Prophecy Resources

Prophecy Resources

TSX-V:PCY

Shares Outstanding: 126 Million
Fully Diluted: 158 Million
Share Price as of 10/14/2010: C$0.66
Cash: C$4 Million

Introduction

Prophecy Resources is not the type of company that would normally be covered in this newsletter,
yet we thought it deserves a special consideration, worthy of your attention. It is a very resource
rich company and in the present environment when all kinds of hard assets are going up in price,
PCY is well positioned to capitalize on the trend. Let us get out of the way the fact that they have
little to no silver to speak of, especially compared to their other holdings. But what do they have?
Quite a list actually: (thermal) coal, platinum, nickel, copper, vanadium-iron-titanium and other
precious metals spread between Mongolia (coal) and Canada (everything else).

Earlier this year we visited the company’s latest addition to its portfolio of projects, which at the
time was in the process of being acquired, the Wellgreen Platinum-Nickel project (the purchase has
since been completed). At the time the shares of the company were trading at lower prices,
perhaps due to summer doldrums, but we decided to wait until a key permit was obtained for
Prophecy’s Ulaan Ovoo coal project in Mongolia. Why? Because that is the immediate focus of the
company is and we’re happy to report that this permit has been secured and the company has now
formally became a coal producer in Mongolia. For now we will focus on the coal and platinum
assets due to their size, stage of development and importance to the company.

Projects

Prophecy just announced the commencement of coal production from the Ulaan Ovoo project. In
our opinion, at this stage this is a key project for the company in that it will enable the company to
carry out its longer term plans with respect to the remaining projects in the portfolio that are much
larger and will require substantial resources to advance. Ulaan Ovoo has some 200+ Million tons of
coal in M & I category which provides for a 20 year mine life at a very ambitious 10 Mt/year mining
rate, comfortable 2:1 strip ratio and robust economics at today’s coal prices. Prophecy is planning
to start production at 5 Mt per annum in 2011, ramping up to 10 Mt per annum by 2014 and
maintain that level of output from that point onward. (We expect coal prices to increase
dramatically along with the oil price in the next 5 years.) For the visually inclined there are a
couple of videos from this mine site filmed this year on youtube.

Margin ($/t): $7.5 $12.5 $22.5 $27.5 $34.5

Margin assumption is based on a top line selling price of $35/t at Mongolia-Russia border tradinghub Naushki and $85/t FOB in Vladivostok, Russia.

As you can see from the graph above (provided by the company) this project itself can spin off
very healthy cashflow and make a big difference on the company’s balance sheet. PCY is using an
Australian contract miner (Leigton) to do the mining and these numbers leave plenty of room for
improvement as the company gets a better handle on the operations. Prophecy has plans to
further improve return on investment by supplying coal to power plants for electricity generation.
At the present time, Leighton and Prophecy have deployed 50+ people staff at Ulaan Ovoo with a
full line of mining equipment to start production at the rate of 120,000 tonnes a month. Over 2
million tonnes of waste has already been removed to expose the project’s massive coal seam at
surface. PCY is looking to become the second Canadian company after SouthGobi Resources to
receive a mining permit in Mongolia. Based on positive meeting with the Mongolian Ministry of
Mineral Resources and Energy, Prophecy has shipped 10,000 tonnes of coal as a trial run to power
stations in Darkhan and Erdenet, Mongolia’s largest cities behind the capital Ulaanbaatar.

If you like this project you will love PCY’s main coal project Chandgana. This is a monster of a
project boasting 1.2 Billion tons of thermal coal in M & I category. Chandgana is already in
permitting stage and slated for mine construction in 2012. Talk about “value-in-the-ground”; for
instance, Prophecy is projecting initial conservative profit of about $5/ton for coal produced from
Ulaan Ovoo. If we use that as basis for Chandgana (1.2B x $5) we’re talking off –the-chart
numbers for a company like Prophecy which as of this writing has a market cap of $67 MM. So you
have to like the prospects of PCY going forward. Granted, there is a lot of work to be done before
this potential is realized, but the company has been able to overcome all hurdles to date and we
have no reason to question their ability to execute in the future. At this time Prophecy is in the
process of applying for land and water use licences as well as doing the prep work for
Environmental Impact Assessment and Feasibility Study at Chandgana.

Further to that point, the company is actively developing plans for construction of a dedicated 600
Megawatt power plant near Chandgana to start and eventually build a series of such modules to
reach total capacity of 4200 MW. It is a very ambitious project involving hundreds of millions of
dollars in capital expenditure, but given the size of the deposit at Chandgana, there is enough coal
to fuel such a power plant for many decades to come. To be clear, we’re not saying that Prophecy
itself would be building a power plant, but rather attract interested parties and facilitate the
project. If successful in getting this project off the ground, Prophecy should have no problems
financing mine construction at Chandgana. We feel that, unless the market decides to reward PCY
shareholders generously, in due course, other parties will emerge, able and willing to pay up for
these assets.

Electricity consumption in Mongolia is rising, there will be further growth in demand from projects
being developed if which Ivanhoe’s Oyu Tolgoi is the best known one. Mongolia itself is
sandwiched between two huge markets – China and Russia – and is within shipping distance, if
need be, to other large markets such as India, Korea and Japan. Therefore prospects for lucrative
electricity and/or coal supply deals are very good. Given our expectations for the oil price and
along with that for the entire energy sector, we can reasonably see the importance (and value) of
projects the size of Chandgana to increase substantially in the coming years. Based on coal assets
alone Prophecy is seriously undervalued, look for the market to rectify this imbalance over time.

Mongolia Energy Grid and proposed lines

But that is not all in terms of upside. Prophecy has a whole host of projects in Canada. The latest
addition to its portfolio came through the acquisition of Northern Platinum, this past September.
The target of this transaction was the Wellgreen platinum-nickel-pgm project that we visited.
This project has been extensively drilled and even had a feasibility study completed back in 1989.
Hudson Yukon Mining (present day successor is Hudbay Minerals) built a mill for this project in the
90ies but never got around to mining it. The mill was subsequently dismantled, but aside from
obvious positives and confirmation that the project has merit is the fact that it has already been
permitted for mining once. The Yukon province of Canada has been consistently among top mining
friendly jurisdictions, and nowadays more than ever. The project is conveniently located only a few
kilometers off the Alaska Highway, so access is not a problem.

More importantly, as one might conclude from previous work, it has seen a lot of drilling over the
years, something on the order of 700 drill holes and all that data including the core is available to
PCY. We had a chance to examine the core from recent as well as historic drilling during our visit.
To date, under previous operators only about 20% of the core was assayed and it was targeting
nickel mineralization. Prophecy is in the process of re-assaying relevant portions of core from
historic drilling to obtain greater detail of information as well as establish the potential presence of
other important metals such as rhodium, ruthenium, rhenium, iridium and osmium that could
increase the rock value.

The project also has a fair amount of underground development work (tunnels) that can be used as
needed for various activities such as drilling or mining when the time comes. From what we were
able to establish, despite extensive previous drilling, it has been sporadic and geared toward
underground mining. However, Prophecy is looking at it as a potential open pit mine. The
mineralization is a classic VMS starting virtually on surface and the deposit currently stands at 50
Million tonnes largely contained within the top 50 meters. Because most drill holes ended in
mineralization, there is excellent potential to extend the deposit at depth.

Blue Sky

According to the technical report by Wardrop Engineering, the mineralization has similar
characteristics to that of Norilsk Nickel’s project in Russia (incidentally, the largest palladium and
one of the top platinum producers in the world). In the same report Wardrop discusses the
potential of the Wellgreen deposit (quote from page 10):

The potential within the Quill Creek Ultramafic intrusion on the Wellgreen property is in
the range of 77 to 254 million tonnes at 0.26 to 0.38 % nickel, 0.26 to 0.36% copper,
0.32 to 0.47 g/t platinum and 0.23 to 0.38 g/t palladium, based on the assumptions of a
specific gravity of 3.22, strike length range of 4000 to 7000 m, depth of 200 to 250 m and a width
of 30 to 35 m. It should be noted that the potential quantity and grade is conceptual in nature, that
there has been insufficient exploration to define a mineral resource and that it is uncertain if
further exploration will result in the target being delineated as a mineral resource.

In “investor-speak” we’re looking at about 150 Mt of 1 gram platinum which can be further
simplified to approximately 5 Million ounces of platinum. As you read above this is a conceptual
target, in other words the proverbial blue sky. However, the most recent drill holes make this
concept ever-more achievable. The company just reported the following results: Prophecy Drills
496.06 meters of 0.596 g/t PGM+Au, 0.27% Ni, 0.18% Cu, 0.02% Co (0.45% NiEq*) from Surface
at Wellgreen, Yukon. Having been on site and knowing that the current 50 Mt resource is situated
within the first 50 meters from surface, wide open at depth, coupled this latest drill holes being

step-out holes to the East, all of a sudden the above target numbers from Wardrop don’t seem
unrealistic. PCY drilled a total of 6 holes in the last campaign and the remaining 4 drill holes are
yet to be released. If they produce comparable intercepts, Wellgreen will be well on its way to rival
other established platinum-nickel VMS deposits in Canada and USA.

A quick look at the list of comparable deposits yields the following:

Company

Deposit
Size (Mt)

Category

Rock
Value
($/t)

Market
Cap ($M)

$Value/Ton
MCap/(Size*RockValue)

Polymet Mining

400

M & I

59

290

$0.012

Duluth Metals

550

I

120

265

$0.024

Maraphon PGM*

91

PP

54

120

$0.004

Wellgreen Project**

50

M & I

104

21

Using $0.004

Wellgreen
Project***

150

M & I

104

192

Using $0.012

* Maraphon PGM has been acquired by Stillwater Mining recently

** Wellgreen projected valuation based on Maraphon’s market valuation at the time it was
acquired

*** Wellgreen projected valuation based on Polymet’s market valuation presently and blue sky
potential of the Wellgreen deposit

Using the lowest possible valuation metric in the table above we arrive at $21 MM in current value
of the Wellgreen project. However, if Wellgreen ever reached say the 150 Mt discussed above, its
value would dramatically increase because the economics of the deposit would improve
commensurately. In short, Wellgreen has the makings of a sizeable platinum deposit and offers
plenty of upside potential to the most conservative investors. We believe Prophecy is currently
getting no value for this project for various reasons, but as it grows in size and importance to the
company, its valuation should change as well. The next set of results from step out holes drilled to
the East of the existing resource should provide an indication as to how fast this deposit can grow.
If they are anything like the results from the two holes that were part of the same program and
released in September (see link above), we believe there will be sufficient reason for optimism with
respect to target numbers discussed in the Wardrop technical report and would be gearing up for
much more drilling at Wellgreen going forward.

Prophecy has a very promising pipeline of projects - each with a timeline for development (see
table below). We suggest that readers review the company’s presentation available on its web site
where they have plenty of other relevant information and provide a lot more detail regarding
specific steps in development of their coal assets. This being an area somewhat outside of our
expertise we encourage you to contact the company directly with any further questions.

Prophecy has a very promising pipeline of projects with a timeline for development

Management

No doubt, most Morgan Report readers know that management is, perhaps, the most important
part of the company. Chances are a great management team with mediocre projects will make
more money for shareholders than a mediocre management team with great projects. In the case
of Prophecy you shouldn’t have trouble making up your mind on either. We discussed the projects
in some detail in this report and we will let you do the work on the management. The names
speak for themselves:

- Arnold Armstrong, Co-Chairman of the Board. We found that the folks at Casey
Research did a fine job when they inducted Arnold into their Explorer’s League;

- John Lee, Co-Chairman and CEO. We have known John for a number of years as fellow
aficionado in the resource sector. This is John’s first endeavor in building a viable company,
especially on the scale Prophecy is aiming at and to date we have been most impressed with
his entrepreneurial abilities and commitment;

- Rob McEwen, Advisor to the Board of Directors. We doubt there is a need to add
anything to that name;

- Harald Batista, Advisor to the Board of Directors. This is a quote from PCY web site:

“Mr. Batista is an accomplished entrepreneur with over 2 decades of sales and marketing
experience. He holds an MBA degree from Santa Clara University in California and is a
member of the prominent Batista family in Brazil that includes Eliezer Batista, the founder
of Vale do Rio Doce Company (now Vale Inco) and Eike Batista, the founder of EBX
Group.”

In the interest of space we will stop there, you get the picture. In a nutshell, that is our take on
this very interesting venture with enormous potential, competent management and accomplished
Board. At current valuation we find it a proposition hard to resist.

October 25, 2010

Sean Rakhimov
Editor, http://SilverStrategies.com
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Disclaimer: David H. Smith, and David Morgan do currently own shares of Prophecy Resources.
This company has been written up very recently by two other newsletters although we began our
work for this issue well before them. Regardless we view the fact the others are interested as a
positive factor.

Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. It is not
intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions
expressed herein are those of the author and are subject to change without notice. The information herein may become
outdated and there is no obligation to update any such information. The author, entities in which he has an interest, family and
associates may from time to time have positions in the securities or commodities discussed. No part of this publication can be
reproduced without the written consent of the author. © Copyright 2010 by Sean Rakhimov.