Gem hunting with a diamond pioneer
The following article was adapted from the August 27, 2014 issue of Resource Opportunities, our premium newsletter (the video below was taped in December 2014 and just released this morning).
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North Arrow Minerals (NAR.TSXV at a glance:
– Diamond exploration in Nunavut, Saskatchewan, Northwest Territories and Ontario
– Share price: $0.56
– Shares outstanding: 49.8 million
– Processing of the Qilalugaq Q1-4 bulk sample, which hosts a population of fancy yellow diamonds, is underway and expected to be finished in April 2015. Preliminary indications are that the profile of the bulk sample is consistent with earlier, smaller samples, according to a Jan. 21 news release. A valuation of stones larger than .85 mm will follow processing.
– 3,000-metre drill program at the Pikoo diamond project in Saskatchewan.
Gem Hunting with a Diamond Pioneer
Our goal as junior resource investors is to identify mispriced assets and capitalize on the discrepancy.
Our mission at Resource Opportunities is to identify stocks with an attractive risk-reward profile, where the upside potential more than mitigates any downside risk. We are on the hunt for stocks that could double or triple in the short term, on the way to becoming ten-baggers and more.
Our featured stock in this edition of Resource Opportunities is run by a mining industry legend who delivered 1,000% plus returns to shareholders of his previous diamond play.
He was a first mover during one of the largest staking rushes the world has ever seen, giving his company valuable land positions that led to a world-class discovery.
And he's back in the hunt, exploring for the same commodity that made him wealthy, in remote terrain that few mineral explorationists know better. His new company has assembled a portfolio of high-quality projects that other companies have spent millions developing. And he's backed by a deep-pocketed mining tycoon whose multi-billion-dollar empire straddles the globe.
The explorer is Gren Thomas and the stock is diamond exploration play North Arrow Minerals.
The North is Thomas's favoured exploration terrain, and Arrow describes the trajectory of his Aber Resources stock after the company's discovery of Diavik. A one-time penny stock, Aber scaled heights of $50 a share en route to deals with Tiffany's and the purchase of luxury jeweller Harry Winston. Aber's successor company is Dominion Diamond, which owns 89% of the Ekati diamond mine (after buying Chuck Fipke's 10% stake) and 40% of Diavik.
Like Mr. Fipke, Gren Thomas is a true pioneer in the Canadian diamond exploration scene.
After Fipke's landmark discovery, Thomas teamed up with partners – including Christopher Jennings and Bob Gannicott – and quickly staked land to the southeast. They set to work evaluating kimberlite indicator minerals and identifying drill targets.
But diamonds are among the most difficult minerals to find – the geological equivalent of a needle in a haystack – and Aber proved it over the next few years with its fruitless hunt for an economic deposit. Then, in the spring of 1994, a breakthrough. An Aber field exploration crew led by Gren's geologist daughter Eira Thomas was drilling the final hole before spring breakup, and pulled out core with an almost 2-carat diamond embedded in it – an almost unheard-of occurrence.
Twenty years later, diamonds are still being pulled out of that kimberlite at Diavik – one of the world's richest diamond mines – and Canada is the world's third-largest producer of the gems.
In addition to making investors rich and establishing Canada as a diamond powerhouse, Aber's discovery helped cripple the De Beers cartel that had dominated all facets of the industry – from mining to trading to sales – for more than a century.
But there's a small problem. The industry built on "Diamonds are forever" is slowly running out of the glittery commodity, just as global demand ramps up. According to Bain and Company, supply is expected to grow by 2% annually over the next 10 years, while demand grows by 5.1% annually – driven by consumer demand in the United States as well as China and India. Few new mines are coming onstream in the next few years.
New Canadian diamond supply is part of the solution. Gahcho Kue in the Northwest Territories is the largest new mine coming on-stream. It's a 51-49% joint venture between De Beers and Mountain Province Diamonds (MPV.TO) that is slated to open in 2016, while Stornoway's smaller Renard mine in Quebec is scheduled to begin commercial production in 2017.
Robust Canadian diamond exploration is also part of the longer-term solution. Interest in the sector is reviving as diamond veterans and new players alike head north to identify diamondiferous kimberlites and seek their fortunes. Analyst coverage is also on the rise – both Dundee Capital Markets and Barclays released extensive diamond research reports in 2014.
On the exploration side, Kennady Diamonds (KDI) was the rock star, for a while. Kennady was spun out of Mountain Province and owns the Kennady Lake North project adjacent to Gahcho Kue. The company is developing four diamondiferous kimberlites that are showing great promise, but the stock has hit some headwinds, dropping to $3.79 from highs of $8 in the fall. Kennady has a deep-pocketed major shareholder – Irish billionaire Dermot Desmond, who owns 37% of S.O.
Another notable junior explorer is Peregrine Diamonds (PGD), which boasts Canada's highest-grade advanced-stage project in Chidliak, its flagship Baffin Island play, as well as impressive stone values. Peregrine also has the Friedland brothers in its corner, with a combined stake of about 34%. If a mine is built at Chidliak, the upside would be substantial, but this stock could severely test your patience in the meantime.
Most of Canada's other diamond exploration plays are either early-stage or bolted on to producers. Canterra Minerals (CTM) is run by Randy Turner, who discovered De Beers' Snap Lake mine and is exploring again in the same neighbourhood, while Margaret Lake Diamonds (DIA) has a land package adjacent to Kennady's, and flew a gravity survey last year. Dominion Diamond (DDD) and Stornoway Diamonds (SWY) also have exploration projects.
Enter North Arrow Minerals and its chairman, Gren Thomas. Before interest in Canadian diamond exploration perked up again, Thomas optioned several "orphaned" properties, including three in the Stornoway Diamonds' exploration portfolio. Thomas's daughter Eira, currently CEO of Kaminak Gold (KAM), is a Stornoway cofounder.
North Arrow shares jumped from 40 cents to the 70-cent level in the days following the company's Nov. 5, 2013 announcement of drill results from Pikoo, an east-central Saskatchewan project optioned from Stornoway. A 210-kg sample of drill core from PK150, the first kimberlite North Arrow discovered there earlier in 2013, returned 745 diamonds larger than the .106 mm sieve size, including 23 diamonds larger than .85 mm.
It was an exceptional result from such an early-stage project, fuelling optimism that North Arrow has an economic deposit on its hands. As Gren Thomas puts it, "we know enough about it now that we can say this thing, if there’s enough tonnes, it can be commercial." North Arrow hit kimberlite in 9 of 10 drill holes completed on the property. Geologists spent the rest of last year collecting and evaluating 560 till samples to help define new drill targets, including several new kimberlite indicator mineral trains. A 3,000-metre drill program is now underway.
North Arrow earned an 80% share of the project from Stornoway, which retains 20% and passed on a one-time back-in right to acquire another 20%.
North Arrow's most interesting property is the unpronounceable – and under-the-radar – Qilalugaq (kill-a-loo-gah-ck) project near Repulse Bay, Nunavut. North Arrow has optioned 80% of Qilalugaq, another of Stornoway's "orphans," but Stornoway retains a one-time back-in right to acquire another 20% of Qilalugaq by paying North Arrow three times its exploration costs. Over $25 million has been spent developing the property, which was originally staked by BHP Billiton Diamonds, so North Arrow is leveraging large amounts of cash spent by others.
Qilalugaq has size – its 12.5-hectare Q1-4 kimberlite is the largest diamondiferous kimberlite pipe found in the eastern Arctic. Qilalugaq is advanced – Q1-4 has an inferred mineral resource estimate of 26 million carats from 48.8 million tonnes of kimberlite, for an average diamond grade of 53.6 carats per hundred tonnes (low by Canadian standards but comparable to some of Renard's pipes). And Qilalugaq has location – it's 7 kilometres from tidewater.
Most importantly, Qilalugaq has rare yellow diamonds. Fewer than 0.1% of all diamonds are yellow, and fewer still are the yellow diamonds so vivid and intense they can be classified as "fancy yellows." Colour is one of the 4 Cs of diamond grading, along with carat, clarity and cut. High-quality coloured diamonds command top prices.
How significant is the presence of yellow diamonds to diamond values? Consider the Ellendale mine in Australia, which is owned by Kimberley Diamonds. Ellendale is the world's leading source of fancy yellows, contributing about half of the world's supply from a depleting reserve. Ellendale's fancy yellows make up only about 15% of total carats sold, but a whopping 80% of the company's revenue.
No wonder North Arrow chairman Gren Thomas calls Qilalugaq "a potential company maker."
Until recently, Kimberley sold all its fancy yellows to Tiffany's – the luxury jeweller that had a relationship with Aber, continues to source diamonds from Aber successor Dominion Diamonds and has viewed some of North Arrow's yellow diamonds. However, Kimberley announced Aug. 22 it would display 750 carats of its fancy yellows from Aug. 28 to Sept. 9 and sell them at auction on Sept. 10. Wonder if anybody from North Arrow stopped by to compare notes?
North Arrow has collected a bulk sample of more than 1,500 tonnes of kimberlite to determine size distribution, what proportion of Q1-4's diamonds are yellow, and the quality of those yellows. The bags of kimberlite were shipped out on the annual sealift that arrived in Repulse Bay late last Summer. Processing began in October in Thunder Bay and North Vancouver, after which about 500 carats of the Q1-4 diamonds will be flown to Antwerp for independent evaluation. The results of that valuation are expected in the second quarter of 2015. That's when Stornoway will have the one-time back-in right to an extra 20% of the project.
During our recent interview with North Arrow president and CEO Ken Armstrong, he helped set expectations for the diamond value. Operating Canadian diamond mines are typically in the order of $100 to $500 per carat, and a result of greater than $150 per carat would be significant for the small company.
"If we get a high valuation, then it immediately becomes a development track project with a pretty clear path for further evaluation," Armstrong said. "We would enter into completing a preliminary economic assessment. The next field work would be more drilling, upgrade the resource to measured and indicated status, drill some deeper holes, some glory holes to 600 meters … to see if the kimberlite is still down there … and then following that up pretty quickly with a larger bulk sample … The project could be on its way, and it could happen very fast."
North Arrow shares – which some days, don't trade at all – are at about the same level they were when Resource Opportunities initiated coverage on Aug. 27.
But North Arrow chairman Gren Thomas has increased his ownership level since then – exactly what we like to see when a company's stock does not reflect a company's operational progress. Since Aug. 27, Thomas has purchased more than 380,000 North Arrow shares in the public market at prices ranging from 47 to 60 cents, according to INK Research. He owns about 6 million shares, a 14.3% stake.
North Arrow's largest shareholder is a Lundin family trust, which owns about 23% of the stock. Billionaire Lukas Lundin has deep pockets and an outstanding track record of creating shareholder value, including at his dividend-paying African diamond producer Lucara Diamond (LUC.TO), which has a market cap approaching $800 million. Eira Thomas is one of Lucara's largest individual shareholders. Lundin has participated in recent North Arrow equity offerings on a pro rata basis, most recently in February 2014 (at 65 cents). With Lundin as a supportive shareholder, raising more cash for exploration programs shouldn't be a problem.
The links between North Arrow and the Lundin Group's Lucara run deep. Eira Thomas is a Lucara director, was key to the formation of Lucara and owns about 2% of outstanding shares, while Lucara CEO William Lamb sits on North Arrow's board of directors. "Lucara's an outstanding diamond company, and I'm hoping of course we can do something similar with North Arrow here," Gren Thomas told me.
With about 50 million shares outstanding, about $5 million in cash (as of October 31) and the stock at 56 cents, the market is assigning North Arrow Minerals an enterprise value of just $23 million. If even one of North Arrow's projects proves economic, the company's market capitalization should correct to multiples of that number.
We contend that North Arrow Minerals is a mispriced asset offering a better-than-average shot at dramatic share price appreciation. If that happens, we don't know when it will happen. North Arrow is also a volatile and thinly traded stock.
However, the lack of liquidity on this closely held stock is a double-edged sword that works in your favour when good news comes out, as illustrated by the share price action following the Pikoo discovery in early November 2013. Gren Thomas and Lukas Lundin are unlikely to sell in the event of bad news, which offers some protection on the downside.
Because investing in diamond exploration plays is such a high-risk venture, a basket approach mitigates risk. But if we had to own a single diamond exploration stock, that stock would be North Arrow Minerals.
Author is a shareholder in North Arrow Minerals. This is not intended to be investment advice of any kind and readers are strongly encouraged to do their own due diligence and consult a professional investment advisor before making any investment decision. This article and video contains “forward-looking statements” including but not limited to statements with respect to North Arrow’s plans, the estimation of a mineral resource and the success of exploration activities. Forward-looking statements, while based on management’s best estimates and assumptions, are subject to risks and uncertainties that may cause actual results to be materially different from those expressed or implied by such forward-looking statements, including but not limited to: risks related to the successful integration of acquisitions; risks related to general economic and market conditions; closing of financing; the timing and content of upcoming work programs; actual results of proposed exploration activities; possible variations in mineral resources or grade; failure of plant, equipment or processes to operate as anticipated; accidents, labour disputes, title disputes, claims and limitations on insurance coverage and other risks of the mining industry; changes in national and local government regulation of mining operations, tax rules and regulations. Although North Arrow has attempted to identify important factors that could cause actual results to differ materially from those contained in forward-looking statements, there may be other factors that cause results not to be as anticipated, estimated or intended. There can be no assurance that such statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Accordingly, readers should not place undue reliance on forward-looking statements. Always do your own due diligence.