Diamonds in Africa
I've recommended Diamond Fields Resources several times since April 1993, basically on a "trust me" basis because, even though I liked the story, I'd not yet conducted a complete investigation on the company. It's only been in the last month that I've had the chance to ride that cigar tube in the sky for 17 hours from New York to Johannesburg, and then on to Kimberley, Capetown, Luderitz, and Windhoek to actually kick the rocks.
I was genuinely impressed.
Diamond Pipes in Kimberley I've never been a fan of diamonds as an investment; longtime subscribers will remember a couple of lengthy warnings at the top of the mania in 1980. I'm still not partial towards them; their high prices have always seemed a contrivance of promotion and controlled supply, and grading (which is everything to price) is as arbitrary as that for rare coins. In 30 years or so, nanotechnology will, among an infinity of other things-see Chapter 35 of my most recent book for a complete discussion-enable the production of perfect diamonds of almost limitless size and shape, molecule by molecule, sans heat and pressure. A flawless 100-carat stone should be worth about what a large marble is today. I'm not kidding.
But that's then, and this is now. As with any mining operation, whether gold, iron, diamonds, or whatever, the object is to process a pile of rock for X dollars, and sell the product for some multiple of X. My personal lack of affinity for diamonds is irrelevant, because the market likes them. And my opinion on their long-term future is academic, at least for the moment.
Diamond stocks have been all the rage in mining circles for the last few years, because of the Diamet and DHK discoveries in Canada's Northwest Territories. I've got to admit that, unlike my friend Bob Bishop, that one sneaked by me completely. Diamet's 10.5 million shares, selling for C$60 each, have a market cap of about US$450 million, based on only a 29% interest in what appears to be an economic pipe. The DHK group together have a market cap of US$l 10 million and that's for only 35% of another, less developed, pipe. These caps aren't the result of rigged markets, or a mania; they're at those levels because some of the largest mining companies in the world, especially RTZ thru its Kennecot subsidiary, are negotiating to buy them out. An economic diamond mine can be a bonanza.
The Genesis of Diamonds The question arises: Whoever heard of diamonds in the northern reaches of Canada? Of course that was what people said about South Africa a hundred years ago, because they were used to diamonds coming from India. Just as recent, and strange, is the concept of mining diamonds from the sea. To understand where diamonds are likely to be found, it's important to have a grip on how they are created. As anyone who's ever watched Superman squeeze a lump of coal into a diamond knows, the gem is simply the crystalline form of carbon, formed under high temperature and pressure. In the real world, this occurs far below the earth's surface; they rise to the surface through volcanoes. The key to finding diamonds, therefore, is to find the throats of ancient volcanoes. It's not an easy task, since they are generally only a few hundred meters square and are often covered by great depths of overburden. The entire process has, after all, been going on for roughly four billion years.
These ancient volcanoes, cones long since eroded away, resemble pipes coming from deep below the surface, and are composed of a grainy rock termed kimberlite, after the region - Kimberley, South Africa-where it was first discovered in 1869. It's not easy to find a kimberlite pipe in the first place, and it's estimated that only 5% of kimberlite pipes are diamondiferous. And, of those, only one out of every 10 is economic.
In and around Kimberley there are dozens of economic pipes; something happened there in Pre-Cambrian times, about two billion years ago, that made the area prolific for diamonds. The DeBeers organization controls almost all of these pipes; some, including the "Big Hole," the largest hand-dug hole in the world, and the location of the initial South African discovery, are mined out. It's estimated, interestingly, the pipes in Kimberleys have lost over 90% of their mass to erosion over the last 100 million years; all their production is from the remaining 10%.
The Dal Loxton and Frank Smith Mines I hope you find the geological/geographical background of value, but right now you're probably asking yourself how this is going to fatten your brokerage account. Elsewhere I describe the huge size and low value of South Africa's gold mines; it's the same story with the diamond mines. Diamond Fields Resources (DFR.V, C$8) was able to buy two non-DeBeers mines cheaply for reasons I'll cover below.
Jean Boulle, the company's founder and CEO, has spent most of his career with DeBeers, and is an old Africa hand; he recognized that it's hard to become truly wealthy working for a large corporation, and he jumped at the chance of using his knowledge and connections entrepreneurially. The first thing he did was buy out the owners of the Dal Loxton and Frank Smith mines.
I visited both, and they're big operations. But the equipment is old, and management is best described as "family style." It was clear that they weren't interested in reinvesting for the future, with the political situation as it is, and would rather get a discounted price in public stock and cash than continue moving dirt, no matter how many carats might be buried in it. DFR now owns 100% of both mines.
The Loxton is currently processing about 50,000 tonnes of ore per year, and recovering about 17,000 carats of mostly industrial stones selling for US$95 each; the mine is netting about $800,000 per year, pretax. Diamond Fields plans to spend US$1.2 million this year, $1.5 million next year, and $400,000 in 1996 to bring production up to 75,000 carats from a throughput of 168,000 tonnes. At constant diamond prices, by the end of 1996, the mine will be throwing off US$5 million annually.
The Frank Smith is treating 140,000 tonnes per year to recover 8,000 carats of mostly gem-quality stones, at about US$220 each; the mine is netting about US$325,000 per year, pretax. Here DFR will spend US$1.9 million this year, US$1.8 million next year, and US$450,000 in 1996 to bring production up to 35,000 carats from a throughput of 540,000 tonnes per year. At constant gem diamond prices, the free cash flow will equal US$3.3 million.
Selling out was an intelligent decision for the present owners for at least two reasons. One, they were unable, because of the constrained nature of the South African financial system, to generate the capital (especially after 40% income taxes) to expand the mines to maximum potential. Two, they recognize that the new government may be unpredictable--especially towards Afrikaners who are in the mining business.
On the other hand, the new government will do everything possible to encourage investment by foreigners, especially Canadians, who tend to be viewed as especially benign. It was a super score for both parties, but especially for DFR. It gives them 10-20 years of cash flow from each mine, equaling about US$0.40 per share pretax.
These mines are thoroughly known and proven commodities; as far as I'm concerned, their cash flow establishes something of a floor under the stock price at around current levels. But the real gem, so to speak, is next door in Namibia.
Namibian Diamonds The Orange River, which currently forms the border between South Africa and Namibia, provides the main drainage to the west for southern Africa, and has done so (in one form or another) for upwards of 100 million years. Over tens of millions of years, its course has migrated north and south, basically over the length of Namibia, spewing sediment from the continent's interior, much in the manner of a gigantic firehose moving to geologic time. With a specific gravity of 3.5, diamonds are relatively heavy stones (they're recovered from host rock thru gravity separation, much like placer gold), and a lot have been recovered from the bed of the Orange. But it was only in 1908, when a railroad worker found a diamond on the beach, that people started to really figure out what was happening. Namely, over tens of millions of years the Orange had been depositing stones in the -ocean. There was a huge diamond rush, and early mining consisted of men crawling in lines on the beach at night, where the stones glinted noticeably in the moonlight.
That may sound romantic, but the outfits running this coast have treated it with deadly earnest since Day One. The Diamond Coast is also called the Speergebiet, which translates as the Forbidden Zone. Ever since the discovery of diamonds, very bad things have happened to anybody who showed up there without strict supervision. All employees were X-rayed (this over 70 years ago), for instance, before being allowed to leave the area. Security is still brutally strict, but in a symbolic show of how things are changing, the group of fund managers, financiers, and investment advisors I was with took down signs in several languages threatening bodily harm to trespassers.
Sea Diamonds By the 1930s, all the easy stones had been found, and DeBeers had acquired the rights to most of the current shoreline and started digging it up on a massive scale. The wind, which blows at gale force from the direction of the Antarctic most of the time, concentrates stones in certain roughly predictable pockets. At the moment, about 100 miles of coastline is the site of one of the most massive earth-moving operations on the planet, since relatively few diamonds conveniently rest on the surface; most are under meters of overburden that has to be shoved around to reach gravels, or even bedrock, where the gems have migrated
Just as the Orange River has shifted its course through a wide range over time, the shoreline has varied from 300 meters above to 500 meters below present levels. The vast majority of the remaining recoverable diamonds are, therefore, under water.
Sea diamonds fall into three zones, depending on how they're mined: near shore (to 10 meters), mid-depth (10-30 meters), and deep (over 30 meters).
The near shore stones are retrieved by divers using compressor-driven airlift machinery from shore. As a longtime diver myself, who's done some treasure-hunting using similar equipment, I've got a pretty good idea of what's involved.
Basically, the divers learn what kind of pockets and crevasses are likely to host the gems, and vacuum up the loose material. The vacuum pipes it to shore, where paydirt is separated from obvious waste rock by a small trommel. The paydirt is transported to town for final separation- where the diamonds are literally picked out, one by one. You'll notice lots of garnet, a semiprecious stone, in this coarse material; it's an indicator mineral that almost always occurs with diamonds, and is a tip-off to redouble your efforts.
The DFR sea claims, which run 110 km along the coast and six kin out to sea, can support scores of independent teams like this for many years, and that's the way they will (and are, because they're doing it now) mine the near shore.
There are two reasons for this. First, the standard deal is for the concession holder and the dive team to split the take 50-50, with the divers paying their own expenses. Second, DFR is already very well connected politically in Namibia, and plans on staying well liked. So what they're doing is training and financing unemployed locals, who eventually buy their equipment from the company with earnings. It's a great deal for both sides.
The mid-depth deposits are accessed from barges, again using divers, but this will be a company-owned operation.
The deep deposits take specialized ships, using remote controlled robots and sophisticated positioning and stabilization technologies, mostly developed for ocean oil drilling. DeBeers currently has six vessels working its claims. DFR is in the last stages of getting its 150-foot fully equipped boat ready. They scooped it up for about 10% of its replacement value at a bankruptcy sale in Australia and drove it to the seaport of Luderitz.
Over 95% of diamonds that have made it to the sea are gem-quality, simply because those with fractures, or of irregular shape, are destroyed in the transportation process. Nonetheless, it's conservatively estimated that between 1.5 and 3 billion carats are sitting on the coast and offshore; about 100 million have been recovered in the 90 years since discovery. A conservative estimate (and, having read the full geologist's report, I believe it's very conservative) is that the DFR concession has at least 81 million carats.
What Does This Mean? DFR has 24.8 million fully diluted shares outstanding, US$13 million in cash, and the ability, to raise a lot more. It has two proven mines in South Africa with positive and rapidly growing cash flow. And it has an extraordinary sea diamond concession that will throw off many millions a year in earnings. How many is pure conjecture at this early stage. Most important, the management, from the CEO to the mine managers to the geologists, is really impressive.
I've been on a lot of mining field trips, but I've never been as impressed with what I saw as I was on this one, despite the fact I have no particular feeling for diamonds.
There are several other public companies that are getting involved in the area, including Namco (NMR.V, C$3.50) and Canadian Overseas (CVC.V, C$0.35) as well as a few juniors in South Africa which have offshore concessions. A company called Leicester (LCD.V, C$1.15) has 60% of a mine in Kimberley. I think they're all in the right place, but I haven't examined them.
I'm reliably assured that the billion-dollar market caps accorded to the diamond discoveries in northern Canada are warranted. But offshore diamonds in Namibia are accessible with a capital cost of $20 million, not the $500 million the Canadian deposits will likely require. They're 95% gems, not mostly small industrial stones. And it won't take until the turn of the century to produce them; it's happening now. This story is one which is unrecognized, but will gain attention in time.
I own a big position in DFR, as has been the case since I first mentioned it last April. The most recent tranche of funds was raised at C$5 and C$5.50, mostly among institutions. Especially in a resource bull market, of upside potential. I have zero doubt there will be other big acquisitions like those above.
Diamond Fields is a stock you should own; it's likely to go a lot higher and appears to have limited risk in the C$7 area. Bob Bishop has said that DFR may be as cheap now as Golden Star was at C$7 or Venezuelan Goldfields at C$2. I think he's right. Information on Diamond Fields Resources may be obtained from Barrington Communications Group, 11th Floor, 900 W. Hastings, Vancouver, B.C. V6C 1E6, (800) 663-0321.
Use brokers Ben Johnson, (800) 5474898, (503) 224-1234 or Rick Rule, (800) 477-7853,(619) 943-3939.