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Playing miners' big gambles

An attack in Burkina Faso this month shows the risks of going off the beaten track in search of profitable deposits
November 28, 2019

All mining investments involve considerable risk. Metals prices fluctuate, deposits are often unpredictable and the heavy lifting itself is fraught with hazards, both in underground and open-pit operations.

Many of the most reliable mining postcodes for investors for well over a century – most notably Australia, Canada and the United States – are proving smaller sources of big deposits. Geologists have been forced to hunt in newer and riskier jurisdictions. Tragically, the possible consequences of this were shown this month in an attack on workers travelling to the Boungou mine in Burkina Faso, owned by Canadian company Semafo (Can:SMF), in which 39 people were killed and 60 others injured. Last year, citing safety reasons, Semafo started using helicopters to move foreign national workers between its two mines in the country and the capital Ouagadougou.

This is an extreme example of what can happen to businesses operating in risky jurisdictions. But Semafo had built a strong valuation on finding low-cost gold in a promising region. In management’s most recent discussion and analysis filing, published just two days before the attack, Semafo said investors had to be clear on the reality of mining in the region. “While we have implemented various measures to ensure the security of our personnel... there can be no assurance that these measures will be successful,” the company warned investors.

Beyond the militant risk, Semafo also outlined potential issues that would be familiar to investors in resources companies in countries such as Spain, Chile or Indonesia. “The possibility that the government may adopt substantially different policies or interpretations, which might extend to the expropriation of assets, cannot be ruled out,” the filing read. This is boilerplate in many cases, but there are plenty of recent examples: Acacia Mining’s struggles in Tanzania, the Demoratic Republic of Congo’s (DRC) change of mining laws, or the higher royalty tariffs unveiled by Zambia this year. In the case of the DRC, the might of Glencore (GLEN), Zijin Mining, Randgold Resources (now part of Barrick Gold) and Ivanhoe Mines (Can:IVN) could not change the mind of either former president Joseph Kabila or his successor Felix Tshisekedi. 

The main question for investors is whether going to riskier areas for cheaper metals is worth it. For companies and investors looking for a life-changing discovery, it’s unlikely a paved road will take you there – these usually come after the deposit has been found. And even when a discovery is outstanding – such as the infamous Simandou iron ore deposit in Guinea – the costs still don’t stack up because of the difficulty of building infrastructure. There are good recent examples of companies going to new jurisdictions and cleaning up. Ivanhoe Mines boss Robert Friedland did it in Mongolia with Oyu Tolgoi and reignited interest in the DRC several years ago when he began sharing mind-boggling drill hits from the Kakula-Kamoa project. 

 

Searching for the next big one

Then again, a frontier mentality is in the DNA of many miners. “I’m comfortable with a lot of African countries,” says Hummingbird Resources' (Aim:HUM) managing director Dan Betts. “In Canada, I’d be just another corporate.” Mr Betts’ company, which he founded in 2005, dived into exploration in Liberia after previous forays into Sierra Leone and Mauritania.

At the time, big players such as ArcelorMittal and BHP were looking at iron ore deposits in the West African country, but Hummingbird was operating on a much smaller scale. In its 2010 listing document, the company said “most parts” of its licensed area were only accessible by footpath or river. This is fairly standard for mining exploration – if there was a nicely paved road right up to a deposit that pokes its head out of the ground, it would have been mined a long time ago. 

Mr Betts says the discovery costs for the 4.2m ounce (oz) resource at the Dugbe project were between $7 and $8 an oz. A good comparison in terms of size is Agnico Eagle’s (Can:AEM) Amaruq project in Nunavut. It was a greenfield discovery 50km from an existing mine, and in 2015 and 2016, when it got to the 4.2m oz indicated and inferred combined open-pit and underground mineral resource estimate, Agnico spent $62m on exploration. Divide the resource by two years of exploration spending, and you get to around $15 an oz – although Agnicio did not confirm this figure. While this is in the far north of Canada and the miner had to build an all-weather road the following year to access the site, taking a large part of the $78m capital expenditure set out in the 2017 budget, it did have the advantage of an existing mine 50km away. Amaruq went into production earlier in 2019 after an investment decision in 2017, which was also when the permits were issued by the province. 

Hummingbird announced a maiden resource at Dugbe in 2010, and eventually more than quadrupled this estimate to 4.2Moz three years later. The company shifted focus to another mine in the region, Yanfolila in Mali, which it bought at an advanced stage in 2014 for $20m in shares from Gold Fields and got into production in 2018. Mr Betts told us that the wait for a permit for Dugbe partly motivated the decision for the switch. While it’s not completely fair to compare two projects when one was backed by a major gold company, Agnico was able to get permitted and begin production soon after defining its resource, while Hummingbird spent years working on permitting and building up the case for Dugbe. 

 

 

Project level 

Both greenfield or brownfield developments have so many variables in mining operations that valuations are tough. The most direct measure of a project’s value is a company’s valuation – but this gets more difficult if a miner has several projects or is discounted because of the capital costs of actually getting into production. Commodity price fluctuations also make this difficult. But there is a vague mechanism for including risk in the net present value (NPV) of a project. This is the discount a company and its advisers apply to a project's NPV. This is highly subjective, however, and the cost of debt is also a factor as this will chip away at cash flow in the first years of a mine. A scan of the current slate of projects shows this usually varies between 5 and 10 per cent. If we look at one of the safer options out there – a fully-funded and permitted brownfield project in the United States – Nevada Copper (CN:NCU) has given its Pumpkin Hollow underground mine an NPV discount of 5 per cent. 

This is the same as Cardinal Resources’ (AU:CDV) Namdini gold project in Ghana. Ghana is an established mining jurisdiction, but Cardinal is a new miner and building an open-pit project from scratch is not easy. Another 5 per cent discount project was TMAC Resources’ Hope Bay mine in Canada’s far north. Investors going by the relatively low discount – especially for a project well inside the Arctic Circle – would have been let down by initial processing issues seeing recoveries (the proportion of gold recovered from the ore) well down on pre-production estimates. The company poured its first gold in early 2017, and the shares were trading around C$18 (£10.5). Once the production troubles became clear, they halved and then by 2018 the company was trading on C$5 a share.
 
There are several London-listed companies that have said their projects currently in development merit a higher discount than 5 per cent. Amur Minerals (AIM:AMC) has an NPV of $615m with a 10 per cent discount for its Kun-Manie nickel project in the far east of Russia. Given a requirement for the project to happen is construction of a 338km, $129m, road with a maximum speed of 60km/h, this discount might be light. Base Resources’ (BSE) Toliara project is another higher-risk option that has an NPV discount of 10 per cent. Given the recent stop-work order from the Madagascan government, this might also be an understatement. Fellow London developer Emmerson (EML) has given itself the same risk rating as the other two for its Moroccan fertiliser plan. So far this looks much more realistic than Sirius Minerals’ (SXX) decision to use the same discount. 

The core question of whether cheaper ounces are worth it is a tough one to answer. To get political and security certainty, you have to pay. But ASX-listed gold miners Evolution Mining (AU:EVN) and Northern Star Resources (AU:NST) are still trading at 15 times forward price/earnings ratio, which is still lower than London precious metals miners Centamin (CEY) at 19 times and the same as Hochschild Mining (HOC). This could be linked to the paucity of non-Russian precious metals miners in London. For Mr Guy, London has an interesting perception gap when it came to comparing Russia with options in various African countries. “The exact same shareholders who wouldn't touch a Russian company would have something like a Randgold as a core holding,” he said. “The point Mark Bristow always made was that every country has risk. If you're operating in parts of the US or Canada, you've got permitting risk. If you're operating somewhere like Mali, the risk is more straightforward, political or security risk.”

Mr Bristow’s portfolio of projects at Barrick in Mali, the DRC and Tanzania shows major companies can play in high-risk jurisdictions and not lose the house if one mine runs into trouble. This is a very different proposition to a junior trying to build its first mine, as Hummingbird found out as it chipped away in Liberia.