It’s entirely appropriate that the famous phrase from Shakespeare’s The Merchant of Venice, “All that glisters is not gold”, is most often misquoted as “glitters”. Gold is a confusing subject, especially for an investor trying to predict its future price. It produces no income, costs a lot to mine, store and insure, and yet many see it as an essential part of a diversified portfolio. It’s certainly had a good run in the last 10 years:
So I spent two days at a gold and other minerals symposium to learn more.
Oscar Wilde said, “The optimist sees the doughnut; the pessimist sees the hole.” If you sit through a couple of dozen presentations by the CEOs of junior mining companies, especially gold prospectors, at a resources conference, the only thing you hear about are the doughnuts. The holes are confined to massive craters in remote locations. There’s a wonderful optimism that the next big strike is just a bulldozer gouge away, and you have to admire the conga line of unbridled, fund-raising enthusiasm. Perhaps you need the self-confidence of Lady Gaga, the zeal of Pink and the resilience of Mick Jagger to dig a kilometre underground in a desert 500 kilometres from the nearest town.
They make it sound so exciting, and it’s little wonder these prospectors and miners love their industry. The maps show Botswana and Namibia and Brazil and Indonesia and Mongolia. Take a jet to a South American capital city, hop on a helicopter, fly over rainforest, and there’s a scarred clearing covered in mining equipment. Not for the new breed an opal mine in Coober Pedy or gold prospect in Hill End. Let’s make it complicated, let’s bring in some sovereign risk and an uneducated native workforce. And did you know that the Government of Congo is very friendly to foreign miners, with special tax incentives, relaxed safety laws and environmental concessions. Just don’t mention the dengue fever.
The hoopla is palpable, even from the explorers who have little more than the rights to prospect over an island off Indonesia without a single sod yet turned. This guy has been going to Zambia three times a year for a decade. There’s the diamond company that has just hit a single gem-quality stone which will fetch half a million dollars. There’s the lithium producer salivating at the growth of electric vehicles needing lithium batteries for the next few decades. And if you think the case for investing in gold is strong with government defacing fiat money, then the silver story is even better.
But just as you want to rush out of the room and buy some shares in this sure thing at five cents, you find out they did a capital raising last week at three cents. That’s half the current price! So you wait for the next presenter. This one is the lowest cost producer in Africa. Didn’t someone else say that this morning? And did you know Indian households hold more gold than the US Government and all European Governments combined? The seven billion people in the world will soon be nine billion, and their demands for food will met by super phosphates. But this phosphate company just did a capital raising, and its shares are worth less than the cash backing? It’s crazy, how can that be?
Then you notice something strange. This conference is ‘the number one event series for mining investment and capital raising’, with representatives from dozens of junior resource stocks, mining equipment companies, consultants and mining magazines. There must be more trade magazines in mining than show business. But where are the folks from BHP, Rio or Fortescue? Wait a minute. Even more serious, where are the investors? The big resource funds are not here, because they want to buy in chunks of $10 million but not own more than 5% of the stock, so no point listening to a company with a market cap of $20 million, regardless of how good the story is. The fund managers are saying: come back to me when you’re out of training wheels. Most resource companies are tiny, using the ASX as a place to raise a few million dollars to finance the sinking of some holes before the money and the ideas run out.
It’s charming how all the CEOs flick past the disclaimer at the start of their talks, then proceed to go so close to giving investment advice that any ASIC official would blush. One CEO tells us it’s time to invest in uranium because, thanks to Fukushima and earthquakes and tsunamis, prices have never been lower. Then the next guy says it’s great to invest in gold because, thanks to global uncertainty and Indian weddings, prices will go through the roof. One chart has a long-term $30,000 an ounce forecast. Obviously, anyone who lives in a Zambian jungle half his life and feels more comfortable in a safari suit is hardly likely to worry about a bit of exaggeration in a Powerpoint presentation. And everyone may be ‘the next Sirius Resources’, which almost ran out of cash and saw its share price fall to five cents, only to fly to $3 on the back of a major nickel-copper discovery.
The only large miner to make a presentation was Hancock Prospecting, and it was hard not to be impressed by the sheer audacity of the project. Its Roy Hill development in the Pilbara is a brave leap of faith. Hancocks is a private company so it’s not so beholden to equity markets, but it still needs to raise the debt. They intend building a 440 kilometre heavy rail line to the coast from the site in the Pilbara, with rail construction camps along the way and an airstrip at the mine. It depends on the iron ore price for the next 20 years, in a market that does not have much idea what it will be next month. Good job Gina is the fifth wealthiest woman in the world.
Then amid this optimism and faith, along comes somebody to spoil the party. Andy Xie was Chief Economist for Asia Pacific at Morgan Stanley from 1997 to 2006, and now is one of China’s leading independent economists. He calls the controlled economy of China “the biggest misallocation of capital in history.” Government officials whose first priority is keeping their jobs tell factory owners that they must continue to produce their goods to maintain local jobs. If there is no demand for the product in such a controlled system, the government buys the output and stockpiles it. A large proportion of government revenue comes from land, and so people keep building even though there now almost 10 billion square metres of buildings finished or nearing completion with no occupants. Xie says ongoing urbanisation is a fiction because rural villagers do not have the money to live in the cities, and in any case, most rural land is free so why would they move. He sums up the claims on economic growth by saying that all aggregated numbers in China are made up. He even says much of the demand for steel in China comes from building new steel mills. Government stimulus is simply building more capacity nobody wants.
Most of the resource projects presented at the conference are facing far more of the hole than the doughnut. As one presenter said, there are 250 gold companies listed on the ASX. You can guarantee that the one you choose to buy will be the one that goes broke.
Even if Andy Xie is wrong and China continues to grow strongly for another 20 years, then the vast majority of these juniors will never be another Sirius Resources. Sirius is the brightest star in the night sky, but down on earth, the money raised on many projects will just be used to make the holes bigger.