Things to Consider When Investing in Mining Enterprises

In previous editions I've written about the mining cycle.  Here I delve into some of the strategic considerations management must consider and why investors must also heed them when placing their bets on mining ventures.

A short paper by Ian Runge serves a good entry point for this discussion.

Every industry, including mining, has to face uncertainty prior to the investment decision; it is the nature of the uncertainty that sets mining apart. A tourism investment, like a mining development, for example, might be subject to the vagaries of the weather, but no amount of study beforehand will necessarily resolve the uncertainty ....

What sets mining investments apart from most other investments is that the economics of resolving the uncertainty are both significant, and endogenous to the investment process. Except in rare circumstances, it is not possible to optimize a mine plan in advance.

The problem lies in obtaining reliable input data

http://www.ceecthefuture.org/wp-content/uploads/2013/02/dr-ian-runge-mining-economics-as-presented-at-discover-mongolia-20121.pdf?dl=1

Once again, Richard Schodde, one of my favourite analysts (and mentioned in earlier editions of The Financial Passage Maker), puts it all into perspective. Here are the salient points of his most recent presentation:

• Only 45% of all discoveries made since 1950 have turned into mines. In terms of contained metal the convestion rates is 57%.
  
• In practice, due to time delays, the final conversion rates will be approximately 15% percentage points higher.
  
• Bigger discoveries have better conversion rates.
  
• For those deposits which were developed, there was an average delay of 12.4 years between discovery and mine start-up. The delay is getting longer over time.
  
• Country risk is important. Projects in low risk countries are 30-40 % quicker to develop.
  
• The business cycle is important. It may require several cycles (and decades) to be developed. In terms of creating value, it is important that you catch the first wave!
  
• Project conversion rates and the time delay between discovery and production are both set to deteriorate over the next decade.
  
• To help offset this, companies will have to improve their risk management practices.
  

I would urge all readers to access the full text of Mr. Schodde's presentation: Key issues affecting the time delay between discovery and development – is it getting harder and longer? (comment: typical Aussie humour here) http://www.minexconsulting.com/publications/Schodde%20presentation%20to%20PDAC%20March%202014.pdf

The following paper was written for company management but it is equally relevant for investors. It addresses the many factors that management must consider in its strategic and tactical planning. Ik recommend it highly. It is interesting to note that the characteristics of the ore body are not mentioned directly in the paper. I will retain this paper and use it to develop a checklist when I read company reports in order to determine whether or not they are investment worthy.  Here are the top 10 issues:

• counting costs
• managing demand uncertainty
• capital project deceleration
• preparing for the M&A storm
• governments eye the mining prize
• combatting corruption
• climbing the social ladder
• plugging the talent gap
• playing it safe
• at the IT edge

Tracking the Trends 2013 – the top 10 issues mining companies may face in the coming year
http://www.deloitte.com/assets/Dcom-Canada/Local%20Assets/Documents/EandR/Mining/ca_en_energy_Tracking_the_trends_2013_112812.pdf#page=6

So ... what to make of make of this when it comes to investing in precious metals mining enterprises? Buy and hold is not a good strategy given the boom and bust nature of the industry. I have learned to heed the mining business cycle and not to invest too early in the early stages. I have learned, that once the cycle starts on the upswing (something I sense by monitoring mining journals), it makes sense to invest in existing operations which can be ramped up quickly. Later, when the financiers get more confident with the prospects of the industry, it's time to invest in junior companies with excellent properties and above all, great management.

Are we “there” yet. No. I'll bide my time with precious metals miners.
This is definitely not the case with oil and gas enterprises where (with the exception of tar sands) development costs are much lower and where discovery-to-production timelines in brownfield patches are much shorter than in the hardrock mining sector. 

At present, the demand for energy remains high and investors are mindful yet of the spector of “peak oil”. It is one area where junior companies can grow quickly if helmed by capable and experienced management – people with reputations that financiers could bank on. Even though financing has been a major problem in recent years, I have the sense that things are changing. For that reason, I remain interested in expanding my holdings in oil and gas ... but only modestly as I already hold a number of assets in that sector.