The Metals Report: Christopher, you believe that the market will recover in 2013. Why?
Chris Ecclestone: We'll have a different type of recovery than we've had in the past, when everything was driven by the financial industry and house price inflation. The U.S. keeps driving along the edge of the cliff like Thelma and Louise, but never actually going over.
I get the feeling that there will inevitably have to be a recuperation. The ducks are in the row now for an industrial recuperation—probably a construction-led one. I'm not talking about a rip-roaring recovery, but there is such a delicate balance in base metals between supply and demand that it doesn't take much recovery to vacuum up lingering stocks and tip the markets back into a deficit situation again.
TMR: The Dow Jones Industrial Average is a couple of hundred points away from its all-time high. Do you get the sense that retail investor sentiment has changed?
CE: Not really. Retail is the last to arrive because retail is not a believer. They're trying to reduce their debts while grappling with flaccid house prices—they're not feeling the love yet. It's been said that the equity markets lead six months ahead of the real economy. I suspect it's being driven by institutional and big money.
TMR: The ongoing stimulus measures being undertaken around the world seem to point toward a higher gold price, yet you believe that gold will drift lower in 2013. Tell us about that.
CE: Federal Reserve Chairman Ben Bernanke will wind down the cash supply as soon as there is stronger growth. He won't stoke the fire the way that Alan Greenspan used to do, where he actually created bubbles. Bernanke was loathe to put out all that extra cash. As soon as he sees signs of a sustained recovery, he will start to rake that money back in and take it out of circulation.
Also, the euro collapse is just not happening. It went very near to the edge early last year, but the euro has veered well away from that danger and it's just not going to happen. Anyone who wanted "apocalypse now" is disappointed. That is why the gold price is just drifting at the moment. If there's an economic recovery, there will be even greater pressure for gold to start heading south because people will perceive that the crisis is over. Feelings of crisis have definitely driven gold in the last five years.
TMR: Junior mining companies are having trouble landing financing for developing their mining projects. If the economy does improve, will it bring more financing for juniors?
CE: They're going to have to continue to wait. There will be a lot of attrition. There are just way too many gold companies out there. Quite a number of them will die off. Some of the others will refocus themselves on industrial metals instead of some totally impractical half gram-per-ton gold project.
TMR: You believe that gold majors have axed their CEOs as a means to appease shareholders, but have also maintained their "businesses as usual" attitudes. What's it going to take for the majors to generate shareholder value?
CE: Some of them have dropped their CEOs and the situation has still not gotten better. It's an ongoing ballooning of capital expenditures. Now there's deterioration in margins because of the conditions that they've made with workers and suppliers during the golden years that are unsustainable. Things will have to be tightened up. These organizations have gotten fat and lazy and axing the CEO doesn't solve that.
TMR: Are you willing to name names?
CE: I don't need to name names because virtually all of the majors are in that category. You name them, they're like that. They've had too many good years. The goal is to improve the bottom line, yet there's very little discussion of the bottom line. No one talks about price-to-earnings ratios in the gold mining world. Some of those ounces in the ground are going to stay there because the capex is rollicking out of control and projects are ending up in the freezer.
TMR: You suggest that a merger of Inmet Mining Corp. (IMN:TSX) and First Quantum Minerals Ltd. (FM:TSX; FQM:LSE) could form a major Canada-based metals producer, which is currently the exclusive territory of Teck Resources Ltd. (TCK:NYSE; TCK.A:TSX). Inmet has rejected First Quantum's offer. Is that deal going to get done?
CE: It will get done. Inmet is doomed! The dividend yield it offered has been lousy. First Quantum has a much higher valuation and dividend yield, which just goes to show what gives stock a currency to do these deals. Inmet has missed a lot of opportunities in recent years.
TMR: Will we see more of the same type of mergers?
CE: Absolutely. First Quantum could move on to be a serial deal-doer. It has been collecting other assets in the past. I wouldn't be surprised if Teck does some deals. Then there's Lundin Mining Corp. (LUN:TSX). Lundin is going to be an acquirer or an acquired entity. Companies are prowling around looking to get their hands on something like Lundin because it's well positioned in zinc. HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) is another entity that should merge with someone. It had piles of cash after the slump in 2008, but failed to acquire the bargains that were lying around. It made a rather ritzy purchase in Peru of a non-producing asset—Norsemont Mining Inc.
TMR: Your model mining portfolio finished 2012 on a high note. What trends do you see that investors could piggyback on?
CE: Gold is not that great at the moment. I thought some of the producers and near-producers would have paid off a bit more, such as Eldorado Gold Corp. (ELD:TSX; EGO:NYSE), which is one of the better-managed majors. If you're not getting a dividend from a major, and there's no upside, then you might as well go for a junior where you know you're playing Russian roulette. They could either fizzle or appreciate, but at least you've got a chance that something will happen. A dull major is pretty damn dull.
TMR: How important is a dividend to you?
CE: It's important for big producers. It is actually something that the juniors should be pushing for. In Australia, for example, investors often collect their dividends from big producers and then buy juniors with the cash. The Canadian model is that the majors pay a measly dividend and keep the money, making serial overpriced bids for juniors. A yield of 0.50% is derisory. It's just to get the company on to the list of dividend payers. If a company is making $0.40/share and paying out $0.05/share, that's pathetic—that's not even worth the effort.
TMR: Are there some companies a little lower on the food chain that you're excited about?
CE: Investors should look toward specialty metals like tungsten and antimony, or base metals like lead and zinc. Those are the areas where there's a critical shortage of product and a deficiency in the construction of additional mines over the last 10 years. Zinc production will fall as some of the biggest mines in the Western world shut down over the coming year or two. They will not be replaced; the cupboard is bare. That lays out a scenario in which zinc could go from $1/pound (lb) to $1.50/lb in the space of two years. I don't see any potential for major metals to make that type of move.
TMR: What are some zinc plays that you're fond of?
The no-brainer zinc play is Lundin. I can only think of Donner Metals Ltd. (DON:TSX.V) as an up-and-coming name. Donner partnered with Xstrata Plc (XTA:LSE) in the Bracemac-McLeod project in Quebec. It is slim pickings out there.
TMR: What about industrial metals?
CE: I like Mandalay Resources Corp. (MND:TSX), which is a gold-silver-antimony play. The phenomenal recent uplift in antimony has been driving the stock. Antimony has been a much better performer than the rare earth elements have. Mandalay's stock has doubled since July—and it's very hard to find any production stock that has doubled in the last six months.
TMR: Is this a management team that will under promise and over deliver?
CE: That's what it's done. It's a pretty low-key company. It's a "by appointment only" sort of investment story that people speak about behind cupped hands. There are a lot of companies out there that talk about what they're doing and don't do anything. This company's not as aggressive in promoting its story, but it hasn't damaged its stock price at all.
TMR: Where is the future growth going to come from for Mandalay?
CE: It did recently announce that it discovered a new zone at its Costerfield mine. The potential to expand there is enormous. It wasn't focusing too much on antimony and then it realized the attractions of that metal. It's certainly the sexiest thing about Mandalay. The antimony is the key at Mandalay if gold and silver start to go down, as I expect them to.
TMR: What are some other industrial metal plays you're following?
CE: Tungsten, mainly. Tungsten has gotten prospective. There were a lot of companies lining up for the tungsten race in 2011, but 2012 proved to be difficult for financing. The tungsten price dropped from around $450/ton down to $320/ton. That took the wind out of the sails. It's still a phenomenal price for tungsten, but without financing ability, companies mothballed their projects. There's no improvement in what was a pretty dire supply dynamic because China has been restricting its tungsten exports.
TMR: How can investors play the tungsten market?
CE: Woulfe Mining (WOF:TSX.V) in South Korea has the world's former largest tungsten mine that it's reactivating.
TMR: What about fluorspar?
CE: Fluorspar has gone through a difficult period. It's linked to a whole swath of industrial applications that are not that sexy, unlike rare earths, so people didn't notice that there was a crisis brewing when China restricted its exports. A number of companies got going, one of them being Canada Fluorspar Inc. (CFI:TSX.V). It just named a major French partner, Arkema Inc. (AKE:EPA). It's brilliantly positioned right on the banks of the St. Lawrence, so it's easy to get the stuff out. It's just a case of dusting it off and bringing it to fruition again.
TMR: Will Arkema provide the kind of financing it needs to get to that point?
CE: It has provided the financing in the past.
TMR: Is there a sufficient market for what it will sell?
CE: There seems to be a good market for fluorspar, but it's linked to industrial demand, which is starting to look better. However, China is slowing down how much it's devouring and then spilling the leftovers back out into the global markets. But if activity in China picks up, it can allow Western projects to get going again—not because they'd be selling into China, but because production in China would be staying at home.
TMR: What's the earliest date that Canada Fluorspar could be shipping its product?
CE: It could be a year or year and a half. The fluorspar mining process is pretty simple because it's largely open cut and not too deep.
TMR: Are there any thoughts you would like to leave us with?
CE: Base metals require less brain work. It's easier to narrow them down and look at what's there. Specialty metals can create some interesting spikes in prices due to supply crises. But that's really hard to predict because it depends on what happens behind closed doors in Beijing regarding what could be exported in any given year.
The supply-demand continuum is constantly fluctuating, but there's been an amount of production going off-stream. There is so little is coming onstream that it looks pretty good for zinc, lead, copper and chromite. I'm less persuaded by nickel at the moment.
TMR: Thanks for speaking with us.
Christopher Ecclestone is a principal and mining strategist at Hallgarten & Co. in New York. He is also a director of Mediterranean Resources, a gold mining company listed on the Toronto Stock Exchange, with properties in Turkey. Prior to founding Hallgarten in 2003, he was the head of research at an economic think tank in New Jersey. Before moving to the U.S., he was the founder and head of research at the esteemed Argentine equity research firm Buenos Aires Trust Co. from 1991 until 2001. Prior to his arrival in Argentina, he worked in London beginning in 1985 as a corporate finance and equities analyst and as a freelance consultant on the restructuring of the securities industry. He graduated in 1981 from the Royal Melbourne Institute of Technology.
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1) Brian Sylvester of The Metals Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Metals Report: Mandalay Resources Corp. and Canada Fluorspar Inc. Interviews are edited for clarity.
3) Christopher Ecclestone: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.