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What to Look For When Investing in an Exploration Company

Calling all mineral explorers. Australia needs your help.

The Australian Institute of Geosciences (AIG) this week released a report noting that the Aussie exploration sector is suffering.

AIG blames the decline on a few things. Major producing companies moving out of greenfields exploration, to focus on near-mine exploration. And lack of a "flow-through" tax scheme that would allow investors in exploration companies to claim significant tax credits, making investment in exploration more attractive.

The upshot being that companies with money are choosing not to explore. And companies that want to explore are having a hard time getting money.

AIG sees this (rightly) as a big issue. The group notes that just six Aussie mines account for a disproportionate amount of output: 86% of copper production, 93% of lead production, 69% of zinc production and 77% of silver production.

More worryingly, five of these six mines are classified as mature (Olympic Dam being the only "young pup"). Across the top gold producing mines in the nation, the average age is a ripe 24 years.

Exploration is obviously critical to ensuring the development pipeline that will keep the smelters in business over the coming decades. But how to pay for it?

This is global problem. Countries like Canada have dealt with it to a certain to agree by introducing the aforementioned "flow-through" tax scheme. Exploration companies get tax credits for the geophysical surveys they fly and the drill holes they put in the ground. They then pass these credits to investors, increasing the likelihood of a positive return on investment.

But this alone can't make up for the hard truth: exploration is a tricky business. How do you attract capital to sector where success rates run below 1%?

With exploration increasingly being left to the junior sector (a number of majors have recently down-sized or eliminated their exploration departments), a few answers are emerging about how exploration will get funded.

The first and most prevalent way is through manias. Irrational enthusiasm for a country or a particular metal tends to loosen investors' purse strings.

Millions of dollars have been raised for exploration in Colombia and the rare earth metals over the past year. Not because prospects in either of these spaces are head-and-shoulders above other areas. Simply because investors got fired up on these stories.

Smart (or opportunistic) explorers use these boom times to stock up on capital. The smart ones will make it last through the inevitable downturn.

Another way to finance exploration is come up with a better business model. The "project generator" companies have been doing this for years.

These companies are in the idea business. They apply their geologic knowledge and come up with mostly-conceptual exploration plays. The good ones then sell these ideas to other, well-funded companies (majors or the opportunistic juniors who raised capital in a boom and have now run out of their own ideas).

Project generators retain interests in all of their projects without having to spend much capital on exploration. Companies like Auex Ventures have used this model to succeed with important greenfields discoveries recently.

Then there's the rarest type of explorer. The truly excellent.

There are a few exploration teams on the planet that seem to be capable of reliably coming up with really, really good concepts. Usually this involves a combination of technical skill and patience.

These teams (or sometimes just one individual) are willing to sift through thousands of exploration ideas until they find the one they know will work. Most companies identify the successful 1% of exploration projects through drilling. The great ones do it in their heads, appraising potential projects against their well-honed internal checklist for success and then relentlessly discarding plays until they find one that fits the bill perfectly. The follow-on drilling is simply confirmation.

These are people like David Lowell. They're certainly not common. But the few that do exist are good enough to attract funding no matter what is going on in the wider sector.

Next time you look at buying into an exploration company, ask: which model am I paying up for?

By. Dave Forest of Notela Resources




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