Here’s how I see junior mining.
The promotional game
Almost all junior mining companies are promotional to some degree. All of the explorers have pretty much zero cash flow and are dependent on raising capital to fund their operations and the insider’s salaries. Most juniors are usually some mixture of a pyramid scheme and a genuine business. Here are some of the things they do: Continue reading
Mines are a depleting resource. Usually you mine the most economic ore first. This causes the economics of the mine to get worse and worse as the mine ages. Yukon Nevada owns the Jerritt Canyon project which is on its last legs. Not surprisingly, its economics have gotten worse and worse.
Some value investors see value in Yukon Nevada (see VIC writeup). I disagree. The mine has negative cash flow and therefore is not making money. It will probably lose even more money in the future and it should be closed. That’s the reason why it was recently closed. Continue reading
I guess I learn something new every day. Even the senior miners will pay money to shill companies to promote their stock. A site called The Gold Report has a list of the companies that they cover on their front page (scroll down if you don’t see it). There are some big names on there like Goldcorp and Nova Gold.
Disclosure: I own a lot of companies that ‘sponsor’ The Gold Report. Northfield Capital owns Goldcorp, Premier Gold, Queenston, etc. Altius owns Alderon and Millrock. I own Pinetree as well (they own a few hundred stocks; chances are, many of them sponsor The Gold Report). Sigh…
Some notes…
They paid $20k to eResearch to say good things about them
To have eResearch conduct research on the Company on an Annual Continuous Basis, Canadian Orebodies Inc. paid eResearch a fee of $20,000 + HST.
http://www.eresearch.ca/_report/CO_061412-B.pdf
What a waste of money. These shills generate no value for society. (If there is a polite way of saying this, I clearly haven’t thought of it.) Here is Canadian Orebodies’ press release regarding eResearch.
Short version of the rest of this post
I don’t think that this is a good long or a good short. This is a sketchy junior (which makes it a bad long) that has found something vaguely promising (which makes it a bad short). Continue reading
The junior mining industry is for the most part a crooked casino. I don’t entirely have a problem with people engaging in high-risk and hopefully high-reward activities. Entrepreneurs do that every day. If I don’t have a problem with the small business casino, then should I really have a problem with the publicly-traded mining casino? But where the junior mining industry fails is in allowing insiders to get away with egregious behaviour.
Giving away free money
Junior miners on the Canadian exchanges are sometimes allowed to give away free money by extending the expiration date on options or by lowering the strike price on them.
Insiders usually paid too much
Especially the board of directors. Their hourly rate is incredible even if you factor in unbillable hours.
Liability insurance
Junior miners often purchase insurance that indemnifies the directors and officers against lawsuits. Why should shareholders be paying for this? The directors and officers shouldn’t be doing unethical things in the first place.
To be somewhat more fair to the junior companies, the officers will sometimes get sued for things that may not be their fault. In the case of Bear Lake Gold, the geologist decided to commit fraud knowing that he would get caught (as far as I can tell… he falsified assay data entry as he entered the results into the database). Insiders were sued and I am guessing that the insurance company settled out of court to avoid a costly legal battle. Even if the insiders committed no wrongdoing (I believe this… but who knows), they could lose the court battle because the other legal team may make some emotional arguments (e.g. junior mining companies are a huge scam, this is like bre-X, etc.) that the judge would go for.
But I would still rather see the company provide legal indemnity to its officers and directors… they do not have to pay an insurance company for this.
White Pine Resources / Northfield Capital
Robert Cudney is the CEO of both companies. Apparently it is allowed for Northfield Capital to buy shares of White Pine in a private placement deal. In my opinion, there is a potential conflict of interest here because it can be in Mr. Cudney’s interest to dilute White Pine’s shareholders in favour of Northfield’s shareholders. And this is not the first time that Mr. Cudney has done something that is potentially unfair to shareholders… several years ago, Northfield’s book value was understated (its stocks were not marked to market) and Mr. Cudney was buying fistfuls of Northfield stock selling below liquidation value. Now that he isn’t buying Northfield stock, transparency has gone up a lot (e.g. the financials are easier to figure out).
To be fair… Northfield right now is one of the most honest companies on the TSX Venture exchange. Insider compensation is very low (Mr. Cudney could be charging 2% of AUM and 20% of profits especially given his track record), there are no egregious related party transactions, the company doesn’t waste money on promotion, and the company does not pay liability insurance.
(*Disclosure: I own shares in both companies, though I own more of Northfield. I’m not sure why I own White Pine shares though.)
Value creation
In an idealized world, junior miners could create value by finding really good exploration geologists / prospectors and giving them capital. Most of the value in the resource extraction industry is created by the explorationists. It is one of the riskiest parts of the resource extraction industry and it is an area where there is a huge range in talent. Some explorationists are superstars while many of them will never find an economic deposit in their entire professional careers. They may not have opportunities to make more money than with their current employer… an exploration company could step in and give them equity and give them an opportunity to make more money and to leverage their talents. (What I’m describing here is maybe what White Pine is doing now under Robert Cudney. It is exactly what Contango Oil and Gas did in its early days and what Altius Resources does.)
But that isn’t what actually happens in practice. Juniors will often explore outside their home country, exposing them to political risks because they are foreigners (all countries in the world discriminate against “evil” foreigners more than non-foreigners). In politically sketchy countries, it is easier to find more gold and higher grades of gold… which makes the junior mining company easier to promote… but such gold is less economic due to the political risk.
And what happens if a junior miner has marginal drill results? There is an incentive to continue drilling and to pretend that the drill results are a lot better than they are. Then there is an excuse to raise more money and insiders will have high-paying jobs for a longer period of time.
For various reasons, junior miners will do all sorts of dumb and crazy things.
Fraud
There is the outright Bre-X style fraud where people just make stuff up. Still happens.
And then there are various forms of exaggeration. Mine engineering and geology is not a precise science. Small errors (often intentional) can be cumulative because the economics of a mine is based on a series of assumptions. This makes early-stage plays very, very, very difficult to evaluate. Companies will spend millions of dollars on feasibility studies before building a mine, and even then the feasibility studies may be wrong. Within all this is the opportunity to exaggerate the economics of a deposit.
Under capitalized
Almost all junior miners put themselves in a position where they HAVE to raise money. They often have to sell shareholders out at a low price to raise money to continue drilling and to continue paying insiders’ inflated salaries.
Basically, the US has very high debt and spending is out of control. Bondholders are not going paid enough interest to compensate them for the risk that they are taking.
Congressional Budget Office
They issue reports on the projected US deficit. Read them for yourself! The issues I have with the reports is that:
Obama’s advisors
Warren Buffet used to be one of Obama’s economic advisors. His shareholder’s letters at Berkshire Hathaway outlines his thoughts on what the administration should do (lower health care costs / make the system more efficient, cut greenback emissions, etc.). Needless to say, Obama does not listen to him.
So who is still one of Obama’s economic advisors? Lawrence Summers. Nothing against him as a human being, but he has a track record of failure. At Harvard, he presided over Harvard’s failed gamble on interest rates. As US treasury secretary, he helped to repeal the Glass-Stegal laws. It turns out that wasn’t such a good idea as investment banks became “too big to fail” and did all sorts of crazy things.
Wasteful spending
The US military is funding the Taliban and Afghan warlords. The US military outsources the trucking/delivery of its supplies to a select list of approved companies. It is cheaper for these companies to pay off the Taliban and local warlords than to protect trucking convoys with troops. (They also aren’t allowed to use heavier weaponry so they may find themselves outgunned.)
Now all governments and organizations are going to have wasteful spending to some degree. But as far as I can tell, the politicians are aware of this counter-productive spending and are doing little about it. It is going to be a little difficult for the US to pay off its debts when you have a system that doesn’t care about correcting its mistakes.
Some of the numbers
10-yr treasury yield: 2.125%
30-yr treasury coupon: 3.750%
Gross debt to GDP: ~98.60%
Revenue to GDP: ~30.83%
Spending to GDP: ~46.41%
Let’s suppose that the US government turns around and starts saving 30% of what it makes (this is the average household savings rates among some Asian countries). The US will be in some incredible pain as government spending will have to drop from ~46% of GDP to ~21% of GDP. The US would have to cut slightly more than half its spending (I am guessing that there would be riots in the street). Then it would take a painful decade to get out of debt. If the US government only saves 10%, spending will still have to drop drastically and it will take three painful decades to get out of debt.
Of course it will never happen. It will probably end up like Greece, where the politicians keep running up the deficit while the citizens and media do not hold their governments accountable. And there will be rioting, much like in Britain. Historically this is the pattern and it does not look like the US will be the exception.
Disclosure: I am also long US stocks like Microsoft and Apple and a lot of commodity stocks (PG.TO, CLQ.TO, NOT.TO, NFD.A, MCF).
Trading/investing in/speculating on stocks
In my opinion, much of the return on commodities stocks will come from ‘speculating’ on commodity prices. The underlying companies are usually leveraged to the price of commodities. A 2X increase in the price of a commodity will usually lead to more than a 2X increase in operating profits of a mine. If the costs of a mine are 50% of the current commodity price, then a doubling in prices will increase mine profits three times.
A small part of the return will come from buying the dips and selling the rallies. (Because let’s face it- this is how most value investors make money. They aren’t always good at picking stocks.)
And a small part of the return will come from stock picking. But very few people are actually good at it. You know, there are hedge fund managers out there who don’t bother reading 10-Ks. And many of them invest in mining stocks without bothering to read some university textbooks on mine exploration and mine engineering. Some people think that it’s a good idea to go long ATPG, without understanding how PUDs can be manipulated.
Royalties
There are two reasons why royalties can be very, very profitable. (But only by people who really, really know what they’re doing.)
Firstly, they are a way to rip off companies which are badly in need of financing. Companies in distress. Or junior mining companies where the CEOs do things that don’t make a lot of sense for its investors. And royalties offer the chance for due diligence, so it’s not as risky as investing in a stock where it’s really difficult to do due diligence. NI 43-101 is not perfect as geologists can do subtle things as using a favorable interpolation method (this can make a 20% difference).
And when dealing with junior miners, royalties offer added protection from the CEO doing awful things to its shareholders. The royalty holder is not affected by share dilution, overpaid CEOs, CEOs wasting money on promotion, excess overhead (e.g. liability insurance for insiders), takeunders, etc.
Secondly, they are leveraged to big increases in commodity prices. If a commodity price skyrockets, then naturally the mining company will want to do more exploration on its property and to expand production. The royalty holder benefits from all this without having to put up any capital. (Though not all royalties have this feature.) This is kind of like an out-of-the-money call option and sometimes people seriously underestimate its value.
On the other hand, sometimes there are downsides to mineral royalties. The mining company may try to underpay its royalties. (This happened to Terra Nova, which went to court.)
If a royalty is too large, it discourages mine expansion whereas a smaller one would not.
Examples of successful royalty strategies
Pierre Lassonde + Seymour Schulich / Franco-Nevada
Altius Minerals (ALS.TO)
Labrador Iron Ore Royalty Corporation (LIF.UN) – They don’t even do anything fancy. Most of the asset value is in their royalty, plus an equity stake in the mine covered by the royalty. On the other hand, this company was rather lucky as iron ore prices have skyrocketed.
Kevin McArthur / “Tip of the iceberg”
Kevin McArthur is the ex-CEO of Goldcorp and now runs Tahoe. He is interviewed by The Globe and Mail here. He seems to attribute his success to finding tip-of-iceberg opportunities. As I understand it, this means buying properties that have a lot of exploration potential. This probably comes in the form of extensions to the existing deposit.
