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Gold Miners? More Juniors Will Fail

Investors would rather lend at negative rates than buy gold miners...
MANAGING EDITOR of The Emerging Trends Report, Richard Karn has a broad, multidisciplinary background and a working knowledge of precious and specialty metals, as well as considerable research, analytical and writing experience.
Speaking here to The Gold Report, Karn explains that when institutional capital eventually comes back to the sector, money will flow first to companies in or nearing production now.
The Gold Report: Junior mining companies are facing what John Kaiser has called the mother of all bear markets and have had a tough time raising money at reasonable valuations. What are your thoughts on that? Is there a light at the end of the tunnel?
Richard Karn: No. We continue to see more junior mining companies failing from here and have been waiting for a final wash out of the junior mining sector for some time.
At the end of the day, capital is the most vital of all resources in producing commodities, and too much capital has been misallocated in the last few years for there to be a sudden resurgence in lending, especially to the junior mining sector. And as we all know, global commodity prices as measured by the S&P GSCI index are down 34% over the last year due to overcapacity and overly rosy projections about future pricing power and consumption and emerging market growth and endless expansion, etc.
Less discussed, however, is the way this misallocation of capital is likely an unintended consequence of years of unprecedented capital injections by central banks globally, which is more than mildly ironic because the Federal Reserve blamed the global financial crisis on the "surfeit of savings globally." As with the housing bubble in the run-up to the global financial crisis, there was such a thorough relaxing of lending standards, not to mention the push to "get deals done", that projects and expansions that should not have been funded were, and now the world is awash in not only oil and iron and cotton and labor but also capital itself.
Belatedly, institutional capital today is increasingly anxious because resource investments made over the last few years are now money-losing positions from this rapid collapse in commodity prices. The knock-on effects have yet to play out, but the market seems to be fervently hoping that commodity prices recover before the bond markets, especially the junk bond market, pitches a fit.
Think about it: institutional capital is now so scared it would prefer to in effect pay profligate governments and central banks a fee to use their money to do more of what has clearly not worked – only harder – than to tie up their funds in infrastructure or mining projects capable of producing a long-term return and benefitting the global economy. Such an approach to fiduciary responsibility smacks of that Mark Twain quip about seeking "a return of his money not a return on his money."
Negative interest rates can only be seen as a condemnation of failed interventionist policy. There can be no recovery until the excesses have been worked off, and we just don't see the resolve to make long-term commitments of capital returning any time soon – and today the junior mining sector is way down the list of possible investments.
Keep in mind that specialty metal projects were either drowned in capital, starving other arguably more deserving projects, or totally ignored, and now all have been left high and dry as capital recedes. Ironically, a number of the projects that were flooded with cash and have failed or are failing were projects that could not possibly have lived up to the frenzied hype because the specialty metals they produce were not what the market needed.
That's what happens when people do not understand what they are investing in – or why – and demonstrates how so-called industry professionals can be as guilty of shallow, shoddy research as a novice retail investor.
This is also why, despite the collapse in broad commodity prices, numerous specialty metal prices have held or even gone up in the last few years: companies with the potential to produce these metals couldn't attract capital, and the tightness today is now likely to become shortages tomorrow. Eventually the market will accept this new reality, and investment Dollars will flow from "story stocks with potential" to producing operations.
When institutional capital eventually comes back to the resource sector, especially to the specialty metal sector, because it is scared, money will flow first to what has been proven to work, that means companies that are funded and in or nearing production now, which will be seen to be a tremendous advantage. Then, because mining costs will have declined so far and cost curves will have been re-based, improving especially private equity's return on investment, merger and acquisition activity will accelerate.
But private equity firms know the longer they wait, the more the resource sector will be starved for capital and the cheaper the deals will become. In other words, because they cannot be sure the bottom in commodity prices is in, they will wait for slam-dunks.
So no, generally speaking we don't see a light at the end of the tunnel for the majority of junior mining companies. That being said, specialty metal companies with good managements and good projects are still finding ways of getting funded and into production, and that is where investors need to be looking – at those companies that are getting the job done despite the collapse in commodity prices.
TGR: Are specialty metals companies, say those producing graphite, tungsten, rare earth elements (REEs), niobium, etc., in a better position than gold and silver companies?
Richard Karn:  No. If anything, it's probably worse, but they are entirely different situations. Gold and silver is pretty easy to understand; the roughly 50 specialty metals we follow are anything but. Gold and silver are hedgeable, which is critical in securing commercial finance; most specialty metals are not.
For the last couple of years, gold, and to a lesser extent, silver companies with proven management and good projects have been able to secure funding because demand remains pretty robust. Over the last decade China has surpassed India as the premier gold buyer, but where India re-exports a portion of its gold, it appears that what gold goes into China tends not to come out again. Only something on the order of 12% of gold production is consumed, primarily in electronics – and most of that is easily recovered – so the global stock of gold increases every year with the majority going either into jewelry production or saved as a store of wealth.
Specialty metals are more utilitarian so their stocks are perpetually drawn down, but projects are difficult to get financed because many specialty metals are not hedgeable. Despite the aforementioned decline in commodity prices, which has certainly caught a number of specialty metal prices in the rip tide, demand and prices on the whole have held up pretty well because these metals are regularly consumed and must be replaced – and I'm not just talking about consumer electronics, but also about the specialty metals used in automobiles, household appliances, military materiel, renewable energy, super alloys, etc., all of which continue to consume specialty metals like there's no tomorrow.
There are exceptions, of course, but by and large only a few high value specialty metals, such as platinum, palladium, silver and gold, have economic recycling protocols, so every year we drain the finite global specialty metal resource base by that much more.
TGR: Is investor interest in specialty metal companies more closely tied to the larger economy or to a specific story?
Richard Karn: My experience has been that investor interest is geared toward a specific specialty metal story that both piques their interest and is easily understood. But I don't think the broad market appreciates what it takes to secure funding for a specialty metal project these days, or what a testament to management innovation and perseverance it is to get a project into production.
To take but one well-publicized example, the electrical storage sector has been attracting a great deal of attention recently. The Tesla/Panasonic lithium-ion battery 5-Gigawatt-hour Gigafactory is slated to consume about 25% of current global lithium production, 35% of current global graphite production and 15% of current global, non-Democratic Republic of Congo cobalt production.
Investors read that BYD, Foxconn, Apple, LG Chem and Samsung are all planning their own similarly sized lithium-ion battery Gigafactories and rightly conclude current supply of these specialty metals cannot possibly meet future demand, so they look to invest in companies producing these specialty metals. This is much easier said than done because what they find is that despite five years having passed and World Trade Organization (WTO) verdicts condemning certain behavior, the situation is largely unchanged and the world is still dependent on China for many of the most critical specialty metals. Further, the broader specialty metal space has been starved of investment capital for at least three years now, which means in real terms very few projects have been put into production.
Graphite was one of those specialty metals that everybody had to have a few years ago, and there were suddenly more graphite companies promoting their deposits and bad-mouthing others' projects than you could shake a stick at. And the best of them were years away from production – and still are.
TGR: Richard, thank you for your insights.

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