SVH Tracker - January 31, 2017: InZinc the most overlooked zinc junior
InZinc Mining Ltd is currently the most overlooked zinc story on the junior scene and is poised to double immediately as the market starts to appreciate that West Desert is beyond optionality, will benefit as a development story from further increases in the price of zinc which could achieve mania inducing elevations, and is exposed to additional discovery potential that could rival the Hermosa-Taylor discovery of Arizona Mining Inc, last year's resource sector champion. During the past week I have done two things which make me believe that InZinc will be the biggest predictable winner in 2017 among my current SVH picks. By "predictable" I mean that the stock is already seriously undervalued in terms of project fundamentals, implying that market recognition of this intrinsic value should propel the stock into the $1-$2 range. Only Scandium International Mining Corp is comparable in "predictable" terms, and theoretically is superior to InZinc because it is not impossible that a magic fountain will erupt from somewhere to fill the warehouses with zinc (only the ignorant think this could happen for scandium). I lean towards the view that China, contrary to the prevailing wisdom that follows the direction of the most recent visible trend, will reverse its seemingly relentless expansion of zinc supply. If that view proves correct, the world will suffer collapsing zinc warehouse stocks with accompanying sharp zinc price increases. As China undergoes an environmental awakening in order to preserve the Communist Party's dominant role, and America embraces Donald Trump's dual strategy of gutting environmental policy and erecting an isolationist wall around itself, we will see two important trends. One will be a soaring zinc price as China scrambles to secure its zinc consumption needs no longer supplied by its numerous small but polluting mines. The other will be a scramble by America to develop domestic raw material supply, something not accomplished overnight by knocking out the EPA, for the NIMBY principle that drives the anti-mining lobby originates from the economic establishment upon which Trump has supposedly declared war. West Desert already enjoys a location that qualifies as "NBBY" (Nobody's Backyard) as far as wildlife, cultural settlements and local bureaucracies are concerned. The closest neighbor is the US military which utilizes the salt flats south of Great Salt Lake for testing purposes. West Desert is an easy "America First" story for Americans to embrace, regardless of political stripe (Californians will appreciate the domestic supply of indium for solar panels no longer imported from China). The Hermosa-Taylor project of Arizona Mining Inc qualifies as an America First story, but its current valuation leaves only a double or triple available as upside from current levels. That is not shabby, which is why Arizona Mining Inc remains a Good Relative Spec Value Buy recommendation. At the start of 2016 I was smart enough to recognize Hermosa-Taylor as an emerging world-class discovery, but after a five year bear market I was so financially crushed I could only watch and marvel in print. I suspect whatever subscribers I had left also only read and wondered. Most of us missed the boat on Arizona Mining, some of us because we were stuck in InZinc Mining Ltd, my favored pick as a zinc optionality play. Today InZinc is the zinc optionality and potential discovery story for everybody who missed the ten-bagger Arizona Mining Inc boat. Recrunching the PEA assumptions showed me that this is the case. A presentation by Kerry Curtis at Roundup last week showed me why there is a very important discovery potential that could enable InZinc to deliver a double or triple on top of a ten-bagger.
When I describe InZinc as the biggest "predictable winner in 2017" I am not just referring to the market's inefficiency with regard to West Desert's mine-making fundamentals. I also intend a more aggressive meaning of "predictable" in terms of the geological context for discovery potential. West Desert today bears a startling similarity to what Arizona Mining Inc was disclosing in 2015 when the company's founder, Richard Warke, was the main party pumping money into the company through private placements to fund ongoing exploration driven by Don Taylor's geological vision of a world class zinc-lead-silver sulphide system emanating away from a silvery black hole called Hermosa-Central into which the company pumped $40 million to arrive at a thumbs down feasibility conclusion. InZinc plans to raise capital for a 10,000 m drill program, 70% of which will be earmarked for lateral expansion of the skarn zone which could expand the current resource 50%-100%, and 30% for assessing the eastward extent of the CRD mineralization which could evolve into a zinc-copper rich equivalent of the Hermosa-Taylor CRD zone. The first is a plausible outcome that contributes to a ten-bagger, the latter is a possible outcome that would land the stock price on the moon (don't laugh, we are not that far from Bingham Canyon).
Spec Value Hunters need to look at InZinc from two perspectives, both of which I addressed last week. The first was through a review I conducted of the West Desert PEA using current metal prices which shows that the project has an after tax NPV range of USD $235 million to $399 million using 10% and 5% discount rates, with an IRR of 28%. Given that CapEx is projected at USD $247 million, and assuming that $1.30/lb is a reasonable new long term price for zinc, this NPV range is well within threshold to justify proceeding with a prefeasibility study aimed at fast-track mine development. The weak Canadian dollar exchange rate of 1.35:1 USD, 100% net project interest, and 82.8 million fully diluted shares allows us to convert this NPV range into a price target range of CAD $3.68 to $6.25 per share. The graphic above shows the project's sensitivity to the zinc price in USD after-tax net present value terms; the graphic below shows those values translated into fully diluted per share terms. If we assume a doubling of fully diluted over the next two years to fund a PFS (ie 166 million fully diluted, less than half the fully diluted of Arizona Mining Inc), the target range drops to $1.84 to $3.13 per shares, well above the current $0.29 level. Since it is unlikely that InZinc would be able to raise CapEx to develop West Desert as a mine, our assumption is that a producer would mount a takeover bid for InZinc.
The sensitivity analysis is based on an updated PEA published by InZinc in April 2014 for a 6,500 tpd underground mining operation for West Desert that would produce 1.6 billion lbs of zinc, 148 million lbs of copper and 569 tonnes of indium over a 15 year mine life. At a base case price of $1.00/lb zinc the PEA projected an after-tax NPV of US $258 million at 8% discount rate, which compared favorably with CapEx of USD $247 million, and a 23% IRR which also exceeded the minimum development hurdle. The updated PEA benefited by converting the magnetite associated with the zinc-copper skarn mineralization from a waste disposal cost to a saleable product for which InZinc expected a $10 premium above the then prevailing China port price of $105 per tonne of 62% iron. Unfortunately iron subsequently plunged below $50 per tonne, zinc below $0.80 per lb, and copper from the $3/lb base case price to just above $2/lb, giving the West Desert project a negative NPV. I had to switch InZinc into a Relative Good Spec Value Buy from Absolute Good Value to reflect the reality that West Desert was simply an optionality play on higher long term zinc prices. Spec Value Hunters had to endure a descent below $0.10 while the junior hibernated, with the former CEO Chris Staargaard departing in 2016 in order to put bread on the table by returning to his consulting business. Since then metal prices have undergone a remarkable turnaround and the street is embracing the idea that a bull market for zinc has finally arrived.
The main driving force is the depletion of western zinc mines without new offsetting supply, caused in part by fear created by China's relentless supply expansion during the past two decades. Now the street is starting to understand Robert Friedland's declaration: "the combination of corruption and pollution is toxic to the future of the Chinese Communist Party". The corruption at the local level which allows waste to be emitted into China's waters and atmosphere is setting the stage for a populist revolution that Beijing can squash only by stopping corruption so that environmental laws get enforced. The biggest coming supply shock will be the curtailment of China's many small scale zinc mines whose heavy metal laced emissions end up in China's rivers from which much of China's agricultural production is irrigated. On January 31, 2017 the spot price of zinc hit $1.30/lb. Iron prices have rebounded to $80 per tonne, making it reasonable to assign an $80/tonne price to West Desert's magnetite output (64% iron). I have updated my West Desert NPV sensitivity analysis using the current metal prices.
The stock has been dragging its heels because the company has only $500,000 working capital left, management has been focused on raising capital from institutional sources, and Bay Street has played coy with InZinc's new CEO Kerry Curtis. What Bay Street is not counting on is an America First juggernaut of retail investors seeking deposits that can be developed inside a country the new president appears determined to wall off from the rest of the world. West Desert's location in mining friendly Utah in a barren region near a bleak military testing area as a small footprint 6,500 tpd underground mine does not need gutting of the EPA to get a green-light, nor does it face the cultural opposition created by Hermosa-Taylor's proximity to Patagonia in southern Arizona. Around this time last year I argued that Bay Street would not touch Arizona Mining Inc unless it passed $1 on the upside, and that is what indeed happened as drilling confirmed the presence of a world class zinc-lead-silver deposit and helped the stock to a recent peak of $3.40 where the project sported an implied value of CAD $983 million, more than 10 times what it was on March 4, 2016 when I made the stock an SVH Buy at $0.46. Unless Spec Value Hunters are bearish on the price of zinc, InZinc at a USD $18.5 million value represents very Good Absolute Spec Value all the way into the $0.60-$0.80 range by when I would like to see a financing of $3-$5 million to get InZinc's proposed drill program underway.
The second perspective at which I have hinted during the past year but for which I did not have strong evidence was delivered last week when I got a technical presentation from InZinc's Kerry Curtis which outlined the exploration upside of West Desert in a manner I have never seen and which revealed why the 60 million tonne skarn resource could be the tip of an iceberg similar to the Hermosa-Central zone. The main difference is that where the Hermosa-Central deposit is an outcropping manto with oxidized silver-zinc-manganese mineralization that Don Taylor has projected down-dip along a northwesterly plunging package of carbonates loaded with high grade carbonate replacement style beds of zinc-lead-silver massive sulphides, the West Desert skarn deposit starts at a depth of 200-700 metres and has an adjoining package of carbonate replacement style mineralization that appears to project upwards in an easterly direction. Just as the Hermosa-Taylor CRD zone passes beneath old high grade lead fissure veins within overlying volcanics that Asarco worked from 1939-1945 (the Trench Mine), the West Desert CRD zone projects beneath the old Utah Mine workings where high grade fissure veins yielded 2.7 million ounces of silver at 144 opt between 1890-1953. In both cases the fissure veins are hosted by not very permissible rocks and likely represent leakage from a major deeper system. The above long section graphic of West Desert represents the manner in which the company has historically represented the expansion potential, namely laterally in an east and west direction and deeper in a southwest direction. The area to the east projecting under the historic Utah silver mine has been historically treated as a "blackness" into which two deep holes have been drilled under the Utah Mine, one which hit nothing at the eastern end before terminating in copper-molybdenum anomalous intrusive rocks, and one which intersected a tantalizing 3.05 m of 7.65% zinc and 3.5% copper which management cannot tell if it crossed the Juab Fault into older Cambrian rocks or still represented Silurian-Devonian rocks. The difference between the two carbonate rocks, both of which were present before the mineralizing event, as was the unconformity created by the Juab Fault, is that the younger Silurian-Devonian rocks are less permissive to fluid flow and thus form massive mineralization rich with magnetite close to the intrusive contact where the ore gets baked into the carbonates. The hypothesis about lateral expansion to the west and east hinges on the assumption that the intrusive contact is present.
The long section above is from Hermosa-Taylor in Arizona which shows the mineralized deep hole Asarco drilled to the northwest of the claim boundary and the CRD sulphides as they dip from the manto deposit at the eastern end, a distance of about 2 km which is similar to that between the West Desert skarn zone and the old fissure veins. What should be understood is that while the limestone stratigraphy is old, the mineralizing event took place after the Tertiary volcanics at Hermosa-Taylor were laid down. The volcanics are less permissive rocks which helped channel fluid flow along the limestone beds enabling carbonate replacement in the form of massive sulphides to develop. The less permissive nature of the volcanics also allowed them to develop cracks which were followed by enriched fluids that formed the fissure veins worked by Asarco.
The cross section above shows the reddish massive sulphide zones as skarns baked into the Silurian-Devonian dolomites by the quart monzonite intrusion which itself hosts barren sulphides. These carbonates are separated to the south from older Cambrian carbonates by the Juab Fault, an east-west structure apparently dipping to the north. The plan view graphic below shows how the deposit straddles the Juab Fault which is south of the old fissure vein workings which are hosted by the younger Silurian-Devonian dolomites. The younger dolomites have the additional complication of hosting quartzite beds which are tight rocks that allow fluid flow only via cracks.
The long section below extends eastwards so as to include all the fissure vein shafts. Kerry Curtis is hypothesizing that the Juab Fault extends eastward, separating the tighter Silurian-Devonian dolomites, which are candidates for skarn mineralization, from the older Cambrian carbonates which are candidates for carbonate replacement mineralization because they contain shale beds that facilitate fluid flow and end up being replaced by massive sulphides. The fluid flow is believed to have been driven by the quartz monzonite intrusion at depth which likely evolved into a porphyry system. There is some suspicion that at depth West Desert hosts a monster equivalent to Bingham Canyon for which the Tintic zinc deposit was understood as a distal outcome. If West Desert is the peripheral expression of such a system, it could be the tip of a major iceberg whose grade would have to be high enough to support underground mining below 700 metres.
The graphic below approximates where InZinc wants to distribute a 10,000 metre drill plan, with 70% intended for lateral expansion along the inferred contact between the intrusion and the Silurian-Devonian dolomites into which the skarn ore has been baked, and 30% intended for deeper holes that test the development of CRD style massive sulphides within Cambrian rocks below the Juab Fault. InZinc plans to conduct a CSAMT geophysical survey which it believes will be helpful as a structural mapping tool to a depth of about 300 metres as a prelude to the riskier "scout" drill holes. The downside risk for the discovery exploration potential is that what we see so far is all that West Desert has, in which case InZinc still qualifies as a buy with an immediate target of $0.60-$0.80 where a financing is needed to fuel advancement of project fundamentals, which leaves a takeout price range of $1.50-$3.00 in the event of a sustained zinc bull market. Should the exploration drilling expand the skarn resource, and or confirm a substantial CRD resource with a grade better than the average in the PEA, then a much higher target is conceivable at the current zinc price of $1.30 per lb.
*JK owns shares in InZinc Mining Ltd