At Global Small Caps, we usually steer away from mining companies and mining stocks, especially those classified as “Junior Miners,” which are companies past the initial prospecting phase and mainly involved in assessing the value of a particular property initially identified as promising. These junior mining companies usually need to raise relatively significant amounts of capital in order to fund the geophysics, drilling, sampling, assaying, testing, and governmental/environmental permitting that are required. Once a junior mining company successfully raises the necessary capital and proves out the reserves, the entire operation is often sold, or otherwise taken over by, another mining company that actually digs the assets out of the ground.
Our cautionary view on most resource companies is based on the need for capital funding which is often found to be excessive, and the risk to be extremely high compared to other areas where risk-averse small investors, the typical readers of our reports, can place capital.
When we were introduced to Kootenay Zinc Corp., at first we were a bit hesitant. However, upon initial analysis we quickly learned that we didn’t have to be experts in the analysis of junior miners in order to understand the opportunity that is in front of the company. We think there is a very interesting opportunity relative to the company that is rather simple to understand for both the experienced mining operation investor and those who are less versed in the intricacies of the sector.
We are intrigued by the significant similarities of the company’s Sully project, which management is working to develop, when compared to the once highly lucrative Sullivan mine, which is only 18 miles away. While drilling data thus far have not proven the extent of the mineralization, the results have not been completely disappointing as it appears the initial work program not only pointed to similar geological features as Sullivan, but also provided the company with valuable information to further its drilling efforts.
Also, very interesting are the prospects for Kootenay relative to the overall market dynamics of the zinc market. Analysts who in 2014 predicted supply constraints with continued strong demand were right on target. While zinc prices dipped in 2015, zinc led the basic metals market very significantly in 2016. The fundamentals of the zinc market appear to be very sound, and while more supply is already coming online, prices remain near long-term highs. We believe that even with a continuation of zinc price drops that have been seen thus far in 2017, the overall market dynamics for the metal appears to be strong, especially considering the often-forecasted reduction in Chinese GDP has failed to materialize.
It’s also exciting to see such an experienced advisory and scientific team on board. Several of the members are leaders in the mining industry and all have significant experience. Noteworthy, in our opinion, is that several team members have specific experience at Sullivan and with its geology. Simply put, we believe a junior mining operation oriented toward zinc would have a difficult time finding a more experienced team.
Zinc is one of the major “base metals” along with copper, aluminum, steel, tin and lead. These metals are vital to virtually every economy throughout the world, as all are major inputs used in manufacturing, construction and production. Zinc is vitally important to most of our lives, although most consumers and investors likely hear a lot less about zinc compared to the other base metals.
As is outlined in Exhibit Two, the most important use of zinc is as an additive or coating to resist corrosion of other metals. The process of galvanizing metals to prevent corrosion is heavily reliant on zinc and plays an important part in most construction and transportation related industries. While more than half of all mined zinc is used in galvanizing, there are many other industrial processes that rely on the metal. These include die-casting, the production of brass, which is a combination of zinc and copper, and as an additive to paints and fertilizers.
In early 2014, one of the hot topics in the metals market was the looming shortage of zinc. The investment premise at that time was that a constrained supply combined with growing demand would result in shortages and significantly rising prices.
In fact, while demand remained strong in 2014, supply was constrained with several large zinc mine closures, including the mega Century mining operation in Australia. By mid-2014, zinc was at a three-year high and demand was such that the amount of zinc being pulled out of the ground began to lag demand.
By the first quarter of 2015, the prediction made one year previously came to fruition. The predicted shortage began to materialize as the effects of the Australian mines closures hit the supply chain and as several Irish mines made final shipments and closed operations. By mid-2015 the metals analysts continued their optimistic forecasts for zinc predicting further supply/demand imbalances to continue for at least several more years.
While the analysts correctly predicted the constrained supply, they didn’t necessarily get it right relative to pricing. Much of the anticipated rally in zinc prices failed to materialize during 2015 as demand from many critical zinc-dependent industries lagged.
While zinc prices plummeted for almost the entire last nine months of 2015, as is outlined in Exhibit Three, at the beginning of 2016 there was a rapid turnaround in the zinc market. Weakness in the U.S. dollar caused a rally in virtually the entire metals sector. While several other metals were not able to sustain the rally, the situation relative to zinc was very different.
As the supply situation grew even tighter, pent-up demand from major industries in India and China hit the limited supply, which resulted in significantly higher prices. As outlined in Exhibit Four, the surge during November 2016 was particularly pronounced with prices by the end of that month gaining 50% over the January 1, 2016 price.
By the end of 2016, with prices up 60% on the year, it became obvious that many of the analyst predictions of constrained supply and robust demand that had they made two years earlier were right on the money.
The period of January 1, 2017 through the end of April 2017 saw an additional 32% jump in the spot price of zinc.
While zinc prices have pulled back from the lofty levels of January 2017, many believe the supply/demand imbalance will continue for the foreseeable future. Much of the decline in early 2017 had nothing to do with the actual supply/demand situation, but was attributable to concerns that the booming price would attract more supply onto the marketplace. While there had been many mine closures during the previous three-year period, several major mining operations were still operating below theoretical capacity. Additionally, during of the first quarter of 2017, there has been significant discussion about the strength of industries that are major consumers of zinc.
Long-term demand for the metal still seems robust in many people’s opinion. With the infrastructure and construction markets taking up over 60% of zinc’s demand, the strength of futures and spot prices are closely correlated to GDP growth. While early in 2017 there were many concerns relative to potential weakness in Chinese GDP growth, weakness certainly did not materialize with GDP at nearly 7% for the March 2017 quarter, the fastest pace for the Chinese economy in more than two years.
For the full year 2016, there was a significant demand versus supply deficit, with several analysts indicating that nearly 300,000 metric tons of zinc was consumed in excess of what was mined, as is shown on Exhibit Five. As is explained above, this was primarily attributable to the closure of several major mining operations.
The price for the rest of 2017, of course, is anyone’s guess. There appears to be some credence to the theory that the strong rally in zinc prices that was related to the supply/demand imbalance may be coming to an end. Several mining operations that had been shut down due to low prices in 2015 are currently the process of restarting as prices moved well above the recent historic averages.
While this increased supply may temper future price rallies, it is generally thought these expanded operations will not be able to bring significant supplies to the market for at least several more years. Therefore, while the sharp price increases in zinc may be over for now, prices are still at very attractive levels on a historic basis.
As discussed above, zinc prices remain high relative to historic levels as a result of continued strong demand at a time when supplies are being constrained. The demand versus supply imbalance is creating significant opportunities for mining operators that either increase production levels of current operations or bring new resources to the marketplace.
While it is certainly clear that mine operators who had curtailed operations during the price slumps of 2015 are in the process of bringing back online some of the shuttered capacity, there are other companies that are seeking to develop entirely new sources of zinc.
Kootenay Zinc Inc. is one such company. Kootenay is an exploration stage company based in Vancouver, British Columbia, Canada that has its eyes on developing what could be one of the largest zinc mining opportunities seen in a long time.
Mineral and metal prospectors look for specific geological formations in order to predict the best locations to explore. For example, one positive sign that gold exists within a geographic formation is the presence of quartz. Therefore, prospectors and geologists search for quartz reef formations as a sign the area may present opportunities for gold mining.
There are also specific geographic formations that point to significant deposits of zinc. Sedimentary Exhaustive Deposits, called SEDEX deposits, are by far the most important geographic formations pointing to significant deposits of zinc and lead, and to a lesser extent silver, gold, copper and tungsten.
The geology of SEDEX formations is significantly outside the scope of this report. Simply put, such formations and deposits form due to a very specific set of geological events occurring over long periods of time. The earth is divided into many different tectonic plates, which are constantly shifting. The source of growth for these tectonic plates occurs deep within the oceans along mid-oceanic ridges, which are somewhat like underwater mountain ranges. As material moves up from the lower layers of the earth through these mid-ocean ridges, the materials are mixed with ocean water. These materials, which include metals such as zinc, when combined with sea water undergo various changes and eventually settle into sedimentary formations, which geologists have named Sedimentary Exhalative Deposits, or SEDEX. Any discussion of zinc prospecting and mining needs to take into consideration SEDEX formations, as such deposits are responsible for more than half of the world’s zinc and lead deposits.
To summarize, if you want to find zinc or lead within the Earth’s crust, a SEDEX deposit is a great place to start. There are of course two options here – the first is to find a new SEDEX deposit. The second is to search for zinc or lead within proximity to an existing SEDEX deposit.
Kootenay is doing the latter.
While geologists have found more than 25 significant SEDEX deposits worldwide, the three largest are located in Australia, the United States, and Canada. Some of these are noted in Exhibit Six. Notice the Sullivan formation is noted as one of the world’s largest, where Kootenay Zinc is exploring 18 miles away.
Mt. Isa, in Australia, is easily the largest accumulation of zinc, lead and silver in the world. The general area has five gigantic SedEx deposits, which have been mined for billions of dollars of these commodities. Arguably, the second-largest deposit is called Red Dog, which is located in Alaska. That site alone produces approximately 6% of all worldwide zinc.
Also of significant size, and particularly germane to the Kootenay Zinc story, is the Sullivan Deposit, which is located in British Columbia, Canada. Prospectors discovered the deposit in 1892 and it was quickly put into service. Sullivan has produced over 17 million tons of zinc, lead and a significant amount of silver. It is estimated the value of the zinc, lead and silver mined at Sullivan is worth more than $40 billion.
The zinc, lead, and silver that was deposited at Sullivan was the result of a unique SEDEX deposit that formed hundreds of millions of years ago in the Aldridge and Selwyn ancient sea basins. After more than 92 years of active production, the Sullivan mine was closed in 2001.
In close proximity to Fort Steele, British Columbia, Canada and approximately 18 miles (30 km) to the east of the Sullivan Mine is the Sully Project, which is being developed by Kootenay Zinc. While there are relatively good odds that the SEDEX deposit extends from the site of the former Sullivan mine for 18 miles to the company’s Sully Project, significant drill work and research needs to be completed to prove out the geological theory.
In fact, there are many geological similarities between Sully and Sullivan. For example, several of the geographic formations are of the same type at both locations and research indicates that the formations at Sully were formed at the exact time, hundreds of millions of years ago, as when the formations were formed at Sullivan. These facts do not prove significant zinc/lead deposits, as additional work must be performed in order to provide more conclusive evidence.
While the intricacies of gravitational and other geological testing techniques are outside the scope of this report, there have been various such tests performed at Sully that compare very favorably to the exact measurement results performed on the Sullivan site. These tests involve complex analysis of gravitational and magnetic abnormalities at both locations, the results of which lead geologists and the management team of Kootenay to believe the SEDEX deposit may extend all the way to the Sully site, indicating at the very least, two large undetermined anomalies present on the property.
But, of course, the data described above, while quite sophisticated, only indicate the likelihood or the possibility of a significant deposit of zinc and lead. In order to prove the existence, the company must continue its drilling program at the site to pull up core samples, which are then tested for the existence of mineralization.
At the beginning of January 2017, the Company updated investors on the latest gravitational model for the Sully project. Based on this updated model and information obtained from test drilling during November of 2016, the Company announced that the drilling program would be expanded.
In mid-March of this year, the Company announced it had completed drill hole SY-17-11, but the test “…did not intersect an extensive high density mass, but did intersect a number of geologically significant features with similarities to the Sullivan sedimentary environment.” This means they did not find evidence of a significant deposit, but what they did pull up further indicated that the geological features of the Sully site are in fact very similar to those of the very lucrative Sullivan mine site. Basically, not great news, because they did not find exactly what they were looking for – but nevertheless it offers hope that they are near the right location.
The Company, at the end of March, announced it had reviewed additional gravitational data relating to the Sully site that further validates their belief in the potential for a significant deposit at Sully. Management indicates this information will be used to further refine the drilling strategy. The Company also indicated that the drilling program would resume in late April of 2017.
As of early May 2017, publication date of this report, management and the Company’s investors are now eagerly awaiting commencement of drilling at the SY17-10/11 site in order to prove that the gravity related tests performed earlier are in fact assisting the geological team to zero in on the anomalies present.
We are intrigued by the team Kootenay Zinc has put together to manage the development of the Sully Project.
It is almost an understatement to indicate that the team is highly experienced, having worked at some of the world’s most significant mining operations. Additionally, on board is a technical team that has very strong expertise, including specific experience at Sullivan.
Mr. Angus is one of the most experienced business advisors to the mining industry. He is the former chairman of the board of B.C. Sugar Refinery Ltd. and he was a director of First Quantum Minerals until June 2005. He was also a director of Canico Resources Corp. until its takeover by CVRD in 2005, and a director of Bema Gold until its takeover by Kinross Gold in 2007.
More recently, he was managing director of mergers and acquisitions for Endeavour Financial, a director of Ventana Gold until its takeover by AUX Canada Acquisition in 2011, and a director of Plutonic Power until its merger with Magma Energy in 2011. He is presently chairman of Nevsun Resources Ltd., which operates one of the highest-grade open-pit copper mines in the world. He is also the current chairman of K92 Mining Inc.
Jonathan Rubinstein is the chairman of Mag Silver Corporation and is vice president of Andagan resources Corporation. We believe it’s significant that he was also one of the founders of Canico Resources Corporation where he acquired and developed the Onca Puma nickel deposit in Brazil. He brings significant management and corporate finance experience to the team.
The Company has also managed to add Peter Meredith to its advisory board. Meredith has been a director of Ivanhoe Mines Ltd. (formerly, Ivan plats Limited) since May 1998. Mr. Meredith is the former Deputy Chairman and Chief Financial Officer of Ivanhoe Mines Ltd. (now Turquoise Hill Resources Ltd.), where he was involved in overseeing Ivanhoe Mines Ltd.’s business development and corporate relations. Mr. Meredith was member of the board of directors of Ivanhoe Mines Ltd. and also served as its Chief Financial Officer from May 2004 to May 2006, and from June 1999 to November 2001, and as its Deputy Chairman from May 2006 to April 2012. Mr. Meredith was also Chairman of SouthGobi Resources Ltd. until September 2012.
We believe a significant addition to the technical team is Paul Ransom, due to his specific experience and knowledge of the Sullivan deposit. Mr. Ransom is a geologist and noted Sullivan SEDEX deposit expert, having worked for over 33 years with Cominco (now Teck Resources Limited) at the Sullivan Mine and on related regional geology. Mr. Ransom has authored and/or co-authored ten papers on geology of the Sullivan deposit. Mr. Ransom also spent 1.5 years as a project geologist under secondment to Mt. Isa Mines in Australia, another large-scale copper, lead, zinc and silver mine. Mr. Ransom has worked extensively in the Kootenay region of B.C., including managing drilling at Sullivan Deeps, but has also worked in the Yukon and Northwest Territories. Mr. Ransom’s passion for finding other mega-SEDEX deposits has been a career-long pursuit.
Dr. David Broughton joined Ivanhoe Mines in January 2008 and has overseen Ivanhoe Mines’ discovery of two major mineral deposits, Kamoa in the DRC and the Flatreef in South Africa.
Dr. Broughton is recognized as an expert in sediment-hosted copper deposits, and has been a key participant in several discoveries and successful development projects: (DRC), Namibia, China, United States, Canada and Poland. He was co-leader of the Kamoa discovery team that is the 2015 recipient of the Prospectors & Developers Association of Canada’s (PDAC) prestigious Thayer Lindsley Award. This award, honouring the memory of one of Canada’s greatest mine finders, recognizes an individual or a team of explorationists credited with a recent significant mineral discovery.
Investment in Kootenay is certainly not without significant risk, but we are intrigued by the opportunity. Over the past two years, zinc has clearly been the all-star base metal. While prices have come back somewhat over the past few months, we are still near all-time historic highs. The Chinese and Indian economies remain very strong and both remain strong consumers of zinc. While the near-record prices seen during 2016 encouraged several operators to bring back idled capacity, it is not clear at this time how much of the demand/supply imbalance these players will be able to address. Overall, it appears that the market for zinc will remain robust for at least the next few years.
While some may characterize recent announcements of less than perfect drilling results as significant negatives, such results are common for junior miners and should be taken in stride based on the overall set of Company dynamics. The close proximity to Sullivan, the intriguing gravitational data and the limited encouraging information from the drilling all continue to point to strong potential at Sully.
While, of course, the significance of the overall strength of the Kootenay team will have no bearing on whether or not there is zinc and lead in the ground, we can nevertheless not avoid being enthusiastic by having such a world-class entrepreneurial-oriented mining team on board for this journey.
With the price of the common shares down on what was perceived as negative drilling results, but with otherwise strong data that could follow, we see an opportunity for risk-adverse investors to consider purchasing the shares.
Certainly, this is a speculative story worth monitoring moving forward and we without a doubt will be watching for positive news over the coming weeks and months.
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