Zincfinger and return-free-risk

Nelson Bunker Hunt died last month in his 88th year. Some of you will be old enough and interested enough to remember that for some reason he thought that he could corner the global silver market with the wealth he had made from Libyan oil. It was a delusion which led to his bankruptcy when the price bubble which he contrived to inflate burst in 1980. Mr Bunker Hunt targeted silver because at the time Americans were not allowed to buy gold – I am not sure exactly why and so much for then idea of unfettered capitalism and free markets. Cornering the market for a metal sounds like a completely daft idea and something dreamt up by an evil megalomaniac like Goldfinger in the Ian Fleming novel. However a few years later Marc Rich, who had clearly not learnt anything from Mr Bunker Hunt’s demise, also attempted to corner a market in the early 1990’s but this time zinc. Mr Rich had made his loot trading oil and his avarice for zinc not only cost him $172 million but drove the commodity trading company he founded to the edge of collapse. It was a deal that finally forced him to sell his company in 1994 in a management buyout to form Glencore – see my blog post in April https://irusconsulting.com/something-has-got-to-give-soon-with-the-zinc-price/. Both these men were driven and big risk takers and believed strongly that without speculation there is no accumulation

So if like many others if you have gone understandably gone “turtle” in this market and sucked your head back into your shell where can you get a yield on your money by taking no risk? Or in the jargon of economists, what is the current price of zero-risk? One way to look at the pricing of zero risk is to consider the fact that in mid October the yield on a US ten-year bond fell to 1.8 per cent. Government bonds in general and certainly US bonds in particular are considered risk free. There is the odd exception as in the defaults on sovereign debt in Argentina, but as we have experienced in Ireland over the last few years, governments prefer to cripple its electorate with taxes rather than burn the bond holders.

So what about inflation? The CPI inflation in the US is 2.5 per cent but the inflation in the cost of living as any American consumer knows is more reliably five to six per cent. So if you buy $100,000 worth of US bonds at a yield of 1.8 per cent on the basis of avoiding all risk then you will end up with about $65,000 in today’s dollars at the end of 10 years. Do the math yourself and if you are inclined be pedantic about the accuracy and miss the stark reality then so be it. Would we call this return-free-risk or maybe tragic value destruction might be more appropriate. Maybe sovereigns are not burning the bond holders but you could take the view that US bond investors are burning their own money.

This indeed is the current reality, not so much an appetite for risk but a widespread and complete allergic response to risk in the mining sector. With the virtual collapse in equity capital markets for Junior explorers and at the same time the Major’s view of exploration just as a cost, their CEO’s becoming cost accountants and why not? Why would a major mining company not see exploration as bad business when with the general collapse in share prices in the sector if you buy a Junior explorer then sometimes you can buy inferred resource ounces of gold in the ground for as little as $5 and much less than spending the high-risk bucks to make the discovery. It then falls to private equity and wealthy individuals to bridge the gap in funding for exploration which to my mind is highly unlikely. The only way these private equity funds do exploration is as a free option on the back of a production story.

Even in the best of times the resource sector’s investment allocation in exploration remained around three percent compared with the IT sector at around 11 percent. Clearly metal prices have to surge and find support at levels high enough to stimulate investor greed and overcome this inertia of paralytic fear. In recent times private equity groups have gathered in big pools of capital to invest in mining projects. Generally the mandate is to invest in de-risked development projects whatever that is or preferably producing mines where there is lots of risk. Fund managers find it easier to allocate relatively large chunks of capital to a project as a small project takes as much time and attention as a large project. Another problem is that the reason given for lack of private equity deals in the mining sector is that there is a lack of quality. Well that is a surprise indeed given that without exploration and discovery we will only uncover what we have already found. What we have already found in the past is likely to be undeveloped for a good reason and if it needs a high metal price to fly then be careful, particularly if it is a zinc project. Beware in the next metal price cycle of carpetbaggers coming out of the woodwork to peddle their wares and the brokers who fumble in a greasy till.

So once again exploration and the creating of substantial value through discovery becomes the pursuit of a leper. Let us not kid ourselves that there is a great deal of risk in exploration and even more so because in many districts the mineral which outcrops out at the surface has already been discovered, the so called low-hanging fruit, and the focus has been for some time now on the search for concealed or blind deposits. These deposits will need to big bigger and higher grade to cover the cost of mining at greater depths – talk to any South African mining engineer. And even if a potentially economic and independently certified resource is delineated there are lots of mitigating factors to be considered that can slide sideways in a squishy sort of way. What we have to hope for is that commodity prices rise to incentive levels quickly before the farmer exhausts this year’s crop because he has very, very little planted. It will have to happen soon because the farmers are getting old and grey. The old grey are retiring and dying. A dwindling grey cohort in now linked by only one degree of separation. This grey knowledge is passing on with them and increasingly not shared with the green which recedes as the desert encroaches without the irrigation of the capital pools. Enter the contrarian investor with the abandon or courage or megalomania or delusion of a Mr Bunker Hunt or a Mr Rich and who knows, they might get lucky and very rich in the process. Maybe platinum and palladium are ripe for another attempt at cornering a market fuelled by a fortune made east of the Urals. It needs a contrarian to see the vision and there are a lot of opportunities for the first to move. I do not think we will see this confluence of failure, negligence; corruption and greed through up so much opportunity again. But in the meantime methinks that this grey geologist at least will cast an eye over the self-immolating Juniors to see if there are pearls to sieve among the ashes.

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