The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

Editor's note: This is the second part of a two-part series on mining and investing that began Thursday.



) - In the first part of this series, I began by laying out the chronology of events which characterizes the development of practically all mining projects.

They included early exploration, resource estimate, economic assessment, major financing, construction of mine and commercial production.

I reviewed the first phase of development -- early exploration -- and began to discuss the second phase: extensive drilling. I wrote in general terms how we as investors plan our investing/trading strategy around these results.

In many respects this extensive drilling is the most crucial phase in the development of any mining project. Obviously the most important aspect of this work is to demonstrate there is enough quantity and quality of ore to justify the huge capital costs which are generally required to bring a mine to production.

Equally important, however, is the efficiency of these mining companies as they explore their properties. Drilling is expensive, labour intensive work. Those management teams who are able to "define" their mineral deposits more quickly and efficiently than their peers will usually reward their shareholders with a superior return on their investments.

Understand that this is typically where most of the "dilution" takes place in the share structure of a mining company. Producing no revenues, the miner must raise fresh capital each time their cash reserves become depleted through prior exploration. Naturally the results obtained in drilling are also a major factor in how much dilution occurs during this phase of development.

A miner who produces some outstanding drill results is usually rewarded with a significant up-tick in the share price of the company. Thus, if a mining company can string together a series of good results in a particular phase of drilling, the significant increase in share price which should accompany those results allows the miner to finance the next stage of operations at a much higher price than the previous stage of drilling.

If shareholders do not observe this "ladder effect" with a miner, where each new financing is being undertaken at a significantly higher share price, this will generally be a warning sign that (for whatever reason) a miner has not been able to "generate value" in a particular project faster than the miner burns through its cash.

Such a trend can quickly turn the share structure of a mining company into a bloated mountain of paper, where even stellar future results may not provide enough "lift" to move such a large float higher. Obviously investors need to watch for such a trend, and look to make an exit from any/every miner which is not able to avoid this dilution-trap.

What complicates the evaluation of these miners, naturally, are overall market conditions. In a very bearish market, even outstanding results can be completely ignored by investors. Thus, a management team can do everything right, and still be undone to a large extent by simple "bad luck." In such a situation, investors have to choose between sticking with a miner labouring under this adversity, or to look for another miner which (for one reason or another) has not been as negatively impacted by sentiment.

On the other hand, we must also be aware that during bullish extremes in the market, we will see virtually all of the miners rocketing higher -- even the "dogs" of the sector. Under-performing companies will have already been punished by the market when sentiment was poorer, so when sentiment soars higher, even the more dubious companies will rise with the market, as investors look for "bargains."

This is why we must be studious in following the developments of these companies, as share-price performance alone will not provide an accurate picture as to whether or not we should continue to hold a particular miner.

Generally, all core samples from drill-holes provide us with two types of information on the particular ore being examined: data on the quality of the ore (defined by the "grades" of the ore encountered) and data on the quantity of ore (i.e. the tonnages implied by the intercepts).


In the ore being sampled by these mining companies, grades of as little as one or two grams of gold per ton (of ore) are now generally considered to be sufficient to mine such ore profitably , assuming there are sufficient tonnages of such ore, and that the "cash costs" of extracting gold from such ore are reasonable.

Where the tonnage of ore is more limited, or the technical challenges to mining the ore are greater, it requires commensurately higher grades for a deposit to justify the construction of a mining facility.

With silver deposits, mining companies were previously looking for much higher quantities of silver in their ore due to silver being so

grossly under-priced

-- both in absolute terms, and even in relation to the price of gold. Thus, even a year or so ago, these miners wanted to see at least 100 grams per ton in their ore samples before they would start to view such a deposit as potentially justifying a mine.

As I discussed in a recent

two-part series

on silver mining, the era of artificially low prices for silver grossly distorting the fundamentals in this sector appears to be permanently over.

Consequently, we will see miners' attitudes toward the data of their silver core samples evolve quickly. Suddenly, even silver concentrations in the range of 40 to 50 grams per ton are now looking potentially lucrative for these companies.

Readers must always be cognizant of the long-term gold/silver price ratio, which is about 15:1 over the nearly

5,000 years

in which we have mined these two metals. This price ratio is confirmed by the actual rate of occurrence of these two elements in the Earth's crust: roughly a 17:1 ratio. Thus any price ratio which is grossly disproportionate to these long-term ratios cannot possibly last.

This is why any/every commentator with even a modest understanding of the silver market has been able to "predict" the recent rise in the price of silver -- since the price ratio had been pushed to ridiculous extremes due to banker-manipulation of this market. That "manipulation" is essentially over, because

all of our silver is gone

("consumed" in various

industrial applications

). Thus, for many years to come, the gold/silver ratio can only go lower, and the price of silver can only go higher.


It is immediately obvious that the "quality" data we obtain from drill core samples concerning the grades of ore provides us with much clearer information than the tonnages implied by these drilling intercepts. As a simple issue of mathematics, we cannot come up with reasonably precise data on tonnages without establishing a rough perimeter on the deposit through an accumulation of such results.

This is known as "fencing" a deposit. While every mineral deposit has its own, unique configuration and geology, the general strategy here is the same. Miners first hit mineralization with one or more "targets" from their preliminary drilling. They then seek to expand the radius of mineralization through "step-out drilling" pushing out further and further until they reach the end of mineralization, at which point they can begin "fencing" the deposit.

Note that this exploration process does not just take place in expanding the perimeter laterally but (hopefully) also vertically. Normally, miners will choose to only go down 100 to 200 meters in their early drilling. Each meter further they descend costs significantly more of their precious capital, so I mmediately commencing deep drilling makes no economic sense.

As a result, when we examine preliminary drill results, we will quite often encounter the phrase "open at depth." This simply means that mineralization continues past the deepest point reached by the initial core sample and necessitates that management go deeper with its future drilling in order to establish the total depth of the deposit. With modern mining technology generally capable of accessing extreme depths, the deeper these deposits extend the better.

When a miner issues a news release concerning drilling results, typically the headline features the most-promising particular intercept. This is expressed as "X" meters of mineralization, containing various grades of one or more metals (usually more than one). Sometimes a drill core sample will hit only a single interval of mineralization. This one interval can be only a foot or so, or it could be (in extreme examples) in excess of 100 meters.

Obviously narrow "veins" of ore are more common than massive, single "intercepts" of mineralization. This also means that typically a drilling core sample will encounter several veins of mineralization, rather than only one. This means that when we examine these results we must look closely at the details. Sometimes the "headline numbers" are relatively unimpressive: only modest grades, and a relatively short width regarding the widest intercept.

However, when we look at these drill results more closely, sometimes we will see four or five such intervals (or possibly even more), with only slightly smaller numbers than the headline. Where we have a multitude of such veins and then can demonstrate that those veins extend for a considerable distance in one or more directions laterally, suddenly the tonnages implied by such "modest" results can appear much, much more prospective.

Here is where the time spent in "due diligence" will generally pay off for investors. Spend the time to attempt to piece-together the drill results (which often have accompanying diagrams) so that you get some sort of mental picture of the "fence" being created by the drilling. Pay attention to all of the drilling intercepts, not merely the headline-numbers. Pay extra attention to reports that the deposit "remains open" in one or more directions, as this directly implies discovering still more ore in the future.

Note that sometimes these smaller, junior miners can almost be too successful. Specifically, with limited capital reserves these companies will sometimes encounter very large deposits, where even after "stepping-out" a significant distance with their drilling the deposit remains open laterally.

At this point these miners must make a strategic decision. Do they continue to push the perimeter of their deposit out even further, or, do they instead begin to focus on "in-fill drilling": the methodical connect-the-dots drilling which is necessary to allow the miner to move on to the next phase of evolution (a scientific estimate of the existing body of ore)?

This is often a difficult choice. The benefits of extending the perimeter of the deposit are obvious, but (again as a matter of arithmetic) as their "fence" becomes larger and larger, the amount of in-fill drilling necessary to produce the data for a resource estimate increases geometrically -- along with the expense of drilling-out and calculating the total ore contained.

For this reason, it is not unusual for smaller miners to do a preliminary resource estimate even though they know this is only a partial representation of total mineralization contained in the deposit. Investors must also pay close attention to the stated intentions of management, so that they understand whether a particular junior will soon be moving onto the next stage of development (a resource estimate), or whether perhaps this miner might still engage in years more drilling before reaching that stage.

If the miner chooses to continue to expand its perimeter, then our evaluation of of this company will continue on the basis of the parameters outlined previously. However, should the miner choose to go immediately to a resource estimate, then the new dynamics which apply to assessing and valuing mining companies at this level of development.