Mine Development Risk Profile

There are several stages in the development of a gold or silver mine -- from the exploration that leads to the initial discovery of a mineral deposit through to commercial production. (The same, of course, applies to the development of any other type of mine, but our focus is on gold and silver.) Furthermore, each stage has its own risks and opportunities.

Displayed below is a chart titled "Mine Development Risk Profile" (MDRP) that shows how we view the mine development process. Our MDRP breaks the process down into 6 stages, with each stage allocated a certain investment risk level relative to other stages. Each stage's relative investment risk is based on our assessment of the potential for good news versus the potential for negative surprises.

Additional explanation of each stage's risk level is warranted, so here we go:

1. Pre-discovery exploration (Stage 1) is by far the riskiest stage. A very small percentage of companies that go looking for gold (or silver) end up finding a valuable deposit, so the probability of failure is orders of magnitude greater than the probability of success. When success does occur the rewards tend to be spectacular, but we prefer situations where we can quantify value. We will occasionally take a small position in a Stage 1 company in our own account, but will never include such companies in the TSI Stocks List.

2. Post-discovery exploration / pre-feasibility (Stage 2) is what we think of as the 'sweet spot'. In this stage the company has proven that it has an attractive deposit on its hands; it's just a question of how big. Companies that are in Stage 2 tend to issue drilling results on a regular basis and each set of results tends to be good. At the same time there is minimal scope for negative surprises such as cost increases and delays.

3. The risk ramps up a little in Stage 3 because the detailed assessment of project economics increases the potential for bad news, particularly with regard to the amount of money the company will need to build a mine. Also, this is the stage where various permits are obtained, opening the door to government- and NGO-related interference. Good news on the drilling front will generally become less frequent and less important during Stage 3, although once a junior mining company has completed a positive Feasibility Study and obtained the necessary construction permits the probability of a takeover bid will rise.

4. Once a company goes into the mine construction phase (Stage 4) there is little scope for good news and considerable scope for bad news in the form of delays and cost overruns. Therefore, all things being equal we would avoid Stage 4 companies, but all things are never equal and Stage 4 stocks sometimes offer excellent risk/reward ratios due to shareholders losing interest or over-reacting to negative surprises.

5. It is necessary to include a stage between construction and commercial production because the initial period of production offers-up the potential for very disappointing news. The point is that you never really know what a mine's operating margin will be until it actually begins to produce, so although the risk declines at the completion of the construction stage it remains at a relatively high level until the design parameters are achieved.

6. Once commercial production is achieved and the mine begins to generate positive cash flow the relative risk plunges to its lowest level. Under normal circumstances a company should therefore receive a substantial upward re-rating in the stock market after it moves from Stage 5 to Stage 6.