Four big things to understand in mining

As you know, I have a passion for geology.

Several conferences and many new geologist friends later, I am enrolled in university as a mature-age student to study rocks.

These days, I’m a significantly better analyst in the exploration sector because I understand the rocks underground better.

While it’s helpful to know your magmatic from your hydrothermal ore bodies, these aren’t the most important things to know when investing in mining companies.

In fact, depending on what stage of the mining cycle a firm is in, there are four big things that you should understand before investing any money in a mining stock.

Interestingly, none of these big things really involve geology (or complicated spreadsheets).

Ask yourself, is it old or new ground?

Mining is largely trial and error. No one really knows what’s underground until the rocks come up above ground.

Investing in miners is pretty much the same. You can never be certain that a certain junior mining stock’s share price is going to take off. Or that they’ll find anything of value. In fact, the odds are against exploration stocks from the start.  

Shareholders of big mining companies hate the risk associated with exploration. However, they are far more tolerant of “brownfield” exploration. Brownfield exploration could be anything from an old mine site to exploring right next to an old mine (something often referred to as “nearology”).

Industry-wide we know a lot more than we did 30 years ago. Depleting mines and higher commodity prices mean that old prospects that had been considered uneconomical are being revisited. It’s common to see multi-billion mining companies invest in brownfield exploration to increase their resource size.

The flip side of this is greenfield exploration. Greenfield exploration is a site that has had little to no prospecting work completed. It can be quite literally a man and a shovel turning the soil over, looking for evidence of mineralisation.

So, what does this mean when picking a stock? Well, a greenfield exploration will surprise the market if it actually finds something and the share price will likely skyrocket on the news… whereas investors are expecting a brownfield site to yield something.

That implies that there won’t be as much of a lift in the share price if they do prove it. However, disappointing the market with a smaller-than-expected resource means that the share is likely to be sold off quite heavily.

In other words: big thing to understand #1 – what is currently expected from the greenfield or the brownfield site?

Is the government a friend or foe?

There’s a reason why the dollars of Canada and Australia are considered to be “commodity-based” currencies. Both countries are mining powerhouses in which the extraction of minerals plays an important role in their respective economies.

Canada and Australia are top-tier mining jurisdictions for good reasons. The rule of law and protection of property rights are well established in both of them. Both have mining friendly governments. By world standards, they also offer reasonably quick permitting and approval processes. Both are richly endowed with almost all minerals that our society needs. Plus, for developed economies with mature mining sectors, Canada and Australia are “well prospected” but not “well explored”.

In other words, the easy-to-find stuff near the surface has already been found. Combined, Australia and Canada have accounted for 32% of the world’s mineral discoveries since 2009.

Money will likely continue to flow to Australia and Canada as the hunt for minerals increases over the rest of the decade.

Despite the United States’ apparent need to be the best at everything, there is ongoing criticism of how slow the exploration/mine permit and planning process is over there. In Australia and Canada, approvals take two to three years; in the United States, it’s up to ten.

Of course, Canada, Australia and the United States are federal countries – in which state/provincial governments also can have a lot to say about whether or not a mining project can proceed.

According to the Fraser Institute, a Canadian think-tank, those states/provinces with the top three mining-friendly policies (such as local taxes, royalties, governments and public process as well as mineral endowment), are Western Australia, the Saskatchewan province (Canada) and Nevada in the United States.

Closer to the UK, Ireland, Finland and Sweden have governments with mining tolerant policies, but the ease of doing business isn’t as seamless as the top three. It’s not as big a financial risk as, say, a project out in the Democratic Republic of the Congo: nevertheless, it is fair to assume that there will be more roadblocks then in a top-tier mining country.

And that brings me to Africa.

The Dark Continent is extraordinarily rich in minerals. We are yet to know the full potential of these African rocks. So far, Morocco is the only African country to make it into the top ten of mining-friendly countries.

The next highest-ranking African member is Ghana in 43rd place. Famous mining countries like South Africa, Zimbabwe and the Democratic Republic of the Congo are all very close to the bottom.

Why is it so? The problems include unstable power grids and currencies, risky and unpredictable politics and civil unrest, to name just a few.

That doesn’t mean that you shouldn’t pick up a mining stock that is focused on Africa. It just means that there is significantly more risk associated to the stock than one which is operating in the top mining countries.

In summary: big thing to understand #2 – what are the actual/potential political risks?

Great people tend to find each other

Management. Management. Management.

Now say it again.

Perhaps the greatest tip I can ever give you when it comes to mining stocks, is know who sits at the top. How many mines have they run before? How many major discoveries have happened on their watch? Are they a banker? Or would you find traces of dirt or mechanic grease under their fingernails?

I passionately had this same discussion with a mining CEO on Monday over an investor lunch.

Who’s in the hot seat is very important. I tend to shy away from companies that have an investment banker sitting in the seat of a company exploring or building a mine.

In this phase of a miner’s life, you want to see someone like a geologist or a mining engineer. You want someone with hands-on experience and an intuitive understanding of how mines work.

Once the mine is operational, I don’t mind a pen pusher in charge. But in the early days, give me someone with dirty fingernails and cracked skin leading the advance.

Another absolute in my book, is domicile experience.

Countries like South Africa and Botswana have very successful mining operations, but only because they are run by people who have extensive knowledge on how to work within problematic mining locations. There’s deal making to be done, a local workforce to please, a sketchy government to anticipate and, often, a private security force to be hired.

Remember that great people want to work with other great people again.

It’s quite common to find two or three well-respected geologists working on the same projects over the years. As a project progresses, geologists will turn to the people in the industry that they trust to help them prove up a discovery.

In turn, those geologists that have a proven track record, will have their own fans in the form of engineers and investment bankers that also want to profit from their success again.

The short version? If it looks as if the band is getting back together again, there’s probably something exciting in the works.

Therefore… big thing to understand #3 – are the right people in the right places within the company?

Where does the water come from?

I cannot emphasise enough how important water is to a mine.

Water is used to keep dust to a minimum, for mineral processing and transport slurry (basically dense materials in water). The inflexible rule is: no water, no mining.

That is why if you’re buying a stock that has a mineral resource but no operational mine yet, investigate where they will get water from.

Granted, freshwater in mining use is quite small on a global level. However, water access is becoming an increasingly tenuous issue between communities and governments in the mine permitting process in water-stressed areas.  

Is a company trucking water in? That’s fine, but it’s expensive. Will the company be building a pipeline to access a nearby community’s water supply? If not already approved, this could see the permitting process fall apart, depending on the mine location.

In already water-stressed areas (like Chile, much of Australia and parts of South Africa, for example) the harder the company must work to get access to water, the more likely a costly solution will be incorporated to the mine, such as a desalination plant.

The cost of building a desalination plant has come down significantly in recent years. But such a plant may still need half-a-billion pounds to set up. The further away from the ocean a mine is, the bigger the bill will be for the pipeline that transports the seawater.

The world’s largest copper mine, Escondida, is a great example of this. The desalination plant cost £202 million, but the pipeline cost £242-323 million. Plus, there was another £40 million or so needed to build the power station to support it.

Now, most mining companies place a huge focus on reusing and recycling water on site, which is excellent news. But, for some, the cost of a desalination plant will be inevitable.

So… big thing to understand #4 – where’s the water?

The mining sector is complex and can be intimidating, but with proper research, it can be a rewarding place.

And with that, happy investing.

Until next time,

Shae Russell
Co-editor, Exponential Investor