Solgold Plc: Striking Discoveries, Financial Uncertainties, and Strategic Maneuvers

Executive Summary

Solgold Plc (“Solgold”) (LSE:SOLG)(TSX:SOLG) is an exploration and development company known around the globe partly for its Australian management and listings in London and Toronto, and partly for its work in Ecuador. The discovery of the three billion tonne Alpala resource at the Cascabel project in Ecuador has captured the imagination of retail, institutions, and mining companies alike, and at times in the past the market capitalisation of the company has been a billion US dollars. With mighty share price rises and falls over the years it has been a wild ride, with many factors influencing the share price from its lows in late 2015 to a high in mid 2018, and falls and gains since then.

A generalist fund manager once reported to Crux Investor that mining is one of the few sectors that can give him the ‘sex and violence’ needed to spice up a diversified portfolio. Solgold has certainly delivered on that front, with prices moving from 1.4 pence to 46.5 pence (exploration), a steady decline to below 20 pence (“boring” and expensive studies), and then back up to 40 pence (exploration again).

The wild ride has also, of course, been affected by external factors. Ecuador continues to open up (albeit stutteringly) to commercial mining, manifest in the commissioning of the country’s first large-scale mines, Fruta del Norte (gold) and Mirador (copper) in 2019. Furthermore, the broader mining industry continues its hunt for Tier 1 assets, and Tier 1 copper assets in particular, capable of sustaining production for decades into the future. For a number of reasons (geological endowment relative to exploration history, politics, and economics - in a nutshell) Ecuador is one of the best places to explore for porphyry copper deposits in the world. Accordingly Solgold has been, and still is, involved in a complicated corporate dance with industry partners lining up as potential suitors for co-development or buy-out.

The many variables and parameters may leave Crux Investor and you, dear reader, scratching heads, trying to fathom out what Solgold is really worth. How much value can one ascribe to Cascabel? How valuable is the rest of the exploration portfolio? Is Porvenir going to be as good as Cascabel, or will it be better? What are the capital demands on Solgold as it pursues its exploration and development goals, and how much dilution, therefore, can be expected? In the face of so much complexity, Crux Investor has gone back to basics. Building a house? Get your foundations right. And in this case that means doing a deep dive on Cascabel. At the end of the report a short section considers the value of the exploration portfolio.

Crux Investor has reviewed the viability and the value of Cascabel and the Alpala PEA. As always great store is set on industry norms, and little truck is given to wishful thinking from the Company trying to persuade consultants that “this time it will be different”, or indeed consultants not wanting to offend a high value client by presenting bad news. Unfortunately, the truth can sometimes hurt. As always Crux Investor gives you a blow-by-blow account of its thinking in the chapters that follow, here is the summary of that thinking:

Solgold is the successor company of Solomon Gold Plc, which changed its name when the focus of activity moved to Ecuador in South America. The company has amassed a large landholding in-country with 76 concession areas of which approximately 42 are distributed among thirteen priority projects and the remainder (approximately 34 concessions) are barely discussed by management. The thirteen priority projects include Alpala, Porvenir and Rio Amarillo among others. Crux Investor will return to the exploration opportunity, commitments (and associated liabilities) of holding 76 concessions later.

The most advanced project is the Alpala Cu-Au porphyry in the far north of the country. Solgold has worked at Alpala since 2012 when it first came into Ecuador. The company stake has reached 86.1% beneficial interest, of which 85% is held directly and the balance through shareholding in Cornerstone Capital Resources Incorporated (“Cornerstone”), the company originally controlling Alpala. It is worth nothing that Cornerstone, in return, states that it has a 21.4% beneficial interest in Cascabel comprised of a direct 15% interest in the project financed through to completion of a feasibility study and repayable out of Cornerstone’s share of project cash flow, plus an indirect interest comprised of 7.6% of the shares of SolGold Plc. Relations between the two companies have deteriorated over time and are currently hostile.

The mineralised system at Alpala is very large and attracted the attention of two major mining companies: Newcrest International Pty Ltd (“Newcrest”) and BHP Billiton Plc (“BHP Billiton”), and they are now the two largest shareholders in Solgold holding 13.57% and 13.64% stakes respectively. More recently (September 2020) Franco Nevada acquired a 1% net smelter return (“NSR”) royalty in Alpala for US$100 M, which can be increased to US$150 M for a commensurate increase in the royalty to 1.5%. The funds will be dedicated to completing a feasibility study at Alpala, and reaching a final investment decision. Solgold and Franco-Nevada are discussing a potential precious metals offtake stream of up to US$1 billion to contribute to development finance.

The Company has released three resource estimations, each with roughly the same amount of metal, but with increasing confidence levels. The latest resource estimate effective March 2020 has almost all in the Measured and Indicated (“M&I) categories, which makes it possible to declared reserves for the project, should a feasibility study be positive. Solgold expects to release the results of a pre-feasibility study (“PFS”) within the next few months, delayed because of restrictions imposed to prevent the spread of the COVID-19 virus.

The economic studies assume that block caving will be the mining method for Alpala, which is logical as the low average grades mean that a low cost mining method is needed. The high grade core only starts at around 600 m below surface, makes open pit mining unattractive with the huge amount of low grade material needing mining before better grades are reached. Hence the employment of the lowest cost underground mining technique available: block caving.

The block caving advantages of high productivity and low operating cost do, however, come at a price of technical risk. Block caving is very inflexible, has a number of pre-requisites that cannot be established with great confidence before start of mining, requires huge capital investments at the start, has a very long lead time and slow ramp-up, and can pose great dangers should the company make wrong assumptions for rock mechanical and geohydrological conditions. It is for this reason that block caving operations are only undertaken by real experts, by mining companies with appropriate experience (and balance sheets). It is no surprise that the industry parties invested in Solgold, BHP Billiton and Newcrest run block cave operations.

Without the benefit of a feasibility study this Crux Investor valuation had to draw on a production schedule in a preliminary economic assessment using mineral resources estimated in November 2018. These resources contain slightly less metal than the 2020 estimate, but at higher grades of 0.41% Cu and 0.29 g/t Au in M&I resources compared to 0.37% Cu and 0.25 g/t Au in 2020. The implication is that the PFS should have a lower average grade in the schedule than for the PEA. Moreover, the PEA seems to ignore dilution as being important, as the average feed grade for copper exceeds the resource grade by 3% and the gold grade treated exceeds the resources grade by 7%. Crux Investor views this as overly-optimistic considering that according to a reference publication on block caving states: “with care, mining recoveries in the order of 80% with dilution below 25% can be achieved”. And this is not the only case of rose-tinted glasses being worn.

This study concludes that Wood, the agency responsible for the PEA study, has been generally far too optimistic in its assumptions. In addition to the overly high forecast grade, Wood suggests a pre-production period of 4 years and ramp-up to full production of 60 million tonnes per annum (“Mtpa”) of 6 years, which is far shorter than for comparable operations. Cash operating cost assumptions of US$10.60/t are very low in comparison with costs of US$10-US$20/t seen in similar operations. After analysis of the Alpala data, Crux Investor arrives at a cash operating cost of US$19.65/t.

The PEA capital estimate of US$2.8 billion is very low with a provision for the process plant being one third of what can be expected for the plant size for the anticipated tonnages. EPCM rate are a fraction of what these are in practice and the contingency of 11% bears no relation to the stated accuracy of +/- (forget the minus) of 35%. On many levels the most optimistic case has been taken by Solgold, which is a significant Red Flag. Crux Investor calculates that initial capital expenditure of US$5.3 billion is a more realistic figure for development of this asset at the proposed tonnages in this location.

Crux Investor, in preparing this valuation has made a number of adjustments bringing the PEA assumptions in line with industry norms, using the large body of benchmark figures that are available in the literature for reference. With these adjustments, and accounting for investments in working capital and including the tax on dividends to non-residents, a real-world valuation was reached, and unfortunately that real-world NPV is negative. It is worth saying again, using benchmark (Crux Investor) assumptions and spot metal prices on 26 October 2020 of US$3.08/ lb Cu, US$1,902/oz Au and US$24.20/oz Ag, the NPV7.5 value turns negative compared to US$3.5 billion in the PEA at initial capital expenditure of US$2.8 billion. Ouch. This is a huge Red Flag for a Company with a market capitalisation of almost US$1 billion.

Not only that, but perhaps Crux Investor is not the only house to have recognised the technical challenges and limitations of Alpala? The resignation of the Newcrest Director in June 2020 from the Board is also a Red Flag. News articles at the time attributed the move to disagreement with the Franco Nevada financing that Solgold lined up. Note that Newcrest’s man was a block caving expert, and Nick Mather (Solgold CEO) was actually quoted as saying, “Craig Jones is a block cave mining expert. If you are intending to help look after the future of the company, why would you take your block cave mining expert off the board?” Quite! Our point exactly. Could it be that Newcrest reached the same conclusion as Crux Investor, and has taken a step back from the Board for technical, not financing reasons?

Where does this leave us? The share price at 26 October 2020 of £0.37 converts to a diluted Enterprise Value (“EV”) of US$890 M. Clearly the EV is a massive premium to the Crux Investor NPV, so either the market is willing to go along with the PEA value, or it rates the blue-sky potential of all other Solgold prospects highly. Crux Investor does note that prior to recent regional exploration fanfare, the EV had shrunk to US$520 M, which is still at least US$520 M more than the calculated NPV of Alpala.

With Solgold having commenced drilling programme at 3 projects (Porvenir, Rio Amarillo and Blanca) that seem to be very large mineralised systems, the premium may well be mostly relating to high expectations for exploration results. At one of the targets, Cacharposa within the Porvenir project area, the company reported on 19 October that it had drilled 893 m of visibly promising mineralisation in the first hole and was still in mineralisation after drilling 258 m of hole two. Good comparables are available in the market for an exploration porphyry story – a recent Big Wave Porphyry Copper event organised by Arlington Group covered six explorers with porphyry projects at various stages of development, and valuations, as shown in the table below. The most appropriate comparable is Solaris Resources, with great results from Warintza, additional project potential in the portfolio, and a fully diluted market capitalisation of US$475 M. Porvenir could prove to be as good as Warintza from initial indications, and the recent share price pop on Porvenir news added about US$255 M to the market capitalisation of Solgold, which is in-line with the Warintza valuation.

It is always good to have exploration results, but how is the company going to pay for the regional programme? And to whom will the value accrue?

Crux Investor notes that Solgold faces considerable expenditures in the future. The Company spent US$57 M on Cascabel and other Ecuadorian projects in the year ending 30 June 2020, and a similar annual spend is anticipated going forward. It has allocated the US$100-150 M from Franco Nevada to cover these costs. The kicker, however, is the cost of the regional programme.

Exploration commitments for the 75 concessions that are not Cascabel are likely to be around three hundred million dollars in the next two years, possibly more. Under article 38 of the Ecuadorian mining law, if the Committed exploration budget that won the concession in the bidding process is not spent within the four-year exploration cycle, the Company needs to pay the government a minimum of 80% of the uninvested total. Red Flag alert, Solgold is facing exploration and development study requirements of possibly US$340 M in the next two years (estimates of US$360 M of promised Exploration Commitments less estimates of US$20 M completed). The company is faced with the choice of either diluting the capital structure, or selling exploration projects as they mature to fund the Company. Cash on hand as of 30 June was US$47 M.

Solgold wants to be a major mining company, which is an admirable ambition. It also is doing good work on the ground, which is also admirable. The problem is that all of this work needs funding. With 2.2 billion shares in issue, further dilution is probable. Raising, say, US$200 M at 40c, would mean another half a billion new shares issued. The market capitalization of the company will grow, but the value per share would not necessarily, especially if the company remains weighed down by Alpala.

Cui bono? Imagine this as a crime scene. Who benefits?

The people and country of Ecuador certainly benefit as Solgold is working professionally and well, even if it has fallen about US$300 M behind in its regional exploration programme. Still, the money will come, either as payments to government along with the return of projects, or as direct investment in exploration.

BHP Billiton benefits as it has the largest shareholding in the company already, and the cost of holding and waiting is trivial relative to its balance sheet. It makes no difference to BHP how many Solgold shares are in issue, it is interested in allocating capital to growing its copper division for the long-term, and it is not even that concerned about the share price. BHP knows the power of a good porphyry deposit, as it owns stakes in several. BHP can afford to wait. Ultimately it can even postpone the development of Alpala indefinitely if other projects offer better returns in-country.

Management benefits as it is paid handsomely to do the job, and grows its position thanks to incentive schemes. Common shareholders, however, will bear the brunt of the funding requirements in the near term. Alpala is a drag on the rations, exploration commitments in Ecuador are large, and overdue, and need funding urgently. Dilution is coming. Expect more growth in the number of shares than in the value per share.

In summary, holding shares in Solgold must be seen as a three-way game of chicken. BHP Billiton is the largest shareholder and given that it has stated it wants to grow its copper division it must be attracted to the optionality of a major land position in Ecuador. Management of Solgold obviously want to emerge as heroes and build a major mining company, and will be racing to produce exploration results that move the needle on the share price before raising lots more money. Common shareholders are desperately waiting for a shoot-the-lights-out drillhole from the regional programme to add another half a billion dollars’ worth of value, and tempt BHP Billiton into making a bid for the entire Company. The likely outcome is that BHP Billiton will be patient, while Solgold will issue more stock to fund its exploration commitments. Alpala does not float the Crux Investor boat, and it is unlikely to add buoyancy to the Solgold share price at current copper prices.

Introduction

Solgold Plc(“Solgold”) (LSE:SOLG)(TSX:SOLG) is a UK company originally incorporated in2005 under the name Solomon Gold Plc, but which changed to the current name inMay 2012. In October 2017 the share listing moved from the AlternativeInvestment Market (”AIM”) of the London Stock Exchange (“LSE”) to the MainMarket. The listing on the Toronto Stock Exchange preceded this by a fewmonths.

The namechange in 2012 is explained by the redirection in geographical focus fromAustralia and the Solomon Islands to the Andean copper belt in northernEcuador. In that year Solgold entered into an earn-in agreement withCornerstone Capital Resources Incorporated (“Cornerstone”) and its Ecuadoriansubsidiaries, whereby SolGold was granted the right to earn a 65% direct interestin one of the Ecuadorean subsidiaries holding a 100% ownership interest in theCascabel Project. This agreement was replaced by other arrangements over theyears leading to Solgold owning an 85% beneficial stake in the Cascabel projectby March 2014. However with Solgold currently owning a 7.6% shareholding inCornerstone its total beneficial holding in Cascabel is 86.14%.

In September2016 Newcrest International Pty Ltd (“Newcrest”) agreed with Solgold it wouldbecome a 10% shareholder for a US$22.9 M consideration. An alternativesubsequent bid of BHP Billiton Plc (“BHP Billiton”) for a 10% shareholding wasrejected by management as it came with an earn-in right for 70% of the Cascabelproject.

Within theCascabel project area there are a number of exploration targets, the mostadvanced being the Alpala porphyry deposit. In January 2018 Solgold announced amaiden mineral resource for this deposit. During the year further drilling atAlpala indicated extensions to what has been previously found. It must haveinterested BHP Billiton sufficiently it acquired an important shareholding inSolgold via a back door by purchasing the shares held by Guyana GoldfieldsIncorporated (“GGI”) representing 6.1% of issued shares. In October 2018Solgold entered into a share subscription agreement with BHP Billiton almostdoubling the latter’s shareholding for US$59.2 M.

In Novemberan updated mineral resource estimation (“MRE”) was announced, which wasfollowed in June 2019 with the filing of a preliminary economic assessment(“PEA”) for the Alpala project. According to a business update announcement bymanagement in March 2020, subject to land acquisitions, the pre-feasibilitystudy (“PFS”) was schedule for completion in Q3 2020 and the definitivefeasibility study (“DFS”) in Q1 2021. However, the restrictions imposed tocombat the spread of the COVID-19 virus, this has postponed the target dates.

Solgold madean offer in January 2019 to acquire all shares of Cornerstone and again made ahostile bid on 20 June 2020, expiring in 14 October 2020, with Cornerstone’smanagement advising its shareholders to reject. Relations have soured betweenthe two companies with Cornerstone, among other, accusing Solgold management of“suspect corporate governance and self-dealing practices” and the bidundervaluing Cornerstone.

In September2020 a royalty agreement was completed with Franco- Nevada Corporation(“Franco-Nevada”) for US$100 M in return for granting a 1% net smelter royalty(“NSR”) from production at the Alpala project. The financing can be upsized atSolgold’s election to US$150 M, with the NSR increasing commensurately toUS$1.5%. Franco- Nevada has indicated its interest in co-financing the minedevelopment at Alpala via a gold stream. SolGold expects that, due to thegold-rich nature of the Alpala porphyry, the project can support up to US$1billion of precious metals stream financing.

On 25 June2020, Newcrest withdrew its director from the Board. Newswire articles at thetime commented that Newcrest wanted Solgold to finance the company throughequity, and was unhappy with the gold stream plan. Solgold not wanting to playinto the deep pockets of BHP and Newcrest insisted on financing through royaltyand retaining the streaming option.

Solgold’s focus on Ecuador is apparent from management claim the company holds 76 “carefully selected, highly prospective” concessions in the country. It has identified 13 priority projects, the location of which are shown in Figure 1_1.

Of these the most relevant at this stage are Cascabel, Rio Amarillo and Blanca in the far north and Porvenir in the far south. The company has announced a spectacular discovery hole at Porvenir in October this year, reporting 893 m of striking visual mineralisation. Drilling is ongoing and assays are awaited. In early October drilling started at Blanca and announced an imminent drill programme at Rio Amarillo.

Figure 1_2 shows the share price of Solgold on the London Stock Exchanges since October 2015.

The graph shows a rapid rise upon exploration success at Alpala, but since July 2017 trending downward despite all exploration success. The latest spike is due to the El Porvenir discovery hole announcements.

Financial Performance

Table 2_1 gives the historical operational and financial performance from 31 July 2015, the year before Solgold started to substantially increase it activities and expenditure, until 30 June 2020.

Table 2_1 shows that Solgold (for calculation of the total values the exchange rate at 30 June 2018 has been used to convert A$ in US$):

• Expenditure ramped up dramatically in the 2017 financial year the year in which Newcrest became an important shareholder following exploration success.
• Operational expenditure rose sharply in parallel to investments.
• Financing was predominantly equity capital amounting to almost US$300 M.
• At 2020 financial year-end the cash balance was a healthy US$47 M. This does not include the impact of the US$100 M royalty financing received in September 2020.

Valuation Of The Alpala Project

Background

The technical information in his report has been drawn from a NI. 43-101 compliant technical report by Mining Plus (“M+”) dated 22 May 2020 in support of an updated mineral resource estimation and a report by Amec Foster Wheeler trading as Wood Plc (“Wood”), dated 6 November 2019 in support of a PEA. Unless specifically otherwise stated all text, information and illustrations were drawn from these documents.

The Cascabel Project is located in northern Ecuador approximately 100 km north of the capital city Quito and 50 km from the provincial capital Ibarra (see Figure 3.1_1). The port of San Lorenzo is 75 km to the northeast.

The property can be reached from Quito by following the Pan-American Highway to Ibarra and then via the E10 highway for 90 km to the northern boundary of the project area. Access to the Aloala camp is via dirt road.

The Cascabel Advanced Exploration Licence area shown in Figure 3.1_2 covers 4,979 hectares and is valid until March 2036, renewable for another 25 years.

At the publication date of the technical report a 2% NSR royalty was applicable in favour of Santa Barbara, but this can be purchased for a total consideration of US$4 M. The company has since granted a 1% NSR in favour of Franco Nevada in return for US$100 M funding. At the option of Solgold, the NSR can be increased to 1.5% in return for an additional US$50 M, taking the total package to US$150 M.

Geology and Mineralisation

Geologically the Cascabel project is located in a region characterised by numerous intrusions caused by shallow angle subduction to the east of other geological terranes such as Pacific oceanic plateaus, island arcs ridges and obducted oceanic crust. With subduction to increasingly deeper levels the rock is partially melted and, with a lower density than the unmelted fraction and surrounding rock, will start to rise upwards as plug like bodies. By its very nature this melt is rich in fluids and volatiles (one of the reasons for the subducting rock to melt) and which are being expelled when the melt crystallised at shallower levels with lower temperature and pressure. The crystallised plugs are usually referred to as porphyritic stocks. The name porphyry is due to a texture of the rock showing large crystals of minerals that formed earlier and slower on the melt’s ascent, allowing these to reach their large dimensions in a ground mass of fine crystals that crystallised quickly when the balance of the melt reached the final position. Porphyry is therefore a term that encompassed a range of compositions and not just one rock type.

At Alpala there is a roughly northwest trending cluster of porphyry intrusions, which have been the primary focus for exploration under SolGold, hosting all the drilling to date. The diamond drilling has defined a north-westerly-trending, steeply northeast-dipping, dyke-stock complex of diorite (= of chemically intermediate composition) to quartz diorite (more quartz rich) intrusions that extends more than 2,000 m northwest by 1,000 m northeast and exceeds 2,000 m in height. A total of 11 phases of intrusion have been recognised, each introducing mineralising fluids, and/or remobilising earlier mineralisation, or destructing pre-existing mineralisation. The most important mineralising event was the second phase of intrusion, followed by five other events of weaker stage mineralisation.

Figure 3.2_1 shows a cross section through the Alpala central zone looking northwest with the geometry of the various lithologies and intrusions.

The intrusions are typically emplaced with a stock-like geometry that is moderately elongate in a northwest direction. Intrusions often hold typically vertically and laterally extensive northwest trending, steeply dipping dyke extensions beyond their stock margins.

The various intrusions resulted a numerous phases of veining (12 phases have been recognised) of which only a few are of economic importance, especially two types with quartz-magnetite (Fe3O4) and chalcopyrite (CuFeS2) referred to as B1 -type veins when magnetite is important and B2-type when chalcopyrite is more common. Chalcopyrite-rich, C-type sulphide veins also contain significant amounts of metal and may be associated with elevated gold grades.

Figure 3.2_2 shows the density of B-type veining to which the grade is highly correlated with the light blue colour representing 0.5%-2%, purple 2%-5%, red 5%-20% and green more than 20%.

Figure 3.2_3 illustrates the close correlation between vein density (left, numbered B) and Cu Eq grade (right, numbered D) in a longitudinal section.

Copper occurs predominantly as chalcopyrite which surrounds cubic and massive crystals of pyrite (FeS2) in C- and D-type veins. Later stage copper mineralisation includes bornite (Cu5FeS4), a mineral with considerably higher copper content. Gold occurs as discrete grains of electrum (typically 65% to 85% Au) that range from 1 to 50 microns in diameter. Electrum is an alloy of gold and silver with trace amounts of other metals such as copper. The electrum grains occur within chalcopyrite, bornite, pyrite and rarely quartz and anhydrite (CaSO4). Grains of low-Ag gold (>90% Au) that are 1 to 3 microns in diameter are associated with sulphide grains and occur locally within silicate minerals.

Mineral Resources and Mineable Inventory

Mineral Resources

The database consists of 114 drill holes, which added 39 holes since the 2018 mineral resource estimation. The additional holes focused on infill drilling and resource extension along and across the northwest trend of the deposit. The current drill hole spacing ranges from less than 60 m in the central core, to 160 m at the margins of the deposit, and up to 240 m at the low-grade extremities of the deposit.

Figure 3.3.1_1 shows the collar positions and traces of holes drilled.

For the geological model for resource estimation three mineralisation wireframes were interpreted by modelling copper equivalent (CuEq) grade and B-vein abundance using for the low-grade domain as criteria for Cu Eq and vein density of respectively >0.15% and >0.55%, for medium grade respectively >0.7% and >4.1% and for high-grade respectively >1.5% and >9.4%.

The Cu Eq grade in percent was determined as Cu % + 0.613 x Au g/t.

Figure 3.3.1_2 shows the grade domain outlines in plan and SW-NE cross sections, the traces of which are shown on the plan.

The level plan has been selected at an altitude where the high-grade core has been best developed. From the cross section it is evident the high grade is generally relatively narrow and dipping somewhat to the northeast. The deposit has a strike direction that is northwest and with a slight plunge of the high grades to the northwest.

For estimation various “estimation domains” were defined based on the geological history and geometry of geological units within each grade domain. For Cu a total of 10 domains were defined and for Au a total of nine. For each estimation domain different capping levels were established upon reviewing grade histograms for these domains. For copper the values varied from nil (two domains) to 5% Cu for the two highest grade domains. For Au the capped values varied from nil for one domain to 20 g/t for the two highest grade domains.

Grade continuity analysis was undertaken for each domain and grade where there are sufficient samples to get a reliable result. A block size of 20 m x 20 m x 10 m (vertical) was chosen for grade estimation and sub cells of 5 m x 4 m x 5 m for geometry of lithology and grade wire frames.

The disseminated nature of porphyry deposits and low nugget effect of the grades make ordinary kriging (“OK”) estimation very suitable for block grade estimation.

For reporting purposes a cut-off grade of 0.21% CuEq was used, being the same threshold as used for the previous resource estimation, effective November 2018. Table 3.3.1_1 gives the March 2020 resource statement, compared to the November 2018 resources, for which SRK Consulting (UK) Ltd (“SRK”) was responsible.

The table shows that the main differences between the 2 resource estimations are:

• The increased confidence level in the 2020 resources, now with a substantial proportion in the Measured category. Total Measured and Indicated (“M&I”) resources have increased by 30% in tonnage, but only 15% in Cu Equivalent metal content.
• The lower increase in metal content compared to 2018 is due to a drop in average grade.
• The inclusion of silver, but at the indicated grade this has negligible economic significance.

The above bullet points indicate that the infill drilling of the high grade core of the deposit resulted in a reduction of the overall grade. The two resource estimation reports include illustrations with block model grades, but unfortunately not using the same units: Cu Eq grade in the 2018 report, separate Cu and Au grades in the 2020 report. A direct comparison is therefore not possible.

Even so, Figure 3.3.1_3 compares the block grades in plan established for the 2020 estimation (at 500 m elevation) with 2018 (at 600 m elevation) at the top and the cross sections through the centre of the deposit at the bottom.

The colours warmer than yellow in the 2018 model are for block grades exceeding 0.5% Cu Eq and any blocks grading higher than 0.4% Cu in the 2020 model has a colour green or warmer. With Au contributing approx. 40% to the Cu Eq grade 0.4% Cu could be seen as equivalent to 0.56% Cu Eq. Accepting the comparison is not perfect at all, the impression is that the 2020 model resulted in lower grades away from the high-grade core explaining the overall drop in grade of the mineral resources.

Mineable Inventory

The 2020 study has not taken the analysis further than the estimation of mineral resources. To get a perspective of the economic significance reference has to be made to the 2018 study which included a preliminary economic assessment. Whereas the 2020 mineral resources are slightly higher in size, this should not change the main input parameters used in the 2018 study. The rest of this discussion therefore draws on the 2018 PEA by Wood with Mining Plus responsible for mineable inventory and mining method.

The estimation of mineable inventory assumes that block caving will be the mining method for Alpala. Block caving is a very specialised mining methods and relatively rarely used for a host of reasons. Usually a company needs to extensively train its employees as the skills are not generally available. The authors of this valuation report have no personal experience with the mining method and had to extensively draw from documentation on the internet, the most important being:

• Underground Block Caving: A Guide for Investors
• Design & Operating Principles in Caving Methods (V.N. Kazakidis)
• Open Pt or Block Caving? A Numerical Ranking Method for Selection (F Rashidi-Nejad et al)

Block Caving is the only mining method that would be potentially economical for Alpala. The average grade the deposit means that it can only be economical by using a very low-cost mining method such as open pit mining. However, the depth at which the better grade blocks are located, starting at around 600 m below surface makes open pit mining unattractive with the huge amount of material needing mining before better grades are fed to the plant. For this reason block caving was chosen as it has the same level of productivity as open pit mining and is a very low-cost method. The low operating cost comes however at the price of very high initial investment on primary development and infrastructure and with a much longer development and ramp-up period, typically between 15 and 20 years, than open pit mining.

There are however a number of major pre-requisites for successful block caving, being:

• A deposit with large dimensions in all directions.
• Suitable geotechnical characteristics of the deposit and surrounding rock. This information was not available at the time the PEA study was undertaken. Assuming block caving will be appropriate and technically possible is a large leap of faith. Mining Plus even observed ”this study recognises the existence of some areas of poor ground and which will be identified in greater detail in further geotechnical testwork”.
• Block caving operations must be away from inhabited centres as they create significant risks for water resources, infrastructure, buildings and human lives due to ground subsidence.
• Being in a low precipitation area and with rock conditions that do not cause great influxes of ground water.

There are a number of risk factors specific to block cave mining and specific to Ecuador, being:

• Unlike other mining operations, block caving is inflexible. Once started, it cannot be changed. This means, if the initial design of a block-caving operation is inappropriate, much of the investment will likely be at risk. Furthermore, a block-cave mining operation cannot be put on care and maintenance.
• Alpala occurs in a high rainfall area which significantly adds to the hydrogeological risks. Managing inflow of water is critical as this can mix with the fine material in the broken rock and cause mud flows that are highly dangerous to man and material.
• The deposit occurs in a very seismic active area significantly adding to the risk of collapse. Earthquakes that might not adversely affect an open-pit mining operation are capable of substantially damaging a block-caving operation through a massive cave-roof collapse.
• Large capital projects such as a US$5.3 billion block cave need to have stable fiscal terms and a stable social operating environment. Ecuador does not have a history of supporting mining companies, despite the current economic imperative of being pro-mining to fund social programmes. Ecuador does have a history of activist anti-mining protests and disruptions, which deter deployment of long-term capital.

The implications of the considerations above are that it will be difficult to secure the enormous amount of funding required to develop a block caving operation for Alpala. Figure 3.3.2_1 has been extracted from the publication by Kazakidis dated 2015 with existing and planned block caving operations to illustrate these are generally in politically stable jurisdictions and relatively dry climates.

Mining Plus claims it used benchmarks against other operations to base their assumptions on. It should be noted that Mining Plus observes “the depth of the proposed mine and height of draw of material may pose some challenges and a detailed study on surface subsidence is recommended in the next phase of design”.

From the empirical analysis a cave angle of 76° was assumed and the extent of failure of 68° at the final cave draw. Whereas Mining Plus observes that “dilution and (mining) recovery are important drivers of block cave success”, it skirts around the issues and does not provide quantitative estimates of either. According to Kazakidis “with care, recoveries in the order of 80% with dilution below 25% can be achieved”.

Mining Plus’ mine design assumes two main production phases, an initial phase during which the highest value material is targeted and a subsequent phase during which “lower value, but potentially economic material is mined”. Figure 3.3.2_2 shows the footprint of the various phases, denoting the first phase blocks “x-1” and the second phase blocks “x-4”.

With the extremely little information about conversion factors provided, it is interesting to compare in Table 3.3.2_1 the total mineable inventory assumed in the production schedule with the 2018 resources estimated.

The table shows that, despite the considerable dilution that can be expected, the average grade of the plant feed is forecast to exceed in-situ grade by 3% for Cu and 7% for Au. Total plant feed in tonnes is 18% less than in-situ total mineral resources.

Crux Investor concludes it is safe to suggest Mining Plus being extremely optimistic in their assumptions. The basis for the mineable inventory is resources with grades that have subsequently been revised downwards in the 2020 resource estimation. Using the PEA production schedule grades give a highly positive bias to annual revenue.

Mining Operations

The discussion on the block caving mining method in this section draws on the documents referenced at the start of Section 3.3.2 and a note by Hans Hamrin entitled Underground Mining Methods and Applications

Block caving uses gravity in conjunction with internal rock stresses to fracture and break a rock mass into pieces that can be handled by miners. Blocks are large sections of several thousand square metres of the ore body. Caving is induced by undercutting the block. A rock slice directly underneath the block is fractured by longhole blasting which destroys its ability to support the overlaying rock. Gravity forces acting on the block cause fractures to spread until the whole block is affected. Continued pressure breaks the rock in smaller pieces that through draw points where the ore is gathered and fed into finger raises (see Figure 3.4_1).

From the finger raises the ore is fed to a grizzly level where oversized blocks are caught and broken up by hydraulic hammers to be amenable for further handling. Through a lower set of finger raises the ore is fed to chutes for train loading.

The underground infrastructure underneath the block are subject to high internal stresses and are therefore excavated with minimal cross section and heavy concrete liners and much rock bolting is required to secure the integrity of drifts and drawpoint openings.

In theory no drilling and blasting is required after the first slice at the bottom of the block. In practice it is often necessary to assist rock fracturing by longhole drilling and blasting in widely spaced patterns. Boulders that that must be broken by drilling and blasting frequently interrupt the rock flow. Large blocks cause hang-ups in the cave that are difficult and dangerous to tackle.

In modern mines trackless mining is used with load-haul-dump (“LHD”) equipment is used to handle the material drawn. Figure 3.4_2 shows the lay-out for such mines.

The mine design for Alpala assumes mine access via a twin decline with a length of 5 km until reaching the footprint of the first lifts. The first lifts are accessed directly from the hanging wall side via a sacrificial twin decline which is later consumed by the lower lifts. In this concept mine plan, a 1 in 6 gradient has been used for both the access decline and the conveyor decline.

As mentioned in Section 3.3.2 the deposit is split into 6 footprints in the first phase, with 2 lifts in each footprint. The second phase includes lower grade material around and above the first 6 footprints. The concept infrastructure design had the objective of minimising the development required to mine footprints in the first phase without being compromised by the mining of material in the second phase.

Figure 3.4_3 has a schematic view looking southeast of the access infrastructure and first phase production columns. The second phase footprints are not shown for clarity.

Metallurgy and Processing

Metallurgical Testwork

Given the enormous investments in drilling and exploration, surprisingly little metallurgical testwork has been carried out to support the preliminary economic assessment. Much of the input parameters used is based on work that is “conceptual in nature with respect to pyrite concentrate recovery, doré and cathode production.

Metallurgical testwork was conducted using 20 samples that, according to Wood, provided “a broad spatial representation relevant to the likely mine plan”.

From these samples three sets of composites were generated, subdivided based on grade as Low Grade with grades of 0.77% Cu and 0.76 g/t Au, Intermediate with 1.19% Cu and 2.39 g/t Au and High Grade with 1.93% Cu and 2.61 g/t Au. These grade all far exceed the mining inventory grade and the results cannot be considered representative.

Comminution tests gave moderate ball mill bond index values (average 13.7 kWh/t) and abrasiveness, but with significant variability indicating secondary crushing may be required before semi-autogenous (“SAG”) milling.

Flotation test were conducted on material with particle sizes of 80% passing (“P80”) 105 μm, 150 μm, 212 μm and 250 μm, which are relatively coarse and 150 μm was found to be the optimum for rougher flotation performance. Following regrind of the rougher concentrate to particle sizes between 15 μm and 53 μm, the material was treated in a three-stage cleaning flotation circuit. Based on the results a cleaner flotation feed grind size P80 of 25 μm was considered the optimum.

A considerable amount of copper and gold is contained in pyrite and Wood speculates that:

“a pyrite concentrate may be produced from the cleaner scavenger tailings stream. This stream contains a large portion of the non-recovered gold and to a lesser extent copper. Treating of pyrite concentrates to recover gold via oxidative leaching and cyanidation, and copper potentially by SX-EW methods or precipitation to produce a high-grade oxide copper concentrate could potentially enhance overall gold and copper recovery.”

The balance of the discussion is not clear on whether or not the forecast recoveries include the assumption of pyrite recovery in concentrate. For copper, recovery is forecast as a function of grade as follows with Cu_f denoting the copper feed grade in percentage.

It should be noted there is a large difference in recovery for the Low Grade and Intermediate/High Grade composites and the relationships above may well not sufficiently account for the much lower Mineable Inventory grade (i.e. <0.37% Cu and <0.24 g/t Au) compared to the Low-Grade composite. There is a distinct risk of overestimating metallurgical performance. It is, of course, entirely possible that metallurgical test work for the PFS or the Feasibility Study will have addressed these issues.

Processing

The process flow assumes processes commonly used throughout the mineral processing industry, including comminution by a SAG Mill- Ball Mill-Pebble Crusher until a target size of P80 150 μm is achieved before feeding the material to a flotation circuit which consist of rougher flotation with rougher concentrate regrind (to P80 of 25 μm), three stages of cleaning plus a scavenger circuit to treat the tailings of the first cleaning circuit. The scavenger concentrate is combined with the rougher concentrate for regrinding. The final product is the third cleaning circuit concentrate.

The final concentrate is thickened to an agitated feed tank which provides surge capacity ahead of the concentrate pipeline. The PEA considered various concentrate transport options, including trucking, rail and pipeline options. It concluded that the favoured option is transport by pipeline through a 200 mm diameter pipeline from the process plant to the concentrate filter plant at the Esmeraldas port over a 217 km long route including two pump stations. A water return pipeline from the filter plant in Esmeraldas to the process plant has been included following the same route.

At the port the concentrate will be filtered to lower the moisture content to below the Transportable Moisture Limit (“TML”). The dewatered concentrate will be stockpiled at the port until shipment to the treatment smelter.

Economic Valuation – Alpala Project

Metal Prices and Marketing Terms

For this valuation the spot prices on 26 October 2020 of US$1,902/oz Au, US$24.2/oz Ag and US$3.08/lb Cu were used. The PEA uses prices which are clearly lower for gold (US$1,300/oz) and silver (US$16.0/ oz), but the long-term copper price more optimistically assumed at US$3.30/lb Cu.

Table 3.6.1_1 reproduces the marketing terms assumed by Wood in the PEA which have been generally adopted as these are industry standard, except for the low treatment charges for smelting.

The table shows that the much higher gold spot price essentially fully compensates for the lower spot copper price. The value of silver is negligible in the scheme of things.

Table 3.6.1_2 shows the relative contribution of each metal to at-mine revenue with in the PEA copper accounting for more than three quarter of at-mine revenue, dropping to less than 66% at current spot metal prices.

The Alpala project is predominantly a copper project with gold as an important by-product.

Production Schedule

Mining Plus investigated four production scenarios with steady state production levels of 40 M tonne per annum (“Mtpa”), 50 Mtpa and 60 Mtpa. For the 50 Mtpa scenario two cases were investigated, one with a phased expansion first to 25 Mtpa and then to 50 Mtpa and one directly ramping up to 50 Mtpa. Why Mining Plus did this is not clear considering the capital expenditure and unit operating expenditure are virtually the same. Given this and the fact that the pre-production period and ramp-up during the first 3 years are exactly the same, naturally the highest production case gives the most favourable result. Mining Plus could has saved itself the effort.

This valuation will keep the analysis uncluttered by analysing the highest production scenario.

As the production schedule is best presented by graphs Figure 3.6.2_1 has been generated to show the amount and grades processed over time.

The pre-production period assumed by Mining Plus is an amazingly short 4 years with ramp up to almost full production again a very short 6 years. The combined period of 10 years is much shorter than the suggested 15-20 years at the start of Section 3.3.2. There are no reasons for the pre-production period to be short as the mine will have to be developed to considerable depth before production can start. The suggested production volume of 60 Mtpa converts to 165,000 tonnes per day (“tpd”), which would make it one of the biggest such operations, again not explaining the short pre-production and ramp-up period. Crux Investor concludes that this aspect of the plan is unrealistic.

The copper and gold grade of early production assumes a grade that is multiple times the mineable inventory grade. Whereas the deposit has clearly a much higher-grade core, it remains to be seen whether early mining can be achieved at the suggested grade without serious dilution of lower grade material evident around the relatively narrow high-grade zones evident in Figure 3.3.1_3.

This valuation has adopted the production schedule, but the reader should keep in mind that the latest resource statement has lower grades than the 2018 resource statement on which the schedule is based. The Mining Plus production schedule also does not seem to include substantial dilution which is typically 20% under well controlled conditions.

This valuation has ignored the impact of dilution, but flags it as an overly optimistic assumption by Mining Plus.

Capital Expenditure

The PEA report does not present a summary table for capital expenditure provisions, but instead gives tables for the most important capital items only and without a life of mine schedule for mine development expenditure, which at US$5,137 M is by far the most important item.

Table 3.6.3_1 gives the breakdown of capital expenditure as derived from the detail provided in the PEA report.

Whereas the initial outlays for process plant were extracted from a pre-production capital cost table, elsewhere in the report a more detailed breakdown adds up to US$724 M for the plant. How the US$724 M reconciles with the calculated total above of US$965 M is unclear and cannot be determined with the available information.

Wood assumes a staged construction with addition of plant modules as the production ramps up. The provision of US$724 M amounts to US$145/t monthly capacity which is way below what such plants generally cost. This cannot be explained by benefit of economies of scale as these are very much diminished above a certain plant size with the very large capacity achieved through the deployment of several plant modules. Crux Investor has assumed (a still very optimistic) provision of US$350 monthly tonne capacity for initial capital expenditure.

The provision of US$80 M for a tailings dam that will eventually have to accommodate 2,400 million tonnes is unclear, but seems woefully short.

The Alpala project will be massive in size and the cost of supporting infrastructure seems very low in relation. The EPCM provision is 5% of the items excluding Underground Mine Development. In practice a rate of 12%-15% is more realistic. The contingency is 7% for an estimate with an accuracy of +/- (forget the minus) 35%. This valuation has increased the contingency to 35% in line with the expressed accuracy for the estimates.

According to the third publication under Section 3.3.2 of this report the conversion of the downward extent of the Chuquicamata deposit under the existing open pit would involve a capital outlay of US$2 billion for a production rate of 44 Mtpa. This for an operation with a process plant and all infrastructure already available. Seventy percent of the capital expenditure of a block caving mine is incurred before any revenue is generated.

In conclusion, there seems to be a lot of incongruence between Wood’s provisions for Alpala and industry experience. It is safe to conclude the suggested Wood’s capital expenditure is massively underestimated.

Operating Expenditure

Wood gives operating cost of US$4.00/t mined, processing cost of US5.9/t treated, which is supposed to include all G&A costs, and US$0.45/t treated for supporting activities such as concentrate transport, water and power supply and running the port facility. Total cost per tonne would be US$10.6.

Should the mining cost be realistic, one would have to ask why there are no more block caving operations in the world as these would have cheaper operating cost than an open pit mining operation with a strip ratio above 1 could achieve.

With reference to the third publication under Section 3.3.2 of this report, typical operating costs estimated in 2012 were in the order of US$10/t to US$20/t. The first publication gives typical block caving cost as 5x-7x open pit mining unit cost. At current mining cost of between US$1.5-US$2.0/t for very large-scale open pit operations, this would again put block caving mining cost in the range US$10-US$15/t. This valuation has assumed mining cost of US$12.5/t.

There is nothing particularly favourable about the mineralisation to have very low processing cost. The required particle size is not particularly coarse, the energy required for comminution is not low and the abrasiveness moderate. To assume a cost rate of US$6/t including all G&A expenses seem too optimistic. This valuation has used a rate of US$6/t but has provided for an additional US$30 M per annum to cover G&A costs.

In conclusion, it seems as if Wood also here stretched their assumptions to pull Alpala over the line as an economical project.

Working Capital

The PEA study ignores investment in working capital, which, for an operation producing a concentrate and having a long period between production and receipt of revenue, is a material oversight.

Table 3.6.5_1 gives the assumptions used to calculate the investment in net current assets.

The total investment has been assumed recovered at the end of life of mine, ignoring obsolesce and pilferage.

Royalties and Taxes

With reference to Section 3.1 the 2% NSR royalty in favour of Santa Barbara can be ignored as the buy-out consideration is negligible compared to total initial capital expenditure. That leaves the 1% NSR in favour of Franco Nevada and royalties due to the Ecuadorean government. According to the technical report, government royalties are 5% for copper and 8% for precious metals.

Applicable taxes and other burdens imposed in Ecuador are:

• Profit Share of 15% on Earning Before Tax. No information was provided whether or not this is deductible for tax purposes, but this valuation has assumed so.
• Income Tax at 25%.
• According to a note by Deloitte (http://www.iberglobal.com/ files/2019-1/ecuador_deloitte_ ficha.pdf there is a withholding tax of 10% on dividends to non-residents.

Amortisation and depreciation rates for new and existing assets is allocated on a straight-line over 10 years.

According to the technical report there is “a sovereign adjustment levy” where project contributions to government (royalties, income tax, government profit share) fall below 50% of cumulative economic project benefits. This has been ignored in the PEA and this valuation.

From the above it is clear the government’s take in Ecuador compared very high to other jurisdictions. The “sovereign adjustment” is indicative of the historic resource nationalisation instinct of the government, and is being quietly dropped as current governments realise that mining is essential for the national economy.

Results

Table 3.6.7_1 gives the forecast financial performance for PEA input parameters and this valuations amendments and at Base Case metal prices.

As could be expected, using Wood’s very favourable inputs gives an attractive return on investment of NPV7.5 of US$3.5 billion on an initial outlay of US$2.8 billion. Consultants will not bite the hand that feeds them and will ensure that their assumptions will pull a project over the line. With the long lead times for block caving operations (which Wood severely reduced from realistic levels for Alpala) a very high operating profit margin is mathematically required to achieve a decent return. For PEA assumptions this is almost 57%. However, with the very high burdens imposed by the government for profit share, income tax and withholding tax (not accounting for the royalties) 31.7% of EBITDA would be handed over by the project. In order to achieve a decent return capital expenditure should be kept low, especially initially. This explains the very favourable assumptions by Mining Plus/Wood in this respect, resulting in 41% of EBITDA becoming available for distribution.

When using Crux Investor (realistic, benchmark, industry standard) assumptions for operating cost and capital expenditure, the impact is not surprisingly major. The reader should keep in mind that this valuation is still very optimistic in ignoring the impact of dilution overlooked by Mining Plus and accepting the very short pre-production period and rapid ramp up.

Revenue is very similar to PEA revenue with the much higher gold price compensating for the lower copper price. However, cash operating cost at US$19.65/t treated is more than twice PEA level and the initial capital expenditure of US$5.3 billion is more than 85% higher. The cash operating margin is at this operating cost only 23.5% and net free cash flow attributable to shareholders (ignoring the impact of corporate overheads) only 6% of EBITDA. It is interesting that, even with these much more onerous assumptions, the undiscounted payback period is only 6 years due to the front loading of net free cash flow through high grading in the early years (see Figure 3.6.7_2)

The diagram above shows the impact of the much higher initial capital expenditure, but also how little difference the much high operating cost makes in the early years when grade is relatively very much higher than in later years. After year 26 continued mining makes very little contribution for PEA assumptions and is a severe cash drain using this valuation’s assumption. The graph illustrates the importance of a short lead time, fast ramp-up and the assumption of being able to have a high feed grade in early years, unaffected by dilution of the much lower grade mineralisation around relatively narrow high-grade zones. The sensitivity to changes in these assumptions is difficult to model but adds to the project risk.

Table 3.6.7_2 expresses the sensitivity of the value of Alpala as the change in Net Present Values per percentage point change in the economic main parameters.

Evident from the table is the little difference in sensitivity between the two scenarios for metal prices, which reflects the similar base for revenue under base case metal prices. Naturally the sensitivity to changes in operating cost and capital expenditure is much higher for this valuation.

For this valuation, every percentage point increase in metal prices (i.e. US$0.03/lb Cu) increases the NPV7.5 by US$112 M and for every percentage point increase in the cash operating cost (i.e. US$0.20/t treated) the NPV7.5 drops by US$53 M, which is a 9% change. The sensitivity to capital expenditure changes is even higher with a drop in NPV7.5 of 10% resulting from a 1%-point increase.

The Alpala project is extremely marginal, in particular for the high-risks associated with block caving operations and its high rainfall and tectonically active location.

The Enterprise Value of Solgold Plc

At the share price of £0.3715 on 26 October 2020 and, with 2,072.2 million shares issued according to a corporate presentation dated September 2020, the market capitalisation of Solgold is £770 M, or US$1,001 M. According to the same corporate presentation the company had a total number of 113.2 million share options outstanding of which 13.9 million are in the money at an average exercise price of £0.333.

The net current assets at 30 June 2020 were US$28.1 M, not accounting for the US$100 M received from Franco Nevada for their 1% NST royalty after the year end. The company has debt of US$15.3 M at 30 June 2020, but some of the Franco Nevada funding was used to redeem the loan.

Based on the above a diluted Enterprise Value for Solgold of £684 M (US$890 M) is derived as shown in Table 4_1.

Compared to the NPV7.5 the Enterprise Value is at a massive premium. Either the market subscribes to some extent the PEA value, or it rates the blue-sky potential of all other Solgold prospects highly.

The next section will have a look at latest developments at other prospects.

Blue Sky Potential for SolGold

Regional Potential

Figure 1_1 in this report identified the numerous prospects held by Solgold in Ecuador.

Upon securing the Franco Nevada funding in mid-September Solgold has embarked on an aggressive exploration campaign at 3 prospects where drilling has now commenced: Porvenir, Blanca and Rio Amarillo.

Porvenir had previously yielded a channel sample at surface measuring almost 148 m with 0.37% Cu and 0.43 g/t Au, including almost 83 m with 0.55% Cu and 0.71 g/t Au. Being at surface this is a very promising grade for a Cu-Au porphyry target, referred to as Cacharposa, and made the company decide to drill 8,000 m. The first hole was started mid-September and by 19 October had drilled 893 m of visual copper sulphide mineralisation in the first hole, and was 258 m into hole #2, and still in mineralisation.

Figure 5_1 shows a cross section through Cacharposa with the mineralisation logged along the trace of the first hole shown in blue and its relation to a magnetic anomaly.

According to Solgold:

“Cacharposa is part of a 1,700 m long, northerly-trending mineralised corridor and up to 1,000 m wide. The mineralisation style and geophysical and geochemical footprints, in conjunction with the 3 dimensional (“3D”) magnetic and geochemical modelling are consistent with surface exposure of a well-preserved porphyry copper-gold system with scope for depth continuation of more than 600 m. Encouragingly, mineralisation continues to be intersected in PDH-20-001 outside the current 3D model limits, which demonstrates that size of the system is not restricted to the limits of these models.”

Photos presented in the press release dated 5 October shows intensive sulphide veining at regular levels along the drill trace.

Given the size and grade at surface together with the potential for a very low waste strip ratio, this discovery has far better potential to be an economic project that Alpala. This is the probable reason for the sharp share price rise in the last few months.

On 6 October 2020 the company announced the start at another target, this time the Cerro Quiroz area of the Blanca gold project in northern Ecuador. The Cerro Quiroz Target is interpreted to represent an extensively mineralised and silicified topographic dome and is characterised by quartz vein and stockwork gold mineralisation at surface that returned rock chip assay results of up to 6.8 g/t Au. The drill target has been defined as a northeast trending corridor of 1 km long by 500 m wide of coincident metal soil geochemical anomalies (see Figure 5_2).

The map above also shows the traces of planned boreholes.

On 8 October 2020 Solgold announced the commencement of drilling at another porphyry target, this time the Varela target of the Rio Amarillo project in northern Ecuador.

In February 2020 the assay results for a 99 m surface channel sample gave 0.34% CuEq, including 25.1 m at 0.58% CuEq. Figure 5_3 shows the planned boreholes which will traverse an area with geochemical anomalies at surface (magenta outlines) located within a mapped lithocap (yellow colour).

Shareholders of Solgold have therefore exposures to much news flow over the next few months. Success at only one of the three targets being drilled could have a dramatic impact on the share price as the exploration targets are large mineralised systems.

Exploration Commitments

The regional portfolio was largely put together in 2016-2017 via competitive tender as the government of Ecuador opened up its mining cadastre in late 2015. With the abolition of a punitive windfall tax and the government’s new commitment to mining as it realised the sector offered essential income as almost every other industry in Ecuador was ex-growth. A land-rush ensued, and projects were only won when technical bids were matched with large investment commitments.

The government was taken aback by the amount of money being offered for exploration, and in 2018 it prevented the mining cadastre from issuing new licences, or accepting new applications for licences. A restructuring is underway.

Nevertheless, Article 38 of the Mining code states that, “In the event that the concessionaire does not comply with the … investment plan, it may avoid the expiration of its mining concession through the payment of an economic compensation equivalent to amount of unrealized investments, provided that you have made investments equivalent to the eighty percent of such minimum investments.”

This is worth repeating. The government requires companies to pay the government the exploration commitment it promised, in cash, if does not want the licences to expire. Clearly the exploration companies in question will argue that it has been difficult to get the right permits (water, environmental, scout drilling etc), and there will be a wrangle over the payments. Fundamentally, however, the money will need to be spent in the ground.

The question is, how much was committed? The mines minister reported US$1.7 billion of exploration commitments made in 2016 and 2017, with an investment target of US$4 billion by 2021. The maths on this is relatively crude but simple. Three mines were slated for development (Mirador, Fruta del Norte, Lomo Larga) with combined build costs of approximately US$2.4 billion in total, leaving an expectation of approximately US$1.6 billion earmarked to come from exploration.

Solgold holds a major land position, and comprises a large part of those committed exploration dollars, perhaps 25% of US$1.6 billion, or around US$400 M. Another way of looking at it is to assume that each project carried a commitment of US$30 M to US$50 M. With 12 projects over and above Cascabel, that is an exploration commitment to the government of US$360 M to US$600 M. The exact figure is not known, but it will be in this range.

The annual reports indicate that the lion’s share of investment has gone into Cascabel. Crux Investor assesses that the regional exploration programme has received approximately $20 M of investment (trenching, mapping, sampling – no drilling) over the past three years. This leaves Solgold with an outstanding liability of US$340 M to US$580 M in due exploration.

Crux Investor believes that this level of funding requirement is not widely understood and could have a material impact on the Company.

Valuation of the Exploration Projects

Solgold has started drilling programmes at 3 projects (Porvenir, Rio Amarillo and Blanca) and all three projects seem to host large mineralised systems. At Porvenir, for example, the Cacharposa target has so far yielded 893 m of visibly promising mineralisation in the first hole and was still in mineralisation after drilling 258 m of hole two (as per the news release on 19 October).

The question is, how much value should be ascribed to a decent porphyry exploration story?

Fortunately, good comparables are available in the market, and some of them are perfect for Solgold. A recent Big Wave Porphyry Copper event organised by Arlington Group was an online event discussing the importance of porphyry copper deposits as a contributor to the 20 Mtpa copper market, how they are formed, targeted, and delineated. The event covered six explorers with porphyry projects at various stages of development, and valuations, as shown in the table below, including Solgold.

Looking through the list it is clear that many of the companies are not directly comparable to Solgold, and in particular Solgold’s Porvenir discovery. Alkane Resources is a mining company with gold production, Stavely Minerals has high grade lodes near surface in Victoria, Kodiak has a buried porphyry in BC, Salazar Resources has only just started drilling its porphyry target… which leaves Solaris Resources.

Solaris Resources is TSXV company, and Solgold shares a TSXV listing, although most of its trade is through the LSE. Like Solgold, Solaris is Ecuador focused, and it has a large land-holding with multiple target potential. The main project, Warintza, has a shallow historic resource on it, and the company is in the early stages of drilling out the fuller exploration potential. In fact, Solaris is a matter of weeks ahead of Porvenir, with the results from its third hole showing 1,010 m at 0.71% copper equivalent. It is interesting to see that Solgold announced that Porvenir #1 was a discovery hole without assays. Publishing without assays is always a risk.

Nevertheless, like Warintza, Porvenir is in southeastern Ecuador with indigenous populations, infrastructure challenges, and all of the same challenges and opportunities that every company operating in Ecuador faces. Like Warintza, Porvenir has strong indications of being part of a larger mineralising system, with strong surface expression, soil and stream sediment geochemical anomalies in the region.

Solaris Resources, with great results from Warintza, additional project potential in the portfolio, has a fully diluted market capitalisation of US$473 M. Porvenir could prove to be as good as Warintza from initial indications, and the recent share price pop on Porvenir news added about US$300 M to the market capitalisation of Solgold, which is in-line with the Warintza valuation. This seems fair and appropriate for good exploration news in a bull market, and a reminder that the regional programme is material to Solgold.

Figure 5.3_1 is a reproduction of a slide presented at the Big Wave Porphyry Copper event on 14 October 2020 with the market capitalisation of peer companies of Solgold.

Conclusion

Crux Investor has reached the conclusion that the extremely marginal Alpala is running with a negative NPV7.5, but that the exploration portfolio is fairly valued at a starting point of around US$300 M. The Company has US$100 M (possibly US$150 M) to fund the ongoing work at Alpala, and it has US$47 M to fund G&A and the exploration programme. The regional exploration programme is the most exciting aspect of Solgold as Ecuador is emerging as THE destination to find porphyry copper and gold epithermal deposits at or near surface. Solgold has a superb portfolio, but it comes with a significant funding commitment, estimated to be US$340 M in the next two years.

How will Solgold fund its exploration projects? The company is faced with the choice of either diluting the capital structure, or selling exploration projects as they mature to fund the Company.

Solgold wants to be a major mining company, which is an admirable ambition. It also is doing good work on the ground, which is admirable. The problem is that all of these programmes need funding. With 2.2 billion shares in issue, further dilution is probable. Raising, say, US$200 M at 40c, would mean another half a billion new shares issued. The market capitalization of the company will grow, but the value per share would not necessarily, especially if the company remains weighed down by Alpala.

For the independent investor it might be worth asking “Cui bono”? Imagine this as a crime scene. Who benefits?

The people and country of Ecuador certainly benefit as Solgold is working professionally and well, even if it has fallen about US$300 M behind in its regional exploration programme. Still, the money will come, either as payments to government along with the return of projects, or as direct investment in exploration.

BHP Billiton benefits as it has the largest shareholding in the company already, and the cost of holding and waiting is trivial relative to its balance sheet. It makes no difference to BHP how many Solgold shares are in issue, it is interested in allocating capital to growing its copper division for the long-term, and it is not even that concerned about the share price. BHP knows the power of a good porphyry deposit, as it owns stakes in several. BHP can afford to wait. Ultimately it can even postpone the development of Alpala indefinitely if other projects offer better returns in-country.

Management benefits as it is paid handsomely to do the job, and grows its position thanks to incentive schemes. Common shareholders, however, will bear the brunt of the funding requirements in the near term. Alpala is a drag on the rations, exploration commitments in Ecuador are large, and overdue, and need funding urgently. Dilution is coming. Expect more growth in the number of shares than in the value per share.

In summary, holding shares in Solgold must be seen as a three-way game of chicken. BHP Billiton is the largest shareholder and given that it has stated it wants to grow its copper division it must be attracted to the optionality of a major land position in Ecuador. Management of Solgold obviously want to emerge as heroes and build a major mining company, and will be racing to produce exploration results that move the needle on the share price before raising lots more money. Common shareholders are desperately waiting for a shoot-the-lights-out drillhole from the regional programme to add another half a billion dollars’ worth of value, and tempt BHP Billiton into making a bid for the entire Company. The likely outcome is that BHP Billiton will be patient, while Solgold will issue more stock to fund its exploration commitments. Alpala does not float the Crux Investor boat, and it is unlikely to add buoyancy to the Solgold share price at current copper prices.

Red Flags

The pros and cons of Solgold have been covered throughout this report, and so this section is little more than a collation of the points. The Red Flags and Green Lights should not be taken out of context and instead should be viewed as discussion points for the Company or the investor to address.

• Alpala is a low grade deposit with a narrow high-grade core buried 600 m below surface
• Infill drilling for the latest MRE resulted in the average grade of the deposit falling, despite tonnage staying the same
• Block caving is a challenging mining method only to be undertaken by proven experts with significant operating experience and strong balance sheets
• Block caving is especially difficult in high rainfall and seismically active areas such as northern Ecuador
• Pre-production and ramp-up times of four years and six years respectively are unrealistically short
• Newcrest withdrew its representative director, an expert in block caving, from the Board in June 2020
• Metallurgical testwork has been carried out on above-average grade material, and results on low-grade material are different. There is metallurgical risk with the deposit, as per the PEA
• Capital and operating cost estimates used in the Alpala PEA are unrealistic
• Using benchmark, industry standard costs, the NPV_7.5 for Alpala is negative. The project is extremely marginal
• Remaining exploration commitments made in 2016-2017 with a four-year time horizon are likely to exceed US$340 M, and could be as much as US$600 M.
• Article 38 of the Mining Code states that uninvested sums must be paid to the government and licences returned
• Solgold has US$47 M available for G&A and Regional Exploration. Further share issues are likely
• Valuation of Porvenir and the exploration portfolio is fair at US$300 M and this could rise to match Solaris Resources on approximately US$500M. The challenge is to make the EV of US$834 M rise, when Alpala has a negative NPV_7.5
• BHP Billiton is more likely to benefit in the future than common shareholders from Solgold
• Ecuador presents many operating challenges, including a history of anti-mining activism, and a historic (but changing) lack of government support

Green Lights

• Ecuador is the premier mining destination if one is looking for well-mineralised copper porphyries and gold epithermal deposits
• Ecuador government needs mining as a mainstay of the economy
• Solgold has a global presence and a strong brand with an Australian management team, and listings in Canada and the UK
• Responsible operations in Ecuador with mostly local employees, good training and CSR credentials
• Solgold has more licences in Ecuador than competitors, with 76 concessions and 13 projects (including Cascabel)
• Financial flexibility for Cascabel from Franco Nevada with the option to increase the NSR to 1.5% and US$150 M, plus the promise of a precious metals stream to contribute to the build-capex
• Top-tier backing from BHP Billiton, and Franco Nevada
• Porvenir discovery is exciting, highlighting the potential of the regional portfolio

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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!