Q&A with Julian Babarczy, Founder and Chief Investment Officer, Jigsaw Investments
You’ve had a long career in the industry, covering both the investment and the corporate leadership side. Can you share where your current focus is?
I left the funds management industry about five years ago, after spending about 15 years at a fund in Sydney, covering predominantly natural resources and also a lot of other sectors. It was a very exciting time to be a part of a successful and fast-growing fund, but there came a time where I wanted to get far more involved in the companies I was investing in, rather than what a fund generally requires, which is to have a high number of positions but stay at a higher level on each. So, since leaving that fund, I set up Jigsaw Investments with the view to taking a much more involved and active/ hands on role at the companies I invest in.
So my portfolio is now structured with some relatively passive investments and a larger weighting towards investments I am deeply involved in, and in some cases, operational within the business. I also have a mix of earlier stage companies through to later stage and more established companies, to provide some balance.
I’ve been a big believer in the critical minerals space for quite some time and have definitely tilted my portfolio towards that. So really my focus in the past few years has been to position myself as more hands on in helping to run and grow these companies with a view to ultimately being a key part of building some substantial sized companies on the back of good assets with good management teams.
What do you see are some of the biggest risks and corresponding impacts on the metals and mining industry today?
The biggest risk that underlies investing in the minerals and mining space is the price volatility of the commodities. That is always going to be a major determinant of the assessment of value of any company in the sector. So, while it’s a difficult art to call the direction of commodity prices in the short term, it’s something you have to have a view if you’re going to invest in the space, or alternatively, just take a much longer-term (3-5 year) investment horizon which ideally smooths out the short term fluctations.
So, while price volatility has been a big factor, inflation is another big theme that has dominated investment returns around the world over the last five years as well. We’ve had rates go up from virtually nothing to something a lot more than that in an attempt to tackle inflation, which has understandably had a big impact on the mining industry. Cost inflation has been high for mining companies, despite it generally always being a constant in the mining space, where it tends to consistently push cost curves up over time, which flows back through to impacts commodity prices because the marginal price tends to come out at a higher and higher level over time, which generally supports commodity prices. So cost inflation has been one of the real thematics in recent years.
Geopolitics is and remains a significant issue for the industry as well. Supply chain disruptions, supply chain onshoring, certainty of supply chains: these are some of the biggest thematics at the moment. When the Biden administration took office in 2020, they determined that they wanted a lot more clean energy, which meant that the globe was going to be more reliant on legacy supply chains for those commodities, built predominantly out of China. And then with Trump coming in, there’s been a real change in sentiment and a shift back towards wanting to onshore or have security of supply outside of some of these dominant Chinese supply chains. We do see some real risk that China may turn the tap off on their exports of some of these key critical minerals which they dominate. As a result, we’ve seen a growing trend for consumers of critical minerals to develop supply chains that don’t touch Asia or China and are more embedded within the US, for example, and that’s creating some distortions in markets and creating opportunities in others.
With Trump’s administration, we see this growing focus on regionalizing supply chains that is really impacting the critical mineral space particularly. What are some of the key impacts?
I think when Trump came into office everyone expected he would focus less on clean energy and more on the traditional hydrocarbon industry, with policies aimed at resuscitating and supporting further US onshore oil production. And while he has definitely has done that, he has also taken some actions around actively deemphasising clean energy, such as taking away EV mandates and those sort of things. But I think his actions have also suggested that his administration is actually very keen to stimulate more critical minerals into the US as well. So while I think that at first people thought it was going to be quite negative for critical minerals, what we’re actually seeing now is proactive steps from the US administration to secure supply of critical minerals, a case in point being the recent move by Department of Energy to underwrite supply of rare earths from MP Materials which is the only US producer of these critical rare earth elements.
At the same time, I think you’ve seen a general slowdown in supply response. There was huge supply response in some of these commodities, particularly lithium, a number of years ago that overwhelmed what was a relatively small market at the time and I think we’ve seen a lot of supply get taken out of the market as prices have fallen. So the higher cost tonnes have come out and that’s been going on for some time and I think we’re seeing a phase of rebalance now. Lithium, for example, is going through somewhat of a mini renaissance, which for those of us who’ve been waiting for the turn, it’s quite heartening to see.
It did feel like everyone was on the momentum trade lower for some of these commodities, with a lot of shorts built up in in some of the listed companies betting that supply would continue to keep prices low, but I think prices got to a point where they were just far too low, where even the highest quality production volume in the market at the lower end of the cost curve was struggling to make much profit.
So, what we’re seeing now is natural normalization of conditions and an environment where good quality mines and exploration projects can actually attract capital again, where greenfields and brownfields expansion can occur and so I think it’s a relatively positive outlook now for a lot more of these critical minerals commodities, much more positive than it was even six or 12 months ago.
Do you see investment going into the critical mineral space in order to help grow the supply of these much needed minerals?
The fact is it does need to happen and without it you just won’t get the required supply response. One of the issues the industry has faced is the harsh reality that critical minerals tend to be akin to, or actually are, industrial minerals. So the product specifications are quite diverse on what different customers want. What that means is that there’s no standardization of indexes or pricing. Most are very opaque markets, and in an opaque market, it’s very hard for bankers and others to fund projects because they’re not quite sure of the specifics of the product quality that mining companies are selling or the projects they’re developing because there’s no exchange traded and standardised pricing in the critical mineral space that can be benchmarked.
It also makes it more challenging to do forward sales and other funding techniques that often de-risk projects and allow capital to flow into an industry. What that’s meant is that there’s been much more confusion and price volatility than what most people would expect, which ultimately means that the industry, being end users of the product, have to step in and fund specific projects because the market frequently finds assessing the projects challenging. So we need the participants within the supply chain to write offtakes at relatively good pricing levels, otherwise new supply won’t come to market. We also now often require end users to prepay some of those offtake funding arrangements to allow companies to attract additional equity capital in parallel. So, overall, it means just been a much more complicated funding process which prohibits new projects progressing and slows supply responses much more than in traditional commodity markets.
As the industry matures, we’ll hopefully get more standardization in pricing and more visible indexes which have decent liquidity, so people can rely on the prices that are visible, and that, ultimately, will embolden equity investors to get behind some of the companies in the critical minerals commodities sectors a bit more. Ultimately, the sectors should mature to the point where more traditional banks and other funding group should be able to fund and provide traditional debt structures, which is typically an essential and valid source of capital as part of the funding stack.
Policy stability is another area that probably needs a little bit of work. A reminder that these critical minerals are immature commodity markets, they’re very small, niche markets and as policy matures, we’ll get a much more benign funding environment, with less volatility that will make capital much easier to flow into the sector and stay there for longer periods of time. A lot of more traditional investors look at some of these niche commodities and, frankly, they get frightened at the volatility around some of the moves within the commodity market or the share prices of the companies themselves.
The last aspect that probably needs to be seen to get more people back into some of these sectors is the industry itself, the end users and offtakers, assisting with making it easier for some of these projects to get funded. Everyone seems to want supply sources for critical minerals that are outside the Chinese supply chain, which makes sense for security of supply. But the problem is customers typically want to pay the prevailing Chinese price, which in many respects is too low to incentivize the supply outside of China from these new projects. What we need to see is the industry being a bit more mature and writing contracts for new production that is above the spot price, with the aim of incentivising supply, which will ultimately ensure that there’s additional tonnes coming from more international supply chains. So, it’s a multifaceted approach just around giving greater confidence to both debt and equity investors to be able to take a longer duration bet on some of these commodities and the companies within the sector with the new and emerging projects.
You’ve talked a lot about de-risking investments and projects for investors. How can investors be a little bit more sure about where they’re putting their money?
That’s always the difficult thing. There are protections in the listed space with the JORC code and in other major commodity markets like Canada there is the NI 43101 code, which are quite prescriptive on the rules around how companies announce results, etc. And that gives some certainty and protection to investors.
But overall, it really comes down to investors looking for higher asset quality because if they’re unsure or it’s a sector they don’t know too intimately, then asset quality is typically best as a risk mitigation strategy. Having higher grades typically leads to lower cost production costs, which gives the project a larger buffer to weather any price volatility. So asset quality should be very high on the list of “must haves” for investors reviewing listed companies.
Commodity mix is also key. We would all like to stay pure in our thinking and invest in and develop good projects, irrespective of the commodity, but the harsh reality is that investment markets tend to crowd into what’s hot at any given time. And so to attract capital through the cycle often means you either need to be a bit lucky to be in the right commodity at the right time, or alternatively, you take a multi commodity approach, which is what some of my companies have taken, where you have a number of different “shots on goal” and therefore are able to continue to source funding through the cycle. This allows these companies to continue moving forward on all projects because it allows you to allocate capital at the bottom of the cycle, meaning that you’re likely in a position to capitalize when markets turn.
Other aspects investors should focus on are strong management teams and strong boards with experience in managing companies through various cycles. Another element is to look for companies with low and frugal cost bases, which suggests they can weather downturns better. Also, companies that take the right actions to reduce cost during downturns rather than just keep diluting investors is also a trait that should be sought out.
So, in summary, it’s really looking for that mix of asset quality, commodity mix, and strong management that ultimately that will lead to capital being raised and projects being developed. Being able to raise capital is the lifeblood of small mining companies who aren’t in production yet, so backing companies with that ability to raise through the cycle really is key.
How are ASX listed juniors faring right now in terms of investment?
I wouldn’t say it’s easy at the moment, unless you’re a gold producer of course! Gold is a very hot commodity now, underpinned by all the geopolitical risks and the devaluation of the US dollar, etc. All this suggests that gold is likely to stay relatively robust. We’re seeing a relative ease in raising capital for gold companies and I think that’s likely to continue.
There are green shoots though in other areas of the market as well. In lithium and other critical minerals, there has been a genuine downturn for a couple of years, and I think we’re seeing that start to turn more positive now. Supply has been taken out of the market, and I think stockpiles have run down in many respects as well. And in the background, you’ve just seen very solid demand continue to chug away. That’s one of the reasons I’m quite attracted to the critical minerals space, because despite all the negative hype, the demand profile is still very strong, in some cases growing anywhere between five and 15% per annum (or more), and it doesn’t take many years for that to grow into much larger numbers of incremental supply that’s needed.
So I think we’re seeing now that the commodity price reductions in recent years led to higher cost production coming out of some of these markets and not enough new supply coming on, which has meant that there’s a genuine shortage growing now.
One of the hallmarks of the market at the moment is a lot of niche commodities are really having their day in the sun. And some examples there are things like antimony. I don’t think many investors knew what that was a couple of years ago, and now we’ve got a number of small niche companies on the ASX that have got relatively decent valuations because these are commodities that everyone presumed they could get from China when they needed, but now that China has restricted supply, there’s a sudden shortage, so there’s a real chase to get hold of some of the companies who are operating in these areas.
Another area is cesium. One of my companies, Perpetual, has got some interesting cesium hits at its project in the Lithium Valley in Brazil, and again, this is a commodity that the market knew very little of previously and is starting to realise the potential of.
At times the market swings towards backing the very well-known bulk commodities or the exchange-traded commodities, but it does feel like a more of a niche commodity focus at the moment. Although I would say that copper is another commodity where there is genuine and wide-held belief that the price is going to remain strong and probably keep going higher, and as a result, investors are chasing companies in this sector, despite having very few ways to play the theme on the ASX and so copper exploration and development companies seem to be getting a lot of attention as well.
What’s your outlook for the next 12-24 months in terms of the commodities markets, and what do you think the industry should be on the lookout for moving forward?
At a very high and thematic level, I think the commodity sector is underappreciated relative to other parts of the market. I think we’re all aware of the “Magnificent Six” in America, these tech companies that are trading at all time highs. Now, don’t get me wrong, they’re brilliant companies that generate staggering amount of free cash, but in terms of a valuation argument, some if not all of them are trading at multiples that just don’t appear sustainable. At the same time, you’ve seen the complete opposite happening in the commodity markets, with a significant de-rating over multiple years. So the rubber band does feel very stretched in as much as commodities and commodity stocks are grossly under-owned and some of these big tech companies are grossly over-owned. What is common at points like this is that we see reversals in relative valuations, and so I would expect that the incremental dollar is likely to, at some point soon, to start to flow into commodities, which means the outlook over the next year or two is likely to be much better than the last couple of years and will support investment returns in the sector.
At the same time, we’re seeing commodity prices bottom out and go higher. We’re seeing some real green shoots. But, like all commodity investing, it’s going to be volatile! We all know that that’s the hallmark of commodities and no matter what we think will happen to pricing and sentiment, we should also be reminded there will always be some mini cycles within the larger move as well.
I also think we’ll see much more M&A in the next year or two, particularly as commodity markets improve. The strong companies will probably re-rate faster and that will create opportunities for them to use their relatively overpriced script to buy underperforming assets, underperforming companies, or companies that haven’t re-rated yet. There’s a lot of companies that lack capital, and so those with access to capital should be taking advantage of that.
The other theme is just the ongoing policy shifts we’ll see around critical minerals and supply chains, which I think will support the sector for some time to come.
