There’s value in them thar hills!

Mining used to be simple. Find a deposit, build a mine, get it out of the ground and sell it. Today the hardest thing to find is a low-risk growth strategy that delivers investors and results
By Ian McGugan

Sweet spot: Among miners that have found business models offering growth with less risk is streaming pioneer Silver Wheaton, led by CEO Randy Smallwood

What a difference a year makes. At the start of 2016, the mining industry was reeling. Metals prices were in freefall and investors had long since fled from the sector.

Then everything changed. As new signs of global growth emerged, prices—even for supposedly despised commodities such as coal and iron ore—surged past expectations and many miners’ shares doubled or more. The abrupt turnaround underlines the first principle of metals forecasting: nobody knows anything. If you feel like trying to predict what the next year will hold for miners, go ahead. Just don’t expect your forecast to be accurate.

Instead of playing guessing games, let’s turn our attention to an equally vexing but slightly more promising question: How does a mining company create value in this unpredictable environment?

The answer used to be relatively straightforward. You found an attractive deposit, mined it efficiently and counted on global growth to create a market for your ore. As profits expanded, you poured money into adding new mines so you could expand production.

The first principle of metals forecasting: nobody knows anything (click to enlarge)

That model worked well enough in more stable times, but is now being undercut by several forces. One is the generally lacklustre return on exploration spending in recent years. While each metal is different, many key commodities, including gold and copper, are becoming more difficult to find. To make matters worse, the most attractive discoveries now demonstrate a depressing tendency to be located in politically volatile jurisdictions in Africa or central Asia.

The dismal payoff from exploration has encouraged many companies to contemplate acquisitions. The problem here is that buying other companies poses its own dangers. Just look at the ugly record of deals completed at the height of the last commodity boom. Intoxicated by rising prices, companies wasted billions on problem-ridden acquisitions.

To be sure, it’s tough to time such takeovers, in large part because it’s so difficult to predict what will happen in China. The Asian giant’s frenetic construction has accounted for roughly half the global consumption of many base metals and bulk commodities in recent years. But to the great discomfort of miners everywhere, its appetite for raw materials has swung back and forth in unpredictable cycles.

Miners don’t know what to expect next. Two years ago, as China eased back on big infrastructure projects and encouraged a more consumer-led economy, the outlook for metals seemed utterly bleak. A year ago, when Beijing jolted back to a more pro-stimulus stance, the outlook for commodities brightened, practically overnight.

Such policy-driven volatility isn’t going away. It may even get worse as Trump-onomics takes hold in the United States. Miners have been able to count on generally open borders in recent decades. With Donald Trump in the White House, that is no longer a sure bet.

So how does a miner attract investors in this treacherous, risk-filled climate? At least three strategies hold promise.

The first is to reduce risk through partnerships or financial engineering. David Garofalo, the chief executive of Goldcorp Inc. (TSX:G), says it now makes sense even for a company as big as his to team up with other senior gold producers on specific projects. It’s a natural evolution as mines become more expensive and more challenging to develop, he says. If nothing else, partnerships help to reduce the damage to a company if any one project goes sour. Garofalo’s not alone. In January at TD Securities’ mining investor conference, Randy Engel, executive vice-president of strategic development at Newmont Mining Corp. (NYSE:NEM), also noted the value of the “partner model.”

Streaming companies offer another twist on this risk-reduction theme. They pay miners a one-time cash fee in exchange for a long-lasting right to buy a “stream,” or share, of a mine’s future production at low, fixed prices. The biggest streamers, such as Franco-Nevada Corp. (TSX:FNV) and Silver Wheaton Corp. (TSX:SLW), have now amassed large, diversified portfolios. They will prosper if metals prices continue to climb.

Just as important, streamers also enjoy substantial protection against bad news. They can shrug off problems at any single property and if the worst were to happen and prices were to fall industry wide, the streamers aren’t on the hook for the cost of shuttering mines or suspending production.

But risk reduction isn’t the only way to play this mining environment. Another strategy is to embrace risk, but in unique and smart ways—for instance, by deliberately pursuing opportunities in politically challenging countries.

Share performance of Robert Friedland's Ivanhoe Mines (click to enlarge)

A mining company that amasses political and geological knowledge about a risky country can differentiate itself from competitors that stick to safer jurisdictions. It can also improve its odds of making a major discovery. Just ask Robert Friedland, whose success with the Oyu Tolgoi copper project in Mongolia and the Kamoa copper deposit in the Democratic Republic of the Congo should provide inspiration to other miners looking for big deposits.

Of course, political risk isn’t for everyone and that brings us to a third value creation strategy: sheer size. This is most applicable in bulk commodities, where deposits have multi-decade lives and success rests on producing product at the lowest possible cost. The immovable giants of the iron ore industry—Rio Tinto, BHP Billiton and Vale—demonstrate that scale pays off. Potash Corp. of Saskatchewan (TSX:POT) is pursuing a similar size-based strategy in the fertilizer space by striking a deal to merge with Agrium.

Such giants seem well positioned to navigate an unpredictable future. So do companies that devise smart ways to reduce risk or businesses that can offer investors a unique window on dicey political jurisdictions. Enterprises that can’t tempt investors with any of these attributes may want to consider whether it’s time for a change in strategy.

Ian McGugan is an award-winning business journalist in Toronto and the founding editor of MoneySense magazine. E-mail: imcgugan4@gmail.com.

Photography: Jeff Kirk

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