The Big Mining Macro Picture
Wednesday, 11/05/2014 19:31
Ugly now, but set to get better. In places. In time...
PAUL ADAMS is a geologist and head of research at D.J.Carmichael in Perth, Australia.
With 16 years of experience in the mining industry, and previously chief geologist and evaluations manager at Placer Dome's Granny Smith mine, he knows investors in Australia's junior mining sector are feeling the same pain as those in North America
But Paul Adams believes select junior resource companies will outperform the broad markets as macro-level events impact certain commodities, as he explains here to
The Gold Report...
The Gold Report: Mining in Australia is dominated by coal and iron ore production, much of which is controlled by large players. Please give our readers an overview of the state of the junior mining sector there.
Paul Adams: Like many companies in the junior space in North America, and Canada in particular, junior miners in Australia have suffered from the downturn in commodity markets. Here in Western Australia, the fall in the iron ore price has not only affected the large miners, it's affected the juniors even more. Some miners have already ceased production at high-cost operations. Many jobs have been cut in both large and small mining companies and in the service companies that supply them.
A general feeling of gloom hangs over Western Australia, even though 2013 and 2014 have been relatively good years for the general market. It's certainly a different story for many of the small- to mid-cap miners, especially the exploration companies. Since Aug. 19, the Small Resources Index has fallen to 1,786 from 2,340 – a decline of 23.6%. I dare say it's going to be hard for many companies in this sector for a while yet.
TGR: Where is the light in that tunnel? Is there investor sentiment that sees the value at these levels?
Paul Adams: There is obviously value in the market. The institutions are starting to talk resources again. It's a question of timing. The markets need to feel more settled. The CBOE Volatility Index (VIX) recently rose above 30. That definitely affected the mood of fund managers and their willingness to enter this sector.
TGR: Are some commodities seeing increased investor interest despite market conditions?
Paul Adams: Yes. There are good prospects for nickel and zinc. From a fundamental supply and demand point of view, the scales are likely to be tipped in the favor of price rises in 2015-2016. In precious metals, the rise of the U.S. economy and the American Dollar has meant a fall in our Australian Dollar. The gold price in Australian Dollars has cushioned our domestic gold producers. That has helped but there's still too much uncertainty.
Another commodity with good prospects is uranium. The general consensus is that we've seen the bottom in the spot uranium market and we ought to see much more activity in that commodity in first half of 2015, especially if Japanese nuclear reactors come back on-line.
TGR: For mined commodities, no other country in the world feels the impact of Chinese demand greater than Australia. Where is Chinese investment in all of this?
Paul Adams: I don't think Chinese interest in Australian commodities has waned. As assets become distressed as commodity prices fall, we see Chinese companies still taking a keen interest in Australian assets. We don't really see that waning.
TGR: At the end of 2013 you stopped covering a number of companies. Was that part of a yearly purge or was there more to it?
Paul Adams: Sometimes things don't work out in the mining exploration business. That's exploration, but we've also undertaken a deliberate change in strategy to focus on higher market-cap, high-growth companies with liquidity that are either in production or quite close. We have become more choosey when it comes to where companies are in their lifecycle, but that's not to say that we've completely moved away from small explorers. But the conviction on the assets has to match the increased market sector risk.
TGR: Is that basically the outline of your investment thesis?
Paul Adams: The macro trumps the micro in the resource sector. From oil and gas through diamonds and everything in between, we've seen the effect of the macro on our markets. That 23% fall in the Small Resources Index indicates that. Going forward we have to make sure that the supply/demand fundamentals for a specific commodity make sense. If the fundamentals make sense, we would be much more willing to look at a small company that has exposure to that commodity.
TGR: Australia's conservative government, headed by Prime Minister Tony Abbott, repealed the mining or "Super Profits Tax" on Oct. 1. Will investors notice the difference?
Paul Adams: The tax did not raise anywhere near the revenue that it was expected to. I suppose its repeal has taken away some negativity toward investment in the sector. We're better off without it but I don't think it will necessarily change the view of Australia as an investment destination. Australia is always going to be seen as a relatively safe jurisdiction for mining projects.
TGR: What are the three or four things you look for in junior mining equities in this market?
Paul Adams: We look at management teams and their delivery on expectations. We'd much rather work with a management team with a track record in promising just enough to garner sufficient investor interest and then over-delivering. Nobody likes surprises but we can all live with a surprise or two on the upside. I love going back to our clients and saying, "I was a bit wrong on that, it actually turned out to be better than we thought it would be." That's a really important point.
Second, we definitely want to see that the asset could turn into a profitable mining operation. Our best calls have occurred when we identified those opportunities as early as possible. Then we try and stick with a company over a number of years as it realizes its vision.
The timing in the lifecycle of a company is very important. Investor interest in long-dated, capital-intensive projects is just not there. But if there's a company with a short-dated timeline to production where an obvious value uplift should occur, then that's a much better position in these markets.
TGR: Do you think brokerages in general no longer form sufficiently long relationships with these companies?
Paul Adams: That's an interesting question. Our model has been to identify – probably sooner than most – companies with really good assets. Obviously, you're going to get investors with different risk profiles and some will want to take some money off the table on a successful exploration event, for instance. If you can afford to have a long-term investment horizon, you often form good relationships with the companies involved and help them through their lifecycle. We've always tried to establish those relationships early on. And as long as the asset keeps delivering, we keep supporting those companies.
TGR: We're getting close to the end of 2014. What's your general outlook for the junior sector in 2015?
Paul Adams: It's still going to be quite hard, but certain commodities are going to do better than others. This comes down to what your views are on the macro. For instance, the supply/demand fundamentals for nickel suggest that nickel prices should start to rise as Chinese stockpiles of Indonesian nickel ore get depleted. That means in 2015 nickel companies should perform better than they have in recent years. We're also likely to see zinc producers and developers outperform their peers in other commodities as several large zinc mines shut down.
Overall, we're not out of the woods, but we're always hopeful that the next year will be better.
TGR: Thank you for your insights, Paul.
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