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Brent Cook: Do NI 43-101s Provide a False Sense of Security?

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Many mining companies find themselves in a high-grading dilemma, according to Brent Cook, publisher of Exploration Insights. As companies deplete higher grade reserves, they have to acquire new deposits. But unless you are a geologist, don't look to NI 43-101s to always give you reliable information about the quality of a resource. They often don't provide the data needed to make intelligent decisions, says Cook in this interview with The Gold Report. Cook is interested in investing only in world-class deposits and shares some of the names on his list.

The Gold Report: Brent, in your August newsletter, you rant about high grading. For our readers who are not familiar with that practice, can you give us a brief explanation?

Brent Cook: Most mine plans or mine reserves are laid out using an economic cutoff grade based on a specific gold price and specific production cost assumptions. Using an example of 0.5 grams/ton (0.5 g/t) as a cutoff grade, any rock pulled out of the mine under 0.5 g/t is waste; you lose money mining it. That's the difference between waste and ore. With ore, you make money. With waste, you lose money.

Say a company based its cutoff grades on a gold price of $1,500/ounce ($1,500/oz). When the price drops below that level, some of the rock that used to be ore becomes waste. To fix that problem, a company goes to its mine plan and selectively mines the higher grade portions of the deposit. That makes perfect sense and the company needs to do that. But down the road, the grade of the material that was meant to be mined but was instead left in the ground is likely to be too low to be mined economically, barring significantly higher metal prices.

The net result is that, unless gold prices go way up, a company's stated reserves will decrease with the lower gold price assumption. The total number of ounces in the reserve will decline because the grade of the remaining rock, the rock that was left behind during the high grading of the deposit, was marginal to begin with and is now probably uneconomic.

TGR: If the reserves go down, there would be a corresponding decrease in the value of the company. Is there anything wrong with management keeping a company viable, even if the share price has to go down a bit?

BC: There's nothing wrong with that, and it is what management has to do. But it means the ounces the company was going to mine in the future go away. Its business has shrunk. The company has to find more ounces to replace what was lost by high grading a deposit. And again, I want to emphasize this is all gold-price and production-cost dependent.

TGR: Are companies high grading just to prove out a project, to position it for sale?

BC: No. Companies like Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and IAMGOLD Corp. (IMG:TSX; IAG:NYSE) are high grading. Most active mines have the ability to adjust the mine plan to current price conditions, unless they are marginal and uniformly low grade to begin with. When the gold price changes or operating costs go up, the whole mine plan changes. What was probably scheduled future production may no longer be economic. That's the problem.

TGR: Is that good news for advanced explorers and near-term producers?

BC: It depends on the quality of what the junior companies own. As a whole, the major mining companies are producing about 80 million ounces gold (80 Moz)/year. My expectation is that, at some point in the near future, they will be in desperate need of new economic deposits because they don't have the reserves to keep production at the same level. This is particularly true of companies with deposits that are marginal at, say $1,400/oz gold. Those companies are high grading out of necessity now and more than likely sterilizing significant portions of their deposits.

This loss of quality reserves is leading to an ideal setup for speculators in the junior mining industry who are identifying and buying those few deposits that make money at lower gold prices. I'm convinced that once mining companies come out of their foxholes, they will want to acquire the few high-grade, high-margin deposits held by juniors.

This is an opportune time for us in the junior end of the business, even though it doesn't feel like it.

TGR: What will motivate mining companies to get out of their foxholes, as you say?

BC: I think it will be the realization that they lack the high-margin reserves needed to keep making money. They weren't ready for the shock of gold dropping from $1,800 to $1,200/oz. In response, they cut exploration and development dramatically and have started high grading.

All of that will bite them, because without new deposits, without new reserves, they don't have a business. As I have reiterated many times in Exploration Insights, one day the board of directors will turn to company management and say; "All right, bring on the new high-margin deposits. We are running out of ore." At that point management will have to explain that it fired all the geologists, shut down exploration, curtailed development and ain't got nuthin' new. There is only one solution: Go out and buy a good deposit.

TGR: At what gold price can lower grade mines become profitable? Do we need a $1,500/oz gold price to stop the high grading?

BC: It depends on the individual deposit. Previously, the gold industry talked a lot about cash costs—what it costs on a cash basis to produce an ounce of gold. However, cash costs don't include all of the other costs that go into keeping a mine going: general and administrative expenses, taxes, exploration and development costs, and sustaining capital costs.

Now companies are switching to reporting all-in sustaining costs, which includes just about everything it takes to produce that ounce of gold. Depending on the company, all-in costs are between $1,300 and $1,500/oz, even $1,700/oz. You can see the problem. Companies can cut costs by laying people off, stopping exploration and development, but that kills their business. It goes back to the need for high-margin deposits.

If readers of The Gold Report contact us, I'll send a newsletter detailing sustaining costs and cash costs, what it really costs to mine an ounce of gold. Just select the "Contact Us" tab at and request the gold cost letter.

TGR: You've told us that before people start investing in exploration and speculative companies, they need to know what a company is looking for. That includes understanding the test results and being able to compare them to expectations. One way to do that is through NI 43-101 reports, but you believe that NI 43-101s provide a false sense of security. How do investors know what information to use?

BC: That's a really good question, and there's no single answer. The NI 43-101 reports are predominately intended to provide sufficient disclosure for an educated investor to make an informed investment decision. It's a regulatory document that describes what you can and can't say. But here's some interesting results from a review of 50 NI 43-101 reports by the Ontario Securities Commission: Eighty percent had some sort of error; 40% had a serious error or were missing information that should have been included.

What it comes down to is that a lot of companies are not giving us the data we need to make intelligent decisions, be it detailed cross-sections, or detailed information on how costs were calculated. That needs to be addressed because all of us in the mining sector need to have confidence in a report's conclusion based on the backing data.

In my opinion, too many resource estimates do not adequately address geological and structural controls to mineralization. Computer jockeys who are really good at plugging numbers into spreadsheets are coming up with results that do not honor the basic geology. That gives people a false sense of security that because the resource is in a spreadsheet with lots of fancy math it has to be legitimate. One needs to be careful.

TGR: What additional data would help investors make intelligent decisions?

BC: Too few NI 43-101s provide the cross-sections to prove where the company draws the line between ore and waste—what the criteria are and how these decisions were arrived at.

Admittedly, a lot of this is subjective and bear in mind the resource estimator is extrapolating the resource from very limited data that, volume-wise, represents less than 1% of the rock. For instance, I could look at 100 drill holes and come up with a different resource than somebody else. It's tough to know who's right or wrong and that is just the nature of the beast.

TGR: How does someone who's not an expert make more informed decisions, short of becoming a geologist?

BC: It isn't easy. Ultimately you do have to rely on the NI 43-101s: Is the documentation there and correct? Who did the documentation and who paid to have it done? Many reports are just sales documents and all too often an engineering firm will assign a less exciting job to its "B" team.

Essentially, you have to rely on an expert. That could be a newsletter writer, an analyst, a relative in the industry or your brokerage firm. You need the advice of someone who knows the industry.

TGR: I like the way you concluded one of your recent rants, "High-quality, high-margin metal deposits are going to become increasingly valuable as current operations are depleted and production begins to decline. This eventuality makes our jobs relatively straightforward. Own the best deposits and discoveries and hope like hell some government doesn't steal them." Which companies have the best deposits?

BC: There are two aspects to answering that question: The first is owning the best deposits. The second is identifying them early on and buying at the right price. There are projects that are great deposits, but are over- or fully valued now.

For example, Reservoir Minerals Inc. (RMC:TSX.V), which has a joint venture with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) in Serbia, drilled the best copper-gold drill hole I've seen in decades. We recognized the potential because we understood the geologic setting and we knew what Freeport was doing. We bought Reservoir at just under $1. It's now around $4/share. It remains a great deposit, and Freeport will, hopefully, eventually buy it out.

TGR: How much additional upside is there if the copper or gold price begins to rally?

BC: I would say a fair bit. If copper or gold rallies, anyone with a deposit stands a chance of going up. We saw that in late August when the rising tide took most companies up, good or bad.

The advantages with Timok, the Reservoir-Freeport deposit, are how rich the grade is and that it's part of a much larger system. Freeport is spending what it will take to bring Timok to a bankable feasibility study. It's in a known mining district and is adjacent to a smelter that can take this sort of ore. It has everything going for it.

TGR: Are there examples when you didn't get in at the right time that could be educational for our readers?

BC: Unfortunately, yes. Midas Gold Corp. (MAX:TSX) has a great deposit in Idaho. It's has 6.5–7 Moz gold at a good grade and will show good margins. You get a bonus kicker of some antimony production. We bought at $3.50/share in 2010 when it came out of the shoot, gold was flying and markets heading up. Since then, it has collapsed along with everything else. We bought again at $0.70 and it's gone back up some. Our timing was wrong, but knowing that it was still a very good deposit, we averaged down and are working our way back up.

TGR: Is that an example of a project that needs a major to get out of the foxhole?

BC: I think so. The company will issue a prefeasibility study and resource update in early 2014. The study is paralleling the permitting process and assuming both turn out positive I think a major takes a run at Midas. The project is in an old mining camp that is a bit of an environmental disaster right now; old tailings, river through a pit and such. The plan, at the end of the mine life, is to fix up the whole area so the salmon can get back upstream and leave mountain meadows full of happy butterflies.

TGR: What is the timing on the permit?

BC: I think final permits are at least two years away.

TGR: What other companies are you following?

BC: I've owned Virginia Mines Inc. (VGQ:TSX) or its predecessor for 12 years. The company sold Éléonore, a very high-grade deposit, to Goldcorp Inc. (G:TSX; GG:NYSE), which is putting it into production. Virginia retained a 2.5–3.5% royalty on Éléonore. The mine will produce on the order of 600,000 ounces (600 Koz)/year. That royalty—probably the best royalty held by a company that's not a major mining company—rolls straight back to Virginia.

If you're positive on the gold price, this is the safest bet possible. Virginia is also moving forward on a number of other projects. Plus, Virginia's CEO, André Gaumond, is the most sincere, hardworking and honest guy around.

TGR: According to Eric Lemieux of Laurentian Bank Securities, Virginia Mines has signed a strategic alliance with Altius Minerals Corp. (ALS:TSX.V). How might that help the junior miner?

BC: The two companies follow very similar business models. Both are now royalty companies that generate ideas and bring other companies in to spend the money. Virginia is in Quebec; Altius has assets in Labrador and Newfoundland. There is terrain in between that they will work on together.

Altius own 32 million (32M) shares of Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.MKT), the owner of one of the best iron ore deposits ready for development in the Western Hemisphere, in Labrador.

TGR: What is the upside for royalty companies that go beyond precious metals?

BC: Altius owns a piece of production in the Kami iron ore mine that could generate $32M/year to Altius, depending on iron ore prices, at no cost to Altius. It also owns a royalty on the Voisey's Bay nickel deposit, which generates between $4–6M a year.

TGR: In our May interview, you mentioned Alderon in the context of diversifying across metals. Is that the focus of this particular play or is this a buyout scenario?

BC: I think Alderon will bring in another partner, probably a Chinese or a Korean group, to develop the iron deposit. This is a world-class deposit and I want to own world-class deposits.

Earlier this year, when I was nervous of the gold price, I diversified into other metals but only into best-in-class deposits. We bought Fission Uranium Corp. (FCU:TSX.V) once it made its discovery in the Athabasca Basin, which could turn into a world-class deposit. The advantage is that it's relatively shallow for the Athabasca Basin, so mining costs are going to be low, as the mine will be open pit. That is a big advantage. The deposit is still growing.

TGR: Is that still your strategy, to diversify out of gold?

BC: To some degree. World-class, high-margin deposits will always be valuable. If we can recognize them very early on, we'll be OK in the long run.

TGR: Any other updates since our last interview?

BC: I visited Lydian International Ltd. (LYD:TSX) in Armenia in 2010, just as it started drilling, and bought it then. This is a large, near surface, oxidized, high-sulphidation gold deposit, which means it's a cheap mine to run. Unfortunately, last month, the Armenian government passed regulations making it harder for Lydian to use cyanide to extract the gold.

TGR: Is it unusual for a government to come in and restrict the use of cyanide?

BC: Particularly in this case. The only way cyanide could possibly enter a drainage tunnel that supposedly poses the problem from Lydian’s planned heap-leach pads would be if you reverse the law of gravity and water started to flow uphill. Last time I checked, and you can ask the people in Colorado, water still ran downhill.

Lydian was one of five gold deposits out of 100 that we considered good enough to talk about when we reviewed it in Exploration Insights.

TGR: What were your criteria for selecting those five?

BC: It is all about margin. We found five that we felt offered the potential to be high margin and large enough to interest a major.

TGR: Have those five names stayed the same or have you made changes?

BC: We bought a sixth, an Australian company called Papillon Resources Inc. (PIR:ASX), which is developing a resource in Mali. Our timing was right this time. We bought it at $0.60/share, and it's almost doubled.

TGR: What makes it a great deposit?

BC: It's open pittable, there's good continuity in grade and it's high grade. It's about 2.2 g/t. It's going to make a lot of money.

TGR: Do you follow any companies in Colombia?

BC: Atico Mining Corp. (ATY:TSX.V; ATCMF:OTCBB) has a small but high-grade deposit in Colombia called El Roble. The people behind Atico are solid miners. These are the people who put together Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE). I think Atico can make money on El Roble and use it as a jumping-off point to acquire other deposits in that part of the world and make more money. I also keep a close eye on Miranda Gold Corp. (MAD:TSX.V), which is technically competent and follows a joint-venture exploration model.

TGR: Are you looking at any other new metals or projects?

BC: I looking at something every day. Nothing has come across the radar screen lately that really excites me and hasn't been discussed in my letter.

TGR: Here's hoping you find some excitement soon. Brent, I appreciate your time and your insights.

Brent Cook brings more than 30 years of experience to his role as a geologist, consultant and investment adviser. His knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. Brent's weekly Exploration Insights newsletter focuses on early discovery, high-reward opportunities, primarily among junior mining and exploration companies.

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1) Karen Roche conducted this interview for The Gold Report and provides services to The Gold Report as an employee. She or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Virginia Mines Inc., Goldcorp Inc., Lydian International Ltd., Atico Mining Corp. and Fortuna Silver Mines Inc. Fission Uranium Corp. is a sponsor of The Energy Report. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Brent Cook: I or my family own shares of the following companies mentioned in this interview: Reservoir Minerals Inc., Midas Gold Corp., Virginia Mines Inc., Altius Minerals Corp., Alderon Iron Ore Corp., Fission Uranium Corp. and Papillon Resources Ltd. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

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