A Junior Mining Upswing
As with the period following the 2008 GFC, the junior mining and exploration sector has experienced a large upswing since the March 2020 COVID-crisis lows. Austex Resource Opportunities reports that the average share price rise of the 631 mining and oil and gas exploration companies (‘5B reporting’ resource companies) listed on the ASX in the 6 months leading up to 6th November 2020 was 106.1%. Of this, the largest rises were seen in the AUD 28-90m market capitalisation group, which is up over 130%. Spectacular share price rises from companies such as De Grey Mining (DEG.ASX) – up over 40x in 2020 from a 52-week low – exemplify the performance.
Gold is the sub-sector which has seen the largest share price rises of ASX-listed exploration companies in the past 12 months (+135%). Nickel and high-purity alumina exploration companies have also outperformed (+124%), as have copper explorers (+87.5%). Lowell Resources Fund, an ASX-listed junior resources investment fund, is up over 160%. The average enterprise value of ASX exploration companies has increased 65% in the past 12 months.
In contrast to the 135% rise in ASX gold exploration companies, the large producers have not seen such increases. For example, the VanEck Vectors Gold Miners ETF (GDX), which comprises the world’s largest gold miners such as Newmont and Barrick, is up around 52% in the same timeframe. It’s still a substantial rise, but the exceptional performance this year has been in the exploration sector.
As a result of the renewed interest in the sector, junior resource company capital raisings have also surged. Austex reports that new capital raisings by ASX exploration companies totalled nearly AUD 1.9bn for the September 2020 quarter, which was up 70% on the AUD 1.11bn raised in Q3 2019. That’s almost double the average amount raised for each quarter over the past five years.
So, what is driving this resurgence in the junior resources sector?
Commodity prices form the basis of profitability for producing mining companies and the potential for explorers and developers. The rise in key metal prices and the fall in the cost of energy have been major contributors to renewed interest in the mining sector.
The major ingredients of infrastructure development – copper and iron ore – have seen significant price rises over the past 12 months due to strong demand out of China. Copper (in US dollar terms) is up 14% over the past year and has climbed roughly 60% from its late-March low. Iron ore has boomed, with the USD price increasing over 30%.
China has weathered the COVID-19 pandemic in better economic shape than any other large economy. China now accounts for more than 50% of demand in steel and copper, and it is the only major economy the International Monetary Fund expects to see expand in 2020. China’s industrial production rose 6.9% in September YoY.
A number of major metal-producing countries have been hit hard by the pandemic, leading to pressures on mine supply. For example, volumes of exported mining products in Peru, the world’s second largest copper producer, fell 40% and Peruvian shipments of copper fell 47.5% (both in September YoY).
Similarly, production of iron ore in Brazil, the world’s second largest producer, has been impacted by COVID-19 as well as by regulatory shuttering due to tailings dam failures. H1 2020 iron ore production by Vale, Brazil’s largest miner, was down over 30% compared to the half year in 2018.
In other metals, reduced Peruvian zinc production has pushed the zinc price up 50% since March. This has forced major Chinese zinc buyers to call for the establishment of a joint organisation of Chinese zinc smelters to negotiate with miners on zinc concentrate supply and pricing.
Aiding the profitability of metal miners, the oil price has languished for much of 2020, with oil futures even plunging into negative territory this year. Fuel can comprise up to 40% of a metal mine’s operating costs, so low oil prices help to open up profit margins for hard rock miners.
While gold is much less influenced by supply and demand than base metals, the total supply of gold fell 3% YoY in Q3 to 1,224t. At the same time, 2020 has seen record buying by exchange traded funds, with year-to-date flows into gold-backed ETFs amounting to 1,003t by Q3 according to the World Gold Council.
The Effect of Low Interest Rates
In August 2020, real US interest rates (nominal rates minus inflation) hit the lowest point in at least 20 years, coinciding with the all-time record gold price of over USD 2,050/oz. Low interest rates have a “double whammy” effect on gold explorers because they
ower the opportunity cost of holding zero-yield bearing investments. As a result, investors suffer little or no loss of income by switching from term deposits into gold. Furthermore, investing in exploration stocks, which generally have no revenue, also does not penalise an investor vis-a-vis holding cash. We have seen a similar phenomenon contribute to the exponential share price rises of growth stocks such as the situation with the FAANG+ group on the Nasdaq. Interestingly, there has been a reasonable correlation with mineral exploration share prices and the Nasdaq this year.
The “Robinhood” Factor
The rise in the share prices of growth stocks has correlated with a surge in new, potentially more speculative investors entering the market. In May, CNBC reported that major North American online brokers Charles Schwab, TD Ameritrade, Etrade, and Robinhood saw new accounts grow as much as 170% in the first quarter of 2020. In August, the Australian Financial Review reported that Commsec had signed up 400,000 new customers in 2020, which is around 2.5 times the normal annual rate. Some have hypothesised, not completely in jest, that these accounts were opened by punters deprived of sport to bet on during lockdowns. Other reasons may be a new generation of investors with time on their hands turning to the share market due to fewer alternatives on which to spend discretionary cash.
M&A – Cash Build in Operating Mining Companies
High profit margins for producing mining companies, in particular gold miners, have resulted in substantial cash building up on their balance sheets. The largest gold miners, Barrick and Newmont, are forecast by UBS to produce nearly USD 6bn of free cashflow in 2021. In FY 2020, free cashflow from the ASX top 10 gold producers (ex NCM) was AUD 1.7bn.
The cash build in the larger companies, and the pressure on these companies to grow, results in a “trickle-down effect” on the exploration sector, which is an obvious place to look for growth. We have seen mergers and acquisitions activity increasing across the gold sector, from ‘mega mergers’ such as Saracen and Northern Star, to local acquisitions such as those by Ramelius of Spectrum and Explaurum, to the Chinese-Russian battle for Cardinal’s 5Moz gold reserve in Ghana.
Where To Next?
It is likely that most of the key drivers of the resurgence in the junior resources sector will be with us for some time. Nominal interest rates are projected to stay very low for a number of years, whilst inflation may push real interest rates even lower. This is supportive for gold, other real assets, and non-yielding growth stocks. As a result, the future looks bright for the junior mining sector.
The cash build in the larger companies, and the pressure on these companies to grow, results in a “trickle-down effect” on the exploration sector, which is an obvious place to look for growth.