Today, Pretium dropped a bomb of a press release: Bulk Sample Surpasses Target of 4,000 Ounces of Gold; Processing Continues. The preliminary results are that there is 4,215 ounces of gold in the 8,090 tonnes processed so far. It looks like the bulk sample results will exceed the resource estimate; this would be strong evidence that there is more gold in the deposit than originally thought. I’d be curious as to how much gold should have been in the 8,090 tonnes processed so far (according to Snowden’s resource model) as the press release does not say. Anyways, here are some possible scenarios for the current results:
- Strathcona messed up. In my opinion, this would be the least bizarre explanation and the most plausible.
- The preliminary results from the bulk sample are fraudulent due to assay problems. (Less likely.)
- Somebody added millions of dollars worth of gold to the bulk sample. (Least likely.)
Why fraud would be bizarre
On one hand, a lot of people are really stupid when committing fraud. Bernard Boily decided to type the wrong numbers into Bear Lake Gold’s assay database. His fraud had little upside and Boily was almost guaranteed to be caught. It is standard procedure for an outside party to detect fraud and other problems by performing QC checks. An independent party would take some of the remaining drillcore and re-assay it. (Incidentally, Boily didn’t get caught by this. The geologist performing the QC check believed Boily’s explanation about the assay lab being wrong and did not follow up by re-assaying the pulp at another laboratory.) The other geologists on Boily’s team could have figured it out since they were also emailed the original assay data. I don’t know how he was caught but ultimately he was. Now he (probably) will never work as a professional geologist again.
With that being said, I will explain why I think fraud would be really stupid in Pretium’s case: it’s extremely likely that the fraud will be discovered!!! Strathcona is involved and the engineering firm is famous for its work in the Bre-X scandal.
In the Bre-X scandal, there was a salting scheme whereby Bre-X geologists added alluvial gold (the type you get from panning for gold) to the drillcore pulps. They weren’t caught right away but the fraud was eventually discovered when Freeport McMoran decided to redrill the drillholes at considerable expense. This led to Bre-X hiring Strathcona, who also discovered the fraud. Farquharson saw that the gold grains were consistent with alluvial gold and didn’t make any sense for the Busang deposit. Michael de Guzman, a Filipino Bre-X geologist, committed suicide by jumping out of a helicopter as the fraud began to unravel (some people say that he was either pushed out of the helicopter or faked his own death). John Felderhof, Bre-X’s head geologist, sold Bre-X shares before the fraud was uncovered. Graham Farquharson of Strathcona has continually attacked Felderhof as Felderhof had to have known that fraud was occurring. Felderhof publicly defended unusual practices such as the destruction of drillcore (it goes against industry standard practice and caused Freeport McMoran to spend a lot more money doing due diligence as the only way to get more drillcore was to drill again). Some have accused Felderhof of committing securities fraud by selling Bre-X shares knowing that the Busang deposit was a fraud. If this is true, Felderhof has definitely gotten away with it and currently lives outside of Canada (extradition would presumably be difficult).
Back to Pretium. It is possible that there has been some type of fraud that is causing the mineral resource estimate to be way too high based on the drillcore data:
- The reserve engineer is far too optimistic. In this type of fraud, it is unlikely that the engineer would face serious consequences for being overly optimistic (e.g. look at Peter George and Barkerville Gold). I think that smart people would go with this type of fraud because there are few consequences if detected. This may not necessarily be fraud; some engineers are naturally optimistic. However, the end result is the same.
- There is some type of salting scheme going on, similar to Bre-X.
- Some other type of fraud that inflates assay results (e.g. typing in the wrong numbers into the assay database, intentionally splitting the core in a way to manipulate results, etc.).
A bulk sample will pretty much detect all of the frauds listed above (unless the degree is fraud is very low and doesn’t inflate the resource estimate by much). Perhaps there is a second round of fraud that is causing the bulk sample results to be fraudulent. However, such a scenario doesn’t make a lot of sense!
If somebody was committing fraud from day 1, they would probably stop before the bulk sample results came in. If they were trying to profit by selling overpriced shares, they had plenty of time to do so before after it was announced that Strathcona would be hired to oversee the bulk sample. The only reason to commit a second round of fraud is to delay the inevitable. However, I don’t see how anybody would profit from that.
One of the safeguards that Strathcona has implemented is a sample tower that is supposed to take a representative sample of the entire 10,000t bulk sample. Strathcona is presumably keeping tight security over its sample tower ore so that other parties cannot add gold to it Bre-X style. Strathcona can also pick their own in assay labs. It is unlikely that Strathcona’s assays are wrong because Strathcona is probably using two or more assay labs and comparing the results against each other.
Why scenario #2 is unlikely
There are safeguards against bad assays. One of them is Strathcona’s sample tower. Pretium’s head geologist should also be taking safeguards to catch/prevent bad assays (e.g. using two assay labs, having good security to make sure nobody tampers with the ore/samples, etc.).
With so much scrutiny over Pretium, it is likely that Pretium’s head geologist would take extra precautions. Key Strathcona employees may face legal repercussions if they don’t do their jobs properly.
Why scenario #3 is unlikely
It requires millions of dollars of gold. Spending so much on a fraud doesn’t make a lot of sense.
On top of that, it is likely that Strathcona’s sample tower would catch this fraud. This scenario makes the least sense.
Why scenario #1 is unlikely
I believe that Strathcona is highly competent and that they would not resign unless they were pretty sure that they are right. Strathcona had access to the sample tower data. The sample tower results should be representative of the bulk sample. There are reasons why the sample tower might vary from the actual bulk sample results. One possible explanation is that the ore is so hetereogenous (or the nugget effect is so strong) that the sample tower ore happens to have lower grades than the bulk sample. By sheer luck, the sample tower ore is not representative. However, if the bulk sample ore is ground up small enough and mixed well enough, this type of error should not occur. The scientific principles behind this are the reason why only 30 grams of a drillcore (technically half of a drillcore) are assayed instead of the entire thing. Done correctly, assaying only 30 grams of a drillcore is sufficient to be representative of the entire drillcore split. Similarly, the sample tower data should be representative of the bulk sample.
Here are some other explanations for why Strathcona might have messed up:
- Maybe Strathcona resigned too early. It resigned before all of the sample tower data was in.
- Maybe Thalenhorst (Strathcona’s engineer responsible for overseeing Pretium’s bulk sample) developed tunnel vision after seeing problems with the resource model.
- Maybe Thalenhorst intentionally pushed Strathcona into resigning, perhaps profiting from doing so in some way.
What I’m doing
Well… I’m stubborn because I’ve increased my short position today. I’ve covered my short common stock position and bought put options. I don’t want to be short the common stock because the stock should be worth a lot more if the deposit is real.
I may be biased because I (want to) believe that Strathcona is a highly competent firm with integrity. Farquharson has demonstrated integrity and competence in the Bre-X scandal.
*Disclosure: No position in the common, long much more puts than calls. I bought some call options intending to turn them into puts but then decided not to.