Are Diamond Royalties Flawed?
Issue 129, June 2015
The royalty sector is the fastest growing subset of the mining industry, expanding in gold, silver, coal and iron ore, but it has repeatedly failed to make headway in the diamond market.
Diamond junior DiamondCorp raised £3.2m ($5m) in equity last week, allowing it to dodge a royalty deal the company entered earlier this year with Acrux Resources, a private South African firm.
The two companies had provisionally agreed to a 3 per cent royalty over DiamondCorp's Lace mine in South Africa, expected to produce low-quality, commercial-grade stones. But the recent recovery of a Type IIA diamond, the rarest category of diamond found, suggests the $7m deal could have cost DiamondCorp as much as $56m.
Whilst precious metals deposits are drilled intensively to monitor grades, diamond deposits rely on bulk sampling, processing a tiny percentage of kimberlite at surface and extrapolating the results. The process creates “known unknowns” as to what will come out of the ground, says analyst Kieron Hodgson, making royalties difficult to price.
Toronto-listed Mountain Province considered selling a royalty over its Gahcho Kue diamond project in Canada in 2011, but limited drilling at depth meant the company could have been giving away claims over as much as 20m-carats not yet in its models, say sources connected to the company. “If you have not drilled out these kimberlites to sufficient depth, then you're basically giving away money."
“Most diamond mines are controlled by the majors,” says broker Jamie Strauss, who has raised capital for Petra Diamonds, the largest producer outside the ranks of De Beers, Rio Tinto and Alrosa. “Then you're getting down to half a dozen mines, most of which are already fully financed.”
The diamond market's most famous royalties are two 1 per cent claims over Rio Tinto's Diavik mine in Canada, held by prospector Chris Jennings and streaming group Sandstorm Gold, which paid $57m for the asset in March.
“It's a high margin asset in Canada operated by one of the best operators in the world,” says Sandstorm's chief executive Nolan Watson. “That was the main reason that it was attractive to us.”
Diavik is expected to generate $7m to $8m for Sandstorm each year, equal to 11 to 13 per cent of its current revenue. It is predictable income that evens-out the company's cash flow, Watson says. “When the economy's chugging along and doing really well, people are spending money and buying diamonds. That's the same market where gold prices are down, so it stabilises the portfolio.”
By dollar value, the diamond market is bigger than silver at around $14bn per annum, but with far fewer mines, royalty deals are less of a “repeatable phenomena,” Watson says.
Diamond royalties remain rare and the unwinding of DiamondCorp's deal, widely welcomed as "good news" for investors, suggests that it is unlikely to change.
Quebec-based Stornoway Diamond sold a 20 per cent stream over its Renard project in Canada for C$275m ($252m) last year, but privately, the deal is widely scorned.
“I know these projects have pretty good numbers, in a bull market, but you can't give 20 per cent of your revenue away,” one analyst says. “It's very, very expensive paper. When I first did my model, I couldn't believe what I was reading.”
"There's an allure to diamonds and people get a glint in their eye when they're running diamond mining companies"
Grippingly close shareholder vote flies into panic after blunder
by Bruce Bone
BHP Billiton's founder gives widest ranging interview of his career, tips "Ivan" for industry leadership
Martin Rapaport's perilous route to becoming the diamond industry's most influential body
Young-Davidson royalty clause acts as "poison pill", say sources pursuing AuRico