The annual meeting of the Prospectors and Developers Association of Canada is traditionally the time when people in the Canadian mining industry take the temperature and pulse of their business. Every March, we ask each other — and frequently ourselves, bleary-eyed and in the mirror — whether things are looking up, down, or into a hideous and gloomy pit.
Nobody needs to be told that in recent years we’ve heard a lot about that pit thing. The optimism that seems to be breaking out lately — inspired by a rising gold price, an evident bottoming in the commodity price cycle, and the return of investor money in the junior exploration market — might be a sign that the tune will change this year.
Interestingly, this seems to be happening in spite of, rather than because of, mining-industry consolidation. The temper of the mineral-exploration industry is improving even as the largest mining companies cut back exploration budgets.
There are reasons for this development. The larger the big mining companies become, the less they can consider exploration as a strategy for building up reserves. The flow of resources from exploration is too volatile for companies that need to keep large smelters and refineries fed and need to deliver dividends to their shareholders. The capital markets used to put up with companies that absorbed some inefficiencies in order to cushion some risks; they don’t any more.
This leaves the biggest producers dependent on acquisitions to keep their reserve base high enough. But even then, the risks to the buyer build up; it’s far from certain that when one mine is nearing the end of its productive life, its owner will find another comparable resource being shopped around.
Even if a project is available at the right time, getting into a bidding war over a particular asset can often force up the price, leaving the “winner” to pay a value-destroying premium for the property he wants. Estimates by analysts at Dundee Securities show average acquisition costs for large gold projects in the high US$200 per oz. range — not far from the price you’d have to pay to buy the gold in good-delivery bars.
And everyone can remember the Inco-Falconbridge battle, in 1996, for control of Diamond Fields Resources, and the kind of premium Inco had to pay to reel in the Voisey’s Bay property. Six years later, there is still no return on that capital.
This may, in part, explain why large companies have been willing to develop alliances with junior explorers. The ageements invariably come with back-in or bid-matching rights that give the major a lock on any projects it decides it really wants. Although provisions like that may cut the junior (and its shareholders) off from the windfall that comes with a protracted auction, it is definitely better for the industry as a whole — and the economy — that capital isn’t wasted on acquisition premiums. Large-denomination bills are lost to the economy when they are used to light the cigars of the newly rich; we got quite enough of that in the dot-com bubble.
Relying on the market to provide just-in-time delivery of a mineral resource inventory comes with a price tag, no matter what. The old, vertically integrated model of the mining company — think Inco in the 1950s — accepted that money would be poured into exploration, and a certain fraction of it would invariably find its way to the drain. It was simply a fact of life that money had to be spent in order to make more money.
That fact of life hasn’t changed; major companies just want that money to be somebody else’s. The catch is that other facts of life have proved equally immutable, including the one that says you don’t get something for nothing, especially access to capital.
So the majors are paying up, but sensibly using their budgets to put money in the right hands and the right drill holes. Some junior companies have access to exploration budgets that rival those the large producers spent a decade or two ago, but with the difference that a discovery could make their shareholders a whole lot wealthier.
Another business the largest companies are turning away from is the small project. The chairmen and presidents of big producers frequently tell their shareholder meetings that only the best projects will do, but what they really mean, in practice, is that only the biggest will do. Only giant projects make an impact on the finances of a giant company.
When a gold company will only develop projects with a million ounces in reserve, or a copper company sets a threshold of two million tonnes of contained metal to bring a project to the feasibility stage, a lot of potentially economic mines fail to make the cut.
Yet these will still be moneymakers in the right hands. They won’t guarantee a 20-year mine life at rates of production rivalling Collahuasi or Grasberg, but if they operate profitably for a decade and pay back capital to their developers, they remain well worth doing.
That is where the “mid-tier” and small producers come in. When a project is profitable, but too small to see on a statement of operations that cuts six zeroes off the figures, then a smaller producer has a ready-made opportunity. And since decently sized, feasible deposits are a whole lot more common than world-beaters of Antamina or Olympic Dam size, there will be plenty more of those opportunities presenting themselves over the next few years.
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