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Express 2008-05
August 18, 2008
Could McFauld's Lake become the Greatest Canadian Area Play ever?
Synopsis: The McFauld's Lake area play which helped generate record TSXV trading volumes last year on the basis of Noront's Eagle One nickel-copper-platinum group discovery looks like it should be chalked off as another Great Canadian Area Play Flop. The Eagle One resource estimate came in with a gross metal value less than $2 billion, and Noront has not yet discovered similar deposits. Valuations for the 30 plus area play juniors are significantly cheaper than last year and trending lower, even though most of the companies are either conducting geophysical surveys or mobilizing drill programs. The market sees McFauld's Lake as a half empty glass that is best avoided. For this sentiment to turn around somebody needs to make another massive sulphide discovery which signals that Eagle One is not just an isolated freak, but part of a rich bounty of deposits waiting to be plucked like low hanging fruit from this largely unexplored region of northern Ontario. Because there is not currently any sign of a bottom for the McFauld's Lake juniors and we need further confirmation of the multiple deposit scenario, I cannot recommend an immediate aggressive accumulation strategy. But I strongly recommend that speculators pay close attention, because the conditions are in place to allow the Greatest Canadian Area Play ever to erupt in short order.
Never before has an exploration frontier the size of the prolific Abitibi Greenstone Belt been this quickly and intensely subjected to state of the art geophysics technology and drilling without the benefit of well-mapped surface geology. While Eagle One by itself is too small to justify a mine, the conjunction of high grade magmatic nickel-copper mineralization with high platinum group values in physical proximity with chromite suggests that this region has undergone unusual enrichment processes driven by a complex under-appreciated geological history hidden by swamp, overburden and in many parts by a veneer of younger sediments. It is conceivable that within five years dozens of high grade deposits will be found, enough to justify development of the transportation and energy infrastructure needed to create a mining district in this remote region. Should this optimistic scenario begin to unfold as several dozen drills start to turn during the next 12 months, especially during a time when metal prices are still finding their bottom as the current economic slowdown sorts itself out, we would see an explosion of market interest in the McFauld's Lake area play. Furthermore, because nobody can legitimately claim they "got it all", and because the nature of this beast is such that there is unlikely to be just one monster orebody on a par with Voisey's Bay and nothing else, the wealth yielded up by the McFauld's Lake area play would be spread among a number of juniors. If this scenario of multiple winners starts to unfold, McFauld's Lake would become the Greatest Canadian Area Play ever. In terms of the rational speculation model good speculative value exists in a number of area play juniors, but because the area play dynamic tends to generate excessive valuations once it turns hot, and McFauld's Lake needs a new bona fide discovery to turn hot, the best strategy for now is to pay close attention and be ready to pounce when drilling starts to deliver new Eagles. Express 2008-05 is thus a heads up to pay attention and free up some capital so that you can seize opportunities when the green light flashes. In this regard we have updated the KBFO McFauld's Lake Area Play Theme Report as a tool for KBFO members to orient themselves, and we will be tracking company developments through "area play" comments published as needed in the Daily Bottom-Fish Action Report.
Initial hopes for a Voisey's Bay scale discovery were shortlived
When Noront Resources Ltd (NOT-V: $2.70) delivered its Eagle One resource estimate on July 4, 2008 it in effect handed the torch for the McFauld's Lake area to the numerous other juniors gearing up to drill targets during the second half of 2008 and well into 2009. Noront's surprise discovery of high grade magmatic style nickel-copper-pgm mineralization in late August 2007 in what had become a tired VMS area play that was missing the critical mass to create a mining camp generated hopes of a world class discovery akin to the Voisey's Bay nickel-copper-cobalt deposit found by Diamond Fields in Labrador in 1994. While the junior market was digesting the initial fallout from the August subprime credit meltdown Noront's discovery led the TSXV to record trading levels. Drilling, however, quickly revealed Eagle One as a small pipe like body very different from the Ovoid and Eastern Deeps deposits in Labrador which have a gross metal value in excess of $50 billion.
Noront's stock price tanked in January 2008 as a new wave of bank writeoffs signaled that the liquidity problem extended far beyond just subprime debt. As it became clear that Eagle One was not a world class deposit, the Voisey's Bay analogy promoted by IBK was replaced by a "Ring of Fire" thought to have hatched many Eagle One deposits. As Noront prepared to drill other coincident magnetic-EM conductor anomalies in February, it closed a $26 million financing, and within a month raised another $16 million through the accelerated expiry of $5 warrants. By late February a Noront news release proclaimed that "Eagle Two has Landed" and the McFauld's Lake area play began to heat up for the mining industry's annual self-celebration at PDAC in Toronto. Unfortunately, by the time the dust settled Eagle Two had turned into a crow squawking about chromite potential, a scenario which definitely requires a railway into the McFauld's Lake region. Other Noront targets failed to deliver and by March Noront had begun a steep descent from its $7.42 peak that bottomed at $2.12 on July 8 in the wake of the Eagle One resource estimate.
Exceptional rock value, but lacking in critical mass tonnage
The indicated and inferred massive sulphide resource at Eagle One came in with high grades that translate into a rock value of $1,841 per tonne at current spot metal prices, and the disseminated resource came in at a not at all shabby $408 per tonne. But the massive sulphide resource came in at only 440,000 tonnes and the disseminated resource came in at 2,471,000 tonnes for a combined gross metal value of $1.8 billion. (For a metal value breakdown based on spot prices and 3 year trailing averages see the Eagle One Resource Estimate in Noront's KBFO Profile. This is a new feature available for all companies for which we have a resource estimate.) If Eagle One existed in the Sudbury or Timmins camp Noront would be rushing to develop a mine with an ultimate project value target of $500 million. Unfortunately, Eagle One exists in the James Bay Lowlands hundreds of kilometres from the nearest road or railhead. As such Eagle One is worthless by itself. Confirmation of Eagle One's small size coincided with another general wave of selling in the market linked to a retreat in commodity prices that has driven TSXV value traded to the lowest level since 2005, and chilled the McFauld's Lake area play just as the juniors are mobilizing to drill geophysics supported targets.
Noront's focus on Voisey's Bay sucked away momentum when the analogy failed
During the Eagle One discovery phase of the McFauld's Lake area play Noront single-handedly carried the torch, and one might add that it did so in a style that undermined the area play dynamic by pumping up the notion of a Voisey's Bay scale discovery, going quiet on the drilling front, and falling woefully short of delivering a world class deposit. From the distant viewpoint of San Francisco the McFauld's Lake area play looks like another failed attempt at a Great Canadian Area Play as prices sag amid growing pessimism that anything worthwhile will come of this play. Structurally, however, McFauld's Lake is positioned to become the Greatest Canadian Area Play ever.
Has the Canadian junior resource sector become too big to sustain a Great Canadian Area Play?
To say that McFauld's Lake has the potential to become the "Greatest" Canadian Area Play is very radical, because for some time now I have worried that a Great Canadian Area Play may no longer be viable. For an area play to evolve into a "Great Canadian Area Play", the scale of the discovery must boggle the minds of speculators and silence the professional cynics. This clearly has not yet happened at McFauld's Lake, and may not be at all geologically possible. But that is not my concern. The Great Canadian Area Play may be little more than a nostalgic dream in the grown up world of today's Canadian resource exploration industry. The biggest change during the past decade has been the growth in the size and breadth of the sector. Since the start of 2002 to mid 2008 companies listed on the TSXV alone have raised $33 billion through private placements, which translates into the creation of 63 billion shares at an average price of $0.53. At least two-thirds of this amount is attributable to resource sector juniors.
Why does everybody remember the $4 billion Diamond Fields takeover of 1997 but know little about the $40 billion worth of takeovers during the past 5 years?
During this five year period there have been dozens of takeover bids involving companies which originated on the TSXV. The value of these takeover bids and mergers exceeds $40 billion. Most people would be hard-pressed to list off even a handful. When Dia Met was bought out by BHP in 2001 the implied value for the entire Ekati diamond project was a mere $2.1 billion, roughly the value during the 1993 peak of the Lac de Gras area play frenzy. Dia Met's diamond discovery jump-started a moribund Canadian junior resource sector. When Inco wrapped up Diamond Fields in 1997 the value was $4 billion. Ten or more years ago such discoveries were a big deal that breathed life and money into the Canadian juniors. The best Cinderella story to emerge during the past decade is the 14 million ounce Fruta del Norte gold deposit discovered by Aurelian in Ecuador. It is set to disappear in an anti-climactic $1 billion takeover bid by Kinross that values Aurelian at about $6, or $24 pre-split. In the old days a world class discovery could command the attention of the entire junior resource sector audience. Today the invested audience is so large that no imaginable discovery could achieve this feat.
Inco's $4 billion buyout of Voisey's Bay would be a drop in the bucket today
The Canadian junior resource sector has grown too big for a world class discovery to ignite an area play that dominates the market's attention. There are nearly 1,500 companies listed on the TSX and TSXV which qualify as resource "juniors" and, ignoring those with a market cap above $1 billion, their collective market capitalization stood at $77 billion even at the depressed mid-summer prices of 2008. A new world class discovery in the style of Ekati or Voisey's Bay worth $4 billion would represent less than 5% of the capital currently at risk in Canadian resource juniors. A typical area play junior has a market cap in the range of $10-$20 million, about 0.02% of the junior sector's entire market cap.
Financing at heavy dilution cost has eliminated the potential for triple digit eye-popping price gains
To make matters worse, the 30 plus McFauld's Lake area play juniors have 2.6 billion shares outstanding that trade at an average price of $0.39 each and dropping during the dog days of the 2008 summer. While the upside value limit for a new discovery has inflated somewhat due to higher metal prices, the inflation in the number of issued shares in today's juniors, typically over 50 million, has been much more dramatic than orebody value inflation during the past decade. The result is that the discovery junior today does not and cannot soar into jaw-dropping triple digit numbers ($160 pre-split for Diamond Fields). Although the total value achieved for shareholders may be the same today as it was yesterday, the wow factor created by astronomical price gains made possible by the low number of issued shares yesterday is largely gone today. Even if Noront's Eagle One had turned out to be a $4 billion deposit, the stock would have gone to only $30 per share. Whoop-dee-doo!
If a single large discovery can no longer drive a Great Canadian Area Play, what about a bunch of pretty large discoveries?
But what if a dozen juniors each find an Eagle One deposit which collectively represent more than $20 billion worth of high rock value metal? And what if they do so in the next five years as they bring all the fruits of modern exploration technology to bear with the help of the modest developed resource venture capital market in the world? Imagine the Abitibi Greenstone Belt as an undiscovered frontier with little outcrop, lots of overburden and swamp, and a large part covered by a veneer of much younger and utterly unprospective limestones. The so called "Ring of Fire" circumscribes a 250 km by 150 km region within the Sachigo Subprovince of northern Ontario, one of the least explored Archean terranes in Canada.
The Lowlands of James and the Barren Lands of Slave, similar in many ways?
Most of the area play staking has taken place at the eastern end of the Sachigo Subprovince in the McFauld's Lake area where the Archean rocks disappear under Paleozoic cover rocks that stretch all the way to Hudsons Bay and James Bay. No mines other than the Victor diamond mine De Beers is putting into production exist anywhere near the McFauld's Lake area play. The western part of the Sachigo SubProvince has been explored for gold, and the McFauld's Lake area itself has been explored for VMS deposits since 2002, but it was not until August 2007 when Noront discovered high grade nickel-copper-pgm magmatic sulphides at Eagle One that geologists started to realize that something very unusual had gone on more than 2 billion years ago in these rocks. This realization is akin to the 1992 realization that the Slave Craton, which theory said could host diamond pipes, really does host them.
The 2008 Geophysics Olympics: a bookie's nightmare
Much of the staking since the Eagle One discovery has focused on magnetic high features that show up in government airborne surveys and which are interpreted as bodies of ultramafic to mafic rocks that are the likely host for magmatic sulphides. But are these Ring of Fire magnetic highs essential for a company's discovery prospects? Not according to Jens Hansen of Melkior, whose large East Nickel Rim property covers a regional gravity high that coincides with a magnetic low. According to Hansen, regional metamorphism can change the magnetic character of basement rocks. His staking strategy is valid because not enough is known about the basement geology to determine if this explanation is applicable. The initial exploration strategy in the McFauld's Lake region does not require much geological genius, but it does require deft application and interpretation of geophysics technology to generate conductivity anomalies that may be attributable to base metal bearing sulphides. The categorical imperative for the next couple years will be "drill to kill" those conductors, and save the geology for later when the basement rocks are better understood. Hansen's point is that everybody is a gold medal contender in this Geophysics Olympics.
Serendipity created Voisey's Bay but has merely jumpstarted McFauld's Lake
What ultimately killed the Voisey's Bay area play was the fact that Voisey's Bay was an isolated monster orebody and none of the other juniors found anything worthwhile despite considerable effort and expenditure. Voisey's Bay was large enough to justify development in its remote location, and lucky to be close to tidewater. Serendipity played a key role in its discovery. The McFauld's Lake region of northern Ontario is remote and far from tidewater, so it needs to have $20 billion worth of in situ base metals to justify the power and transportation infrastructure investment required for a major mining camp. Serendipity played a role in the discovery of Eagle One, but turning McFauld's Lake into a world class mining camp will have to be a function of systematic exploration. And that is why I am paying very close attention this play.
McFauld's Lake has attracted well-heeled "gamblers"
Noront has managed to hit massive sulphides in a promising new target called AT12 just north of Freewest's 100% owned property, but the dynamic of the McFauld's Lake has expanded beyond the "Ring of Fire" as other juniors develop a case for magmatic style mineralization well beyond the land-holdings of IBK's "Ring of Fire" clients. The magmatic style mineralization based area play is not even a year old, and numerous companies are set to drill targets spread over a very large area. The high risk Nickel Bay venture of Diamondex which postulates a second "Ring of Fire" east of the first one has attracted a new joint venture partner in the form of a private company called Canada Nickel Corp headed by John Proust which has already raised $9 million in seed money and hopes to do a $10 million IPO in the fall. The market largely overlooked this important announcement in early July, and poor Diamondex's stock price headed lower. Not only did Diamondex recover the $5 million it had sunk into its Nickel Bay venture, but it is carried for the next $20 million in exploration and will still have 49%. You can dismiss John Proust as a gambler, just as one can dismiss Pierre Lassonde and Rob McEwen as gamblers for betting on Noront and MacDonald, but they are gamblers only in the sense that they conceptually see the potential. All visionaries are gamblers until proven correct. The arrival of well-heeled "gamblers" in an emerging area play plays a critical role in the evolution of a Great Canadian Area Play, and this condition has been amply met at McFauld's Lake. Now we need the confirmation of multiple Eagles.
Conclusion: Whatever "we got it all" sentiments Noront may have fostered during the past 12 months, the new reality is that anything found by anybody in this remote region is good for Noront, because what Eagle One needs to be worth mining is a regional abundance of orebodies that justify bringing mining and transportation infrastructure into this godforsaken mosquito swamp. It is my view that the McFauld's Lake area play will begin to heat up this fall as the juniors drill new discovery holes and the market warms up to the notion that northern Ontario will get its due as the final exploration frontier. At the very least speculators should pull up a ring side seat.
*JK does not own shares in any of the securities mentioned herein
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