It’s no secret that the mining sector has been a bad place to invest for quite a while. The S&P/TSX Capped Materials index, which includes all of Canada’s major mining companies, lost more than 10 per cent of its value in 2018. That performance came after the index showed no gain from the summer of 2016 to the beginning of last year, as the overall stock market soared.
Now that the market has corrected, many investors are taking advantage of discounts in high-flying technology stocks, or looking for bargains in the especially hard-hit energy sector. But perhaps now is a good time to consider the overlooked mining sector, and identify cheap stocks that could be poised to rally.
Lyle Stein, managing director and senior portfolio manager at Vestcap Investment Management in Toronto, feels sentiment for investing in mining is at a bottom – “as bad as any sector out there, along with oil and gas.” But he says that since little money has been flowing into the industry, and share prices have been depressed, the risk of investing in the sector is greatly reduced.
Mr. Stein looks to buy shares in companies with assets that will be long-term generators of cash. He notes that mines meet that definition, as they have an average lifespan of about 20 years – as opposed to a technology product that is likely to be supplanted by a competitor within a year or two. He says most well-run mining companies will make money over the long term, but their returns will be cyclical, rising and falling with the economic cycle.
Mr. Stein identifies supply as a key factor that is set to boost the mining sector. “Mines haven’t been built in the last several years, so shortages are arising in basic materials.” He says zinc is experiencing shortages now, and copper and nickel will experience similar shortfalls in the next two to three years. “It takes about five years to build a mine, so it’s easy to see supply shortages ahead.”
Mr. Stein uses a three-tiered approach to identify mining stocks worth buying. The first step is to analyze the outlook for various commodities. His firm ranks the commodities in order of their attractiveness. He notes copper currently ranks highly, and gold is also positive, in part because there has been very little capital market investment in gold companies.
The second step is to look at which companies in the most attractive commodities are best positioned to make money. Mr. Stein says cost structure is key – “the low-cost producers always win.”
The third step is to look at the management team, including their track record and how disciplined they are with using shareholder money.
Mr. Stein has one other tip for buying mining stocks, and it may seem counterintuitive. “You want to buy them when their price-to-earnings multiples are ridiculously high.” That happens when the companies are making little or no profit, and the cycle is set to start turning in their favour. “When the multiples are low they are making lots of money, which means it’s the end of the cycle and it’s a bad time to buy.”
While the outlook may be improving for some base metals, there are also positive factors for precious metals. “Gold seems to be catching a bid,” says Joe Mazumdar, co-editor and analyst at Exploration Insights, a mining investment newsletter based in Vancouver that focuses on junior miners.
Among the factors he sees helping the gold price include the U.S. Federal Reserve slowing its rate of interest-rate increases, political uncertainty in the United States and Britain, and the underfunding of exploration, which has led to undersupply in the gold production pipeline.
Interest in the gold sector has also been sparked by major activity at the top end: Canada’s Barrick Gold Corp. combined with African miner Randgold Resources Ltd.; then, Denver-based Newmont Mining Corp.’s made a $10-billion bid for Vancouver’s Goldcorp Inc.; followed by Barrick’s somewhat hostile and surprising bid for Newmont. Mr. Mazumdar expects these megadeals to lead to divestitures – assets being sold by the newly merged giants.
“I call it the little fish eating stuff coming off the big fish,” Mr. Mazumdar says. As well, he thinks junior miners will have to seek some consolidation to gain relevance in capital markets – perhaps even three-way mergers. The trend may be especially pronounced in Canada, where the big mergers have led to a “hollowing out” at the top end of the industry, as the largest companies become “less Canadian” as a result of their new structures. “You could see a ‘Canadian champion’ coming together,” Mr. Mazumdar says.
Like Mr. Stein, Mr. Mazumdar’s investment process begins with looking at which commodities have a positive outlook. “We’re not interested in a great asset in a commodity that isn’t going anywhere,” he says. He then looks for companies with the best quality assets in that sector, including whether there are any political risks in the locations in which the company operates.
Mr. Mazumdar then considers the quality of the company’s management. He looks for a track record of finding and developing the best assets, and experience in attracting offers for those assets.
“Our goal is an acquisition,” he says. “The likelihood of a junior miner successfully developing a deposit themselves is very small.” He also checks to see whether management’s previous experience matches with their current role: “If they were previously in potash in Saskatchewan it may not help managing a gold project in the Andes.”
As well, he looks for relationships with senior companies, and an appreciation of shareholder concerns in capital structure – for example, not issuing excess shares.
Mr. Mazumdar also guards against “value traps,” that is, stocks that are cheap but are not worth buying because their share price will likely stay low. “A company may say, ‘Look how big our deposit is, and how low our share price is.’ But unless there’s a specific catalyst, the stock will do nothing.” He says these are often deposits that are marginally profitable at current commodity prices, in unfavourable locations, with illiquid shares, and management teams without a plan to surface the company’s value.
There are quality cheap mining stocks to be had right now. With valuations low, the upside is enticing. As Mr. Stein says: “Anyone who’s been around in the Canadian investing world knows, nothing beats a good mining rally.”
Stocks with potential
Lyle Stein, managing director and senior portfolio manager, Vestcap Investment Management
Teck Resources Ltd. (TSX: TECK-B)
“It’s the great Canadian base metal provider,” Mr. Stein says. He likes the company’s exposure to copper, zinc and metallurgical coal, which are all at positive stages in their cycles. Mr. Stein recalls Teck CEO Don Lindsay saying the company’s earnings may be modest at some stages in the economic cycle, “but in others we’ll make so much money it’ll make your head spin.”
Agnico Eagle Mines Ltd. (TSX: AEM)
Mr. Stein says the company is a proven gold producer, with mining operations in Canada, Finland and Mexico, and it is a good time for the metal. He notes they have shown over the years a consistent ability to mine at a low cost and on budget.
Hudbay Minerals Inc. (TSX: HBM)
Mr. Stein likes the company’s exposure to zinc and copper.
Joe Mazumdar, co-editor and analyst, Exploration Insights
Mr. Mazumdar notes that in a resurgent gold market, the first stocks to rally are those that are already in production. Both of these listings qualify; he likes Sandstorm’s royalty stream model, and the quality and location of Premier’s assets.
Mirasol Resources Ltd. (TSX: MRZ-X)
For a microcap pick, Mr. Mazumdar favours Mirasol Resources. He points to their strong technical team with expertise in the areas where the company is operating (Chile and Argentina).
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