Industry News
LOWDOWN: Investing in junior miners
30/01/2009
By Martin Li
“A hole in the ground with a liar at the top,” is how Mark Twain once famously described a mine. A trifle harsh maybe, although many who have recently invested in mining shares might echo the sentiment. The mining sector is far from being flavour of the month. Negative sentiment is particularly acute towards junior miners in the early stages of projects and still many years from any prospect of mining let alone revenue generation.
Inextricably linked with the industrialised economy, mining is here to stay – as are the returns offered by the sector. While these can be high, so are the risks. Firstly, mining timeframes are long. It can take seven or eight years from project inception to first production, assuming a project makes it all the way. Many don’t.
Junior mining is currently out of favour, but the slump provides high-growth opportunities longer term.
Investing in equities is always a long-term play and this is particularly true in junior mining. Companies might only have one project and progress won’t always be smooth. Investors must be able to ride out delays, glitches and inevitable disappointments.
In particular, investors punting on junior mining mustn’t expect spectacular returns during 2009 (except in the case of a very rare huge discovery). The severity of the global recession suggests there won’t be a return to the mining good times for at least a year. Taking the required investment timeframe, however, the mining slump provides many attractive high growth opportunities, provided investors choose carefully.
The commodity to be mined is critically important. Precious metals (gold, silver, platinum, etc) have different price cycles from base metals (copper, iron, tin, etc) and diamonds. Individual commodities may depend heavily on specific factors, for example platinum, where the motor industry accounts for half of all demand, or localised use, for example coal in power-starved South Africa.
Diamonds are currently out of favour as the recession hits would-be buyers. The struggling car industry has stagnated platinum demand. A recovery in base metals will require signs of resurgent economic activity, particularly from the developing giants China and India. Gold could offer a glimmer of hope. In its capacity as a safe haven, growing numbers of nervous investors who have abandoned currencies, in particular the US dollar, are increasingly looking to gold as money.
Miners drill holes in the ground hoping to intercept mineralisation, from which they estimate how much mineable material is available, and how much commodity that material contains. ‘High grade’ deposits contain a lot of commodity for a given amount of earth, and are good because they are cheaper to mine. The greater the drilling a miner carries out, the greater should be the confidence in the scale and quality of the ore body. Successful drilling converts approximated ‘resources’ into more confidently estimated ‘reserves’.
Mining production costs can vary considerably, which directly impacts a company’s profit prospects. Much depends on the nature and location of the ore body. A shallow, high grade ore body can be mined as a low cost open pit using earth movers and dump trucks. Deeper deposits require more expensive mining using underground shafts. The more overlying earth (‘overburden’) that needs to be moved before the ore body is reached, the more expensive operations will be.
Getting the commodity out of the ground is only part of the challenge. Miners must also transport often heavy and bulky products to market. This is where the location of a mine is crucial, particularly for base metals. A high grade, cheap-to-mine deposit might be uneconomic located in the middle of nowhere with no nearby railway lines, roads or ports. Similarly, transport capacity constraints suffered in South African and Australian rail and port terminals have restricted otherwise commercial mining operations.
Having identified a junior miner targeting an in-demand commodity from an ore body offering attractive economics and transport infrastructure, investors must be acutely aware of a company’s finances. With capital markets not currently functioning, companies needing development funding are struggling to survive, particularly if their projects are in any way questionable. The most secure investments will be well financed and be in or very close to production and therefore able to generate the vital lifeblood of cash flow.
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