Fear and Loathing or an Opportunity?

Note here, however, that I have plotted metals prices in Australian Dollars, rather than US Dollars in which prices are denominated, and most people react to and base their judgements on.

Also, so the graph is easier to read, the copper price shown is actually half of the actual price.

What does the graph tell us?

In Australian Dollar terms, as I have previously mentioned, major metal prices have stayed stable or else increased in nominal terms over the last four years.

In real terms knock off around 7 per cent to take into account Australian CPI increases.

So why all the doom and gloom, as shown by the XSR?

Unfortunately, even over four years after peak of the ‘super-cycle’, investors are still gun-shy, and the XSR basically reflects investor sentiment.

As can be seen, it is less than a quarter of what it was at the peak.

Remember any investments in the sector are risky, and investors are continuing to pull and keep their heads in, largely given the uncertainty in the global economy, particularly regarding China and the Eurozone, but also due to the fact that a number did lose money in the boom, and have lost faith in the sector.

Investors are now correctly being more prudent in their investments, but does this mean that they should ignore the sector completely?

There are good medium to longer term investment opportunities to be had.

However, a lot of potential investors still think of the exploration game in terms of the short term stage (as promoted by the pumpers and dumpers in the last and preceding booms) rather than a patience game.

This lack of funds is particularly affecting earlier stage exploration – even companies with quality exploration ground are still finding it extremely difficult to source the equity required to fund effective exploration.

Another key issue is the lack of funding for project capital, which is affecting how some companies are operating, and also critically affects valuations in the sector.

Most companies with advanced projects that may need significant development capital in the short to medium term are being heavily discounted.

I say most– there have been examples, most notably Sirius with the Nova-Bollinger discovery, that, given the nature of the project have suffered no discounting.

Also, where funding can be sourced, a question that the relevant company may need to ask is, “how far would you like me to bend over?”

There have been some particularly onerous funding deals done where the only beneficiary is the financier.

Another factor coming into play is project scale.

We are seeing a number of smaller projects being promoted and developed – these are ones that would have been ignored during the euphoria and, dare I say it, megalomania of the boom, where capital was freely available for large scale projects with forecast shareholder returns and economics predicated on metals prices that were going to increase for ever.

In hindsight, the failure of a number of these projects comes as no surprise.

Unfortunately a lot of money was lost, leaving a lot of gun-shy investors!

Small start-ups are also being looked at as a way to fund exploration without having to raise pure risk equity at sub-optimal prices.

These smaller projects have lower capital requirements, and can be candidates for a number of different funding options, in addition to the standard debt/equity funding.

Such options include production sharing arrangements.

What however has to be taken into account are economics of scale – these projects will cost more, both in regards to capex and opex, per unit of production than their larger cousins.

However, a successful small start-up, although not immediately generating multiple returns on share prices can form the basis for longer term expansion, fund exploration and give the board and management team market kudos.

Onto metals prices.

The above graph shows some developing (or developed) strong trends in AUD denominated metals prices, and, for investments in at least Australia (or countries with a currency that acts like the Australian Dollar) should give some comfort.

On the broad front, tying in prices and the XSR, we saw the peak of the boom in early 2011, and it has generally all been downhill in the sector in the subsequent 4 ½ years since.

We note an inflection point in late 2011 – a false dawn so to speak, but one which saw the end of falls in AUD denominated metals prices.

This was followed by another inflection in the index in August 2012, coincident with a change to an upward trend in AUD denominated lead and zinc prices.

Mid May this year saw yet another inflection, however does this mark a downward change in long term trends (particularly in the case of lead and zinc), or just a typical short term fluctuation?

So what does it all mean?

There should be some confidence in investing in the right stories (and I have gone through what I consider criteria to look at ad nauseam in the past).

Most metal prices are (at least for the moment) behaving themselves in AUD terms, with prices being the key parameter that a company has no control over.

You may note that I have not included silver or nickel in the above graph and discussion – these are more volatile and haven’t behaved as well as the others, as seen in the graph below.

However there is possibly a floor on the AUD denominated prices for these commodities that can be used in assessing projects.

Silver also has a natural hedge, being both used both in jewellery and industrial applications.

As a wrap up of the above, with anecdotal evidence of Australian costs decreasing, it would appear that the fundamentals are in place for confidence in investing in companies that have quality projects in Australia, else countries that show similar behaviour between exchange rates and metals prices.

Although the overall sector is still depressed, there are good investment opportunities out there, and there is interest in such stories.

As I have said repeatedly, good due diligence is required to sort the wheat from the chaff, and patience is required.

Now just to get confidence back into the exploration sector as a whole (and not just the nearology stories, e.g. the companies operating in the Fraser Range that are rightfully holding investor interest) – without exploration there will not be the discoveries that are needed to sustain our great industry, and which Australia needs.

Mark Gordon – Senior Resource Analyst Breakaway Research



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