Tracker 2010-03

April 7, 2010

Quest Uranium Corp (QUC-V: $3.49)

Resource Estimate establishes Strange Lake B Zone as World Class

Synopsis: Quest Uranium Corp (QUC-V: $3.49) released on April 7, 2010 an initial 43-101 compliant resource estimate for the B Zone on the Quebec side of its Strange Lake project which confirms it as a top contender for the solution to the problem of non-Chinese rare earth supply, especially with regard to the "heavy" rare earths. Wardrop Engineering Inc provided inferred tonnage and grade estimates for 8 different cutoff grades which produce results remarkably similar to what I estimated in Tracker 2009-11 published on December 15, 2009. The similarity between my "back-of-the-napkin" calculations and those of a formal resource estimate is not surprising because the B Zone is a flat-lying, overburden covered body of continuous mineralization with layer cake style grade variation typically associated with distinct pegmatitic horizons. The similarity is more a testimony to the simplicity of this world class deposit than any acumen on my part, and thus the outcome should be no surprise to bottom-fishers who have held onto their positions since I converted the original extreme risk bottom-fish buy recommendation made at $0.10 on May 4, 2009 to a Spec Cycle Hold 100% on July 10, 2009 when the great awakening of rare earth mania started, and to spec value hunters who have been accumulating Quest since my initial Good Relative Spec Value Buy at $3.14 on September 23, 2009 when it became apparent to me that the B Zone was emerging as a major new rare earth discovery rivaling the original Strange Lake Main Zone, most of which lies on the Labrador side of the border withdrawn from exploration and development. This important milestone of an initial resource estimate sets the stage for the next key milestone expected in June, namely an initial metallurgical study which sheds light on the recovery character of the B Zone and the most likely recovery process. This second milestone will be followed in July by a third key milestone, a preliminary economic assessment which gives shape to the likely cost structure of developing and operating Strange Lake as a world class rare earth mine. By September 2010 we will have sufficient information to put the tens of billion dollars worth of metal in the ground into the context of economic logic. For now we have sufficient information to put Strange Lake on the radar of parties concerned with the strategic logic involved in securing supply for their critical inputs.

Sticking to our position has not been easy in the face of widespread skepticism not just from the sour grapes shut out entirely from the rare earth sector, but also from those married to "competing" rare earth projects, and, even worse, from the industry itself whose relentless pessimism forces me to borrow from Don Coxe, "those who know it best love it least". The initial B Zone resource estimate puts Strange Lake back on the map after a two decade hiatus since the Iron Ore Company of Canada gave up on what it once viewed as a potential zirconium-yttrium mine with rare earth by-product credits. The Strange Lake B Zone is so big and rich that it can become the long term foundation of the North American rare earth industry, a role that will boost rather than undermine the development prospects of other North American rare earth projects whose throughput limitations raise the question of whether the end-user industry should trouble with prolonging the agony through small scale solutions or simply accept Chinese domination of rare earth supply and build their factories in China. By the time Quest fully delineates the Strange Lake system and the Labrador Inuit figure out what to do with the Main Zone, the overall resource of the Strange Lake complex will range 300-400 million tonnes with an in situ value exceeding $100 billion in today's rare earth oxide prices. The significance of this statement is not that Strange Lake may host the equivalent of a 100 million ounce gold deposit, but that it has a resource which is large enough to feed the non-Chinese world's rare earth needs for the next century. This is particularly important in light of recent estimates which suggest that the heavy rare earth bearing ion adsorption clay deposits in southern China have only 15-20 years left before depletion. Strange Lake may take longer to get developed than we might wish because of its remote location, but if the Quebec government recognizes the long term strategic implication of becoming the world's long term solution to heavy rare earth supply, and initiates policies that extend transportation infrastructure into northern Quebec and that cultivate development of downstream processing on the shores of the St Lawrence River, we will see a rush of capital into smaller advanced rare earth projects which can bridge the transition years until Strange Lake is fully operational.

Based on the $3.49 closing price on April 6 and 48.5 million shares fully diluted, the implied value of Quest's 100% owned Strange Lake project was $169 million, which now looks very cheap compared to the valuation of other advanced rare earth projects. A short term doubling of the stock price is a plausible response to this resource estimate milestone, with further gains contingent on the next arguably far more critical milestone expected in June 2010: an initial metallurgical study by Hazen Research on B Zone material. While the in situ numbers ranging $30-$40 billion with rock values ranging $200-$400 per tonne at current rare earth prices are impressive, which does not even take into account the possibility that rare earth oxide prices are poised for triple digit gains reminiscent of what molybdenum experienced during the past decade when supply and demand ended up severely imbalanced for a critical but minor input, none of these "impressive" numbers means anything unless the recoverable grade and associated cost make sense. We are still missing this information, and if the Quest market has a weak response to the resource estimate news, it will be because in the rare earth sector, once you have size and grade, it is all about recovery, recovery and recovery. It is one thing to hear from Quest management that the B Zone ore, unlike the primary mineralization at the Main Zone, was hammered a second time by mother nature to render the mineralization more amenable to concentration and cracking. That makes us think a little too much about what Tony Mariano says happened to the original bastnaesite ore at Mt Weld which got supergene enriched after sun and rain hammered it for eons. We'd like to learn from an independent metallurgist that the secondary hydrothermal pulses at the B Zone weakened rather than strengthened the rare earth bearing minerals! Just as a Wardrop resource estimate for the B Zone means a lot more than a Kaiser approximation, so will a formal metallurgical report by Hazen on the B Zone's mineralogy and process amenability give another major credibility boost to the B Zone. This, of course, will be a prelude to pilot plant scale studies of representative material which will turn 2011 into a waiting game unless mergers & acquisition activity has swept into the rare earth sector. But if the next two milestones deliver satisfactory result, we can expect Strange Lake to end up with an implied project value of $500 million plus as is currently the case with Lynas and Mt Weld.

I thus expect Quest's stock to bounce around in the $5-$10 range while it awaits the metallurgy milestone, followed by a related milestone in July consisting of a preliminary economic assessment which establishes the cost structure of developing Strange Lake. The three milestones consisting of resource estimate, metallurgy and cost structure are required before big institutional or end user money gets seriously interested in Strange Lake, and politicians wholeheartedly jump onto the bandwagon. We have reached one of these milestones with a green light, and can expect the other two during the next three months. The metallurgy milestone is critical, because it will nail down the revenue side of the equation and shed a lot of light on the cost side of the equation. Complicating the matter is the fact that a maverick called Cliffs Natural Resources Inc already owns just under 10% courtesy of its acquisition of Freewest and its northern Ontario chromite deposit, an "out-of-the-box" move redolent of the sort of "strategic logic" over which the Chinese dread losing their monopoly. No doubt an iron ore producer like Cliffs is mulling whether that other iron ore producer was simply ahead of its time when it tackled Strange Lake. The significance of today's news is that finally there is data on the table which can be crunched by an audience far removed from newsletter writers and speculators, and this sets the stage for market activity not so easily explainable.

The resource estimate boils down to the table below which displays the tonnage and grade associated with each of the cutoff grades provided by Wardrop in Tables 1 & 2 of the news release. It also includes the per tonne rock value of each estimate and the total in situ value based on two pricing regimes, the four year average Wardrop used in February 2009 for its technical report on Avalon's Nechalacho deposit, and the current prices published by Metal-Pages.com, a site that matches buyers and sellers of rare earth oxides. Regulatory disclosure rules forbid public companies from publishing such monetary figures in the absence of a prefeasibility study, which is why it is up to analysts and investors to complete this final step of multiplying contained metal by metal price in order to quantify the potential value of any early stage deposit. What the table shows is that the B Zone currently has a high grade resource with an in situ value of $3.2 billion at a rock value of $271 per tonne at the highest cutoff grade of 1.2% TREO, contained within a larger lower grade resource with an in situ value of $24.3 billion at a rock value of $177 per tonne at the lowest cutoff grade of 0.7% TREO. If we plug in current rare earth oxide prices, these numbers swell to $4.6 billion in situ with a $393 rock value at the high cutoff, and a staggering $35.3 billion in situ with a $243 rock value at the low cutoff. Keep in mind that these are "gross" numbers before applying commercial recovery rates. Also keep in mind that unlike a gold deposit, rare earth deposits involve complex and expensive recovery processes which need to be customized for each deposit. Until a prefeasibility study has been done which includes a pilot plant study, the economics of a rare earth project are anybody's guess. Quest intends to drill 13,000 metres of infill holes on the B Zone this summer on 50-75 metre centres; based on what we know about the pegmatitic horizons within the B Zone, we can expect the grade and tonnage at the higher cutoff grades to improve when the inferred resource is converted to an indicated resource in early 2010. This is important because initial mining would target near surface higher grade horizons with low cost open pit excavation.

Wardrop also reported that the zirconium oxide (ZrO2) grade ranged 1.96% to 2.1% from the lowest to highest TREO cutoff grade, while hafnium oxide (HfO2) ranged 0.053% to 0.055%. This is not surprising in that zirconium and hafnium occur together, and Iron Ore Company of Canada was initially focused on Strange Lake as a zirconium-yttrium project. Zirconium and hafnium metal are important alloying materials for nuclear reactor components. They are normally recovered from zircon minerals mined along with other heavy minerals in beach sand deposits. Other zirconium bearing minerals include gittinsite, vlasovite and eudyalite often found in alkaline igneous complexes such as Strange Lake. In the case of Strange Lake the dominant zirconium bearing mineral appears to be gittinsite. At this point it is uncertain if zirconium and hafnium can be recovered at a cost less than their commerical value; it is also difficult to determine the size of the market for these metals. The BZone also has a beryllium oxide (BeO2) grade ranging from 0.077% to 0.129%. It is not yet known what mineral hosts the beryllium in the B Zone and what is involved in extracting beryllium oxide. Global beryllium production is dominated by Brush Wellman's low grade Spor Mountain deposit in Utah. Beryllium is an expensive metal for which demand could increase if the price were lower; rare earth projects such as B Zone which have a significant recoverable beryllium byproduct credit could reshape the market for beryllium. For now I am discounting the zirconium, hafnium and beryllium as worthless, but these are significant aspects of the B Zone which could turn out to have commercial value.

Inferred Resource Estimate for Strange Lake B Zone - Wardrop Engineering - April 7, 2010

Cutoff TREO%	Tonnage	Grade TREO%	HREO%	Rock Value $/t 4 year avg	Rock Value $/t Current	In Situ Value 4 year avg	In Situ Value Current
1.20%	11,809,000	1.35%	51%	$271	$393	$3.2 billion	$4.6 billion
1.10%	21,757,000	1.26%	50%	$249	$362	$5.4 billion	$7.8 billion
1.00%	40,388,000	1.16%	47%	$226	$329	$9.1 billion	$13.3 billion
0.95%	54,560,000	1.11%	46%	$208	$304	$11.3 billion	$16.6 billion
0.90%	82,451,000	1.05%	44%	$192	$281	$15.8 billion	$23.2 billion
0.85%	114,823,000	1.00%	43%	$185	$269	$21.2 billion	$29.5 billion
0.80%	133,654,000	0.98%	43%	$177	$257	$23.7 billion	$34.3 billion
0.70%	137,639,000	0.97%	43%	$177	$257	$24.3 billion	$35.3 billion
Note 1	4 year average prices based on set established by Wardrop as of Feb 2009.
Note 2	Current prices are the average of the bid-ask posted by Metal-Pages.com on April 6, 2010, except for holmium, erbium, thulium, ytterbium and lutetium which are not quoted and for which the 4 year Wardrop average was used.
Note 3	The obscure heavy rare earth oxides holmium, erbium, thulium, ytterbium and lutetium for which there are small markets represent 15%-20% of the rock value.
Note 4	Rock and in situ value figures assume 100% recovery of contained TREO. Recoverable grade will depend on the mineralogy and the optimal recovery process developed for the material to be mined and processed.
Note 5	Prices have been applied to the rare earth oxide grades provided in Table 2 of Quest news release for each of La2O3, Ce2O3, Pr2O3, Nd2O3, Sm2O3, Eu2O3, Gd2O3, Tb2O3, Dy2O3, Ho2O3, Er2O3, Tm2O3, Yb2O3, Lu2O3, Y2O3.
Note 6	Wardrop used a specific gravity of 2.72 based on 80 measurements, a database of 19 holes (3,905.3 m) with 150 m spacing, and a block model estimated by ordinary kriging interpolation of blocks 40 m x 40 m x 10 m.

Conclusion: In less that a year Quest Uranium Corp has gone from a penny dreadful with some interesting rare earth showings and possibly part of the Strange Lake Main Zone to the owner of a world class scale rare earth deposit which has the critical mass to counterbalance China's domination of rare earth supply. And yet as of this writing the market is assigning an implied value of only $170 million to the B Zone and the surrounding land position. The easiest money has been made by the bottom-fishers, but big money remains to be made by spec value hunters.

*JK owns shares of Quest Uranium

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