Adrian Day: Buying size doesn’t always mean you’re buying quality
As cyclicality in natural resource markets expresses itself in earnest, Adrian Day, of Adrian Day Asset Management, was kind enough to share a few comments on symptoms of resource market tops and bottoms.
Reflecting on nearly 35 years of experience in the resource business (starting as an editor-turned-money manager), Adrian noted that one must realize, “Mining is a very cyclical business for lots of reasons.” One of those reasons he stated, is the likelihood of, “Over-enthusiastic management teams…buying projects & investments at the top just like investors [buy shares most aggressively at market tops].”
As in buying investments of any kind during markets of exuberance, many projects and investments made during resource market tops guarantee “sub-economic” performance, Adrian explained.
On the other hand, investors and management team embracing the volatility and cyclicality of resource markets are better positioned to capture “Very attractive deals… [as bear markets offer] the right time[s] to be buying,” Adrian added.
Here are his full interview comments with Sprott Global Resource Investment’s Tekoa Da Silva:
Tekoa Da Silva: Adrian, you delivered an interesting talk recently at the 2015 PDAC that I’d like to ask you about, but before doing so – for the person reading – can you tell us a little bit about yourself and your background?
Adrian Day: Sure. I was born in England and graduated from the London School of Economics. I’ve been in the U.S. for about 45 years now, and I started in the money management business in 1991 after having edited an investment newsletter for 10 years. Our business offers accounts not just in resources but in global markets as well.
TD: It seems the natural resource and mining business has seen dramatic changes over the last 25 years. You’ve participated firsthand starting in 1991; what are your thoughts after having observed the market for all this time?
AD: Well, I think the first thing investors have to realize about the sector is that it’s an inherently volatile sector.
Mining is also a very cyclical business for lots of reasons. Unfortunately, poor management teams and over-enthusiastic management teams exacerbate the cycle by buying projects and investments at the top just like investors. They buy projects at the top and they don’t buy at the bottom. All the companies [during this last up-cycle] were out making acquisitions — all very expensive, often non-synergistic and quite frankly, many acquisitions were very, very marginal or even sub-economic deposits.
At the bottom over the last year, how many companies have been saving money when they should be spending money?
As it’s turned out, I’ve noticed a big change at the recent PDAC show. But if you look at the last 12 months, Franco Nevada has spent over $900 million. But other than that, it’s just a handful of companies that have done anything. Agnico Eagle has been buying, but some of the big companies like Barrick, Newmont, Kinross—they’ve been divesting. They haven’t been buying, and this is the right time to be buying.
TD: Where are all those assets going – the assets that the majors are divesting?
AD: That’s a good question. A lot of times, smaller companies are buying them, but other times private equities are buying them. The truth is that the majors are not getting good prices for them. That’s the real point, I guess. Obviously, anytime someone sells something, someone else is buying it, so it’s really a question of price. But bottom line, a major company should be buying things right now, not selling.
TD: Are there any individuals or management teams here Adrian that are doing some interesting things—sort of building out of this wreckage?
AD: Oh, absolutely. Among the seniors, Franco Nevada’s David Harquail is an extremely smart person. That’s a person and a company that takes a very long term view.
I was on a panel yesterday chaired by Rick Rule, in which David was talking about how his company looks at the market in terms of decades. That’s interesting, and there aren’t too many companies anywhere that think in terms of decades, and frankly in the mining business you have too.
Franco Nevada two years ago had a couple royalty streams that started paying them for the first time. One of those royalties had been purchased 25 years ago.
Then some of the very small companies are doing interesting things. One almost hates to mention them, but there are some small companies and small teams, with strong people that are very dedicated, honest, and hardworking. They’re disciplined people that are running those companies and actually doing quality work.
TD: Adrian, for the person reading that might be completely new to the mining sector—is there any talk you usually go through to say, “OK, this is what the arena looks like. Here are the layers. Here are the segments. Here are the people?” How do you usually explain this business to a layman?
AD: Well, that’s a good question. The same concepts apply to all mining businesses. First thing I say to people is that they have to realize this is a cyclical business, and a cyclical business means volatile stocks, and the stocks as we know are extremely volatile both on a short term basis and a long term basis.
Even if you look at the best and most conservative of companies in the space, they’re volatile by any normal investment standard. So you have to accept the volatility, and more so, you have to embrace it. As Rick often says, make volatility your friend.
So that’s the first thing you have to understand, and you cannot avoid it. Even if you only buy bullion, or a bullion-backed ETF, you’re still going to have the volatility. That’s the first thing. The second thing is geology.
At Sprott you have some excellent geologists on your team. But I’m not a geologist, so I have no edge there. So when I look at, particularly, smaller companies, I’m not looking at the property or the prospectivity of that property, per se. I’m looking at the management. I’m looking at their approach, their philosophy, their business plan and balance sheet.
I would say if there’s one thing that’s more important than anything else in this business, its people, and the second thing would be the balance sheet because, of course, if you don’t have any money, you can’t have a great project. But if you don’t have any money, you’ve got to keep raising money and diluting shareholders. So shareholders may not do well even if a property, in the end, does well itself.
TD: Adrian, are there any questions you ask management teams or individuals to solicit their character; to find out who they are quickly? How do you get a sense of ‘good management’ if you’re new to this business?
AD: That’s a very good question. I like to spend time with people and that’s the way to really sense who people are.
It might be going out for lunch and just seeing how a person treats other people. I’ve been at lunches where a company wants to take you to the most expensive restaurant in town, or order the most expensive wine on the menu, but treat the waitresses like dirt.
Well, that tells you something about their character and if they treating others like that, they’re probably doing the same thing in running the business. So that’s something I watch for.
I otherwise try never to invest in a company unless I know the management at the company. Certainly with a junior, I don’t invest unless I actually know the management team and have spent some time with them, whether it’s in a restaurant in Toronto or whether it’s on a property in Chile. You want to spend time with them if you’re able to.
TD: Where do you see the greatest opportunity in the market today?
AD: That’s a good question. I would divide the gold space into sort of four areas: royalty companies, major miners, junior miners, and then exploration.
Frankly, I think there are opportunities in all four. I’m a big proponent of the royalty companies like Franco and Royal Gold, and the smaller ones as well.
They’re not cheap by any normal metric, but I think royalty companies offer the lowest risk in the business and they do offer some upside.
The big miners are the most problematic in my view because big mining companies have inherent difficulties. This is a very tough business. Murphy’s Law runs overtime in the mining business. Anything that can go wrong will go wrong, and many things that shouldn’t go wrong do go wrong.
So it’s a tough business and I think management teams have made it more difficult by making bad decisions. Just look at the huge write-offs we’ve seen in this business because of bad decisions made only three or four years ago in many cases.
But a company like Newmont or Barrick has to replace five to seven million ounces of gold each and every year. That’s a daunting task and it means in most cases that they overpay just to get those assets. So I’m not a big fan of the big mining companies.
I think the juniors—the developing producers will probably be a space that will attract a lot of money in the next up cycle. Those smaller but growing producers I think will be a good space in the next upcycle.
But I think the biggest returns as you guys have found, can be among the exploration companies. You just have to be so incredibly selective about it. One of the things I often tell people when they’re new to this space is, don’t confuse size with quality. A lot of people say, “Well, I want exposure to gold but I’m really a very conservative person. So how about we buy Barrick, or Kinross or Newmont?” That’s not being conservative.
TD: As a final question Adrian—what is the most valuable activity a person can do here? Is there any type of learning or investigation you would recommend over the next year?
AD: That’s a good question. A lot of people say that you really need to know and understand this business, follow it, and so on. I don’t always agree with that, because I say, “Look, when I go to the dentist, I know that I don’t know a heck of a lot about dentistry. Therefore, I look for a good dentist and I trust that person.”
So you should spend some time finding out who the good dentists are. Same goes with my car. I wouldn’t know how to fix a car if I was in the middle of a desert and it broke on me. If the carburetor broke I wouldn’t know what to do. I don’t even know where carburetors are in cars. So instead you go to a good mechanic.
So you don’t necessarily have to be an expert yourself, and certainly one way of doing it is to find someone that you trust, someone whose philosophy aligns with yours. At Sprott—I’m not trying to just pat you on the back here, but I have said it to many people—you’ve got brokers there who truly understand the business, and you pay a little more than you pay a TD or Schwab, but you’re paying for people with experience. Take the advice of a person with experience. Listen to them. They’re not always going to be right, of course, and you can’t always be right in this business. So finding good people to work with I think is the most important thing.
TD: Adrian Day of Adrian Day Asset Management, thanks for sharing your comments with us.
AD: Well, thank you very much.
By: Tekoa Da Silva
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