diamond characteristics
diamonds exploration
diamond mining
linksDIAMONDS FOR EVER
MINING ENGINEERING STUDY
diamonds forming diamond characteristics
diamonds exploration
diamond mining
links
How and where are diamonds formed?
Diamonds form between 120-200 km or 75-120 miles
below the earth's surface. According to geologists the first delivery of
diamonds was somewhere around 2.5 billion years ago and the most recent was 45
million years ago. According to science, the carbon that makes diamonds,
comes from the melting of pre-existing rocks in the Earth's upper mantle. There
is an abundance of carbon atoms in the mantle. Temperature changes in the upper
mantle forces the carbon atoms to go deeper where it melts and finally becomes
new rock, when the temperature reduces. If other conditions like pressure and
chemistry is right then the carbon atoms in the melting crystal rock bond to
build diamond crystals.
There is no guarantee that these carbon atoms will turn into diamonds. If the
temperature rises or the pressure drops then the diamond crystals may melt
partially or totally dissolve. Even if they do form, it takes thousands of years
for those diamonds to come anywhere near the surface.
GEOLOGICAL CHARACTERISTICS
CAPSULE DESCRIPTION: Diamonds in kimberlites occur as sparse xenocrysts and within diamondiferous xenoliths hosted by intrusives emplaced as subvertical pipes or resedimented volcaniclastic and pyroclastic rocks deposited in craters. Kimberlites are volatile-rich, potassic ultrabasic rocks with macrocrysts (and sometimes megacrysts and xenoliths) set in a fine grained matrix. Economic concentrations of diamonds occur in approximately 1% of the kimberlites throughout the world.
TECTONIC SETTING: Predominantly regions underlain by stable Archean cratons.
DEPOSITIONAL ENVIRONMENT / GEOLOGICAL SETTING: The kimberlites rise quickly from the mantle and are emplaced as multi-stage, high-level diatremes, tuff-cones and rings, hypabyssal dikes and sills.
AGE OF MINERALIZATION: Any age except Archean for host intrusions. Economic deposits occur in kimberlites from Proterozoic to Tertiary in age. The diamonds vary from early Archean to as young as 990 Ma.
HOST/ASSOCIATED ROCK TYPES: The kimberlite host rocks are small hypabyssal intrusions which grade upwards into diatreme breccias near surface and pyroclastic rocks in the crater facies at surface. Kimberlites are volatile-rich, potassic ultrabasic rocks that commonly exhibit a distinctive inequigranular texture resulting from the presence of macrocrysts (and sometimes megacrysts and xenoliths) set in a fine grained matrix. The megacryst and macrocryst assemblage in kimberlites includes anhedral crystals of olivine, magnesian ilmenite, pyrope garnet, phlogopite, Ti-poor chromite, diopside and enstatite. Some of these phases may be xenocrystic in origin. Matrix minerals include microphenocrysts of olivine and one or more of: monticellite, perovskite, spinel, phlogopite, apatite, and primary carbonate and serpentine. Kimberlites crosscut all types of rocks.
DEPOSIT FORM: Kimberlites commonly occur in steep-sided, downward tapering, cone-shaped diatremes which may have complex root zones with multiple dikes and "blows". Diatreme contacts are sharp. Surface exposures of diamond-bearing pipes range from less than 2 up to 146 hectares (Mwadui). In some diatremes the associated crater and tuff ring may be preserved. Kimberlite craters and tuff cones may also form without associated diatremes (e.g. Saskatchewan); the bedded units can be shallowly-dipping. Hypabyssal kimberlites commonly form dikes and sills.
TEXTURE/STRUCTURE: Diamonds occur as discrete grains of xenocrystic origin and tend to be randomly distributed within kimberlite diatremes. In complex root zones and multiphase intrusions, each phase is characterized by unique diamond content (e.g. Wesselton, South Africa). Some crater-facies kimberlites are enriched in diamonds relative to their associated diatreme (e.g. Mwadui, Tanzania) due to winnowing of fines. Kimberlite dikes may display a dominant linear trend which is parallel to joints, dikes or other structures.
ORE MINERALOGY: Diamond.
GANGUE MINERALOGY (Principal and subordinate): Olivine, phlogopite, pyrope and eclogitic garnet, chrome diopside, magnesian ilmenite, enstatite, chromite, carbonate, serpentine; monticellite, perovskite, spinel, apatite. Magma contaminated by crustal xenoliths can crystallize minerals that are atypical of kimberlites.
ALTERATION MINERALOGY: Serpentinization in many deposits; silicification or bleaching along contacts. Secondary calcite, quartz and zeolites can occur on fractures. Diamonds can undergo graphitization or resorption.
WEATHERING: In tropical climates, kimberlite weathers quite readily and deeply to "yellowground" which is predominantly comprised of clays. In temperate climates, weathering is less pronounced, but clays are still the predominant weathering product. Diatreme and crater facies tend to form topographic depressions while hypabyssal dikes may be more resistant.
ORE CONTROLS: Kimberlites typically occur in fields comprising up to 100 individual intrusions which often group in clusters. Each field can exhibit considerable diversity with respect to the petrology, mineralogy, mantle xenolith and diamond content of individual kimberlites. Economically diamondiferous and barren kimberlites can occur in close proximity. Controls on the differences in diamond content between kimberlites are not completely understood. They may be due to: depths of origin of the kimberlite magmas (above or below the diamond stability field); differences in the diamond content of the mantle sampled by the kimberlitic magma; degree of resorption of diamonds during transport; flow differentiation, batch mixing or, some combination of these factors.
GENETIC MODEL: Kimberlites form from a small amount of partial melting in the asthenospheric mantle at depths generally in excess of 150 km. The magma ascends rapidly to the surface, entraining fragments of the mantle and crust, en route. Macroscopic diamonds do not crystallize from the kimberlitic magma. They are derived from harzburgitic peridotites and eclogites within regions of the sub-cratonic lithospheric mantle where the pressure, temperature and oxygen fugacity allow them to form. If a kimberlite magma passes through diamondiferous portions of the mantle, it may sample and bring diamonds to the surface provided they are not resorbed during ascent. The rapid degassing of carbon dioxide from the magma near surface produce fluidized intrusive breccias (diatremes) and explosive volcanic eruptions.
ASSOCIATED DEPOSIT TYPES: Diamonds can be concentrated by weathering to produce residual concentrations or within placer deposits (C01, C02, C03). Lamproite-hosted diamond deposits (N03) form in a similar manner, but the magmas may be of different origin.
COMMENTS: In British Columbia the Cross kimberlite diatreme and adjacent Ram diatremes (MINFILE # - 082JSE019) are found near Elkford, east of the Rocky Mountain Trench. Several daimond fragments and one diamond are reported from the Ram pipes.
DIAMOND
EXPLORATION
GEOCHEMICAL SIGNATURE: Kimberlites commonly have high Ti, Cr, Ni, Mg, Ba and Nb values in overlying residual soils. However, caution must be exercised as other alkaline rocks can give similar geochemical signatures. Mineral chemistry is used extensively to help determine whether the kimberlite source is diamondiferous or barren (see other exploration guides). Diamond-bearing kimberlites can contain high-Cr, low-Ca pyrope garnets (G10 garnets), sodium-enriched eclogitic garnets, high chrome chromites with moderate to high Mg contents and magnesian ilmenites.
GEOPHYSICAL SIGNATURE: Geophysical techniques are used to locate kimberlites, but give no indication as to their diamond content. Ground and airborne magnetometer surveys are commonly used; kimberlites can show as either magnetic highs or lows. In equatorial regions the anomalies are characterized by a magnetic dipolar signature in contrast to the "bulls-eye" pattern in higher latitudes. Some kimberlites, however, have no magnetic contrast with surrounding rocks. Some pipes can be detected using electrical methods (EM, VLF, resistivity) in airborne or ground surveys. These techniques are particularly useful where the weathered, clay-rich, upper portions of pipes are developed and preserved since they are conductive and may contrast sufficiently with the host rocks to be detected. Ground based gravity surveys can be useful in detecting kimberlites that have no other geophysical signature and in delineating pipes. Deeply weathered kimberlites or those with a thick sequence of crater sediments generally give negative responses and where fresh kimberlite is found at surface, a positive gravity anomaly may be obtained.
OTHER EXPLORATION GUIDES: Indicator minerals are used extensively in the search for kimberlites and are one of the most important tools, other than bulk sampling, to assess the diamond content of a particular pipe. Pyrope and eclogitic garnet, chrome diopside, picroilmenite, chromite and, to a lesser extent, olivine in surficial materials (tills, stream sediments, loam, etc.) indicate a kimberlitic source. Diamonds are also usually indicative of a kimberlitic or lamproitic source; however, due to their extremely low concentration in the source, they are rarely encountered in surficial sediments. Weathered kimberlite produces a local variation in soil type that can be reflected in vegetation.
ECONOMIC FACTORS
TYPICAL GRADE AND TONNAGE: When assessing diamond deposits, grade, tonnage and the average value ($/carat) of the diamonds must be considered.. Diamonds, unlike commodities such as gold, do not have a set value. They can be worth from a few $/carat to thousands of $/carat depending on their quality (evaluated on the size, colour and clarity of the stone). Also, the diamond business is very secretive and it is often difficult to acquire accurate data on producing mines. Some deposits have higher grades at surface due to residual concentration. Some estimates for African producers is as follows:
| Pipe | Tonnage (Mt) | Grade (carats*/100 tonne) |
| Orapa | 117.8 | 68 |
| Jwaneng | 44.3 | 140 |
| Venetia | 66 | 120 |
| Premier | 339 | 40 |
* one carat of diamonds weighs 0.2 grams
ECONOMIC LIMITATIONS: Most kimberlites are mined initially as open pit operations; therefore, stripping ratios are an important aspect of economic assessments. Serpentinized and altered kimberlites are more friable and easier to process.
|
Kimberlite composition and comp ration with ultramafic rock
|
Kimberlite
Found in the world's most ancient shield areas, kimberlite has been the
main source rock for diamond production throughout history. Diamondiferous
kimberlite bodies fall into two categories, the first being called a
"pipe". Large pipes range from volcanic tuffs, in their upper part,
through breccias, consisting of rock torn from great depths. Finally, the root
zone consists of coarse-grained kimberlite material. The second form is known
as a "dyke", which defines a crack at a bedrock surface, steeply
dipping due to erosion of the surface.
Kimberlites most commonly occur as carrot-shaped pipes, dykes or, more rarely,
as sills (figure 1). Three zones have been recognized within kimberlite pipes:
the crater, diatreme and root zones. Kimberlite pipes vary in size, up to 216
hectares (fig, 1a). The present surface area of kimberlite bodies not only
reflects the nature of the eruption but also the degree of erosion within the
kimberlite pipe. The root zones are infilled with rocks which have
crystallized from magmatic kimberlite and have hypabyssal textures. These
kimberlites are composed of relatively coarse-grained xenocrysts, which have
been incorporated into the magma, and phenocrysts, both of which crystallized
from the magma prior to implacement. These xenocrysts and phenocrysts are set
in a fine-grained groundmass which is composed predominantly of minerals that
crystallized from the magma near the surface. Many of these rocks contain
abundant primary carbonate and serpentine, testifying to their volatile-rich
nature. Hypabyssal kimberlites also occur in dykes and sills. Hypabyssal
kimberlites can be subdivided into kimberlite and kimberlite breccia, based
firstly on their xenolyth content (Clement and Skinner, 1985) and secondly on
the modal abundance of the primary groundmass minerals (Clement and Skinner,
1979). Only minor quantities of hypabyssal kimberlites occur within known
diatreme and crater zones.
The root zones are characteristically highly irregular in shape (see figure
2). They are typically formed by several intrusive pulses of kimberlite magma
with different compositions, reflected by contrasting groundmass mineralogies.
Many of these hypabyssal kimberlites formed during embryonic pipe development
and may not have reached the surface (Clement, 1982; Clement and Reid, 1989).
The diatreme zone forms the main part of a kimberlite pipe (see figure 2). In
comparison to the root zone, it typically is comprised of fewer phases of
intrusion. This zone typically has regular, steep contacts (Clement, 1982).
The diatreme zones are mostly infilled with texturally unusual rocks which are
the product of complex, vapor-rich fluidised intrusive systems (Clement and
Skinner, 1985) and degassing of the associated CO 2 . These rocks have been
termed tuffisitic kimberlites (Clement, 1982; Clement and Skinner, 1985) or
tuffisitic kimberlite breccias if they contain abundant xenoliths. Pelletal
lapilli are a characteristic constituent of these rocks, and the cementing
matrix usually is composed of serpentine and microlitic clinopyroxene. The
diatreme facies grades upward into crater-facies kimberlite and downward into
hypabyssal-facies rocks.
Geology of diamond deposits
Diamond Mining
(Coming soon)
Links
|
The Diamonds
I has followed the diamond exploration sector since 1992 when Dia Met's Ekati discovery in the Northwest Territories put Canada on course toward becoming a major diamond producer. In just over a dozen years Canada has catapulted into third place behind Botswana and Russia in terms of diamond production value. The Ekati and Diavik Mines are now in production after the most rigorous permitting process ever required of a major mine. Snap Lake and Jericho, also in the NWT, have also cleared key permitting hurdles, and two major deposits controlled by De Beers, the Gahcho Kue in the NWT and Victor in Ontario, are at the feasibility/permitting stage. Bulk sampling programs are underway at Fort a la Corne in Saskatchewan and the Otish Mountains in Quebec which may demonstrate that these regions also have economic diamond mine potential. Huge tracts of land have been staked in the West and East Arctic where systematic exploration that hopes to repeat the success of the Slave Craton experience has barely begun. Although the diamond exploration cycle is long and expensive, with evidence of an economic deposit not apparent until carat values have been obtained through bulk sampling, a milestone that takes at least 2 years and $5 million to reach from the discovery of a pipe, diamond plays are ideal speculations for exploration juniors because the reward can be staggeringly high. Furthermore, because kimberlites originate from depths of 150 km or more, punch through whatever rock is present at the surface, and generally get obscured by dirt, water or swamp, surface geology is irrelevant to their location. Diamond exploration involves filtering large chunks of land at increasing levels of detail until pipe targets emerge. The tiniest junior could end up staking claims on top of a world class pipe or cluster whose discovery is a matter of filtering, filtering and filtering. Because the smallest junior committed to diamond exploration could make a discovery worth billions that delivers a 10,000% or better stock price gain, diamond plays are very well suited to evaluation in terms of Rational Speculation Model. For this reason a education is devoted to diamond stocks. |
|
The American Museum of Natural History provides a wonderful
online exhibition about diamonds at American
Museum of Natural History - A World of Diamonds. The diamond
exhibit is well laid out for exploring the various topics, but you can
also use the index below to look up specific items. |
The Diamond Exploration Cycle
|
Diamond Exploration Milestones And Success Probability
World Class Potential of a Diamond Project not confirmed until 5 Work Stages are Complete The diamond exploration cycle consists of nine distinct stages starting from a grassroots land position and culminating in production. Each of these work stages constitutes a milestone labeled zero through eight. In a best case scenario where seasonal constraints are not a factor a brand new diamond project will need five years to make it through the diamond exploration cycle from land acquisition to production. In a difficult setting such as the Arctic where certain types of work can only be done during winter or summer, the time frame from start to finish will last 8-10 years. Failure is possible at all but the final two stages, requiring the project to start fresh with new targets if the project's potential for a world class diamond mine remains alive. Unlike a gold or base metals project, which usually focuses on outlining the orebodies within a mineralized system, a diamond project looks for "vertical needles" in what can be a very large "haystack". These "vertical needles" or kimberlite pipes tend to have readily identifiable tonnages in excess of 5 million tonnes, but their grade and value only becomes apparent through a series of larger sample tests. What makes diamond exploration particularly risky is the fact that the third critical component for assessing the project's economic potential, namely the average carat value, does not become apparent until Milestone 4 has been reached. The logistics of diamond exploration is such that Milestone 4 cannot be reached any sooner than two years after initiation of the exploration cycle on a grassroots diamond project. Except in very rare cases where a kimberlite is found that is so rich a diamond is visible in the core of the discovery hole, as was the case with the Diavik project's A154 pipe, diamond exploration does not produce "discovery holes" that signal a world class project as was the case with the Voisey's Bay nickel discovery and appeared to be the case with the first salted hole into the Busang Southeast Zone. To make matters worse, it almost never happens that the first kimberlite discovered in a diamond project turns out to be economic. So one can add at least one year to the diamond exploration cycle to account for the extreme likelihood that the first round of target drilling will not snag the best pipes hosted by the project. Metal Discovery Plays provide a Speculative Continuum When a discovery hole is pulled in a gold or base metals project the market can immediately calculate the rock value of the intersection based on the assayed grade and prevailing metal prices. Cost factors associated with this style of deposit and its location based on similar mines are roughly understood, so it is easy for speculators to estimate ultimate project values for different tonnage and grade scenarios. The economic potential of a new metals discovery is thus immediately evident. But how big will the zone turn out to be and what will the rest of it grade? In metal play speculation investors focus on the tonnage potential of the zone and how the grade varies with stepout drilling. The metals exploration cycle delineates the orebody through both stepout and infill drillling. A metals discovery play is fueled by a continuous flow of information consisting of visual assessments of whether or not the zone has been intersected and the actual assays of those intersections. Metal discovery plays lose their momentum when drilling has found the zone's limits. For a metal discovery play the greatest volatility exists during the period following the discovery hole while the limits of the deposit remain unknown. In metal bull markets, such as when the price of gold is rising or base metals are at their cyclical peaks, speculators will bet on the potential of targets before they are drilled based on size implications and surface sampling. Diamond Play Speculation Reacts to widely spaced Milestone News Events When a kimberlite is discovered the market can usually figure out the tonnage potential very quickly, but the sort of economic value number crunching that metal discovery plays allow cannot happen until the kimberlite has gone through three more testing stages: testing for micro diamond content, testing for macro diamond grade, and testing for macro diamond value. Each of these stages can take 3-6 months to accomplish, creating speculative dead zones during which investors can only sit and wait. Usually there is nothing visually revealing about the material extracted and submitted for processing that gives the market a basis for optimism or pessimism. Diamond exploration news for a specific project consequently occurs as widely spaced milestone news events whose content can have a powerful upward or downward effect on the stock's price. The market reaction reflects the market's judgment about whether the news keeps the ultimate project value alive, justifying graduation to the next exploration stage, or kills the dream for this particular pipe, forcing the company back to an earlier stage in the project exploration cycle. If it were not for the fact that positive milestones can generate rapid five fold appreciation in market valuation of the project, raising venture capital for diamond exploration by junior companies would be next to impossible. Diamond Play Valuation tracks a Success Probability Ladder of Milestones The Diamond Exploration Cycle Milestone and Probability system was developed to quantify the valuation behaviour of a diamond project in which a publicly traded junior company has an ownership stake. It is based on the market action observed during the Lac de Gras diamond play of the early nineties when Dia Met discovered what became the Ekati project in the Northwest Territories. It is also based on the probability system Kennecott Exploration (a wholly owned subsidiary of Rio Tinto, operator of the Diavik project) uses to quantify the failure risk of projects with world class potential. Kennecott gives a one in a thousand chance that a grassroots diamond project in the proper geological setting will deliver a world class diamond mine. Of particular importance is the 90% failure rate Kennecott expects with the completion of each major exploration stage. Kennecott's system of failure rates has been adapted to reflect the unique milestones of the diamond exploration cycle. Ultimate Project Value versus Theoretical Project Value Using the concept of fair speculative value as presented in the rational speculation model developed by John Kaiser, a probability table has been developed which indicates the probability that a project at any given stage of the diamond exploration cycle will progress all the way through into production where its ultimate project value (UPV) is defined as the net present value of the diamond mine as calculated using the discounted cash flow model. For example, a diamond project that has reached Milestone 2, namely discovery of a kimberlite, has a probability of 2.5-5% of turning out to be an economic diamond deposit. If the craton setting is known to host world class kimberlites, the target is supported by an indicator mineral train whose chemistry suggests excellent diamond grade potential, and the target's dimensions suggest a resource in excess of 20 million tonnes, an ultimate project value of $2 billion is a reasonable outcome for a speculator to dream about. Following the example of the rational speculation model, which says that the payout return should match the success probability, the theoretical project value (TPV) should be equal to percentage of the ultimate project value that matches the success probability. For example, a kimberlite discovery with sufficient evidence to make a $2 billion ultimate project value a reasonable outcome for a speculator to entertain, would have a theoretical project value of 2.5% to 5% of $2 billion, or a theoretical valuation range of $50-$100 million at Milestone 2. Alternatively, if the evidence suggests a more modest dream target of $500 million, the theoretical project value would be $12.5-$25 million. If micro diamond testing produces results which keep the dream alive so that the next exploration stage consisting of a mini bulk sample to determine grade is justified, the project moves on to Milestone 3 where the success probability of going all the way now ranges 5-10%. In the case of a $2 billion UPV the TPV at Milestone 3 should range $100-200 million. As a diamond project travels through the exploration cycle while keeping the UPV dream alive, its theoretical project value will oscillate within the theoretical valuation channel associated with a particular UPV. When the diamond project reaches the final production milestone ultimate and theoretical project value converge to one and the same number. IPV Chart System provides analytical framework for diamond play analysis According to the rational speculation model the implied project value (IPV) should fall within the theoretical project value range associated with the dream target and the project's current exploration stage. The IPV is the value assigned by the market to the diamond project based on the trading price of the company's stock, the fully diluted shares outstanding, and the company's net interest in the project. Many factors determine a stock's trading price, some completely unrelated to the fundamentals of a diamond project. The IPV Chart system was developed as tool to allow a speculator to place the market's valuation of a diamond project into an analytical framework. An IPV chart graphically portrays where a diamond project sits in the exploration cycle and how the market is presently valuing the project. A standard IPV Chart contains two theoretical valuation channels based on the Milestone Probability System and the two different ultimate project value outcomes of $2 billion and $500 million. The choice of these UPV's is arbitrary. A person could pick any ultimate project value and work out the theoretical project values associated with each milestone using the Milestone Probability System. And a person could customize the probabilities associated with each exploration stage to reflect the UPV chosen. The purpose of the Diamond Exploration Milestone and Success Probability System is to allow a speculator to see how a particular diamond project compares to others in terms of market valuation, and to use the questions these comparisons generate as a starting point for understanding the underlying fundamentals. Why does this project have such a low IPV compared to this other one which is at the same exploration stage? Or, why does this one have a higher IPV even though its project stage is not as advanced as the other? Has the market made a mistake in assessing the success probability? Or does it have widely different expectations of ultimate project value for the two projects? Sometimes a bit of research will show that the different IPV's are well justified. At other times it will become evident that the market has a profound misconception about the underlying fundamentals of a project. This analysis can generate very timely and lucrative buy or sell signals not just for long run speculators, but also for traders who focus on milestone news events. The nature of the diamond exploration cycle is such that valuations change in a series of abrupt upward or downward steps, often with overreactions that provide additional buying or selling opportunities. A diamond project that is trading within a valuation channel can undergo up to 500% gains on good news as the project graduates to the next stage, but the move can be substantially greater if the IPV was well below the theoretical valuation channel associated with a UPV that the milestone news event has suddenly turned into a reasonable outcome dream. The IPV Charts thus can serve as a useful bottom-fishing tool for diamond play juniors. How are the milestone stages assigned? While the implied project value is a mathematical calculation based on factual figures (stock price, fully diluted capitalization and net project interest), the assignment of project stage is somewhat more subjective because it relates to the current focus of exploration activity on a project. Keeping the project stage up to date is an ongoing research process conducted by Canspec Research (John Kaiser). It is assumed that all exploration activity has as its goal the discovery and development of a diamond mine. Milestone 0: Grassroots Exploration All projects start with a "grassroots" or Milestone 0 classification, meaning that there are no known kimberlitic or lamproitic bodies deserving of additional exploration work. Sometimes that is a matter of opinion; the Tli Kwi Cho, Ranch Lake and Drybones pipes in the NWT are examples of kimberlites on which work stopped after discouraging results but which are and may be revisited with further work. Grassroots status is assigned to any new acquisition where insufficient work has been done to generate drill ready targets. Location, property size, and acquisition logic will determine the IPV> Milestone 1: Target Drilling Once a company has done sufficient target generation work to justify a drilling program, the project gets upgraded to "target drilling" or Milestone 1. A project qualifies for Milestone 1 if a database consisting of geophysical surveys and indicator minerals, if applicable, has been generated. Targets supported by both indicator mineral trains and geophysical anomalies have a higher probability of being converted into pipes than targets supported by only one or the other. Milestone 2: Micro Diamond Testing Upon discovery of a kimberlitic body that merits testing for micro diamonds, a key indicator of grade and stone size potential, the project gets upgraded to "micro diamond testing" or Milestone 2. The exception would be dyke or sill like bodies where drilling does not yield enough material for micro diamond testing. Sometimes a body is intersected that looks similar to a kimberlite. Samples are first submitted for petrographic analysis. Projects are not promoted to Milestone 2 unless the material is actually submitted for micro diamond testing. Milestone 3: Mini Bulk Sampling for Grade A diamond project truly starts becoming interesting from a speculative standpoint when micro diamond results for a kimberlitic or lamproitic body are sufficiently encouraging to justify a larger sample called a "mini bulk sample" whose goal is to establish a grade for the resource. Micro diamond results provide a stone size distribution curve consisting of below commercial size diamonds that is indicative of grade potential for commercial sized diamonds. The theory behind micro diamond analysis, which requires familiarity with lognormal distributions and statistics, is poorly understood by both the diamond exploration industry and the market. The reporting standards for micro diamond results are also improperly defined, which has created a situation at the time of this writing where micro diamond results get reported in a variety of formats, some highly misleading and even meaningless, others very revealing. The result is a high degree of inefficiency in the market's assessment of Milestone 3 news events, an inefficiency which knowledgeable speculators can exploit. Even when reported properly, micro diamond results can be misleading in positive and negative terms for several reasons, but in general they provide a good basis for deciding on the next exploration stage. If micro diamond results are discouraging and there remain no untested kimberlite discoveries, and no further exploration is planned on the project, the project's status drops back to "grassroots". If the company intends to continue generating new targets or upgrading existing undrilled targets, the project is only downgraded to Milestone 1, "target drilling", to reflect that a geophysical and indicator mineral database already exists for the project. A project graduates to Milestone 3 or "mini bulk sampling" if the company sets out to extract a bulk sample of at least 5 tonnes to process by dense media separation (DMS) for the recovery of "commercial" sized diamonds, usually stones caught by a 0.8 mm or larger screen. While the slope and height of the micro diamond size distribution curve provides useful hints about the macro diamond curve, the stones recovered through caustic fusion or acid dissolution are usually below the minimum commercial screen size of 1.5 mm. DMS, which is much cheaper than caustic fusion on a per unit processing basis, recovers only the commercial sized stones that constitute the "grade" of a diamond mine. The higher the grade, the better. Whereas the material for micro diamond testing is recovered through small diameter core drilling, the mini bulk sample is recovered through large diameter drilling. Usually the mini bulk sample drilling is designed to simultaneously delineate the geometry of a kimberlite body. This provides a sense of the overall tonnage potential as well has variations in internal geometry due to different facies (related to an emplacement event) and multiple magmatic phases (related to time separated emplacement events). Milestone 4: Bulk Sampling for Value A project moves into the "bulk sample" or Milestone 4 stage following grade results from a mini bulk sample if the goal of the next bulk sample is to produce a parcel of diamonds whose value can be "measured" or which can be the basis for "modeled" values. What constitutes a statistically meaningful parcel size for valuation purposes depends on the size and complexity of the pipe. Sometimes the project operator decides that more delineation drilling and bulk sampling for grade only is required before going after a bulk sample large enough to furnish sufficient diamonds for valuation purposes. Such projects remain classified as Milestone 3 or "mini bulk sampling". It might be more appropriate to call this "bulk sampling for grade" than "mini bulk sampling" while "bulk sampling" should be called "bulk sampling for value". But here it has been decided to classify a project as being at the "bulk sample" or Milestone 4 stage if the goal of the sampling program is to generate a value for the diamonds. The economic potential of a kimberlitic body does not become clear until tonnage, grade and carat value figures are on the table. The average carat value of a pipe can range from very low (ie $10 per carat to several hundred dollars per carat). High carat values are less frequent and require either a uniform population of high quality diamonds or a sub-population that delivers large, high quality stones. As a rule the market assigns much higher valuations to projects with a high indicated grade than a low grade because a low grade pipe needs a high carat value to be economic. Scoping or desktop studies are often done at this stage to provide a preliminary economic framework for what this project needs to look like before it is submitted to a prefeasibility study. Milestone 5: Prefeasibility Once a project has yielded tonnage, grade and value figures for a kimberlite body, the next step involves reducing the error margin of these figures and sorting out the operating and capital costs associated with production scenarios. Usually this involves additional bulk sampling, "geotectonic" studies related to engineering issues, and environmental studies aimed at identifying mitigation requirements and associated costs. This is the prefeasibility stage of Milestone 5. Once a prefeasibility study is published the economic value of the project can be calculated. Milestone 6: Permitting and Final Feasibility Assuming target internal rates of return are met, the project proceeds to the permitting stage or Milestone 6, which goes hand in hand with a feasibility study. At this stage very little physical work is actually being done on the diamond deposit itself. The permitting stage is usually accompanied by declining values as the market deals with time delays and cost increases created by unexpected permitting obstacles. The result can turn a positive prefeasibility study into a negative feasibility study. Milestone 7: Construction A project does not graduate to the construction stage of Milestone 7 until all permits are in place and a feasibility study recommends going into production. Once construction is underway the market has a concrete handle on the timing of production startup and the cash flows the project is likely to generate. The IPV will become a function of traditional valuation methods such as projected P/E rations or net present values based on the discounted cash flow model. Milestone 8: Production Once production commences there is still a period of uncertainty while the market awaits confirmation of grade and value. The conservative nature of the diamond exploration cycle is such that production revenue can be better than expected as large scale mining turns up rarer, high quality large stones whose exponentially higher value was not factored into the resource value because such stones simply do not show up in small scale bulk samples. Assuming the internal geometry of a pipe was properly delineated and the diamond content modeled, no major cost overruns emerged, and the diamond market remained stable, a diamond project which made it all the way through the diamond exploration cycle should perform at least as good as expected. Once the diamond mine is producing as expected, the junior partner becomes a candidate for a buyout by the senior partner or another diamond producer if the junior has not assigned marketing rights to a third party. |
|
Diamond Play Checklist Key Milestones And Success Probability Table for the Diamond Exploration Cycle
Milestone #0 - Is The Land Position Prospective?
Milestone #1 - Generating Kimberlite Targets
Milestone #2 - Hitting A Kimberlite Pipe
Tonnage Estimates For Craters And Diatremes
Use This Table To Estimate A Circular Pipe'S Size Potential. Note That The Crater Numbers Assume Angled Walls While The Diatreme Assumes A Cylindrical Shape. If You Know The Diameter (Metres) Of A Circular Target, Calculate The Hectare Area As Follows: 0.8 X Diameter Squared Divided By 10000, Or Use The Diameter Column In The Table. Milestone #3 - Demonstrating Diamond Content
Milestone #4 - Getting A Grade By Mini-Bulk Sample
Square Mesh Micro Diamond Size Distributions
Plot The Normalized Counts Against Size Range Using A Log Scale For The Counts. The Higher The Curve And The Shallower The Slope, The Better. Plot New Square Mesh Micro-Diamond Results And Compare To The Above To Get A Feel For Grade Potential. Do Not Use Longest Dimension Based Counts - Their Correlation With Macro Grade Is Random. Milestone #5 - Getting A Grade And Value
Milestone #6 & #7- Completing A Pre-Feasibility Study And Securing A Development Permit
Milestone #8 - Production Startup
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
How does the System work?
| The Fishing System Bottom-fishing is the investment strategy of buying stocks when they or their sector are unpopular, and selling them off in stages as they become popular. Penny stocks are influenced by five key cycles: a general market cycle, a sectoral cycle, a seasonal cycle, an individual company life cycle, and story driven speculation cycles. Any combination of these cycles can create peaks of extreme optimism and valleys of deep pessimism. Bottom-fishing targets the valleys of deep pessimism on the assumption that in the long run extreme market conditions never prevail. Cyclical Factors 1) General market cycle (economy related) 2) Sectoral cycle (ie Internet or gold) 3) Seasonal cycle (ie information flow cycles) 4) Life cycle (the rise and fall of insider ownership) 5) Speculation cycle (driven by expectations) The general market cycle is influenced by the economy and is reflected in the performance of major stock exchanges. Penny stocks generally do best in the advanced stages of a general bull market, which happens to be the case today. Sectors such as resource and technology stocks follow their own cycles with the result that there are always sectors that are hot while others are cold. The seasonal cycle reflects the nature of information flow, whose gaps and spurts are most pronounced in exploration juniors with weather constrained work seasons. Another form of the seasonal cycle is the psychology of the calendar year, which weds tax strategies with a natural inclination towards optimism early in the year that wanes in summer and eventually culminates in disappointment driven tax loss selling. Every junior company has a life cycle, which starts out with a high percentage of the stock in the hands of insiders and ends with a reorganization when the insiders have little stock left., or, more rarely, when it is bought out by a bigger company. We call a stock early life cycle if the insider network owns 50% or more of the paper, mid life cycle if the insider stake is below 50% but still significant, and late life cycle when it has dropped below 10%. A speculation cycle is a period of rising prices and volumes driven by market speculation about the success potential of a company's story. A junior company can have one or more speculation cycles during its life cycle. The strength of a spec cycle will depend on where the stock is in terms of the other cycles. Bottom-Fish Criteria 1) Bottoming chart pattern 2) Structure 3) People 4) Capital 5) Story 6) Project valuation The bottom-fishing strategy targets juniors that are early in their life cycle and consequently have not yet undergone a spec cycle, or that are trading in the trough between spec cycles. Only companies with a flat-lining or bottoming chart are treated as bottom-fish candidates. For a stock to qualify as a bottom-fish buy, evaluation of its chart, structure, people, capital, story, and project value must lead to the conclusion that the probability of a spec cycle that generates a gain of 500% or more above the bottom-fish buy range is good. Structure reflects the amount of stock in the hands of people in a position to affect the destiny of the company. The potential for a major spec cycle is directly related to the track record of the people behind the company. Capital is the means by which a company acquires a venture and tries to turn it into a fundamental success. The story is the venture or project that the people motivated by structure intend to use capital to turn into hard value. The project valuation is the value assigned by the market to the project (fully diluted capitalization times price divided by net project interest). This condition, important for asset plays, is met if it is plausible that a success story would entail a theoretical value at least five times the current project value. Priority Rankings 1) Top (spec cycle imminent) 2) Medium (needs good news to launch spec cycle) 3) Low (spec launch timing uncertain or long term) 4) Extreme (high reorganization or suspension risk) A bottom-fish is ranked a top, medium, or low priority buy according to the expected timing of a spec cycle's launch. Top priority goes to bottom-fish which could launch a spec cycle immediately. Medium priority goes to bottom-fish which need developments beyond management's control to launch a spec cycle. Low priority is for when the timing and reason of a spec cycle launch is uncertain or long term. Extreme priority goes to bottom-fish trading below $0.10 which are threatened by a rollback or trading suspension but which may emerge unscathed. Extreme bottom-fish are "extremely" high risk, but because they are often available in huge volumes at very low prices a bottom-fisher has the potential to make a tremendous score if the rollback or suspension is definitively averted. We recommend that everybody but sophisticated bottom-fishers stay away from low and extreme priority bottom-fish. Novices or bottom-fishers who do not want to do their own homework should stick with top priority bottom-fish because these are the ones most likely to receive detailed coverage in Bottom-Fish Action and Tracker comments. Bottom-Fish Risks (TROCL) 1) Timing of spec cycle (when, lord, when?) 2) Reorganization risk (oh no, a rollback) 3) Opportunity Cost (a dud spec cycle) 4) Catastrophe Risk (you mean he died?) 5) Liquidity (sell to whom, to whom?) The bottom-fishing strategy involves buying bottom-fish, monitoring their continuing eligibility as bottom-fish, and selling the position off in stages as the stock works its way through a spec cycle. The Kaiser Bottom-Fishing System flags stocks as bottom-fish, monitors their status as bottom-fish, provides detailed analysis of the spec cycle when it gets underway, and suggests selling windows through the issue of partial sell recommendations. Because the bottom-fishing strategy is a statistical approach to penny stocks, it is recommended that bottom-fishers maintain a portfolio of at least six different companies to diversify away the special risks associated with bottom-fish. These risks are that the timing of a spec cycle may be far down the road, the stock might undergo a reorganization, the story that drives the spec cycle could be a dud that turns ownership of the bottom-fish into an opportunity cost, a catastrophe affecting key people or the story could curtail the stock's life cycle, and liquidity may be so poor that a bottom-fisher would have a tough time unloading a position at will without a loss. Bottom-Fish Buy Brackets When we classify a stock as a bottom-fish buy we provide our readers with the essential details related to the bottom-fish criteria. We also assign a bottom-fish buying range that reflects the equilibrium price range within which a bottom-fish fluctuates while it awaits a trigger for a spec cycle launch. For standardization sake we have fixed the bottom-fish ranges at <$0.10, $0.10-$0.19, $0.20-$0.29, $0.30-$0.49, $0.50-$0.75, and $0.76-$1.00. For higher priced bottom-fish we set the bottom-fish accumulation range on the basis of the stock's bottom-fish trading range. We used to consider only stocks below $1 as bottom-fish candidates, but in view of the broad capitalization range we see these days, such a restriction serves no purpose. The bottom-fishing strategy requires that you not chase the stock above the bottom-fish buy limit. Bottom-fish by nature have poor liquidity, so we avoid calling a stock a bottom-fish buy at a specific price. When we call a stock a bottom-fish we are saying it has the potential to launch a spec cycle that takes the stock 500% or more above the upper limit of the buy bracket. We assume our readers will accumulate positions within this range. When we calculate bottom-fish performance for bragging purposes we assume the upper limit as the cost base. Actual gains experienced by bottom-fishers may thus be better than what we post. We don't regard a bottom-fish gain as meaningful until it passes 200%. Technical Holds It is up to the reader to decide which bottom-fish he or she wants to accumulate for their bottom-fish portfolio. Bottom-fish should not be chased beyond the upper limit of the accumulation range. On occasion we change the buy bracket to a lower bracket if the stock has developed a new bottom. In that case we "close out" the old bottom-fish recommendation, record the loss in the recommendation history, and set a new bottom-fishing range. We change the priority ranking if our opinion about the timing or potential of the bottom-fish changes. If a stock rises above the bottom-fish range we check to see if the move signals the launch of a spec cycle. If not, we consider the bottom-fish a "technical hold" and make no comment. By nature bottom-fish are volatile and can fluctuate outside the bottom-fish equilibrium range for insignificant reasons such as buying or selling pressure from a bottom-fisher. Any bottom-fish trading above the bottom-fish range which we have not reclassified as a "spec cycle hold" is deemed a "technical hold". Bottom-fishers should refrain from further buying when a technical hold prevails. The Spec Cycle Hold System If we conclude that a speculation cycle has begun we will issue a notice through a Bottom-Fish Action or Tracker comment declaring that the stock is now a Spec Cycle Hold. From that point on our coverage is geared toward managing the selling strategy for readers who bought the stock as a bottom-fish. At times our spec cycle commentaries may be very optimistic about higher prices, but readers should not interpret this as buy recommendations. Bottom-fish coverage is for people who bought the stock as a bottom-fish. We want to avoid as much as possible the self-fulfilling prophecy role where a bottom-fish is doing well only because subscribers are buying the stock. The Kaiser Bottom-Fishing Report is all about speculating on the speculation process, and things become rather complicated when we are the speculation process. Initially the bottom-fish will be tagged as a Spec Cycle 100% Hold, but at certain stages of the spec cycle we will issue partial sells in increments no smaller than 25%. These partial sells will be issued in the spirit of the "sell some to soon and some to late" rule, and are intended only for readers who bought the stock as a bottom-fish. This does cause confusion in the market when others hear or report that Kaiser issued a sell, but that is their problem and not one for subscribers to the Kaiser Bottom-Fishing Report. Readers do not need to follow these partial sells religiously; just use them as a risk management guide for your bottom-fish portfolio. When you see "Spec Cycle 50% Hold" it means we have recommended the sale of at least half the original bottom-fish position. Performance calculations take into account the partial sells and are based on the closing price prior to the issue of a Partial Sell. Because we wish to minimize the market impact of partial sells, we try to avoid issuing them during downtrends unless we are closing out a position. Until the partial sells add up to 100% and the bottom-fish is tagged a Spec Cycle 0% Hold, the Kaiser Bottom-Fishing Report will continue to cover the bottom-fish. Depending on where we are in the market and sectoral cycles, a spec cycle can last two months or two years. Once a bottom-fish has been reclassified as a "spec cycle hold" the only recommendations we issue are "sells" until the stock has been "closed out". Once a bottom-fish has been closed out it is eligible to be adopted as a new bottom-fish buy if it meets bottom-fish criteria. A stock closed out as a bottom-fish may continue to be the subject of analytical coverage as a "game-fish". We describe game-fish as representing good, fair or poor speculative value in the context of the rational speculation model, but we do not offer buy-hold-sell recommendations for game-fish. Bottom-Fish Duds and Closeouts There will, unfortunately, be cases where a bottom-fish turns into a dud such as when management decides on a reorganization after a story fizzles or when something happens that kills any potential for a 500% speculation cycle. Such bottom-fish get designated "Bottom-fish Dud - Hold 0%". Where we are repricing a bottom-fish range to reflect the reality of a new bottom trough we quietly "close out" the old recommendation and reclassify the stock as a bottom-fish with a new buying range. 10 Rule Bottom-Fishing Strategy In addition to bottom-fish criteria, the bottom-fishing strategy requires a state of mind that runs counter to natural human emotions. The following 10 Rule Bottom-Fishing Strategy sums up our investment approach. Rule #1 - Buy them when nobody wants them Buy a penny stock before a speculation cycle gets underway, such as early in its life cycle, when it is seasonally depressed, or when it is in the trough between spec cycles. We buy before promotion starts or a positive industry consensus develops. Bottom-fishing is truly contrarian in that almost everybody thinks you are wrong. Rule #2 - Buy a basket to diversify away the risk Always diversify a bottom-fish portfolio. While we think our bottom-fish have potential for 500% or better gains, each stock is vulnerable to the TROCL risks: timing, reorganization, opportunity cost, catastrophe and liquidity. On its own each bottom-fish has a high failure risk and a big reward potential, but as a group they have a reward potential that outweighs their collective failure risk. Rule #3 - Don't be a top picker Always sell some too soon, some too late. Everybody dreads making a mistake. When we sell too soon we correct the mistake by doing something foolish. When we miss the top we deny the mistake. The dread, not the mistake, is the enemy, so we pre-empt the dread through a strategy that guarantees we will almost never get it right. Some we will sell too soon, some too late, and at the end of the day it will average out into a nasty tax bill. We believe in the speculation process, not the story's happy ending. Rule #4 - Divorce your winners Never buy back a sold position unless the speculation cycle is over, a bottom has developed, and signs of a new speculation cycle are evident. We don't think we are clever enough to trade stocks, are too busy with real jobs and lives to monitor markets constantly, and know our enemies are gambling impulses and our emotions. Momentum trading is an addiction with the familiar motto "I know when to stop". Bottom-fishing has its good and bad periods, but it never wipes you out if you stick to the strategy. Rule #5 - Don't chase other winners Re-invest profits in other bottom-fish. Jumping onto a momentum play and riding it higher is the natural impulse after a big win, but we resist the temptation. As we take profits on bottom-fish undergoing a spec cycle we reinvest them in other "boring" bottom-fish, or sit on the cash if good bottom-fish are scarce. Rule #6 - Know why you own it Always have a reason for buying or holding a stock and periodically check if that reason is still valid. Not knowing why you own a stock, and why you profited or lost through it, gives you the same degree of control over your financial destiny as enjoyed by ocean flotsam. Without some sort of expectation and timeframe, you cannot manage opportunity cost or your risk/reward exposure. Rule #7 - Read between the lines Talk to management to get a better grip on the story and a feel for the company's "voice". Anything in print is history, and very quickly so if the source is credible. You must take responsibility for tracking your bottom-fish and verify your expectations and timeframes with management. Don't look for inside information, because if you get it and act on it, you are breaking the law. But the law does not forbid you to listen to the tone of insiders and read between the lines. The "voice" is not a reliable input for buying decisions, but it is a valuable resource for selling decisions. Don't worry that you are not a technical expert. With skillful questioning you can prompt most insiders to reveal any red flags. Rule #8 - Spend some of the profits on real things Regularly pull money out of the bottom-fishing account to set aside for future taxes or purchase hard assets. The impulse to let it ride is powerful. But most bear market cycle shifts are recognized only in retrospect. Do not get caught with unfunded tax liabilities, and don't forget that the purpose behind investing is to make money to buy real things, not end up with a great big pot of paper wealth. Rule #9 - Don't mix bottom-fishing and trading Apply the bottom-fishing strategy in a special account and do your trading elsewhere. Nobody can perfectly resist the temptation to take a flyer. But each flyer is a slippery slope for the bottom-fishing strategy. Physical separation is the best protection. Rule #10 - Be open-minded Never believe you know or have seen it all. Certain structures in the speculative market never change, but the form and scale in which they manifest themselves do change. By the time we have figured out how something works, the rules are probably changing. Open-mindedness and flexibility combined with cautious skepticism is the best attitude for bottom-fishers.
|
The TROCL Risk System Explained
| TROCL Risk System The TROCL Risk scoring system quantifies the five factors that can turn a bottom-fish into a dud. The TROCL Risk ranking system can be applied to any speculative stock, though it is important to recognize that it does not evaluate a junior's merits or success potential. The lower the score, the better. As a stock's price increases the TROCL score can change, often to a worse score. Each risk factor is rated high (2), medium (1) or low (0). The TROCL Risk is the sum of the five factor ratings. A full score of 10 means you are dealing with a beast called a troglodyte which you want to avoid. TROCL risk scores above 5 generally disqualify a stock as a good bottom-fish. Risk scores are re-assessed whenever the company is reviewed. The results show up in the Risk Analysis section of a company's profile in the following format: Timing Risk: When is something going to happen that will make this stock go up? Getting the timing right is the biggest headache in bottom-fishing. Everybody's goal is to buy a stock just before it goes up, but once it is apparent that the timing of a speculation cycle is imminent, very little stock remains available for accumulation at bottom-fish prices. So you have to bottom-fish when the timing is not obvious or clearly down the road. If the nature of a junior's story is such that key fundamentals needed to drive a speculation cycle will clearly take more than 12 months to materialize, or the company is contemplating a reorganization, the timing risk is high for a score of 2. On the minus side higher prices are a long time off, but on the plus side one has time to accumulate a good position at cheap prices. If a speculation cycle is imminent or underway the timing risk is low for a 0 score. The downside of a low timing risk is that the speculation cycle could collapse, a risk that would be reflected in a high catastrophe risk ranking. Another drawback of low timing risk is that the stock is no longer available at bottom-fish prices, at least not in meaningful amounts. A medium risk score of 1 is assigned when a speculation cycle could start within 12 months because either a work program is planned, or, in the case of a shell, the company is ripe for acquisition of a new story. A key aspect of the medium timing risk rating is that it remains uncertain that a speculation cycle, particularly a big one, will develop within 12 months. The probability of a decent speculation cycle will depend on the status of the overall market cycle. Reorganization Risk: A high reorganization risk or two score means that a junior plans to roll back its stock or merge with another company on rollback terms. A reorganization is bad for bottom-fishers because it not only implies lower prices, but also a minimum 3-6 month dead zone during which no speculation cycle will develop. Not until shareholder approvals have been obtained and the company refinanced through cheap paper will the stock be ready for a new story. Because of private placement hold restrictions, unless a junior is an Annual Information Form filer, which reduces the hold period from 12 months to 4 months, the wait for a bottom-fish with a high reorganization risk could be 12-18 months. A high reorganization risk is a signal for sophisticated bottom-fishers to check the situation out for "extreme" bottom-fishing opportunities. A medium risk score of one means that a rollback is not yet planned, but may soon be necessary if the next speculation cycle fails. Late life cycle juniors are usually assigned a high or medium reorganization risk. A low risk or zero score means there are neither reasons nor plans to do a rollback. A freshly reorganized junior or one that is well financed one with active projects will have a low reorganization risk. Opportunity Cost Risk: This is an attempt to quantify the upside potential of a junior's story. A high opportunity cost risk score of 2 is assigned when the story appears to have limited reward potential. An example would be a small vein target. If a story is mediocre it is not likely to generate a speculation cycle with an amplitude of 500% or better above the bottom-fish price range. During bull market cycles one wants to avoid high opportunity cost risk because investors will avoid stories lacking pie-in-the-sky potential. A zero score (low risk) generally applies when the market value of the junior is very low relative to the project outcome potential. In terms of the rational speculation model, high opportunity cost risk is equivalent to poor speculative value, and low opportunity cost risk is equivalent to good speculative value. A medium risk score is assigned when the story and its current pricing represents fair speculative value. Catastrophe Risk: If a junior's current value and future depend heavily on one individual or a specific project, the catastrophe risk is high with a 2 score. Speculators should be very careful when the catastrophe risk is high, particularly when the company's market capitalization is tied to a specific project. A high catastrophe risk rating is not a negative comment on the merits of the project, but just a warning that if something unexpected goes wrong, the stock will tank. Key man related high catastrophe risk is typically assigned to mid to late life cycle stocks where it is the reputation and drive of the key person that keeps the stock from undergoing a reorganization. Robert Friedland and the late Murray Pezim are examples of key people whose companies would be assigned a high catastrophe risk. A low catastrophe risk score of zero means that a junior has multiple projects and a management team in which leadership is not concentrated in one individual. A medium catastrophe risk rating is assigned to companies that fall between these extremes. Liquidity Risk: A high liquidity risk score of 2 means the stock is thinly traded at prevailing prices. If you do manage to accumulate a large position, be prepared to sit on it. On the plus side, when a speculation cycle kicks in for such a stock, the price can increase several times before selling develops, giving the bottom-fisher an instant windfall. Bottom-fish frequently have a high liquidity risk because the act of developing a bottom involves the disappearance of both sellers and buyers. A big spread between bid and ask is usually a good sign of poor liquidity. A high liquidity risk rating for a stock at the peak of a speculation cycle is a danger sign. A low liquidity risk with a zero score means that the stock trades actively at prevailing prices, allowing a speculator to move in and out at will without significantly disturbing the market. Generally only mid to late life cycle juniors get a low liquidity risk rating. A medium risk score indicates the stock can be bought and sold over time if one applies a delicate touch. |
Rational Speculation Model: an Introduction
| A Rational Speculation Model What represents good speculative value? Is there such a thing? Is rational speculation possible? It certainly is, but not in the sense most people would expect. Rational speculation involves the assessment of the probability of an imagined outcome based on available information, comparing that fundamental probability to the payout implied by the market's current valuation of that play should that imagined outcome become reality, and making a speculative investment if the payout would match or exceed the fundamental probability that the imagined outcome would become reality. Rational Gambling: no such thing Whether a play represents good, fair or poor speculative value depends on how the payout leverage based on a play's current market pricing compares to the fundamental odds that the expected payout will be achieved. That also happens to be the primary principle of gambling, which, because it is a zero sum game, is at best a wash in the long run unless the payout consistently exceeds the fundamental probability of delivering that payout. In gambling this condition exists only if the game is rigged, in other words, the player cheats, or the other players are consistently mistaken about the probability of outcomes, in other words, they are fools. All gambling forums defend themselves against cheating, and stupid participants get financially eliminated before their stupidity becomes a recognizable pattern open to systematic exploitation. A winning streak attributable to "luck" is not a factor because it is never sustainable in the long run. Because gambling systems are zero sum processes involving random outcome generators, "rational gambling" can never qualify as an investment strategy. In fact, because of the percentage collected by the operators of gambling systems, even a gambler with perfect knowledge of outcome probabilities cannot break even in the long run. Victimizing fools and cheating excluded, gambling cannot qualify as rational unless the entertainment value of the gambling activity exceeds the value of the lost capital. Rational Speculation: it works because venture capital markets create new wealth Speculative venture capital markets, however, where the potential outcome consists of the creation of new wealth, where human ingenuity and effort are key inputs in determining the outcome, and where by definition all bets are fluid in the sense that they can be made and taken back at any time, are not the same thing as gambling. Gambling is a process that rearranges ownership of existing wealth. Venture capital speculation also rearranges ownership of existing wealth, but it is also capable of creating new wealth through its role as a mechanism for matching risk capital with venture projects that have the greatest likelihood of creating new wealth. Provided the venture capital market is not undermined by fraud, corruption, and disclosure suppression policies, the pool of wealth whose ownership is under constant rearrangement also undergoes long run growth. There will always be winners and losers, but unlike gambling where the payout to the winners is completely at the expense of the losers, the payout to the winners in an efficient speculative venture capital market is on an aggregate basis greater than the losses suffered by the losers. (The winners include the recipients of the capital spent by the ventures.) For any capital deployment to qualify as an investment, there must be a reasonable probability that the value of the output will be greater than the value of the input. Because this is the case for legitimate venture capital, the rational speculation model, which is built on the similarities and differences between gambling "projects" and venture capital projects, qualifies as an investment strategy. Economic value versus market value Speculative value is very different from the traditional concepts of economic and market value. "Economic value" refers to the intrinsic worth of an asset. An asset is something tangible or intangible which has the ability to generate cash flow in exchange for delivering a good or service without transferring ownership of the asset in whole or in part. Economic value is thus a measure of the asset's ability to generate cash flow, not the "market value", which is what somebody is willing to pay for it. Theoretically the economic value of an asset and what somebody is willing to pay for it, the "market value", should be one and the same thing. But as we saw in the dot-com boom, the two can diverge wildly. Such divergence is possible because perception and expectations drive the market, and these may bear no relationship to reality in the form of cash flow potential either because perception is distorted by mistakes or expectations have become trapped in a greater fool spiral where the market is guided by perception of its own behaviour rather than fundamental reality. If this sounds to you like philosophy, you are right. The market cycles perpetually between a mode where reality operates as an extension of the imagination and a mode where the imagination shrinks to a time bound sliver trapped on the surface of an opaque, ubiquitous and immovable reality. This flip-flopping between unbridled "idealism" and inertia soaked "realism" is what gives the "efficient market hypothesis" a bad name. Speculative value arises through the imperfect interplay between economic and market value. A contemporary version of these extremes is the "new economy" dot-com mania of yesterday that envisioned the Internet rewriting "old economy" rules, and the dot-bomb gloom that sees the Internet sinking into an old economy morass. A fundamental principle that keeps the market alive is that in the long run the market value, namely what somebody is willing to pay for an asset, converges with the economic value that measures the asset's ability to generate cash flow. It is thus very meaningful to describe an asset as under, fairly, or over valued. How can something that only potentially exists have value? The same cannot be so obviously said about a speculative venture, which is a project that merely has the "potential" to become an asset. Whether or not the speculative venture becomes an asset, what the scale of the asset's cash flow ability will turn out to be, and when the asset shifts from "potential" to "actual" are all uncertain. Consequently, a speculative venture has no economic value. Classic examples of a speculative venture are mineral plays and biotech research projects. Such and such a grassroots property could very well host a world class diamond project, but the diamond deposit's existence is not yet demonstrated. Even when a kimberlite is found it must still go through a series of exploration steps that quantify its cash flow potential and eventually demonstrate its cash flow ability through production. Such and such a promising drug could be a cure for AIDS, but until it passes all the milestones in the approval process, it remains just a potential asset. Gambling and venture capital speculation both bet on uncertain outcomes Speculative markets resemble gambling forums in that they allow individuals to bet on an uncertain outcome. But there are also important differences. In the case of junior exploration companies the objective is to create new wealth by combining creativity and capital in an effort to discover or establish an orebody that can be turned into cash flow. When an exploration venture is a fundamental success, all the shareholders go home as winners. This never happens in gambling forums, which merely reshuffle the ownership of existing wealth. What also never happens in gambling forums is that the bettor can collect a payout before the outcome is known. To win anything a gambler has to be put at the mercy of fate. Either the horse wins the race or it doesn't. Either the winning cards come up or they don't. Betting stops when the dice are rolled or the race begins. To break even in the long run a gambler must understand the probabilities of a game's possible outcomes and bet accordingly. To win in the long run a gambler must cheat or play only against "handicapped" gamblers in a forum such as poker where the human factor is a partial contributor to the outcome. Racetrack Gambling: a perfect analogy for the rational speculation model Speculative ventures and horse races are very similar in that people bet on the outcome and get paid out according to the odds of success. The stock market, however, is different in that stock prices can go up before the outcome of the "race" is known. It allows investors to bet not just on the fundamental outcome, but on probabilities that actually change as exploration progress is made, or that are perceived by the market to have changed. Furthermore, speculators can collect their reward anytime by simply selling their stock. The stock market is a horse race where betting never stops until the race is finished. Stock market bettors can collect payouts in the middle of a race when a "horse" is merely leading. Furthermore, in speculative ventures all bets are to win, show and place. You can set your hopes on a billion dollar world class discovery, and still go home very happy when only a $200 million deposit is found. In horse racing a win bet means a horse has to finish first for you to get a payout. A place bet means a horse can come in first or second for the bettor to receive a payout. For a show bet the horse can finish first, second or third. The payouts for a horse are higher on a win bet than a show bet. Owning a speculative stock is like placing a single bet with three different payout possibilities. An exploration venture has a fundamental track and a market track which are supposed to move in tandem. Often they do not, such as when a speculative bubble prices a stock as though the expected outcome had already been achieved, or when deep pessimism causes the market to ignore major milestones that significantly boost the venture's success potential. Rational speculation is all about understanding and monitoring the relationship between the two tracks. The interplay between the fundamental and market tracks makes possible speculation on speculation, which is what technical analysis ultimately is all about. A racetrack gambling example involving Horse A and Horse B Here is a good example that intuitively explains how rational speculation works. A "smart" racetrack gambler studies the race history of horses in a race lineup and assesses the fundamental odds of winning the race for each horse. Based on the gambler's analysis of the "fundamentals", Horse A is the favorite with 2:1 odds while Horse B is a longshot with 10:1 odds. Other gamblers have similarly done their homework, though their conclusions may be different. Handicappers have published what they think are the fundamental odds. As the gamblers place their bets, the pari-mutuel betting system posts the payouts that would happen for each horse if it should win. Because gambling is a zero-sum activity minus the racetrack percentage, the proposed payouts adjust according to how gamblers place their bets. Theoretically, the payout ratio (ie 10:1) for each horse is the same thing as the fundamental odds of winning the race. The riskier "longshot" horse pays higher if it wins than the lower risk "sure thing" horse. But the payouts that stand when betting closes and the race begins are created by the collective betting activity of gamblers who act both on their own assessment of the fundamental odds and the changing implied odds on the payout board. It is thus possible that Horse A, which our gambler gave 2:1 odds, will pay out 10:1 while the gambler's 10:1 longshot will pay only 2:1 if it wins the race. The collective wisdom of individual bettors has assigned a new set of odds for Horses A and B. A venture capital speculation example involving Stock A and Stock B The stock market operates in a manner similar to the pari-mutuel betting system. Let's substitute Stock A and Stock B for Horse A and Horse B. Stock A has a diamond prospect in an area with exceptional indicator mineral chemistry that suggests a world class kimberlite may be present. Stock B is a proximity play with no evidence of similar indicator minerals on its property. In fact, Stock A's exploration team ignored Stock B's ground when their regional sampling failed to turn up anything of note. Both stocks have the same number of shares fully diluted and the same net interest in their respective projects. Stock A trades at $2 reflecting investor expectations that the odds of finding a kimberlite that makes Stock A worth $6 are 2:1. Stock B trades at $0.55 reflecting investor expectations that the longer odds of a kimberlite discovery on Stock B's ground making Stock B worth $6 are 10:1. Both companies are set to drill geophysical targets that could be kimberlite pipes. At this stage the market track is pretty much in line with the fundamental track. Holy mackeral, the longshot is soaring and the favorite is plummeting! Who has bought Stock A and who has bought Stock B? Speculators buying Stock A prefer a more modest 200% profit potential in exchange for a lower failure risk, while Stock B buyers prefer the 1,000% profit potential of their longshot while accepting a much higher failure risk. (A fundamental principle is that a high reward comes with a high failure risk while a low failure risk delivers a low reward. A prudent investment strategy always sticks to this rule. Almost every successful fraud can be traced to the victim believing that high reward and low risk can co-exist in an investment opportunity. Because of market inefficiency this condition can exist, but, because it is so rare, nobody who discovers such a situation will ever share knowledge of it with a stranger.) In our example the risks and rewards are nicely balanced, but then a strange thing happens. Stock B starts to go up while Stock A declines even though the drills are not yet turning. There is no new information that a kimberlite in this region could be worth more or less than $6. But there are rumours on the street that a new government geological survey study is forcing a rethinking of the glacial history of the region where Stocks A and B have their diamond projects. Could it be that the exceptional indicator minerals on Stock A's ground actually originate from Stock B's ground? How does that affect their respective probability of finding a diamond pipe worth $6 per share? By the time the scheduled drilling date arrives, Stock A has sunk to $0.55 and Stock B has soared to $2, reversing the implied probabilities of a $6 payout for each project. Stock A is now the 10:1 longshot while Stock B is the favoured 2:1 bet, the same situation that prevails at the start of the race in our racetrack example. Stock market bets can be changed without betting more money but not so with gambling bets As betting closes and the race begins, which racetrack gamblers are happy and which are not? Unlike the stock market where speculators can change their bets by buying and selling stock, the racetrack gamblers can change their bets only by making more bets. Once a racetrack bet is made it cannot be withdrawn. For an individual gambler his personal outcome depends on the outcome of the game. For the individual speculator who owns free trading stock his outcome is determined continually by the stock's price and liquidity, and only additionally by the fundamental game of drilling the kimberlite targets. The racetrack gambler can modify his risk exposure only by placing more bets, but the speculator can modify his risk exposure by changing his bets, not just before the "race" but also during the "race". How a fair value bet can turn into a good value bet For the racetrack gambler his happiness at the start of the race depends on what fundamental odds the gambler assigned a horse, which bets he placed, and the degree that his assessment of the odds has changed as a result of watching the payouts change and picking up additional information during the betting window. It boils down to this simple formula. The guy who played it safe and bet on Horse A with 2:1 odds will be thrilled to see a win set to pay out 10:1, provided he remains convinced that Horse A's real odds remain 2:1. Perhaps the other gamblers are mistaken, picked up a false rumour that Horse A has been doped, or went just plain gaga about that new hot to trot Horse B which our gambler had dismissed as a 10:1 longshot. This guy's bet represents good value. Note that the assessment of "good value" is relative to the gambler's actual bets, his perception of the success probabilities, and the payout pricing established by the pari-mutuel betting system at the close of betting. His fair value bet has turned into a good value bet. How a fair value bet can turn into a poor value bet The gambler who bet on the 10:1 longshot only to see the payout plummet to 2:1, will be very unhappy, especially if he still thinks Horse B is a 10:1 longshot. His fair value bet has turned into a poor value bet. On the other hand, a gambler who had privately assessed Horse B as a 2:1 ringer even though the other handicappers had pegged it as 10:1, but then watched the payout plummet to 2:1 as word got out among the gambling crowd that Horse B was a ringer, ends up with a bet that represents fair value. This gambler watched his good value bet turn into a fair value bet. He is disappointed, but not unhappy. Gambling strategies all have a similar quest: to place a bet where the fundamental odds of losing are much lower than the reward paid out by a win. Do that consistently and in the long run you will theoretically be a net winner. In reality, because of operator leakage in zero sum gambling systems and because the racetrack gambler cannot know that he has scavenged all relevant information and properly evaluated their relationship to establish the success probabilities, the racetrack gambler will be a net loser. For gamblers it ain't over until it's over The racetrack is similar to the venture capital market because in both forums the gamblers and speculators are largely unable to influence the outcome of the race itself, but both forums offer a rich abundance of fundamental information whose interpretation by the gamblers and speculators has a tremendous effect on the percentage payouts associated with the actual outcome of the race or venture. The difference is that in the horse race the payout is made after the race is won, hence the saying, "it ain't over until it's over". But in the speculative stock market the payout is continuously available. For speculators it can be over before it has begun The speculator who bought the 10:1 longshot Stock B at $0.55 and does not believe the glacial history story can cash out at $2 for a 264% gain without having to wait for outcome of the drilling program. On the other hand the speculator who bought the 2:1 favorite Stock A at $2 is facing a 73% loss on paper. The fact that the loss is still only on paper is no consolation, even if this speculator does not buy the new glacial history story and remains convinced that the fundamental odds are still 2:1 that Stock A's drill program will deliver a diamond pipe worth $6 per share. The reason this is no consolation is the fact that had he waited and not placed his bet while Stock A was at $2, he could have bought nearly four times as much stock for the same amount of money. And if he agrees that the glacial history story has indeed reduced Stock A to a 10:1 longshot, then his unhappiness is even greater, for not only has he already lost money but he is stuck with a bet that represents poor speculative value. The speculator who bought Stock B at $0.55 because his private research gave him reason to mistrust the conventional interpretation of ice directions, with the result that he assigned the much more optimistic 2:1 odds to Stock B, is the happiest of the lot. At $2 his bet remains fair speculative value, and he has the option to take sufficient profits to reduce his financial loss risk on his original investment to zero. The common denominator in rational speculation: the implied project value Because of the uncertainty associated with speculative ventures and the rich variety of fundamental information available on the venture, there will be many different opinions about the outcome potential of a speculative venture. Not only will there be different opinions about the success odds, but there will be different opinions about the size potential of the prize. There will, however, be one figure common to all possible outcome scenarios, and that figure is the value assigned to the project by the market. The value implied for a project by the market is based on the stock price, the company's fully diluted capitalization, and the net interest the company has in the project. If a company has a market value of $100 million and a 50% interest in its project, that is the same thing as saying the project has an implied value of $200 million. It is much easier to evaluate speculative ventures if their market valuations are normalized to a 100% basis. No matter what outcome fantasy and success probabilities a speculator holds, they all share the same project value implied by the stock price times fully diluted capitalization divided by the net project interest. A three step rational speculation model Rational speculation starts with an analysis of what the potential outcome of a speculative venture might look like and what it would be worth if it became a reality. This analysis can be generated by applying personal knowledge and experience to raw data, or it can be gleaned as a consensus compilation of outcome analyses prepared by other "experts". Rational speculation then evaluates the probability of this potential outcome becoming reality in the context of where the project is in the development cycle and what fundamental evidence supporting the potential outcome is available. This analysis is done by investigating the particulars of a project and comparing them to experience. Finally, the speculative value is assessed by comparing the fundamental probability of the potential outcome with the payout implied by the project value assigned by the market. The first number is tricky to obtain, but the second number involves only looking up three published figures, plugging them into a simple equation, and dividing this implied project value into the ultimate project value imagined through the potential outcome analysis. If the implied payout ratio is greater than the fundamental success probability, the stock represents good speculative value (for example, the stock will pay a high reward of 10:1 but the fundamental odds are a lower risk 2:1). When they match the stock represents fair speculative value (for example, the stock will pay a high reward of 10:1 and has an equally high risk 10:1 success probability). When the implied payout ratio is less than the fundamental success odds, the speculative value is poor (for example, the stock will pay out a low 2:1 reward, but the success probability is a high risk 10:1). |
Rational Speculation Model: 3 Step Application to Mineral Plays
| Spec Value Appraisal: the Rational Speculation Model applied in 3
steps to mineral plays The rational speculation model involves a three step procedure that can be applied to any mineral play. What follows is a formal description of the Spec Value Appraisal system. It is intended for sophisticated investors who want to visualize the real world potential of a mineral play, to understand the news flow timeline that dictates an exploration play's progression from imagined potential to quantified actuality, to know in advance what upcoming project news should look like to make or break the outcome scenario, to be able to modify an outcome scenario in response to fresh information, to evaluate how the rest of the market perceives the mineral play's potential, and to apply a profitable speculation strategy that pursues good speculative value and steers clear of poor speculative value. How's that for a mouthful? Failure risk declines as a play moves through the exploration cycle The Spec Value Appraiser can be applied to any mineral exploration play involving gold, silver, platinum group metals, base metals, industrial minerals, specialty metals and diamonds. It can also be applied to oil and gas plays, and to some degree to biotech plays. All involve a hypothesis which is tested and modified through a series of steps that culminate in production cash flow. In the case of mineral and energy projects the resource is generally finite and has an absolute value limit. Biotech projects have a limit value in a different sense defined by the population that needs a cure or treatment. The biotech project's cash flow potential is also limited by patent expiry and the stark reality that patent violation can and will destroy an overly lucrative supply monopoly. Until the project is actually in production there prevails an uncertainty that cash flow will ever begin. The market value of the project will hinge on this uncertainty, which is also the probability production will be achieved. As a project approaches production the cash flow parameters become clear and the failure risk declines. The failure risk, also known as the success probability, thus declines because progression through the exploration cycle generates more reliable and extensive information about the project, which in turn forces the outcome scenario and its ultimate project value to be tailored until it conforms with the fundamentals. Imagination and reality become one and the same. The progressive decline in failure risk is the essence of venture capital speculation, which takes as its object not only the probability that the ultimate outcome will be achieved, but also the probability that a project will progress from one stage to the next. This secondary stage shift speculation is the reason project values implied by market pricing of public companies with a stake in the project can fluctuate above and below the valuation channel associated with that project's probability curve. The market values plays properly well before the engineers go to work It is important to keep in mind that potential outcome scenarios are constructed from very sketchy information and risky assumptions using a simplistic discounted cash flow valuation model. This type of analysis is best suited for the early stages of the mineral exploration cycle before a prefeasibility study has defined the parameters of a mineral play with the sort of hard numbers with which engineers are comfortable. Back-of-the-napkin style value speculation is appropriate when the uncertainty surrounding a project's potential is still too high for the engineers to touch. By the time it is "safe" for the engineers to tackle valuation of a mineral deposit, the market will already have assigned a value within the ballpark range that the engineers eventually come up with. The biggest speculation gains are thus made during the early stages of the exploration cycle as the market tries to quantify the implications of a discovery play. Knowing when and why to change your expectations is a speculator's survival key Stock prices are extremely volatile during the discovery phase because investors can visualize scenarios with a wide range of grade, tonnage, commodity price and cost variables. Almost every scenario generated during the early stages of a mineral play will turn out to be incorrect, which is why there will be wide disagreement among market participants. While most commodities are priced within a long term cyclical range, certain minerals such as gold whose value is not dominated by consumption demand have a far less predictable future price range than base metals such as copper and zinc. While exploration work gradually defines the deposit's physical parameters, which in turn limit the mining scenarios and bring the cost parameters into focus, there is no reduction in the uncertainty of the commodity prices that will prevail during the life of the mine. This unavoidable uncertainty about future commodity price is the mother of disagreement over the ultimate value of mineral projects even as they go into production. Disagreement happens to be a necessary condition for market liquidity. Stocks do not trade when the market is in agreement about the company's outcome scenario and failure risk, the definition of fair speculative value. (Of course, even when such agreement does exist, the equilibrium is undermined by the availability of alternative plays that offer good speculative value which a speculator will seek to capture by selling shares that have only fair speculative value.) As exploration work gradually defines the limits of the play, the scenarios converge toward a consensus that changes only with the arrival of new, unanticipated information. That is the reason the trading pattern of companies with a mineral project headed toward production forms a flat line. Spec value appraisal is not so much important in enabling a speculator to correctly visualize a project's ultimate value as it is in giving the speculator a framework to modify expectations in response to new information and judge whether the investment still represents fair to good speculative value. The promise of changing information in the form of exploration results makes it all work. The 3 steps in spec value appraisal 1) Outcome Analysis 2) Probability Analysis 3) Risk-Reward Analysis Outcome analysis requires you to identify the target outcome (what is the junior trying to accomplish?), establish ultimate project values (what would it be worth?), and construct expectation sets for possible outcomes (what would the fundamentals need to look like in order to justify the ultimate project values?). To complete an outcome analysis you must understand the discounted cash flow valuation model, and have access to cost information for the type of production scenario implied by the target outcome. Outcome analysis is an exercise in visualization which requires both imagination and attention to the facts of reality. Probability analysis requires you to identify a set of milestones leading to the target outcome, and to assign fundamental odds that the target outcome will be achieved from each milestone. To complete a probability analysis you must understand the exploration process for the target outcome, and have access to the probabilities associated with the exploration target. When these probabilities are linked to an ultimate project value so as to generate theoretical project values appropriate for each stage in the exploration cycle, and these theoretical project values are plotted against their corresponding exploration stage, the result is a probability curve whose upper and lower limits define the valuation channel for a certain ultimate project value. The Implied Project Value Charts at DiamondPlay.com contain two such valuation channels for $2 billion and $500 million ultimate project values. Risk-reward analysis requires you to compare the project's fundamental odds with the odds assigned by the market so that you can arrive at a Spec Value Rating. It also requires you to make a personal decision about what risk level is acceptable to you, and how much money you can afford to risk at that level. The Implied Value Charts for diamond plays graphically portray how the project value implied by the market relates to the valuation channels. The Spec Value Appraiser requires considerable work to set up for a project, and requires regular adjustment as the scope of the target outcome and its ultimate project value change. The payoff for this effort is that you will be in a much stronger position to recognize quantum leaps or falls in the success potential of a project. It will also allow you to recognize risk-reward imbalances that signal buy or sell decisions. Most importantly, it forces you to understand what your speculative bet is really all about. The data structure of DiamondPlay.com and its IPV Charts has been designed so as to save speculators much of the tedium associated with setting up and operating the Spec Value Appraiser. Step One: Outcome Analysis Before you run a junior through the Spec Value Appraiser you must make sure the company has a project it is exploring for a specific type of target. Exploration can still be at the grassroots stage where the target is purely conceptual, or it can be at a more advanced stage where the target has become a partly outlined deposit. For a junior's theoretical target to be taken seriously, the junior must offer an existing deposit as a model, preferably one in the region. A case must be made why the regional geology is prospective for the deposit type. A secondary case must be made that the junior's land position has the right geology. Once you have established that the junior's target is within the realm of geological possibility, you must address what the best possible outcome will be worth. You can approach this in two ways. You can take a figure such as $1 billion and declare that the junior's target is to define a resource worth $1 billion. In that case you have to work out various deposit configurations whose associated capital and operating costs for a minimum 10 year mine life will equal the ultimate project value in net present value terms. The other way is to define the target in terms of tonnage and grade, and work out the ultimate project value using the discounted cash flow method for a mine with a minimum 10 year life. The former approach works best when the project is still at a grassroots stage, and the latter approach takes over once the conceptual target has turned into an actual target. The outcome analysis gets repeated throughout the exploration cycle, and becomes more detailed with more precise input parameters as each milestone in the exploration cycle is achieved. This can involve shrinking or expanding the target outcome. Ultimate Project Value = Net Present Value of a Production Ready Project Using the Hard Value Appraiser in Outcome Analysis Doing a back-of-the-envelope calculation of what a deposit might be worth if it is put into production at a rate which will deplete the deposit in no less than ten years is straightforward. Figuring out what a deposit needs to look like to be worth a stipulated ultimate project value is more complicated. The reason is that many combinations of grade and tonnage can create the same ultimate project value. However, anybody who remembers their basic algebra and knows how to use a spreadsheet can design a matrix for several distinct possible scenarios. An example of such a matrix, which I call an "Expectation Set of Possible Outcomes", is presented later on. In what follows I will only demonstrate how to produce a value when we have tonnage and grade estimates for a deposit. The Hard Value Appraiser ignores details such as royalties, freight, recovery rates, stripping ratios and concentrate rates. There is no limit as to the complexity you can build into a cash flow model, though the practicality of the model is limited by the reliability of the inputs. During the discovery stage of a mineral play the overall uncertainty is so high that fussing with unknown details does not make a positive contribution to the relaibility of the outcome scenario. For the purposes of the Spec Value Appraiser, which is dealing with deposits that are only exploration goals or early stage targets, all we need is a very crude method to give us a ballpark sense of what the deposit might be worth if it were proven up. For hard core mining analysts my Hard Value Appraiser is a joke. For the typical investor who has no idea whether a company's project might be worth $1 million or $1 billion, the Hard Value Appraiser is a quick and dirty way to put the potential outcome into perspective. The Hard Value Appraiser A deposit's hard value is the net present value of the future cash flow arising from mining the deposit, extracting the key commodities, and selling them at prevailing market prices. Cash flow is the gross revenue less the operating costs and taxes. The annual cash flows over the life of the mine are discounted to their present value at a rate that reflects the cash flow's risk. The net present value is the present value less the up front capital cost needed to put the deposit into production. If you really want to be fussy, you can discount the NPV again to reflect the number of years it will take before production starts up. I don't do that for the Spec Value Appraiser because the ultimate project value is only a goal toward which the exploration cycle marches. The Spec Value Appraiser is intended to generate theoretical project values for the early stages of the exploration cycle. A more rigorous valuation treatment is required when the project has reached the prefeasibility stage. Annual Cash Flow Formula Gross Revenues Less Operating Costs equals Operating Profit Less Taxes equals After Tax Cash Flow Here is how you get the items in this formula: Gross Revenues =Annual production rate (tpy) times grade times commodity price The tonnage and grade are given, and the commodity price is looked up. The current price may be unrealistic if it is a cyclical high or low. As long as there are no major changes happening in the supply & demand structure of the commodity's market (ie as when new technology renders a commodity obsolete or creates a new demand for it), it may be prudent to use the 10 year cyclical average. The production rate is the tonnage divided by the mine life. I use ten years as a mine life because most deposits are put into production on a scale that ensures a mine life of at least ten years. The bigger the production rate, the greater will be the need to develop infrastructure, and the longer will be the projected mine life for both social and economic reasons. Because the cash flow 11 years or later down the road has a substantially lower present value than that of the first ten years, and because the commodity prices are hopelessly unpredictable that far down the road, I use ten years as the time to deplete a deposit. When calculating the gross revenue you must make sure the tonnage, grade and price variables use common units. For example, don't multiply a g/t gold grade by a $/oz price. Operating Cost = Annual production times Cost/tonne The simplest way to get a reasonable figure for the operating cost is to look up the figure for a similar deposit that is in production at a comparable rate. Mining analysts have this sort of data at their disposal, and the reason they get paid big bucks to produce research reports is that they know how to size up a deposit, and match it with appropriate operating costs. The problem with mainstream analysts is that they keep their reference databases secret, and only apply their skills to advanced projects where the deposit is fairly well defined. As rigorous number-crunchers they abhor dealing with fictitious or vaguely defined scenarios. No self-respecting mining analyst would want to be caught dead running a project through something like the Spec Value Appraiser. Some analysts and newsletter writers offer price targets for a project, but they do not offer the parameters and method used to arrive at these targets. For all we know, they might be guessing. In fact, if no effort has been made to contextualize a project with an outcome scenario visualization, price target predicts are just plain arbitrary. As a result there is a huge analytical gap between early stage and advanced projects. The challenge for the average resource stock speculator is to acquire a source of operating cost ranges that allows one to plug ballpark numbers into the Hard Value Appraiser. Taxes = Operating profit times tax rate The tax rate will depend on the location of the project. Some countries collect royalties on the gross revenue in addition to a tax on operating profit. The Hard Value Appraiser is only concerned with the effective tax rate on profits. The economics of a mine can be affected by the tax treatment. For reporting earnings companies depreciate the capital cost of the mine on a straight line basis over the projected life of the mine. But for tax purposes different reporting procedures are permissible. There may be a tax holiday where no tax is payable until the capital cost has been recovered. Or the tax rules may require a percentage of declining balance treatment for depreciation. Until we have an advanced project on our hands, it doesn't make sense to worry about the complexities of tax treatment. So we pick a tax rate that is lower than the official tax rate at a level that hopefully would balance out the effect of different depreciation schedules. Present Value = Annual after tax cash flow times 7.72 Once you have estimated an annual after tax cash flow for a ten year mine life, calculating the present value is simple. What you have is a simple annuity. Just plug the annual cash flow, the number of years, and the discount rate into the present value formula of your spreadsheet or financial calculator. I suggest using 10% if you want a present value that a major would pay to own the project, or 5% if you think the junior who owns the project will survive as a publicly traded company. The reason for the valuation difference is that a deposit bought by a major will disappear into a portfolio of many mines where the deposit's cash flow will only make an incremental difference to the major's financial clout. In contrast, this cash flow within a smaller company will attract a premium from the market on the assumption that a smaller company will be more creative and flexible than a major company in utilizing the cash flow to generate new projects. For the Hard Value Appraiser we don't need to use a financial calculator. For a ten year mine life we can use a cash-flow multiplier that is 7.72 at 5% and 6.14 at 10%. Net Present Value = Present Value less Capital Cost The present value figure, however, does not include the up front cost of putting the deposit into production. When we looked up the operating cost for the proposed production rate, we will also have looked for approximate capital costs. Here we are being very superficial because we do not know what special environmental problems the project would face, or what sort of pre-stripping costs or metallurgical complexities a fictitious deposit might have. So we need to make a reasonable guess. The hard value of a project is its net present value, which is the present value less the capital cost of the project. Again, we are only trying to get ballpark figures. As more information becomes available about a project, we can fine-tune both the model and the input parameters. The purpose of outcome analysis is not to see how big we can make the ultimate project value, but to put reasonable limits on it, and provide a framework for refining the calculation of the ultimate project value as more information becomes available. Expectation Set of Possible Outcomes (example)
Above is an example of an Expectation Set for Possible Outcomes of a search for a bulk tonnage gold deposit. The numbers have been arbitrarily chosen to illustrate the concept. Do not use them for anything! The target outcome is a 200 million tonne deposit of 3 g/t gold worth $2 billion. Each possible project value in the matrix would have been derived using the Hard Value Appraiser. An expectation set like this gives a good sense of what a deposit needs to look like to be worth a target value. At the beginning of the discovery cycle the sky isn't quite the limit, but a $2 billion deposit probably is. At the beginning when a specific target isn't in focus yet, the outcome could be anything or nothing. As a target comes into focus and begins to take shape, the speculator will use the Expectation Set to adapt his expected ultimate project value to one that corresponds to the fundamentals being served up by reality. If the deposit falls somewhere between the matrix slots, such as say 75 million tonnes of 1.5 g/t, you can see that the ultimate project value would be somewhere between $300-500 million. Keep in mind that the market will not value a project at the ultimate project value until the exploration cycle has been completed. The market's valuation, or implied project value, at any stage of the discovery cycle will reflect the probability that the project will make it through the rest of the discovery cycle and confirm the ultimate project value. Aberrations do occur, but eventually the implied project value will converge with the theoretical project value. Working out the exploration cycle and the success probabilities is done in Step Two of the Spec Value Appraiser. Step Two: Probability Analysis Probability analysis requires us to map out the milestones in the exploration cycle leading to the validation of a commercial deposit, and to assign success probabilities to each level that reflect the chance that the project will go all the way. The milestone sequence is simple enough; mineral deposits go through a fairly standard series of steps from grass roots exploration to a positive feasibility study. However, the probability of achieving the target outcome from each milestone depends on the size of the expected ultimate project value. The bigger the dream, the more improbable will be the achievement of its reality. Speculative exploration ventures are all about chasing after high risk targets. Whatever the odds may initially be at the grassroots stage when a geological target has not yet been identified, each milestone reduces the odds. As the exploration cycle progresses a target comes into focus, acquiring tonnage and grade parameters that gradually match the ultimate project value. As it becomes clear that the deposit no longer has room to grow towards the ultimate project value of the initial expectation set, the original ultimate project value has to be reduced to the reality emerging as a result of the exploration cycle. Sometimes the reality is a sub-economic deposit, in which case the exploration cycle becomes a scratch: there is no payout for the race has been lost. Sometimes the reality is equivalent to a horse that has placed or shown. The payout can still be substantial, just not as big as had been projected in the expectation set. For speculators this realization is of extraordinary importance. Much money is lost because investors fail to realize that reality is falling short of expectations. Most of the time it does. The secret to rational speculation is not about picking those ventures which go all the way to win the race. It is about exploiting the quantum leaps in probability that accompany the achievement of key milestones before the ultimate outcome is known. Probability Table for $1 billion Ultimate Project Value
Reading the Probability Table Over-valued |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Fairly valued |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Under-valued |
