There were a lot of
long faces at the PDAC this year. Many of the companies there were pulled off
the waiting list when long standing attendee companies decided there was no
point having a booth. Others have expressed surprise that few companies
seemed to be trying to market financings. This was taken as complacency but
it felt more like resignation to me. For the record, resignation is better if
you're a contrarian.
The editorial this
month deals with the sea change that seems to have taken place among major
companies. They are looking for a different type of project and that creates
difficulties for Juniors that focused on things majors are not buying right
now. It's a long topic and I will cover the remainder of it in the next
issue.
It was a very quiet
month as you'll see from the update section. A lot of companies aren't active
enough to even come up with the traditional "PDAC Look at Me" news
release. That reinforced the point I've made before that it will be a slow
turnaround and there will be only a small number of companies participating
in the early stages of a rally. I'm pleased at how gold has held up against a
very strong $US. The type of strong economic stats I feared would knock gold
down farther hasn't done that. I hope that means this bottom doesn't drag on
too much longer.
This year's trip to the
Prospectors and Developers of Canada convention in Toronto was less
enlightening than usual but was a good gauge of sentiment.
Just about everyone goes
to PDAC and it's a good chance to talk to mining executives, explorers and
analysts from across the globe. The conference is also famous for its
hospitality suites. Good places to collect intelligence from a large number
of people who actually buy resource stocks (sometimes), not to mention
hangovers.
Not surprisingly, almost
everyone was downbeat. Estimates of when the market would turn around ranged
from "at least a year" to "never". A lot of comparisons
were made to the post-Bre-X meltdown. That bear
market lasted for 5-6 years.
David and I lived through
it and it wasn't pretty. The sector was decimated at both the financial level
and at the personnel level. Many suppliers disappeared and even more geologists
went off to teach high school science, most never to return.
I understand the
pessimism after two years of down markets but I have trouble drawing a
parallel between now and 1997. After the Asian currency crisis and Bre-X-- the former was at least as large a problem as the
latter--commodity prices declined across the board for several years.
Precious and base metals couldn't catch a bid for four years and it took a
couple more before anyone but the diehards noticed a bottom was in.
This time around there is
concern about commodity prices but we are dealing with completely different
levels of "concern". If high demand regions (China, the US) don't
have good years there will be metals that move into or remain in oversupply.
That isn't news and no one expects a commodity apocalypse.
Precious metals and most
base metals are up anywhere from 300% to 600% in the past 10 years. Even
commodity bears are not expecting pullbacks larger than 10-20% from current
levels; the jury is still out on whether even that comes to pass. There is a
big difference between that scenario and the late 1990's.
Back then there were
widespread mine closures and almost all mines were left operating on razor
thin profits or limping along generating losses, eating up equity and praying
for a turn in prices. Most producers had mountains of debt back then. Now
most have fairly clean balance sheets and large cash balances.
Recently, a lot of top of
the mountain, high capex projects have been called
off. Not good news but hardly the same as mines going under left, right and
center. It doesn't represent the same level of industry decimation, but it
does beg the question of where the sector goes from here.
In the past few years the
level of project cost inflation has been incredible. Some of that is energy costs. Hard rock operations require a lot of
energy .In many parts of the world that means generator sets, usually diesel
fired, rather than just plugging into a grid. Oil has been a big winner this
commodity cycle and higher fuel costs go right to the bottom line in a mining
operation.
That is only one aspect
of costs though. The truth is that virtually every cost associated with mine
development from steel to concrete to heavy equipment to engineers and
designers have gone through the roof. Some of that is super cycle impact on
other commodities but some is the cost escalation that comes when any sector
has a good run. Everyone associated wants their piece of the action. Everyone
raises their prices or level of professional fees.
I think the fun's over
for now for these suppliers. Senior miners' shareholders are demanding more
accountability and cost control. I was raised in the mining business. I know
how hard things were for a long time so I'm the last person to begrudge
people in the sector getting a good payday. That said,
shareholders have put the mining sector on notice that they only inflation
they want to hear about is inflation of the bottom line.
I think you will see
suppliers up and down the supply chain getting squeezed hard for the next
couple of years. What large company executives can't enforce the markets will
take care of. Margin compression that has been the bane of the mining sector
is now being passed onto the suppliers of the mining sector and that's not a
bad thing.
Cost over runs affect
operating costs just as they do capital costs. A big factor in operating cost
increases is decline in grade. Most precious and base metal operations have
seen the average grade of producing deposits decline for decades. More rock
has to be moved to produce the same amount of metal. In large part that is a
reflection of the fact big high grade deposits are getting harder to find.
That statistic is an argument for higher commodity prices, not lower ones.
While I think difficulty
in finding new ore is the main culprit for the drop in grade it's not the
only one. I think there has been some "selection bias" in the past
decade especially.
Mining companies faced
unprecedented increases in demand in the past decade. Commodity prices were
rising fast and the market was signaling it was able to absorb larger
quantities of new ore than miners dared dream a few years earlier.
Miners had to generate
very large increases in production growth. Since mines, be they large or
small, need similar levels of executive staffing miners saw efficiency gains
in opening a smaller number of large operations. Size mattered.
Large producers wanted
deposits that offered the biggest annual metals production and maximum
scalability. That meant large, bulk tonnage open pit deposits. Gold miners
found themselves drawn to large lower grade deposits where production rates
in the 100,000 tonne per day plus were achievable.
Copper miners focused on
similar deposits because they were favoring sulphides--large
milling operations that allowed for scalability and overall output scale that
would be difficult to achieve with an oxide heap leach deposit--assuming you
could find a copper oxide deposit that large.
For the junior mining
space the preferred end game is take over by a
major. Seeing the preferences of the large companies juniors dutifully went
out and acquired large low grade bulk tonnage targets. Quite a few of them
had some success drilling off large low margin deposits. They were all the
rage for a few years and some did indeed get taken out at high prices.
Many more deposits were
found than were bought. Quite a few of these are simply not that good for
logistical reasons, poor metallurgy, uncertain politics or some combination
of all three. They were available because they were uneconomic at circa 2001
metal prices but many of them are marginal even at todays.
When gold and silver were
less favored many juniors chased rare earths, or graphite or lithium. Nothing
wrong with any of this except that some of these market sectors are not
large, at least right now. In the case of most specialty or industrial metals
only a handful of new deposits are required short and medium term. Best in
class projects can make a go of it but the rest may not find buyers.
Things started shifting
in the past 18 months. Metal prices plateaued and the combination of capital
cost inflation, permitting and development holdups and increased operating
costs shelved scores of projects and made those that did get built less
profitable than expected.
Major mining companies
didn't deliver promised profit growth and shareholders have been revolting in
the boardroom and voting with their feet. Many CEOs have been fired and their
replacements and peers are terrified of repeating mistakes that cost others their
jobs.
I've had discussions with
senior execs at several major companies recently that reinforce the comments
above. These companies have shifted from looking for scale to looking for
margin. That is a sensible move--it's what they always should have been
looking for. It does create a large problem for the Juniors though.
All these small companies
worked diligently for years to find resources they thought would be salable.
They are now being told they are not. Where is the endgame for these deals
now? I can envision several endgame scenarios, which will only work for some
of these companies.
The first scenario is
companies with resources getting so cheap they become irresistible. I'm not
sure what defines "irresistible" in this new paradigm but I'm afraid
it may be cheaper than shareholders want to consider.
At some point, majors and
mid-size producers will buy up a bunch of these deposits. If they are merely
putting them in inventory don't expect miracles when it comes to pricing. I
don't think "buyout as endgame" has gone away for these companies
but, for the time being, deals will be done at prices that are not accretive
to either shareholder value or happiness.
Where does that leave
these companies? They could go it alone, but only in theory in most cases.
Many companies have generated a PEA (Preliminary Economic Assessment) for
projects in the hopes this would smoke out a buyer. I did a quick search for
the past six months and found well over 100 PEA announcements. In most cases
these have capital cost estimates in the hundreds of millions if not billions
of dollars.
Once PEA numbers are
released the die is cast as far as shareholders are concerned. They wait for
a major to show up and offer to buy them out. If it doesn't arrive quickly
the company's value starts to deteriorate.
Post-PEA news flow is
often the boring technical variety, and full Bankable Feasibility Studies
cost millions. Right now, the market is littered with companies that have
$20-30 million market values sitting on resources that will require a billion
plus to put in production. You can't make those numbers work. If you're not
offered a buyout you need a Plan B.
One alternative is to
focus on higher grade sections of the deposit (if they exist) that might be
amenable to a smaller, tighter production plan. If there is leachable gold,
or high grade near surface that can be pitted or ramped down to the company
could come back with a small production scenario that has a sub $100 million
cost. It won't be massive but it might be doable and may, on a per unit
basis, be much more profitable.
If the cash cost was low
enough it could be of immediate interest to a producer. It might even be
something the junior could tackle on its own. I'm expecting to see a lot of
rejigged studies and some will even make sense.
If management has the
skills to get the project through development this could breathe new life
into the company. The skills required to get a mine into production are a lot
different from the skills needed to find one. SilverCrest
Mines (SVL-V), a long time HRA favorite is a great example of a company
that has management with both skill sets. Not many do.
Another scenario involves
picking up new ground to try and restart the discovery process. This will
provide the company with news flow and, hopefully, some excitement to draw in
new shareholders and cheer up present ones. This scenario may not please
institutional shareholders but I don't think there are institutional
shareholders in the space right now. There is no point trying to please shareholders
that have already sold.
Perhaps the best recent
example of this game plan is Exeter Resources (XRC-T) optioning two projects
from HRA list company San Marco (SMN-V; see update). Some XRC
shareholders may have wondered why a company with several million ounces in
resources would option early stage projects. I didn't. I thought it made
total sense.
Returning to exploration
gives a company news flow and a shot at new discoveries that they may be able
to develop in house. There are some particular attributes I think would work
best in this new paradigm. I'll go into that next issue.
From The March 2013 HRA Journal
Eric Coffin recently
presented at the Toronto Subscriber Investment Summit on March 2, 2013. To
watch this exclusive subscriber only video of Eric's presentation titled
"Is This It...Or?" please click here now.