Mining Services Part II
February 16, 2010
What To Look For In Small Company Management
March 7, 2010

Mining-worse than airlines

Quick, what’s the world’s worst investment sector?

Airlines? Autos? Biotech? Give up? Junior mining is way worse. Airlines limp on for years in quasi-bankruptcy—so do autos. A few companies like Toyota even do well. Biotech companies sometimes find something interesting. Even if your junior mining company finds something, you still will probably lose money.

Junior mining companies span the universe from a guy with a pickaxe looking for something interesting, to a company with a good property that is trying to put it into production. In theory, mining lends itself to our strategies. There are thousands of mining companies so it’s natural that good ones are passed over. Most managers worked at larger mining houses for decades before deciding to set off on their own. They should know what they are doing. The management teams usually have significant personal stakes in their companies and take minimal salaries. Finally, it is a sector that has significant volatility. Every year, a discovery or two propels a 20 cent stock to 10 dollars a share. If you put your time and energy into it, one would think that you should be able to make money—maybe you can. I think the odds are so horribly stacked against you that it is futile to try.

For the record, I have invested in mining stocks for years. Over that time, I’m up a good deal of money. My mining investments have outperformed the mining indexes and I like to believe that I understand something about the mining industry. I have also frequently lost a lot of money on these investments. I have had way more losers than winners. If not for a few investments that went up ten and twenty-fold, I would have lost a lot of money in mining stocks. I would also have been much better off had I invested in real businesses instead of mining stocks. Mining stocks have been in a strong bull market for most of this decade. If not for that fact, I probably would not have made any money at all. With that in mind, I still make investments in mining stocks from time to time. Maybe I am just a sucker.

Despite what you hear, most guys in Vancouver are NOT criminals. They are NOT out to steal people’s money. They are trying their best to make people rich. I have become friends with many of these people. They mean well. However, the laws of economics are stacked against them.

What makes junior mining stocks such awful investments? To start with, an interesting property by its very nature is not a business. There’s no revenue and no profits—just endless losses. Every few months, a junior mining stock needs to raise more capital in order to continue pushing the project towards production. This is the first pitfall. The company is at the mercy of the capital markets. If the markets are not strong, the company cannot raise money on good terms. Sometimes, it cannot raise money on any terms. Even if it can raise money on decent terms, you are subjecting yourself to endless dilution.

Mines are always subject to country risk. Despite the fact that a mine creates jobs and taxes for the country where the mine is located, there is always a sentiment that THEY are stealing OUR stuff. No one ever points out that a mining company takes massive risks to build a mine and that the reason the country itself didn’t mine the deposit was because mining is a bad business. Still, this sentiment means that laws change haphazardly, taxes can increase on you arbitrarily and you can lose your mine at any time. I hate politically charged situations. They’re unpredictable. Politicians routinely make bad decisions—especially if they think bad decisions will earn them votes.

Environmental standards have increased drastically in the last few decades. Despite what you may think, standards are stringent even in the Third World. This is a good thing. Mining companies have cleaned up their ways and most new mines have minimal impact on the environment. However, the industry has a legacy of creating messes and environmentalists use that fact to target these companies. Sometimes, environmentalists raise pertinent objections to environmentally difficult projects. These objections result in changes to mine plans. Sometimes, these objections even result in mines that are never built. Often, the environmentalists are just trying to seem busy and necessary—otherwise they couldn’t earn their hefty salaries working for charities.

Environmentalists are often as arbitrary as politicians. At least politicians have to be sensible to local interests. They care about creating jobs and generating tax revenue. Environmentalists are indifferent to local poverty. Often they find that poverty somewhat ‘charming.’ To invite progress, would be to change a native society’s way of life. They don’t care what the locals want. The locals do not contribute to their environmental charity.

After a successful campaign to thwart a mine and save some inhospitable place from progress, they go home to their wealthy cities and focus on giving lectures and raising funds for the next fight. This leaves poor countries poor. Environmentalists want you to believe that native peoples around the world want to live like their ancestors did in some idealized version of an ancient empire that no longer exists—an anthropologic zoo of sorts. My experience is that people want progress. Well planned mines bring progress. While this all makes sense, don’t expect environmentalists to care. They can pop up at any time and destroy your investment

Here are things to look for so you can environmentally bulletproof a mining investment. Stick to countries that are known to be mining friendly. Avoid areas near rivers and lakes. Avoid areas near touristy areas or places where the wealthy congregate. They usually are indifferent to the poor people around them—they just want to ensure that no one ruins their vacation homes. Avoid politically or religiously sensitive places. An ore body built under a sacred glacier which straddles the border of two countries is probably a bad place to mine. In general, stick to remote places where people are looking for decent jobs.

Watch out for metallurgy. Just because an ore body has a lot of gold, that doesn’t mean you can actually mine or recover it. Some recovery methods are prohibitively expensive.

Avoid massive low grade operations. Companies like to throw big numbers at you. A property with 5 million ounces of gold that will produce 200 million dollars a year of cash flow sounds interesting if the market cap is only 400 million. However, there is probably a reason that it’s that cheap. Maybe no one believes the numbers. Especially avoid NPV calculations. They’re worthless. Low grade operations have no margin of error. If they’re off on their estimates—and this is mining—the mine may not produce any profit at all.

Be dubious of any cap-ex estimates. Juniors need a huge piece of starting capital to build their mines. They go to bankers and to investors and try to put a good face on a bad situation. They chronically understate the cost to build the mine. Once a bank has lent a company 300 million, what’s another 200 million to finish the mine?

If you’ve just read all of this, and still think you want to invest in junior mining stocks, good luck to you. In my experience, this is what makes for a good investment.

Stick to potential mines where most of the drilling is done and the company has started the economic assessment on the deposit. Stick to assets that have so far met minimal environmental and political resistance. Finally, stick to assets that should be producing cash flow in three years or less. Ignore drill plays.

It’s all about management. Building a junior mining company takes different skills than just building and operating a mine for a major company. Capital market experience is critical. You need a guy who will tell the story well, raise money intelligently and not waste that money. There’s about 20 guys who consistently do this well. Stick with them.

Stick to small properties that are high grade. Look for companies that can pay off their cap-ex budgets within 18 months. When you invest in real companies, you want to invest in businesses with high returns on capital. Mining is no different.

Go to the site. Ask around. See what the locals think. They usually know if something is afoot, either politically or environmentally.

Finally, ask around. Get some friends who REALLY know about mining. Someone will know what’s wrong with your asset. It’s not likely that the CEO will tell you, because he needs you to help finance his dreams.

Good luck, you’ll need it. I’ve essentially sworn off mining investments.

Categories: General
Positions Mentioned: none

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