Lawrence was a guest on the Korelin Economics Report with Al Korelin. The topic of their interview is the current outlook for junior and mid-tier resource companies.
I am very pleased to welcome Tommy Humphreys to the Resource Opportunities team.
Tommy is a bright, energetic young man with exceptional contacts in the mining industry. He earned a great deal of respect for building the website www.CEO.ca, which has become an important information source, especially with regard to people and insights in the mining industry (See Lukas Lundin, Dave Lowell and other examples of Tommy’s unprecedented interviews).
One of the most important elements in the success of Resource Opportunities over the years has been in building close relationships with influential people, and in identifying the rising stars. We learned early that the people running the company and advancing the projects are the most important element in the success of any company.
Tommy has the respect of the old guard in our industry, and is equally tied in with the new generation of younger mining executives, geologists, engineers, investment bankers and analysts.
He is committed to identifying the up-coming talent: to being the first to identify the people who the other media will report on in two or three years’ time, after they have achieved success. Tommy will also continue to gain knowledge and insights from the people who are now the most influential players in this market. His relationships (current and future) will greatly enhance our analytical abilities and help us to be the first to identify the exciting new deals that can make money for subscribers.
I am looking forward to working with Tommy on upcoming issues, and the renewed energy he brings this newsletter.
We plan to further strengthen the team in the near term, with the next target being an experienced mining engineer.
Please join me in welcoming Tommy Humphreys to the Resource Opportunities team.
At the 2014 Vancouver Resource Investment Conference, Lawrence joined Even Keel Media to discuss the ongoing bifurcation taking place in junior resource markets.
Many companies in the resource sector try to sell themselves to investors as proxies for the underlying commodity. Every company in the industry that has any sort of resource works out the market value of the company divided by the ounces or pounds. The implication is that if you can buy silver in the ground for, say, fifty cents an ounce, then an investment in the company will increase at a faster pace than the price of silver.
In arriving at those measures of value per ounce, of course every company uses the approach that makes them look best against a carefully selected peer group. Some use market value per ounce. Others use enterprise value per ounce. For the number of ounces, they can use proven and probable reserves, reserves plus resources, measured and indicated resources or total resources.
And, in determining the number of ounces, some companies stick with the number of ounces of silver. Most companies with byproduct gold will convert the gold to silver equivalent. A few companies will convert the base metal credits to silver equivalent ounces. I don’t like incorporating base metals into a silver equivalent, because most investors are looking at these companies as a play on precious metals.
It is vitally important that investors recognize that every ounce of silver in the ground is different from every other ounce of silver in the ground. Comparisons against peers are useful only as rough indicators of potential value and should be carefully evaluated.
Let’s look at an example of the share price of a silver company over time compared to the price of silver. Please note that this is not a rigorous analysis. It is intended as a first pass to arrive at some broad observations.
For many years, Silver Standard was a go-to silver equity for investors wanting exposure to the silver market. As expected, the Silver Standard share price rose much faster than the silver price from 2003 to 2007. In that time, the silver price rose three-fold while the Silver Standard share price rose by nine-fold. That is, Silver Standard rose 3 times faster than the silver price.
But, look what happened in 2008. Continue reading Bullion vs. Silver in the Ground: Assessing the Risks and Rewards
After a really dismal year for the resource industry, there are finally signs that the market is at the bottom.
Before looking at where the markets are headed from here, let’s have a quick look at a couple of indicators of the junior resource market to show just how bad the destruction has been.
The Toronto Stock Exchange Venture Index is not a perfect measure, with junior resources roughly two thirds of the index, but is probably the best indicator available of the overall junior resource market. The VIXJ declined 66% from its high in early 2011 to the low point in late June.
News that the US Federal Reserve may begin cutting back on Quantitative Easing panicked investors around the world. The mere suggestion that the easy money might be cut back if the economy continues to improve exemplifies how dependent investors have become on what is effectively a government handout.
The sharp drop in the gold price resulting from the Fed comments had a hugely negative impact on resource stocks generally. There may be further downside for many companies as investors globally have taken a decidedly bearish stance on everything related to resources.
At some time, that sentiment will begin to reverse, as prices have fallen to irrationally low levels for many companies. In the meantime, we are looking for companies that are generating news of suitable magnitude that it might impact share values.
Following are some excerpts from a talk that I was invited to present at a conference in Australia. These comments summarize my current view of the resource markets.
The Current State of the Resource Markets
Excerpts from a presentation by Lawrence Roulston to the Africa Mining & Investment Conference, Sydney, Australia, June 24-25.
We all know that the market for junior resource companies is in a terrible state. We also know that this industry is cyclical, and no matter how bad it gets, it eventually turns around.
I have experienced a few cycles in the resource industry. In some ways, this is the worst situation that I have ever seen. But, this time is different and it is important to understand those differences to know what to do next.
In 2008, the resource industry was clobbered, along with most investments around the world. That sharp selloff was driven by external forces. Everything went down sharply, but then everything rebounded in tandem. Over the next two years, the TSX Venture index tripled.
If we look back a little further, 1999 through 2001 was considered the “nuclear winter” of the mining industry. At that time, the mining industry was still in the classic era, when high metal prices led to increased production which led to oversupply and declining prices. Several big new mines had just come on stream and demand for metals was sluggish. At that time, nobody dreamed that China and the rest of the developing world would soon begin to take off. Metal prices were down: copper, at $.60 a pound, was at the lowest price ever in real terms; gold hit a low of $252 an ounce. The producing companies were losing money.
Market commentators called mining a “sunset industry”, implying that the world’s need for metals was going to suddenly evaporate.
Mining industry news of late has been dominated by massive write-downs: $6.5 billion for Barrick; Kinross added $3.2 billion to the $2.5 billion written off last year on its West Africa operations; in total, the mining industry wrote off $50 billion last year.
The write-offs follow a shopping spree over the past few years that saw all of the top-tier majors making aggressive acquisition aimed at growing the size of their businesses. Higher operating expenses in the face of softening metal prices slashed operating margins, emphasizing that the companies had grossly overpaid for those acquisitions. Those deals were done by management teams who were committed to growing for the sake of growth.
Barrick has stated that it has no further mine development plans in the works and the other top-tier majors also assured their shareholders that they have shifted their focus from growth to maximizing return on capital.
Investors in the resource industry are inundated with metal price forecasts, and indeed often go out of their way to seek opinions on where metal prices are headed. Investors, the media and pretty much everybody else with even a passing interest in resource investing obsesses over metal price forecasts. Yet, does anybody ever take a moment to consider whether those projections have any value whatsoever?
A couple of years back, I referred in the newsletter to a study by global consultancy Ernst & Young which determined that, over the previous decade, analysts’ forecasts of metal prices had consistently understated future metal prices.
A recent study by the Bloomberg information service further graphically illustrates the extent to which analysts completely miss the mark in forecasting metal prices. On the enclosed chart: The upward trending line represents the actual gold price while the downward sloping lines to the right of the trend line represents three-year forecasts made in each year from 2006 to 2012. The flat line near the top represents futures prices that could be locked in by investors in 2012.
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The last year was a brutal time to be an investor in the junior mining sector – the worst that I’ve seen in more than 30 years in the industry. After that painful experience, now is a good time to be investing in this sector: BUT, invery selective companies.
We are all familiar with many of the reasons for that broad sell-off: Investors shunned risk in the face of extraordinary global financial uncertainty. The gold companies delivered disappointing operating performances, driving many investors away from the gold sector. The lack of upward movement in the commodity prices and the perception of further downside risk in metal prices have all added to the unfavorable investment climate. The net result has been that shares of nearly all junior mining companies have been clobbered, the good along with the bad.
Another Factor That Is Depressing Junior Resource Stocks
There is another factor that many are probably familiar with, but you may not appreciate its magnitude. During 2010 and 2011, there was an extraordinary amount of new capital coming into the junior mining sector. Just looking at the Toronto Stock Exchange Venture board, there was $20 billion of new primary investment in TSXV-listed companies.
Roughly three quarters of the companies on the venture board are mining related, implying about $15 billion worth of new share certificates were created over a two year period, more than at any other time. That was a period of irrational exuberance, with the Venture index coming off the low point in early 2009 to triple by early 2011.
During that time of exuberance, Fund managers seemingly suspended their judgment and due diligence, making private placement investments into an astounding array of companies, many with questionable geological merit.
Unfortunately, much of that new money failed to generate any real value for shareholders. A lot of it was eaten up by management salaries, head office rent and investor relations activities. A portion of it funded drilling programs aimed at making new discoveries. Very few new discoveries resulted from all that geophysics, trenching and drilling.
There was $15 billion of new money added in those two years. Today, the total value of the TSXV-listed mining companies is $11 billion and still falling.
In my opinion, many exploration and development companies are still trading at share prices well above their fundamental value. The ongoing sinking feeling of so many companies declining in price is creating the impression that the whole market is still declining. Indeed, many share prices still have a long way to fall, even if they are now at a level of a few pennies. Over the past few weeks, tax-loss selling has added to the downward pressure on prices.
Share Prices Are Reacting to Various Forces
There are a number of factors that influence the different trajectories of the various companies.
Some people like to speculate on a new discovery. Finding a big new metal deposit can be enormously rewarding for shareholders: We recently saw GoldQuest go from a nickel to $2 in a matter of weeks. Unfortunately, new discoveries are few and far between.
Many people invest in resource companies on the basis of the expectation of rising metal prices. That works as long as the company actually holds some of the metal in question. You won’t get much leverage to a metal price off a company’s best intentions to make a discovery next week.
Another big pit-fall is to get caught up in the various fads that go through the sector. For example, there is enormous merit in the fundamentals of the critical elements story, or graphite, or lithium or whatever the story. It’s just that most of the companies that get caught up in the flavor-of-the-month fads have little to contribute to the fundamental story.
Looking For Companies Which Are Adding Value
Another approach, and the main driving force in all of the companies listed above, is to seek out companies that have a high-quality metal deposit in hand. In this way, you avoid the discovery risk, yet there is still potential for enormous gains. For example, a gold deposit with widely spaced drilling and which is classed as an inferred resource will be valued by investors at just $10 per ounce of gold in the ground. By the time those same ounces advance to production, the value per ounce has increased by 30 or 40 times.
Finding companies with high quality metal deposits which have the potential to advance toward production requires a great deal of hard work. One must sort through a pool of companies that numbers a couple of thousand to identify those few that have quality assets; and then, it is necessary to do extensive due diligence. Many metal deposits that look attractive on the surface may have metallurgical problems or permitting issues or some other fatal flaw.
This approach continues to have validity because the exploration and development companies are vital to the future of the mining industry. Most of the discoveries and re-discoveries are made by the juniors. The juniors supply deposits on which the mining industry builds new mines to replace depleted mines and enables the industry to keep up with the growing demand for metals.
As important as these companies are, they are presently shunned by investors. There are a number of notions, which are not accurate, that are impacting on investor sentiment.
For example, there is a perception that metal prices aren’t moving. But, that perception is because people are so focused on the near term. If we take a longer term perspective, we see the gold price is up 6-fold in the past decade. The silver price is also up six times in that period.
Some people are surprised that the copper price is up by nearly the same 6-fold ratio as gold and silver. There is a perception that the world economy is in a state of suspended animation and therefore base metals are no longer needed.
The reality is that Europe is using slightly less metal this year than last. America is using slightly more. China, by far the largest consumer of metals, is using more than 7% more metal this year than last. Even at a time of slow growth, demand for metals continues to grow.
Another of the important misperceptions comes from basic economic theory, which tells us that when the price of a commodity increases, the supply of that commodity will expand to bring down the price. The expectation that there will be a jump in production has meant that forecasts of metal prices have consistently understated the actual metal prices.
In the case of gold, the price is up 6-fold in a decade while the production level has barely increased. New mine development over the past decade has barely offset depletion of older mines.
Whether for gold, or nearly any the other metals, actual metal supply growth has consistently fallen short of analyst projections. New projects are nearly always delayed, for a host of reasons: problems with permitting, lack of adequate capital and the like.
The net result is that expanding metal production is much more difficult than just assuming a production increase, as the economists tend to do. Geology doesn’t follow basic economic theory: It is getting harder all the time to expand metal production. The big, high grade deposits that were once sticking out of the ground have long since been developed, and are now largely mined out.
New deposits are lower grade, more remote, metallurgically challenging, and often in places where investors don’t want to put their money. The last year when the gold industry found as many ounces as it mined was in 1998.
Mining Companies Are On A Shopping Spree
While investors continue to shun the junior resource companies, the larger companies are actively shopping. Recently two companies – Galway and Inter-Citic –received takeover offers. Both are cash offers, one worth $250 million, the other $300 million.
A really interesting point is that both offers came from companies in emerging markets. Last year, over half of all M&A activity involved companies in emerging markets. That trend is going to continue.
In Europe and North America we moan about the slow pace of economic growth, and therefore avoid resource companies. In the developing world, people look at what is happening around them and wonder how they will find enough resources. I recently participated in resource investment conferences in China and Hong Kong. There is a feeding frenzy for projects ready to go into production. Investors and mining companies are gaining awareness of the earlier stage projects and beginning to actively shop.
Is This The Right Time?
It’s not hard to understand the longer term fundamentals of the resource industry. The important question at this time: Is now the time to invest in junior resource companies?
The answer is: Yes! But, very, very selectively.
As I noted earlier: Probably the majority of companies will continue to decline in value. Tax-loss selling is further depressing share prices, which can provide good entry points for investors, in carefully selected companies
On the other hand, a few companies are already moving up. Some of the companies with good deposits, strong management and access to cash are being accumulated by knowledgeable investors.
One of the important criteria at this time is to identify companies that are potential takeover targets: That means deposits that are large, advanced stage and well located. Identifying these potential targets for subscribers will remain a priority for me.
By the time someone rings a bell to tell us that we are at the bottom of the market, the better quality companies will already have enjoyed big gains.