Mining companies as a path to a low carbon economy

Who are mineral miners companies?

Mining and mineral exploration companies are involved in the identification of mineral deposits, confirmation of the existence of a mineral resource, devising technical plans for the development of mines, fund-raising for the development of mines, constructing and operating mines for the economic extraction of the minerals which are supplied to the industrial supply chain that requires the mineral.

‍

‍

Typically such companies are segregated into three separate categories:

• Exploration
• Development
• Production

‍

Some companies have aspects of all of the above, however, more usually each company management team has the expertise that is specific to each of the above categories, and then if there is a progression to the next stage, the company is typically acquired or the management team may change as the company matures.

‍

‍

Usually, the market capitalization or Enterprise Value of the company will increase as it progresses from exploration, development, and into production. However, most exploration companies are not able to produce an economically viable resource estimate as the drilling carried out by the explorer does not demonstrate sufficient grade or tonnage of material, or there may be problems with the ability to extract the mineral from the rock due to lack of infrastructure or difficult processing or metallurgy of the mineral contained within the rock. Therefore, there is a higher risk of failure for exploration companies, and perhaps only 5% or s may end up progressing to the next stage of being able to develop an economic project to build a mine.

‍

‍

Explorers have no revenue generation, so they depend on raising money by issuing shares to equity investors, which can depress the stock price due to the dilution from new shares issued. Producers tend to have more stable stock prices as there is cash flow generation and an ability to forecast production, and they are usually not dependent on fundraising via equity issues. Dilution is less of a risk to producers. Developers are intermediate in risk between explorers and producers, but there are many steps for a developer to become a miner including environmental and social permits, government permits to mine, and of course, fund-raising and technical or construction risks or failures.

‍

‍

The type of mineral that is being targeted can range from:

• Precious metals – gold, silver, palladium, platinum, rhodium
• Base metals – copper, aluminium, zinc, nickel
• Minor metals – cobalt, tin, tungsten, niobium, tantalum, vanadium, manganese, chromium
• Fertilizer – potash and phosphate
• Graphite
• Lithium
• Uranium
• Rare earths
• Salt

Where do these companies mine and do exploration?

‍

The mineral industry splits into Tier 1 and non-Tier 1 jurisdictions. Tier 1 jurisdictions have a stable political and legal environment and legislation in place to permit the exploration, development, and production stages of mining, as well as a regulatory structure that ensures investors are protected from poor practices by management and have high standards of environmental and social protection (i.e. ESG friendly). These jurisdictions include Canada, Australia, the USA, and many European countries. However, mineral deposits are not distributed evenly around the world, so large mines can exist anywhere in the world, no matter the jurisdiction. Africa and South America are very well endowed with mineral deposits. The map below shows gold production around the world as of 2012

‍

‍

However, mineral resource location does not guarantee that it will be ideal jurisdiction to try to explore, develop or produce minerals. The legal and political situation in the jurisdiction is important for investors. The Fraser Institute carries out an annual survey of mining and exploration companies. The survey is an attempt to assess how mineral endowments and public policy factors such as taxation and regulatory uncertainty affect exploration investment. According to the 2021 survey:

‍

‍

"The top jurisdiction in the world for investment based on the Investment Attractiveness Index is Western Australia, which moved up from 4th place in 2020. Saskatchewan continues to be on the podium, going from a rank of 3rd in 2020 to 2nd this year. Nevada, which topped the ranking last year, ranked 3rd in 2021. Rounding out the top 10 are Alaska, Arizona, Quebec, Idaho, Morocco, Yukon, and South Australia. The United States has the most jurisdictions (4) in this year's top 10, followed by Canada (3), Australia (2), and Africa (1)."

‍

‍

How do mining companies help in the transition to a low-carbon economy?

A low carbon economy requires a move away from fossil burning fuels such as natural gas, crude oil (and derivative products such as petrol and diesel), and thermal coal or coking coal. This fuel usually burns for electricity generation, direct heating, or transportation. A move away from these fuels requires replacement with:

• Solar power
• Wind power
• Nuclear power
• Electrification of thetransport sector
• Electrification of the electric grid

‍

‍

Each of these new segments of the economy will require an increased supply of specialized minerals that the world economy is not currently producing in sufficient quantity for the projected demand required by these segments. The following table gives an idea of the minerals required for each segment

‍

‍

‍

An example of the requirement for the transition to a low carbon economy provides the following graphic from the IEA:

‍

‍

‍

‍

What are the estimated investment horizon and yields?

Many commodity markets are cyclical, which means that the price of the commodity can fall in response to falling demand as well as rising supply. After several years of low prices, the demand can increase, and also supply will drop as the price of the commodity is not sufficient to allow new mines to come into production as the financial metrics of the mine project are not sufficiently good for investors to be willing to finance the mine. Conversely, after a period of high commodity prices, many companies will try to explore, develop and then finance new mine production and this increases supply which can in coming years depress the price. The process of demand destruction and new supply arising from high commodity prices can take anywhere from a few months to a few years, depending on the commodity.

‍

‍

Ideally, investors should target investments in the mineral resources sector where there is an identifiable demand increase as well as a forecast supply shortage. The investment horizon can be anywhere, from a few months to a few years. The investment horizon will depend on each particular company and also each commodity. For example, the investment horizon for investments in the lithium sector may encompass several years because of the identifiable structural demand that will be required for lithium in the electric vehicle battery sector. Conversely, investments in more "macro" related commodities like precious metals may be much shorter given the current economic situation and outlook for the world economy. The following chart demonstrates the cyclical price nature of many commodities:

‍

‍

By focusing on smaller market capitalization companies, it is possible to achieve returns on individual stocks of more than 100% per year, however, due to the high risks and volatility of capital flows into the sector a portfolio-based approach is required to diversify risks. Portfolio returns will be enhanced by a few sizable winners, which will more than compensate for a few moderate losers.

‍

‍

Why should I start investing into mining companies?

Mineral resource sector investing can be rewarding if the macroeconomic, sector-specific, and stock-specific factors align together. However, at any given time, there can be poorly performing commodities as well as poorly performing sectors. At the same time, there can be very well-performing companies. When these companies perform, they tend to outperform the broader market and can increase investment returns.

‍

‍

The following table shows how the investment performance of a portfolio can be positively skewed and improved by a single company showing a 200% gain, balanced by nine other stocks that are in various stages of a bear market, defined by a drop of 20% or more in the year:

‍

‍

Even though 9/10 stocks were in a severe bear market in the portfolio example above, surprisingly, the single big winner with a 200% gain for the year means that for this portfolio, the overall return for the year was precisely 0% (i.e. unchanged). Small cap resource stocks can perform in the manner of the winner presented here as they can re-rate following discovery or as they proceed from development towards production or even if they are a producer that benefits from a rising commodity price improving profit margins significantly.

‍

‍

A recent example in our portfolio has been Snowline Gold which is a company listed on the Canadian Stock Exchange with ticker SGD which is exploring gold in the Yukon province of Canada with an attractive land package. The stock has done very well this year despite the price of gold going down somewhat and also despite most other gold producers or junior gold companies significantly under-performing and indeed both being in bear markets in 2022 with a year-to-date return of over 300% in 2022 as of the start of November 2022. A few stocks with this kind of performance can assist a diversified portfolio to outperform the broader market even if the broader market is in a bear market.

‍

‍

‍

It requires significant experience and expertise to be able to identify and evaluate companies like Snowline Gold, and therefore investors should not invest in the sector without some understanding of the valuation of such companies and also of the macro-economic environment. Investors should ideally seek the assistance of advisors who have experience in this area.

‍

‍