The global economy has steadily become more resource-intensive, creating the need for capital expansion in the underinvested mining sector. Yet demand for minerals and metals is poised to accelerate further thanks to two still-underappreciated drivers: The green energy transition and the global expansion of upper- and lower middle-income status consumers. These trends are also helping to create significant near-term investment opportunities.
Governments are enacting extensive legislation – most notably, California’s recent 2035 zero-emissions-vehicle (ZEV) mandate – to combat climate change and decarbonize the planet. Electric vehicles (EVs), EV batteries, and the solar panels, wind turbines, and nuclear power plants that will supply them with carbon-free electricity, all require significantly more mineral inputs than current technologies. At the same time, a growing global middle class, forecast to reach 5.8 billion people by 20301, wants access to the conveniences of modern life, including buying homes, transportation vehicles, washing machines, air conditioners, cars, TVs, and especially, smartphones and computing equipment (Figure 1). All these items require metals and minerals in quantities not currently available – and the multinational resource companies and the wider investment community are gradually starting to grapple with the implications.
Figure 1: GDP Per Capita and Population Growth
Demand for minerals, driven by rising living standards, urbanization, and industrialization, is strongly correlated to global GDP growth
These secular trends indicate the beginning of a new commodities supercycle – a sustained period of increasing demand growth that raises prices for a broad range of commodities. But there’s uncertainty over how broadly commodities will rise: Some believe the supercycle will be focused, and concentrated in a limited range of metals and minerals essential to technology and green energy applications, such as copper, lithium, cobalt, nickel, and rare earth elements.
Dislocations are creating opportunities
While a seismic shift in long-term demand trends for metals and minerals is clear, capital has been hesitant to follow the demand signals, and investors, by and large, are still on the sidelines. Some hesitation is understandable. A few stressors have impacted mining over the past two to three years, including COVID shutdowns, global supply-chain disruptions, the Russia-Ukraine war, inflation, monetary tightening, and fears of global recession. These events are creating dislocations in the market. Two striking examples are shown in Figures 2 and 3 below: despite the fact that warehouse inventory levels sit at multi-decade lows, commodity prices are falling. It may not make sense, but it does create an opening for knowledgeable investors.
Additionally, financial speculation has driven down the price for base and precious metals beyond where fundamental supply and demand would balance the market. This negative financial positioning is artificial and anticipatory ahead of a potential global slowdown. The impact will be a delay in required investment, which will likely lead to higher price volatility and greater physical supply deficits in the next few years. That presents strong opportunities for knowledgeable investors who remain selective and nimble in uncovering opportunities within current market dynamics.
Figure 2: Copper Inventory vs Price – all exchanges (LME, SHFE, COMEX)2
Figure 3: Zinc Inventory vs Price – all exchanges (LME, SHFE)2
Historically speaking, when commodity prices decline, the value of the mining assets and companies that produce those commodities also decline – often in disproportion to their intrinsic value. When metal commodities fall hardest3, funding becomes increasingly scarce, which can result in the best opportunities to invest in high-quality mining assets. Such dislocations are currently happening throughout the mining industry, creating the opportunity to capture scarce mineral assets – which will soon be in high demand – at a fraction of their intrinsic value. Or, to articulate it in much more vernacular terms: “it’s like everything is suddenly on sale”.
As with all dislocations, the current situation is transitory, and the market will eventually correct itself. However, the combination of mega-demand trends along with mispriced assets creates unique opportunities for investors. How to best take advantage of the demand dynamics and dislocations currently unfolding? By combining a deep understanding of the sector with the ability to deploy capital in a nimble and selective manner to find specific opportunities where favorable terms can be achieved.
The “Juniors” Need Capital: A Countercyclical Investment Opportunity
Broadly speaking, mining companies can be divided into three tiers. Junior mining firms (typically referred to as the “juniors”) make up the largest population within the mining sector – approximately 2,500 companies with market capitalizations under $1B. Mid-tiers represent about 200 firms, and then there are about 10-15 major mining companies with market caps over $20B. As a result, the overall structure of the industry is imbalanced: a vast majority of the value of the industry lies within the 10-15 largest companies that have stable cash flows and consistent access to capital. The remaining 99% of the industry is either establishing and growing production, or focused on resource discovery and de-risking development-stage assets.
Current market dislocations are magnified for the lower 99% of the mining sector – and this adds flexibility for investors. Understanding the junior mining dynamics is important to successfully unlocking opportunities in the space.
Difficulty breaking out from the pack
A small percentage of junior explorers will make it into production. However, not every junior mining company is a long shot. Many have fairly advanced projects with upside potential that can be better defined and developed with a modest capital investment, but they may have to offer the same funding terms as more speculative ventures in the earliest stages of exploration.
The struggle for funding
Juniors are at the early stages of the mining lifecycle, and they all need to attract capital for exploration and development. But funding isn’t readily accessible: there are often more companies seeking funding than there are investors to provide it. The competition to attract capital gives investors the chance to select the best projects at attractive valuations, and often, obtain “sweeteners” – like royalties, warrants and rights that make investment more valuable and desirable.
Consistent access to capital is vital
Lack of consistent funding creates a cycle of inefficiency if not managed properly. It is imperative for juniors to maintain their sources of funding, which is deployed to generate results to facilitate the next fundraise. So, flexibility is crucial; companies need to be willing to take funding when it’s available – and when it isn’t, they need to be open to offering special terms and/or greater company ownership to attract investors.
Five Considerations for Investors
The mining sector has been underinvested for over a decade. Falling commodity prices disincentivized capital investment from 2011 to 20164, which resulted in stalled project planning and limited mine development activity. But those with the capital and know-how understand that conditions are changing, and this is the time to invest. BHP, the largest mining company in the world, recent made a cash offer of $5.8 billion for OZ Minerals in a bid to secure copper and nickel assets5, and Elon Musk has made high-profile nickel offtake commitments in Indonesia and Minnesota6. With secular demand for metals accelerating, more capital will inevitably flow into the sector – but for now, many investors remain on the sidelines, so there is still a need for funding – and deals to be had.
While some investors hope to gain exposure to mining via general or specific ETFs, the best opportunities tend to be found deeper in the value chain, and in specific projects. Sector-specific investment experts are best positioned to uncover a greater selection of opportunities and are most likely to secure attractive and flexible financing terms across the capital structure of companies requiring funding. Those looking to capitalize on current market conditions should consider a mining investment partner who offers the following attributes:
1. Selectivity
Finding the right opportunities that balance greater risk with greater reward requires first-hand experience, knowledge, and analysis. These opportunities occur throughout commodity cycles, but they are particularly abundant now, when fundamental value is not always in sync with current or forecasted commodity prices. But expertise, patience, on-the-ground knowledge – and knowing when to say “No” – are keys to uncovering the best opportunities.
2. Dislocations
Mining is not a monolithic market. There are many dozens of different metal and mineral types, each with different demand cycles and economic profiles. The industry is simply too diverse to apply trends across the board accurately. However, weakness in well-known commodities, such as copper or nickel, can create a halo effect that depresses capital investment across the industry. Opportunistic investors who understand that each commodity has different market dynamics, demand cycles, and supply constraints can take advantage of this knowledge. For instance, gold and other precious metals’ inverse correlation with the US dollar may make it an attractive hedge as a generally liability-free store of wealth.
3. Fundamentals
There are a variety of investment types available, and it is worth considering each option carefully. For example, there are opportunities in both private and public companies for directly negotiated transactions. Similarly, there are opportunities from micro- to mid-capitalization mining companies. Investing across the project development spectrum and with broad commodity exposure helps mitigate risk. And it is essential that a commitment to good ESG practices be at the forefront of any evaluation of risks and rewards.
4. Opportunism
Investments should be guided by a fit-for-purpose mandate – including the ability to take profits when liquidity is present – to take advantage of inherent industry fluctuations. Also, investors with ready capital can take advantage of sweeteners, such as warrants, options, royalties, and convertible loans that are not normally available when capital is plentiful.
5. Nimbleness
Fund managers should have the flexibility to explore the broadest investable universe to invest in event-driven situations. Considerations include creative transaction structures that can realize value without relying on a mine to be fully constructed to obtain a re-rating or a liquidity event. And while it is sometimes beneficial to require control of a company or a seat on the board, less complex investment structure to unwind can facilitate more opportunistic exits.
The Time is Now
The mining industry is complex, diverse, and subject to a wide variety of geopolitical forces. A range of factors needs to be considered before capital investments are made. Significant industry expertise and background is required to evaluate and prioritize opportunities — and to execute aggressively once they’ve been identified. But high-quality projects exist across the mining value chain, and lack of available capital combined with long-term demand pressure creates a window of opportunity. We believe the time to look for value and outsized returns is now.
Source of Data
1 Nasdaq, World Reimagined: The Rise of the Global Middle Class. https://www.nasdaq.com/articles/world-reimagined%3A-the-rise-of-the-global-middle-class-2021-07-09
2 Bloomberg data, RCF Analysis, 1 Sep 2022
3 Bloomberg, Metal Haven’t This Hard Since the Great Recession. https://www.bloomberg.com/news/articles/2022-06-26/metal-prices-are-headed-for-the-worst-quarter-since-the-financial-crisis
4 Bloomberg and company data, RCF Analysis, July 2022
5 Reuters, BHP rebuffed in $5.8 billion takeover bid for OZ Minerals. https://www.reuters.com/markets/deals/oz-minerals-rejects-bhps-58-bln-nickel-copper-play-undervalued-2022-08-07/
6 Fortune, Tesla needs nickel to dominate the car industry. It just signed a $5 billion deal with the metal’s largest source. https://fortune.com/2022/08/11/tesla-elon-musk-nickel-indonesia-deal-jokowi-tsingshan/
Important Information
This material is provided for educational purposes only and should not be construed as research. The information presented is not a complete analysis of the commodities landscape.
The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Resource Capital Funds and/or its affiliates (together, “RCF”) to be reliable. No representation is made that this information is accurate or complete. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
None of the information constitutes a recommendation by RCF, or an offer to sell, or a solicitation of any offer to buy or sell any securities, product or service. The information is not intended to provide investment advice. RCF does not guarantee the suitability or potential value of any particular investment. The information contained herein may not be relied upon by you in evaluating the merits of any investment.
Investing involves risk, including possible loss of principal.
Enhanced terms investors can look for
Current market dynamics allow those with capital to require more flexible transaction terms from mining companies, such as:
- Warrants – These provide additional equity upside should shares perform strongly. They also provide greater certainty for the issuer, which can count on funds coming in at a known price, within a certain timeframe, provided the share price performs.
- Pro-rata participation rights – Having funded a material component at a critical time, these ensure a supportive investor can maintain its ownership level through future financings.
- Royalties – In early-stage assets, these are often issued as a “fee” for being a first mover and can be part of the capital structure in the development of more advanced stage assets. These are permanent, long-term options which can provide significant upside to those who invest at opportune times and are alternatives to direct equity dilution for companies when share prices are low.
- Convertible loans – Usually shorter-term loans which are converted into a larger financing or on the back of a specific, transformative event (such as an IPO). The coupon on the loan provides immediate equity exposure and aligns a provider’s objectives with management and other stakeholders as interest payments are typically paid in shares. Overall, this structure provides some downside protection for the investor and helps manage dilution for the issuer.
- First right to fund in the future – Most commonly, this relates to the issuance of future securities but could be more broadly applied.
- Board and Committee Rights – An investment fund or major investor can negotiate board and/or committee participation rights via its investment structure.