In the Gold Sector, Value Isn’t Always What It Seems…
Submitted by Sprott’s Thoughts:
Tekoa Da Silva: Neil, can you tell the reader a little bit about your background and role here in the organization?
Neil Adshead: Thanks Tekoa. My background is mostly as an exploration geologist. I completed an undergraduate degree in Earth Sciences at Birmingham University in the UK. I worked on oil rigs of the North Sea for a year at the start of the 90’s and graduated with a Ph.D. in Economic Geology from James Cook University of North Queensland in Australia in 1995. I joined a major Canadian mining company called Placer Dome, and worked on a mine in Papua New Guinea for six years in exploration and mining roles.
The company then moved me to the head office in Vancouver at the start of 2001 and I’ve been in Canada ever since. I’ve been in Vancouver now for 16 years. So I have a knowledge of ‘who’s who’ in the Canadian, Australian and UK junior mining sector.
After leaving Placer Dome in 2004 I joined a hedge fund based in San Francisco called Passport Capital. I spent 7.5 years at Passport doing a lot of global travel, sifting through the junior mining market.
I got to know Rick Rule around that time and when I left Passport in 2011 (because Passport was less interested in investing in the junior mining sector post-GFC), I joined Rick and the Sprott team. I’m in my sixth year at Sprott.
TD: Neil, I’ve noticed that you help set the perspective of our team here in terms of security analysis and technical (geological) analysis of deposits and projects.
Which leads me to ask – how do you view price and value in the context of security analysis? And, how have you viewed the interplay between those two items throughout your career?
NA: Well, they [price and value] are two terms that are used quite a lot. Those terms are probably misused sometimes, when I think about what they actually mean to me personally.
Price, in my opinion, essentially just means the “amount paid.” So it’s a snapshot data-point that two parties agree to, and if the market changes, sentiment changes, and the price will change.
We can see the same asset sell for very different prices at different times, depending on what’s happening under the prevailing market conditions at that particular point.
Value, in my opinion, is essentially what you believe an item to be “worth” — which should fluctuate much less (than price) over time.
But Value should stay reasonably constant – or within a fairly narrow range, until there is a material improvement or degradation in the item which you are valuing.
From the point of view of mining investments, obviously we’re always looking for fundamental value, and we’re looking for big valuation mismatches in the market.
What I mean by that is if we think an asset is worth X, the market (based on the price set in the most recent transaction) may suggest it’s worth a materially different amount. We’re really looking for those valuation mismatches mostly on the long side, where we think the value is worth a lot more than what the market thinks, in terms of the market price.
So that’s my definition of the difference between price and value.
Tekoa, in the past you’ve also asked about the emotional aspect of price and value. From a ‘human emotion’ aspect, it’s difficult not to be impacted by the price.
When we look at the share price of a company, we see the price change every day. When you buy a share at a certain price you can tend to get anchored at the price at which you pay for it, thinking that that is what it is worth.
But you should always do the fundamental value exercise and have an idea in your mind as to what you think the underlying value of the asset is, as it relates to share price.
So there is a big emotional dictator with price that you have to be careful you don’t fall into. I would probably call it a “price trap”. You’ve got to fundamentally believe that the work you’ve done is correct on the valuation you’ve derived.
TD: What has your career-journey been like Neil, as you refine and polish your ability to see price and value clearly in the resource sector?
NA: Ultimately the value [of a resource deposit] is driven by the geological quality. So it’s obviously important that geologists, metallurgists, and mine engineers provide input into an assessment of the overall quality of the asset.
As metal prices change, and let’s say the external infrastructure around the project changes, the perceived value of that asset will change somewhat as the context of the asset is modified.
TD: Continuing on the ‘price and value’ theme—I remember in 2015, you circulated internally, a list of about 30-40 metals and mining companies trading at or below cash.
When you look at the snapshot of the 2015 metals & mining market compared to where we are now in 2017—is the contrast becoming stark?
NA: Well, there has been a huge change. In 2015 – as you said, there were many companies whose share price was below the cash backing per share. It was kind of crazy. You could essentially buy $1.00 for $0.80 cents.
Mineral properties within those companies were essentially regarded as liabilities back in 2015, which is pretty common in a bear market. You could say in hindsight it was crazy but we recognized it was crazy at the time.
Hence we were doing financings at the bottom of the market at attractive valuations backed by quality assets.
Now today, obviously, there has been an improvement in sentiment. It’s very rare to see a junior today that’s trading below its cash backing, and investor sentiment has shifted hugely.
There’s now a desire for growth and demonstrable upside potential. Most mineral projects are seen as valuable assets and people want to invest money into juniors that are going to spend the money wisely and materially increase the value of those assets.
So yeah, there has been a big change in overall sentiment over the last couple of years.
Now you could argue—has the underlying value of many mineral project assets changed that much? Not really. Not fundamentally, apart from projects where there has been a new discovery or a lot of new drilling has resulted in growth in the resource. The value of those project assets has increased.
And that leads us into the early innings of a bull market, with a lot of capital flowing into the sector, a lot of holes getting drilled, a lot of projects increasing in value, and investors benefitting from rising share prices.
TD: Are there any pockets of the resource space today that are showing speculative excess, where when you look at price and value?
NA: Well, there are always going to be excesses – you could use the word “bubble” as a comparison there.
Every now and then, a theme comes along, a commodity theme whether it’s lithium or graphite or rare earths or uranium. It seems to catch a huge tailwind for some reason, with massive optimism moving into that commodity.
One theme attracting a lot of interest right now is cobalt. So any company with the word “cobalt” in it, and any projects with a sniff of cobalt are being bid up in price — to what I would argue to be excessive valuations. Eventually the current valuation may turn out to be accurate or even understated, but a lot of valuation back-fill is required, the majority of which will come from a materially higher cobalt price.
So that’s one theme where I would say there’s speculative excess at the moment.
In a bull market, there are nearly always one or two hot themes, whether it’s a specific commodity theme like copper or zinc — or it could be a particular geographic ‘area-play’ that attracts speculative excess.
An example is the Yukon Territory in 2011-2012. Nearly every single junior with a precious metal project in the Yukon was flying very high in the market, and could raise lots of money at a very low cost of capital.
TD: Neil, as you look back on the bear markets in your career that offered you the most attractive conditions as an investor (or speculator), what were the sentiment conditions like?
NA: Mineral projects were seen as liabilities. [Projects] were trading at a negative value because investors didn’t want the company spending any money on them.
Investors thought, “Well, if you spend money on them, nobody cares. All you’re really doing is burning cash, so the best thing you can have right now to survive the bear market is cash in the bank.”
So basically don’t spend any money, let all your staff go, and just sit on the project and wait for better sentiment.
It’s kind of crazy in reality, how it works.
TD: If the person reading is a prospective exploration or development-stage investor, do you have any thoughts on how they can reduce their risk, and/or what they should be thinking about in terms of safety?
NA: Well, I wouldn’t say you invest in exploration stocks for safety reasons. If you’re looking for safety, I would suggest you don’t invest in junior mining stocks.
Investing in junior mining stocks – some people say it’s a little bit like gambling. In gambling, you have a chance of having a big win, and it’s exciting. I would argue that you also have quite a bit of fun along the way, trying to find something of value that the market has not appreciated.
That’s what drives a lot of exploration geologists: the thrill of the hunt.
Now if you’re looking to get into the exploration game but you don’t want to make it too speculative — then I would get friendly with a geologist or two who understands mineral deposit quality and who knows ‘who’s who’ in the sector.
Ideally you would put your money with juniors that are run by top quartile management teams that have top quartile mineral projects, and plan to or are executing high quality, value-adding work programs.
There are quite a few of them out there and that’s a big part of our modus operandi: to find the people and projects and back them along the way.
TD: Neil, are there any parts of the market (regions, or commodity themes) currently that you’re looking at in terms of opportunities?
NA: Well, I won’t mention any specific equities, but one area that is a recently warm theme is the Canadian gold [exploration] sector. There has been quite a bit of money moving into the sector in recent months.
It’s encouraging to see that there are almost dozens of aggressive drill programs underway across Ontario, Quebec, parts of B.C., Newfoundland and Nova Scotia.
Mineral discovery, mineral definition, and ultimately resource extraction requires well-delineated ore bodies, and those ore bodies are delineated only one way and that’s by drilling holes.
So it’s good to see there’s a mini-boom going on in the Canadian gold sector at the moment, and we’ve allocated some capital into that sector over the last 12 to 18 months.
So far it has been a productive experience.
TD: Do you see excesses in that sector Neil?
NA: Well, there are always excesses. Certain stocks are promoted beyond their fundamental value and they get overbought.
Often what happens in that case is that the investors get a bit carried away as to what the company “might” have. Sometimes the drill results have to catch up to reality and quite often they do if the project pans out as hoped. We only know though during and after the holes are drilling.
The market, you can argue, is sometimes reasonably efficient and also forward-looking.
A geologist can see the drill results come out and say, “OK, the resource is currently 1 million ounces. But you can study the plans and cross sections – and really there’s 1.5 million ounces there,” and the market can get a little bit ahead of itself.
But I wouldn’t say it’s a true bull market there yet. I wouldn’t say there is an excessive number of crazy valuations in the Canadian gold sector.
TD: Neil Adshead, Ph.D., Investment Strategist with the Sprott Organization. Thank you for sharing your comments.
NA: No problem. Thank you Tekoa.
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