In my previous article we looked at the life cycle of a typical mine. We'll now explore a critical aspect of exploration and smaller resources companies: mineral resources and ore reserves.
Mineral reserves and ore resources
You may have noticed mining company announcements stating inferred, indicated and measured resources, or perhaps probable and proved reserves? For those who aren't geologists (consider yourself lucky as you probably still have a job), the classification system can be confusing but it is an important area to understand.
The Joint Ore Reserves Committee (JORC) produces The Australasian Code for Reporting Exploration Results, Mineral Resources and Ore Reserves, conveniently abbreviated to the JORC Code. The JORC Code was first released in 1989 however its development, along with similar codes around the world, was expedited in the mid-1990's after the Bre-X scandal hit the world.
The story of Bre-X Minerals Ltd, a Canadian gold exploration company, has all the requirements for a blockbuster movie – arson, murder and international intrigue combined with one of the largest gold deposits ever discovered. What the world didn't know was that the exceptional exploration results were being fabricated by the geologist, Michael Guzman, who was adding external gold (initially from his wedding ring!) to the samples. Eager investors launched Bre-X shares from $0.30 up to $280 on the way to a market capitalisation of more than $4 billion, most of which subsequently vapourised when investigations uncovered the truth.
To increase the mineral reporting standard of companies, the JORC Code requires that all statements regarding exploration results, resources or reserves must be prepared by and signed off by a "competent person".
A competent person must have a minimum of 5 years' experience working with the type of ore deposit under consideration which is relevant to the activity.
The figure below provides a summary of the JORC Code classification system.
Exploration Results will usually include the results of drilling assays (samples) and is common in the early stages of exploration. These results are of interest to investors, but the quantity of data available is generally not sufficient to allow any reasonable estimates of Mineral Resources.
A Mineral Resource is a concentration of a mineral in the earth's crust in a high enough grade and quantity that there are reasonable prospects for economic recovery. They are not precise calculations and are dependent on the interpretation of limited information about the mineral resource.
An Ore Reserve is the economically mineable part of the Mineral Resource. It includes allowances for losses during the mining process which is defined through the feasibility studies. "Economically mineable" implies that extraction of the Ore Reserves has been demonstrated to be viable under reasonable financial assumptions. In simple terms, the company should be able to mine the deposit and make a profit.
As an exploration program increases the number of drill holes, the geological knowledge and confidence of the ore body increases. This allows the inferred mineral resource to transition to indicated resources and finally to the measured resources category. The same is true for ore reserves, which transition from probable reserves to proved reserves.
As mentioned earlier, the competent person is responsible for preparing and releasing exploration results, mineral resource and ore reserve details to the market. The success of exploration companies and smaller mining companies relies heavily on successful exploration results, creating what I would consider a conflict of interest for the competent person – usually a company employee – and investors should thoroughly examine these announcements with this knowledge in mind.
Here's one example.
Soon after a resource upgrade in April 2014, gold exploration company Aurelia Metals Ltd (ASX: AMI) released a concerning resource revision (PDF) statement in July 2015 announcing that a "coding problem was found which served to overestimate volumes by approximately 12%" and that "the resource has been re-estimated with this issue resolved and by adopting more conservative geo-statistical parameters."
After the re-estimate was completed the gold resource reduced from 390,000 ounces down to 280,000 ounces, a 30% reduction. The error was picked up following an independent review of the companies data.
There would be few competent persons who would deliberately mislead investors in these statements, however, there are many internal and external influences that would lead me to believe that they are more often overstated than understated. Without an independent review of the data, I would always err on the side of caution when digesting these reports, particularly for smaller companies.
Large and established mining companies such as Newcrest Mining Limited (ASX: NCM) provide extensive resource and reserve statements within their annual report to shareholders. These companies have many years of experience both in mining and exploration and are most likely to provide conservative estimates that investors can rely upon.
I highly recommend that you read the key areas of the freely available and clearly explained JORC Code when trying to interpret mineral resource and ore reserve statements.
Later in this series we will take an in-depth look at some exploration results released to the ASX and what they mean for investors.
