by Louis James
No one, not even Warren Buffett, can pick market winners every time. I’m a big boy, so I don’t get all bent out of shape when a trade goes south. I’m at peace knowing that I win more than I lose. The losses I take are the price I pay for the gains I make.
But I hate losing money. And I hate it even more when readers lose money. People trust me and look to me for guidance on what to do with their hard-earned cash. I take it as a solemn duty to do my very best for them. So it not only wounds my pride, it hurts me somewhere deep inside when a speculation doesn’t work out.
The worst is when I make mistakes that I could have avoided.
This is worth emphasizing: I am fallible.
I don’t claim to have a perfect track record. I have done quite well on average—but that average includes losers and winners. Readers should keep this in mind.
There are, however, two stocks in particular that I do wish I’d never recommended…
I’ll tell you both tales of woe. They’re worth covering in some detail, as both taught me very important lessons. I hope this will spare you from making the same mistakes I did.
Banks Island Gold
This defunct company had a small gold project on Banks Island in Canada, optimistically named Yellow Giant.
That right there was a warning sign; the story didn’t pass the “go big or go home” test my mentors had taught me early on to apply to mining projects. That rule of thumb is based on the reality that small mines face almost all the same challenges larger ones do, but yield much less reward. They’re usually just not worth the trouble.
Still, while Yellow Giant was small, it was very high grade. The gold was right near surface. There was exploration potential for a lot more on the property. Best of all, initial testing had shown that most of the gold could be recovered by cheap, simple gravity separation. That meant the mine could be built for a few million dollars and would not use cyanide or other scary-sounding chemicals, making it easier to permit.
In fact, the tonnage was so small and the grade so high, a substantial amount of gold could be recovered under the company’s exploration license. It was to start out like a big bulk sample. Preliminary economics showed an enormous return for the investment.
However, that was not enough to make me stray from the path of “go big or go home” wisdom. The company also had a much larger project called Red Mountain not far away. That one had million-plus ounce potential, at excellent grade. The idea was that Yellow Giant would be quick and easy—and it would pay for exploration of the bigger prize. And if lady luck smiled on us, more gold would be discovered at Yellow Giant. That could help pay for construction of the larger Red Mountain project.
It was an audacious plan. I knew that CEO Ben Mossman had directly relevant experience and a good reputation. I liked his no-nonsense, can-do attitude.
But things started to go wrong right from the beginning. The company only needed about $10 million to build the initial mine, explore for more gold at Yellow Giant, and make property payments on Red Mountain. But Banks Island wasn’t able to raise all the money.
Ben decided to go ahead anyway. He figured they had enough gold in the first, high-grade zones to pay back the initial capital and pay for the next steps.
In retrospect, I should never have entered the trade, but once in, I should have exited at this point. Ben’s plan could have worked if things went well—but things rarely go smoothly in building a mine. If Banks Island had had extra cash to cover the unpleasant surprises along the way, it might have made it… but it didn’t.
My more serious mistake, however, was discounting the risk posed by the project not having a full feasibility study. The numbers looked great, but they were based on a preliminary economic assessment (PEA).
I knew this. I knew it was risky. But the gold was right there, so close to surface, it could almost be mined with a bulldozer. There was no complicated or dangerous chemistry involved. And the project was so small, it would cost more to conduct a feasibility study than it would to just go ahead and build the mine. It looked so simple, and it was so high grade, it seemed worth a shot.
Among the many problems encountered, one of the biggest was that it turned out that there were garnets in the veins. These had about the same density as the pyrite nuggets that carried the gold. This meant that the gravity separation recovered the worthless garnets along with the gold, greatly reducing the value of the mine’s output.
The second major problem was that the host rock was less competent than expected. This resulted in a lot of the surrounding waste rock falling into the ore as the veins were blasted. That meant processing more rock to get the same amount of gold out.
Bottom line: higher costs and lower profits.
Both of these problems would have been identified in a full feasibility study. But that never happened, so the cash-strapped company had to improvise. This took time, and the lack of revenue resulted in the company not having enough cash to make its property payments for the Red Mountain project. That was a major blow, as it took away the bigger upside the little starter project was supposed to make possible.
I should definitely have exited the trade at this point. Before deciding, however, I flew out to have a look at Yellow Giant. Ben had done a terrific job overcoming the project’s problems, and the mine was starting to make money. They had also discovered more high-grade gold and were preparing new zones for mining in more competent rock.
I decided to give them a chance, since they were visibly on the verge of success. Big mistake. Cash flow started to pick up, but just as the company was about to achieve a record month, Yellow Giant was hit with exceptionally heavy rain. This caused a mined-out area being used to store waste to overflow.
There was nothing toxic in that spill. It was just ground up rock. And it was tiny. It was about as much mud as a common dump truck might hold. But this was not long after the Mount Polley mine disaster in British Columbia. You may recall that Mount Polley’s tailings dam failed, sending millions of tonnes of mine waste into a nearby river. So, when Yellow Giant had its insignificant spill, local First Nations raised objections. The regulators took no chances and shut the mine down.
If Banks Island had started out with more cash, it might have weathered this storm. As it was just scraping by, even a brief pause in cash flow was fatal.
The worst part of this story may be that the company had ordered and received a pump that would have prevented the spill. It was on site and due for installation within 48 hours when the storm hit. If Banks Island had started out with enough capital, it would have had this pump from the beginning. The spill wouldn’t have happened. Despite the serious problems encountered, the company might have succeeded.
But the shutdown quickly led to insolvency. I visited the site the day after the spill was announced and became convinced this would happen. I urged my readers to sell. Later, I counted myself lucky to have exited the position before the bankruptcy was announced.
Lesson learned: I don’t speculate on projects that fail the “go big or go home” test.
Rubicon passed the “go big or go home” test long before I came to the story, but it ran into problems for other reasons. It had—or seemed to have—a large, high-grade gold project in Canada’s prolific Red Lake district, called Phoenix. This is “elephant country” for gold deposits.
Unfortunately, the deposit was deep. It wasn’t too deep to mine profitably, not given the apparent high grade. But it was deep enough to make it very expensive to drill the deposit off to the level of detail needed for a full feasibility study.
For a little more money, the company could sink a shaft down into the deposit and drill it off in even greater detail from underground. That’s a big job, however, and if they were going to spend hundreds of millions of dollars on a mine shaft, management decided to go ahead and build a full, production-sized shaft. Since that was the lion’s share of the capital needed to build the whole mine, they decided to do just that—even though all they had at the time was a PEA.
Again, I knew this was risky. I stayed away from the stock when it was riding high on high-grade drill results, and watched it slide as the reality of trying to build the Phoenix mine sank in with investors.
Then new management stepped in and slashed the average grade of the deposit model. That made for a smaller, but supposedly more conservative resource estimate. This pushed share prices down even more, while making the project look more credible. It seemed like a “better + cheaper = opportunity” situation.
Also, the limitations of the drilling kept the model in lower confidence categories defined by Canada’s 43-101 regulations. That meant the resource model couldn’t be used for a full feasibility study. But that didn’t stop the company from doing other advanced engineering. That resulted in a level of understanding of the project and its economics that wasn’t as preliminary as “PEA” suggests.
But the big thing for me was that new management included Michael Lalonde, previously General Manager of Goldcorp’s world-class Red Lake Gold Mine. Rubicon’s Phoenix was supposed to have the same type of mineralization and operate in much the same way as Goldcorp’s mine next door. So if there was anyone who should know how to get the job done—and reassure me that it could be done—Lalonde was the guy.
He looked me in the eye and told me he was seeing the same things he saw at Goldcorp, and was sure the mine would deliver more and better results than estimated in the PEA. I believed him.
He might have been telling the truth as he saw it, but he was definitely wrong.
Once Rubicon got underground, the results immediately started differing from what the conservative model predicted. Rather like what happened with Banks Island, the reality was more complex and difficult. But a lot of mines have teething pains. It was even happening to Goldcorp at around the same time, at its new Eleonore gold mine in Quebec. Given Lalonde’s credentials and reassurances, I gave management some time to right the ship. Another big mistake.
Instead of things getting better, the processing plant started having problems, sending higher levels of blasting residues to the tailings pond than permitted. It wasn’t much, but this was a major failing, in my view. I could understand the need to work out the geometry of the deposit once they got into it underground, but the plant was built by some of the best in the business. If management was on the ball, this sort of problem should never have happened.
And suddenly, Lalonde was out.
That was three strikes in my book, so I recommended selling the stock.
Many readers sold on that call—but many did not. They didn’t want to take the loss, and hoped the company would pull through. I know, because I heard from them. But the kind of problems Phoenix was having told me there was more bad news to come. Sadly, I was right. A series of setbacks and revelations took the share price down and down. The mine was shut down. The company eventually issued a new resource estimate, slashing the deposit to about a tenth of its former size.
At this point, it’s a total write-off for investors who didn’t sell before the wipeout. Even if this Phoenix were to rise from its ashes and drive current share prices up a hundredfold, it would not make pre-crash shareholders whole.
Lesson learned: when a speculation goes bad, just get out.
I learned a lot from both of these debacles. The two lessons highlighted above are critical, but there’s one key takeaway from both stories:
Critical lesson learned: building a mine without a fully bankable feasibility study is inviting failure.
In both cases, the mines got built but failed to deliver. There’s so much that can go wrong in building and operating a modern mine, even when it’s thoroughly studied—it’s just too risky to do it without as much detailed knowledge as you can get.
If the project is too small or too deep—or too anything—to make it worthwhile to study in detail, it’s probably not worth building.
This is why—no matter how reasonable the arguments for not doing a full study are—I’m not investing in a mine-building project unless there’s a full feasibility study. It’s also why I generally look to take profits or sell when a company finishes building its first mine—not later, when the world finds out whether it makes money or not. Learning experiences like mine are too painful to repeat.
No matter how tempting a story seems, and as much as I like the pre-production sweet spot, it’s just not worth the risk.
That’s the way I see it.
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