Ahead of his appearance at Mines and Money London, We caught up with Author and investor-extraordinaire Willem Middelkoop to discuss what mining companies and investors should be focusing on to adapt and thrive as the market begins to turn – as well as the reappearing theme of India vs. China.
M&M: As an investor what are key criteria you are looking for when making an investment into a mining company?
WM: Firstly, companies need to be active in commodities that will in high demand, for which the fundamentals are good. Without this basis, a major upside to company valuation is missing. Currently we are very active in precious metals like gold, silver, platinum and palladium because we see or expect stress in these markets. Before 2020 we also expect growing deficits in zinc and copper. Next the being commodities in high demand, gold and silver also stand out as monetary metals, which make them unique.
Our discovery investment thesis is based around putting money into companies we believe will get taken over because of the size of their discoveries. Besides the take-over premium, only the best projects get taken over, and it is only these projects that would normally add a lot of value during their development. So project quality is crucial. Around half of our positions are discovery related exploration and developers companies.
We also need to see a management that is capable of advancing the project towards take-over. Often exploration companies get stuck in exploration mode, and they need a new and competent management to advance. Management that is well connected and capable of locking in capital. For near-producers, we like seeing mine builders with proven track records, combined with people who have access to capital.
“A company needs to show integrity.”
M&M: What are the red flags that would cause you not to invest?
WM: A company needs to show integrity. No misrepresentation or window dressing. They have to do what they say. We see too many former brokers acting as snake oil salesmen in the mining business. So checking out the management team is very important. We often prefer to see geologists in leading board positions. Related to this is the way management pays itself. Are they pay check takers, and how large is their salary? What proportion of the company is owned by management, and was this acquired through options or on the market? These are clear indications of how motivated key personnel is in moving the project forward.
Another factor is the quality of the project the team is working at. If it is a rehash of an old project that has been on offer for quite a while, it usually means there is a terminal issue.Obviously, metallurgy is sometimes an issue when gold is refractory, or when it is difficult to liberate silver. Metallurgy is a particular issue in the special metals such as the rare earths.
Unreported financial issues are another big red flag, particularly in this market. Checking out the balance sheet can be very rewarding. We also try to avoid countries, without reliable politics. We also watch social issues, and like to see them reported by the company should they arise. They are not often show stoppers, but could certainly delay projects. On the flip side, we like socially responsible companies that make a real effort to engage locally. And they need to be able to survive in periods like this.
“We like socially responsible companies that make a real effort to engage locally”
M&M: There has been a lot of economic unrest recently, the crisis in Greece, falling stock markets in China and tumbling commodity prices. How has this affected your investment outlook?
WM: Although it has certainly affected our performance, the pillars of our investment philosophy have only strengthened. The first pillar concentrates on the growing supply deficits in many commodities the coming years. The other pillar centres on precious metals, which will remain the true measure of value and act as safe havens, especially during times of crises. Despite what we are being conditioned to believe in the media, the solution to the global debt crisis through adding more debt is a complete failure. So this provides opportunities for contrarian investors like us. This financial system is utterly unsustainable, and increases perceived insecurity. People are looking for ways to retain value, and as the situation gets direr and the market bubble collapses, there will be hardly any alternative than to flee towards hard assets, like real estate and commodities. We believe there will eventually be a concerted worldwide effort to guide this crisis towards a global financial reset that will bring the current system to a new phase. In this environment, we believe people will reinvent the role of precious metals as the true measure of value, and that would imply a significant increase in their value. Currently there is a huge disconnect between price and value. All listed gold producers worldwide are valued at less then $100 billion. That’s just one-thirth of the value of the Greek national debt.
The second major component is the emerging role of China. As China slowly transitions from a developing country to a developed one, there is still a large role to play for urbanisation. This process has only just begun, and brings with it all sorts of interesting developments for certain metals. Firstly, the huge infrastructure projects have by no means finished. In fact, we believe they are only about halfway through the building of cities and related infrastructure to accommodate the more or less forced urbanisation that is part of formal government policy. Secondly, as the population becomes wealthier, their demands for luxury goods will also rise.
“China’s reliance on carbon-based energy is causing a frantic effort to transition to solar and nuclear”
Demand for electronic devices, cars and jewellery will rise. Thirdly, China recently initiated the role-out of the new Silk Road that stretches out across three continents. Underlying this initiative is China’s aim to wrest free from America’s dominance, and will entail more political conflict. Both these developments will continue to support the already hugely increased demand for physical precious metals and base metals. Fourthly, China’s reliance on carbon-based energy is causing a frantic effort to transition to solar and nuclear as a means to become more independent as energy needs rise in the country. Related to this are the huge financial and human costs of current industrial activity in China, which is causing massive environmental damage in the form of smog, contaminated groundwater, and is literally killing people.
M&M: The market is still tough at the moment. What should mining companies be focusing on to adapt to the current market situation?
WM: Stay financially viable. Cut all the fat and streamline the production process. Companies that make money at these prices will make money exponentially once higher precious metals prices prevail. This is also a great time to buy good projects, so go out and stir up some M&A. Miners need the resources, and ounces come cheap at the moment. This may be a once-in-a-lifetime opportunity, given the current massive undervaluation.
“This is also a great time to buy good projects… This may be a once-in-a-lifetime opportunity”
The developers are more hard-pressed, as they have to balance between closing for business or getting unsustainably expensive money, in terms of high interest rates for debt, unattractive streaming deals, or great share dilution. Only the best projects and management with best access to capital are exempted from this dilemma. Cash rich companies, like the streaming and royalty companies, can get some great deals now.
Many explorers now have to choose between hibernation and going for broke on the last drill hole in the hope of hitting bonanza. The odds of success are extremely low. For most of them the best strategy is probably the former, as the current under-exploration will cause supply issues further down the road. Any company still around with a decent project in a few years’ time once the sector returns to its cyclical peak, will benefit greatly. Obviously, we love following companies that have large exploration budgets in this market, as they are the only ones with a chance of gaining in value.
M&M: What would be your top investment tip for resource investors to make gains when the market begins to turn? When will it turn?
WM: A world class discovery is always rewarded on the market. One of our holdings, Nexgen Energy, working on a uranium discovery in Saskatchewan, is up a lot this year. Good companies in the developing stage or with starting production, will also do pretty well. A company that is able to make money in their first phase of production is always rewarded.
The first to turn are always the best quality miners, like Randgold. We are more weighted towards these at the moment. In a later stage time will come to switch weighting to the developers and explorers. Most of the absolute gains are made here, but timing and selection of companies are crucial.
It also pays to watch the various metals individually. Different markets have different dynamics. The copper market may lag any general correction, whilst the zinc market may turn quicker. Platinum will have a different cycle than palladium, but we expect strong gains in both metals. Energy storage metals are highly newsworthy at the moment, which is likely to help company valuations. Uranium and the rare earths may be a while yet, and it could take a decade for iron to recover.
“The first to turn are always the best quality miners, like Randgold”
Silver is an accident waiting to happen, now we see the first signs of production declines and very strong demand. It’s just a question of time to see the first real physical shortages. Because of stress in the silver market post-Lehman, the price exploded to $49 in 2011. Once prices rise significantly, the road is freed for companies to return to a situation of normal or even overvaluation. We might see ‘ten beggars’ all over the market again.
M&M: One of the themes of this year’s conference is ‘What’s Next’? What’s Next for the mining industry? Is it India replacing China as a source of commodities demand? Is it more growth in investment from alternative funding sources? Or is it something else?
WM: In many respects India is lagging China around ten years. We expect India to show near double digit GDP-growth for years to come. So when you add the growing Indian demand for commodities to China’s ongoing development story, you can expect strong commodities markets for some time to come. Around 2020 many metals will show the first shortages, after years of declining production. Platinum production is down 20% in the last few years.
“While the whole commodity world is caught in gloom and doom, we see a very bright future for selected commodities”
And alternative forms of financing are already the order of the day, what with state-controlled miners and sovereign wealth funds gradually taking a place in the vacuum that historic investors have left. We will see a strong influence from the BRICS-countries. China just announced the start of a $16bln gold fund, which will provide funding for Asian gold projects along the New Silk road. That amount is larger than the value of all Western gold funds combined.
While the whole commodity world is caught in gloom and doom, we see a very bright future for selected commodities. As discussed, many metals have rising demand, whilst supply is reaching peaks. Silver has been in deficit for about twenty years, and shortages have been prevented only by running down inventories and silver in vaults. We don’t know when these are emptied, but the fact is that mining and scrap are unable to keep up with demand, an unsustainable situation. So we see deficits and shortages as the theme of the future, and it is not unthinkable we may get conflict or even war over other natural resources than oil.
M&M: Willem, you recently published ‘The Big Reset’ – can you tell us a little about the book?
WM: For the very first time in history, a financial and monetary crisis has emerged which is so severe that it has the capacity to end in an all-encompassing distrust of paper assets because of infinite worldwide QE. This could even lead to an unprecedented wave of hyperinflation in which prices of real goods explode, debts melt away, and the economy collapse and banks world wide will have to close.
Central bankers are therefore very much aware that it is essential to come up with a monetary reset plan before this will occur. Authorities will do everything possible to modify the financial system in order to avoid another 2008-style collapse. It’s not a matter of if, but only when, they will introduce their reset plans. We know China prefers to work on a joint reset, engineered by the US controlled IMF. The idea to reintroduce IMF’s Special Drawing Rights (SDR), with or without a gold link, could work out quite well. It could work as a new global ‘dollar’ and give us enough extra time to work on a global debt restructuring. In September a revised edition will be published which contains an extra 100 pages, especially on the recent Chinese developments. They push for the a rebalancing of the SDR in which the Renminbi will be added as a fifth currency, next to the dollar, euro, pound and yen. They also would like to see a link established between money and gold.
Catch Willem Middelkoop at Mines and Money London 2015 on Tuesday December 1.
Find Willem’s book ‘The Big Reset‘ here
The post “This may be a once-in-a-lifetime opportunity” Willem Middelkoop, Author and Co-Founder, Commodity Discovery Fund appeared first on Mines and Money.