Right now there is a lot of carnage in my portfolio.
Oftentimes metallurgical recovery may be (intentionally) overstated. Actual recoveries when mining commences is often lower than figures given by management.
A mining company will always run tests to determine the optimal amount of mineral processing. More expensive mineral processing techniques will yield higher recoveries. However, the higher recovery may not be economically justified.
Company management may quote the highest recovery achieved in initial testing. However, this may not have anything to do with actual recoveries as the additional mineral processing may not be economically justified. Also, the recovery figure may only be applicable to the high grade ore in a mine. The recovery for high grade ore may be higher for lower grade ore.
How mining companies guess future recoveries
#1- Compare the ore to similar ores in other mines.
There are obvious methods of cheating here. It is possible to cherry pick higher numbers from mines with higher recoveries.
The author of a preliminary economic assessment may also conveniently “forget” that the ore has problems that make it difficult to process (these ores are usually referred to as refractory ores).
I would not take this method very seriously in any type of economic assessment.
#2- Run tests on drill core
One method is to take drill core and to form 2 samples: one from high-grade ore and one from low-grade ore. High-grade ore may have higher recoveries than low-grade ore.
Tests may look at:
- Energy needed to grind the ore to particular sizes.
- Grind size versus recovery
- Usefulness of different mineral processing techniques
#3- Take a bulk sample
The problem with small scale tests is that they may not necessarily extrapolate to a full-scale operation. For example, milling equipment in a lab scale behaves very differently than a production-scale model. You can run tests using a production-scale mill, but it requires a lot of ore. If it is not possible to obtain that much ore (or production-scale equipment does not exist because it uses new processing techniques), then an engineer can run tests at various scales and build a model to predict how a full-scale operation would behave. These models are never perfect.
Mining companies may obtain a bulk sample by digging a trench and mining a small amount of ore for testing purposes. Or they may sink an exploration shaft if the ore is not close to the surface.
The bottom line is that larger scale tests are usually more accurate. However, they are not necessarily economically justified for a given stage in mine development.
The things to watch out for
- As previously mentioned, economic assessments should include information from more reliable methods of metallurgical testing.
- Refractory ores and ores that are difficult to process. A simple check is to skim through the technical report and look for the word refractory. Unfortunately this may not be enough. Ideally, you should know potential problems for that particular mineral or that type of ore.
- Marginal low-grade deposits. In these deposits, mineral processing will likely be critical to the economics of the project. This information depends on a number of different factors and information that may not be available without expensive testing. Mining companies will perform such testing in feasibility studies before building a mine. However, they may not necessarily release such information to shareholders. (Personally I don’t think that these types of projects are good investments because insiders can have such a huge information advantage and usually have incentives to promote the stock.)
- New cutting-edge mineral processing techniques. You don’t really know what exactly will happen unless the company runs a large-scale test. Bench-scale/lab-scale tests may be wrong. It is rare for mining companies to emphasize the risk involved. Sometimes this is because a mining company badly needs to raise capital and to promote itself. Sometimes it is simply a matter of professional pride or ego. Some people may not like to say: “Actually we don’t really know if our science project will work on a production scale.”
Does focusing on the recovery figure really make sense?
In my opinion, not really. There is always a balance between higher recovery and lower mineral processing costs. This balance isn’t well known until a feasibility study is run. A lower recovery may be a good thing. However, management may prematurely cite recovery figures and these are usually overly optimistic.
What investors want to know is the predicted future cash flow of a particular project. And these predictions are heavily dependent on engineering data such as grind size versus recovery, energy costs for particular grind sizes, mineral processing costs, and a large number of other factors. “Knowing” the expected metallurgical recovery (which may change or be totally inaccurate) doesn’t necessarily help an investor predict the future cash flow of a given project.
Originally my thesis for investing in these related stocks were:
- It’s undervalued. (Unless it is a fraud.)
- Insiders will try to inflate earnings and to promote the stock.
I am probably wrong on both counts. As far as promoting the stock goes, investor communication has been terrible (e.g. website not updated in ages) and insiders have not responded to Shah Capital Management’s letter to the board.
As far as undervaluation goes, the stock will likely ultimately be a zero if insiders are intent on stealing (almost) everything. The mining companies that were merged into XING may be a fraud considering Riu Lin Wu’s history with Real Gold (see posts on chinaminingblog.com). QXM hasn’t released new models of cell phones in a long time and there is little information on what happened to its VEVA stores. I don’t believe that QXM has a cell phone business that is really operational right now.
So unfortunately for my net worth, I was incredibly wrong on these stocks. Perhaps there is some residual value in these companies from cash that hasn’t been misappropriated yet. I suppose I will find out when these companies undergo forensic audits.