My readers will notice that I often favor resource
companies that have unconventional business models:
Meanwhile, most junior resource investors choose companies with more
traditional "explore-develop-produce" models. There is little doubt
that this model can work and that it can generate fortunes for early
investors. However it is also a model that is high risk since it requires a
lot of time and capital to develop.
There are cases where long-term investors made little to no money (or they
lost money) despite the fact that the project in question is a success. A
great example of this is Romarco Minerals. The Haile project is a
high-quality multimillion-ounce deposit, but due to the amount of time and
capital it took to prove this out Romarco Minerals had more than a billion
shares outstanding. While most very early shareholders made money, it was not
enough to justify the wait given the high risk of investing in junior
resource companies. Most shareholders who bought during the last upcycle (2009�11)
or subsequent to that lost money despite the derisking that was taking place,
and despite the takeover by OceanaGold Corp. (OGC:TSX; OGC:ASX), a multi-mine
regional producer (Southeast Asia/Oceania) with global aspirations. One can
always point to company-specific issues, as well as cases in which companies
have gotten into production quickly and without blowing out the
share-structure (e.g., Tahoe Resources Inc. (TAHO:NYSE; THO:TSX)), however there
is no denying the risks and difficulties of following this model.
The above-listed three companies, among several others, operate under the
assumption that these risks merit a proactive rethinking of the
explore-develop-produce model, with the goal of reducing the amount of time
and/or capital it takes to get into business.
The explore-develop-produce model cannot be eliminated, but there are
plenty of models that work within it or alongside it. Two are worth
mentioning.
Narrow the Focus of the Business
The first is to narrow the scope of the business. The full extent of the
value chain starts with rocks in the ground and ends with a marketable
product. By working on adding value through just one piece of the value
chain, companies reduce the complexity of their businesses and their capital
costs. A great example of a success story here is Dynacor Gold
Mines Inc. (DNG:TSX), which is a toll miller. It doesn't mine, rather it
buys ore from local artisanal miners and processes it. The company has done
very well, having generated profits in every year of the precious metals bear
market and having grown its business. Dynacor has no debt, a tight share
structure and rapid growth potential. We cannot simply attribute Dynacor's
success to its model�after all, Inca One Gold
Corp. (IO:TSX.V) is struggling with a similar approach�but we must
attribute at least some of the company's success to the aforementioned
benefits of focusing on a smaller-than-normal piece of the value-add chain.
There are two start-ups that I like that employ a somewhat similar model.
More important, their management teams developed models geared toward
mitigating timeline and capital risks. Great Lakes Graphite is buying
graphite that it will process at its Matheson, Ontario, micronization
facility. Micronized graphite is a saleable product or it can be further
processed into material that is used in, among other things, lithium ion
batteries. The company is selling graphite even while other non-producing
companies got a 2+ year head start. The one thing these competitors have in common
is that they are all looking to build mines and participate in a larger piece
of the value-add chain: from ore in the ground to processed graphite ready
for industry. The capex estimates for these projects are consistently above
$25 million, usually above $100 million, and sometimes even above $250
million�quite a large fraction of the value of the entire graphite market.
Medallion Resources is looking to purchase monazite sand�a rare-earth
phosphate mineral that is concentrated as a byproduct during heavy mineral
sands mining operations. Heavy mineral sands are beach sands that are mined
and processed for the production of titanium, zirconium and hafnium, among
other things. This monazite material is treated as tailings, though it
contains a much higher percentage of rare earths than any rare-earth mine or
proposed mine. It has also been processed for its rare earths and thorium in
the past, meaning the processes are known and the operating risk is
mitigated.
Invest Passively In Projects
The second approach is to invest passively in projects. Usually this means
holding a royalty or a stream, though it can also be a free carried interest
in a project. Royalty and streaming companies come with several advantages,
and the performance of the major players' stocks over the long-run speaks to
this. But what makes the model�as opposed to the asset qualities�attractive
from a derisking/simplification standpoint is the fact that streaming
companies don't have to put up any capital once they've acquired the
royalty/stream, except when it is specified and agreed to by the
royalty/streaming company (usually to help finance a project expansion [e.g.,
Silver
Wheaton Corp.'s (SLW:TSX; SLW:NYSE) Salobo stream]). Royalty and
streaming companies benefit from all of the capital expenditures by its
mining partners for as long as there is production or some other form of
development. The mining companies do the development work and assume the risk
of cost uncertainty, while the royalty/streaming partner has no capital costs
and fixed, low/no operating costs.
Get In Early!
Companies that have been successful in developing non-conventional resource
businesses have seen tremendous investor enthusiasm. We've discussed Dynacor
and the major royalty companies, all of which have generated outsized
long-term returns and appear on resource investors' radars.
But when such companies are early stage the market tends to overlook them.
Investors in early-stage companies want something familiar, and for junior
resource investors this means the explore-develop-produce model. If they are
looking at an early-stage junior then what is familiar is generally a deposit
or a geological anomaly that indicates that there is a heightened probability
of finding a deposit. A toll processor such as Dynacor or a graphite
processing and marketing company such as Great Lakes Graphite cannot show
this to the market (both companies actually have exploration projects, though
the development of these projects is peripheral to their respective business
plans). In addition to the fact that these non-conventional companies
actively work to mitigate certain risk factors, this heightened potential for
investors to overlook such stories can create market disparities worth
exploiting.
The Bottom Line
While resource investors are drawn to companies that work within a standard
explore-develop-produce model, there are excellent opportunities in companies
that don't utilize this model. Companies develop new models, for the most
part, to combat the capital and timeline risks that come with the standard
model. There are various approaches, of which we think two are worth your
consideration. The first is to purchase material, rather than mine it, for
further processing and marketing. The second is to invest passively in
projects being developed via the conventional explore-develop-produce model,
such as through a royalty, stream, or (rarer) via a free carried interest.
These are certainly not risk-free approaches, but they do address the
aforementioned capital and/or timeline risks, indicating that such businesses
are inherently less risky, at least from a general standpoint. An added risk
is that the advantages that are apparent to us are not readily recognized by
or marketable to investors, but this is a double edged sword as it means
there are hidden gems waiting to be found by those willing to step outside of
the box and look for them.
Ben Kramer-Miller is the chief analyst at miningWEALTH.
He is well respected for his unique ability to find under-the-radar precious
metals opportunities, as well as for his extensive research into rare earth
elements and other critical materials. His research has been featured by
Nasdaq, Kitco, Mining.com, The Financial Post, The Globe and Mail,
Investing News Network and RealClearDefense, among others.
Disclosure:1) Ben Kramer-Miller: I, or members of my immediate
household or family, own shares of the following companies mentioned in this
article: Silver Wheaton Corp., Great Lakes Graphite Inc. and Medallion
Resources Ltd. I personally am, or members of my immediate household or
family are, paid by the following companies mentioned in this article: None.
My company has a financial relationship with the following companies
mentioned in this article: None. I determined which companies would be
included in this article based on my research and understanding of the
sector.
2) The following companies mentioned in this article are sponsors of
Streetwise Reports: Silver Wheaton Corp., Tahoe Resources Inc. and Terraco
Gold Corp. The companies mentioned in this article were not involved in any
aspect of the article preparation. Streetwise Reports does not accept stock
in exchange for its services. The information provided above is for
informational purposes only and is not a recommendation to buy or sell any
security.
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