Throughout 2013 world economic instabilities, lower commodity prices and decreased consumption growth in emerging markets all conspired to see many companies in the metals and mining sector witness their share prices plummet; the great wheel of change could finally start turning, however, heralding the start of a new, inevitable, up-cycle.
For the mining industry, 2013 proved to be a challenging year indeed, particularly for those companies in the junior space seeking to raise capital.
The ‘sins’ of the past in many cases con- tributed to the current negative investor sentiment. The narrative for the current calendar year will, for most, centre on getting their houses in order, before they could take advantage of the inevitable cyclical bull market that ostensibly lies around the corner.
The last year was also characterised by several significant mining projects stalling, and soaring project costs. The year saw several billion-dollar project writedowns and impairment charges, mainly driven by significant decreases in long-term metal price assumptions following the sharp declines in spot gold prices in the period.
Some of the top-of-mind examples include gold major Barrick Gold’s roughly $8.5-billion Pascua-Lama gold mine project, straddling the Argentine/Chilean border, where the Chilean environmental regulator suspended the controversial investment last year, citing “severe environmental harm”, as pre-stripping activities had begun before water protection infrastructure was finished, threatening the local water supply.
Also, fellow Canadian miner Goldcorp’s $3.9-billion El Morro copper and gold mine, also located in Chile, was blocked. An indige- nous community said it was not properly consulted about the project, which it said was located on sacred ancestral land and could pollute a local river.
For many firms operating in the junior sector; however, the clock to the inevitable end is ticking, as they burn through their capital, in many cases only to cover corporate overheads – except of course, those that have managed to find commercially viable deposits.
Considering mining’s cyclical nature, it is understandable that economic volatility around the world was a major contributing driver to last year’s considerable market-based losses, with many an investor’s trust in the metals and mining industries having been shaken, compounding the dearth of traditional financing options available to current project promoters.
The TMX Group, the operator of the TSX and TSX-V, where close to 60% of the world’s mining companies are listed, with more than 1 000 companies operating in over 100 countries, in January released its financing statistics for 2013 for all issuers.
The TMX Group said the total financings for 2013 on the main exchange were down from 723, to 599 – a 17.2% drop. The TMX also revealed that the total financings raised on the TSX totalled $39.9-billion, 21.2% less than the $50.6-billion in 2012.
On the TSX-V, the total financings decreased 14.5% to 1 614, down from 1 888. The TSX-V’s total financings raised $3.78-billion in 2013, down 36.8% from $5.98-billion in 2012, illustrating in striking clarity how difficult it has become to obtain project financing – especially for junior explorers a few steps from the verge of major discoveries.
The road to recovery in 2014 will be bumpy, but, if Canadian equity investors develop an appetite for risk this year, it could benefit the volatile, cyclical stocks.
The Prospectors and Developers Association of Canada (PDAC) executive director Ross Gallinger tells Mining Weekly that money will be a dominant topic during 2014. From access to capital, to capital allocation, margins and profitability – money is on everyone’s minds.
He observes that the junior sector is struggling to raise exploration funds, and operators are pulling back on growth and trying to reduce costs, while simultaneously trying to improve profit margins as a means of attracting further investment.
The critical question, he asks, will be, however: “Have we hit the bottom and when will we see an upturn?”
Gallinger expects many a senior company to be reviewing capital expenditures this year by rationalising operations, and trying to sell their higher-cost operations that could fit well with other companies.
“Stabilising the situation will depend on the commodity prices. While the mining sector is suffering from lack of investment interest, other industries are doing well, so costs are not decreasing,” he notes.
One of the overarching narratives that will define 2014 from a mining perspective, is the ability of mining companies to control costs in an era of lower metals prices and higher costs of doing business.
Christopher Ecclestone, a principal and mining strategist at economic think-tank Hallgarten & Company, in New York, agrees that financing is one of the most critical themes of 2014. He argues that “metals prices are not bad, so why is the sector in the dumps? Purely and simply, the lack of capital allocated”.
He says many juniors could be singled out for being money-wasters, but majors are guilty of bad management, and in particular, cost management.
Ecclestone comments that miners, in general, have “terrible” management, pointing out that even the biggest global miners such as BHP Billiton and Rio Tinto have disappointed on this front in recent times.
“The trouble is that managers from outside don’t get it when they move into mining. Traders will continue to rise as they understand the market end, at least, of the equation,” he says.
Ecclestone notes that costs are the decisive factor. “Look after costs and the bottom line looks after itself. Juniors need to differentiate themselves from those that won’t survive (the lepers). At the moment, all juniors are lepers by default,” he declares.
“Put simply, Walmart would go broke if it was run by people from the mining industry. They have given no pushback on supply. Too many managers wanted Rolls-Royce, when they should have been thinking Fiat.
“So, the financing is not forthcoming because managements have not persuaded the market they can adequately use investors’ cash to generate real returns,” he says.
Sins of the Past
Canadian mining companies need to change the way they do business to weather ongoing market volatility and remain viable into the future, a December Deloitte report has found.
“Mining is a tough business; costs keep rising, grades keep going down and miners are unable to replace quality reserves with quality reserves,” Deloitte’s Americas mining leader, Glenn Ives, tells Mining Weekly.
Deloitte expects mining firms to continue to be confronted with the compounding challenges of cost inflation, falling commodity prices, supply-demand imbalances and decreased productivity levels.
Some gold miners have felt the squeeze of lower prices in 2013’s 24% plunge in prices, and a number, including Canada’s Kinross and Russia’s Polymetal, suspended marginal mines and projects after a theatrical price drop.
But as prices fall, other miners are actually increasing output to maintain revenue and profit levels. In some cases, they are targeting higher-grade ore to keep marginal mines operating and generating cash, at the expense of future production.
The resources industry needs to become profitable again, create a return for shareholders and ensure returns for shareholders before investors will be attracted to mining once more.
“The mining industry is making up for the sins of the past,” Mickey Fulp, author of the Mercenary Geologist website tells Mining Weekly.
“The seniors must become profitable. Over the last decade, the miners have treated the mining industry as a growth industry, and it is not that. It is a value industry. They need to get their balance sheets in order, focus on high-margin deposits, cutting costs, generating cash flow and returning that to shareholders as dividends,” he believes.
Fulp expects seniors to continue to write off the bad assets, bad investments and bad acquisitions in order to improve their cost margins.
When it comes to the juniors, Fulp sketches a gloomy picture, saying most of the juniors have already failed, or will fail during the year.
“[And] they should fail. We don’t need 1 700 juniors on the Toronto or Toronto-Venture exchanges, that’s way too many. They are not failing fast enough.
“This business cannot come out of this until half or more of the juniors fail and we clean house and start over again,” he says.
Fulp argues that the reason for juniors not failing fast enough, is that the stock exchange is throwing them too many lifelines, claiming that the stock exchange wants the listing fees.
In addition, he stresses that there are too many junior companies with too few legitimate projects.
“The good projects will continue to be advanced. Business is not dead, good companies will continue, but what it will affect is the rate at which new grass roots discoveries are announced,” he says, adding that “the exploration business has not been all that successful in the last ten years, to begin with”.
Conversely, Fulp says it is encouraging that the good juniors can still raise money, as there is, according to him, private placement and debt money available.
“The new discoveries are often being rewarded, we have seen this happen to a dozen companies this last year,” he says.
The Wheel Turns
House Mountain Partners founder and co-author of Morning Notes Chris Berry tells Mining Weekly that he does not believe that the commodity super-cycle is over. But that broadly speaking, metals prices have reached a plateau.
“Given this reality, mining companies will need to repair and strengthen their balance sheets to remain viable investment opportunities. This means more discipline regarding capital spending,” he says.
Berry argues that publicly listed mining and exploration companies will have their work cut out to regain investor trust. He points to many mining companies having made acquisitions that did not enhance market capitalisation or shareholder returns over the last decade.
“Companies must find ways to drive shareholder returns in the absence of higher metals prices. Share buybacks and dividends are possibilities, but this doesn’t drive organic growth. I do believe that majors will work to ‘get their house in order’, but this will take several quarters of earnings announcements and proven results,” he says.
Junior mining and exploration companies need to focus on survival. With a diminished investor appetite for exploration, those juniors with healthy balance sheets stand the best chance of surviving the current financing drought, notes Berry.
Sprott US Holdings chairperson Rick Rule tells Mining Weekly that juniors need to focus on relevance by doing something well enough to justify existing, and then they need to find a financial constituency to sponsor them.
By contrast, the seniors need to focus on capital efficiency. They also have to use the downturn to build their project pipelines.
“Mines are depleting assets, and in the absence of development pipelines, investors must recapitalise self-liquidating miners through dividends. There are many investors walking around trying to deploy capital, if the project promoters could ‘answer the unanswered questions’,” he says.
Meanwhile, securities regulatory reform could also once more open the door for many exploration firms to access capital. Head of Kaiser Research John Kaiser tells Mining Weekly that all the Canadian securities commissions, except Ontario, have put out for comment a proposal for a new private placement exemption that targets non- accredited investors (investors with a net worth of less than $1-million, excluding primary residential real estate).
“The retail audience has effectively been shut out from financing resource juniors, and their willingness to buy paper in the open market from existing shareholders and algorithm traders has vanished.
“The $15 000 prospectus exemption is a promising step to bring retail investors back into the resource juniors in a manner that would help the juniors deliver the exploration results needed to justify their existence,” he says.
The prevailing sentiment is that the way forward for many mining companies in 2014 will be to focus on organic growth rather than grow through acquisition, Morning Notes’ Berry remarks.
However, that might not be the optimal long-term strategy. Numerous assets are currently undervalued to a great degree, and an opportunity now exists for many companies to acquire these undervalued properties and take advantage of the potentially higher prices in the future.
“Senior miners are more focused on cost control and organic growth – exploration is an afterthought and mergers and acquisitions [M&A] are going to happen much more selec- tively, despite the cheap prices of various assets. The many new CEOs of major mining companies will need multiple quarters to prove themselves and their turnaround plans to a sceptical investorate,” Berry says.
He adds that while M&A would be another prevailing premise during 2014, it will be less about synergies and value creation, and more about survival. The precarious state of many juniors’ balance sheets almost demands this.
And indeed, a number of potential deals have already emerged. In January, Canada’s Goldcorp made a $2.4-billion bid for smaller Quebec-based rival Osisko Mining. In December, Asanko Gold agreed to buy Africa-focused PMI for $173-million, while Centamin’s $37-million offer for Ampella Mining was recommended by the target’s board.
Berry explains that it does not make a great deal of sense for a company trading at $0.03 a share to go to the market and raise $250 000, for example. “This dilutes existing shareholders and just pays for the company’s overheads,” he says.
Further, M&A among the majors is unlikely, while higher metals prices are absent. “That said, with interest rates so low currently, debt financing is an attractive option. It’s important to remember that this is a cyclical industry and M&A will return to the mining industry when demand picks up,” says Berry.
Many exploration projects are now shelved because of many junior companies now either failing or going into ‘hibernation’. In turn, this could result in a dearth of new grassroots projects becoming available to the industry for some time.
However, Berry believes that this disconnect will set up the mining industry for the next cyclical boom.
“The funding drought we’re witnessing here will set up the sector for its next move higher in the 2015/16 timeframe. Eventually, the majors will need to replace mined ounces and will enter back into an acquisition frame of mind. This is why finding de-risked junior stories with balance sheet strength are crucial,” he says.
Both the retail and institutional investor can currently take advantage of the most valuable commodity of all – time.
“Now is the time to undertake due diligence on various companies, commodities, and properties because I think we are at a cyclical bottom. Timing the ‘turn’ upwards is impossible, but those investors scouring the space for values now, will, I believe, be rewarded in the future,” Berry says.
The Inevitable Bull Run
“Bear markets are the authors of bull markets,” Sprott’s Rule asserts.
According to him, the next ten-year commodity-pricing scenario is so bullish compared with today’s outlook, that uninformed observers would describe it as fictional.
And he agrees that the market exhibits signs of having reached the bottom.
To be sure, improved credit availability is set to drive momentum in the mining and metals sector in the year ahead, according to professional services firm EY’s December ‘Capital Confidence Barometer: Mining & metals sector’ report.
“The last four markets have ended with a very violent, very short capitulation – a two-week long capitulation. The down cycle has also ended with issuer capitulation, which saw issuers issuing 30% or 40% of the company at current prices in order to save the company.
“While we haven’t seen total violent market capitulation or issuer capitulation, there is also no reason to believe that it has to happen only because it had happened four times in the past,” Rule says.
During a December 10 phone call with investors, Rule pointed to previous bear markets in 1981 and 1982, or 1990 and 1991, when the small and micro-cap equities fell with very high volatility. Indexes that track these stocks had fallen by 50% or 60% in short timeframes. “Today, small gold companies, as measured by the GDXJ index, have declined by around 80% in three years.
“My experience in the past is that the gain after a bear market compensates you for the pain when stocks were falling. In resource bull markets, carefully selected portfolios can see gains that more than compensate for the losses during the pullback,” he says, adding that Sprott is in this ‘game’ because, historically, the gains that occur are disproportionate between a bear market bottom and a bull market top.
But Rule cautions that history does not always repeat itself, noting that he believes the market is now entering the recovery period.
“I can tell you that having suffered an 80% decline, the sector is likely a lot closer to the bottom than to the top,” he says.
Rule explains that the natural resource markets are cyclical and highly volatile. Stocks are most expensive when they look their best. Conversely, stocks tend to offer the best upside when the market’s outlook is the ugliest.
Rule adds that natural resource markets have always recovered following recoil, pointing to the gold bull market from 1970 to 1980. The price of gold went from $30/oz to $850/oz. In the middle of this bull market – in 1975 – the gold price fell by half.
Starting from around $35/oz in 1970, the price of gold rose to around $175/oz in 1975. It then declined, sliding to a low of $103/oz in August 1976, before subsequently recovering and then surging ahead to reach $850/oz by 1980. Rule points out that those investors who bailed in 1975 missed out on an 850% move across four years.
“If past is prologue, this cyclical bear market is a sale.”
The Morning Notes’ Berry agrees. He is optimistic about global economic growth in 2014 and points to several macroeconomic factors that could start pulling the market out of what has been termed the Great Recession.
He is optimistic about global economic growth in 2014, as markets continue to slowly emerge from the long shadow of the Great Recession. One of the main stories he will be watching in 2014 is whether the US economy will continue to recover and grow when faced with higher interest rates.
In addition, the Asian economies are forecast to grow at above-trend rates and will lead global growth for the foreseeable future. Berry does not expect those economies to grow sharply, but notes that with China growing at 7%, it is still something to be optimistic about.
It is also important to remember that there are a number of other emerging markets, such as Indonesia, Colombia or Nigeria, which are growing strongly and adding to the global middle class. It is in countries like these where the bulk of commodity demand in the future will emanate from, Berry says.
Returning to the US, and effective January, the US Federal Reserve is reducing its rate of bond purchasing to $75-billion a month, down from $85-billion a month. This tapering to the Fed’s “quantitative easing” programme, follows strong third-quarter gross domestic product data and falling unemployment levels.
The data portrays an economy that is strengthening or even, as some might be bold enough to say, accelerating.
“However, there are a number of headwinds, including strong deflationary forces like a falling velocity of money, falling labour force participation, and a lack of capital expenditure spending. These trends must reverse to maintain strong and stable growth in the US,” Berry says.
Berry adds that it appears as if the European Union has emerged from a multi-quarter recession, with some countries healthier than others.
“I wouldn’t be looking for the eurozone to lead the world in growth, but the fact that growth has turned positive is a good sign heading into 2014. As in the US, deflation is a bigger worry in the eurozone than inflation, for now,” he points out.
Meanwhile, Mining Association of Canada president and CEO Pierre Gratton tells Mining Weekly that from a Canadian national advocacy standpoint, the main theme for 2014 will continue to be within the regulatory environment, particularly around the obligations of the mining industry to consult and accommodate Aboriginal people.
He says the Canadian mining industry is the largest client of the Canadian Environment Assessment Agency, with about 90% of the projects being reviewed originating from the mining industry.
“There still is a lot of activity happening in this current market and here are a lot of new potential mines to be built in Canada in the next few years. But the industry has been undergoing a signifi- cant regulatory change over the last number of years with the current government. Directionally it has been helpful, but there have been devils in the details,” he says.
Gratton points out that some real challenges are changes to the Fisheries Act, which is a major piece of legislation affecting the industry. “Government has neglected to plan for transition, so we now have a few companies who have prepared fish compensation plans according to the old Act, and have now been told that won’t do. That means about a year’s work and a lot of money that were wasted for each of the affected companies.”
He says a number of new fede- ral laws have been passed and the reforms have been completed, which now leads into the regu- latory phase of implementing it. The regulations are now either being published, or are in the process of being clarified.
Gratton says he believes that once fully implemented, the policy reforms have the potential to improve Canada’s overall competitiveness in the mining and resources sector from a regulatory standpoint.
“It is still early days, but I think the world will recognise that it is getting a bit more straightforward here and manageable. From a tax perspective, Canada now has one of the lowest corporate tax rates in the world. We are quite competitive from a tax standpoint. We don’t see that changing, with the exception of Quebec,” he notes.
He also says that large infrastructure investment projects stand to benefit the mining industry significantly.
The Premier of the Northwest Territories Bob McLeod has developed an energy plan for the territory that, if implemented, will be able to connect the region to the national grid. None of the three diamond mines in the region are connected to the grid, and are all diesel powered, with the exception of Diavik, which has installed wind power.
“The new energy project would be a game changer for the north and make a lot of projects more economic, which would translate to some real competitiveness improvements in those areas.
“Even with the Ring of Fire [in Northern Ontario], infrastructure investment is the key to advancing projects. However, with chromite not being a hot commodity right now, interest is limited,” he says.
Gratton also stresses that the skills shortage has not gone away, but that the edge is certainly off in the current market.
However, this pressure will be felt once more as soon as the market rebounds. “We have quite a lot of work to be done to address the acute skills shortage. Not just in Canadian mining, but also in the global sphere,” he says.