The resource investment paradigm

A scan of the ASX will reveal there are no fewer than 1,000 mining and energy companies listed on our major trading bourse. 

Including other global exchanges, and those in the unlisted space, there are infinitely more.

Almost all of them would have ambitions (and in some cases delusions) of funding their projects through to successful production status, but the reality is that only a select few will reach this stage.  Why? Because they are all competing for a finite pool of capital and, quite simply, there is not enough of it to fund them all.

The weakest among them will miss out and fail. It’s a case of capital Darwinism – survival of the fittest, so to speak, where only the best in breed will survive and flourish.
A 2013 mining industry study by PricewaterhouseCoopers suggested return on investment across the mining sector is currently at its lowest level in nearly a decade.  There are numerous reasons for this – record commodity price volatility, decreased productivity, falling grades, cost blowouts and poor project planning are certainly among them. 

We now find ourselves in a period where capital will be deployed more discerningly and cautiously.  The exuberance that lifted the entire resource sector five years ago before the onset of the GFC may never return again, so investors will have to be more diligent than ever with how and whom they elect to invest in.

While there are no guarantees of success when investing there are a number of intangibles that investors should consider when making their investment decisions, particularly in the junior resources space.

Quality of management team

In navigating a ship through choppy waters, it pays to have a good captain and crew, one that is battled tested and experienced.  This analogy is equally applicable in the small/midcap resources space, where a quality management team is paramount to both survival in troubled times and maximising success when the market is booming.

Where the company in question is not a ‘known name’ or a member of a noted index, capital backing and investment inflows are not assured. As a result it is highly advantageous if management can point to a strong track record of success.

• Have they taken a project through its various phases – drilling and exploration, pre-feasibility, feasibility, procurement and construction, commissioning, ramp-up?
• Do they have the capacity and the market backing to raise funding in a tight market?
• Can they attract cornerstone investors/strategic partners to their share register and/or projects?

Think about how many companies had to close their doors or mothball their projects during the GFC because they couldn’t demonstrate some of these traits.  Investors should understand that quality management teams are those that exhibit patience and perseverance and have the ability to navigate the ebbs and flows of the resources cycle.

Quality of the resource/project

In the resources world you’ll hear lots of terms such as ‘low strip ratios’, ‘high in-situ value’ and ‘amazing grades’.   Just about every company uses these terms very liberally, so investors should be wary not to take such claims as gospel. 

In many cases, it’s not much more than marketing spiel. It’s also amazing how many juniors seem to justifying their existence and prospects solely on their proximity to a noted producer or deposit.

Investors should always be asking themselves -- can this orebody be commercialised?  At the end of the day, there’s no point having $1 billion of copper in the ground if it’s going to cost $2 billion to extract it!   

Access to infrastructure

An infrastructure solution is often the missing link in the commercialisation equation. 

It’s one thing having a resource that can justify a mine, but it’s another thing having the logistics to truck it or train it to port for export. Many of the world’s most mineralised regions (think Mongolia, and numerous African and South American nations) continue to remain underdeveloped due to lack of a clear infrastructure solution.

Presence of a strategic partner/cornerstone investor on the register

Often for many smaller less-established companies the presence of a ‘global’ name (Noble Group for example) on its share register is important from a marketing perspective as it can demonstrate both confidence in a project and a degree of credibility for management.   

A strategic investor may also alleviate future funding concerns via ongoing financial backing (real or implied) as well as serving as a potential off-take partner for future production.  Such strategic partner benefits also serve a company well when it comes to dealing with its banking group for debt funding to develop its project.

Having noted all of the above, it is important to acknowledge there are no absolute guarantees when it comes to investing.

No matter how thorough you think you might have been in your due diligence, things don’t always go to plan.  Global economic data can surprise to the upside or downside, leading to unforeseen commodity price volatility. 

Additionally, investments in resource companies can be impacted by sovereign risk, regulatory or environmental hold-ups, exchange rates, natural disasters and a multitude of other issues which can derail expected investment performance. (See Tim Treadgold’s article, Scrambling out of Africa).

To help mitigate such factors, investors should consider their portfolio construction from a holistic approach.  

A mix of explorers offering “blue sky” potential along with those in operation and generating cash flows is a means of achieving a necessary degree of diversification. Investors might also consider investing across a spread of commodities. 

You may be a gold bug, for instance, but a portfolio of gold stocks may not be optimal in a time of accelerating global growth.  In this instance you might want to hold some copper or energy names that are more leveraged to a growth recovery.

At the end of the day, the best one can do is apply a diligent framework for investment decision making. 

Over the course of the coming months, and utilising some of the criteria identified above, we will try and uncover a few former market darlings and hidden gems that could benefit your portfolio.