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There's (Possibly) Gold in Them Thar Hills

Junior mining outfits such as NovaGold and Seabridge have rallied even more than
the price of gold. But they're good investments only if their estimates of their gold
resources and the cost of extraction prove out.
By
Bill Alpert
Updated Feb. 15, 2010 12:01 a.m. ET

GOLD PRICES HAVE TREBLED IN RECENT YEARS. The big returns, however, have
been in little gold stocks -- exploration outfits known as "juniors." These are the ever-hopeful
speculations built upon the drill cores and inferences of a small number of hired geologists.
During gold's ascent to $1,218 an ounce, for example, shares of major producers like Newmont
Mining (ticker: NEM) went nowhere. But the stocks of two of the biggest juniors, NovaGold
Resources (NG) and Seabridge Gold (SA), rocketed tenfold to valuations of about $1 billion
apiece, as the companies' consultants expanded their estimates of the quantity of gold hidden
underground.

Enlarge Image

Martin Kozlowski for Barron's

Unburdened by gold sales or profits, the billion-dollar valuations of stocks like NovaGold and
Seabridge depend mainly on how many million ounces of gold the companies think lie in their
properties. And that tally comes from the technical experts who extrapolate from drilling
samples to estimate the unseen gold resource and its recovery cost.
Seabridge and NovaGold have used some of the same key experts to support their estimates.
When junior miners' resource and cost estimates have proven overly optimistic in the past,
they've buried shareholders. That's the lesson NovaGold investors learned in November 2007,
when the company lost half its share value in a day, as it retracted the experts' estimates of what

could be profitably mined at a gold project called Galore Creek. Two of the lead experts in that
NovaGold disaster are now consulting for Seabridge.
Bulls argue that Seabridge and NovaGold look cheap at respective share prices of 25 and 6,
which represent about $14 and $49 for each ounce of gold the companies claim they've got
underground. Other junior gold explorers have been acquired by gold majors at upward of $100
an ounce.
But NovaGold and Seabridge are bargains only if the gold estimates prove out. The gold
industry's recent decades have featured many disappointments in ore grade, tonnage and
processing cost. At Seabridge and NovaGold, the track records of important technical experts,
managers and controlling shareholders raise worries about whether the mines will meet
expectations.

Table: Precarious Balancing Act

"It is very difficult to make precise estimates," concedes Michael J. Lechner, the geologist who
certified the since-revised gold-ore estimate for NovaGold's Galore Creek and who now
oversees the audit of Seabridge's gold estimates.
"It isn't like counting washers in a jar," allows Lechner, who has consulted for successful
majors like Barrick Gold (ABX) as well as for disappointments like Esperanza Silver (ESPZF)
and GLR Resources (GLRAF), which haven't delivered the bonanzas suggested by his resource
estimates. "It is subjective as all get-out," he says.
Forecasting the costs of Seabridge's mine is James H. Gray, the consultant who signed off on
NovaGold's disavowed estimates of Galore Creek gold reserves and mining costs. Gray's firm
has worked for big outfits like Teck Resources (TCK) and penny-stock juniors like Canarc
Resource (CRCUF). In November, the British Columbia Securities Commission told Canarc
that Gray's economic assessment report failed to comply with Canadian disclosure standards.
"The work that we do are estimates," Gray says. "That's it."
GOLD MINERS ATTRACT INVESTORS as leveraged plays on the metal, because
company profits can rise faster than the commodity's price, once fixed costs are covered. And
gold has risen fabulously for reasons that most readers know: smaller mined supply,
government deficits, financial turmoil. For a 40-year stretch that ended fairly recently, central
bankers were selling gold reserves. But now bankers of Asia's developing economies want to
diversify their sovereign reserves away from U.S. Treasuries, says Albert Friedberg, a currency
and commodities expert often quoted in Barron's over the years. The prospect of China and
India boosting their gold reserves is what inspired the Toronto-based hedge-fund manager to
take a controlling stake in Seabridge, with 23% of Seabridge shares now held by Friedberg's
family-owned firms. "Sovereign buying is the one single bullish case for gold," Friedberg says.
"That's the bid under the market and it's going to be there permanently."
Supply-demand imbalances and economic turbulence have created a "perfect storm" that won't
soon abate, says William Natbony, the chief executive at Electrum Strategic Resources, a
vehicle of investor Thomas S. Kaplan. Electrum controls NovaGold with a 28% stake and
warrants for 14% more.

Since 1998, NovaGold has assembled a handful of properties in Alaska and Canada with
promising deposits of copper, silver and gold. NovaGold shares were recommended by pundit
Marc Faber at the recent Barron's Roundtable ("A Few Good Ideas," Jan. 25). The Vancouver,
British Columbia-based company has interests in two of the world's largest undeveloped gold
resources: Galore Creek, a remote mountain spot in northwest British Columbia, and Donlin
Creek, in southwest Alaska.
"We are feeling very good about our future," says Chief Executive Rick Van Nieuwenhuyse.
Soon after raising $165 million in a 2006 stock offering, NovaGold found itself the target of a
hostile tender offer by Barrick Gold. In urging shareholders to reject Barrick's $1.5 billion bid,
NovaGold released a technical report assembled by the engineering firm Hatch Ltd., which said
the Galore Creek project was worth almost $14 billion -- promising 17 million ounces of gold,
19 billion pounds of copper and 270 million ounces of silver after a total capital cost of $1.9
billion. Those metal tallies were endorsed by the experts Lechner and Gray (both brought in
through Hatch), with Gray also blessing the cost estimate. Shareholders rejected Barrick's $16 a
share bid. Touting the forecasts, NovaGold conducted another stock offering for $194 million
and secured Teck Resources as Galore Creek's partner.

Six months after Teck jumped into Galore Creek, the two companies said they were suspending
work on the project. The prior year's engineering report was "not to be relied upon," according
NovaGold's securities filings.
A new team of experts estimated that the project would cost $4.4 billion -- more than double
what NovaGold had been advertising. The 17 million ounces of gold now looked more like 11
million, none of it recoverable at a profit. In a day, NovaGold shares fell from 20 to 9.

Ensuing class-action lawsuits alleged that Van Nieuwenhuyse and his NovaGold colleagues
had concealed Galore Creek's spiraling costs in order to sell stock, fight off a Barrick takeover
and hook Teck as a partner. In Manhattan's federal district court last June, Judge Denise Cote
dismissed the engineering report's authors from the fraud suit, noting that experts clearly warn
that their forecasts are estimates. But the judge is allowing a trial on whether NovaGold's
management misled investors about Galore Creek's economics. The NovaGold defendants say
they acted in good faith and made no material misstatements. Lechner and Gray were not sued.
Each says his work on Galore Creek hasn't been questioned.
With the subsequent rise in gold's price, NovaGold and Teck are working on a new mining plan
that they hope to complete near the end of the first quarter.
NovaGold settled its differences with Barrick and they agreed to a 50/50 partnership on Donlin
Creek. NovaGold estimates its half-interest at 20 million ounces of gold. NovaGold's experts
certified 15 million of those ounces as "reserves," which means they are profitably 'mineable,'
in the parlance of Canadian disclosure rules. The remaining five million ounces were
"resources," a category for less densely sampled minerals whose economics -- or existence -are less certain.
But Barrick's resource estimates for Donlin Creek are different. The miner shows none of the
Donlin Creek gold as mineable reserves, instead putting its 20 million ounces in the less
bankable category of resources. Asked about the discrepant presentations, Van Nieuwenhuyse
says, "What's material to NovaGold is different from what's material to Barrick." At Barrick,
spokesman Vince Borg says, "We are conservative in reporting reserves."
NovaGold's fans are undeterred by the Galore Creek mishap. "Management made its errors and
learned from its errors," says Natbony, who acts as a spokesman for investor Kaplan, a boldface
name in New York's society pages who heads the board of the 92nd Street Y, a well-known
cultural institution. "We have taken a very close look at Donlin Creek," says Natbony. "Our
conclusion is that the resources are accurately described and the potential for discovering
additional resources is tremendous."
Kaplan's firm acquired its controlling stake in NovaGold about a year ago. Natbony says his
boss has a proven skill in natural-resource investing. Among Kaplan's big successes, says
Natbony, were Apex Silver -- a miner that Kaplan promoted into a billion-dollar market cap -and Leor Energy, a natural-gas venture that Kaplan sold to EnCana (ECA) a couple of years
ago for $2.5 billion.
The Bottom Line

Shares of NovaGold Resources and Seabridge Gold could be vulnerable if the companies
don't eventually meet their experts' estimates of their gold resources.
Apex Silver collapsed from its billion-dollar height after consuming $740 million from
investors, without producing a profit. By January 2009, it was in bankruptcy court. After
receiving lavish compensation as CEO from 1996 to 2002 and board chairman through 2004 -as Apex cumulatively lost almost $100 million -- Kaplan stepped down before the implosion.
The successor firm to Apex, called Golden Minerals, says the Justice Department is

investigating bribes that the company admits were paid in 2003 and 2004 to government
officials in South America. The SEC warned the company last year that the agency plans an
antifraud suit over the matter. Barron's asked repeatedly to speak with Kaplan, without success.
Natbony says that Apex's financial problems arose after Kaplan left and that no action has been
brought against Apex officers.
Kaplan's Leor Energy bonanza is itself the subject of lawsuits in which his nephew, Guma
Aguiar, alleges that Kaplan and attorney Natbony swindled Aguiar out of his half-interest in the
venture; while Kaplan alleges that Aguiar committed embezzlement. Natbony says the dispute
will be decided in Kaplan's favor.
While NovaGold has gotten major companies like Barrick and Teck to venture on projects,
Seabridge Gold has no partner yet for its KSM gold project on British Columbia's border. The
KSM deposit holds almost 50 million ounces of gold, according to the technical reports of
Lechner. None of the deposit has been classified as reserves. Seabridge Chief Executive Rudi
Fronk says his Toronto company is developing estimates of mining costs -- with the help of
Gray, also a Seabridge consultant -- to merit moving some of those ounces from resources to
reserves.
"The largest guys would rather buy reserves," Fronk says. "Especially if you have the right
technical people making the estimate." Lechner is the right person, says Fronk, claiming that
when Barrick wants an outsider to audit its resource estimates it hires Lechner. Barrick
spokesman Borg confirmed that the miner used Lechner at times in the past. "But the
fundamental question in assessing a project," says Borg, "is whether it's economic or not."
Seabridge has never mined an ounce of metal; it would rather spend its cash to acquire and
explore mineral claims. Fronk says he developed this philosophy after he ran a Central
American miner called Greenstone Resources in the 1990s. Fronk touted Greenstone to a
billion-dollar market cap and raised $300 million in financing on promises of seven million
ounces in gold reserves and 600,000 ounces in annual production. Within a year and half of
Fronk's announcement of a "super" mine, Greenstone collapsed. Fronk blames a hurricane, a
drop in gold prices and expropriation by the Honduran government.
Friedberg, Seabridge's controlling shareholder, says his investment was a "top-down" bet on
gold. "I know as much about mining as you do," the hedge-fund manager tells a reporter. "I am
really a commodities person."
The folks involved with Seabridge might not have sold any gold yet, but they've sold stock.
SEC filings show that Friedberg's hedge fund sold a half-million shares in the past few months,
at prices averaging above 25 bucks a share. Friedberg says he did it for ethical reasons, after
concluding that his hedge fund shouldn't trade a stock in which he has a large personal holding.
Fronk and other Seabridge insiders also have taken $36 million off the table through stock sales
in the past four years. The Seabridge chief defends these transactions by saying he regrets not
having sold stock before Greenstone collapsed.
Seabridge recently filed a shelf registration to raise $100 million, while NovaGold's filed to
raise $500 million. These filings might signal that the junior miners don't soon expect cash

infusions from a big firm. For that, they need to move more ounces of gold -- on paper, at least
-- from the resource to reserve category.
Geostatistician Mike Lechner says such classifications are highly subjective, and he retells an
industry joke in which a mine manager asks employees to add 2 plus 2. The geologist answers,
"It's a number between 3 and 5." The engineer says, "4.000."
The geostatistician closes the door and asks, "What do you want it to be?"

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