Mastering Discovery Hole Investing with Geologist and Broker Steve Todoruk

Key Concepts

• Discovery Hole Investing: The strategy of investing in junior mining exploration companies at the early stages of a significant mineral discovery.
• Junior Mining Exploration Companies: Smaller companies focused on finding new mineral deposits.
• Major Mining Companies: Larger, established companies that acquire discoveries from juniors to develop them into mines.
• Takeover: The acquisition of a junior mining company by a major mining company, often a primary exit strategy for investors.
• Prospect Generator: A type of junior company that acquires prospective land packages, conducts early-stage exploration, and then joint ventures these projects with larger companies to fund drilling.
• Discovery Hole: The first drill hole that intersects significant mineralization, indicating a potential new deposit.
• Grade: The concentration of a mineral within a deposit (e.g., grams of gold per ton of rock).
• Interval: The width or thickness of the mineralized zone intersected by a drill hole.
• Copper Equivalent (CuEq): A metric used to express the value of multiple metals in a single grade, often used in copper and gold exploration.
• Joint Venture (JV): An agreement where two or more companies share the costs and risks of a project.
• Rollback: A corporate action where a company consolidates its shares, often to increase the per-share price.

Overview of Discovery Hole Investing

This discussion, featuring Steve Tatarok, a geologist and broker with SPAT Global, delves into the strategy of "discovery hole investing" within the junior mining exploration sector. The core premise is that significant returns for investors can be achieved by identifying and investing in small companies that make substantial new mineral discoveries, which are subsequently acquired by larger mining corporations. The interview, originally from 2017, is presented as timeless advice for investors.

Current Market Environment and Junior Explorers

Tatarok describes the mining exploration market as significantly improved over the preceding 3-4 years, which he characterized as a prolonged and ugly bear market. He notes that current gold and silver prices are reasonably good, though copper could be better. Major mining companies, having undergone cost-cutting measures, are now profitable and are beginning to reinvest in the junior sector, increasing investor confidence in higher-risk junior companies. The fundamental role of juniors is to explore for new deposits, which majors then acquire to build new mines.

Ideal Profile of a Junior Explorer for Takeover

Tatarok emphasizes that truly significant discoveries are rare, estimating only two to five "good-looking discoveries" annually. His criteria for recommending a junior company to clients are stringent, aiming for a high probability of a successful takeover. He seeks companies that have the potential to discover at least 1 million ounces of gold with good grade. However, he considers a 1 million ounce deposit insufficient for acquisition by mid-tier or major mining companies. Ideally, he looks for the potential for multi-million ounce gold deposits. He clarifies that while a 1 million ounce discovery can transform a junior into a mining company, it's not typically large enough for a takeover by major players.

Investing in Different Junior Company Models

Prospect Generators

Tatarok acknowledges that many investors, lacking a geological background, benefit from strategies like investing in prospect generator companies. These companies, such as Altus Minerals (formerly Virginia Mines), spend other people's money to identify prospective ground. Their management teams, with a track record of discoveries, conduct early-stage exploration (stream sediment sampling, soil sampling, prospecting, geological mapping, geophysics) to identify anomalies. They then seek joint ventures with larger companies to fund the expensive drilling phase. A key factor for success in this model is a low number of outstanding shares. Tatarok suggests investors buy a basket of prospect generator companies to diversify risk, as multiple properties being drilled increases the chance of a discovery.

Direct Exploration Companies (100% Ownership)

In contrast, Tatarok's preferred approach is to invest directly in companies that make a brand new discovery and successfully drill it out into a valuable deposit, leading to a takeover. He advocates for getting in "real early" and riding the investment through to the acquisition. His strategy involves waiting for the "discovery announcement" and then evaluating the opportunity.

Criteria for Discovery Hole Investing

Tatarok's investment decision hinges on the initial discovery drill hole. He looks for:

• Wide Intervals: Large drill hole widths are crucial for defining big deposits. He contrasts this with small, narrow drill holes that typically result in smaller deposits.
• Good Grade: The concentration of the mineral must be high enough to be profitable at current and potentially lower metal prices.
• Potential for Large Deposits: He seeks evidence suggesting the potential for multi-million ounce deposits, not just 1 million ounce discoveries.

Timeframe and Investor Perspective for Discovery Plays

Developing a large deposit from a discovery hole typically takes 2 to 3 years. This involves drilling numerous holes, with each hole taking 1 to 3 weeks. Investors need patience, as news releases are expected every 4 to 6 weeks during active drilling. Tatarok advises that not all drill holes will be successful; a 60-70% success rate is considered good. He cautions against immediately selling after a single poor drill hole, as blank zones can occur within a larger deposit. However, he also notes that a series of "duster" holes after initial success can indicate the edge of a deposit or a smaller-than-expected discovery, leading to a potential end to the story. He shares personal experiences where he should have sold earlier when a deposit failed to grow.

Risk and Reward in Discovery Hole Investing

Tatarok estimates that this strategy works out "pretty good" 60-80% of the time. He recalls only two significant losses in his experience, neither of which went to zero. In one case, an investment from $0.60-$0.70 rose to $4.00-$4.25 before declining to $0.15. He managed to exit around $0.30, resulting in a roughly 50% loss, but he had profited significantly before the decline. He emphasizes that when a deposit's growth potential is confirmed as over, the stock can crash rapidly, leaving little time to exit.

Case Study: Mariana Resources

Tatarok highlights Mariana Resources as a recent winner. Approximately three years prior to the interview, Mariana and its joint venture partner, Lydia, in Turkey announced two "fabulous" drill holes with good widths and high grades, suggesting the potential for a multi-million ounce deposit. The drilling continued to yield even better results, ultimately defining over 4 million ounces of good-grade gold. He notes that even at a low gold price of $1,050/ounce, the deposit would have been profitable. He also addresses the political risk of operating in Turkey, but felt confident due to Mariana's partnership with a large Turkish conglomerate, which he believed would facilitate permitting and mine construction. The initial investment was around $0.30 (equivalent to 3 pence in London before a 10-for-1 rollback), and the stock reached approximately $1.70-$1.75 before trading ceased due to a merger.

Case Study: Aurelian Resources

Tatarok considers Aurelian Resources his biggest winner on a discovery play. In 2006, Aurelian announced a new gold discovery in Ecuador with a significant drill hole: 242 meters of 4.5 g/t gold, including a high-grade interval of 60 meters of 30 g/t. He described this as the best drill hole he had seen in 15 years. The stock surged from $0.50 to $3.00 in three days. He began investing his clients at $3.00. Aurelian continued to drill even better holes, and within two years, the stock reached a high of $42.00 before Kinross Gold acquired the company at $34.00.

Holding Through Feasibility and Mine Development

While takeovers often occur at the initial peak of a share cycle, Tatarok explains that if a junior is not acquired, management faces a decision: abandon the project or advance it. For large deposits, a lack of takeover suggests unanswered questions. Management may then bring in new expertise to advance the project through studies and potentially mine construction. Majors can acquire juniors at any stage, even during a downturn. If an investor believes in the project, holding on through these phases can still lead to profit, even if some gains are left on the table. The hope is that the stock price during a downturn does not fall below its pre-discovery low.

Investing in Uranium Explorers

Tatarok's experience with uranium exploration includes Paladin Energy (investing at $0.06 Australian in 2003-2004, with uranium later reaching $10) and Hathor Exploration, which drilled a significant discovery (5 meters of 11% uranium). Hathor was eventually acquired by Rio Tinto for approximately $4.50. He also mentions Alpha Minerals and NexGen Energy.

However, his current opinion on uranium exploration is cautious. He sees no immediate signs of uranium price increases due to the Fukushima disaster, the availability of cheap fossil fuels and alternative energy sources, and general hesitancy towards nuclear energy, especially in Western countries. He is reluctant to invest in uranium stocks in the next 1-3 years, though he would consider it if a new, high-grade discovery, particularly in Canada's Athabasca Basin, emerged. He suggests playing the uranium space by acquiring full warrants with long expiry dates (e.g., 5 years) to allow time for potential price appreciation.

Contact Information

Steve Tatarok can be contacted for investment purposes at 1-800-477-853 or via email at s.toddter@sprglobal.com.

Conclusion

The interview emphasizes that successful discovery hole investing requires patience, a deep understanding of geological potential, and a disciplined approach to risk management. While prospect generators offer a diversified entry point, Tatarok's preferred strategy focuses on identifying and investing in companies at the cusp of significant discoveries, aiming for substantial returns through eventual takeovers by major mining companies. The current market environment is seen as favorable for such investments, with majors actively seeking new growth opportunities.