The Great Canadian Area Play

Area plays have long been a mainstay of the Canadian junior exploration scene that periodically dominates market speculation and media coverage. They have generally erupted amid dismal bear market conditions, fuelled by a new discovery whose magnitude greatly exceeded expectations and forced a dramatic rethinking of a region's potential. Some noteworthy examples include Hemlo in 1982, Eskay Creek (1990), the Lac de Gras diamond rush (1992), and the Labrador nickel-copper rush (1995).

Technically any region that undergoes a staking rush by multiple companies in response to a new discovery qualifies as an "area play," but to qualify as a Great Canadian Area Play a staking rush must blossom into a market mania. For that to happen, an area play must meet several conditions -- the most important being that the new discovery is truly world class in grade and size, items not usually established until the second year of follow-up exploration.

Today's best candidate for a Great Canadian Area Play is the McFauld's Lake region, situated in the James Bay Lowlands of northern Ontario, where Noront Resources (NOT-V) discovered the high-grade nickel-copper-platinum group Eagle One deposit in August 2007. The indicated and inferred high-grade massive sulphide resource at Eagle One came in with an exceptional rock value of $1,841 per tonne at current spot metal prices, and the disseminated resource came in at $408 per tonne. But the massive sulphide resource totalled only 440,000 tonnes and the disseminated resource totalled 2,471,000 tonnes for a combined gross metal value of $1.8 billion. That pales in comparison to the $60 billion value of the Ovoid and Eastern Deeps deposits at Voisey's Bay, or the more than $20 billion worth of diamonds identified in the Northwest Territories.

Barely a year old, McFauld's Lake needs to deliver additional discoveries to keep the area play alive. With a dozen companies gearing up to drill targets during the next 12 months, McFauld's Lake certainly is in a position to become a Great Canadian Area Play, especially if the bear market continues to erode the prices of juniors trying to develop existing deposits. These juniors have dominated the market's attention during the commodity price boom of the past five years but are now suffering from a widening disconnect between persistent high metal prices and investor anxiety over a looming price bust. That does not spell a revival of interest in isolated exploration plays, but it does prime the market for the self-reinforcing dynamic of an area play.

Another important condition is that the discovery be a geological surprise either in the type of deposit or its scale. Although De Beers had explored the barren lands of the Slave Craton, the dis- covery of diamondiferous kimberlites in late 1991 came as a surprise. Labrador was known to have nickel-copper showings and geology prospective for magmatic-style deposits, but nothing had been found even remotely comparable to the 30-million-tonne high-grade nickel-copper-cobalt Ovoid deposit at Voisey's Bay.

Much of the McFauld's Lake region is blanketed by young limestone, and most of it is covered by swamp water with very little outcrop. The region was initially explored for kimberlites, which in 2002 led to the discovery of poly-metallic volcanogenic massive sulphide (VMS) mineralization in the Archean basement rocks beneath the limestone cover. Despite considerable exploration effort only a couple small copper-zinc deposits with a combined gross metal value of about $300 million were found, and the area play was dying when Noront hit magmatic-style mineralization associated with ultramafic intrusions that had once been shunned as exploration targets.

Closely linked to the surprise nature of a new discovery is the apparent simplicity of the discovery, which could have been made by anybody who bothered to take a closer look. Kidd Creek is legendary for having an electromagnetic signature so strong that pilots used it as a navigational tool until somebody troubled to drill it. The Voisey's Bay deposit has a gossanous outcrop that a government geologist once sampled, albeit in a spot that yielded no values. And an abundance of garnets on a beach at Point Lake alerted Chuck Fipke to the possibility of a kimberlite field.

At McFauld's Lake the Eagle One deposit consisted of a coincident magnetic high and EM conductor that had initially been staked as a kimberlite target. Even though Eagle One did not qualify as a good VMS target, Noront drilled it anyway. Now everybody is taking a fresh look at magnetic-high anomalies with EM conductors in the hope of finding other "Eagle One" deposits.

WEAK SHARE STRUCTURE

A fourth condition is that the participants in an area play include a fair number of juniors with fairly weak share structures who experience a sharp turnaround in fortune. In street parlance "structure" refers to the ownership distribution of a company's shares. The more shares outstanding, and the more widely they are held, the "weaker" the structure. Such companies are viewed as being near the end of their life cycles and headed for a delisting or a re-organization in the form of a stock consolidation.

Dia Met Minerals was a company with an oddball assortment of shareholders consisting of true believers and flow-through funds when it found diamonds; Dia Met shares hit $60 pre-split apiece inside 18 months. Diamond Fields was a sinking ship with a failed diamond strategy when salvation came in the form of the Voisey's Bay nickel-copper discovery. Diamond Fields was bought out at a pre-split equivalent of $160 per share within two years. These were awe-inspiring gains that sealed their status as Great Canadian Area Plays.

At McFauld's Lake, Noront was a widely held company with 100 million issued shares and a price sinking toward $0.30 when Eagle One happened. The subsequent rise to a peak of $7.42 laid the foundation for the McFauld's Lake area play, though the price gains do not yet qualify as awe-inspiring.

The diamond and Labrador staking rushes included many feeble companies whose shareholders saw new value injected into their worthless positions. A widespread and rapid positive turnaround in fortune becomes a powerful promotional force as the beneficiaries individually spread the word and recycle profits into other area play participants. The McFauld's Lake area play consists of 30 juniors, most of them with weak structures; its evolution into a Great Canadian Area Play would benefit many investors, but McFauld's Lake still needs to confirm its world-class status.

Area plays flourish in bear markets because a new discovery rekindles faith in the rags-to-riches story. The element of surprise associated with a new discovery, often buttressed by a fair amount of serendipity, fosters optimism that anybody with a land position in the relevant region can and, in the eyes of speculators, will duplicate the flagship discovery. It is this sense of equal opportunity that coaxes money into the market, creating in the hope of finding other "Eagle One" deposits.

WEAK SHARE STRUCTURE

A fourth condition is that the participants in an area play include a fair number of juniors with fairly weak share structures who experience a sharp turnaround in fortune. In street parlance "structure" refers to the ownership distribution of a company's shares. The more shares outstanding, and the more widely they are held, the "weaker" the structure. Such companies are viewed as being near the end of their life cycles and headed for a delisting or a re-organization in the form of a stock consolidation.

Dia Met Minerals was a company with an oddball assortment of shareholders consisting of true believers and flow-through funds when it found diamonds; Dia Met shares hit $60 pre-split apiece inside 18 months. Diamond Fields was a sinking ship with a failed diamond strategy when salvation came in the form of the Voisey's Bay nickel-copper discovery. Diamond Fields was bought out at a pre-split equivalent of $160 per share within two years. These were awe-inspiring gains that sealed their status as Great Canadian Area Plays.

At McFauld's Lake, Noront was a widely held company with 100 million issued shares and a price sinking toward $0.30 when Eagle One happened. The subsequent rise to a peak of $7.42 laid the foundation for the McFauld's Lake area play, though the price gains do not yet qualify as awe-inspiring.

The diamond and Labrador staking rushes included many feeble companies whose shareholders saw new value injected into their worthless positions. A widespread and rapid positive turnaround in fortune becomes a powerful promotional force as the beneficiaries individually spread the word and recycle profits into other area play participants. The McFauld's Lake area play consists of 30 juniors, most of them with weak structures; its evolution into a Great Canadian Area Play would benefit many investors, but McFauld's Lake still needs to confirm its world-class status.

Area plays flourish in bear markets because a new discovery rekindles faith in the rags-to-riches story. The element of surprise associated with a new discovery, often buttressed by a fair amount of serendipity, fosters optimism that anybody with a land position in the relevant region can and, in the eyes of speculators, will duplicate the flagship discovery. It is this sense of equal opportunity that coaxes money into the market, creating a whirlpool of liquidity where every new fragment of information boosts stock prices as more speculators vacate the sidelines. While there is plenty of bad-mouthing by management teams about their competitors, it seems to fall on deaf ears as one company's stock price surge stimulates sympathetic activity in other area play participants'. There is comfort in a crowd, particularly a gathering crowd, and a Great Canadian Area Play is just such a crowd, with a self-fuelling dynamic. The results are high valuations, whose dumbfounding nature further fuel the mania.

EARLY STAGES

The initial stage of an area play involves a staking rush as various groups scramble to acquire what is thought to be the most geologically prospective ground for the new discovery. If the discovery company is working by itself in a remote region, it will stake additional land before publishing any news. Once Dia Met understood that it had discovered a new diamond field at Lac de Gras, it expanded its core land position several times in an effort to "get it all." Robert Friedland's Diamond Fields did the same at Voisey's Bay and then went one step further in staking other parts of Labrador mapped with the same host geology. As it turned out, Fipke did not get it all, but Friedland did, at least as far as the Voisey's Bay area play cycle was concerned.

The first outsider staking wave starts as soon as the discovery is announced. It consists of companies already in the area that expand their land positions or whose management is plugged into the people behind the discovery junior. They grab anything within the proximity of the discovery. Aber Diamond and associates staked the first adjacent land package at Lac de Gras, which eventually yielded the world class Diavik cluster. Then the DHK group, tipped off by Yellowknife insiders who had done staking work for others, joined the fray to stake land that led to the DO27 discovery. The assumption is that the discovery company failed to appreciate the implications of its discovery and that it is presumptuous to dismiss any ground as "moose pasture" until proven so by exploration. An area play is alive as long as this "glass-half-full" mentality grants the benefit of the doubt to the area play juniors.

THE SECOND WAVE

The second outsider staking wave consists of groups which have extrapolated the geological implications of the discovery to a much broader region of open ground beyond the first staking wave. Lytton Minerals, which eventually became Tahera, staked large land positions within the Slave Craton well beyond Dia Met's core claims. The arrival of such groups, typically well-financed and managed, gives a strong boost to an emerging area play because it underscores the significance of the flagship discovery. In the Northwest Territories this far flung staking eventually led to the Snap Lake and Gahcho Kue diamond discoveries. At McFauld's Lake the second staking wave was led by Temex Resources (TME-V) and MacDonald Mines (BMK-V), which thickened and lengthened the "Ring of Fire." In an intriguing geological extrapolation Diamondex spent $2 million staking the Nickel Bay package to cover a second "Ring of Fire" inferred beneath the James Bay Lowland limestones to the east. This gambit received a strong endorsement in July 2008 with the farm-out to Canada Nickel Corp, a private company being funded solely to explore the Nickel Bay land.

An area play that evolves into a Great Canadian Area Play typically runs 2-3 years before it runs out of steam, which is usually enough to revive broader speculation in the junior resource exploration sector. During the first year there is uncertainty about the size and economics of the discovery, and the market is generally cautious about embracing the other area play juniors. By the second year the flagship junior will have financed itself and mobilized a major exploration campaign which fleshes out the initial discovery or generates additional ones. Most of the area play juniors will still be busy generating targets during the second year, but those which are ready to drill will attract speculators if the flagship junior is still on track. From the perspective of a speculator this is the most lucrative phase because the identities of all the participants and their projects are known, prices have usually fallen after the initial staking frenzy, and it is fairly easy to plot the exploration story lines.

This is the situation that prevailed during the summer of 2008 at McFauld's Lake, with the only fly in the ointment being that Noront's discovery did not qualify as world class by itself. In an established mining camp preparations would now be under way to put Eagle One into production. The McFauld's Lake region, however, is remote and lacking in both transportation and mining infrastructure. So the focus has shifted to the question of how many other Eagle One size deposits will be found during the next couple years of intense exploration. The McFauld's Lake region needs to push the in situ value of its resources past the $10 billion mark in order to justify infrastructure development. Any and every discovery made by the area play juniors thus benefits the area play. This unusual dynamic along with the notion that McFauld's Lake is the last high stakes exploration frontier in Ontario may keep the area play alive until it does achieve the critical mass needed for a Great Canadian Area Play.

SILENCING THE CYNICS

For an area play to evolve into a Great Canadian Area Play, the scale of the discovery must boggle the minds of speculators and silence the professional cynics.

But perhaps this is no longer possible. The Great Canadian Area Play may be little more than a nostalgic dream in the grown up world of today's resource exploration industry. To understand why we need to consider the ways in which the junior resource sector has changed during the past decade. The biggest change has been the growth in the size and breadth of the sector. Consider that since the start of 2002 to mid-2008 companies listed on Vancouver's TSX Venture Exchange alone have raised $33 billion through private placements, which translates into the creation of 63 billion shares at an average price of $0.53. At least two-thirds of this amount is attributable to resource sector juniors.

During this period there have been dozens of takeover bids involving companies that started on the TSX Venture Exchange. The value of these takeover bids and mergers exceeds $40 billion. Most people would be hard-pressed to list off even a handful. When Dia Met was bought by BHP in 2002 the implied value for the entire Ekati diamond project was a mere $2.1 billion. When Inco wrapped up Diamond Fields in 1997, the value was $4 billion -- that was a big deal 10-15 years ago. The best Cinderella story to emerge during the past decade is the 14-million-oz. Fruta del Norte gold deposit discovered by Aurelian Resources (ARU-T) in Ecuador. It is set to disappear in an anti-climactic $1-billion takeover bid by Kinross Gold (K-T). In the old days, a world-class discovery could command the attention of the entire junior resource sector audience. Today, the audience is so large that no imaginable discovery could achieve that.

There are nearly 1,500 companies listed on the TSX and TSX Venture that qualify as resource "juniors" and, ignoring those with a market cap above $1 billion, their collective market capitalization stood at $77 billion, even at the depressed mid-summer prices of 2008. A new world-class discovery tomorrow would represent less than 5% of the capital at risk in Canadian resource juniors. To make matters worse, the 30 McFauld's Lake juniors have 2.6 billion shares issued that trade at an average of $0.39 each. While the upside value limit for a new discovery has inflated somewhat due to higher metal prices, the inflation in the number of issued shares in today's juniors, typically over 50 million, has been much more dramatic during the past decade. The result is that the discovery junior rarely soars into optically pleasing double-digit numbers, and while the total value achieved for shareholders may be the same today as it was yesterday, the wow factor created by astronomical price gains made possible by the low number of issued shares yesterday is largely gone today. And that may be the reason that an area play can no longer dominate the market and escalate into the Great Canadian Area Play of yore.

Unless, of course, the McFauld's Lake region is another Sudbury or Abitibi camp in waiting, one that yields a multitude of billion-dollar deposits in very short order as the Canadian exploration industry brings the grown-up extent of its expertise and funding reach to bear in record time. Now that would be something we have never seen before.

-- The author writes the kaiser bottom-fishing report. you can read more of his research and opinions by visiting www.kaiserbottomfish.com