Junior mining investment model on life support
There are interesting parallels between mining and the pharmaceutical industry.
Both involve high risk and long payback periods for investors, but offer potentially big payoffs.
Just as big pharmaceutical companies rely on small biotechs to discover new drug candidates, big mining companies need junior explorers to find new deposits.
But just as investors have gone cold on pharmaceutical companies that invest in early-stage drug discovery, so too have they abandoned junior exploration, said David Harquail, CEO of the gold royalty and streaming company Franco-Nevada (TSX:FVN).
Investors are no longer playing the long game and have become increasingly focused on short-term payoffs, he said.
“The market now is valuing higher those pharmaceutical companies that don’t do R&D and drug research. The market has figured out that you can make more money in the near term by not doing R&D. I think they made the same assumption on the exploration business and mining sector.”
Harquail made the comparison during a keynote speech at the Association for Mineral Exploration BC’s (AME BC) annual Mineral Exploration Roundup in the last week of January.
Last year, Franco-Nevada invested $900 million in new mining projects. But Harquail said his company does not invest in junior exploration because the market won’t support it.
“Franco-Nevada has tried to make exploration a business. We can’t figure out a way right now to make money by investing in grassroots exploration.”
And that is worrisome, Harquail said, because as mines are exhausted, shareholders will wake up one day and ask why no one was investing in the next generation of mines.
Harquail lays much of the blame at the feet of mining executives and directors who catered too much to investors. Good miners know that commodity cycles come and go, so they time a mine’s development to catch at least a couple of higher price cycles during its expected lifespan.
But investors no longer have that kind of patience. Harquail said they’re interested only in the latest upswing, not the next one, and too many mining companies have high-graded their operations and focused on big-budget, high-volume, low-grade deposits.
“There’s been too much catering now to the marginal investor, which right now tends to be the traders and hedge funds that only invest for the nanosecond,” Harquail said.
Yet even when gold prices hit all-time highs during the last bull run, big mining companies failed to reward investors because their costs had gone up.
“The big mining companies have concentrated on big, as opposed to profitable,” Till Capital (TSX-V:TIL) CEO Bill Sheriff told Business in Vancouver.
About 35% of Till Capital’s assets are invested in resource companies.
“In keeping with the bigger-is-better [principle], all these exploration companies kept drilling and drilling and getting bigger and bigger [on] lower and lower grade deposits that need a $1 billion or $2 billion capex.”
Sheriff said there are too many juniors chasing too few dollars. He expects many will simply disappear.
“We say the junior model’s broken,” he said. “We think it’s irreparably broken, and by irreparably, I mean at least 20 years.”
Harquail urged mining companies to stop thinking like investors. That, he said, means spending money when investors don’t want them to, buying assets for the next cycle when they are cheap and accumulating cash in the good times instead of handing out dividends.
Despite the current slump, some juniors have financed their projects through alternative sources, including private venture capital, said Gavin Dirom, CEO of AME BC. Some have also managed to strike partnerships with large foreign companies.
Fjordland Exploration Inc. (TSX-V:FEX), for example, has partnered with Sumac Mines Ltd., a subsidiary of Japan’s Sumitomo Metal Mining Co. Ltd.
Ultimately, though, it may fall to the large mining companies to finance the next generation of discoveries, something Dirom said has already started to happen.