We saw that exploration budgets were up slightly in 2022. What do you see happening as we progress through 2023?
We need to look back at the longer-term cycle of the industry. The industry went through a significant market period between 2002 and 2012 where exploration budgets blew way over previous levels. This led to an overshooting in the market.
Then in the subsequent six-year bear market of 2018, when gold prices consolidated lower, the market was very negative towards mining companies, believing that they were overspending their budgets and that they had leveraged their balance sheets.
So, the mining companies retreated into lowering operating costs, trying to pay down debt, restoring their balance sheets, and surviving this dramatic bear market and downturn in the industry. According to market intelligence data, initial resources announced in the last two years were less than a third of those announced in 2012. So, it shows that this dramatic cutback on capital expenditure in exploration spending has resulted in less resources coming through the market.
And obviously that impacts the reserve replenishment ratios of most companies and the size of deposits that are being brought to market.
So, it’s only in the last couple of years that we have seen a little bit of recovery in exploration activity and a rise in the budgets. But again, it is by no means anything close to what we saw in 2012.
For those that are financing exploration projects, where is the money coming from?
Well, it is still a very sensitive market, I would say, where we have seen gold prices consolidate or trading sideways for the last year and a half now, which was a surprise to many following the Russian invasion in Ukraine and the geopolitical tensions and risks rising globally. Most of us would have thought that gold as a safe haven would rise significantly higher.
It’s also that investors have been very cautious about the mining companies. And we only see specialist investors participating in financings and willing to provide capital for development projects.
And it is needless to say that most investors still shy away from grassroots explorations.
As the cycle develops, there will be a lot more capital coming back into the sector
Is the interest in the brownfield projects mostly due to that risk aversion by investors?
Precisely. Investors focus on existing discoveries or past producing operations that can be restructured and brought back into production if there is a clear economic viability analysis that demonstrates that the costs of bringing them back to production are modest in relation to the value of the production profile.
And in addition to that, we have also had the impact of high inflation in recent months because of commodity prices across the board rising. And also, the logistics breakdown in the world which as we know have resulted in delays in provision of equipment. Hence, the development of brownfield projects is even being hampered by higher costs of development, but also potential delays in implementation.
In past years we saw quite a bit of large scale M&A activity from the larger gold mining groups. Is this the way forward then for these smaller companies?
I think corporate activity in the sector goes hand in hand with the sentiment of the investment community. And, obviously, when we see generalist investors standing back and not willing to participate by investing in the midcap companies, management teams also tend to be more defensive and guarded.
So far in the last couple of years we have seen some mega mergers among the majors, which in my mind, do not really result in any operational efficiencies and operational cost improvements. It’s more a case of growing in size, having a greater diversity of operations, lowering risks, being able to return capital to investors, which is what investors have demanded.
But we haven’t seen participation in corporate activity by the midcap producers. And this has been a little bit of a puzzle, because most producing companies now have strong balance sheets that generate very healthy free cash-flows because commodity prices for precious metals are relatively high compared to the long-term historical averages.
Therefore, many midcap producing companies have significant capital to deploy for corporate transactions. And in addition to that, we can see that most of these companies suffer from the so-called reserve replenishment, i.e., they produce more than they find, and therefore the life of mine on average as corporates tends to be shrinking. So, I believe it’s a confluence of events, it’s a function of the investor sentiment.
The topic of ESG has been coming up quite a bit around impacting investment decision making. Do you see this question about gold’s use or role within the energy transition impacting investor interest?
Yes, it has a significant impact, but I believe that ESG and the very negative connotations against gold mining was a theme of 2018 and 2019. And that was the height of this ESG movement when many large funds decided they wouldn’t invest in mining projects, or they wouldn’t invest in oil and gas because of the negative impact to the environment, being considered as heavily polluting industries.
And it was particularly negative on gold mining because gold is seen as a non-essential commodity to global economic activity. Rather, it is considered a safe-haven financial asset.
So we saw some fairly negative backlash, but the gold mining sector listened and most companies have taken very, very strong actions to present a better ESG profile. In all the elements of ESG, environment, social, and governance. And we believe now that most of the companies follow best practice, they are managing to reduce their emissions and optimize their operations.
They are contributing a lot to the local stakeholders in society by engaging in development programmes in the region of their operations. And they have strengthened the governance of their operations with responsible and independent parties who are able to encourage the best adherence to ESG principles.
For juniors looking to raise cash for exploration programmes, what are their options and where do you see the market as we progress through the year?
The market has improved dramatically in the last three to four months. We went through a very severe bear market in 2022 that saw a bottoming out process during the summer. And come September, October, obviously gold prices recovered and therefore so did the outlook for the mining companies, including exploration or development of brownfield projects, so to speak.
But financing is still scarce. Non-debt financing for development projects is still tough to structure. Financiers are aware of the potential delays in the supply of equipment. They tend to factor-in large contingencies for cost inflation. So these aspects make financing more expensive, require more equity from the sponsoring company, and involve multiple structures of debt mezzanine and various tiers of collateral.
It’s still not an easy market, there’s not a lot of capital available for the mining sector. I think as the cycle develops, there will be a lot more capital coming back into the sector but nowhere in the region of the heights we saw in 2010 to 2012.
