A Golden Mirage?: Novo Resources Pilbara Prospects Examined

Resource

Novo Resources, led by Dr Quentin Hennigh, has been behind one of the most spectacular geological discoveries in recent times, recognising the Gold potential conglomerates of the Pilbara, West Australia. Before getting carried away, remember that success has many fathers and true discoveries are very rare. Nevertheless, the Canadian market viewed it as a discovery and the share price trajectory from 2010 to 2017 was spectacular.

For shareholders, however, the flush of excitement has passed. The spectacular images of metal detectorists unearthing handfuls of nuggets the size of watermelon seeds are now three years old. Yes, Novo continues to find Gold (see the news release from 13 February: a new terrace Gold discovery, Road to Paradise, in an area approximately 11km north-northeast of ... Egina) but the power of each new discovery to drive the share prices appears to have faded. Why is this the case?

It seems as if the market is less interested in finding yet another Gold-bearing conglomerate and instead is thirsty for more information about what has already been discovered. This is understandable. Parents know that children need time and money invested in them in order for them to flourish. There comes a point when having more mouths to feed detracts from the ability to nurture the older children as much as they need. So it is with exploration. There needs to be a balance between exploring for new Resources and evaluating existing Resources. And Novo seems to be struggling to find that balance.

Novo’s stated focus is “to explore and develop Gold projects in the Pilbara region of Western Australia” and those words ‘explore and develop’ does include the concept of evaluation. It is not enough to keep finding new indications of Gold over the next horizon or in the next gully.

That is the art and science of Resource Estimation. The stock market does not reward science or overly academic projects. Running an Exploration company is about taking an investment dollar and multiplying that value of that dollar through smart, commercial geology.

Novo Resources has repeatedly stated that the gold occurrences it is exploring are different from other gold deposits, perhaps in the hope that investors should afford Novo Resources different rules to other companies. For example, Dr Hennigh, in an interview in February 2019 says “The conglomerate gold systems in our project portfolio are different gold deposits than most people are used to seeing. …. At Comet Well and Purdy’s Reward … because it is a very coarse gold system, this is not your average gold deposit.” He then thanks his shareholders and notes that “these projects … need time and patience to advance”.

Claiming that the Novo mineralisation is so different to other deposits that normal rules do not apply is, of course, nonsense. There are examples of deposits in conglomerate gold systems that have been evaluated and advanced to production, notably the gold mines of the Witwatersrand in South Africa. There are also examples of gold deposits with a very coarse gold component to the mineralising system that have been evaluated and advanced to production, notably Pretium Resources. In fact, the Novo Resources consultant commissioned to carry out the resource estimation and mineralisation reports for Karratha and Beaton’s Creek (Optiro Pty Ltd) is the same consultant that has completed the third-party technical reports for Pretium Resources. Novo Resources is a gold company pure and simple. If management feels that the market does not understand the potential of the district, then it is the responsibility of the management to demonstrate that potential by derisking and advancing the assets through resource statements and economic studies.

If you look back through the Novo news releases, there are lots of announcements about new discoveries and the next zone of mineralisation; and about sampling and sorting techniques, but there are very few announcements about Resource Estimates. To be precise, Novo published its first Mineral Resource Estimate (MRE1) for Beaton’s Creek back in September 2015, followed by MRE2 in November 2018 and MRE3 in April 2019. Exploration started at Beaton’s Creek in 2011, and the stated Resource now stands at 457,000oz of Indicated Resources and 446,000oz of Inferred Resources. For one of the world’s new and great Gold fields, reaching a resource of almost 1Moz of Gold in 10-years is not spectacular progress. Note also that there has not been a Resource Estimate generated for Comet Well / Purdy’s Reward at Karratha.

Why is this? Why does it take Novo so long to establish or upgrade Resources? And why is the market not rewarding every new discovery of Gold-bearing gravels made by the Company? The answer, we believe, lies in the fact that the Gold can be extremely coarse grained and ‘nuggety’, which is a word worth understanding, so here is an explanation:

At the heart of Novo’s slow progress in defining Resources is something called the “nugget effect”. Coarse grained, nuggety, highly variable Gold is probably the hardest kind of Gold Resource to estimate accurately. For example, if a drill hits a nugget, the grade at that sample point is high, but had the drill passed just to the left or right the sample interval would have a low-grade. If you sample the nugget, the effect is to disproportionately skew the Resource grade too high, but if you do not sample the nugget you miss out a valuable component of the Resource, and you may underestimate the grade of the deposit.

In statistical terms, for samples to be representative of the population they must provide a fair indication of how the population behaves. Simplistically speaking when there are different Gold grain sizes (ranging from fine to coarse Gold) the coarser the Gold, the larger the sample size needs to be to counteract the nugget effect. To put this into context, most Gold deposits can be evaluated by using half core from normal diamond drilling (sample weight in the range of 3kg-4kg per sample) where normal Gold grain size is measured in microns. Geologists still get a kick out of seeing visible Gold (vg) in drill core because it is such a rarity and it is generally good news. In the Pilbara, where Novo gets such visually spectacular occurrences, the Company is having to take larger and larger samples in an attempt to get samples that are statistically representative of the resource as a whole. These are called bulk samples, and the size needed to reach representativity varies from deposit to deposit depending on a lot of applied and theoretical geostatistics.

At Beaton’s Creek, where a Resource has been established, 58 bulk samples were taken, with an average weight of 2.6t. At Egina work is progressing on the basis of 4m x 16m pits. These pits (0.8-1.5m depth) and with typical gravel densities give bulk samples sizes of ~130t-250t each. At Karratha, the Gold occurs both as fine Gold and in nuggets up to 2cms long, and the extreme nugget effect is causing major headaches.

In a technical report from April 2018 (www.sedar.com), the technical consultant noted the difficulty in finding a representative sample at Karratha, he suggested that bulk samples of up to 20,000t each would be needed, and he concluded that

“there is no guarantee that a Mineral Resource estimate may ever be able to be generated for the Karratha mineralisation.” Wow!

Those are words that no public mining company ever wants to read in a third-party report. Clearly Novo Resources wanted to solve the conundrum, which lead to another round of work which culminated in a news released in May 2019 which stated that “Comet Well-Purdy’s Reward exhibits much larger Gold nuggets, requiring a substantially larger sample (of the order of 100,000t) to adequately assess Gold grade.” Wow, again!

A 100,000t sample to evaluate the grade at Purdy’s Reward / Comet Well (Karratha)? What are the practical considerations needed to take a huge sample like that in a horizon that dips into the hill?

In short, the deposits that Novo are working on are difficult to evaluate. Slow, technically difficult and expensive.

It is no surprise that Resource estimates are slow to emerge from Beaton’s Creek. And with 100,000t samples needed at Karratha, it is no surprise that the focus has shifted to Egina in the hope of making faster and easier progress there.

Returning to the heading at the top of the page, “what is the scale and grade of the deposit, and what does it mean?” we can safely say that Novo Resources has spent a lot of money on this Gold-field in the Pilbara and can be credited with bringing the area to the market’s attention. Unfortunately, the scale and the grade of the deposit at Beaton’s Creek has been published and it looks to be sub-economic on both counts. Meanwhile the definition of a resource at Karratha depends on the huge 100,000t bulk sample going ahead. Egina appears to be widespread terrace gravels, that need many ~150t samples to be processed before a Resource estimate can be made.

What started as a great and glorious discovery has evolved into being a hugely complex, expensive and difficult process.

Novo Resources has a habit of saying that it is looking to ‘set a path to production’ but it is repeated so often and the phraseology is so generic that it loses its meaning. In the corporate presentation, Novo uses the phrase ‘set path to production’ three times, once for each project. In the announcement of the joint venture with Sumitomo in June last year, Dr Hennigh talks about ‘setting the project on a path to production’. And in April 2019 Dr Hennigh signed off an interview with a rallying cry, ‘Beatons Creek, Karratha, as well as Egina, all have extremely good potential to be very large, and hopefully very high margin, deposits. … that’s the path we’re going to take: Novo would like to become an established Western Australian gold producer’.

Technical

When resource companies say that they’re Exploration and Development companies, they actually mean that they are Exploration, Evaluation and Development companies. Or in layman’s terms, the companies need to do three things:

1. Find out how much Gold-bearing rock there is,
2. Work out the economics of getting the Gold out of the ground, and then
3. Either sell the company or dig the Gold out of the ground.

Of course, it is not an easy thing to do, and there are lots of steps that need to be taken and lots of factors that need to be considered. For instance, metal prices vary, and capital is or isn’t available and countries and commodities come in and out of vogue.

One approach to an inherently difficult and complex subject is to take the easiest route through it. Make things simple and make things consistent as much as possible. Which is why Gold is by far the most popular commodity chosen by executive teams. Gold companies are easy to understand, and easy to value. The Resource types are well understood, the processing is generally not too complicated or expensive, and the product can be sold at the mine gate into a highly efficient liquid market. All companies need to advance projects along a well-established path for the market to ascribe value to them, the Gold development path being the best known, simplest and most common, and that path is as follows:

• Exploration → target evaluation, remote sensing, mapping, sampling, geophysics, early drilling phases etc
• Discovery → a drillhole with “100-gram x metres” often heralds the feeling that this could be a discovery
• Drill Out → expand the envelope of known mineralisation as fast as possible
• Mineral Resource Estimate → quantified grade and tonnes that have a reasonable prospect of economic extraction
• Preliminary Economic Assessment (PEA) → early stage conceptual assessment of the potential economic viability of the MRE, often giving the company the first NPV and IRR on the project
• Pre-feasibility Study (PFS) → realistic economic and engineering studies sufficient to demonstrate economic viability and establish mineral reserves, cost estimates usually accurate to within 25%
• Feasibility Study (FS) → detailed study of how the mine will be built, used as the basis for a production decision
• Got all of that? Good, now let’s get back to Novo Resources.

As we know Novo is chasing Gold in the sediments of the Pilbara and according to our thinking, the way it will create sustainable value for shareholders is to find Gold at a core project and then advance that Discovery from Exploration to Feasibility Study along the well-trodden path laid out above.

If it has money available to continue exploring after making a first Discovery, it can run a twin-track of advancing project number one (the firstborn, in this case a deposit called Beaton’s Creek), expanding the Resource at project number one, and even possibly start exploring at project numbers two and three. But woe betide the company that does not advance a project from Resource status to PEA or PFS or FS over the years. If the Company is not bought out during the Resource stage, then it needs to underpin shareholder value by advancing core assets up the Evaluation and Development curve.

Back in September 2015 when Novo announced a Resource of some 292,000oz in near-surface oxides at its Beaton’s Creek project, it also stated that there was a plan to release a PEA within the next 2-months. This was a great start and an admirable goal. However, Exploration continued, expanding the envelope of known mineralisation, but the proposed PEA for Beaton’s Creek was not completed.

Over 18-months later, in May 2017, the company announced that it would drill another 10,000m and dig another 800 trenches to expand and upgrade near-surface mineral Resources at Beaton’s Creek. It also stated that it was “targeting completion of a Prefeasibility Study (PFS) for the Beaton’s Creek Gold project by fourth quarter of 2017.” Shareholders must have been delighted. Not only was Karratha turning up fistfuls of nuggets, but the core asset at Beaton’s Creek promised to be de-risked to the point of a PFS.

Note that in 2017 it is the more advanced report that is promised - a Pre-Feasibility Study (PFS), which is considerably more detailed than the PEA, that was promised in 2015. What happened next is that Exploration continued, expanding the envelope of known mineralisation, but the proposed PFS was never published. At this point, technical credibility starts to be questioned. Paraphrasing Oscar Wilde, to lose one Study may be regarded as a misfortune, to lose both looks like carelessness.

Perhaps learning from this habit of over-promising, by the time the November 2018 Resource Update for Beaton’s Creek was published, the accompanying technical language had been toned down. No studies were promised, instead, an opinion was aired that management thought it was one of the best deposits in that part of the Pilbara… hard to quantify what that means.

Fast forward to April 2019 when another Resource Update was announced for Beaton’s Creek, this time taking Indicated Resources to 457,000oz and Inferred Resources to 446,000oz . The accompanying language was circumspect, saying that the Resource “demonstrates the potential for conglomerate Gold deposits in the Pilbara”. In the same month it was announced that an Options Study would be completed on Beaton’s Creek and Karratha combined, for delivery in Q3 2019.

In addition, the lumping together of Karratha (no Resource, no permit) with Beaton’s Creek (Resource, mining permit for the oxide portion) suggests that management do not believe that Beaton’s Creek will be economically viable as a standalone operation. Perhaps shareholders should be told?

It would certainly explain why Novo Resources has lagged behind in marching the projects up the value curve. Let’s look at some of the reasons why Beaton’s Creek may not be a quick win.

The Beaton’s Creek Resource numbers were released, but the accompanying technical report published last year did not contain any good quality cross-sections of the deposit showing overburden or give any indication of potential strip ratio. It was interesting to note that old-timers in the late 19th century mined gold out of horizontal tunnels (adits) approximately 1m high in pockets of high-grade, and that the ore blocks in the Novo model are 20m x 20m x 1m and 40m x 40m x 1m. These are thin, gently dipping deposits, so the shape of the channels and the amount of overburden will play critical roles in determining the strip ratio of the deposit and therefore how economic it will be to extract the gold. No indication of strip ratios in the open pit has been given yet, which suggests that it is not good as bad news travels slow.

There is also the question of how to process the fresh material as the buried conglomerates, 2.8 billion years old, are hard and sometimes abrasive rock. All in all, there are a number of technical considerations that would be addressed in a standard PEA and further de-risked as the deposit is worked up the value curve through PFS and finally Feasibility Study.

It should be noted that in recent interviews Dr Hennigh has discussed the possibility of buying a second-hand mill for $50MM. For the record, it is not good practice to start mining without technically de-risking the project and having a clear idea of the costs and engineering implications involved. Any discussion of the purchase of mills, or concrete production plans prior to completing these technical studies is premature.

Junior companies often talk about getting started on a small scale and using cash flow to fund the larger project. Experience shows that this hardly ever works (First Quantum’s Bwana Makubwa tailings project in Zambia in 1999 being a notable exception) and small-scale production in alluvial gold is best suited to family-run private companies.

As for the question “is it ever coming out of the ground?” the facile response is “not in a hurry”. A more considered response is best provided by the management of Novo Resources tackling the technical aspects of all three deposits.

Permitting

The permitting of mineral deposits is a process that can take years. A 2016 industry report showed an average of 10-years was needed in the US, and anecdotally a recent Gold mine in Ontario took 7-years to receive its permit. Multi-asset companies usually finesse these long timelines by allocating some Resources to the permitting process while different parts of the business focus on other things.

The guidelines for mining permits in Western Australia are comprehensive, transparent and entirely conventional. Nothing untoward, it is just a case of getting the work done to a satisfactory standard. http://www.dmp.wa.gov.au/Documents/Environment/REC-EC-114D.pdf

Beaton’s Creek

Novo Resources has an environmental permit for the oxide portion of the resource at Beaton’s Creek, and mining permits for licences that cover 99% of the stated resource.

As far as it goes, having permits to mine the oxides at Beaton’s Creek is good. However, any discussion of mining or mills is premature as the project still needs to be taken through the standard studies. The entire reason for doing the standard studies is to make sure that the company does not make a costly mistake when allocating capital. If a mine is going to cost $100M to build, then it is worth spending $1M on a PEA to make sure that the scale and process route is the right one. It is also worth spending about $5M on the Feasibility Study (and possibly a pre- Feasibility as well, depending on project complexity) to make sure that the engineering is correct, and the resource is robust, and the process flow sheet is properly designed, and that the cost of the construction and start-up and working capital requirements are properly calculated.

Without de-risking Beaton’s Creek via the well-trodden path of PEA, PFS or Feasibility Study then any development plan would by definition carry risk, and a level of risk that is too high for right-thinking shareholders. Talk about buying a processing plant is a smokescreen, not a value-accretive action.

Karratha

At Karratha, as we know, Novo is struggling to define a Resource. It is also true that in order to apply for a mining permit in Western Australia, an externally validated resource statement is needed (NI 43-101 in Canada, JORC in Australia). The trouble is, at Karratha to validate a resource statement very large bulk samples are needed. The samples are so big that a Mining Permit is potentially required in order to take them. But one cannot get a Mining Permit without a Resource Statement … which is a Catch-22 situation.

Surely companies have the right to take bulk samples? Yes, companies do have the right to take bulk samples - it just depends on what is considered a bulk sample, and what is considered a small mining operation. Over and above traditional exploration activities, prospecting work that would otherwise be considered mining can take place as long as certain criteria are met, and the correct permit known as a Programme of Work (PoW) is granted. These criteria are helpfully laid out in Section 48 of the 1978 Mining Act, and “activities that can be deemed as prospecting include....small bulk sampling projects (e.g. less than 10,000t).” The regulation goes on to state that if the activity falls outside this classification then a Mining Lease is needed.

The proposed Karratha samples are 10x larger than the limit envisaged by the PoW, but there is wiggle-room and space to appeal. On May 28, 2019, Novo Resources reported that “planned work at Comet Well and Purdy’s Reward includes [to] Submit Program of Works approval for a circa 100,000t large-scale bulk sample to the Department of Minerals, Industry Regulation and Safety.”

Some of the language in the PoW prospecting policy is open to interpretation and does note that “for prospecting activities to be considered to be exploration as opposed to mining, the activities must satisfy the following criteria:

• The activity can be considered to be “low impact” by the Department of Mines, Industry Regulation and Safety.
• (DMIRS) Environmental Officer (e.g. minimal ground disturbance).
• No permanent infrastructure required (e.g. plant and camp are mobile).
• No permanent waste or ore stockpiles required.
• Rehabilitation is progressive, low cost and easily achievable.
• Area can be rehabilitated to pre-mining ground conditions.
• Tonnage is appropriate for type of activity and tenure.
• If the application meets the above criteria, then the PoW may be used.”

Looking through the list above, it is easy to imagine some of the objections from the DMIRS. Can 100,000t samples be deemed to be low impact?

What about not leaving any permanent waste or stockpiles? The 2018 technical report that envisaged ‘only’ 20,000t bulk samples also noted that “one of the challenges for Novo will be to collect samples of a sufficient size from the down-dip portion of the conglomerate horizons…. With the conglomerates, in general, dipping at between 5 and 10 degrees to the Southeast, any potential estimate of Mineral Resources will require the collection of samples at depth, for instance up to 50m vertically below the surface.” With a 100,000t sample, depths will be greater, and volumes of rock displaced will be great. Consider the engineering as well required to take these samples safely, or at all. The 2018 technical report for Karratha added that “Novo is considering … winzing, portal and underground development.”

All in all, it is hard to see how the DMIRS would approve a PoW, and we know that it cannot grant a mining permit without an independent Resource Statement. There has been no news on Karratha bulk sampling permits from Novo. We do not know if an application for a PoW at Karratha was actually made by Novo in 2019. We do not know if the DMIRS has responded to any application.

The Company has gone quiet on bulk sampling at Karratha, which in itself is revealing. In junior exploration companies, good news tends to be released quickly, but bad news tends to make glacial progress into the public domain. Unfortunately, no news is usually bad news.

Egina

At Egina, exploration work is in a relatively early stage of Development. The company clearly has PoW permission as it is actively taking bulk samples. In addition, Novo completed an Initial Heritage Survey at Egina in September 2019, which is a key step in the National Native Title Tribunal designed to assist resolution between native titleholders and other land users. With the Initial Heritage Survey complete, Novo has permission to sample and explore (and presumably some places where it should not sample and explore). If Novo Resources completes a Resource Estimate and advances to Production, it will need to apply for a Mining Lease and negotiate with all registered native title claimants.

Note that the principal economic targets at Egina are unconsolidated shallow gravels that are amenable to free-dig and mechanical processing. While this may make mining physically easier, the footprint of mining will be extensive. One description could be strip mining which has become a byword for unacceptable practice in the resources sector. Mining generally has a very small footprint, with a high impact on a tiny area. Strip mines, however, are high impact on a huge area, and they can only be permitted under the most stringent regulation, if at all with the modern-day level of scrutiny and transparency.

The Environmental Protection Agency of Australia states that “the Pilbara biogeographic region of Western Australia has a wealth of biodiversity and other environmental values … and ecological features found only in the Pilbara.” The EPA goes on further to report that “The environmental impact from clearing of vegetation is exacerbated by the lack of successful rehabilitation of mines in the Pilbara. Although there has been mining in the Pilbara for over 60 years, there is limited evidence that proponents have successfully rehabilitated any areas that have been subject to large-scale mining.” Not only that, but “Without confidence that successful rehabilitation can be achieved post-mining, the residual environmental impacts of proposals are likely to be significant. The EPA has recommended a rehabilitation condition for most mining and associated infrastructure proposals in the Pilbara, requiring rehabilitation to this high standard.”

Management

Time and time again investors say that the management running companies is one of the most important factors in their investment decision. Nowhere does this hold truer than in the junior Resources space where the company does not have the cushion of regular income and every single dollar spent needs to be spent wisely if value is to be created.

The Novo Resources website, as it should, has a list of directors and senior management with their credentials and biographies shown.

The CEO, Rob Humphryson, is a mining expert with decades as an operator and consultant and he was hired in 2017 to develop a mine. As Dr Hennigh said at the time, “Mr. Humphryson fills a critical role within our Company that will assist Novo in growing from an explorer to a mining company. ... I will be refocusing more of my time on exploring our newly unveiled large conglomerate-hosted Gold project near Karratha.” As we have already seen, Beaton’s Creek is no closer to being a mine than it was in 2017, nevertheless Mr Humphryson is kept very busy running the day to day of the company, and executing the bulk sampling programme. In terms of strategic input and decision making, it is likely that Dr Hennigh is still driving the bus.

The Board is a curious one. Akiko Levinson looks like a trusted work colleague of Dr Hennigh, having worked with him at Gold Canyon Resources and is still working with him at Irving Resources, as well as Novo Resources. Ms Levinson seems to be in the company for the long haul, and we would expect her to back Dr Hennigh with a great deal of loyalty.

Mr Ishikawa is an employee of Sumitomo and as the website states he “was … instrumental in coordinating Sumitomo’s US$30M farm in and joint venture arrangement with Novo over the Egina Gold project in June 2017.” Mr Ishikawa is not an independent director, and yet we venture that his concern for regular shareholders is aligned to some degree, as his personal reputation within Sumitomo depends on Egina working out well.

The only director that could be characterised as truly independent is Michael Barrett, with “over 26 years international experience in top-rated organizations, including Deloitte, Rio Tinto, WMC Resources and PWC.” Interestingly Mr Barrett joined Novo in October 2017 at a time when the Karratha discovery was front and centre, and the market capitalisation was over $1Bn. It looks as if his appointment was part and parcel of the graduation of the company to the big league, hand in hand with the C$56M investment by Kirkland Lake (5 September 2017), and Eric Sprott joining the board (1 November 2017). Now that Mr Sprott has left the board (March 2020), Karratha is in permitting limbo, Beaton’s Creek is showing marginal economics and Egina is early stage, the prospects of the Company look very different. What this means is that Mr Barrett’s experience and strategic savvy is needed more than ever.

       The dominant figure in the Company, featuring in all of the marketing, the founder, the inspiration, the genius behind it all is Dr Quinton Hennigh. He has a PhD in Geology in Geochemistry, a good geological brain and he has used that for decades in the Resources sector, specializing in Exploration and Resource targeting. Dr Hennigh is fantastic at finding new deposits, thinking of the next geological idea and going and testing it. He is the classic early-stage expert, and that has shown itself time and again at Novo Resources. Dr Hennigh has thought of the next geological idea and gone on to test it at Beaton’s Creek, and at Purdy’s Reward / Comet Well, and at Blue Spec and Marble Bar, and at Egina, and at Tuscarora in Nevada. Where he appears to have less traction is in consolidating the early discovery and taking it up the value curve, along the traditional path of PEA, PFS, Feasibility; although that could of course be a function of the underlying geology not a lack of will or application on Dr Hennigh’s part.

The Novo Resources website does, however, have omissions. When it comes to a biography, we feel that shareholders should be able to know what a Chairman / President / Founder figure does with his time, and where his remuneration comes from. When a large number of roles are not mentioned in the website biography, it is disingenuous at best and one could legitimately ask if he is short-changing Novo Resources shareholders. If Bill Gates and Warren Buffett ascribe their success to focus, a lack of focus is surely a potential cause of failure. In addition to being the Chairman and President of Novo Resources, Dr Hennigh fails to mention that he is also:

• Director and Technical Advisor to Irving Resources (CSE, pre¬cious metal projects in Japan and joint venture interests with Japan Oil, Gas and Metals National Corporation (JOGMEC) in a rare earth element project in Africa). Note that Ms Levinson is President and CEO of Irving Resources.
• Director of TriStar Gold, Inc. (TSXV, 100% owned flagship Castelo de Sonhos Gold project, located in Pará state, Brazil)
• Director of Precipitate Gold Corp (TSXV, District-Scale Stra¬tegic Land Positions in the Dominican Republic’s Two Most Prospective and Active Gold and Copper Mining and Explora¬tion Camps)
• Director of NV Gold Corp (TSXV, Discovering Nevada’s next multi-million-ounce Gold resource through focused explora¬tion activities)
• Member of the Geological Advisory Team, Hannan Metals (TSXV, a copper-silver exploration company opening up new search spaces in Peru), as of 14 January 2020.
• Member of Geological Advisory Team, Eskay Mining Corp (TSXV, a gold and silver exploration company operating in British Columbia’s Golden Triangle)

There is also a track record of investments made by Novo Resources in other companies and projects outside of the core business which indicates a lack of focus. The deals bear the hallmarks of Dr Hennigh’s questioning geological mind, but it is hard to see how value will accrue to shareholders. In fact, if Novo Resources is spending time, equity and money on other projects, what does it signal to shareholders where the remaining Novo treasury funds should be spent?

On 14 January 2020 (incidentally the same day that Dr Hennigh’s appointment to Hannan Metals was announced), Novo Resources announced that it was investing A$4M into Kalamazoo Resources Limited (ASX: KZR), to earn an 8.17% stake in Kalamazoo.

      On 2 March 2020, Novo announced that it was taking a 15.97% stake in New Found Gold Corp. This was paid for in Novo shares (thanks Novo shareholders!) for a deal value of C$16.4M thereby ascribing a value of approximately C$100M to the private New Found Gold Corp, and an accompanying 3.8% dilution of Novo Resources.

Incidentally, Eric Sprott co-invested in the Kalamazoo deal with Novo Resources, but he did not co-invest in the New Found Gold Corp. Mr Sprott also resigned from the Board of Directors the day after the New Found Gold deal. Could these two events be related? And is Mr Sprott holding his Novo Resources shares or selling?

On 30 March 2020, Novo announced an earn-in to ASX-listed GBM Resources Limited, with the right to acquire 60-75% of the Malmsbury gold project, Victoria. The earn-in will be paid in a mix of shares issued, part warrants, and exploration dollars in the ground (A$5M over four years).

This latest investment represents a clear shift away from the Pilbara and a new focus on the Bendigo zone of the Victoria Gold-fields. This is another worrying signal to investors that the Novo Resources exploration in the Pilbara has proven to be difficult and expensive and it is not creating nor has it created lasting shareholder value.

At the start of this section, a question was asked: “are these the right people for the job in hand?” It is always problematic and poor corporate governance when a person such as Dr Hennigh is the Founder and Chairman and President of a Company. This is the reason why the London Stock Exchange discourages Executive Chairmen. In the UK, the Chairman has two jobs. One is to run the Board meetings, and the other is to hire or fire the CEO. In Novo Resources, Dr Hennigh has no boss, and so the Company strategy risks becoming a reflection of his thought processes.

Given the number of roles that Dr Hennigh is currently doing, and his stated and demonstrable interest in picking up and running with new ideas rather than consolidating and advancing the core business, in first instance it is the role of the Board to decide whether it is appropriate for him to be Chairman and President of the core business? In the second instance, it is up to shareholders to decide what kind of Company they want to be invested in.

Funding

One of the key strengths of Novo Resources derives from the capital raises it completed in 2017. Thanks to C$56M from Kirkland Late at C$4 per share, and a C$15M raise in May 2017 (with a warrant that chipped in a further C$20M in 2019), Novo is currently still sitting on approximately C$30M in cash. The last reported figure was C$37.4M on 31 October, but that was before 6-months of expenditure and an investment of A$4M in Kalamazoo.

It should be remembered that when Kirkland Lake invested C$56M in 2017, Kirkland was then a C$5Bn company buying a seat at the table in what was potentially a new Witwatersrand at the height of the metal detector - water melon seed nuggets at Purdy’s Reward / Comet Well at the Karratha project in 2017. Kirkland Lake was buying into a geological concept that appeared to be gaining rapid momentum, and it publicly staked a claim to be a participant in the new Gold field should it amount to that. The C$56M was hugely important and valuable to Novo Resources then and now, both in financial terms and also in the endorsement of Novo Resources exploration strategy. But it was a relatively ‘low-risk small-scale option payment’ by the larger company. Kirkland Lake is now a $13Bn company. Now that the Pilbara assets look to be a long way from supporting a large-scale mining development, it is likely that Kirkland Lake has filed the Novo Resources share certificate in a bottom drawer somewhere.

       Again, thanks to the capital raises of 2017 and the top-up from the exercised warrants in 2019, Novo Resource does not need fresh capital in the near term. In public Dr Hennigh has mentioned the possible purchase of a mill for A$50M, but it is unlikely that this transaction will go ahead. As has already been mentioned, it is unlikely that Beaton’s Creek is near a mining decision given that it is still at the Option Study phase. What size of mill should be bought? Where should it be placed? What will it process? When will it be needed? And so on.

Karratha is stalled in permitting, and Egina is at an early stage of development and is anyhow funded through the Sumitomo earn-in agreement.

Novo Resources has plenty of cash for now and is unlikely to want to raise any capital in the near term, unless it decides as was indicated to us in Dr Hennigh’s interview that they still wish to buy the mill. It will be interesting to see how the market reacts to that possibility, or indeed if any of the current institutional investors would elect to further invest.

Red Flags

Working through this report, a number of red flags appear when researching Novo Resources. A collated list of concerns reads as follows:

• Claiming that the Novo mineralisation is so different to other deposits that normal rules do not apply.
• The slow progress of resource estimates at Beaton’s Creek and the lack of a resource estimate for Comet Well / Purdy’s Reward at Karratha.
• The nugget effect which means that the deposits that Novo is working on are slow, technically difficult and expensive to evaluate. In addition, the independent consultant considers that there is no guarantee that a Mineral Resource estimate may ever be able to be generated for the Karratha mineralization.
• An absence of promised economic studies on Beaton’s Creek. Novo has consistently promised to deliver a PEA or a PFS or an Option Study for the project, and equally consistently it has not delivered one.
• Lack of clarity on the permitting situation at Karratha and the law around large bulk samples needing a mining permit, but mining permits not being granted without resource estimates, and Karratha dependent on large bulk samples to validate the resource statement.
• Lack of clarity regarding the environmental permitting likely to be required to strip mine at Egina.
• Problematic issues around management focus with Dr Hennigh holding multiple senior roles at a large number of different companies.
• Worrying corporate developments and lack of strategic focus with Novo Resources investing in non-core assets, undermining the integrity of the investment case for developing the Pilbara gold assets.
• Poor corporate governance, with a dominant Chairman and President, and only one truly independent NED.
• A lack of transparency around budgets, timelines and strategic plans that would underpin an investment case for owning Novo Resources shares.
• Public discussions around buying a mill and plans to start mining without technical data or a resource to support the development.
• Overly complex academic theorising about a new paradigm when gold companies should be simple to understand and value.

What has not really been discussed is the way the Company communicates with shareholders, and yet corporate communication is so important. It is not enough to be visible and vocal; communication needs to be well structured, consistent and clear.

We can make a case that the marketing materials for Novo Resources are not laid out in a manner that assists investors make an investment decision. Take a look at the current corporate presentation for example. The front cover is an indeterminate picture of an electronic machine with a strapline saying, “Conglomerate Gold in the Pilbara – A World Class Discovery”. The majority of the presentation slides 3 to 33 contains pictures of mechanical sorting, bulk samples, and photographs of conglomerates and gravels. There are no budgets, no timelines, and no strategy beyond a plan to “set a path to production” for Beaton’s Creek and Karratha, and a desire to start trial mining at Egina. The presentation does not set out a clear investment case backed up by reasonable numbers.

The presentations are academic and complex, and the news releases are rich in complexity, data and statistics but poor in plain language. There is too much information on the science of mechanical sorting and the source of the Gold, and not enough information on economics of extraction, timelines to milestone, delivery of promises, budgets and investment strategy. In this regard, the way the Company presents its marketing materials is a significant Red Flag.

Green Lights

There are several reasons to want to be invested in Novo Resources:

• The Gold focus of the Company is a key attribute. As simple as it sounds, having a clear Gold focus is a major bonus for many investors.
• The land position that Novo Resources has tied up in the Pilbara and Karratha regions is a significant bonus. Yes, exploration licenses are to some degree a funding liability, and yes, Novo has struggled to define resources so far, but it is a Gold province, and Novo is learning how to explore the region more efficiently with time. Ground penetrating radar and mechanical sorting are not ends in themselves, but they are useful tools that help identify Gold-rich ground and then subsequently quantify bulk samples more quickly. The fact that Novo has a dominant land position and improved tools for exploring that land position is a positive for the Company.
• Another positive factor in the Company is the farm-in agreement with Sumitomo. Sumitomo has the right to earn-in 40% of the Egina project, by spending US$30M over 3-years. This puts the value of the carried 60% to be held by Novo at US$45M (or C$60M) on a look through basis.
• The Sumitomo deal helps preserve cash as well. Egina appears to be the most active project, and Sumitomo is funding this activity.
• Another positive factor for the Company is the good work that Dr Hennigh has carried out at the Corporate level. The Kirkland Lake transaction was transformative for the Company in 2017 and the Sumitomo deal in June 2019 was equally good. Although Sumitomo entered into the partnership with a specific project interest in Egina, having Sumitomo as a close confidant has strategic value for Novo shareholders. Sumitomo knows Novo Resources very well, and Mr Ishikawa sits on the Board. If at some point Karratha or Beaton’s Creek arrive at some point in the future where they are the projects that will open up the potential of the region, it will be easy to have a funding / partnership conversation with Sumitomo as the relationship is already establishe.

Investment Case & Exit Strategy

When looking at the investment case for a company, any company, it is always useful to understand the building blocks of value.

NAV & Mkt Cap

• How much cash (or debt) is there in the Company? Hypothetically, let’s say C$50M.
• What are the main projects worth? Let’s say the NPV of the main project is C$100M.
• What about the non-core assets? Let’s say C$10M.

This gives a Net Asset Value (NAV) of Cash + NPV + non-core (in this case NAV = C$160M).

The next step is to review what your peers are trading at. If other companies (that are a good peer match for yours) are trading at a premium or a discount to their NAV then it is reasonable to expect that your Company, the Company in question should trade at a similar premium or discount to its NAV. Often NAV is used for companies in production or with advanced studies (PEA or better) on key assets. In these turbulent markets it is not uncommon to find companies trading at 0.5x NAV, so in our hypothetical case this would mean C$160M x 0.5 = C$80M.

Once you have understood the NAV of your own company, and how its peers are trading it is important to look at the market capitalisation of the Company in question. For NAV analysis, if it is trading above the market value (in this case C$80M) then it is too expensive and you should either not buy shares, or you should sell your position, or you should have a very strong understanding of what the near-term catalysts that are going to drive the share price in the way that you want it.

If the Company in question is trading below the market value (in this case C$80M) then it is trading at a discount to fair value and you should either buy shares, or you should hold your position, as long as you have a good understanding of the near-term catalysts that will drive the share price.

For Gold companies there are so many comparables that valuation is relatively easy…

Enterprise Value (EV)

Another really useful way of looking at the Company is Enterprise Value, which is the value of the business ascribed by the market (via the mechanism of the share price) adjusted for net cash (or debt).

What is the Market Capitalisation (number of shares x share price)? Let’s say C$80M

How much cash (or debt) is in the business? Let’s say C$30M

The Enterprise Value (EV) = Mkt Cap - Cash (or + Debt)? In this case EV = C$50M

Using this technique, it is possible to generate EV figures of resources in the ground. For example, if the hypothetical company shown above has 2 million ounces (Moz) in the ground, then the EV/oz is C$50M/2Moz = C$25/oz. If the peer group is trading at an average of C$10/oz then the Company in question is over-valued relative to its peers. If the peer group is trading at an average of C$50/oz then the Company in question is under-valued relative to its peers. Less value is ascribed to Inferred Resources when few de-risking studies have been completed on the project. More value is ascribed when the Resource base is growing, and the core Resource is advancing through the study phases. Very little value should ever be ascribed to blue-sky.

Comparing EV per resource ounce is a crude measure that can sometimes (but only sometimes) be useful. When comparing EV/ oz between peers it is essential to review companies that really are very similar in nature and make-up.

Of course, the valuation methodologies can be mixed and matched. The EV/oz calculation may be useful in ascribing value to a non-core asset for example, with the NAV (correctly adjusted for the prevailing premium / discount) providing the valuation block for the core asset.

So much for Company valuation 101. The key point is that Executive Management should be able to articulate the building blocks of value in the company simply and clearly. It does not just apply to small companies. Look at the home page of Agnico Eagle, a C$13Bn company, and one can see that its “mission is to build a high quality, easy to understand business.” Now that is classy.

Valuing Novo Resources

Now, suppose we applying the same philosophy to Novo Resources. The Company does not have an economic report such as a PEA so perhaps the most appropriate method would be the EV/resource ounce approach. Given that Beaton’s Creek is the only asset with a resource base, this does rather exclude Egina and Karratha as a value proposition, but we can address those two assets separately:

• Step 1. Market capitalisation = C$357M
• Step 2. Cash = C$30M
• Step 3. EV = Mkt Cap – Cash = C$357M – C$30M = C$327M

EV per resource ounce = 327 / 0.9 = C$363/oz.

As shown above the company has approximately C$30M in cash, approximately 900,000oz of ounces in the Resource category (yes, we know the TSX does not permit adding Indicated and Inferred ounces together, but it is good to give projects the benefit of the doubt sometimes). This generates an EV per resource ounce figure of C$363/ oz.

Maybe, given the thin nature of the beds, and the variable grades, it is safer just to include the oxide portion of the deposit that can be mined in an open pit. Which is 272,000oz of inferred resources and 44,000oz of indicated resources. If the open pit portion only is used the EV/oz figure jumps to C$1,035/oz.

As it happens there is an excellent peer to compare with Novo Resources. ASX listed Bellevue Gold Corporation was a company called Draig Resources exploring for Mongolian coal until mid 2016 when it bought the Bellevue Gold project, changed its name and started exploring. The company now has a market capitalisation of A$185M, and this is supported by the following features:

• 6.1Mt @ 11.3 g/t Au for 2.2 million oz gold
• 3,600km2 strategic land position (just as Novo has)
• Resources are OPEN (just as in the Pilbara)
• A$21M cash (healthy treasury, just as Novo has)
• No economic mining studies yet

Running the same EV/oz calculation (EV = 185 – 21 = 164. And 164/2.2 = $75/oz), one can see that Bellevue Gold is trading at A$75/oz, or converting to Canadian, C$64/oz. Note that Bellevue has been a well-run company with a clear strategic plan and focus, and excellent marketing materials explaining the investment case to investors. One would expect Bellevue to trade at a premium to Novo Resources if one looks at the clarity of the investment thesis and the confidence that promises for 2020 will be met.

If we apply the ‘Bellevue EV/oz’ to Novo Resources, it gives an implicit value of C$20M for the oxide portion of the resource (64 x 0.32 = 20), and an implicit value of C$58M for the combined indicated and inferred resources (64 x 0.9 = 58).

       One can then look at the NAV of Novo Resources and observe that is has C$30M of value in cash, about C$58M of value in Beaton’s Creek (being generous), or C$20M at Beaton’s Creek (if you do not think the underground will ever work), for a total NAV of C$50-88M before one considers the blue sky potential of Karratha and / or Egina.

Investors are free to ascribe value wherever they please. It is likely, however, that if there are two stores selling a product and one store offers it for C$10 and the other store offers the same product for C$300, then every customer sound in mind would buy the product in the store offering it for C$10. Equally, when one looks at the Blue-Sky value of Novo Resources, investors are likely, over time, to pay as much for Novo Blue-Sky as Blue-Sky belonging to other companies. Returning to the excellent comparable of Bellevue Gold Corp, one can see that there is no value ascribed to Blue-Sky potential, or if there is then the EV per ounce value has to be adjusted lower, which would in turn make Beaton’s Creek look worse. Again, investors are free to ascribe value wherever they please and supporters of Novo Resources will argue that the large ground position and a new paradigm in a new gold field is worth approximately C$300M. Independent voices might point out that ten years of investment in exploration that has not resulted in any defined resources means that Novo shareholders have paid for an expensive education in bulk sampling but that it certainly has not created C$300M of value.

If the value number you have just calculated for Novo Resources exceeds the C$357M market capitalisation you should buy some shares and wait for the rest of the market to catch up with your analysis and buy the shares up to your ‘level’. If the total value you have just calculated is only C$50M or does not reach the Mkt Cap of C$357M then the Company is over-valued, and you should sell your shares before enough other people reach that same conclusion as you. And if the Company is over-valued note that there are two ways out of the situation.

The first is that the share price will settle at a more appropriate (lower) level. The second is that management articulates extremely clearly how it is going to create 2x or 3x or 10x value, and then it goes ahead and does just that, thereby back-filling value.

All of this is a reminder that management needs to articulate and quantify the inherent building blocks of value. It also needs to apply itself with great focus to the job in hand and explain clearly and coherently budgets and strategy.

On one level it is very simple. Management needs to say what it is going to do and why that course of action will create value. Then it needs to go away and deliver on its promises (such as publishing a PEA when it says it will publish a PEA). Finally, management needs to come back and report on how it kept its promises and outline the next steps and strategy. Credibility and integrity are established by the very simple but achingly difficult task of delivering on what was promised.

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These CRUX Reports are written for expert investors AND for people new to natural resource investing. But whether you are an expert or a newbie, we all have the same driver. We invest to make money. Sometimes investors get emotional about the investment. They actually think they own a mine. They don’t. They own shares in a company. So focus on your investment strategy, work out the best plan for your needs, stick to the fundamentals and remember that the only way you make money is if your shares go up in value… assuming you don’t forget to cash them in!