Before the wave of COVID-19 enveloped global markets, released a barrage of fiscal policy dynamism, and set employment tumbling, the mining sector – particularly the equities with a precious metals orientation – had witnessed heightened market interest. This was led by operational performances from larger producers in a commodity price environment showing an upward trajectory. Luckily, investor interest in the junior explorers has begun to blossom again and is filtering into the equity markets. Such an impact is, in part, a consequence of GDX and GDXJ outperformance of more broad indices, particularly since March 2020 (see Figure 1).
We believe that precious metals development and exploration companies, particularly those domiciled in first-world jurisdictions, are moving towards an appreciable return of market interest and participation: something not seen in a concerted way for some time. The pathway to this ‘jumping up’ point has been a harmonic culmination of fundamental sector performance (e.g., operations, balance sheet, and sector consolidation) and commodity price leading to equity market participation.
An important aspect to consider in this reorientation is that the sector is managed in a significantly different manner now than during the previous boom. The change has been organic and has taken the necessary time to adjust to new ‘balance sheet’-oriented outcomes. As a result, broad-based demand in the precious metals sector has focused on a top-down look for leverage to the gold price, as investors focused on larger producers with performance history, balance sheet health, and a propensity to return cash to the shareholder via delivering dividends. This interest was arguably seeded by many of the Australian-listed producers (e.g., NST-ASX, KLA-ASX, and EVN-ASX with a few exceptions) some years ago, but lately they have been joined by select North American-listed producers (e.g., BTO-TSX) who have delivered operational plans fostering dividend initiation and/or growth.
As a consequence of industry reorientation and a lack of external funding sources, this sector has been largely one of autogenous growth whereby funding for exploration has been underpinned by producers and other select groups. This ‘self-funding’ mode has led to progressive atrophy in gross exploration expenditure, and also atrophy in participant diversity in exploration, resulting in less grassroots-driven work being carried out (see Figure 2).
Furthermore, concurrent growing shareholder confidence in select producers – mainly operations and balance sheet driven – has been a driver for rekindling of interest in M&A. This wave of M&A action has been largely enjoyed by the senior and intermediate producers who are looking to augment their asset portfolios and improve costs, while improving corporate liquidity and streamlining G&A structures (see Figure 3). With little debate, the focus has been on assets domiciled in first-world jurisdictions, with the early outperformers (largely ASX-listed companies in recent past with solid positive ROIC-WACC spreads; e.g., NST-ASX) using equity and balance strength to add to their portfolios, either at home or in North America. Such action over the last two or so years has led to the concentration of senior producers and the decimation of the sizeable, single asset-producing companies.
Looking at 2020 so far, we’ve seen a year that started on the wave-front of gold price momentum (primarily underpinned by concerns of global recession) and fragile global growth. Since then, the situation has been compounded by the emergence of an unprecedented pandemic crisis. So far, no light has been shed on how the critically injured global economy – hemorrhaging despite a plethora of fast-flung fiscal Band-Aids – will recover. While the human population is looking forward to reaching escape velocity beyond COVID-19, triage is still being performed on employment and demand profiles to bolster future fiscal incomes. With this in mind, risk tolerance has moderated, and attention has been turned to ‘safe haven’ investments (e.g., gold and gold-related equities).
“We believe that now is the time for leverage and investment in the precious metals sector, particularly regarding smaller-scale producers and development-stage to exploration-stage companies.”
Considering the investor mindset evolution and a renewed vigor for precious metals, we expect that further consolidation is set to emerge. Catalysts signifying further consolidation include pure resource augmentation (proximal to headframes and infrastructure), portfolio optimization and asset divestiture (right sizing for operation’s performance and capital deployment), and down-stream consolidation of smaller producers to heighten production and asset profiles, and strengthen market liquidity.
In this context, we believe that now is the time for leverage and investment in the precious metals sector, particularly regarding smaller-scale producers and development-stage to exploration-stage companies. However, most importantly, we believe that focus should be placed on companies with the capacity to execute in this COVID-19 environment, from the drill bit to the mine face.