Your Grandfather's Mining Portfolio

This presentation was delivered by David Coffin, co-editor of the Hard Rock Analyst, at the New York Hard Assets Investment Conference, held 12-13 May 2008 at the New York Marriott Marquis on Times Square.

NEW YORK - Good morning. What I’m going to do first is talk a little bit about what’s worked, and that does build into what we think is coming. Of the dozen or so takeovers we have been involved with in terms of recommending the cycle, about eight of those, two-thirds, have been producing companies. This is coming from us, who focus on exploration stories, and in fact our two best gainers - I’ll drop a couple of names here. These aren’t so much recommendations as just to give you some background on where we’re coming from.

First Quantum, which developed copper mines in Zambia - in other words, they were in early in an emerging belt. The other is a company called Virginia - who are here, and worth talking to still - who discovered a significant gold resource in northern Quebec. In other words, in the underexplored part of Quebec.

And recently, we have started talking about a company that discovered a gold deposit in Canada, in a portion of Canada where it was unexpected. It’s still to be seen whether that will work the way that everybody hopes, but the point is that newness is still an important factor in the discovery game. But what in fact has worked best has been the tried and true - these eight producers, these companies who are already spending cash flow, who had larger peers come and take them out.

In that list are a couple of very large companies: Falconbridge and Inco. Inco was our base for nickel, although we did have other nickel stocks on the list. And Falconbridge was a special case when it was reorganized against its parent Noranda. We talked about it for that reason, and it was taken out 12 months later.

That is the difference in this cycle versus the last three or four short warehousing cycles. Companies do have a much better opportunity. As Eric said, cash flows are incredible. To take small deposits that would have died on the vine during development process as the warehousing cycle died off and prices fell before they could put them in production.

And in this cycle, it’s very possible - in fact, it’s very profitable - to take relatively small deposits, put them in production, and start flowing cash.

Now, we haven’t given up on exploration stories. The list I haven’t talked about is the half dozen or so stories that are doing very well, giving us very good gains, by finding new deposits from grassroots. There is another half dozen or so that - some have done better than others - that are just now bringing mines into production. And those are the ones we’re focused on. We still talk to our subscribers about speculations. It’s what we do. It’s what we understand. I’ve got 30 years in the exploration business. We certainly don’t ignore it.

But right now we are telling subscribers - and I’m telling you - that a focus on these small-deposit, small-mine developers, can do you very, very well. However, as with any startup, you do need to be cautious. You do have to find the right ones. There will be some that also fail and obviously will be anything but successes in the market. And the difficulty with a failed mine startup, if it’s the only development in the company, is it’s very hard to get that company restarted.

So while I’m saying this, I’m not saying they are risk free by any means. Anything in the equities market has a risk; it’s a matter of understanding it, understanding your own risk tolerance and then making some decisions.

My ‘grandfather’s deposits,’ as Eric said, which is a talk I’ve given before, is a reference to the fact, as I’ve pointed out, it’s not so much my grandfather as my father. We grew up in an environment where my father was part of a number of companies - one-mine, two-mine companies - that did well in his generation from cash flow. Why they did well, here’s a few reasons. This is what you need to focus on when you’re looking at companies moving towards mine startup.

One is the corporate structure. That’s very critical. Through that period, they’re spending money; they’re not making money. The mine-development process, even for a small mine, is something that takes several years in an established district. In a new district, it’s something that’s going to take 4 or 5 years.

So you have to be aware of that time frame. They have to raise funds through that time period in the equity markets. And in periods like this, that becomes difficult. Share prices drop. If they’re forced to raise money now, at low equity prices, they may create profitable mine but also create so much stock that the gain on a PE ratio is weak. So you have to bear that in mind. If they don’t already have cash, what is their game plan to finance to carry on?

And on that note, and in this cycle - not in a typical cycle, not in a warehousing cycle - that’s why for metals we have a focus on grade rather than tonnage. We want to see the higher grade, in other words, low cost per pound or per ounce for precious metals deposit that will kick them off, that will pay down their capital costs quickly, and then allow them to carry on.

It’s not the number of pounds or the number of ounces. It’s the quality of them which is critical. What helps with that, and this will increasingly be the case: existing plant. Neighbors who are already mining who will at some point need new ore source.

That’s always had a potential. In this cycle, it has more potential than usual because the neighbor won’t be willing to wait for the next downturn before they come in to negotiate and buy out. That’s been the history in the sector. Smart from the producer’s perspective.

Now, they’re going to want to keep that plant running. They’re going to want to keep sending metal to the market because metal prices are high. Even though they’ve pulled back in the last 9 months, zinc - which has been the weakest of the larger base metals - is still up 300%. So, existing plant, proximity to transport and the two that are the most important: the currency in which the project will operate and, where possible, a sustained low power cost. Those are the two biggest variables in a mining operation.

That gives a decided edge to American deposits or deposits in countries that are tied either directly or indirectly, such as Mexico, to the U.S. dollar. It gives them a significant advantage because their cost structure in local currency terms is going to stay low.

Access to ready power, that typically means a power grid in an area where they can write a contract that fixes those costs. And right now, that power concern is simply growing. The oil price - and we don’t talk about oil companies much, but that oil price continues to rise, in fact, to a worrying degree. And that will heavily impact the mining operation, which can be 40% power costs in this environment, 50% in some cases.

So you need to look at those. And then you need to think in terms of what’s doable. Part of the reason that we’re favoring these companies right now is the extreme difficulty of getting any mine into production. The reality is that the plants required for a smaller deposit are easier to get. The very large scale equipment needed for bulk tonnage that the large players want to focus on - you can get it, but you’re looking 5 years out for some types of equipment.

For a smaller plant, where you are running 500 tonnes a day, 1,000 tonnes a day, or for a heap-leach situation, 5,000 tonnes a day - that you can pull together. That and a mining contractor, and you have an operation that’s ready to go. That’s a big part of the reason why we’re focused. And that means some deposit types that haven’t done well in past cycles are also a focus. I can name these briefly. Volcanogenic massive sulfide [VMS] deposits, which are small deposits - typically in the 5-million-tonne range - they can be 50 million tonnes. Rich in copper and zinc. VMS explorers, VMS developers we’re looking at.

Epithermal gold and epithermal silver developers, we’re looking at. Again, these can be high-grade, readily put into production deposits. And also any surface oxide deposit in copper and in gold. Now in saying this, I want to emphasize we are not excluding other deposit classes. But for this specific game, which is to look for small mine developers, these are just areas that we focus on.

There are some very good mines that will go into production in what are called mesothermal and other gold camps of the world. And if you can find a SEDEX (sedimentary exhalative) type zinc deposit, which are the large ones that created BHP and Cominco, sure. Go for it. It’s just that they’ve become very hard to find, and I’m naming deposit types that have been left behind in the last few cycles because the major companies didn’t think they would have scale.

Well, again, my emphasis is not scale. It’s grade. There’s one important set of exceptions to that, and it happens to be pertinent right now. This is the first cycle in five, I believe it is, where the large bulk tonnage commodities such as iron, such as coal, such as potash, have done exceptionally well, and where startups are doing well within that environment.

For those large bulk commodities, your focus is less on grade than on high-grade infrastructure. The quality of the infrastructure, the ability to deliver to market, is your most important criteria. I have just enough time to say it’s time to wrap it up.

I didn’t get into companies. We will talk a bit more about companies and some more specifics relating to this in our workshop. But in the final analysis, my bottom line is this: There are probably a number of people in this audience who in the past have invested in small startup-level companies, had difficulties with them. I’m saying, be cautious. But in this cycle, the potential is there to do well with them. Find them, but be patient. Thank you.

David Coffin is the geologist half of the Coffin brothers' Hard Rock Analyst team. He attended the Haileybury School of Mines and has been active in prospecting, resource calculation and feasibility studies for resource companies for 29 years. He also has authored numerous qualifying reports for resource companies and has managed and designed field programs for more than 15 years.

David and Eric Coffin

Editors, HRA Journal

David Coffin and Eric Coffin are the editors of the HRA Journal, HRA Dispatch and HRA Special Delivery publications focused on metals exploration, development and production stocks. They were among the first to draw attention to the current commodities super cycle and have generated one of the best track records in the business thanks to decades of experience and contacts throughout the industry that help them get the story to their readers first. Please visit their website at  www.hraadvisory.com for more information.

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