The information provided herein aims to provide investors with a systematic approach to be applied when evaluating junior mining companies as an avenue for investment. The potential gains can be substantial, but it should also be mentioned that price movement is often volatile so if you are completely risk averse, investing in this industry might not be for you.
To preface this blog, let’s identify what a ‘junior miner’ really is. A junior mining company may own a producing asset but most often these companies are solely in the mineral exploration and development business. The companies create value for their shareholders by making a new mineral discovery or adding to an existing mineral deposit by additional exploration and development. See our blogs from April 3rd and April 17th for more information on the mineral exploration and development process.
Investors should know that the mining industry is cyclical in nature, and as in any industry you want to buy stocks when the industry is at its low and sell when is nearing its high. Overall, the mining industry is in a downturn and has been since 2012. Recent instability, for example the U.S.-China trade war and Brexit have contributed to a decrease in global economic activity. In response to these developments, businesses and organizations have been cautious to deploy capital due to fears of a looming recession. These factors work to create less demand for certain commodities and has led to depressed pricing for numerous metals.
In North America, risk capital for mining has been reduced considerably in recent years and been funneled into the tech and cannabis industries, resulting in industry-wide financing weakness that has been felt by all companies – from the majors to the juniors. There is increasing speculation amongst veteran mining investors that junior equities have bottomed out, and these investors are increasing their investments dramatically.
In a time of economic uncertainty and volatility, investors can look to the performance of precious metals, specifically Gold but also Silver and the Platinum Group Metals (PGMs). Considered a safe-haven asset worldwide, Gold has been performing very well this year, with prices up approximately 20% as of November, 2019. Although its use is more industrial in nature, investors in Palladium (one of six PGMs) has seen its value ($/Oz.) increase by more than 50% in the past twelve months.
Gold is the longest standing form of currency and has a finite supply, unlike money, which central banks can print endlessly to fund deficits which leads to a devalued currency and weakens the corresponding nations competitiveness in global markets. A recent report by the World Gold Council found that of all surveyed age groups, an astounding 61% of respondents trust Gold more than the currency of the country they reside. In response, many central banks have been purchasing record levels of Gold to hedge their portfolio and back up their currencies, this trend is set to continue.
So, what does all this mean?
Depressed prices present investors with the opportunity to buy into public mining companies at a discount, especially in the junior mining industry where the gradual decline of available capital in recent years has put the weaker operators out of business and has depressed public company stock prices.
Before deciding on where to invest your money in the junior mining market, there are five main metrics you should consider when evaluating a junior miner.
- Metal Demand
- Metal Supply
#1 – Management:
Qualified leadership and management teams are crucial to the success of a junior miner. Just like any other business, you want to make sure they have all the boxes ticked when it comes to having people that have considerable experience and a proven track record in geology, operations, finance and marketing. In the digitally connected world we live in today, there are many tools that help investors conduct research on professionals. Ensuring that the management team is qualified is an extremely important consideration for a prospective investor.
Often, junior mining companies are structured as follows: the board of directors and Chief Executive will employ consultants to assist in the different elements of a junior mining business. An experienced and proven leader is required to coordinate these different elements and associated consultants. In conjunction with the board of directors, decisions are made on the future direction of the company and these decisions are implemented with consultants help and with the oversight of the Chief Executive.
Without a strong board of directors, there is limited decision-making ability based on a lack of different perspectives that can impair the future potential of a company and its projects. Without a board of directors that have different strengths related to the mining industry and a Chief Executive that compliments the board of directors and implement the decisions made at the table, a company is much less likely to provide returns to its investors.
By researching a company’s human capital and reaching out to management by email, phone or even in person to relay your interest to invest and ask questions you can expect to have a much better idea of the company and its potential.
#2 – Demand:
When investing in any company, you always want to define the market in which they operate in and determine the economic fundamentals (supply and demand) of the products and/or services the company provides. There should be no doubt about it, the global population is only increasing and the lifestyles of many in developing nations is improving. This creates an increasing demand for metals used for infrastructure, transportation and daily life. Also, there is a focus on green initiatives such as renewable energy and other technology-based initiatives. If wind turbines, solar panels and electric cars all were to become commonplace worldwide this would require an massive increase of production in the metals used for the manufacture of these technologies.
Demand changes over time and it is known that both metals and subsequently, mining are cyclical industries. For example, lets look at lithium because it is a good example of the ‘boom and bust’ cycle that metals commonly experience. Since 2015 demand growth for lithium has been increasing at 13% per year and demand is expected to increase six-fold between 2018-2028. Initially, the increasing demand led to what some say was an overshot increase in prices for the different types of lithium supply used in battery technologies (lithium carbonate and lithium hydroxide).
Whenever the price of a metal spikes, you can often assume that mining companies are anticipating the upward price movement and will react with increased production of the metal if they have the capability to do so. This can lead to oversupply such as what is currently the case with lithium, even in the face of a dramatic increase in future demand there is a glut of supply that may not be cleared until a couple years from now. A lack of processing facilities has also created a bottleneck for lithium supply, this is a large part of the reason prices have declined over the past year. Numerous processing facilities and battery gigafactories are currently being built all around the world which should help to address this problem.
In the meantime, the oversupply has led to a pronounced downturn in prices causing producing companies to scale back operations and investment, which ironically may be the main cause of the next boom cycle if supplies become insufficient to meet demand.
In conclusion, depressed prices (in a historical context) for a metal do not always indicate the future demand of said metal. Do your research on future demand for the metal from each industry the metal is used in and try to anticipate demand risks for each industry. By completing this research, investors have a good start on an investment thesis of a company that they may want to invest in.
#3 – Supply
As we previously mentioned, lithium is currently in oversupply due to numerous companies ramping up production too quickly in response to an anticipated increase in demand, in addition to a lack of processing facilities. This was not the result of a single company but rather a collective effort from multiple companies in the lithium space. Obviously, the availability of supply (and associated demand) directly impacts the price of any mined product.
Let’s consider the supply of Palladium and its sister metal Rhodium, two of the eight precious metals that have risen in price ($/oz.) by over 50% and 100% respectively so far this year, sometimes experiencing volatile price movement. There are three main reasons for the rapid increases in price, explained just below.
Both Palladium and Rhodium are extremely rare and have a superior ability to act together as a catalyst (commonly known as the ‘auto-catalyst’ or ‘catalytic converter’), which reduces the toxic emissions released from passenger and commercial vehicles. In recent years, Europe and Asia have been introducing increasingly stringent emissions legislation that force automakers to comply, meaning automakers are required to use more and more of these important metals. Due to their relative rarity (Palladium content in the earths crust is 30x rarer than Gold content, with Rhodium even rarer), most miners have not been able to increase production, leading to a slow decrease in stockpiles and rapid increase in price as automakers try to secure supply for future production of auto-catalysts.
Whenever the industry is struggling, major miners will often reduce their spending on exploration and development to focus on increasing the profitability and efficiency of their operations. When the situation is improving, as some think what is currently happening in the Gold industry, the majors begin to look at the projects owned and operated by juniors. Junior miners are leaders in identifying minerals deposits and developing them to a point where a major will enter into an agreement to earn-in to a majority interest in the project. This type of agreement is usually referred to as an Option/Joint Venture partnership. These partnerships are lucrative for junior miners in the short term and the majors in the long term once production occurs.
A way for the junior miners to receive longstanding benefit from the deal is to negotiate a ‘royalty’ on the project which essentially means the junior gets a percentage of the profits from the site until the mine is exhausted of all its mineral resources. For more information on the types of funding a junior miner uses to operate as a mineral explorer and developer, read our blog from May 15th on the subject.
To determine what future supply might be, an investor can screen the market to determine the major producers of any particular metal, and where these players are operating in the world. By looking at the actions of the key players like the decisions being made relating to expanding or reducing production you can gain an idea of whether supply is growing or decreasing. A prospective investor should also be aware of the projects in the pipeline that juniors are exploring and developing in order to better predict when new supply will come online for the producing companies in the future. Like demand however, there is always factors not commonly known that can derail the demand or supply of any mineral in question. Investors should appropriately assess these risks before investing.
#4 – Jurisdiction
This point for consideration was originally going to follow our next point (geology) because obviously, you need to have the appropriate resources in the ground to be able to extract them economically. The thing is, a resource might have the right geology for profitable extraction but if political and/or social unrest is occurring in the area, sometimes this creates too much risk to justify commencing operations.
Governments who feel they have not been getting their fair share often react by appropriating assets, introducing or increasing royalties/ownership, and banning exports of a specific ore (forcing miners to refine the metal in the country and/or attract manufacturing, for more value added domestically). Usually these tactics are more frequently used by undeveloped nations that have considerable mineral resources but lack other sources of revenue. It is becoming increasingly common for mining operations to have sophisticated security system’s; although this adds to the overhead cost of the mine and reduces profitability.
#5 – Geology
It could go without saying that without the right geology presenting a business case for investment, there is no way a mine should be built. There have been blunders in the past, which have led to investors getting burned and exiting the industry altogether. You might be thinking, “How am I supposed to know if what they have in the ground is actually geologically attractive? I’m not a Geologist”. This is where trust has been lost, because it is up to a company’s management to accurately dictate the potential of a resource based on what they know and what information is public.
Bringing in a third-party consultant is a common way for a company to confirm the geology that their projects have, these consultants will develop reports called ‘Mineral Resource Estimates’ (MRE), which is essentially the first report in identifying a resource after a considerable amount of exploration work has been completed. Following the MRE in order is a ‘Preliminary Economic Assessment’, a ‘Pre-Feasibility Study’ and finally a ‘Feasibility Study’. These reports are extremely comprehensive and can collectively cost millions of dollars, not including the costs for exploration and development. A positive Feasibility study outlining a mining operation is usually required by most mining companies before they even consider building the extensive infrastructure needed for a mining operation. Investors should read these technical reports that are available to the public in order to gain a better understanding of a junior miner’s project(s).
In Canada, mining companies must follow guidelines to disclosing reports as all reporting is required to be NI 43-101 Compliant.
Once juniors have developed a considerable Mineral Resource Estimate or completed a positive Preliminary Economic Assessment for a project, it becomes easier to attract a major mining company as a joint venture partner or get bought out. As an investor, you need to be honest with your understanding of the industry before you embark on reading a company’s public disclosures to make an investment decision. If possible, when you are not an expert on the subject matter, it is suggested to seek advice from an expert on the industry to help in identifying if a project hosts favourable geology.
Junior miners contribute greatly to the pipeline of projects that will become the mines of tomorrow. Much of the value that investors receive from a junior mining company occurs immediately after a junior makes a significant discovery and again when the project is sold to a major mining company.
Hopefully, with the help of this guide, you feel equipped to start evaluating junior mining companies and invest in these public companies that contribute greatly to our society by way of the delivery of metals that are abundant in everything we see and touch in our daily lives. Be sure to check out our past blogs on mining industry norms, trends and insights to learn more and sign up to receive news and updates from New Age Metals.
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