Why I Like What I Like: Probabilities, Bayesian Statistics And Margin of Safety

Probabilities, Bayesian Statistics And Margin of Safety

In this article I will discuss some aspects/events of Novo Resources, Irving Resources and Kalamazoo Resources and reflect on what implied probabilities of success might be derived from said aspects/events (subjective of course)…

What does a given snippet of information tell us in terms of subjective odds of success?

… In other words: What is the probability of upside scenario A given information snippet B?

… Lastly I look at how it might relate to downside scenarios and ultimately “Margin of Safety”.

(Note that I am just using the concept of Bayesian Statistics and not actual formulas)

Novo (Implied probabilities):

• Stock option incentives (X%+ belief in reaching Y production within time Z)
  • “These options vest once Novo reaches certain production milestones, goals our team feels confident they can meet”
  • … Implies a real belief of Novo becoming an actual producer
• Sumitomo board appointment (75%+ Sumitomo sized prize?)
  • Conservative and very forward looking culture
  • … Does not make rash decisions
  • … Only interested in a long lived venture(s)
  • … i.e. not short term “punters”
• AUD$4 M cash expenditure to Kalamazoo (50%+ imminent cash flow)
  • Implies a belief that cash will not become a problem within a certain time frame given the current burn rate
• “Mill negotiations going well” (75%+ of getting a mill?)
  • Jives with the Kalamazoo placement

Subjective conclusions in light of the above:

• Probability of “imminent” production and/or cash infusion: 50%-75%+?
• Probability of Novo’s projects hosting a Sumitomo sized prize: 75%+?
  • … Probability of Novo’s ventures having a gross NPV of  at least $1B+

Margin of Safety:

Fully permitted high-grade, near surface, oxide gold deposit located close to a mill. If access to a mill is confirmed then Beaton’s Creek could underpin most of the current Enterprise Value and everything including Egina would be “free” upside.

= Would transform Novo into a very asymmetrical bet and would improve Risk/Reward considerably.

Summed Up:

• Say 75% chance of Beaton’s Creek underpinning 75% of the current Enterprise Value within 12 months
• Say 75% chance of Novo’s venture being worth billions
• = High implied chance of limited downside and high chance of significant upside (aka Nirvana)

Irving Resources (Implied probabilities):

• High skin in the game and no profit taking
• Newmont backing (pre-drill and pre-CSAMT)
• Abnormal drilling success (statistically)
  • Either extremely lucky or the systems are extremely well endowed
• Abnormal CSAMT readings (Especially Hokuryu)
• Omui deep drilling guided by CSAMT –> 9+ veins (success, confirmation)
• Omu Sinter drilling guided by CSAMT –> Multiple veins (success, confirmation)
• CSAMT efficiency/accuracy confirmation

Subjective conclusions in light of the above:

• Probability of Omu Project hosting a Newmont sized deposit(s): 50%+
• Probability of Omu Project hosting 3+ high quality mines: 40%+ ??

Comments: Whatever Newmont’s internal requirement in terms of chance of success for Irving to have a Newmont sized prize ($1B+), the chance of success ought to have gone up substantially since a) Drilling success was statistically anomalous, b) CSAMT readings were better than expected (especially at Hokuryu), and c) Most recent drilling seems to confirm the relationship between CSAMT readings and prospectivity (Encountered 9+ vein s in the boiling zone at Omui and the first hole on phase 2 at Omu Sinter has already hit multiple vein intercepts above the boiling zone).

= A lot of factors that have significantly increased the likelihood of there being a Newmont sized price within the greater Omu Project.

Margin of Safety:

Given the amount of outcropping high-grade veins, as well as high hit rate in terms of high-grade shallow veins to date, it has increased the likelihood of there being a decent amount of at/near surface high-grade vein material for bulk shipping to smelters. Historic reports also mentions the presence of additional outcropping high-grade veins within the Mining Permitted Omui Mine Site.

If Irving is soon able to ship 1,500 tonnes of ore grading 15 gpt per month at a cash cost of say$500 (probably lower than that to start off with), then Irving could have Free Cash Flow of US$9.1 M/year and would imply a current forward looking PE ration of 16.3, based on bulk sampling alone. In that case one could say that Irving would be a almost fairly valued based on something so seemingly trivial such as a bulk sampling exercise (it sounds weirder than it is because most miners don’t even have ANY margins).

In order for this to happen, a lot of factors needs to be in place:

• Shallow mineralization [X]
• High grade ore [X]
• Within a mining permit [X]
• Clean ore suitable as smelter flux [X]
• Good infrastructure and close to a port facility [X]
• Nearby smelters and demand for smelter flux [X]

… Make no mistake about it, Irving is in a truly unique position that any exploration junior would kill for.

In essence I consider Irving to be in a very unique position, because it is the only junior with Newmont sized potential that I know of that could also have a cash flowing operation that would underpin a lot of the current valuation. Thus, any blue sky exploration success, which looks increasingly likely, would almost be “free” upside. In other words, one could perhaps soon consider Irving to be a small scale but high-margin producer that ALSO happens to have a high likelihood of finding 1+ Newmont sized deposits.

Resulting in: Hopefully high margin ore –> Self funded high potential exploration –> Guided by one of the best exploration geologists in the world and supported by Newmont tech…

What’s the ROI and value of that chain…? And what about the 5 additional projects in the pipeline after that?

Bottom Line: If Irving’s current Enterprise Value could be mostly underpinned (at least say 50%) by the hopefully coming bulk sampling revenue, and the odds of finding something worth billions of dollars have gone up considerably, then Irving ought to de facto be one of the best Risk/Reward cases in the space despite it’s current Enterprise Value of US$145 M. All this together is the simple reason for why I have a very high % of my portfolio in Irving.

Summed Up:

• Say 75% chance of 75% of current Enterprise Value to be backed by the bulk sampling alone
• Say 50%+ chance of finding a deposit worthy of Newmont which would be worth billions
• Say 40%+ chance of finding multiple such deposits
• = Relatively high implied chance of limited downside and high chance of significant upside (aka Nirvana)

Kalamazoo Resources (KZR.AX)

• Who can better gauge the merits of Castlemaine etc than Quinton Hennigh who accurately predicted Fosterville would get a lot better?
  • Why should I even bother coming up with a view of Castlemaine when I can look at what THE expert thinks instead…?
• What chance of success of finding another Fosterville type deposit would Quinton personally believe in order to even bother spending $4M for a 8% stake at this point in Novo’s life cycle?
• Take that % and multiply it by what a Fosterville deposit would be worth, or even half a Fosterville and you get a crude measure of implied value for Kalamazoo
  • FWIW Fosterville produced 619,400 ounces of gold in 2019 at a cash cost of $125/oz and AISC of $306/oz

… One could make it really simple and just take whatever number a Fosterville type deposit would be worth and then multiply it with whatever chance of success one would expect Quinton to believe is present at this stage and come up with a best guesstimate for an implied value for Kalamazoo at this point in time. If one believes a Fosterville would be worth say $3B (Fosterville is obviously valued higher but anyway) and then multiply that by lets say a theoretical “Quinton conviction number” of say 25%. That would imply a “fair value” of $750 M for Kalamazoo (excluding time and dilution discounts!). This obviously sounds bonkers and the market would never dare to reflect this without further proof, but that doesn’t mean it’s a bad theory. All I know is that I am comfortable HODL:ing my entire Kalamazoo position at this point in time because it seems the current Enterprise Value is reflecting a sub 3% chance of Kalamazoo’s ground hosting a Fosterville type deposit and I simply think those implied odds are way too low given that Quinton would never bother investing in it if he thought the odds were at least over 10%.

Closing Thoughts

You probably have noticed by now that I like to discuss investing theory. Not only do I think it is more important to work towards becoming a better INVESTOR than it is to know everything there is to know about GEOLOGY or MINING, but there is also a severe lack of discussion about Investing as far as I can see. Furthermore, I think sound investing theory is not only more important than the latter but it has a way higher ROI given that investing theory translates over to every other sector or business decision etc you will ever make, while geology and mining doesn’t. Most newsletter writers etc throw around cases left and right, but I almost never see them explain a case on the basis of probabilities, risk/reward and sound investing principles. With that said, there are a few who seem to be both good investors as well as having a decent to good grasp on geology and mining.

It has become exceedingly obvious that I have a totally different way of evaluating the merits of junior mining companies than most, with Novo as a prime example. With every passing day I get more convinced that even though a lot of people in this industry know a lot more about mining and geology than me,  they seem to no real competence as it relates to INVESTING theory. This is probably why my portfolio does not seem to overlap with most peoples (Is there anyone except Moriarty and Erfle that even gives Novo a second thought for example?). Another example would be Irving, which many have harped on about how overvalued it is. Well, in this article I hope I made it painfully obvious that not only do I think Irving is not overvalued, but it’s possibly the second best risk/reward proposition that I know of. Since I think most pundits are rather poor investors (arrogant of me to say I know) it gives me added comfort knowing that I’m a “contrarian”. Furthermore, most peoples top picks make little sense to me in light of everything I have stated in my last 10+ articles that cover investing theory. I really do think that if I stopped listening to myself and started listening to what most “industry veterans” told me to do, my portfolio would be worse off for various reasons.

My edge, if I have any, does not come from being a better geologist or miner than most. I’m not. I do however make sure to learn more about companies that I like than 99% of people and I spend a LOT of time synthesizing everything I know into an investment case… And I think in terms of probabilities and do a lot of “reading between the lines”. Why? Because I KNOW I don’t know more or am as competent as insiders for example so I pay close attention to every word or action they take.

… An obvious example: How much more does Sumitomo know about Novo than me? A lot I would assume. Are they known to “punt”? NOPE… Just these two realizations tells an investor a LOT and why I recently stated that one could pretty much throw away every article, comment or video that I have ever done and just realize that Sumitomo would NOT bother with a board seat if they thought Novo having Sumitomo sized potential was a long shot. It’s really that SIMPLE. Somehow this simple train of thought seems to go over the head of every basher/troll and that is IMHO the tell tale sign of people seemingly not having a good grasp on investing, inferred probabilities or reading between the lines. On that note I find it absolutely hilarious that I used to be trolled because I used to play poker, since poker is all about the things I just mentioned, and the ones trolling just show how these concepts are completely foreign to them… Oh, the irony.

(Note: These is not buy or sell recommendations. This is not investment advice and I am not a geologist. This article is highly speculative, forward looking and I can’t guarantee accuracy. Always do your own due diligence. I own a lot of shares of Novo Resources, Irving Resources and Kalamazoo Resources which I have bought in the open market and am thus biased.  Novo is a passive banner sponsor on my site. )

Best regards,

The Hedgeless Horseman

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