My portfolio was largely:
I lagged the S&P 500 index but still had a profitable year.
Cliffs has announced that it is pulling out of the Ring of Fire and has no plans to restart its activities (press release). I think that Cliffs is making the right decision because its own investors presentation showed that its chromite project was uneconomic (with the spot prices back then). This is very unfortunate for me because I own shares in Noront and KWG Resources.
I used to assume that large mining companies would not chase projects with negative returns. This is a dangerous assumption that I need to rethink. I’m starting to realize that most large miners regularly chase projects with poor return. Or, they engage in business decisions that don’t make a lot of sense. I shouldn’t rely on the due diligence of senior mining companies when trying to value the assets of a junior.
Here’s my analysis of various large mining companies and why they are crazy.
A year ago, Cliffs put out some information on the economics of its Black Thor project in its Investor’s Day presentation by Bill Boor (see Cliffs’ website). I’ve only stumbled across it and read it now. In the figures given out in the presentation, there are some extremely aggressive price assumptions used and the stated IRR is only 14-17%. The projects’ economics are overstated and this project doesn’t look economic at all. I wish I had realized this sooner.
Now I’m in an uncomfortable position with KWG Resources and Noront. Both their fortunes are tied to Cliffs building a mine and smelter that it shouldn’t.
Noront is in the process of getting a loan from its largest shareholder (RCF, a hedge fund with many mining professionals on its staff). Overall, this looks a lot like a convertible junk bond. The effective interest rate is really high once you sort out the financial engineering. This makes sense as Noront has negative cash flow and is not safe to lend to. The lender needs to be compensated for the risks on its loan.
Setting aside the trickiness of the loan for a second, I think that it is somewhat of a good sign that RCF decided to lend money to Noront. It shows faith in Noront. If it turns out that the nickel and chromite projects are not economic (and this could well happen), then RCF could lose a lot of money on its loan and be left with assets that aren’t worth that much.
KB Home (KBH): The stock ran up (around $19.57). Originally I said that they should sell stock… now they are doing exactly that. This is somewhat bad for the shorts (~34% of the float is short) as intrinsic value will move closer to the secondary offering price. I plan on waiting to see if the short thesis plays out.
