Unlike Kinross Gold's (NYSE: KGC) pending takeover of mid-tier African producer Red Back Mining, Fronteer Gold's (AMEX: FRG) offer for joint venture partner AuEx Ventures probably won't even register on most mining investors' radar screens. Fronteer, a development stage company that has yet to produce an ounce of gold, is a fairly small company, while explorer AuEx is just plain tiny. Still, this deal's quite close to my heart (and wallet).
For over a year now, AuEx has been the largest position in my highly concentrated stock portfolio. By a mile.
I'm not here to gloat. Rather, I'd like to share some of the insights that gave me the conviction to place such an outsized bet on a company that, to most eyes, would look like a speculative penny stock. How did I decide that this company and its assets were the real deal?
Minding the ore store
This might sound obvious, but when I think about investing in a mineral exploration company, I usually look for a company led by a guy that has past discoveries under his belt. Crazy, right?
There are hundreds, if not thousands, of exploration "juniors" out there led by people with backgrounds in sales, investor relations, balloon animals, and so on. When it comes to a discovery track record of mineral deposits that became mines, the list narrows dramatically.
To be clear, I'm not saying that the CEO needs to be the explorer. Maybe it's the VP of Exploration, or a contracted third party that's got the golden touch. Someone involved needs to have hit pay dirt in the past, though. It's really that simple.
AuEx passed this test with flying colors, as CEO Ron Parratt has been instrumental in numerous discoveries, including the very large Rabbit Creek deposit, now part of Newmont Mining's (NYSE: NEM) Twin Creeks complex.
Has a flagship been found?
It's certainly possible to meet with investment success by blindly following a proven explorer into his latest venture. If, like me, you're less inclined to speculate, you probably don't want to jump in before the company has hit upon a promising deposit, and has established some tangible asset value. Sure, you miss out on the fabled 50-bagger that can follow a major grassroots discovery, but it's still possible to score multibagger returns on the stocks of explorers that have already discovered their "company-maker" asset. It takes years for a discovery to move into mine development and production, and Mr. Market's bound to have mood swings in the interim.
In the case of AuEx, the company made its discovery at Long Canyon in 2005. I didn't buy my first shares until 2008. Investors had all the time they needed to evaluate the quality of this promising discovery, which was made crystal clear in the preliminary economic assessment released in late 2009. This report confirmed for me that we were looking at not a merely nice-looking deposit, but America's Next Top Gold Mine.
Shareholder friendliness
A lot of exploration companies out there continually raise money and burn it on some combination of corporate overhead, promotional activity, and drilling (preferably more on the latter). Some companies meet with success before much cash is spent, as was the case of Canplats Resources, which Goldcorp (NYSE: GG) acquired earlier this year. For every Canplats, though, there are easily dozens of companies that drill themselves into the dustbin of history.
Some explorers have hit on a more sustainable model, which involves bringing in joint venture partners to help foot the bill on early stage projects. This "prospect generator" approach stretches a small firm's dollars, and allows a company like AuEx to test many more of its drilling hypotheses than the company would be able to fund internally. In addition to its joint ownership with Fronteer at Long Canyon, AuEx also has partnerships with Agnico-Eagle Mines (NYSE: AEM) and Eldorado Gold (NYSE: EGO).
Joint ventures minimize the need for a company to issue scads of shares, and help managers to protect per-share value. It's probably no coincidence that those management teams and Boards choosing the prospect generator model also tend to have significant ownership stakes in their companies, as the AuEx team does.
A golden lesson
There's no quantitative measure that neatly captures any of the above considerations. At best, there are signposts and rules of thumb like number/size of past discoveries, projected internal rate of return from a project's pre-feasibility study, and percentage of insider ownership. These are all important figures, but at the end of the day, when investing in a company that monkeys can't run, you're betting on people -- their skills, their commitment, and their integrity. You can't find these qualities in the footnotes to the financial statements.
