The rise of the small cap resources stocks #70

by Barry Dawes

Dawes Points: The Rise Of The Small Cap Resources Stocks

Key Points

ASX.XSR Small Resources Index up 5% for week 6 Oct and about to surge
Commodity prices rising
Battery metals looking very strong
Pilbara ‘Wits’ stocks providing boom concepts
Industrial metals stocks ready to rise
Oil and gas stocks offer outstanding value
The world still awash with cash
All Ords finally through 5,800!

Call me to discuss ways of participating bdawes@mpsecurities.com.au +61 2 9222 9111

The Global Resources Sector is now well on its way to substantial value rerating as investors have their awakening to the perfectly robust economic data from most countries and especially from China and the US. The whole concept of rising living standards Chindia and ASEAN is coming back to mainstream.

Resources commodity prices are rallying and multi year highs have been achieved by zinc, copper, aluminium and lead. Many other positive and exciting actions throughout the broad resources sector are assisting.

The lead in this Global Resources recovery has been taken by the Australian gold sector which bottomed in Dec Qtr 2014, a full year ahead of the next sector which has been the large resources stocks such as BHP, RIO, S32, FMG and OZL. The resources sector small caps have had mixed results but recent action, especially the 5% gain in the week ending 6 October 2017 has set them ready for a strong run.

Dawes Points has continually pointed out the strength in the Chinese and global steel industries and the positive effects on iron ore.

Steel is just a proxy for consumption of all metals and the price responses in copper, zinc, lead, aluminium and tin amongst the industrial metals and even stronger price responses in technology metals tungsten, antimony, lithium and cobalt reflect robust demand, supply limitations and low inventories.

Price responses over the next few years should be very strong.

This graphic was displayed last month but is still is telling a very strong story.

The world is on track.

It is pleasing to see BHP taking up the One Belt One Road Initiative (Belt Road Initiative – `BRI‘) and pointing out the need for another 150mt of steel for already identified projects over the next decade.

The BRI will affect many countries in Asia and Eurasia so it is no coincidence that this graphic of emerging markets is telling us that the recent break out of this portfolio has many, many years to run.

And even the Australian Department of Industry, Innovation and Science has entered the commentary on growth scenarios for India for 2035 with >1000mt of steel demand in the high intensity option.

Source: Department of Industry, Innovation and Science

Some fancy numbers for an India that might surpass China in resources commodity consumption.

All these add to the Dawes Points expectation of at least a decade of economic boom to benefit Australia’s resources sector.

Sorry if this is repetitive but it is happening and the markets have yet to properly value the stocks. This expectation has been tenaciously held here and has been unwavering.

The Australian Department of Industry, Innovation and Science has produced some helpful graphics on various Australian key exports.

This one depicts the iron ore markets:-

And this one is thermal coal.

Note that despite the ravings of most Australian State Governments and the nonsense from so called environmental activists there are 365 advanced technology coal fired power stations planned or under construction around the world. 135 are in India and it will be importing very large tonnages of low sulphur coal. Where will it come from? Mostly Australia.

It defies logic that closing of coal-fired power stations in Australia will have any impact on global emissions when 100 times Australia’s near term needs are being built elsewhere.

All this has been excellent for the larger resources stocks as seen by the rises in BHP, RIO, FMG and S32 and as being suggested by Dawes Points over the past year.

The Metals and Mining Index has broken its downtrend and has moved higher after its own `goodbye kiss’.

This index is matching the Global Resources Indices as mapped by S&P.

But more importantly for us is the increase in market share of All Ordinaries turnover and the five week trailing moving average is now above 20% again.

So all that is very good for the bigger stocks but now let’s just focus on the ASX.XSR which closed at 2342, up 5% for the week.

The current 2342 is now finally above the Dec 2008 GFC low of 2265 and the targets I see are over 4000 by end 2018 and 5000 within two years.

Note, too, that XSR market share of ASX.XAO turnover was 6% for week ending 6 October! The five week trailing moving average is over 4%.

This is a vital indicator and it is so positive.

The XSR has 38 stocks of which

Gold companies	12
Oil and gas	8
Battery tech materials	6
Mining Services	6
Metals	4
Coal	2
Total	38

The gold sector therefore has a big bearing on this index.

Given that almost all the gold stocks in the XSR are gold producers and about half are paying dividends.

Market share of turnover is creeping up again after the last pullback in US$ gold. Expect this to be averaging closer to 5% in 2018 as gold prices head higher.

The ASX XGD Index has not been a particularly good index prior to about the beginning of 2015 and so not surprisingly the XSR isn’t too wonderful either.

As noted, it has 38 stocks in various subsectors but I would question the inclusion of the 6 mining services companies and it has just 4 industrial metals-related and no iron ore stocks.

Also for a small cap index, 15 of the 38 are over A$1,000m in market cap including 5 over A$2,000m. Just five are less than A$300m.

38 stocks with a combined market cap of $41bn.

Nevertheless, I particularly like the oil and gas sector and there are 8 here in the XSR. The Australian Eastern Seaboard gas debacle will assist gas producers capable of supplying this need and benefit will also flow to WA Perth Basin players. In addition, global oil demand continues to exceed forecasts whilst US tight oil output continues to underdeliver. Expect higher oil prices.

Also the XSR has six companies in the battery technology resources that cover lithium, graphite and cobalt.

Note that lithium producer Orecobre (floated by MPS in 2007) is making >US$6000/t operating margin on its FY18 target of 14,000tpa lithium carbonate and aims to more than double output to 35,000tpa. ORE has a market cap of around A$1000m (is this really a small cap stock?) and has recently made new highs above A$5.00.

Orecobre’s view of electric vehicle demand is suggesting that the supply of lithium carbonate will not match demand so that higher prices are inevitable.

Source:Orecobre

The lithium battery market will require supply from many new sources and graphics like this show many players are in the game at differing stages of development. Opportunities are many.

Selection of Lithium Development Project Companies

Source: Sayona Mining Ltd

Graphite is the other key component in lithium batteries (along with cobalt and nickel) and within that expansive universe of development projects these are some with reasonable prospects.

Selection of Graphite Development Companies

Source: Bass Metals Ltd

Of the four metals companies in the XSR only one is under A$600m and the two coal companies have a combined market cap of A$5,300m.

In contrast, there are literally hundreds of small cap resources stocks with market caps below A$100m and many under A$10m.

So these do not get representation in any index but so many are very active.

One subgroup that is having its own boom is the new Pilbara Conglomerate Gold Rush that is bringing forth an exciting new concept.

The Witwatersrand Gold Deposits of South Africa are the by far the largest gold source so far on the planet. The gold occurrence is considered to be an alluvial accumulation of gold in thin layers of conglomerate (ie rocks made up of other rocks and generally deposited in some active riverine environment) rocks. The source of the gold and the actual occurrence of the gold is not yet conclusively determined but it certainly is a lot of gold.

Schematic Diagram of Witwatersrand Gold Deposits

The global inventory of gold combining all the gold ever mined is around 180,000 tonnes. About 60,000 tonnes at about 15g/t are considered to have come from the mines of the Witwatersrand and current estimates are that there are another 35,000t as resources and there would probably be another 50,000t that would be unmineable due to depth and other considerations.

This is around 150,000t of gold.

In comparison, Australia’s biggest and best (so far) Kalgoorlie Golden Mile has produced about 3,000t (or about 100moz).

The idea of a Witwatersrand paleoplacer conglomerate analogue in Australia has been mooted around the Nullagine region in WA for many years and several groups have explored this target. Additionally small gold recoveries had been reported along the north west and north east rim outcrops of the basal unit of the Fortescue Basin but no economic significance had been given to these.

However in more recent years around Karratha, about 350km to the north, prospectors had been fossicking with metal detectors along a 10 km zone of outcrop of conglomerates and had a reasonable degree of success. (I have been advised that Karratha has the highest number of boats per capita in Australia. And the highest number of metal detectors per capita!)

Their shallow diggings have actually left a clear geochem signature over about 8km for professional explorers to now follow.

This surface rim outcrop is a basal unit of the Fortescue Group sediments.

The Fortescue Basin is a mafic (iron and magnesium-rich) volcanic rock dominated sedimentary formation that sits unconformably over the Pilbara Craton. The basin dips about 3-5% to the south. The age of the Fortescue Basin is the same as the Witswatersrand basin and the stratigraphy is quite similar.

The Beaton’s Creek paleoplacer conglomerate deposit at Nullagine was in more recent years actively explored by Canadian company Novo Resources as a Witwatersrand target. The deposit is multiple stacked alluvial gold reefs and Novo considers it a major target for low cost near surface mining. Sumitomo has an option to farm in. This project has resources of 6.4mt @ 2.7g/t (558koz) made up of Measured and Indicated Resources of 3.39mt @ 2.7g/t and Inferred Resources of 3.0mt @ 2.7g/t.

Novo Resources became intrigued with the success of the prospectors subsequently revised its strategies and over the past year acquired extensive tenement around Karratha.

Source: Novo Resources

Recognition of a larger scale to these other conglomerates led to Novo Resources acquiring the Comet Well tenements and consequently in July 2017 entering into a JV with Artemis Resources at the contiguous Purdy’s Reward tenement which has actual surface outcrop and an opportunity to economically test the concept.

As far as the exploration industry is concerned this is probably universally seen as a unique style of gold mineralisation not seen before.

Gold nuggets in the shape of watermelon seeds have been found throughout the thickness of the strata. In addition, quite high volumes of fine gold has accompanied the larger nuggets.

A few of these per cubic metre can give you those high grades.

Source: Artemis Resources

The Witwatersrand is similar but very different. A paleoplacer conglomerate is also known in Ghana at Tarkwa where a very large +15moz gold deposit @ 1.2g/t is being mined by AngloGold-Ashanti.

Conceptual Cross Section of Basal Conglomerates Extending 10km downdip

Source: Novo Resources

CRA had drilled a 2200m deep vertical hole deeper in the basin in the 1980s and intersected conglomeratic sediments at a depth of 1756m that assayed 11.7g/t. The important basal units were evidently not assayed.

This hole was about 65km away from Comet Well/Purdy’s Reward to the south so the continuity down dip is possibly very high. Keep in mind the dip is only 3-5^o.

Recent trenching bulk samples at Purdy’s Reward provided 67g/t and some further trenching work with metal detectors was beamed live into the recent Denver Gold Conference. You can see it here. Worth spending 10 mins on this.

https://www.youtube.com/watch?v=Z-YK4r6VUoc

Novo is now undertaking a programme to further test the surface outcrop with trenching and some innovative 17.5 inch large diameter RC drilling rigs in a two month programme that should provide some definitive answers on downdip continuity by end 2017.

Novo is also using some innovative X-ray ore sorting machines to reduce ore bulk and processing costs.

Detailed Cross Section of Comet Well/Purdy’s Find showing Drill and Trenching Programme

Source: Novo Resources

The drilling programme will be to confirm the extent of the conglomerate along this section and down dip. With the nuggety nature of the gold it will be the presence of the conglomerate itself rather than an assay that will be important.

Prominent Canadian Gold Producer Kirkland Lake owns the Fosterville mine in Victoria which produced 77,000oz in the June Qtr at 17.2g/t and is rumoured to have found over 500,000oz @>50g/t deeper in the mine. It likes high grade mines and has taken a C$50m investment for a 9.2% holding in Novo Resources.

Novo is now cashed up for a big exploration programme and with Artemis also having the 450ktpa Radio Hill Mill ready to start production here or on its own tenements after minor refurbishment.

Another ASX gold minnow De Grey Mining has also tenements at Louden’s Patch in the Fortescue Basin and has also received funding from Kirkland Lake.

Cross section showing orientation of target area at Louden’s Patch

Source: DeGreys Mining

Loudens Patch nuggets

Source: DeGreys Mining

The potential size of these deposits is without peer in Australia.

The Chairman of Novo, Dr Quinton Hennigh, is a highly regarded geologist and his view of the formation of the Witwatersrand was through precipitation of the gold from seawater and this allows for very large areas to collect the gold. The areas covered by Novo’s tenements are over 10,000km² and, like coal deposits or iron ore deposits, tend to be quite continuous.

Trying to put together a target size is very difficult.

If the 8km strike length at Purdy’s Reward is continuous as the metal detector fossickers’ track suggest and if the conglomerate is at least 5m thick (most up are up to 20m) and if it continues for at least 1000m down dip (as indicated by the cross section above) then a large volume of 40million m³ is generated.

If the grades are 10g/m³ (say 5g/t @ a Specific Gravity of 2.0) then 13moz would be a reasonable target.

Increase any of the components other than strike then we could have any of these:-

300moz is only about 10,000 tonnes.

And consider that the CRA hole was 65km away at 1756m depth.

Witwatersrand is 150,000 tonnes.

But clearly, proof of continuity will be critical.

Small resources stocks just might have a very strong run.

And the Gold Index just might double within the next 10 months.

Don’t forget Mustang, ASX.MUS, now with over 350,000 carats of rubies to auction this month. At what received price?

At US$60/ct this is US$21m (A$27m)gross revenue but with US$100/ct it is US$35m(A$45m).

Costs should be well under US$10m. MUS currently has about 65% equity.

Not bad for 9 months work against a market cap of A$85m!

Of course as was noted in Dawes Points #69 local investors are very well cashed up.

Class Super SMSF asset Allocation Showing Low Equities and High Cash

The bigger brothers in the Future Fund have had a good steady record of appropriate returns but with just A$8bn in Australian Equities (6.0% of funds) and A$28bn in cash (21%) they will be missing out on the Resources Boom.