Executive Summary

Pure Gold Mining Incorporated ("Pure Gold") is a Canadian gold mining company that is traded on the NEX, TSX Venture and the London Stock exchange. The focus of Pure Gold is the Madsen Gold Project, located in Red Lake, Ontario, Canada. Last year the company and the project made headlines not for success but for failure. In October 2022 operations were suspended and the mine placed on care and maintenance.

Crux Investor has reviewed the news releases and technical reports published by Pure Gold. This retrospective note is an attempt to identify early warning signs, without the benefit of hindsight. The intention of the Analysts is to objectively determine gaps, oversights and overoptimism with respect to input parameters at odds with comparable projects.

Successful mining development requires four key areas to work in harmony – Geology, Mining, Processing, and Economics. In the case of Pure Gold and Madsen, only the Processing proved to be entirely unproblematic and the problems with Geology only became apparent in retrospect.

The two major flaws in the assumptions were related to Mining and Economics. Mining dilution was greatly aggravated by unrealistically low operating costs in the calculation of the cut-off grade. Given that costs were higher than expected, and grades lower than expected, the mine became a perpetual loss-making enterprise. By not using real-world costs, Pure Gold embarked on a value-destruction exercise.

Crux Investor notes that single-asset companies are in an unenviable position. The company is so invested in developing one particular project that bias tends to enter into the decision-making process. Furthermore, many technical reports are not generated by truly independent agencies. Consultants will typically work hard to ensure a favourable outcome on the project is reached.

Crux Investor believes that the degree of bias is proportional to the marginality of the project. More bias is likely on a marginal project than on a high margin project.

All mining companies and any serious investors should compare the input assumptions for economic studies with actual results from similar operations. This report has illustrated how important it is to check the credibility of suggested cost parameters by carrying out a benchmarking exercise.

Introduction

Pure Gold Mining Incorporated ("Pure Gold") is a Canadian gold mining company that is traded on the NEX, TSX Venture and the London Stock exchange. The focus of Pure Gold is the Madsen Gold Project, located in Red Lake, Ontario, Canada. Last year the company and the project made headlines not for success but for failure. In October 2022 operations were suspended and the mine placed on care and maintenance.

Crux Investor has reviewed the news releases and technical reports published by Pure Gold. This retrospective note is an attempt to identify early warning signs, without the benefit of hindsight. The intention of the Analysts is to objectively determine gaps, oversights and overoptimism with respect to input parameters at odds with comparable projects.

The original Pure Gold plan had been to develop an underground mine and processing operation with a 12-year productive life. Madsen is near the historical Madsen Mine, which produced 2.5 million ounces (“Moz”) of gold at an average grade of 9.7 g/t Au from treating 7.9 million tonnes (“Mt”) between 1938 and 1976 and from 1997 to 1999.

To achieve its goals Pure Gold explored and published several mineral resource estimates and economic assessments on the property from 2014 onwards. A feasibility study dated 5 February 2019 was based on a resource estimation for the Madsen deposit (using exploration results up to 16 January 2018).  Declared Mineral Reserves were all in the Probable category and contained just above 1 Moz gold grading 8.97 g/t Au. The feasibility study conclusion on the project was positive. Pure Gold advanced to the next stage.

By August 2019 Pure Gold had secured the required project financing and approved mine construction. Design contracts were awarded and an updated capital budget (the “Definitive Budget”) was published in December 2019. Capital Expenditure of the development was C$124.6 M, up 31% from the C$95 M estimate in the feasibility study. In December 2019 the company expected to bring first ore to the mill in Q4 of 2020. This was duly achieved, but other signs of trouble became apparent. 

By the end of 2020 actual construction capital expenditure had reached C$145.6 M with certain facilities still not completed, which needed an extra C$3.3 M. The 3,535 tonnes material fed to the mill by December 2020 had a grade of 7.80 g/t Au which was 13% below the reserve grade. Furthermore, the 19,067 tonnes stockpiled on the Run-Of-Mine (“ROM”) pad graded only 3.32 g/t Au. Gold “production” was 860 ounces, of which 148 ounces were recovered and 712 ounces were locked up in the plant.  The lower poured ounces versus processed ounces were, according to Pure Gold, the result of only capturing gold from the gravity circuit in the first instance. The remaining 712 oz of gold was to allow for higher loadings on carbon in the CIP circuit, before recovery. 

In Q1 2021 production underperformance continued. Several challenges were cited, including:

i) Excess overbreak (causing waste to mix with ore, therefore increasing dilution);

ii) Delays in receiving final permits;

iii) A significant volume of non-mineralised dykes encountered in one of the stopes. 

The Run-Of-Mine (“ROM”) (what actually comes out of the mine) grade was significantly lower than the reserve grade and the planned ROM grade. With lower ROM grades than planned, there was a shortfall of gold production. The shortfall in production forced the company to seek additional financing. 

The company declared commercial production on 1 August 2021. This was inappropriate as only mill throughput and metallurgical recovery could have been considered close to target rates.  All other metrics were well short of plan. With the company unable to correct matters in the subsequent year, it was finally placed under creditor protection on 30 October 2022.

What went wrong? Why did this happen?

Determining Fatal Flaws Before a Go-ahead Decision

Key determinants for the success of any project are Geology, Mining, Metallurgy, and Economics. More specifically:

· The resource estimate and whether this reflects the nature of the deposit(s).

· The reserve estimate and whether the appropriate cut-off grade and conversion factors were applied, especially when it comes to the realities of mining.

· Whether the amenability to processing has been sufficiently established and the metallurgical performance for the chosen process route has been properly established.

· The operating and capital cost inputs.

Crux Investor reviews each of these four categories and how they apply to the Madsen project. The Analysts assess if an independent third party could have seen shortcomings before a final construction decision was made.

1. The Resource Estimation for Madsen

First Pass

The 2019 mineral resource estimate (“MRE”) (used in the feasibility study) derives from a previous MRE dated August 2017. The updated MRE grades are almost exactly the same as the 2017 MRE grades, and tonnages are approximately 10% higher. The increased tonnage is a function of adding in more drill holes to the estimate. This is a logical progression. Ginto Consulting Inc (“Ginto”) did the Resource Estimation work for both mres.

Interestingly, a bulk sample was taken from underground to test the resource model against a larger sample size. In addition, a second bulk sample was taken to test the robustness of the reserve model. The feasibility study (available on SEDAR) details the work around the bulk sample, in Section 14.1.14 (pp. 213-218).  

In the stopes designed to test the resource model, actual tonnes were +46%, actual grades were +8%, giving an overall increase in ‘production ounces’ of +56%. Similarly, the sample designed to test the reserve model, returned actual tonnes +36%, actual grades +12%, and an overall increase in ‘production ounces’ of +52%.  From an outsiders’ perspective the logical conclusion is that the resources and reserves err on the conservative side. 

In hindsight the exercise was flawed.  Either certain aspects were not disclosed, or the protocols did not reflect the operational conditions of a mine.  At the time, however, the majority of Investors or analysts would have drawn confidence from the estimation process.

Review in hindsight

Knowing that the project failed, Crux Investor went back further into the historical information, parsing for clues. Some obvious clues emerged during 2022, such as repeat financings. With specific reference to the resource estimate, the main clue was the appointment of fresh consultants led by SRK Consulting (Canada) Inc (“SRK”).  The job for the consultants was to prepare an updated mineral reserve, mineral resource, and life of mine (“LOM”) plan for the mine.

The updated resource estimation by SRK in 2022 did not model low grade domains and used the same approach as for the Ginto MRE for outlining high-grade domains.  However, the number of wireframes used increased from 14 to 50. A wireframe outlines an envelope of rock at a certain density and grade. By increasing the number of wireframes so much, it indicates that there is a greater distinction in the new resource model between waste and ore. This important change is not discussed by SRK or by Pure Gold.

Both Ginto and SRK carried out visual checks of the block model. Visual checks consist of plotting drill hole data and the block model using the same colour scheme and looking to see that the resource blocks are consistent with the grades seen downhole. Section 14.1.7.1 Visual Inspection in the Feasibility Study covers pages 189-198.

Crux Investor notes that slices through the block models prepared by Ginto shows there is evidence of smearing of the high-grade drill intercepts. Some of the Ginto cross-sections in the feasibility study show high-grade drill intercepts influencing grade down-hole all the way to a low-grade assay. Usual practice is for good grades only to be projected halfway or up to a given maximum distance away from the assayed point. The effect at Madsen is not obvious but it is discernible. Perhaps more importantly, the Ginto cross-sections in Section 14.1.7.1 show mineable structures of up to 30 m wide. Crux Investor has not included examples of the Ginto sections in this report because the resolution of the original images is poor.

Figure 1 shows examples of visual checks by SRK between borehole intercept grade and block grade for two cross sections through the SRK block model.  The colours of the dots represent grade in the drill hole, the colour the surrounding hatched area represents the grade of the mineable block within the resource model.

The SRK block model highlights narrow structures. These are narrower than those from the Ginto resource model. This explains the drop in resources estimated by SRK.  The illustrations also demonstrate the relatively small size of areas where the grade exceeds cut-off grade. 

Table 1 is the resource statement of SRK, effective 31December 2021, below which reflects the changes from the Ginto MRE numbers.

The slightly higher grade of the Indicated Resources of SRK is accounted for by their use of a cut-off grade off 3.36 g/t Au compared to 3.0 g/t Au by Ginto.  There is however a marked change in total tonnage.  As mining up to 31 December 2021 only accounts for 0.17 million tonne (“Mt”), which would be roughly 2½ more for resources (i.e. 0.4 Mt), this does not explain the large changes in resource tonnages.

Crux Investor speculates that the significant reduction in tonnage, especially is due to more restrictive wire framing of the high-grade domains.  The SRK resources also benefited from a much narrower exclusion zone around the old stopes, dropping from 5 m to 2 m.  This makes the drop in tonnage even more striking. 

Very noticeable of the SRK report is however the absence of a reconciliation between actually mined and predicted from the resource model.  This should have been the main focus of the exercise.  It may well have been carried out, but the results too poor for the project to be reported. Speculation!

2. The Reserve Estimation for Madsen

A review of the Reserve Estimation process can be broken into three key areas:

i) the appropriateness of the chosen mining method(s)

ii) the assumed Run-of-Mine grade, after dilution

iii) the appropriateness of the cut-off grade

2.i The appropriateness of the chosen mining method(s)

Pure Gold’s planned use of longhole open stoping (“LOP”) for subvertical deposits is a logical choice provided there is sufficient width and rock stability. A designed stope width of 2 m will generally lead to high dilution. Significant dilution can occur when rock conditions are poor. As a reminder, dilution is the waste material not separated from the ore in the stages of mining, and is sent to the processing plant.

The other planned mining method was Cut and Fill (“C&F"). This a technique is usually used where the dip is too low to allow broken ore to free flow to the draw points, or where the outline of the stope is too irregular to allow for LOP. C&F has low productivity. When it is not mechanised, the method is very laborious. The cost of C&F mining is higher than LOP, but control of dilution is better.

2.ii The assumed Run-of-Mine grade, after dilution

In planning, engineers make an estimate of the inevitable but expected dilution during mining. What can cause problems is when there is unplanned dilution during mining. Figure 2, below, shows the difference between planned reserve limits and true reserve limits. There can be significant operating cost and ROM grade differences between the plan and the actual if there is much unplanned dilution. This happened at Madsen.

JDS Energy & Mining Incorporated (“JDS”), the agency responsible for the 2019 feasibility study, assumed total dilution of 13% which is low for narrow deposits.  JDS relied on the resource model of Ginto which indicated decent widths of the veins (Figure 3).

When referring to the cross sections in the SRK block model it is apparent resource widths are generally 2 m or less and with irregular outlines. If JDS had the SRK model they surely would have used a much higher dilution rate, possibly as high as 25%. Dilution rates of 25% make a huge change to the economics of an underground mine.

2.iii The appropriateness of the cut-off grade

Within the broader resource base at Madsen there are a variety of different sub-resources with different characteristics. Each sub-resource area will have different grades, dilution factors and mining recoveries. After dilution and mining recoveries are applied, mineable stopes were defined based on a cut-off grade of 4.0 g/t Au for the McVeigh zone. Using the different parameters, a higher cut-off grade of 4.75 g/t Au was applied to the Austin, South Austin (including A3 domain), and the 8 Zone.  See Figure 4, below for the location and outline of stopes by Mining Method.

Note the small average size of the stopes and the relatively large distances between the stopes. Only the deepest stopes show more consistent dimensions. Development and operation are always difficult when stopes are small, and operating costs will be high.

Crux Investor disagrees with the cut-off grades used. Table 2, below, shows how JDS arrived at its cut-off grade of 4.75 g/t Au after accounting for dilution. The method is a relatively simple economic back-calculation from a given reserve gold price, in this case US$1,275 per ounce, using operating cost and dilution assumptions. In the column on the right of the table, Crux Investor calculates what the cut-off grade should have been. The Crux Investor calculation uses realistic inputs for dilution applied to the Ginto resource model AND operating cost based on actual costs known from financial reporting at the Macassa mine (See Section 4 of this report for the motivation to use Macassa costs).

Table 2 shows that the appropriate cut-off grade for the Madsen mine should have been 7.45 g/t Au, using a dilution factor of 20% and the real operating costs from Macassa. Remember that dilution could have been modelled at 25%.

The key factors here are the dilution factor, and the known operating cost from a similar operation. Time and time again companies estimate that ‘their operation’ is going to be lower cost than the group. Benchmarking is a very powerful dataset that should never be ignored.

Clearly, with a cut-off grade of 7.45 g/t Au a significant portion of the resource would have been rendered uneconomic. The feasibility study, if done properly, would have not recommended advancing with the project. For a single-asset company, with a stated focus on the Madsen gold mine, reaching a conclusion not to advance with the project would have been devastating. The consultants JDS must have been under considerable pressure to deliver.

Note that major mining companies with multiple operating assets often decide not to develop a project if it does not reach critical thresholds. It is much harder for single-asset companies to work with the same level of objectivity.

3. Metallurgy and Processing

Given the long production history of the Madsen mine, the metallurgical performance was well known. Crucially, simple metallurgy meant that processing was a non-issue in terms of risk to feasibility. There could be differences between actual and forecast, but these are negligible in terms of affecting the project economics.

4. Input Cost Parameters

Crux Investor advises never to rely on technical report with operating and capital cost estimates solely derived from “first principles’. It is imperative to have costs undergo a reality-check by benchmarking the overall numbers against actual costs from similar operations. 

Figure 4, above showed small stopes widely spaced both laterally and vertically. Mining methods for Madsen were always going to be labour-intensive and inefficient as a result. With haulage over a long distance, both horizontally and vertically, costs were always likely to be at the top end of suitable benchmark ranges. The suggested unit cost used in the feasibility study of C$223/t is simply not credible.

Table 3, below, compares the rates of unit cost across broadly similar Canadian underground gold mining operations. The operations all extract ore from relatively narrow deposits.

The Macassa mine is most comparable to Madsen as it also uses predominantly cut-and fill mining on narrow deposits.  The total cash cost and capital expenditure for Macassa are as reported for the 2017 calendar year, but the breakdown of operating cost into the cost component are in the same proportion as the budgeted in the technical report dated 30 March 2017 for the Macassa mine. Crucially, the operating cost for Macassa is C$305/t.

As noted in Section 2, using C$305/t to calculate cut-off grades for Madsen would have rendered the mine economic. The upside is that shareholders would not have lost so much money and the company could have survived to find another deposit and live another day.

Conclusions

Successful mining development requires four key areas to work in harmony – Geology, Mining, Processing, and Economics.

In the case of Pure Gold and Madsen, only the Processing proved to be entirely unproblematic. The historical production performance with excellent recoveries was a decisive de-risking factor.

The problems with Geology only became apparent in retrospect. A review of the resource estimation would not have raised any red flags. Confidence would have been boosted by the bulk sample exercise. This indicated a conservative bias to the resource estimation numbers. 

The two major flaws in the assumptions were related to Mining and Economics. The reserve estimation suffered from applying very low dilution figures given the nature of the deposit and the mining methods chosen. When operations started the real dilutions figures where much higher than forecast, which meant that ROM grades were much lower than expected.

The cut-off grade underestimation was greatly aggravated by unrealistically low operating costs in the calculation of the cut-off grade. Given that costs were higher than expected, and grades lower than expected, the mine became a perpetual loss-making enterprise. The data for real operating costs in Canada exists. Benchmarking is an incredibly powerful and important exercise. By not using real-world costs, Pure Gold embarked on a value-destruction exercise.

Crux Investor’s Warning and Advice

Crux Investor notes that single-asset companies are in an unenviable position. The company is so invested in developing one particular project that bias tends to enter into the decision-making process. “We have come so far that the only way is forward….” and “Mines are Made not Found”. Greater objectivity and better decision-making can be found in companies with multiple assets. Multi-asset Companies have greater balance sheet stability, which can empower management to take long-term decisions with greater impartiality than the choices facing management running single-asset companies.

An additional factor is that technical reports are not generated by truly independent agencies. Consultants will typically work hard to ensure a favourable outcome on the project is reached. Consultancies are businesses that make money from doing more work with existing clients (as well as picking up contracts with new clients). A negative report typically does not lead to more work and therefore technical reports have a tendency to be positively biased. Remember also that technical reports are often a collaboration by many different consultants. It only takes one consultant to include an unrealistic assumption, or to overlook key data, for the entire calculation to be flawed.

Crux Investor believes that for as long as the authorities fail to penalise agencies for being blatantly wrong, technical reports will have a positive bias. Note that the degree of bias is proportional to the marginality of the project. More bias is likely on a marginal project than on a high margin project.

All mining companies and any serious investors should compare the input assumptions for economic studies with actual results from similar operations.  This report has illustrated how important it is to check the credibility of suggested cost parameters by carrying out a benchmarking exercise.

If you are a Family Office investor, or an Institutional investor, and you would like the full report behind this article, please contact matthew@cruxinvestor.com

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