We’re currently in a bit of a high-risk environment. How are our investors looking at the industry and investing at the moment?
Jonathan Goodman: We spend more time on the long term than the short term. We look at the US and recognize that whenever the Federal Reserve System (Fed) lowers rates, it’s going to be very good for the gold market, whether it’s this year or next. Even so, the outlook for gold is very positive. The same goes for nickel, cobalt, and all the battery metal stocks over the next five to 10 years. For us, it’s not about spending a lot of time talking about the macro, but the micro. If you look at junior mining stocks particularly, they have underperformed dramatically for the last 15 years.
Looking at the gold market, if you bought a gold mining company exchange-traded fund in the middle of the 2010s because the price of gold was around US$650/oz, and thought that in 2023 gold was going to be over US$1950 – you would’ve lost money. If people think the reason to buy gold stocks is as a proxy for gold, it hasn’t been for 15-16 years.
As an industry, we need to do a better job building mines and businesses — doing better on the ground. Otherwise, we’re going to lose all the investment that the world needs.
What’s different about this cycle from the last? Are you seeing more positive signs for the industry? Are things like the Inflation Reduction Act (IRA) changing the sentiment towards mining?
Jonathan Goodman: It’ll bring a lot of people in, but unless we do things differently, the industry will find a way for it to end in tears. I think the reality of it is most of the technical reports are garbage. We used to joke that if you took some of the greatest investors in the world — handed them the best and worst report ever written and asked them to differentiate which is which, they wouldn’t have a clue. This is because what makes them good or bad isn’t in the document.
As companies, we need to do a better job of proper disclosure, treating our investors as if they’re actual owners of the businesses, and having open and honest discussions about risk. Every promoter out there is going to give you the best-case scenario for their project, but the best-case scenario never happens in mining.
There’s a myriad of risks around project development, but there must be some good actors?
Jonathan Goodman: Every serious transaction in this industry starts with a signed confidentiality agreement (CA). So ask yourself, if all of this disclosure is out in public (the resource studies, the feasibility studies), why does a professional that knows the industry not make an investment without signing a CA, but traditional investors that are actually buying these stocks and securities are expected to believe everything the company tells them? And so, we signed CAs. We do lots of deals and we’ve done very well over the last few years, but we do it because we invest in projects we like. By bringing in good technical prowess, I think we get to know these deposits better than some companies do.
That’s where we make our money – identifying good deposits early and working with the companies we invest in to help them not make mistakes that we, or others in the industry have made over the last 30-40 years.
Avi, can you tell us about what you do with DWS?
Avi Feinberg: At DWS Group, we manage physical commodities as well as the underlying equities. We have a broad commodities fund, natural resources equities funds, and also gold and precious metals funds that invest in both physical and equities. We do a lot of work across business cycle analysis and try to think about the medium-term view, and where we are in the larger secular picture.
I think that we can separate our views of the business cycle, the commodity cycle, and then also the secular longer term view of what’s changing now, versus in past cycles. I’d agree with the analysis of the business cycle in terms of the risks of higher inflation remaining sticky in the coming months. There are signs that inflation will come down, but it has surprised many people in how long and sticky it has been given core inflation and the underlying drivers there. For now, consumers still have excess savings. Since the end of 2019, consumers have saved some US$6T, and at its peak, excess savings were over US$2T. That has come down a lot since then, maybe somewhere around US$500B.
We’re seeing signs that the labour market is softening, and I think that’s going to be important for containing inflation in a way where the Fed doesn’t have to destroy the business cycle. It’s tricky to navigate. Inflation and the labour market are both lagging indicators and that’s what the Fed is focused on. As they continue to tighten policy here, that could induce softness across all assets. We’ve seen a bid for the dollar, showing resurgence when everyone thought it was dead. Generally, that’s not bullish for commodities in the short run.
In the medium term, while also looking at the commodities cycle, we can see that investment levels are very low. Whether it’s in the mining or energy space.
If you look back over the past decade, all our junior mining companies were destroying capital in a fierce way. Hopefully they have learned some lessons, but I think there is more to be learned. In the large cap space, a lot of companies are not investing, and shareholders are demanding that capital be returned in the form of dividends and buybacks. Companies have de-leveraged their balance sheets and the free cash flow yields are quite attractive relative to equities. So, I think the companies by and large are very well situated to navigate a downturn in the business cycle compared to the past. Deals we see are cautiously equity funded as opposed to large cash deals.
Lastly, people want to compare this decade to the 20s, 40s, 60s, 70s, the “.com bust”, etc. It’s true that there are many similarities to these different timeframes. What’s different from those periods, however, is that debt levels are much higher today than they were then.
It’s most like the 1940s from a debt perspective, where we have wartime levels of finance, and are running budget deficits of six to seven per cent in normal times just to fund entitlement programmes effectively. A lot of that spending is on autopilot. With the negotiations around the debt ceiling, not that much changed at the end of the day. Spending is not coming down dramatically.
Ultimately if the Fed is forced to choose between financial stability or containing inflation, financial stability comes first every time. We see that with the recent bank bailouts, where policies are easing at the same time as they’re tightening. I think that’s indicative of what could come, where ultimately that will be rolled over, and if the buyer of last resort is the Fed, and if the US banking system can’t do that, ultimately that’s going to be bullish for all metals.
Looking at everything you’ve described, how is it channeling your investment strategy into global natural resources? Is there a pivot at this moment or a change of strategy? Is it more bullish for real assets?
Avi Feinberg: It’s broadly positive for real assets. One thing I haven’t touched on a lot is geopolitics. I think that we need to be mindful of whether it’s a bipolar or a multipolar world that is emerging. With the war in Ukraine and the US seizing of Russian reserves, these countries are understandably working on ways to find alternatives to the US dollar as a payment currency. I think as a reserve currency that’s much harder but even there, the US dollar as a share of global reserves has shrunk from around 73% at the turn of the century to about 60%. From an investment perspective, we need to be mindful of where our capital is welcome and respected. We also see resource nationalism on the rise.
In many countries; Chile, Mexico, Indonesia, Zimbabwe, we see governments being more possessive over resources, and wanting to be more involved in extracting more value from resources. That creates potential for mining concessions to be changed, or eliminated in some cases, through the sales of assets. You could see more of a premium for assets in places like Australia, Canada, or the US as that continues. Ultimately, we want to be in companies that are in good jurisdictions that have well managed, attractive assets that are low on the cost curve. Management is going to be critical for all of that.
We’re creating some excellent opportunities for private equity here with some of these trends. What’s the general view across the sector?
Carl Tricoli: Let me go back to the title of the talk, Green Energy Tailwinds vs. Macroeconomic Tailwinds: Which Will Prevail? I think both, because what we’re seeing right now is that everything is in place for a secular shift based on energy transition and everything that people are familiar with, you can see a train wreck coming. Governments are requiring a shift from internal combustion engines (ICE) to electric vehicles (EV), and the metals requirements are shifting. That’s a medium-term secular shift. Right now, we have macroeconomic headwinds. I don’t think they changed in a secular sense that we’re going to see eventually, but now metal prices have come down about 10% in the last four to six months.
There’s an increase in M&A activity right now in share buybacks because these companies are trading below replacement costs of where the metals are. So, particularly for the larger companies, it’s cheaper to buy resources than it is to put that money in the ground and build mines. In the short term, there are lower valuations. You’re seeing the macroeconomic headwinds. Copper, for example, is very constructive in the long term, but you have these short-term headwinds, particularly because China coming out of lockdown has not re-entered growth as rapidly as people thought.
We see this as a great investment from a longer time horizon. Now we’re involved in private equity. Sometimes that involves public companies, but mostly it’s private. We are completely focused on the intrinsic underlying value of these assets. We create value in two ways. First, our capital goes in to develop mines, so there’s an intrinsic value that you get from taking something that’s not cash flowing to something that is. On top of that, we think there’s an overlay of the potential of right-hand skew from commodity price increases, particularly in the energy transition metals.
In summary, we’re very constructive for metals prices based on the energy transition, but I think right now we’re in a bit of a lull that represents a good buying opportunity.
Looking at projects and opportunities out there, do you feel that there’s some good quality at the moment? Are management teams doing what they need to do despite these conditions?
Carl Tricoli: To be honest, there’s not a lot of great projects, which I think is what leads us to being so constructive. There are really two things. First, there is a complete dearth of capital overall into the mining sector, particularly with junior miners. Junior miners require multiples of their market cap in funding to get projects going. They have no hope of getting that development capital and there’s no money flowing in from the public markets. On top of that, projects are tough. I mean our best projects right now are in the DRC and Indonesia. They’re tougher places and harder projects. We have a list of 30 or 40 projects that we follow, but globally, there’s not a lot, which again translates itself between the lack of capital and projects as to why we are constructed in the medium market.
James Steel: Just to mention longer term outlook, we are positive on gold. One reason is because when central banks sold, they sold for over 20 years, from 1991 to 2011. And now that they’re buying again, we expect this to continue for a very long time. Also, as income rises, we expect the levels at which those in the non-OECD world can enter the gold market will continue to rise, but we’re a little shaky about prices where they are. We are very positive on platinum, which we see as moving into deficit from a long period of surplus, and the opposite on palladium. Although we’re positive on palladium this year, we are bearish going forward because of accumulated surpluses due to substitution in the auto catalytic industry and hydrogen. Platinum is used for a lot of other things and the supply is limited.
There’s about 1Boz in reserves in the Driefontein, other parts of South Africa, and Zimbabwe, but they can’t get it out partly because of electricity and power shortages. We are also facing the lack of reserve replacement in gold. What we have is peak gold and the reserves are dropping.
Lastly on inflation, remember that when a portfolio manager sees it going up, they do not buy gold or silver based on that. They look to the anticipated monetary response to higher inflation. And if they think that means that the Fed, the Bank of Japan, or the ECB are going to raise rates, they will sell. That’s why we saw ETF liquidation in the past 15 of 16 months despite a massive gold rally.
Can you talk about the risk of Russia eventually getting back a large portion of its gold reserves that the US is currently holding?
James Steel: I think this is part of why central banks are buying more gold. If the US is going to use its authority to freeze assets, it’s generally positive for the gold market. It might make some actors on the world stage choose gold and hold it outside the US. I’m not making a negative comment on US policy. I’m all for it, generally speaking.
Jonathan Goodman: I think the risk of having assets confiscated is probably driving some of the central bank demand right now, because you don’t really own some of what you think you own.
Avi Feinberg: You never know what can happen with a change in leadership, but for now they’re not getting access to the dollar reserve. I think this is the first time in recent decades where central bank purchases exceeded investor purchases in gold. That’s quite a change. Over a decade ago, central banks were selling gold. It’s a completely different environment today. So maybe people are looking through a period of higher real rates right now. Any real rates model would show you that there’s demand that normally wouldn’t be the case under a real rates model.
Thinking of green energy particularly, there is a complete migration that will happen over the next few decades from 2% EVs to say 20 or 30% as ICE vehicles disappear. With that migration there will be massive demand for lead, but 80% or 90% of lead is controlled by China. What should be the strategy for the developed world to diversify away from China into more favourable jurisdiction demand?
Jonathan Goodman: Battery demand is more than just lithium. It’s lithium, nickel, cobalt, platinum group metals, and copper. And you’re right, all these things are going to get driven higher. There was a big conference in Sudbury, the nickel capital of Canada, and some auto companies were there. One company was explaining that even when you look at the nickel market and ESG practices, they can’t buy or source nickel from a lot of places.
They were there in Sudbury because they wanted to see it continue to develop. It’s an incredible mining jurisdiction and a city of 200,000 people. They’ve got great relations with the native community and great environmental practices. The mayor is very pro-mining. Most people in the city have a link to the industry and like the outdoors, snowmobiles, hunting, fishing, and are cottage-type people. It’s an incredible example of how mining and communities can evolve.
But as you start coupling ESG requirements for minerals, the demand to develop assets in our part of the world is going to be very high. And I expect at some point we’re going to have differential pricing, particularly with nickel.
Can you discuss how you’re looking to integrate artificial intelligence (AI) into your work?
Avi Feinberg: I think it’s still early days for AI in the natural resources space, but we are seeing companies continuing to try to reduce costs wherever they can. Labour is obviously a big cost. So, whether it’s automated trucks and mines, or using better algorithms to help find resources in the ground, I think that there’s scope for AI to help reduce those costs in the future. There’s also the economy-wide impact of AI where all the things we do every day, all the technologies we use, maybe those will change.
Things that we take for granted will change. That’s the nature of technology and how productivity grows. That’s deflationary in a good way and something that could maybe help us grow into the debt that we have. It’s an economy-wide phenomenon. And productivity numbers have really been a business lately. You could argue it’s from COVID and the very tight labour markets, but whether it’s a short term or longer-term phenomenon will ultimately depend on whether we must monetize more of the debt or can productively grow our way out of it.
Can you speak more about dealing with difficult jurisdictions such as Indonesia and the DRC?
Carl Tricoli: First, with respect to those more challenging jurisdictions, from our firm’s perspective, you only go to those places if there’s something really special. For example, in the DRC, they have the highest-grade tin mine in the world and following our expansion, it’ll also be the largest tin mine in the world. We are very fortunate, we have members of our team who this will be their third mine they will have successfully built there. They know their way around but we have had incredible support from the US government, the UN, the government of South Africa as an equity owner, as well as numerous NGOs. This is the first time this region has had cell service, electricity. We’ve built a school, a hospital, roads, and infrastructure. This brings incredible benefits to the region and that’s why it works.
Reflecting back to the question you asked, forget about the resource, a lot of the downstream processing is in China. There’s a great effort and race amongst countries to create independent supply chains. The problem is, you have ESG concerns on top of that. In many cases you have conflicting objectives. The easiest example would be metallurgical coal. You can’t build wind turbines or solar panels without metallurgical coal, but you virtually can’t get a project funded or permitted in metallurgical coal, just because it’s coal. People don’t understand the difference between steel making coal and thermal coal.
So this goes back to the comment I made earlier, all of these challenges, we know these mines take 10 to 15 years to bring online, is why we see this great train wreck coming. There were conflicting objectives that at some point are just not going to be reconciled. You have to slow down the energy transition, or what’s going to happen in the medium term is a price response. And that’s again, why we’re so successful.
Panellists:
PanaliJonathan Goodman, President & CEO, Dundee Corporation & Dundee Goodman Merchant Partners
James Steel, Analyst, Precious Metals, HSBC
Carl Tricoli, Managing Partner, Denham Capital
Avi Feinberg, Head of Investment Strategy – Global Natural Resources, DWS Group
