The Mining Report: The last time we talked, you predicted that the commodity supercycle would reappear in 2017. Does that mean three more years of tough going for mining companies?
John Kaiser: I would say mining companies have one more year of tough going, not three. We are in a transition zone.
China and the U.S. are weaning their economies off the interventionist stimulation that followed the 2008 crash. China has curtailed its infrastructure stimulus program and is pulling in its shadow banking system. Its real estate market is cooling off; a real estate bubble implosion would significantly hurt the Chinese economy. The U.S. continues to taper quantitative easing. The drip feed solution to the Great Recession and the inevitable uncertainty associated with it has discouraged businesses from making the significant capital investments that stimulate employment, and discouraged banks from lending to consumers.
Uncertainty will persist through the transition. Metal prices will languish. Right now, we’re working through the stockpiles generated in the last five years as a result of new mine supply mobilized in response to the higher metal prices of the past decade and weaker-than-expected demand. It will take about a year to know if the weaning process is over, and the economy is growing organically again. If we are growing, metals prices will creep up, along with the valuations of mining stocks. After one more year of misery, a gradual upward trend for the mining sector will culminate with the supercycle being back on track in 2017.
TMR: What about growth in Europe?
JK: Europe is the problem child. It listened to the austerity siren call of the semi-libertarian ideologues, and put the Eurozone into a very slow recovery mode. Now, it is grappling with deflation and the conflict between Russia and Ukraine. The Eurozone is very dependent on raw material supplies from Russia. Russia depends on the cash from its sales of oil, gas and other materials to Europe. If the problem does not get resolved, both sides will be hurt. Overall, I do not see any great help for the global economy coming from the Eurozone.
TMR: Do the recent Toronto Stock Exchange (TSX) company filings confirm your thesis from last year about the likely disappearance of as many as 500 companies from the Venture exchange (TSX.V)? Are the healthy companies the only ones left?
JK: The statistics are grim. Of the 1,700 companies we cover, 40% have negative working capital. These are zombie companies, still listed and trading, but in no position to create new wealth. Another 20% have between $0–500,000 ($0–500K) working capital. To me these represent good bottom-fishing territory because the market has already written them off as future zombie companies. Unfortunately, these statistics do not yet include the Dec. 31, 2013 annual filings for about 600 TSX.V-listed companies. Once we process those filings, we will know what the numbers are. I expect them to be worse because monthly financing activity among the resource juniors is back to what it was in 2003 and during the six-month trough straddling 2008-2009.
To date, about 600 junior companies remain in reasonable financial shape. But even they hesitate to spend money, because they don’t see any easy way to replace it except in the case of outstanding results. The whole idea of a venture capital market as a funding mechanism is stalled. In the absence of upward trends in metals prices, this makes it hard for investors to be optimistic about the sector. And with little money going into discovery exploration, the chances of a world-class discovery that brings investors running back are low.
TMR: How do you determine if a company might be one of the survivors?
JK: Ideally, it will have sufficient capital to continue to advance its prospect in the next year, be that an exploration play or a mine development play. It might have plenty of working capital or it might have farmed the project out to another company with deep pockets to advance the project, without worrying about what the market in general is doing.
TMR: What are the most important factors someone reading your company profiles should look for?
JK: It’s the standard triad of people, capital and story. Is there a well-rounded team of people involved? For this to be the case, the company needs sufficient working capital to pay salaries that will keep the technical and executive teams intact and at work. You also need capital to advance the project. And of course, there has to be something compelling about the story.
On the exploration side, that story would be a strategy or an idea that makes investors believe that the company can increase the stock price 10, 20 or even 30 times—a discovery play. The story behind an existing deposit would be the grades and cost structure that could allow the deposit to be developed at current prices. However, at current prices, most of the projects in the hands of juniors are not very exciting. Their projects have become options on higher metal prices.
The strategy for investors now would be to buy juniors, stash them away and hope they do not get bought up cheap by bigger companies planning to inventory them until the metal price cycle turns positive.
TMR: If that’s a gold-going-to-a-higher-price story, what about a story on another metal?
JK: Zinc could develop a sustainable uptrend in the next few years. Zinc never really rallied like nickel and copper did during the last decade. The mining industry responded to both copper and nickel. Only China responded to zinc, which helped put zinc into the doghouse as far as price is concerned.
Several major Western zinc deposits are depleting. China’s ability to ramp up its zinc supply has stalled and will likely go into reverse as China addresses its pollution problem.
In the rest of the world, it will take time to develop the large zinc deposits because they are in remote locations and will require infrastructure development.
TMR: Does being in an historic mining area appeal to investors?
JK: Yes. You can make discoveries three ways. One is regional exploration that looks at surface anomalies in the form of mineralized outcrop or soil geochemical anomalies. You generate targets by prospecting the old-fashioned way, conducting soil sampling surveys, and even examining satellite images for evidence of alteration halos, which signal that potentially ore forming fluid flow took place.
The second way is to use sophisticated geochemical or geophysical methods and conceptual thinking to generate targets that are hidden under barren cover. That is difficult, expensive and outside the capacity of many juniors because it requires sophisticated geology and drilling. A hammer or backhoe are useless for blind targets.
The third is to look at old districts where smaller-scale mineralization such as gold veins were found and exploited long ago by mom-and-pop-scale operations until the easy pickings were depleted. When you return with modern geological models and drill for lower grade in the context of a higher metal price, you can come up with a bigger zone within what had been dismissed as a small potatoes system.
TMR: Let’s switch to scandium. What’s the supply and demand picture going forward?
JK: Scandium is fairly abundant in the earth’s crust but it does not concentrate well in the manner of less abundant metals such as lead. When it’s alloyed at very low percentages, 0.5%, with aluminum, it makes the resulting alloy much stronger. It has an anti-corrosion characteristic, good conductivity and is much more heat resistant. If the $100 billion ($100B) aluminum industry had a reliable annual supply of hundreds of tonnes of scandium oxide, there would be no shortage of applications using aluminum scandium alloy, which end-users would rush to commercialize.
Unfortunately, the world only produces about 10 tonnes of scandium oxide annually from a hodgepodge of byproduct sources that are not scalable. Emerging byproduct sources include certain titanium dioxide processing operations in China. Another source is in situ leaching of uranium deposits in Russia and Kazahkstan, as well as nickel-cobalt operations in the Philippines. Tests are underway to see if scandium can be recovered through the remediation of red mud, the toxic waste created when bauxite is converted into alumina. The only primary scandium mine was the Zhovti Vody deposit in Ukraine, which was part of an iron mine in which the Soviets discovered 100 g/t scandium that they exploited to make aluminum scandium alloy for their MiG fighter jets. The supply situation of 10 ton per annum (10 tpa), even at a $2,000/kilogram ($2,000/kg) price, has an inconsequential value of $20–40M/year. But over the last six years scandium-enriched laterite deposits were discovered in Queensland and New South Wales, Australia at or near surface with grades of 200-500 g/t.
TMR: You consider investing in scandium an investment in changing the world. How will scandium make the world a better place?
JK: If airlines converted the skins of the planes and all the brackets into aluminum-scandium alloy, it would reduce the weight by 15–20%. That would greatly reduce fuel consumption. It might even persuade the airlines to shelve their very unwelcome plan to add a fifth seat to the middle row of their overseas aircraft.
Ford is producing aluminum-based pickup trucks to help it reach the 2025 target of 54-mile-per-gallon fuel efficiency. Apart from fiddling with the engine and aerodynamics, the only way you can do that is reducing the weight of the vehicle. Even electric cars would benefit from a lighter weight that does not sacrifice safety. Unlike other metals such as beryllium, which bestow remarkable properties to alloys, scandium is not toxic. It is not often that resource juniors can positively change the world by finding and developing a mine. Scandium is that opportunity.
TMR: What’s your message for the Cambridge House Vancouver Resource Investment Conference in June?
JK: It’s the unfortunate message that we appear to be in the fourth year of a resource sector bear market. Without significantly higher gold prices, it will be difficult for companies to raise capital for feasibility demonstration or discovery exploration without the cost of hideous dilution.
Investors need to look for stories that can attract capital, even if it involves a rollback and dilutionary financing.
We’re in the trough of a turning point. Stock prices are likely to weaken again in the summer doldrums. It will be an excellent bottom-fishing opportunity, especially with so many companies clearly sidelined. But there will be competition from high-net-worth groups looking to scoop the better stories. Minority shareholders will see their stake reduced, as their companies get rolled back and refinanced by new money.
Going forward, there will be opportunity to make significant money, but 700 companies will be left in the dust. They have no story. They will be shells waiting for whatever the momentum traders are willing to pile into next.
TMR: John, thanks for your time and insights.
John Kaiser, a mining analyst with 25-plus years of experience, produces Kaiser Research Online. After graduating from the University of British Columbia in 1982, he joined Continental Carlisle Douglas as a research assistant. Six years later, he moved to Pacific International Securities as research director, and also became a registered investment adviser. He moved to the U.S. with his family in 1994.
Article published courtesy of The Mining Report – a subsection of The Gold Report –www.theaureport.com