Contango Ore: A promising deposit

This illiquid $35M exploration company is very difficult to value but could be worth up to $75-235M.

Contango Ore has issued a press release announcing (A) its initial resource estimate and (B) the engagement of a “strategic advisor”.  The CEO, Brad Juneau, has stated: “We feel we have reached the stage of proving sufficient known resources and defined upside to attract a buyer for the Company.”

I’ll start with the resource estimate.

My previous estimate

In my July 2013 post on the company, I made the following guess as to the deposit’s economics:

Assume that the deposit measures 500m along strike, 200m along dip, and has a true width of 40m.  Arbitrarily assume specific gravity of 2.2 and a grade of 2 grams/ton.  That’s 621k ounces of gold.  If each ounce has a NPV of $200, the deposit has a NPV of $124M (versus a market cap of $32M).  Of course, this figure is likely completely wrong.  Most gold projects turn out to be unviable, with a tiny handful making almost all of the industry’s profit.  There is a very small chance that the deposit will turn out to be a lot larger than originally anticipated and that it is worth a lot more than $124M.  There is a very high chance that the deposit isn’t economic at all.

It turns out I goofed.  I did not actually look up the specific gravity of the rock type(s) in the deposit.  I guessed 2.2.  The actual figures are stated in the press release:

Specific gravity estimates were obtained on-site from direct measurements of mineralized and unmineralized drill core. Specific gravities averaged 2.81 for unmineralized waste rock and 3.15 for mineralized rock.

I wasn’t even close.  I also overestimated the tonnage in the deposit (though this depends on the cut-off grade).  The two errors sort of cancel each other out.  In the end, it turns out I was close to the initial resource estimate.

I guessed 621K ounces of gold.
The press release states 783K indicated ounces of gold equivalent and 332K inferred ounces.

Any accuracy on my part was mostly luck.  My estimate was amateurish work.

*The company used a cut-off grade of 0.5g/t.  Using a higher cut-off grade of 1.0g/t would give substantially similar results as illustrated in the press release.

Project economics

The site has road access.  The deposit is close to Tetlin Village (population 127?).  Tetlin village should be a 6+ hours drive to Anchorage and 3.5+ hours to Fairbanks.  Road access is very good for the project’s economics.  The project won’t require expensive bridges and total infrastructure costs should be reasonable.  As a shortcut, I like to use drilling costs to get a rough idea of what everything might cost.  Contango Ore’s drilling costs have been around $129/ft (2012 company presentation).  It doesn’t get much cheaper than a hundred dollars per foot.  As a point of reference, drilling in the Ring of Fire in Canada costs somewhere around six hundred dollars per foot.  This is mainly because the Ring of Fire has no road access and is so remote.

I’m guessing that the mine will use power generators and truck in diesel.  Electricity will cost a few to several times more than what it normally would.  The capex needed to build a power line may or may not be justified.  A Dec 2013 company presentation states that the nearest high capacity power is approximately 60 miles away.

Labour will be more expensive than normal because the site is a few hours away from major population areas in Alaska.  The worst-case scenario is to use fly-in fly-out labour.  The mine will likely be open-pit, which is one of the least labour-intensive mining methods.

The rock in the deposit contains sulfides and will likely be acid generating.  This will increase the costs of dealing with the tailings.  It will cost a lot more than normal but I don’t see this as breaking the project’s viability.

Because the project contains three metals worth extracting (gold, silver, copper), overall recoveries will be slightly lower than for a single-metal deposit.  This likely will not have much of an impact (several percent lower recoveries???).

With the grade being 4.08g/t of gold equivalent, this project seems to me like it will have above-average margins.

Other mines in Alaska

The Donlin Creek deposit is a 50/50 joint venture between Nova Gold and Barrick Gold.  I don’t trust Nova Gold as NG is the more promotional of the two companies.  Nova Gold states that the deposit has 33.9M ounces of gold at 2.1g/t.  Barrick has stated that it will not pursue this deposit so the implication is that Donlin Creek is uneconomic.

There is the Fort Knox mine that is within an hour’s drive of Fairbanks, Alaska.  This is an open-pit mine with grades of 0.68g/t from the mine and 0.35g/t in stockpiled ore according to this 2007 technical report.  The Kinross website states that the grade of the reserves is 0.47g/t.  At such low grades, I believe this mine only works because heap leaching is viable for that particular deposit (various factors affect the effectiveness of heap leaching, such as temperature, rainfall, and characteristics of the ore).  You might be wondering why Donlin Creek isn’t viable at over 4 times the grade.  I haven’t done my research, but I suspect it is a combination of:

  1. The grade at Donlin Creek may have been overstated.
  2. For some reason heap leaching is not very cost-effective for Donlin Creek.  (If I had actually read their technical reports I would actually be informed about the metallurgical issues.)
  3. Donlin Creek is far away from civilization and will have high infrastructure costs.  One of the numbers thrown out was $4.5B in capital costs.

As far as Contango Ore’s flagship Chief Danny deposit goes, it has over 8 times the grade of Fort Knox.  I think that Chief Danny will have higher margins.  There shouldn’t be anything too unusual about Chief Danny’s costs.  Electricity (assuming diesel generation) will be much more expensive than Fort Knox but probably not significantly more than 8X.  Labour will cost a little more but probably not more than 1.5X.  Fort Knox enjoys economies of scale; the advantage is probably not more than 2X.  Fort Knox does not have problems with acid-generating rock; the advantage may be very significant but probably not more than 8X.

Lastly, there is the Pogo underground mine.  The grade is around 10.4g/t.  An underground mine is not a good comparison for an open-pit mine.

Valuing the deposit

I’d arbitrarily give zero value to the inferred resources and put a range of $100 to $300/oz to the indicated resources.  This gives a valuation of $78.3M to $234.9M.  There is a small chance (???at least 10%… maybe up to 33%???) that the deposit won’t turn into a mine.  Many development-stage deposits don’t become a mine.

The other land assets might be worth something too… anywhere from $1M to $20M.  However, the company has no other promising prospects other than the Peak Zone of the Chief Danny zone in my opinion.  All the other good targets are undrilled and high risk.  I ignore the value of the other land because it’s not that material.  I don’t want to waste my time on false precision.  I’m sure the company has cash on hand but I will ascribe zero value to it.

As far as the expansion potential goes, the press release doesn’t say anything about the deposit being open along any direction.  I’m guessing the deposit doesn’t have much exploration because otherwise the press release would mention it in the discussion of the resource estimate.

Bottom line

My guess is that this deposit looks extremely promising.  However, I have been wrong about some mining projects before (e.g. KWG, Noront, Selwyn, probably Premier Gold) and right about some other ones (e.g. Yukon Nevada, Queenston Mining, probably Canada Lithium).  My predictions have not been very good.

As far as management goes, Brad Juneau strikes me as somebody with integrity.  He doesn’t seem like a money-oriented person as he passed on being the CEO of Contango Oil and Gas.  I don’t think that the technical reporting has been inflated in a major way.  It’s possible that the resource estimate slightly understates or overstates the deposit; this is very difficult for me to verify.

Mr. Juneau likely genuinely believes that the deposit is extremely promising and has high chances of turning into a mine.  This is why Contango Ore is advancing the deposit and hiring a strategic advisor.  They want to bring in somebody else with (A) financing and (B) the technical expertise to build a mine.  I could see Teck Resources being interested as they have previously purchased a deposit discovered by Avalon Hill, the company currently providing geological services to Contango Ore.  Senior gold miners would also be interested in this asset as they have been having great difficulty in replacing reserves.  Some seniors are acquisition-happy because they are trying to use their overvalued stock as takeover currency.  You’d probably figure out who they are by looking at the companies paying for the shills over at theaureport.com.

*Disclosure:  Long CTGO.  I may or may not increase my position in the future.

Advertisements

4 thoughts on “Contango Ore: A promising deposit

  1. Pingback: CTGO: Closed my position | Glenn Chan's Random Notes on Investing

  2. Glenn, long-time holder of CTGO, have you kept up with their recent drilling and JV with Royal Gold, I would be curious to know your thoughts since you wrote this article.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s