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Monday, February 01, 1999
WSP-V WINSPEAR RESOURCES LTD
VPIC SPEECH: WINSPEAR AND THE NEED FOR NEW DIAMOND REPORTING STANDARDS
Vancouver Personal Investment Conference Speech - January 24, 1999
Winspear and the Need for New Diamond Reporting Standards
Written and delivered by John Kaiser, editor of the Kaiser Bottom-Fishing Report
Two years ago I gave a speech in Toronto which argued not only that Bre-X was a fraud, but that the fallout would plunge the Canadian juniors into a bear market. During the past couple of weeks I have found myself in the middle of a new controversy surrounding revelations that the Winspear Dream at this stage hinges on three unusually spectacular diamonds. No doubt there are people in today's audience expecting an encore to April 1997. They are going to be
disappointed. To kill the suspense let me say right away that I do not believe Snap Lake is a salt job. In fact, I have never expressed the opinion that Snap Lake might be a salt job. But I have not pretended that this was impossible. No exploration project is 100% immune to
tampering designed to distort its fundamental potential. But through a combination of management safeguards and investor scrutiny of those safeguards and the project data we can reduce the salt job risk to an extreme improbability. In the case of a diamond project such as Snap Lake it is not obviously easy to reach this level of confidence. It takes a fair degree of thought and co-operation from management in the disclosure department. Trust in management's integrity and competence is not enough, especially when management goes out of its way to suppress information that sets alarm bells ringing in the heads of diamond experts. These alarm bells are not ringing because the experts think the Snap Lake parcel was salted with some very good diamonds. They are ringing because the market has drawn strong conclusions about Snap Lake's economic potential that are not scientifically supportable by three statistically irrelevant stones.
The fact that the value of the Snap Lake bulk sample diamond parcel is badly skewed by the three largest stones has been known in the diamond community for at least a couple months.
It has been a source of growing unease among diamond experts as they watched the market build the Winspear dream bubble through the application of faulty logic to false premises. When the project value of Snap Lake as implied by Winspear's market cap pushed through $300 million in early January and passed that of the substantially more advanced Kennady Lake project of Mountain Province, anxiety began to build within the Canadian diamond community that the Canadian diamond industry was being pushed toward a catastrophe akin to the billion dollar meltdown that followed Kennecott's bombshell in August 1994 that the Tli Kwi Cho pipe was a bust.
For those who don't remember, Tli Kwi Cho was a large pipe whose initial micro diamond counts were comparable to the best micro diamond reports provided by Dia Met, the unquestioned leader in the Lac de Gras diamond play. Kennecott was so impressed by initial micro diamond counts that it skipped the mini bulk sampling stage and mounted a $20 million underground bulk sampling program. But instead of a large pipe grading 1-2 ct/t and loade with clear and colourless diamonds as extrapolated from the micro diamond data, Kennecott found a complex system of hypabyssal and crater facies that averaged from next to no grade to only 0.35 ct/t. Even worse, the bigger diamonds were of such poor quality that Tli Kwi Cho's average rock value worked out to less than $20 per tonne. For a market which was preoccupied with the question of whether the bulk sample would show Tli Kwi Cho to be worth one, two or three billion dollars, this outcome was as incommprehensible as the news in early 1997 that Freeport was not finding any gold at Busang. However, the response in the market was
similarly instantaneous and wide ranging. The market cap of Kettle River, Dentonia and Horseshoe evaporated. I didn't own these stocks anymore because the upside potential didn't seem high enough to justify the downside risk. But that didn't spare my portfolio, which was loaded with other diamond juniors hoping to find the next Tli Kwi Cho. The massive disappointment delivered by Tli Kwi Cho shattered the market's confidence in the diamond play. The fallout extended to Dia Met, whose key pipes had passed the bulk sample test, and Aber, whose new Diavik discovery had not only yielded higher micro diamond counts than had so far been seen in the Northwest Territories, but had even yielded a visible 1 carat stone in drill core.
Today we have a rough idea of what went wrong. Tli Kwi Cho is now known to have at least three distinct diamond populations originating from the mantle: a set of peridotitic diamonds, a set of eclogitic diamonds, and a set of so-called super-deep diamonds. The set that showed up at the drill stage was of fairly good quality up to the 0.1-0.2 carat size, but disappeared in the bigger sizes. According to Chris Jennings of Southernera, the micro diamonds recovered through drilling had a size distribution curve that dropped off sharply, and had Kennecott presented him with the micro diamond data as a size frequency distribution plot, he would have known immediately to cool expectations for the bulk sample. Tli Kwi Cho does have big diamonds, but they are generally of very poor quality. Their presence is not obviously indicated by the smaller micro diamonds. Why did Kennecott push ahead with a $20 million program? It is probably fair to say that Kennecott was still working its way up the learning curve. But I have
heard that a key influence was the fact that delineation holes encountered pockets with very high micro diamond counts. Extrapolation of those micro diamond weights generated grades not unlike the 3-4 ct/t range extrapolated from the Snap Lake micro diamonds.
he lesson I learned from Tli Kwi Cho was that early stage drill results reported as macro and micro diamond counts were meaningless. This conclusion has been reinforced by other disappointments such as the Torrie pipe of Tanqueray and the C lobe of Ashton's K14 pipe.
Since 1992 the Canadian market has been hung up on the macro question. How many macros per kg do you have and what is the macro/micro ratio? Unfortunately, the difference between macro and a micro is that a macro is a diamond greater than 0.5 mm in its largest dimensions.The problem with this definition is that it is entirely arbitrary. It pretends to divide diamonds into two classes: big and small. That is not the reality of diamond populations. The reality is that diamond populations have a size distribution which statisticians call lognormal. Like most of the people in today's audience, my grasp of statistics is very superficial. And that is part of the problem with the market's perception of Winspear's upside potential.
In very simple terms, a lognormal size distribution means that for any natural population of diamonds you will have a lot more small stones than large stones. That is easy to understand. What it means is that while you may find a 0.1 carat stone in every tonne, it may take you 10 tonnes to find a 1 carat stone, and a 100 tonnes to find a 10 carat stone. But things are more complicated than that. Each diamond population has a unique size distribution. You may find only one 0.1 carat stone every 10 tonnes, and a 1 carat stone every thousand tonnes. But what is universal to all diamond populations is that they have an orderly progression from the small to the large sizes. The mathematics of this progression is what we call lognormal. Diamond
experts figure out the grade potential of a kimberlite by plotting up the size frequencies and studying the curve that best fits these data points. The larger the sample is, the closer the size frequency points will conform to a straight line. The straighter the line, the more comfortable the diamond experts are that they understand a kimberlite's grade. What they want to see is a line that indicates not just lots of diamonds, but lots of big diamonds. The important part of the line is the large stone size end. But the data does not become statistically relevant until at least a thousand carats or more have been recovered. Much more if a kimberlite is large with different emplacement phases.
When we only have a population of diamonds recovered from small drill core samples we cannot with accuracy project the line so that it will tell us the frequency of big stones and the average grade. We also don't know to what degree these results are a cross section of different phases with unknown tonnage volumes. But we can get a rough idea of the kimberite's potential if we break the micro diamonds down into a series of square mesh screen sizes. In late November De Beers gave the Canadian diamond exploration industry a tremendous gift whose significance has not yet been appreciated. Major General and Ascot were allowed to report the micro diamond counts for four of their Victoria Island pipes according to a half dozen screen sizes. A diamond mining executive familiar with the methodology of De Beers
expressed profound shock when he saw this reporting format. He told me that De Beers had developed these screen sizes through decades of research and had insisted on their extreme confidentiality. De Beers plots up its micro diamonds according to these screen sizes and looks for a line with a shallow slope. The shallower the slope, the better the potential for big stones. If De Beers would honour the Canadian diamond industry with a technical paper explaining the scientific basis for these screen sizes and their relevance to exploration
decision-making, we would have a new reporting standard on a platter in front of us.
This brings me to the most important point. It is why I have been so passionate about Winspear and its Snap Lake project. With Dia met's Ekati Mine in production the Canadian diamond industry is at the threshold of legitimacy, and a natural consequence should be growing investor interest in diamond exploration by the juniors. But the junior diamond exploration industry is also at a critical crossroads. The experience of the past five years has been that the market has had to rely on blind faith in order to make money on diamond stocks.
The limited disclosures by diamond companies and the reporting formats have bordered on meaningless, and operated as misleading. As an investor and analyst I need to allocate my money to the junior whose project and market cap offers the best risk-reward potential. I need to assess the failure risk and the payout potential. I need to do this at every level of the diamond discovery cycle. A diamond project is very much like a pharmaceutical drug. It must pass a number of trials before it is worth anything. At each level there is a strong chance that the drug or project will fail. As a pipe passes each exploration stage we get a better idea of what the project might be worth if it passes the final test. But what we also need to know is the failure risk. And to do that we as investors need to understand the nature of diamond deposits better and we need to get disclosures from the juniors that allow us to make educated guesses about the failure risk. This in turn will allow us to make rational decisions about whether to buy or sell a stock based on its price and the fundamental facts of the project.
I cannot overemphasize how pivotal Winspear has become in this evolutionary process for the Canadian diamond exploration industry. The Snap Lake project has been dubbed by some people as the "find of the century". That, of course, is a gross exaggeration. But Snap Lake
has the potential to unleash a new round of exploration for the NWT. So far the NWT has been characterized as a region with smallish pipes that tend to have high grades but not overly exceptional stone size distributions. This makes the NWT somewhat problematic, because much of the $4-6 billion annual market for rough diamonds is represented by larger, higher quality stones that are a minority of annual production. Snap Lake has shown us that large, high quality stones are present. The Tuzo pipe of Mountain Province has also shown us that
large stones are possible. Lytton's Jericho pipe has similarly produced large diamonds through bulk sampling.
We are now starting to hear that the first exploration pass in the NWT had fundamental flaws. Among these was that geophysical tools were effective only in certain areas with minimal background magnetic noise such as the Lac de Gras area. We have also learned that indicator mineral sampling techniques were often poor and inconsistent. We have learned that complex glacial movements have distorted indicator mineral trains. We have learned that collapsing lakes have created great outwashes that wiped out indicator mineral trains like some giant with a firehose. Now at Snap Lake we are seeing kimberlite dyke sheets with impressive and consistent thicknesses unlike the experience in South Africa. This opens up a new exploration target. The Snap Lake parcel is hinting that the NWT harbours treasure troves that could rival the Ekati and Diavik projects, both of which rank as world class multi billion dollar projects. I am excited as hell. Many of the juniors in the NWT are dirt cheap. Some like Intertech have
projects funded by major companies. Others like Gerle will need financing to fund projects on their own. There is a window of opportunity to make an awful lot of money. But this window will close if we do not get a new set of meaningful reporting standards that allows us to speculate intelligently. Until recently Winspear had the potential to slam this window shut. What we need is for Winspear to go to the moon as it step by step builds a case for the Winspear Dream.
What we didn't need is for Winspear to crank to the moon thanks to a profound misunderstanding of the underlying failure risk. A key problem with the Canadian diamond industry is that the investors who have made big scores have done so for all the wrong reasons. Right now the outcome of Winspear's 6,000 tonne bulk sample is an open question. If it gives us hundred dollar rock, it will be a disappointment. If it gives us $300 rock, we will be ecstatic. What I want people to understand is that the odds for the positive outcome are not as good as management and many shareholders seem to think.
Two weeks ago I let my subscribers know through a Tracker that 75% of the parcel's value resided in only three stones out of more than a thousand, a fact about which the public was largely ignorant. As the Winspear Dream began to get fleshed out with a vision of a 40-60
million tonne cone sheet system averaging 2-3 metres thick that a scoping study indicated could be mined from underground at less than $100 per tonne, the stock's price began to rise dramatically. It was rising because the market was plugging a $300 rock value into standard
valuation models, and coming up with multi-billion dollar project values. I should know, for I was doing the same thing in my Trackers until late November. I was not saying that we were already there and that the stock should be trading at $20 or more. I was simply saying that if the kimberlite system was indeed a single phase with a uniform distribution of the diamonds found at the bulk sample locations, and that the kimberlite was continuous and consistently 2 metres or more thick, we would see the stock eventually trade at ten times the current price. The caveat was that this dream scenario still needed confirmation through large bulk samples, delineation drilling, and development of a geostatistical model that would allow Winspear to
estimate grade and, hopefully, value through micro diamond and petrological analysis of the delineation holes. Those were still pretty big ifs, but the promise of a 10:1 payout for a project with 10:1 fundamental success odds struck me as an excellent speculative venture. When I discovered that the $300 rock value depended on only three stones, I freaked out. Suddenly the failure odds looked more like a 100:1, with a promised payout of only 10:1. The market was
building a bubble of optimism on the basis of a profound misunderstanding of the considerably greater failure risk of the Winspear Dream.
As I contemplated this situation I realized that Winspear would eventually be forced to disclose this fact, and the bigger the market bubble had grown, the more negative would be investor reaction. I also realized that investors had a very poor understanding about the statistical nature of diamond deposits, and would divide into two camps, both based on false premises. The simplest reaction would be to dismiss Snap Lake as a salt job. Bre-X and its sisters have been burned into the market's memory. When you add in the knowledge that Winspear ignored from day one the recommendation of its JV partner to disclose the skewed value distribution, and that its disclosure was the consensus position within the diamond industry, it is easy to become suspicious. The opposite reaction is to dismiss the salt job explanation and instead cling to the false mantra that the commercial value of a diamond deposit hinges on the presence of big stones, and that the Snap Lake kimberlite was chock full of big stones. Both
positions are simplistic because they reveal an ignorance about diamond populations.
As those of you in the audience who are my subscribers know, Winspear was the biggest winner on my 1998 bottom-fishing list. Even better, Winspear was not a bottom-fish which zoomed to the moon while I was looking in the other direction. It was a stock I covered in detail, and when it broke down to the $0.50 level last spring I put out trackers with buy recommendations. I have provided continuous coverage of all key developments since release of the bulk sample results, and recommended that my readers buy until the stock broke through $2. And odd as this may sound after two really crappy years in the juniors where stay away should have been the only advice, my readers actually listened to me and bought Winspear. When I wrote my recent Tracker my biggest concern was that the market would jump to the salting connclusion and tank the stock. I thus went to great pains to pre-empt this outcome by addressing the salting issue. The media, and many investors who obviously haven't read my material, heard only the word salt job and assumed that I was making an accusation. What I did do was explain the sort of information Winspear could examine to minimize the possibility of tampering, and what a salting conspiracy would have to look like in order to be undertaken. What I came up with was an evil genius who had to be a senior employee of Winspear who worked in isolation and not only took extraordinary personal risks of detection, but an extreme fundamental risk that the market would embrace the story of a world class dyke sheet. This salt job would have had to be pulled off with the assumption that delineation drilling would show the Northwest Peninsula dyke to have a consistent 2-3 metre thickness rather than the narrow discontinuity typical of dykes. The only salt job scenario that has any plausible logic is so far-fetched that it is the stuff of novels and screenplays, not reality. When you add the fact that the Winspear management team has people on it known for integrity and very high standards of professionalism, you can virtually rule out the possibility of a salt job.
In the wake of the Bre-X scandal and other salt jobs, any serious commentator about the junior resource market has to address the salt job risk. Bre-X happened because raising the salt job topic is an industry taboo. I think this taboo is wrong. With any major new discovery it is critical that we tackle the salting possibility first, and then move on to the real question of how big and good can it be, and what are the odds that further work will prove the dream scenario.
The real issue with Winspear is how much importance should we assign to three stones out of more than a thousand stones that also happen to be the largest stones with exceptionally high quality compared to the rest of the stones in the parcel. The concern among diamond experts
is not whether these stones were salted into the parcel, but whether they were a statistical aberration better known as a fluke. Winspear has done enough work on the parcel to be comfortable that all the stones come from the bulk sample. Malcom McCallum has examined the surface features of these stones and classified them into various groups. The three largest stones have been called Russian stones because they are clear octahedrons with sharp, unresorbed edges and clean faces. This is actually a superficial comparison, because to
classify a stone in regional terms you would need to conduct nitrogen aggregation studies and scan the stones with an electron microscope. This has not been done by anybody, including the diamantaires in Antwerp who first made the Russian stone comparison. What the
McCallum study has shown is that the three largest stones belong to a morphological set that is represented in most of the size categories. The Winspear parcel has several morphological sets of diamonds, at least one of which Winspear describes as having overgrowth features not previously reported in the NWT. A simple way to understand this is to imagine a parcel of Smarties, M&M's and Skittles. From a distance they all look the same. But when you look at them closely, you can see that they came from different factories. As the Snap Lake kimberlite
magma worked its way through the mantle, it sampled several diamond factories. As it ascended it mixed the Smarties, M&M's and Skittles throughout the kimberlite. The high value stones might be equivalent to red Skittles. The question a larger bulk sample will answer is
whether the Skittles are all coloured red, or whether the mini bulk sample just got lucky in coming up with three red Skittles rather than the other lower value colour Skittles.
Obviously I hope that Snap Lake contains a population of unusually high quality diamonds with a fabulous size distribution. But we should not treat this as a given at this stage. To put things into perspective, how many people know that the parcel from pit one had an average carat value about a fourth of the other pit? This means that the two most valuable stones came from one site, probably the 8 and 11 carat stones. Perhaps those two stones were in a rare nodule whose recovery was pure luck. Strip out those two stones and the Snap Lake dyke mining dream rests on very shaky economic ground. When trading Winspear, keep this in mind. I have told my subscribers to recover their investment by selling at least 25% of their investment. I
want them to let the rest ride because this is a very exciting story. I will continue to cover Winspear and explain to my readers what the information flow means. My sense is that Winspear will take the lead role in pioneering disclosure standards for diamond exploration. It
has to do so because Snap Lake now has to climb a wall of skepticism. If Winspear wants to go beyond a cult stock with a following of blind true believers, it needs to show us everything it has. That need not hurt the play. After all, the worst true believer is somebody who thinks his beliefs are based on facts and not blind faith.
As the Winspear play evolves it will pull in lots of new money that will give the entire NWT diamond play a big lift. I am a bottom-fisher, not a sports-fisher. I go for the stocks that the
market hates. The NWT stocks that I think people should be buying now are Lytton, Intertech, Gerle and Mountain Province. I might even add the DHK stocks on the basis of Archon's farm-in. Mountain Province as a bottom-fish? In terms of where it is in its exploration cycle this
stock is a bottom-fish that I think offers the best risk-reward exposure among the NWT diamond stocks.
With regard to the Alberta diamond play, I am afraid that Ashton has blown the market's goodwill through its poor reporting standards. Until Ashton and the other Alberta participants start reporting early stage results in a more meaningful format, the market will not give the ADP the benefit of doubt. This does illustrate the need for diamond juniors to adopt meaningful reporting standards. By the end of this year Ashton will have only $3 million left if it does not finance. Given that the market is now inclined to wait for a major bulk sample that yields spectacular results, it is clear that fund-raising for the Alberta diamond play is a problem. I personally think that Alberta still has potential to host a world class pipe such as Orapa. Unfortunately lack of funding may not let us find that one in a hundred pipes if luck says that the good one will be the hundredth one Ashton looks at. At least with the NWT diamond play we know that really good pipes exist. But even here we will need maningful reporting standards if diamond exploration is to hold the market's interest.
John Kaiser
miniman, Kaiser never alleged salting, the parcel of diamonds has been examined and share unique characteristics, the CF results have been released, the large diamonds are lognormal with the CF results and analysis. You are a liar and a fraud. You slander and misrepresent both Kaiser and Winspear. You know that what you say is false. Please go away.
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