A Crazy and Necessary Business

A Crazy and Necessary Business

Charles Funk – CEO Heliostar Metals

Matt Badiali – CEO Mangrove Investor

Imagine taking on a task that only succeeds 1 in 10,000 times.

And, when successful, requires hundreds of millions of dollars and a decade or more to make money.?Then you typically only have 10-15 years of making money until it runs out.

That is Mining.?When framed like this, it’s a crazy business!

We only do it because our modern lives require these commodities.?There is a direct correlation between higher living standards and higher commodity consumption. According to the U.S. Geologic Survey, each person in the U.S. requires over 40,630 pounds of minerals every year. That includes:

·????????5 pounds of manganese

·????????6 pounds of zinc

·????????12 pounds of copper

·????????11 pounds of lead

·????????34 pounds of aluminum

·????????168 pounds of phosphate rock

·????????275 pounds of iron ore

That means each person consumes a weight of more than six Ford F-150’s in mined materials each year!

All that material must be found by exploration. A business model that has evolved to take on the risks and fund the process needed to find these commodities.

At its core, it’s built on the premise that outsized risk must be compensated by outsized returns quickly.?For example, the giant Voiseys Bay nickel mine was found and sold for $4.3 billion in two years!

In a macro sense, exploration is just an industry specific version of research and development (R&D).?The same as you see for drug or technology companies.?In R&D, value is created from an idea.?

It can be as simple as figuring out how to play music from a phone or developing the software to allow us to buy all manner of things from our desktop computer.?

In exploration, we take a geologic concept, an idea in somebody’s mind, and turn it into an ore body. And it’s one of the most incredibly profitable forms of R&D on the planet.

Just stop and consider for a moment, that many of the best features of our modern lives began as an idea in somebody’s mind: ??Cell phones, Velcro, commercial aviation, even the internet.?It’s incredible to think how turning an idea into reality can change so many lives for the better.

Also, all of those realities require more commodities.

The Business Cycle

R&D needs money, a lot of money.

And that money should come from people who are prepared to take extreme risks for the small chance of a huge reward. During the best times of the market, that’s the case. Informed investors use risk capital to empower exploration R&D.

They typically deploy money back into companies that had success in the past. Because people with one successful idea often have multiple – think Benjamin Franklin or the infamous Thomas Midgley Jr. (of Ethyl Corp. fame).

But successes get media attention and fuel risk appetite.

And as the market improves, less informed capital comes into the space. Money that probably shouldn’t be in R&D, moves in. And the cycle escalates. More capital allows for more success. That creates headlines in financial media. Companies begin to market heavily for more capital.

Eventually, speculators flood the space, creating massive liquidity. ?With so much hot money around, the industry sows the seeds of failure. At this point in the cycle, the limit to success is not available money, but available people and ideas.?

This is compounded by communication between legitimate companies and these new investors. Mining companies use jargon that can be indecipherable to outsiders, which creates opportunity for mayhem.

This is the period when marketers outshine legitimate companies. Speculators seek out any small company they can. Stock promoters make outrageous promises in clear terms. They know they can raise money by sounding smart and yelling loudly.

They draw in capital that doesn’t understand the risk. And that is where cyclicity in the exploration business model creates problems.?Because the bull market must end.

Something always triggers a collapse. It can either be a broad macro scale recession such as we are seeing today. An industry specific lack of trust like the Bre-X crisis for mining in the late 1990’s. Or a stagnant or falling commodity price like we saw in 2011.

The event creates a ceiling on price escalation and smart capital begins to exit.

But like breaking an earth dam, the trickle becomes a flood. Speculators take profits until they can’t. And then they sell whatever gets a bid.?This leads to a bust as the cycle breaks and the liquidity dries-up. Trading volumes fall to nothing, and companies can’t raise capital.

The Bottom of the Cycle

Today we are at the bottom of the liquidity cycle.?

People don’t want to speculate on R&D.?The majority of investors and speculators want certainty. They do not want the risk of exploration delivering one of the 9,999 out of 10,000 outcomes.??We can see this clearly from Venture Market of the Toronto Stock Exchange:

Source (TSX Venture Market)

This data is for the first half of 2022. And to say it was a tough year is an understatement.?Volume, transactions, and their value all fell by more than 50% on same period last year!

If you are in the space, you know this intellectually. However, these data put it in stark clarity. Investors aren’t here. And the ones who are, aren’t buying much.

The Junior Mining Paradox

This illustrates the paradox for junior mining companies.

When R&D is the entire business, there is no revenue. Companies shift from work to survival, during these low-liquidity, bear markets.

Their only access to capital is through dilution at a project or corporate level. Either they take on a partner for the project, or they issue shares to raise capital. However, during periods of non-liquidity both partners and cash are scarce.

The instinct, for many principals, is to stop.?Stop working. Stop fighting the market. Preserve capital and hibernate until these conditions change.?

While this works in theory, doing so leads to:

A.?????the loss of the people who drive the ideas that the business is built upon and,

B.?????Share price destruction, which creates more dilution on restart than raising money

Speculators supply money to exploration companies expecting it to be spent on a particular idea. Most have short timeframes for a result from that concept.?This means, in the current exploration business model, raising money occurs approximately once per year on average.

To complete the paradox, bear markets arrive unexpectedly.?It they weren’t a surprise; company valuations wouldn’t climb so high and sell-offs wouldn’t happen to create a bear market.

That’s the paradox faced by most junior mining management today.

Stopping isn’t the correct approach. And full speed ahead has the same outcome as the Titanic. What should an exploration company manager do in such in a challenging time??

In our opinion, they must be prudent with money. Raising it has a cost to existing shareholders.?Expenses have to be trimmed hard and dollars stretched as far as you can, while still making progress.

You need to find new opportunities. Despite how poorly your company is doing, ideas and people have become just as cheap. Being flexible and open to innovative ideas in this market can create huge opportunities.

Survival favors management teams that are good at the key parts of R&D: attracting capital, idea generation, or project execution.?Those that don’t have one of these skills get absorbed by those that do. And they create companies with a better chance of success when the liquidity improves.

Mining exploration R&D isn’t a fairy tale. It’s a necessary part of the modern commodity supply chain. And ?the cycles drive an evolution of these companies. Teams that survive the meteorite impact of a bear market have first mover advantage in the next cycle.