Exploration Risk and Return

Press/Media: Press / Media


A discussion of aspects of mineral exploration through a lens of risk and return

Period1 Sep 2012

Media contributions


Media contributions

  • TitleSizing Up the Prize (in Mineral Exploration)
    Degree of recognitionNational
    Media name/outletResourceStocks Magazine - Aspermont
    Media typePrint
    Duration/Length/Size1 page
    DescriptionEven seasoned resources sector investors can struggle to quantify the risk/reward leverage in their equity portfolio. That statement is not intended as a criticism: It is simply a reflection of the significant challenge in quantifying the upside (although to a lesser extent the downside) pertaining to exploration investments.

    So let’s look at some of the four of the risk/reward factors at play – so that at least in qualitative terms, investors can then ascertain whether they have true material upside exposure in their investments.

    1) The Size of the Prize.

    Here the concepts of ‘greenfields’ and ‘brownfields’ exploration come into play. Although a simplification of the definition, a ‘greenfields’ mineral discovery can be thought of as one that lies well away from the beaten track – and which will require new infrastructure to develop. Conversely, a ‘brownfields’ discovery lies closer to existing infrastructure – if not quite within sight of the headframes of other mines – then perhaps within trucking distance of existing facilities. Again to over-simplify, the size of the exploration prize is typically far greater (although the risk is consequently higher, as is the development cost) for greenfields exploration plays. So ask yourself if the company is successful in making a discovery, will the immediate return shift the company’s value upwards ten-fold or more? If yes, more often the case in greenfields situations than brownfields despite the higher project development cost, then you have investment leverage relating to the ‘size of the prize’.  
    2) The Type of Commodity.
    Digging Deeper likes to think of commodities as either of the ‘convex’ or ‘concave’ variety – rather than other more commonly used metals and minerals classifications such as precious metals, base metals or bulk commodities. Convex commodities realise the project’s true value very early on in the mining cycle – potentially right from the first drillhole. Why? Because once discovered in economic quantities, the rest of the mining cycle should follow on smoothly for these commodities – critically with little difficulty either in the processing or marketing aspects of project delivery. So nickel sulphides for example, tend to be convex by nature (returning high immediate value upon exploration discovery) whereas nickel laterites are concave – as there are significant technical difficulties to be overcome in processing, if not perhaps in marketing. Diamonds are convex, whereas kaolin, and graphite for that matter, are both concave commodities. Investors seeking immediate exploration returns should bias their portfolio towards convex commodities (or more correctly convex mineral deposit types). So ask yourself whether you have more convex than concave investment exposure in commodity terms across your exploration portfolio?
    3) The Country Risk
    Investors as a general rule overplay the importance of country risk in their assessment of early-stage exploration risk and then underplay its importance at the late-stage exploration and project development points in the mining cycle. It is correct that a developing country government may pose a greater sovereign risk than for a developed world jurisdiction, but that sovereign risk becomes critical only quite late in the discovery cycle – usually when the size of the prize is well defined. Exploration drill hits therefore should deliver share price gains to the company (and to the investor) independent of the location of the discovery in jurisdictional terms early on. That said, country risk becomes more and more important as projects progress beyond exploration into the delineation and project development phases – where the risk rankings of the likes of RESOURCESTOCKS country risk survey are very useful indeed to the investor seeking to manage their risk exposure.
    4) The Level of Cash
    They say that grade is king in mining – to drive low costs per unit of output – but amongst mineral explorers, cash is king (as much as grade). In theory, the presence of cash acts to lower the leverage to the investor – but the maths makes such dampening of the risk-reward pay-off minimal. Let me explain. Take an explorer with a mere $2 million starting cash balance upon making a potential $500 million exploration discovery. The leverage in such a circumstance is magnificent (250 times if one ignores the enterprise value of the company’s other assets beyond cash). Theoretically, the leverage is dampened however should the pre-discovery starting point be a cash balance of say $20 million (now being only 25 times) – but the fact that the latter explorer has no immediate need to return to equity markets prior to discovery (and one can never predict the exact timing of discovery) means an investor in the latter has far less exposure to corporate risk (specifically to the risk of a heavily dilutive capital raising). The exact level of cash to target in selecting investments is debatable – but making sure that an explorer is not in immediate need of additional exploration funds is a good starting point to manage ‘capital-raising’ risk. A 250-times up-tick in share price value is phenomenal – but 25 times isn’t too shoddy either – remembering that such gains accrue quicker for convex than concave commodity types.
    Producer/AuthorAllan Trench
    PersonsAllan Trench


  • exploration
  • risk
  • return
  • investment