I once again caught up with fund manager Matt Geiger and got his views on Nickel, Uranium, and if he thinks we are in another mining bear market.
Hi Matt, welcome back to The Next Bull Market Move. Let’s start with a recent article you wrote entitled ‘Are We in Another Mining Bear Market?’ In that article you really put into context of where we are within the mining space. Can you give us a brief overview of that article and why you felt now was the time to write it?
Thank you Kerem. It’s a pleasure to be back. There’s no doubt that 2018 has been a disappointing year for mining investors, many of whom (myself included) came into the year with high expectations. Starting in the early summer, the pessimism began to reach extreme levels. We saw spec short positions in metals such as copper, gold, and silver hit record levels. We saw a well-followed resource investor throw in the towel and proclaim that mining shares would decline through the rest of the year. We saw large funds rebranding and switching mandates away from metals and mining. Despite the pessimism, the gist of the article is that we are NOT in a new mining bear market. Instead, the weakness we’ve seen for most of this year should be viewed as a consolidation period within the mining bull market that began in early 2016.
My rationale for this is twofold. The first reason is that, by historical standards, the bull market that began in January 2016 would have been abnormally short and weak if it indeed ended this past January. As pointed out by newsletter writer Gwen Preston, the average junior mining bull market has "averaged 47 months with a 202% gain. . . If this [bull] market indeed ended in January (the last high), it would have been the shortest (25 months) and the weakest (73%) in four decades."
This in and of itself is not conclusive evidence that this bull market is still ongoing. It is indeed possible that a decade from now we'll look back on the two-year period between January 2016 and January 2018 as the shortest resource bull market of the past 50 years.
However, it is my belief that markets generally adhere to Newton's Third Law: For every action, there is an equal and opposite reaction. This is particularly true for mining, which, like shipping, is abnormally cyclical due to the capital-intensive nature of the business. It is said that bear markets are the authors of the following bull market. And we generally find that the more ugly the bear, the more attractive the bull. With this logic, the devastating 2011-2015 bear market is unlikely to be followed by the shortest bull market in 50 years.
The second and more persuasive piece of evidence is that the M&A activity surrounding companies such as Arizona Mining, Nevsun, Novagold, Peregrine and Northern Empire indicates that we are still in a bull market. I mentioned that we were seeing an increased appetite for strategic investments into earlier stage juniors led by major miners such as South32, Newcrest, and Goldcorp. I then commented that this trend was sustainable and that “more deals are coming, and soon.”
The article was published in mid August and I think the thesis has been supported by what’s happened in the weeks since. Most notably, the M&A activity has only picked up in intensity. In mid September, we saw Ross Beaty-led Equinox Gold pay $158m for New Gold’s producing Mesquite Gold Mine in California. Less than a week later, Barrick Gold announced the acquisition of Rangold in a mammoth $18.3b deal. On the same day, Great Panther announced an all-share takeover of ASX-listed Beadell Resources. Just this week, Americas Silver announced an all-share takeover of Pershing Gold. We’ve also seen SolGold hit a 52-week high as takeover rumors swirl around the company’s Cascabel Project.
Additionally, resource prices themselves seem to have hit an inflection point in mid September. Just look at the charts of the Bloomberg Commodity Index, the UBS Bloomberg CMCI, the Reuters/Jeffries CRB, the Rogers International Index, or the S&P GSCI. In each of these commodity-centric indexes, prices begin to rise in a V-shaped fashion starting on September 17th. While it is still early days and commodity prices are notoriously fickle, this may be the start of a substantial move higher.
Over the last few weeks I’ve been meeting and interviewing CEO’s from a few junior uranium companies and I get the sense that sentiment is starting to change in the uranium sector. The recent climb in the spot price helps with this sentiment but other factors are perhaps starting to influence the market. Palisade Radio are also currently in the middle of a ‘Uranium Series Special’ in which Collin Kettell is interviewing a lot of the major players in the Uranium sector (click here to view Palisade Radio’s most recent interview). So what are your current views on the uranium market?
We’ve had significant uranium exposure for a few years now and it’s been a mostly painful experience. The sector has been mired in a devastating bear market since the Fukushima disaster in March 2011. It is a certainty that the industry will turn at some point, the question of course is when. In the recent past, U308 bulls have been fooled by a few head fakes. Most notably, uranium equities rallied sharply between November 2016 and February 2017. Many investors jumped in at the top of this move, only to be greeted with eight consecutive months of losses. The uranium space showed life again in mid October 2017 and rallied through the first week of January 2018. But again, this move fizzled out and U308 equities dropped sharply in the following two months.
Most recently, uranium equities have been in a solid uptrend since mid March 2018. Uranium bulls are growing in excitement and we’ve seen some dramatic share price increases over the past 2-3 months. This begs the question of whether this move is real, or whether this is yet another head fake. I’m of the opinion that the current move is sustainable. The difference this time is that the catalyst is coming from the demand side. This differs from the late 2016 move, which was driven by expectations of the initial Kazatomprom supply cut that eventually materialized in January 2017. Same story with the late 2017 uranium rally, which was fueled by a November 2017 announcement from Cameco that it was shutting down production at McArthur River. This more recent move, however, has been fueled by excitement surrounding U308 demand. More specifically, we now have two big buyers in the spot market that we didn’t have in either of the past two years.
The first is Yellow Cake PLC, a London-based company whose stated strategy is to become a long-term holder of physical uranium. The company listed on the AIM in early July after completing an impressive financing of roughly US$200m. Shortly thereafter, Yellow Cake confirmed the implementation of a ten-year contract with Kazatomprom, which was signed on 10 May and covers the annual delivery to Yellow Cake of up to US$100 million of uranium at market-related prices. This is material that would otherwise be available for utilities to buy. Instead, it will be taken off the market and sit in long-term storage at the Port Hope-Blind River facility in Canada.
Even more significant is that Cameco itself is now a significant buyer in the spot market as well. Due in part to the indefinite suspension of production at McArthur announced in July, Cameco is expected to produce only 17m pounds of uranium this year. However, Cameco is on the hook to deliver a full 37m pounds to its customers by the end of the year. The company will be able to fill half of this 20m pound shortfall with inventory, but that still leaves another 10m pounds. Where will Cameco find this 10m pounds? On the spot market. And considering that the spot market is only estimated at 20m pounds annually, this is a massive new source of demand that was absent in prior years. There’s a reason that the spot U308 price is up 40% in just the past 6 months. A final point differentiating this current run up from the 2016 and 2017 disappointments is that the move has been more gradual and U-shaped. Steady climbs are more sustainable and long-lived than violent spikes. This current run in U308 equities has now eclipsed in duration both of the two recent head fakes.
From an investment perspective, my recommendation is to focus only on uranium equities that are cashed up for at least the next 12 months. The list of U308 equities that fall into this category is relatively short. Examples include Cameco, Nexgen, Fission, Denison, and Energy Fuels. (For full disclosure, the MJG fund owns Denison common shares and Energy Fuels publicly traded warrants.) Otherwise it’s best for investors to sit on their hands and evaluate the placements as they come. Just in the past month, we’ve had a handful of uranium companies come to market including Ur-Energy, UEC Energy Corp, and UEX Corporation. Many more will be coming to market in the next 90 days to take advantage of the renewed interest in the space. Investors should evaluate the terms carefully and participate in the right deals opportunistically. Look for a full warrant with a minimum of 3 years to expiry and no accelerator.
Let’s move onto the Nickel market. To me, it looks like the spot price is consolidating at around the 5-6 dollars per pound mark after a strong run up earlier in the year. But also the inventories of available Nickel keep falling, month after month. What does this suggest to you?
Over the past 3-4 months, nickel has been hit with the rest of the base metal complex over fears that the Trump-China trade showdown may derail the global economy. Those fears reached a fever pitch in mid August where we saw capitulation selling across base metals and the associated equities. That said, we seem to have reached an inflection point in the week after the Labor Day holiday. The market is beginning to recognize than an isolated China-US trade dispute does not have the potential to seriously undermine global GDP and, if anything, may lead to higher US inflation. With this backdrop, we’ve seen the prices of copper, zinc, and nickel strengthen notably over the past five weeks. Speaking specifically about copper, Reuters analyst Andy Home recently commented that “current positive internal dynamics are increasingly at odds with a price that remains depressed by global macro gloom. Short-term fundamentals may yet bite back the many fund shorts.” The same characterization can be made of the nickel market. As you alluded to in your question, global nickel inventories have plunged to levels last seen in 2013. In fact, as seen in the below chart, LME warehouse inventories have fallen by 40% in just the past year.
This is undeniably bullish for the nickel price and the inventory drop has so far showed little sign of slowing down. That said, from a longer-term perspective, what’s happening on the demand front is even more exciting. As I wrote in my February 2018 article “Nickel: Is it the New Lithium?”, the real beneficiary of the EV revolution will end up being nickel as battery manufacturers continue to transition to nickel-heavy chemistries.
Remember, just a few years ago, the average NMC cathode contained 33% nickel, 33% manganese, and 33% cobalt. This is otherwise known as 111. Nowadays, the prevailing cathode chemistry contains 50% nickel, 20% manganese, and 30% cobalt. This is known as 523. And in just a few years, the expectation is that the default chemistry will be 811.
Battery manufacturers are transitioning to nickel-heavy chemistries for a few reasons. The most important factor is price; cobalt is 5x more expensive than nickel per pound. Security of supply concerns are another factor, given that 60% of global cobalt supply comes from the Democratic Republic of Congo. CSR concerns are another factor as a not insignificant percentage of cobalt supply stems from child labor.
It is worth noting that 50% of global nickel supply is NOT of sufficient quality to be used as an input into batteries. Investors should focus on nickel sulphide deposits and limonitic laterities amenable to battery-grade nickel production through HPAL.
In general, what are the company characteristics that junior investors should be looking for at this part in the cycle?
In any cycle, management is at the top of the list. Look for teams that have made shareholders money in the past. Look for management that is able to effectively market a story and attract capital. And most importantly, look for management with significant skin in the game which I’d define as greater than 10% insider ownership.
Skin in the game inherently solves many of the problems that plague the junior industry. Management teams with significant insider ownership are more judicious with the company’s cash and more willing to cut expenses when the circumstances call for it. They are more discerning with potential acquisitions and more focused on value creation than growth for growth’s sake. And there is a strong inverse correlation between skin in the game and the company’s rate of share dilution. For these reasons, this is the place to start when evaluating any company.
Also worth considering is the company’s working capital position. Particularly in challenging financing markets like we’re seeing now, look for companies with at least 12 months of runway at the current burn rate. If the company has a major forthcoming catalyst, then you can get away with 6 months. But anything less than that and it is far smarter for investors to sit on their hands and wait to evaluate the next placement.
In terms of project characteristics, focus on quality development stage assets that make sense developing at spot metal prices. Geopolitical risk is ok. So is permitting risk. So is technical risk. But this is not the market to be betting on optionality plays and praying for higher metal prices. Additionally, post-discovery plays are working extremely well in this market environment. Just look at the excitement that has surrounded names such as GT Gold, Great Bear Resources, Aurion Resources, RNC Minerals, White Gold, and Adriatic Metals to name a few. (For full disclosure, the MJG fund recently initiated a position in Adriatic Metals.)
Keep in mind that post-discovery plays are risky and the chances of failure are well higher than those of success. Sometimes the deposit ends up being smaller than expected. Other times the metallurgy doesn’t work out. But when things go right, the upside can be enormous. Five and ten baggers do happen. Especially as M&A heats up and the remaining top tier development projects get swallowed up by majors, post-discovery stories will receive increasing attention over the coming year.
And finally, give us an overview on your fund and the types of investments you make within it. And how can prospective investors get in touch?
MJG Capital Fund, LP is an open-ended investment partnership specializing in natural resource investments. We are long-only and hold a portfolio of 15-25 positions. Holdings include explorers, developers, and producers of energy metals, industrial metals, precious metals, and ag minerals. We also invest in agriculture, forestry, water, and protein. Investments are selected on a bottom-up basis with a particular emphasis on serially successful management teams and near-term catalysts. Roughly half of our positions are initiated through private placements directly with the company. These placements almost always include full warrants.
All MJG limited partners have agreed to a ten year lock up on their investment. To build wealth in natural resources, it’s essential to have an exceptionally long-term time horizon. I’m fortunate enough to have some very patient investors and look forward to rewarding their commitment over the coming years. I’m always happy to chat about the fund and our investments. For those interested, my contact information can be found at www.mjgcapital.com.
Many thanks Matt.
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