Harking back to my days studying economics, one of the concepts that has most stuck with me and indeed has almost become a guiding principle is that of “opportunity cost”. In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone, where a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the “cost” incurred by not enjoying the benefit that would be had by taking the second best choice available.
The New Oxford American Dictionary defines it as “the loss of potential gain from other alternatives when one alternative is chosen.” Opportunity cost is a key concept in economics, and has been described as expressing “the basic relationship between scarcity and choice.” The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently.
When we apply it to mining we are thinking that one dollar given to a no-hope story is one dollar less for a “serious” story. While that misallocated dollar may seem immaterial in the easy money days like 2007 or 2010, in the lean times it can be the difference between a worthy project, run by determined people, surviving or not. There has been a massive misallocation of funds in the mining space and some of the most egregious examples have been in the specialty metals that have been subject to boomlets and fads over the last decade. In the final wash the unworthy have ended up ultimately disappearing no matter how much money was thrown at them and the collateral damage has been the starvation to death (or near-death) of those with projects that might have made a realistic contribution to global supply in their respective metals.
Here we shall review the scope of this opportunity cost and the price that was “paid” by choosing the path less travelled of seriousness and gravitas.
Has there ever been such a great destruction of value, by so few, in the mining space, in so short a time, as the Rare Earth boom of 2009-12? By our estimate around $8-10bn of value was “destroyed” in the process with, so far, the only thing to show for it being the production flows from Lynas.
Past estimates have claimed that the REE surge involved over 300 companies. This still challenges our imagination and we suspect it includes any party that even muttered “rare earths” under their breath at a cocktail party. By our count there was one in London, one in Germany, one in South Africa, between 10-15 in Australia, two in the US and somewhere between 60-100 in Canada.
How does one measure the destruction of value? Is it the amount of capital raised that now no longer exists in balance sheets with an asset of the same value? We would frankly prefer the change from peak market cap (no matter how realistic that might have been in most cases).
Molycorp was of course the biggest black hole but like any universe there is always more than one black hole. Using change from peak market cap (and excluding Molycorp) one can see that billions have been wiped out by just tallying up Avalon, Rare Element Resources and Lynas. Hundreds of millions more in market cap were wiped out by the retreat from peak values at Great Western, Frontier and Arafura. To these must be added the total peak market caps of the “rest”. Some never got more than $2-3mn market caps, but quite a lot could manage several tens of millions in valuation, albeit briefly. Thus we would be looking at $1-1.5bn lost in the “rest”. Some have salvaged value like Ucore by going into technology/patents and Quantum Rare Earths preserved its market cap by becoming Niocorp and shifting metal. Medallion morphed from a wannabe miner, to a wannabe processor and now is neither.
As part of another exercise, we totted up the number of companies we now think will (maybe) make it to production, or are in production, and it came to a mere seven. Rare Earths have become the mining space’s equivalent of the dot-com bust. However, one can draw hope that Facebook, Twitter, Linkedin and Google were not even around (in public markets) during that bust and maybe the Rare Earth giant of 2025 is a company not yet even formed. Though Lynas looks well-positioned to take that title.
This was the first boomlet off the taxi-rank after the shock and awe of the global financial slump of 2008. However, it was built upon an already established though admittedly small group of very large producers (i.e. the cartel). That universe burgeoned to around 20-30 wannabes pretty fast but some never found roots and went away rather quickly. In any case the Vancouver promo-listing machine had scarcely started to crank its gears before the REE boom came along and stole Lithium’s thunder. There was also a perception that two or three of the projects coming on stream would satisfy mid-decade demand so this calmed some of the more fevered claims that could be made.
By late 2010 the focus was elsewhere and the sector was left to get on with business. Galaxy was added to the ranks of producers, while others like Orocobre and Neometals (back then Reed) worked away on their projects which are now coming to fruition. Quebec Lithium managed to go all the way to production then stumbled. Talison made it to production and was snapped up. Nemaska proved to be the most durable Canadian player. In Australia, General Mining has been added to the producer mix via their earn-in to Galaxy’s Mt Cattlin.
This group of lithium companies now have a powerful lead. The latest price uplift in the metal has drawn a number of new players into the fray. Most will be years away from production, even with the best will in the world. It will be interesting to see if the market disciplines itself and keeps the number of entrants down.
The opportunity cost of this space has been much less than in others. The takeover of Talison for over $700mn made investors way more money (net/net) than was lost from the few juniors that expired or the other players that lost market value.
While we encountered Northern Graphite as far back as 2009, the investor enthusiasm for graphite did manifest itself broadly until 2013-14 and peaked rather swiftly. The dizzying array of flake types boggled an audience that had only just got their brains around the many Lanthanide elements. The fact that some of the graphite stories were rehashed REE vehicles also gave investors a sense of caution. Our antennas started waving when we met a company called Canada Rare Earths that had the powerpoint in its new name as Canada Graphite but still was registered as the old name. It now is called something totally different and is reporting gold sampling results.
The universe of graphite players was never much more than 25 in number. Most are still around, some still have sizeable market caps. Most are probably going nowhere and will be repurposed as gold or something else. Value destruction here has been limited to maybe a few hundred millions. The potential for more to be lost exists though if some of the big players do not deliver and instead wither on the vine. The “serious” players may very well be below the radar still.
This space might be nuanced as a recurring fad with an overlay of seriousness and production. In this category it is now being joined by Lithium. Like the others it revives or retreats on price trends but it is not driven by technological advances because in its big picture not much has changed since the 1960s.
The ultimate payday for any mining story is a takeover. Also good is an ongoing flow of dividends, but that is a rare thing indeed, particularly in Canada, where executives dangle the prospect of a takeover as an excuse to not pay a dividend. However when it comes to the types of stocks we are talking about in this research note, dividends are unlikely as so few of the contenders have even got within spitting distance of having earnings from which to pay a dividend.
So what of takeovers? In the graphite space we can think of none. In the Rare Earth, the shocking thing is that could have been so many players and yet so little action. The only transactions we can recall involving publicly listed targets was the merger between Molycorp and Neomaterials and the takeover by Great Western of the JSE-listed RareCo. The latter was a transaction not many noticed and even we are not too sure if RareCo was delisted or in administration at the time that it succumbed to GWG’s charms.
Lithium stands out as a space that had transactions right from the get-go. Literally the ink was not dry on our research piece on Admiralty Resources’ Rincon deposit when that asset was taken over by the Sentient funds. A little while later, Salares Lithium absorbed the unlisted Talison Lithium (controlled by Resource Capital) and created a vehicle that was then a target for a Chinese buyer with an outsized $738mn offer, from which it later resold part to cartel-member Rockwood, which was itself recently taken over by the chemical company Albemarle. Other transactions have included Galazy exiting its Chinese processing plant by selling out to its Chinese partner and now Neometals cashing out (partially) from its Mt Marion deposit to Ganfeng. Another merger in the space was the recent combination of Western Lithium with Lithium Americas. If the measure of a real “boom” over a fad is corporate actions (and no, a press release of surface samples is NOT a corporate action) then Lithium definitely qualifies over the other two mining sub-spaces.
What constitutes a “serious” story? If we wind back to 2010, the “serious” stories in Rare Earths were those with the biggest market caps, enormous ambitions and large resources (invariably in very challenged locations) and advisory boards freighted with a slew of academics and boffins that had not seen daylight since the 1950s. Almost all of these have not stood the test of time and their demise is now mentioned with guffaws and titters of laughter rather than reverential sighs with their fatal flaws (literally and in the scientific sense) being all too obvious in retrospect. One in particular that had the word “lake” in its project name (mainly because it was under one!) thought it would escape geographical destiny by going aboriginal in a name change. Not unsurprisingly that did not work.
The ancient Egyptians believed they could weigh goodness in the afterlife, and often pictured a god with some scales with a feather in one side and a soul of the dead in the other. The mining sector felt that “seriousness” could be weighed with a project in one side of the balance and a stack of Resource Estimates, PEAs, PFSs and BFS’s on the other side. As destiny has shown these products of the consultants might have been the Book(s) of the Dead.
Looking back to the graphite space, the company that struck me as the most serious from the get-go was Elcora with its dinky little mine revival story in Sri Lanka. Less than 18mths later it’s in production and they are working towards a processing plant in Europe. Its price is on the up while everyone else’s is sagging. It ticked none of Toronto investment bankers’ boxes of “seriousness” and yet is now maybe the most serious of the whole lot.
Then there is Lithium. In the beginning there were Lithium producers that really doubled as chemical companies (or vice versa). They were big, they were dominant and they had been around for decades. Then appeared the baby-boomers of the space and these transitioned into producers, Talison, Orocobre, Galaxy, Neometals and Nemaska. Several others will follow. The first batch were winnowed out by the long drought of investor interest now there is a second phase, largely price driven that has brought in new names. Some of these are real (dare we say serious) while others are carpetbaggers. Time will tell.
In the Darwinian world of mining it seems that the loudest inherit the earth (for a short while at least) until the more persistent and nimble start to pull ahead of the pack. The greatest problem is that the loudest (like any squeaky wheel) get the grease and indeed hog the grease to the detriment of everyone else. The opportunity cost of the failure of bankers, analysts, consultants and investors to discriminate between the real and the surreal is that enormous amounts of money are squandered on transient companies, projects and managements while the worthier projects, maybe run by managements without a bullhorn are the victims of the misallocation of funds. It is the task for all those in the industry to redefine “serious” and spy out and weed out those that fail that test before they have consumed what we now know to our grief are ultimately finite funding resources.