DAILY NEWS Aug 14, 2013 2:45 PM - 0 comments

IBK Capital CEO calls the market bottom

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2013-08-14

Mining Markets recently spoke with Michael White, president and CEO of Toronto-based IBK Capital, for his views on the junior mining market. As the head of IBK, a private investment bank that largely deals with junior miners, White has had a front-row seat to the suffering of these companies over the past two years. While some companies won’t survive the current market malaise, White believes the market is at, or near, a bottom — and predicts a migration of talent from the majors to juniors that will build the next generation of majors.

Mining Markets: IBK does a lot of work with resource juniors, so you’ve got a front-row seat to the difficult markets they’ve been facing. Could you describe the current financing environment for the juniors?

Michael White: In the industry we talk about windows being open and windows being closed, and arguably, the window is closed. There are a few financings getting done, it’s not impossible to get financings completed. Sometimes these companies have to be a bit creative in order to fund their exploration or development, but generally speaking, the mining market today is much poorer than it was a couple years ago.

We really have seen a decrease in value in the equities for the exploration companies and the producing companies in metals and mining over the last two years. So it’s not something that’s new if you look back at the charts, the sell-off has been going on for two years. It’s a tough environment for financing.

MM: You must be seeing some desperation out there.

MW: Yes, some companies are at the point where they’re just keeping the lights on. They’ve suspended operations in the sense that they’re no longer active in the field, or if they are, it’s on a very limited basis. They’re paying their overhead, which typically is their office rental space, listing fees, accounting fees — public companies do have a minimum amount of expenses they have to cover each year. And some of them are doing just that — they’re just raising small amounts of money, passing the hat, so to speak, and pulling in a few hundred thousand dollars to stay afloat.

There are some people in the industry who believe that 50%-plus — and I’ve heard as many as 85% — of these juniors will disappear. I don’t believe that it will be that many, but certainly we will have many that decide to delist. And then even if they delist from the Toronto Stock Exchange, there are alternatives. They may find themselves listing on the CNSX as an example, which is a cheaper exchange in terms of listing expenses.

So we’ll see, there’s definitely a shakeup going on and it’s fuelled by a lack of fuel if you will — there’s no money in the system. But this is nothing new, this business is cyclical and we happen to be, I believe, at the bottom end of the cycle, or at least close to it. This didn’t just happen a few months ago — we’ve been experiencing a selloff now for two years now.

MM: Are you keeping up to date with the Venture Company Association in Vancouver? John Kaiser and Joe Martin of Cambridge House are involved with it — they’re talking about the regulatory environment for juniors, the cost for juniors to operate — and a whole bunch of other things that they believe are putting more pressure on juniors — high-frequency trading, accredited investor rules, things like that.

MW: I am not active with them, but certainly that’s something that the Emerging Market Dealers Association (EMDA), has been talking about — the idea of improving the investing environment by expanding the audience. And that’s something that’s been kicked around for a while now. Ontario doesn’t have an offering memorandum prospectus exemption as they do out west. There are also thoughts of lowering the bar when it comes to accredited investors, allowing more people to become accredited investors based on their wealth, but also based on their experience and what they do in life. For example, why can’t a securities lawyer be an accredited investor? They’re supposed to understand a little more than the average person about this business.

I’m all for expanding the audience. Certainly if there are people out there that would like to invest in these companies and understand the risks that come with owning these shares, and understand the rules and regulations around private placements, then perhaps it’s something that should be looked at. But I’m not sure how much that would add to what we do in terms of funding our clients. There is a lot of money available to participate in private placements, it’s just not interested in mining and metals at the moment.

MM: So what will solve the problem? Historically, what do we see at this point in the cycle?

MW: You need to see a complete selloff, which causes the bottom of the cycle. We’ve had that – we might see a little bit more selling, but we’re certainly close to the bottom, I believe, if not at the bottom. So you need to see that these equities are oversold, that they’re trading at a deep discount to historical norms, and then you need to have confidence in the value of the underlying metals going forward, that there won’t be further erosion, within reason, to the value of the metal.

On top of that, you would like to see a healthy broader market that is arguably overbought in sectors. We may be seeing this, it’s been chugging along doing quite well. I look at that as inflation in the market. If there’s inflation in the broader market, then these fund managers that look for value are going to start looking back at the metals and mining sector and thinking geez, this appears to be oversold and we should be buying in — the value’s there. There are guys like Sprott Resource's Rick Rule who love to say it’s all on sale — everything’s on sale, why wouldn’t you buy it?

MM: He’s been saying that for a while now.

MW: He has been, but you know he’s been in this business for a long time, he’s seen many cycles. I’ve been in it since ’92 and I’ve seen my fair share of cycles, and you know what, history repeats. I liken where we are today very much to where we were back in 2000, 2001.

I remember I was doing a lot of work with our issuer clients, a lot of analysis pulling together documents and writeups, and back then I remember looking at some of our clients thinking, my goodness, how could a company be trading for so low given the assets they have? This is what happens, nobody cares about the sector and then at some point eventually people will wake up to this and they’ll say, “Hey, you know what, it’s time to start buying again.” It happens cycle after cycle after cycle.

And there are lots of people out there who love this type of market because it’s absolutely a buying opportunity. They’re out there and they’re buying, they are outnumbered — I think there are more people in this business who just follow trends — but there are the contrarians who are out there right now and they’re picking up positions and should be well rewarded. There are a number of companies out there — a lot of companies — that have really good assets and they’re trading at 5-year lows, 10-year lows, 15-year lows.

MM: You’re talking about producers?

MW: Some of them are producers, some of them are advanced exploration companies that have been working on projects for the last eight or nine years. Some companies are a little newer, a little more grassroots, but are trading at market values of $1 million or $2 million, which is unheard of, again, if the underlying asset is a bona fide asset where you can see value.

Of the companies that will disappear, I would say that most of them will be companies that don’t have good assets when judged in today’s metal price environment. Those companies may find it very, very difficult to fund their exploration projects and they might fall away or delist. The companies that have good assets, I don’t see them disappearing. There is always money out there — you just have to knock on enough doors, you’ll find enough money to get yourself through this if you have good assets.

MM: In the market recently, we’ve seen a lot of writedowns, big writedowns. Do we need to see some production come off the market before we see metals prices come back a little bit — is that the next step in the cycle?

MW: I think we’ve seen production come off. There are some producers out there that have had to rationalize their production and look at material that can be mined at a lower cost. It’s sometimes a bad word in this industry, but high-grading your mine is where you go in there and you start pulling ore out in a way that perhaps shouldn’t be done if you’re looking at Plan A, which is the long-term plan. Unfortunately, if your average cost is above where the metal’s trading at right now, you’ve got to go to plan B, higher grade, and typically when companies do that, their production drops off. I think we’re seeing that. These companies are not just simply firing people and tightening the belt around the corporate head office, they’re also rationalizing their mines and if we haven’t seen it looking back a quarter or two, we will see it looking forward a quarter or two. These cost-saving methods were tabled over the last four, five, six months, so they’re just now getting into it.

Will this fix things? If you’re just looking at pure supply and demand, then absolutely, eventually you do get to a point where you simply aren’t producing enough to supply demand, and if that happens, then prices will start to come back up. Gold’s a little bit different, arguably — some people like to pick on gold because they don’t see it as being consumed. But you can’t forget that these ounces that are produced support a very large options and derivatives market in precious metals, and they need to be produced. It’s almost like people have a call on those ounces, and if they’re not produced, the system is strained and prices will rise — people have to cover their positions. Mine’s are not turned on and off like a light switch. Significant production will disappear if metal prices hover around or drop below the average cost to produce the metals.

Some argue today’s gold prices are close to the global average cost for gold production. Gold right now is very volatile, it’s been consolidated, crushed down. I’m not a gold bug, I’m a gold bull: I don’t believe that we’re going to see US$5,000 gold — I don’t want to live in that environment — but I do see gold perhaps trading up around US$2,000 an oz. over the next couple of years, purely to sustain necessary production.

More broadly speaking with the other metals, you really just have to look at the world and you have to make a decision — do you think the world is cooling off, in other words contracting in terms of growth, or do you think we’re still expanding? I would think that we’re still expanding given the vast amounts of work, labour that’s being done overseas so that North Americans and the Europeans and others can have very cheap goods. Goods purchased by economies supported by or perhaps addicted to cheap debt and an expanding supply of money worldwide.

There’s an argument out there against gold saying that there’s no inflation, generally speaking. Some people counter the argument saying we’re printing money like crazy, how is there no inflation? In my mind, it’s a transfer of wealth offshore, and the workers oversees are like western workers — they want more, their wages are going up and they are buying more houses and filling these houses and buying more food. So I believe the world will continue to expand. The demand on the world’s resources will continue to grow. Prices over time will continue to increase — that’s inflation.

I’ve stepped way back — take yourself out of the day-to-day and out of the volatility that’s in the market in metals and just look long term — I think there’s a good argument to be made that we’ll be consuming more as a planet rather than less.

MM: So for people who are ready to buy mining equities, whether they’re juniors or producers, given that not all companies, especially on the junior side will survive, what should investors look for?

MW: You have to look for a company that’s got really good assets, especially since everything’s on sale. IBK Capital funds junior companies, we don’t fund the Barricks of the world — we certainly show the seniors product — but I’ve made most of my wealth investing in the junior world, so for me, discovery is where you can make a lot of money.

Generally speaking, you want to look for good grade, a project that’s in a friendly jurisdiction, and one that doesn’t require a huge amount of expense and time and resources to go into production, or to expand production. I would stay away from the projects that require a billion dollars plus to go into production because it’s getting increasingly difficult to move those projects forward, and we’ve seen that with some of the majors. There’s a lot of work that has to be done to align all the stakeholders in a major project to put it into production, more work is more time and that strains project economics, whereas smaller projects with a good management team can be simpler to put into production.

If you’re looking at gold companies, look at projects that will require $100, $200, $300 million to go into production — you could see production numbers of 80,000, 100,000, 120,000 oz. a year. For a junior company, 100,000 oz. of gold production actually is a huge step forward, and once the market sees that, you can have a rerating of the ounces in the ground in terms of value. You might have a company that today is trading for US$9 an ounce in the ground — in a good gold market the value should be between US$35 and US$50 an ounce — so not only can you have an improvement as the market comes back to say US$15-20 an oz., but then as you complete your feasibility studies, if it’s a robust project that looks like it can be fairly readily put into production, then you can start seeing a rerating on those ounces again in the market. As it becomes more attractive from a production perspective, it can be very attractive to potential buyers. Even in this declining market, we’ve seen buyouts of junior companies for $70 per ounce. In a good market it can be hundreds of dollars an ounce. A lot of money will be made in the junior market.

Back in the day, we used to call it step-up financing — you finance these companies as the value increases, as they step up in value. Because we’ve pulled back so dramatically here, I see that happening again. Prices are so cheap.

I would advise people to do their homework, talk to people in the business that understand these projects. You want a robust grade, because high grade protects you against a further selloff in metals prices — and high grade relative to the type of mining, it doesn’t mean it has to be 10 grams per tonne. A one-gram-per-tonne production situation can be very robust if it’s right at surface, in a friendly jurisdiction with infrastructure. We don’t have a crystal ball, so we can’t say with certainty that metals prices have bottomed, so you want to protect yourself against that with grade.

And even before all of that, the key is good management. You really want to be buying good management teams. There are some really good people in the junior world today and I think we’ll see more really good people coming into the junior market. Major mining companies are contracting, and as they contract, people are let go. A lot of people are happy to be let go, because they’re tired of being beaten up by their shareholders and not meeting their numbers and being beaten up by upper management or the board if that’s the case, and it’s because you’re in an environment of contracting metals prices and rising costs — it’s a really tough business to be in.

Some of these guys have their eyes on projects that they know they can do a very good job of dusting off and ultimately putting them into production. I think we’re going to see more really talented people come into the junior market, which is a great thing. It’s nice to have a redistribution of people in this industry, because when times are great, a lot of very talented people are persuaded to join or stick with large companies. They’re paid well, and they should be paid well, but when times are tough and those companies contract, they’re let go or they put their hand up and say, “let me go” – let me go because I’ve got a few other things I’ve got my eyes on. Sometimes entire teams come together from the majors to work on a junior project.

MM: That could mean a lot more discoveries in the years ahead.

MW: It could mean a lot more discoveries. But sometimes discovery doesn’t mean putting a drill in the ground and finding a brand new deposit — sometimes it’s dusting off an old one and with some new thinking, dramatically increasing the value of the asset.

We saw that back in the mid-2000s, because the gold market was on its knees back in 2001, and in 2002, 2003, it was evident that gold was on a run — more and more people were becoming bullish, and there were a number of assets that almost overnight, went from being orphans to darlings on the street.

We worked on one of them, Western Goldfields here, which merged with New Gold (TSX: NGD; NYSE-AMEX: NGD), they bought the Mesquite mine from Newmont. Newmont had very good reasons to sell it, it had been passed from company to company to company and it was depleting, it didn’t fit, but Western Goldfields and Ray Threlkeld and Randall Oliphant, who were ex-Barrick Gold (TSX: ABX; NYSE: ABX), and Brian Penny who was the ex-CFO from Kinross Gold (TSX: K; NYSE: KGC) decided you know what, this is a wonderful asset and there are things that we can do to produce a lot of gold. They created a tremendous amount of value. We did a share offering at around 35¢ back in ’06 and today, even in these markets, those shares, share for share, are trading at $7. Now it’s a nicely integrated company, they’ve merged with New Gold and they have other assets: it’s a major mining company.

Rob McEwen did the same thing with his Red Lake mine at Goldcorp (TSX: G; NYSE: GG), just applied some new thinking. Red Lake was always the poor cousin of the two mines up there for many years — decades — and he took the opportunity of a poor gold market to really shake things up. And there are many others too: Wheaton River which eventually merged with Goldcorp, was another one in the early 2000s. It came out of obscurity, it was founded on a tiny little gold mine in British Columbia and they used that mine as a platform to go out and acquire other mines, and that was a huge home run. These were all big discoveries.

I believe this will happen again – soon. These types of discoveries will help drive the recovery in the junior exploration and mining market.

Again, coming back to our portfolio, we’re looking at companies that have good assets, good management and the ability to attract some of this talent as they execute on their development plan. Another great thing about a junior exploration company is that as it evolves, as it moves forward, you need to layer in new talent — there are different skill sets that are required at different phases for these companies, and that opens up opportunities to bring in some of these high-calibre people looking to be involved in the junior world.

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