Nick Brusatore wanted to create a leading Canadian medical marijuana company. So he turned to a logical source: a hopeless junior mining company.
He bought a controlling interest in Affinor Resources Inc. in March, and then met with the management team. His pitch was simple: the great marijuana gold rush of our generation is just starting, while the junior mining gold rush is pretty much dead. The Affinor team listened and loved what they heard.
"They were clearly looking for something to do with this shell that they'd been keeping on the market, because the mining thing just kind of went bust," Mr. Brusatore said in a matter-of-fact tone.
I think the Canadian resource junior is an endangered species
Affinor followed his lead, and was wise to do so. Its stock price has shot up an astounding 2,600% in the nine weeks since the company moved into pot, meaning its market cap has jumped to roughly $50-million from less than $2-million. Quitting the mining universe was clearly the smartest thing this company ever did, but it's not the only one doing it.
More than a dozen Canadian mining companies have announced shifts into medical marijuana. Given that raising capital for exploration is impossible for most juniors, the moves make sense if they want to do something productive.
This "Breaking Bad" strategy has generated some chuckles in the investment community. But it underlines the fact that investor interest in mining stocks has fallen to a shocking low. And there is no consensus on when that will change, or what catalyst will turn things around.
The malaise is being felt right across the industry, from the tiniest junior to the largest producer. The hot money has moved on to stocks in technology, oil and gas, health care and other sectors where returns have been superior to mining, which is just about all of them.
The sector continues to chug along and generate decent earnings, but the lack of noise about them on the street is almost deafening. To take one example, the HUI gold equity index is at roughly the same level it was 10 years ago, when gold prices were below US$400 an ounce.
People who talk about the lack of investor interest in mining almost always boil it down to two issues: weaker metal prices due to slowing Chinese growth, and self-inflicted damage by the mining companies through poor cost control and/or terrible acquisitions at the top of the cycle.
Those are certainly central issues. But experts wonder if there are other deeper root causes.
One of them may just be fatigue. Metal prices have been in an overall bull market (albeit a rocky one with big ups and downs) since 2002. History suggests that 12 years is fairly short by the standards of commodity cycles, which can last for two decades or more.
Metal prices are below their 2011 highs, but they are still fairly healthy (coal and iron ore aside). National Bank economist Stefane Marion said this week that commodity prices overall are at their highest point since 2008, even after stripping out energy.
But investment horizons have become so short that many people never think about the sector that way. To them, the cycle has been going on for an eternity and the upside is long gone.
The short-term horizon has also affected the companies, which are being asked to deliver more profits and production growth in increasingly short periods of time. Not surprisingly, they have failed, and that line of thinking has pushed companies into many foolish acquisitions that backfired.
"People don't understand," said Terry Ortslan, an independent mining analyst. "They think you press a button, drill a hole and discover your ore body."
He offered up another key reason for investor frustration: mining companies during this entire commodity upswing have failed to make a single world-class discovery that has created real value, despite many claims to the contrary by the industry. "Let's get real," he said.
Miners have become very proficient at processing low-grade ores and making them profitable, as Osisko Mining Corp. did at its hugely successful Canadian Malartic mine. But one could argue that all the high-grade, "world-class" deposits that were developed during the past decade (such as Cigar Lake, Oyu Tolgoi and the half-built Pascua-Lama project) were found before it started.
Another key factor working against miners is what could be described as the fool-me-once syndrome. Investors made the mistake of bingeing on mining stocks in the peak years last decade, and a lot of low-quality companies that never should have raised a penny received tens of millions of dollars as a result. Virtually any miner that had words like uranium or potash in its title was getting financing with ease.
In 2007 alone, Toronto-listed miners completed 577 deals that raised close to $15-billion, according toFinancial Post data. A whopping 416 of those financings were for exploration companies on the TSX Venture exchange. By comparison, there were 61 financings by miners on the junior exchange in 2013.
"The funds took on so much stuff that they just didn't know what to do with it," said Stan Bharti, a well-known mining financier and founder of merchant bank Forbes & Manhattan. "It's so destroyed in value that they're just shell-shocked."
Investors have no desire to make that same mistake again. Last year, Toronto-listed miners raised just $2.8-billion, not counting Barrick Gold Corp.'s $3-billion equity offering (which was a big outlier). The pace of deals has picked up a bit in 2014, but is still a fraction of the peak years.
At its core, mining is a simple business with three elements: find it, extract it and sell it. But it has become increasingly hard to spot value in the past decade for all sorts of reasons: governments demanded a bigger share of the pie, financial players distorted the market with exchange-traded funds and other variables, discoveries became more remote and difficult to develop, and anti-mining activists stepped up their fight against the sector with considerable success.In addition, there is a broad sense among industry experts that the mining story has become too complicated for investors to bother with.
Mining companies also kept changing their mind on what they wanted to provide investors. Gold miners, for example, offered optionality, followed by net present value, followed by production growth, and now the current mantra is free cash flow. It could be something entirely different in a year or two.
JUNIOR MALAISE
The investor frustration with large companies such as Barrick is well documented. But it pales in comparison to their total abandonment of exploration juniors, which are in such a crisis that many insiders believe their existence is under threat.
Very few of these companies can raise capital. Since the start of 2013, miners on the TSX Venture have raised $660-million, Financial Post data shows. In the peak year of 2007, they raised $4.3-billion. Not surprisingly, the boutique investment banks that made so much money servicing these firms in the boom years are now chopping staff or closing down entirely.
Junior mining analyst John Kaiser offers much scarier data. Of the 1,731 Canadian juniors that he covers, 881 have less than $200,000 of working capital, and more than 700 have negative working capital. These companies may claim to be in the "mining" business, but they can't possibly be doing anything that would build value for investors.
It might benefit Canadian capital markets if hundreds of these companies disappear or go into medical marijuana, but it wouldn't make it any easier for the survivors to raise money.
As Mr. Kaiser sees it, the entire business model of greenfield exploration firms is dead and gone. The Canadian retail investor, who could always be counted on to finance these things, has moved on to other sectors. The rumour mill that used to build excitement over these names has been destroyed by the Internet, which ensures that information is everywhere. And automated trading has been particularly tough on juniors, as they trade on speculative value and can be crushed by unfriendly trades.
"We're heading towards an institutional, structural collapse at multiple levels," Mr. Kaiser said. "I think the Canadian resource junior is an endangered species."
Part of the problem is that there hasn't been anything to generate excitement in several years. Over the past few decades, there was almost always something that got people talking: a plethora of copper and gold discoveries in the 1980s; Voisey's Bay and the Arctic diamond finds in the 1990s; and the opening up of new exploration ground in Africa, Latin America and the former Soviet states in the 1990s and 2000s.
Most companies that had land in these places were able to raise money, regardless of market conditions.
The last time there was real excitement in the junior exploration space was in 2007 and 2008, with the discovery of the Ring of Fire mineral belt in Northern Ontario. Since then, nothing has captured the imagination of investors to a substantial degree. Fission Uranium Corp.'s recent find in Saskatchewan triggered a big staking rush, but without the corresponding investor frenzy.
The slow death of the junior exploration sector has real implications for Canadian mining as a whole. If these companies can't raise money, new mineral discoveries will become scarcer than they already are, and a generation of geologists and engineers might decide they are better off in another industry (as thousands did in the lean years of the 1990s).
The senior companies will also find it harder to secure new projects and find quality people, meaning it will become increasingly tough for them to capitalize on future commodity upswings.
STILL HOPING
The big picture may look grim, but mining industry folks have always been an optimistic bunch. For the most part, they are confident that investors who bailed out of the sector will come back in large numbers, if only because they always have in the past. But it is hard to predict when that will happen.
History suggests that a quick drop in global metal inventories, either because of a supply disruption or rising demand, is all it takes to get everybody talking about mining again. The recent run in nickel prices, brought about by export restrictions in Indonesia, is viewed by many insiders as a small example of what a recovery in this sector will look like.
In the meantime, miners have to console themselves with the fact that underlying commodity demand remains solid, regardless of whether the broader investment community wants to talk about them or not.
Mr. Bharti recalls the big fund managers in the late 1990s telling him they would never have anything to do with mining again. By the mid-2000s, they were setting up standalone resource divisions and plowing billions of dollars into the sector.
"When people see these stocks going up three, four, five times, they'll all be back. It's human nature," he said. He thinks interest in the mining space will start growing again by mid-2015, and 2016 should be another monster year for the sector.
Maybe so. But for the hundreds of companies struggling to keep the lights on today, that turnaround can't come soon enough. If they can't find someone willing to give them some cash, their future is going up in smoke like so much medical marijuana.
Clarification: The financing statistics used in this story come from internally-derived Financial Postdata. This data is different from the TMX Group's financing numbers as it counts only brokered deals and excludes deals smaller than $1.5-million, warrants or rights issues, and foreign-incorporated transactions. The TMX statistics can be viewed here
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