Book Of The Week

A mine is a hole with a crook on top
ON JOINING the venture capital business 20 years ago, my first boss advised me that each day two people enter the business world. One has a plausible idea for making a lot of money, an idea which is subtly but fatally flawed. The other has invented a new way to defraud you. "Your job is to avoid dealing with both," he said. With this resonating in my mind I plunged into Jennifer Wells' book with interest.

What I discovered was a ripping tale of the mining industry. The story is quite simple. In the early Nineties a tiny Canadian shell company called Bre-X started prospecting for gold deep in the heart of the Indonesian jungle at a place called Busang. Following a series of press releases which made ever-more optimistic, but clearly false, claims about the nature of the prospect, Bre-X claimed to have discovered the largest deposit of gold in the world. Support for this story was provided by several mining analysts at well-regarded investment banks.

Little more than a year later, Freeport McMoran, who had negotiated the right to buy into this "reserve" completed its review of Bre-X's drilling programme only to discover that the prospect was barren. It became clear that for the previous four years a small group of Bre-X employees had been "salting" the core samples, adding traces of gold to otherwise worthless rock before it went to be tested. Needless to say the share price of Bre- X crashed, many investors lost money and several reputations were tarnished.

What did I learn from this? More than I thought. First, it sheds some light on the world of mining. The behaviour of some of the world's largest mining houses, if Wells' account is in fact true, could never be described as proper.

The processes adopted by this junior mining company and, on face value, accepted by analysts and some of the larger industry players leave a lot to be desired. Obvious gaps in due diligence and the failure to sense warning signs are a constant feature.

We are also provided with a primer into how to do business in Indonesia. The name of the game here was to plug into the right areas, with the assistance of a local business magnate blind-siding government officials.

Turning back to the stock market and Toronto, the promoter David Walsh successfully pushed the stock through the stratosphere, avoiding all the filters that for normal companies prevent abuse of the market. In this case, a heady combination of untold riches (the "proven reserves") which were used to stimulate demand and a short supply of stock (cash needs were modest relative to market capitalisation) led to a gold fever.

Myth became reality, the final episode of this "Emperor's Clothes" tale of the capital markets is that Bre-X entered the Toronto Index and accordingly its shares were bought by "no-risk" tracker funds.

I found it sad that the personalities behind this scam were people who, in the main, had achieved little. In short, mediocre managers with scrappy track records succeeded in duping the industry and the markets.

One question that remains unanswered is who was in on this fraud. De Guzman, the ambitious Filipino who perpetuated the salting seam, was either killed or committed suicide. The promoter, David Walsh, died from a coronary shortly after the crash. Nobody knows whether Walsh and his colleagues in Canada had knowledge of de Guzman's activities. Only Felderhoff, the self-styled Indiana Jones of mining, survives.

This is a very intriguing yarn, which brought together both of the people my boss warned me not to deal with. Bre-X suggests that the definition of a mine is a hole in the ground with a crook on top.