Disruptive Discoveries Journal

Mining Investment in Hong Kong – Optimistic but Searching for the Turn

Chris BerryComment

By Chris Berry (@cberry1)

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I have recently returned from Hong Kong where I was privileged to deliver a keynote address at the 121 Mining Investment Forum. In an environment which is crying out for a new conference model, the founders at 121 are on to something. There is an institutional appetite in Asia for mining deals despite the cyclical and structural disinflationary headwinds that appear to be intensifying.

My motive in attending the conference, aside from networking, was to get a feel for how Asia-based investors viewed the metals markets and what sort of questions they were asking. With institutions from Hong Kong, mainland China, Australia, and other countries in attendance, I figured I’d get a good cross section of ideas not skewed by a North American viewpoint. I list each of these ideas or insights below with short commentary, but perhaps the most interesting point was that the fundamental question we in North America and Europe are asking ourselves is EXACTLY the same in Asia.

Specifically: When will the mining markets turn and what will the catalyst be?

This question would seem to validate my thesis of the dual headwinds of excess supply and faltering demand casting a pall over the industry, requiring a new way of creating value in the space. I think disruption and innovation is the answer but it really is a question that nobody can answer for sure. With each metal or mineral exhibiting its own supply and demand dynamic, searching out those metals demonstrating strong demand growth is a must. This is why I continue to look favorably on lithium and cobalt.

What follows are my observations from conversations and meetings while in Hong Kong. Your comments are welcome as they can only add to the discussion (hopefully!).

  • There was much discussion of the all-in sustaining costs (AISC) to produce an ounce of gold and silver. Given the relentless pressure the precious metals have been under, many are wondering where the “floor” is. If you assume an all-in sustaining cost to be this floor then, approximately US$1,025 for gold and US$15 for silver (on a global basis) would be the answer based on discussions I had. Of course, with both a paper and physical price for gold and silver, the prices could fall below the AISC for an indeterminate time and this is one issue several conference participants voiced concern with.  

 

  • Continuing on the pricing theme above, several people at the conference wondered aloud why, if copper and silver have seen persistent supply deficits in recent years, are the spot prices down so much? The differential between the spot and paper markets is the culprit, but how to rectify this headed towards goldbug/conspiracy theory talk which was refreshingly absent.

 

  • The Chinese investors I spoke with were most bullish in 2015 on nickel and gold. The bullishness with nickel permeated from the ore export ban Indonesia instituted. 100% of the people I spoke with expected the ban to remain in place indefinitely. This ought to help tin as well, although it really hasn’t thus far. The bullish case for gold rests with Asian (specifically Chinese and India) consumer demand. The primary bearish call was iron ore with one panelist forecasting a $68/tonne price in 2015.

 

  • The perceived slowdown in economic growth in China was another question that loomed large. One presenter from Gavekal Economics gave a mixed take on the longer-term prospects for the country. Leverage and economic growth are highly correlated and the increased credit growth in China since 2009 arguably saved the entire world from a much deeper global recession or depression. While Fixed Asset Investment is falling as the country alters its growth model, it remains to be seen how quickly the Chinese consumer can soak up the excess capacity and really become an engine of growth for China and the world. The threat of an internal deflationary episode in China is a legitimate possibility as credit growth loses its punch and excess capacity must be soaked up. The long-term equilibrium growth rate in China (out to 2020) is thought to be 5 to 6%. I’m not terribly discouraged by this as China continues to grow strongly and though the growth rate is lower, the capital base is strong and much larger than before.  

 

  • M&A will continue in the mining space, but there will be a focus on “squeezing” more out of existing assets rather than a blind insistence on “bolt on” acquisitions. During a private equity discussion, the general feeling was that private equity can’t and won’t help the junior space and this sector of the market must fix itself either through mergers of necessity or simply by vanishing. Not a terribly optimistic forecast, but very hard to argue with.

 

  • The Energy Metals are true contrarian opportunities. While many I spoke with were familiar with lithium, graphite, cobalt, rare earths, etc, they were not familiar with the demand growth rates. Many investors have avoided this space in the past due to the fact that they are small markets (lithium at 160,000 tpy) with opaque pricing structures. Ignoring the opportunities here while fretting about copper or iron ore seems short-sighted. That said, the Energy Metals selectively suffer from the same excess supply and muted demand issue hurting most metals. My theory of finding disruptive opportunities, or those opportunities which allow for a low cost of production to mitigate against supply gluts, was well received. I am biased, to be sure, but after attending this conference, I really believe that the Energy Metals offer the most upside going forward due to the fact that they are not well understood and demand is growing at rates well above global GDP.    

Some might think that flying so far to get a feel for a market that has been under relentless pressure for the past couple of years as unwise or foolhardy. Jet lag aside, I disagree.

While it is clear that the “turn” we’re all searching for is elusive and will happen much more slowly than many would like, what I realized was that there are a number of asymmetric opportunities in the mining space and positioning for them now is what will generate the above average returns in the future. While major mining companies continue to shed assets and the junior space reluctantly consolidates, any patient investors should see this for what it is: an opportunity to selectively purchase assets cheap on an absolute and relative basis.

 

 

 

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