2011 ushered in a wave of devastating hits to the junior end of the mining market. For nearly the past decade it has remained pillaged. The junior gold market, as measured by the GDX-J, in its entirety is down by around 82%. This decline in the index only captures part of the loss of value within the industry. In 2017, the GDX-J was rebalanced to include larger cap companies, moving the junior index further upmarket. With the growth of the ETF market and the decline in the mining market, the GDX-J began to push the restrictions of their ownership thresholds. The fund managers had a choice: (1) close the fund, or (2) change the definition of a junior gold company. As many in the financial industry know, you can never let logic get in the way of making money; so they changed the definition of what is a junior mining company. This change further served the interest of the ETF fund managers as it allowed them to increase the size of the fund and thereby increase their revenue. This change also resulted in many of the real junior gold stocks orphaned by the market.
During this time, retail investors switched from investing into mining funds to an ETF strategy (indexing), which separated the market into the haves and have-nots. Companies that qualify for an ETF have significantly more liquidity than those that do not. Most sophisticated investors have a stigma against mining as an asset class, seeing it as an unworthy investment. Mark Twain once said that a mine is “a hole in the ground with a liar on top”; many investors maintain this sentiment. Investors looking for a more speculative investment path moved on trend into the Cannabis, Bitcoin, and other Block Chain technology sectors. The culmination of these factors has left us where we are today – with an abandoned junior gold market.
Thus, the massive decline in the GDXJ over the past 8 years is actually a very understated figure. The reported 82% decline only represents the fall of the best performing junior gold mining companies while excluding and therefore orphaning those who did not meet the ETF’s thresholds. There are around 1,025 companies on the TSX and TSX-V that call themselves mining companies and have a market cap of US$75 million or less but have an average market cap of US$11.6 million. Looking closer at the small-cap miners, they are down significantly more than the 82% represented by the GDX-J decline. The combination of the rise of the ETFs and the upmarket move of the junior gold index has created a dislocation of value, as capital has fled the most capital needy projects.
To understand the full scope of dislocation, we first need to look back further. From 2001 until 2010, the metals’ price bull market prompted significant investment into the mining industry. The industry, however, was not well positioned to handle it. A significant number of mining companies made grave errors such as incorrect interpretation of scientific data and poor execution on projects. These errors were amplified by tremendous inflationary pressures on mining labour, equipment, and a shortage of skilled professionals. In turn, oversights were also made by the investment community; chasing returns and giving money to the wrong people at the wrong time. Many of these deals were funded using a high-pressure selling tactic called the “bought deal”, putting unnecessary stress on investors to chase deals without the required due diligence. Suffice to say that everyone made mistakes and the whole industry paid the price.
As someone who has been an investor, an investment banker, and CEO of an operating mining company, I have always been amazed at the disconnect between the mining industry, the investors in the mining industry, and capital markets that support it. It is all a bit of a game. Bankers and the investment community like good stories. The better the story, the easier it is to raise money. While sometimes they send an analyst or geologist to the project; usually little to no real due diligence is done. CEO’s become talking heads, spreading the word about their investment opportunities as if there are no real challenges other than raising the money. Deals are done, commissions are paid, and then problems begin. When the real difficulties emerge, no one takes responsibility. The company says that they “did not know”, pleading ignorance. The bankers support the mining company’s management, and the investors accuse management of lying. The truth is that mining is a very complex business. There are many moving parts, and a project can easily fall off the rails if not properly managed. Significant skills are required to “get it right”. No one in the mining business possesses all the skills. When done right, mining is a team sport. The key to success in mining is to know what you do not know. Acquiring this knowledge is the byproduct of the right tools and a capable team.
Industry players do not do transactions without significant due diligence. Whether a stream, debt instrument, equity placement or a takeover, confidentiality agreements (CA’s) are signed. Data is then exchanged, and significant work is completed before investing. Companies often have a due diligence team of five or six individuals analyzing a project. Public market investors, on the other hand, must rely on publicly available information. If corporate disclosures are so thorough, why do serious industry players not depend on it? The truth is that the publicly available information is not comprehensive. As a response to the Bre-X fraud, regulators have created technical studies called 43-101 reports. These regulated documents all have the same professional look and cover the same standard material. Unfortunately, the professionalism of these studies’ only goes veneer-deep, and they are only as sound as the assumptions that go into them. Many of them are complete shams or are just poorly composed and grossly optimistic. These reports have become less and less about creating an accurate technical study and more about producing a “best-case scenario” manual. The result is a situation where by most investors have voted to leave the industry rather than continue to get beaten by the market. This provides us with an opportunity as many of the underlying securities are now priced at a deep discount; levels that have not been seen since the financial crisis in 2009.
Dundee Goodman Merchant Partners was created to capitalize on this opportunity. We are investors who plan to make money by making solid investments. In a regulated environment, a 20% ownership level is as far as you can go before losing significant liquidity. To that end, we will need like-minded partners to represent the other 80%. We have chosen a partnership model over a sales-driven transaction model because we don’t agree in asking anyone to invest in a deal unless we are investing significantly as well. We will sign the CA, do the due diligence, participate in goo governance and work with the company and co-investors to create investments that put the needs of the asset first. Interests must be aligned from the investor through to field geologists. To make this work, we have created a dream team of industry and financial professionals with over 200 years of combined experience in the mining and mining investment sectors. At Dundee Goodman Merchant Partners, we see this as a generational opportunity. We are engineers, geologists, environmental experts, and financial experts. We understand the risks that a mining project may encounter and are prepared to partner with companies to help them raise money and de-risk their projects. To achieve success, we need to make a return on our investments; this aligns our interests with those who co-invest with us in our deals. It is our fundamental belief that to make money in this industry; you need good projects, good people and complete alignment of interests so that everyone either succeeds or fails together.
