PCF Capital Group describes the investment trends currently affecting the Australian mining industry.
How did the Australian mining sector navigate the consequences of the 2008 financial crisis and what strategy did PCF Capital use to mitigate its impact?
Initially the Australian resources sector was protected when the market crashed in 2008 because we had a large wave of Chinese money that protected us from the global financial crisis (GFC). However in 2011, we began to feel the impact and for the next four to five years the market was terrible. PCF Capital struggled like everyone else, but fortunately we have always had great success in selling mines as our core business. We have a business called Mines Online, which is like an eBay for mines. Through Mines Online, PCF offers a very effective budget service to manage the sale of a mine and the average transaction size is about A$3 million. That business has underwritten PCF for the past 20 years and over the last 10 years, we have sold 115 mines covering projects on every continent.
How would you describe the current state of the market?
The market is up 90% from where we were this time last year and all the indices are on the way up for the mining sector. However, most of the money has been focused on the producers and developers. Being able to demonstrate a clear pathway to production and cashflow will gain the support of the financiers. However, the exploration sector is still struggling to raise capital. The risk appetite is low at the moment following the GFC, the rolling Euro crisis and worry about China and whether it can sustain its current levels of growth. While global GDP is on the way up and there is a greater degree of positivity, investors are still focusing on less risky projects.
Is the lack of finance in the exploration sector caused by a fundamentally new shift in the market or a component of the industry’s cyclical nature?
When the market turns, all the value goes into the producers. When they get overvalued, it cascades down into the developers, and then when they become overpriced — which is where we are close to now — it will cascade into the explorers. However, the exploration sector is highly saturated and investors need a means to discern where they will put those funds. Where we are seeing some interest is in explorers that can demonstrate a defined resource. Valuation for those juniors that have shown strong exploration potential has increased materially over the last 12 months.
What sort of investor profiles do you see as key to the market right now?
The key change we are seeing is the increasing role of Exchange Trader Funds (ETFs) whereby an algorithm is used to buy shares with little or no regard for a company’s exploration or development pipeline. ETFs have come to the fore over the last three or four years and this mechanism has allowed for the producers’ share prices to really take off. However, the issue arises when the algorithm changes. For example, Van Eck might have 10-15% of every single major resource company, certainly those between $1.5 -3 billion market caps, but many junior companies that were part of the Van Eck ETF were sold off when Van Eck announced that its investment algorithm was being re-calibrated to only include companies with market caps of $3 billion or more. Subsequently, the market is attempting to predict who is going to be dropped from the ETF. Institutions absolutely have a role to play, but the dynamics of ETFs will have increasing influence over the market. For juniors, this will mean learning how to cope with new shareholders that are not interested in your management team or your development pipeline, but are only investing because of a computer driven program that is seeking matching criteria such as market cap and whether or not you are in production.
From which geographic locations do you observe increased levels of investment in the Australian mining industry?
Capital controls from China have made it more challenging for finance to reach companies in Australia. There is also a concern that the Chinese business model has not worked following the $51 billion investment bust from 2009-2014. It was not a pleasant experience for them or the Australians.
The Australian resource market is pretty comfortable with Chinese investors because they have deep pockets, but they still must meet our environmental regulations and follow our employment law. We believe the best and safest investment model for Chinese investment into Australia is via a joint venture. Having a local partner shares the risk and provides local knowledge.
Recently, North American investors have been much more inclined to invest in Australian stocks. In the past, they had preferred to invest in companies listed on the TSX. Now, they are quite happy with the regulations and the governance by the ASX and we are seeing a lot more North American money coming through. For example, 40% of investors in the highly successful Gold Road Resources are from North America. Whist one could argue about the relative size and capacity of the ASX versus the TSX, the key difference between the two markets is that the TSX has 300 million potential investors via the largest economy in the world i.e. the USA just to the south. Australia has no such equivalent market and we must seek more engagement with North American investors and their deep capital pools.
How is the Tianqi lithium facility going to affect the Australian mining sector?
Most of the Australian mining profits are derived from digging up the commodity in question and shipping it out with minimal value adding. Because of this, any advantages that might come with downstream processing and the development of a broader manufacturing base are almost nonexistent. The great thing about Tianqi is that we will have one of the most advanced facilities with battery technology in WA. This will provide a pool of skills and expertise that will make Western Australia a leading centre of excellence for a very exciting industry that I am sure will reap great dividends in the future. A great move beyond just digging holes.