery and successful exploitation of an economic mineral deposit is a very rare event—the end result of a multitude of factors coming together under specific circumstances. From a scientific perspective, the geology, chemistry, mineralization, and rock types have to interact perfectly to allow the deposition of a high concentration of metal in one place. Moreover, the metal has to be economically extractable from the rock and must occur at a depth in the earth’s crust at which it can be mined at a profit. The mineral deposit has to be located in a politically, socially, and environmentally workable location that offers relatively long term stability and the probability of a reasonable return on investment. Until all those very unique qualifications are met, a company’s mineral prospect is nothing more than a geologic anomaly—something on which to spend money.
For resource investors, it is critical to keep in mind that geochemical or geophysical anomalies are not at all unique. There are literally billions of such anomalies scattered across the globe that simply reflect the Earth’s constant evolution over its ~4 billion-year history. That basic geological fact is responsible for the very low odds of success in the minerals exploration sector.
In the precious metal sector alone, there are in the order of 10,000 mineral prospects being explored to some degree around the world. Based on Newmont data, out of that 10,000, roughly one in 1,000 will result in a resource of greater than 100,000 ounces, and one in 10,000 a resource of 4 million ounces or better, annually. Similar studies by Phelps Dodge (now Freeport) and Rio Tinto suggest the odds of success for copper exploration are better, although still not great. Of the 3,000 copper prospects in their database, 350 were drill tested, five made it to the scoping study level, and one through feasibility.
Playing the odds
In effect, the generator business model’s key strength is that it capitalizes on a junior company’s intellectual advantage in a particular region or deposit type, and passes on the high cost and risk of exploration to better-funded partners. Ultimately, shareholders are exposed to more chances of success, albeit owning less of a bonafide economic discovery, over a time frame that allows a company’s intellectual advantage to succeed.
Expenditure statistics from a number junior prospect generator companies in that I own and are in the Exploration Insights portfolio bear this out. One company that has been following the business model for eight years has seen in excess of $45 million spent by partners testing their internally generated targets, and has recouped nearly two thirds of their own generative exploration costs through management fees and stock and property sales. They have undertaken this major exploration effort on approximately 20 of their properties while maintaining a tight share structure of only about 50 million shares outstanding and a strong balance sheet.
Likewise, some of the smaller prospect generator companies I follow will see the equivalent of their entire market capitalization spent by partners exploring their properties this year. That is true bang for your buck.
Why gamblers prefer to bet against the casino
Admittedly, this dilution at the property level versus the corporate share structure level is not popular among most junior resource market speculators. The majority of gamblers in the junior sector tend to believe that their company will be the one in 1,000; therefore, vending the property out to a third party will destroy their rights to a ten-fold win. Possibly, but when you consider the odds of success are somewhere between one in 100 and one in 1,000, betting on the results of a drill hole works out to be a losing long term strategy.
The difference between investors in the prospect generator business model versus the all-or-nothing strategy is that they are investing in a business designed to increase the odds of success over time. They recognize that actually discovering an economic mineral deposit requires considerable time (years) and money (tens to hundreds of millions of dollars). Hence, it takes a lot of looking and drilling to find the unique set of circumstances responsible for an economic mineral deposit. This realistic perspective hardly plays to the gambler that wants to walk into the casino, lay down a bet, get that “free” drink and come out wealthy (or broke).
Minerals exploration is a very expensive endeavor in which the odds of successfully discovering an economic deposit are exceptionally low. Although less exciting than a throw of the dice, the prospect generator model offers an intelligent and relatively lower risk alternative for speculating in the junior exploration market. In acknowledging that the discovery process is essentially an intellectual endeavor that combines the science of geology with the art of extrapolating a limited amount of data into the unknown, it makes sense for investors to maintain a larger percentage of the “idea” business, as opposed to the much riskier property business. By doing so, investors have the added advantage of time to fully build the business of ideas and eventually participate in a discovery—owning a relatively undiluted share of the outcome.