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Diamonds: the Diamond Exploration Cycle

Diamond Exploration Milestones And Success Probability

Project Status
(Milestone Reached - Followup Work)
Theoretical Project Value (At $2B Upv) Leverage Odds Chance
Time Frame Arctic Time Frame Non-Arctic
M0: Grassroots Land Position - Generating Targets $10-20M 100-200 99-199:1 0.5-1% 1 Year 6 Mths
M1: Targets - Drilling For Kimberlite $20-50M 40-100 39-99:1 1-2.5% 6 Mths 3 Mths
M2: Kimberlite-Testing For Diamonds $50-100M 20-40 19-39:1 2.5-5% 6 Mths 3 Mths
M3: Diamondiferous Kimberlite - Mini-Bulk Sample Best Ones For Grade $100-200M 10-20 9-19:1 5-10% 1 Year 6 Mths
M4: Diamond Grade - Bulk Sampling Best Ones For Commercial Value $200-500M 4-10 3-9:1 10-25% 1 Year 6 Mths
M5: Grade & Value - Prefeasibility Study To Determine Economics $500-1,000M 2-4 1-3:1 25-50% 6 Mths 6 Mths
M6: Economic Pipe - Permitting & Final Feasibility Study $1-2B 1-2 0-1:1 50-100% 18 Mths 1 Year
M7: Mine Approval - Construction Leading To Production $2B 1 0:1 100% 2 Years 1 Year
M8: Production - What Next?            

World Class Potential of a Diamond Project not confirmed until 5 Work Stages are Complete

The diamond exploration cycle consists of nine distinct stages starting from a grassroots land position and culminating in production. Each of these work stages constitutes a milestone labeled zero through eight. In a best case scenario where seasonal constraints are not a factor a brand new diamond project will need five years to make it through the diamond exploration cycle from land acquisition to production. In a difficult setting such as the Arctic where certain types of work can only be done during winter or summer, the time frame from start to finish will last 8-10 years. Failure is possible at all but the final two stages, requiring the project to start fresh with new targets if the project's potential for a world class diamond mine remains alive. Unlike a gold or base metals project, which usually focuses on outlining the orebodies within a mineralized system, a diamond project looks for "vertical needles" in what can be a very large "haystack". These "vertical needles" or kimberlite pipes tend to have readily identifiable tonnages in excess of 5 million tonnes, but their grade and value only becomes apparent through a series of larger sample tests. What makes diamond exploration particularly risky is the fact that the third critical component for assessing the project's economic potential, namely the average carat value, does not become apparent until Milestone 4 has been reached. The logistics of diamond exploration is such that Milestone 4 cannot be reached any sooner than two years after initiation of the exploration cycle on a grassroots diamond project. Except in very rare cases where a kimberlite is found that is so rich a diamond is visible in the core of the discovery hole, as was the case with the Diavik project's A154 pipe, diamond exploration does not produce "discovery holes" that signal a world class project as was the case with the Voisey's Bay nickel discovery and appeared to be the case with the first salted hole into the Busang Southeast Zone. To make matters worse, it almost never happens that the first kimberlite discovered in a diamond project turns out to be economic. So one can add at least one year to the diamond exploration cycle to account for the extreme likelihood that the first round of target drilling will not snag the best pipes hosted by the project.

Metal Discovery Plays provide a Speculative Continuum

When a discovery hole is pulled in a gold or base metals project the market can immediately calculate the rock value of the intersection based on the assayed grade and prevailing metal prices. Cost factors associated with this style of deposit and its location based on similar mines are roughly understood, so it is easy for speculators to estimate ultimate project values for different tonnage and grade scenarios. The economic potential of a new metals discovery is thus immediately evident. But how big will the zone turn out to be and what will the rest of it grade? In metal play speculation investors focus on the tonnage potential of the zone and how the grade varies with stepout drilling. The metals exploration cycle delineates the orebody through both stepout and infill drillling. A metals discovery play is fueled by a continuous flow of information consisting of visual assessments of whether or not the zone has been intersected and the actual assays of those intersections. Metal discovery plays lose their momentum when drilling has found the zone's limits. For a metal discovery play the greatest volatility exists during the period following the discovery hole while the limits of the deposit remain unknown. In metal bull markets, such as when the price of gold is rising or base metals are at their cyclical peaks, speculators will bet on the potential of targets before they are drilled based on size implications and surface sampling.

Diamond Play Speculation Reacts to widely spaced Milestone News Events

When a kimberlite is discovered the market can usually figure out the tonnage potential very quickly, but the sort of economic value number crunching that metal discovery plays allow cannot happen until the kimberlite has gone through three more testing stages: testing for micro diamond content, testing for macro diamond grade, and testing for macro diamond value. Each of these stages can take 3-6 months to accomplish, creating speculative dead zones during which investors can only sit and wait. Usually there is nothing visually revealing about the material extracted and submitted for processing that gives the market a basis for optimism or pessimism. Diamond exploration news for a specific project consequently occurs as widely spaced milestone news events whose content can have a powerful upward or downward effect on the stock's price. The market reaction reflects the market's judgment about whether the news keeps the ultimate project value alive, justifying graduation to the next exploration stage, or kills the dream for this particular pipe, forcing the company back to an earlier stage in the project exploration cycle. If it were not for the fact that positive milestones can generate rapid five fold appreciation in market valuation of the project, raising venture capital for diamond exploration by junior companies would be next to impossible.

Diamond Play Valuation tracks a Success Probability Ladder of Milestones

The Diamond Exploration Cycle Milestone and Probability system was developed to quantify the valuation behaviour of a diamond project in which a publicly traded junior company has an ownership stake. It is based on the market action observed during the Lac de Gras diamond play of the early nineties when Dia Met discovered what became the Ekati project in the Northwest Territories. It is also based on the probability system Kennecott Exploration (a wholly owned subsidiary of Rio Tinto, operator of the Diavik project) uses to quantify the failure risk of projects with world class potential. Kennecott gives a one in a thousand chance that a grassroots diamond project in the proper geological setting will deliver a world class diamond mine. Of particular importance is the 90% failure rate Kennecott expects with the completion of each major exploration stage. Kennecott's system of failure rates has been adapted to reflect the unique milestones of the diamond exploration cycle.

Ultimate Project Value versus Theoretical Project Value

Using the concept of fair speculative value as presented in the rational speculation model developed by John Kaiser, a probability table has been developed which indicates the probability that a project at any given stage of the diamond exploration cycle will progress all the way through into production where its ultimate project value (UPV) is defined as the net present value of the diamond mine as calculated using the discounted cash flow model. For example, a diamond project that has reached Milestone 2, namely discovery of a kimberlite, has a probability of 2.5-5% of turning out to be an economic diamond deposit. If the craton setting is known to host world class kimberlites, the target is supported by an indicator mineral train whose chemistry suggests excellent diamond grade potential, and the target's dimensions suggest a resource in excess of 20 million tonnes, an ultimate project value of $2 billion is a reasonable outcome for a speculator to dream about. Following the example of the rational speculation model, which says that the payout return should match the success probability, the theoretical project value (TPV) should be equal to percentage of the ultimate project value that matches the success probability. For example, a kimberlite discovery with sufficient evidence to make a $2 billion ultimate project value a reasonable outcome for a speculator to entertain, would have a theoretical project value of 2.5% to 5% of $2 billion, or a theoretical valuation range of $50-$100 million at Milestone 2. Alternatively, if the evidence suggests a more modest dream target of $500 million, the theoretical project value would be $12.5-$25 million. If micro diamond testing produces results which keep the dream alive so that the next exploration stage consisting of a mini bulk sample to determine grade is justified, the project moves on to Milestone 3 where the success probability of going all the way now ranges 5-10%. In the case of a $2 billion UPV the TPV at Milestone 3 should range $100-200 million. As a diamond project travels through the exploration cycle while keeping the UPV dream alive, its theoretical project value will oscillate within the theoretical valuation channel associated with a particular UPV. When the diamond project reaches the final production milestone ultimate and theoretical project value converge to one and the same number.

IPV Chart System provides analytical framework for diamond play analysis

According to the rational speculation model the implied project value (IPV) should fall within the theoretical project value range associated with the dream target and the project's current exploration stage. The IPV is the value assigned by the market to the diamond project based on the trading price of the company's stock, the fully diluted shares outstanding, and the company's net interest in the project. Many factors determine a stock's trading price, some completely unrelated to the fundamentals of a diamond project. The IPV Chart system was developed as tool to allow a speculator to place the market's valuation of a diamond project into an analytical framework. An IPV chart graphically portrays where a diamond project sits in the exploration cycle and how the market is presently valuing the project. A standard IPV Chart contains two theoretical valuation channels based on the Milestone Probability System and the two different ultimate project value outcomes of $2 billion and $500 million. The choice of these UPV's is arbitrary. A person could pick any ultimate project value and work out the theoretical project values associated with each milestone using the Milestone Probability System. And a person could customize the probabilities associated with each exploration stage to reflect the UPV chosen. The purpose of the Diamond Exploration Milestone and Success Probability System is to allow a speculator to see how a particular diamond project compares to others in terms of market valuation, and to use the questions these comparisons generate as a starting point for understanding the underlying fundamentals. Why does this project have such a low IPV compared to this other one which is at the same exploration stage? Or, why does this one have a higher IPV even though its project stage is not as advanced as the other? Has the market made a mistake in assessing the success probability? Or does it have widely different expectations of ultimate project value for the two projects? Sometimes a bit of research will show that the different IPV's are well justified. At other times it will become evident that the market has a profound misconception about the underlying fundamentals of a project. This analysis can generate very timely and lucrative buy or sell signals not just for long run speculators, but also for traders who focus on milestone news events. The nature of the diamond exploration cycle is such that valuations change in a series of abrupt upward or downward steps, often with overreactions that provide additional buying or selling opportunities. A diamond project that is trading within a valuation channel can undergo up to 500% gains on good news as the project graduates to the next stage, but the move can be substantially greater if the IPV was well below the theoretical valuation channel associated with a UPV that the milestone news event has suddenly turned into a reasonable outcome dream. The IPV Charts thus can serve as a useful bottom-fishing tool for diamond play juniors.

How are the milestone stages assigned?

While the implied project value is a mathematical calculation based on factual figures (stock price, fully diluted capitalization and net project interest), the assignment of project stage is somewhat more subjective because it relates to the current focus of exploration activity on a project. Keeping the project stage up to date is an ongoing research process conducted by Canspec Research (John Kaiser). It is assumed that all exploration activity has as its goal the discovery and development of a diamond mine. The IPV a project will attract at any stage will depend on the answer give to the questions in the Diamond Exploration Cycle Checklist developed by John Kaiser.

Milestone 0: Grassroots Exploration

All projects start with a "grassroots" or Milestone 0 classification, meaning that there are no known kimberlitic or lamproitic bodies deserving of additional exploration work. Sometimes that is a matter of opinion; the Tli Kwi Cho, Ranch Lake and Drybones pipes in the NWT are examples of kimberlites on which work stopped after discouraging results but which are and may be revisited with further work. Grassroots status is assigned to any new acquisition where insufficient work has been done to generate drill ready targets. Location, property size, and acquisition logic will determine the IPV>

Milestone 1: Target Drilling

Once a company has done sufficient target generation work to justify a drilling program, the project gets upgraded to "target drilling" or Milestone 1. A project qualifies for Milestone 1 if a database consisting of geophysical surveys and indicator minerals, if applicable, has been generated. Targets supported by both indicator mineral trains and geophysical anomalies have a higher probability of being converted into pipes than targets supported by only one or the other.

Milestone 2: Micro Diamond Testing

Upon discovery of a kimberlitic body that merits testing for micro diamonds, a key indicator of grade and stone size potential, the project gets upgraded to "micro diamond testing" or Milestone 2. The exception would be dyke or sill like bodies where drilling does not yield enough material for micro diamond testing. Sometimes a body is intersected that looks similar to a kimberlite. Samples are first submitted for petrographic analysis. Projects are not promoted to Milestone 2 unless the material is actually submitted for micro diamond testing.

Milestone 3: Mini Bulk Sampling for Grade

A diamond project truly starts becoming interesting from a speculative standpoint when micro diamond results for a kimberlitic or lamproitic body are sufficiently encouraging to justify a larger sample called a "mini bulk sample" whose goal is to establish a grade for the resource. Micro diamond results provide a stone size distribution curve consisting of below commercial size diamonds that is indicative of grade potential for commercial sized diamonds. The theory behind micro diamond analysis, which requires familiarity with lognormal distributions and statistics, is poorly understood by both the diamond exploration industry and the market. The reporting standards for micro diamond results are also improperly defined, which has created a situation at the time of this writing where micro diamond results get reported in a variety of formats, some highly misleading and even meaningless, others very revealing. The result is a high degree of inefficiency in the market's assessment of Milestone 3 news events, an inefficiency which knowledgeable speculators can exploit. Even when reported properly, micro diamond results can be misleading in positive and negative terms for several reasons, but in general they provide a good basis for deciding on the next exploration stage. If micro diamond results are discouraging and there remain no untested kimberlite discoveries, and no further exploration is planned on the project, the project's status drops back to "grassroots". If the company intends to continue generating new targets or upgrading existing undrilled targets, the project is only downgraded to Milestone 1, "target drilling", to reflect that a geophysical and indicator mineral database already exists for the project.

A project graduates to Milestone 3 or "mini bulk sampling" if the company sets out to extract a bulk sample of at least 5 tonnes to process by dense media separation (DMS) for the recovery of "commercial" sized diamonds, usually stones caught by a 0.8 mm or larger screen. While the slope and height of the micro diamond size distribution curve provides useful hints about the macro diamond curve, the stones recovered through caustic fusion or acid dissolution are usually below the minimum commercial screen size of 1.5 mm. DMS, which is much cheaper than caustic fusion on a per unit processing basis, recovers only the commercial sized stones that constitute the "grade" of a diamond mine. The higher the grade, the better. Whereas the material for micro diamond testing is recovered through small diameter core drilling, the mini bulk sample is recovered through large diameter drilling. Usually the mini bulk sample drilling is designed to simultaneously delineate the geometry of a kimberlite body. This provides a sense of the overall tonnage potential as well has variations in internal geometry due to different facies (related to an emplacement event) and multiple magmatic phases (related to time separated emplacement events).

Milestone 4: Bulk Sampling for Value

A project moves into the "bulk sample" or Milestone 4 stage following grade results from a mini bulk sample if the goal of the next bulk sample is to produce a parcel of diamonds whose value can be "measured" or which can be the basis for "modeled" values. What constitutes a statistically meaningful parcel size for valuation purposes depends on the size and complexity of the pipe. Sometimes the project operator decides that more delineation drilling and bulk sampling for grade only is required before going after a bulk sample large enough to furnish sufficient diamonds for valuation purposes. Such projects remain classified as Milestone 3 or "mini bulk sampling". It might be more appropriate to call this "bulk sampling for grade" than "mini bulk sampling" while "bulk sampling" should be called "bulk sampling for value". But here it has been decided to classify a project as being at the "bulk sample" or Milestone 4 stage if the goal of the sampling program is to generate a value for the diamonds. The economic potential of a kimberlitic body does not become clear until tonnage, grade and carat value figures are on the table.

The average carat value of a pipe can range from very low (ie $10 per carat to several hundred dollars per carat). High carat values are less frequent and require either a uniform population of high quality diamonds or a sub-population that delivers large, high quality stones. As a rule the market assigns much higher valuations to projects with a high indicated grade than a low grade because a low grade pipe needs a high carat value to be economic. Scoping or desktop studies are often done at this stage to provide a preliminary economic framework for what this project needs to look like before it is submitted to a prefeasibility study.

Milestone 5: Prefeasibility

Once a project has yielded tonnage, grade and value figures for a kimberlite body, the next step involves reducing the error margin of these figures and sorting out the operating and capital costs associated with production scenarios. Usually this involves additional bulk sampling, "geotectonic" studies related to engineering issues, and environmental studies aimed at identifying mitigation requirements and associated costs. This is the prefeasibility stage of Milestone 5. Once a prefeasibility study is published the economic value of the project can be calculated.

Milestone 6: Permitting and Final Feasibility

Assuming target internal rates of return are met, the project proceeds to the permitting stage or Milestone 6, which goes hand in hand with a feasibility study. At this stage very little physical work is actually being done on the diamond deposit itself. The permitting stage is usually accompanied by declining values as the market deals with time delays and cost increases created by unexpected permitting obstacles. The result can turn a positive prefeasibility study into a negative feasibility study.

Milestone 7: Construction

A project does not graduate to the construction stage of Milestone 7 until all permits are in place and a feasibility study recommends going into production. Once construction is underway the market has a concrete handle on the timing of production startup and the cash flows the project is likely to generate. The IPV will become a function of traditional valuation methods such as projected P/E rations or net present values based on the discounted cash flow model.

Milestone 8: Production

Once production commences there is still a period of uncertainty while the market awaits confirmation of grade and value. The conservative nature of the diamond exploration cycle is such that production revenue can be better than expected as large scale mining turns up rarer, high quality large stones whose exponentially higher value was not factored into the resource value because such stones simply do not show up in small scale bulk samples. Assuming the internal geometry of a pipe was properly delineated and the diamond content modeled, no major cost overruns emerged, and the diamond market remained stable, a diamond project which made it all the way through the diamond exploration cycle should perform at least as good as expected. Once the diamond mine is producing as expected, the junior partner becomes a candidate for a buyout by the senior partner or another diamond producer if the junior has not assigned marketing rights to a third party.

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