A slap in the face for junior miners

Political risk has increased dramatically in the oil and minerals sector lately, says Tom Bulford. But there's another reason junior miners are suffering - and it's less well-known.

It had already been a tough year for junior miners. Then, Argentina's populist president Cristina Fernandez called a snap press conference

Fernandez grabbed control of or, if you will, stole the majority Spanish-owned Argentinian oil company YPF. And that certainly grabbed the attention of oil and mineral explorers.

In fact, political risk is now a major problem in the industry. In Africa, licences purportedly held by Stellar Diamonds (AIM:STEL) have been challenged by Sierra Leone's Ministry of Mining. And shares in Hambledon Mining (AIM:HMB) have been hit by news that its proposed purchase of Akmola Gold is being contested by the Kazakhstan state mining company Tau-Ken Samruk.

While the major mining companies have some political clout and the benefits of geographical diversification, many junior miners have all their eggs in the basket of one country, are at its mercy.

But there is another reason why junior miners are suffering. And it's not as well publicised

Costs are killing many junior miners

Political interference is spooking the market, but the dynamics of global supply and demand are perhaps even more threatening. According to the World Bank, the Chinese economy will grow by 8.2% this year a healthy enough figure if you believe it but this still represents China's worst year since 1999.

This is affecting sentiment in the metal markets, and miners are also concerned about rising costs. Marius Kloppers chief executive of BHP, has warned that some of the company's operations are struggling with low product prices. Although this may run contrary to popular perception, the prices of aluminium, nickel and copper are no higher today than they were seven or eight years ago and there is no sign of improvement. The Intierra Resource Intelligence consultancy, for example, sees metal prices dipping in 2012 before staging a modest recovery in 2013.

Kloppers also flags rising costs. An example that I noticed concerns Scotgold (AIM: SGZ), which wants to mine gold in Scotland. Its estimate for pre-production spending has already risen to £22.3m from a 2009 estimate of £12.3m.

And just as demand is slowing and costs arerising, the industry has splurged on an unprecedented level of new exploration. A recent report by The Metals Economics Group has calculated that exploration costs for non-ferrous metals ran at $2bn-$6bn annually in the decade to 2005.They then climbed steeply to $14bn in 2008 and after a setback in 2009,they havesince more than doubled to a 2011 total of $18bn. Even allowing for rising costs, less accessible resources and lower grades this is still a lot of cash to be throwing at the problem.

Where is it all going?

Evidently more attracted by its gold than its politics, the most popular exploration destination is Latin America. That region attracted 25% of global spending in 2011. Canada, the industry's second favourite for the last decade, attracted 18% of global exploration spending. In third place with 16%, boosted by its proximity to China and Russia, was the Eurasian region stretching from Finland and Turkey in the west to Mongolia in the east. This was followed by Australia and Africa, where the rapid ascent of Burkina Faso has made it the third most popular African destination after South Africa and the Congo. For more on the West African mining rush, see my12 AprilPenny Sleuth.

So most countries saw increased exploration expenditure in 2011 and, according to The Metals Economics Group, "explorers demonstrated a higher tolerance for risk despite additional concerns about security, policy, taxation and tenure." Out of 121 countries "those commonly perceived to be high risk accounted for 23% of the 2011 exploration total, up from less than 15% in 2010."

Up to a point, explorers need to go tothe places where they might reasonably expect to make a discovery, and trust the politics. But this strategy now looks dangerous. With the sector under a cloud the Metals Economics Group sounds a warning. "Since most of the money a junior spends on exploration is typically raised between the fourth quarter of the previous year and the middle of the current year, if equity markets fail to improve many juniors may have trouble raising the necessary funds to sustain or increase exploration spending in 2012."

Against that background, mining juniors may have to source funds from bigger players in the industry and "majors and intermediaries looking to finance or joint-venture with cash-strapped junior explorers are likely to negotiate far more favourable terms than they would have in 2011."

These truly are hard times for the junior mining sector.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Recommended

Will the base metals rally last?
Industrial metals

Will the base metals rally last?

The price of copper, hit $7,000 a tonne last week, driven by soaring Chinese demand. Other metals are also on the way up. But can it continue?
29 Oct 2020
Make money from the metals mining boom in Latin America
Industrial metals

Make money from the metals mining boom in Latin America

Covid-19 has hit Latin America harder than any other. But the continent's highly competitive mining sector looks poised to profit handsomely over the …
23 Oct 2020
Why commodities could be the best investment for 2021
Commodities

Why commodities could be the best investment for 2021

There’s plenty for investors to worry about right now. But things will inevitably recover. And the sector most likely to do best when they do, says Jo…
22 Oct 2020
China adds shine to base metals
Industrial metals

China adds shine to base metals

Metals prices have rallied hard after China's government unveiling plans for new infrastructure building, including railways, power lines and electric…
28 Aug 2020

Most Popular

This week’s rally in value stocks is just the beginning
Value investing

This week’s rally in value stocks is just the beginning

The arrival of a vaccine this week saw huge gains in the markets and investors switching out of big-tech growth stocks and into “value” stocks in more…
13 Nov 2020
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
13 Nov 2020
Time for investors to be fearful, not greedy – and sell?
Investment strategy

Time for investors to be fearful, not greedy – and sell?

The Covid-19 crash proved a great investment opportunity. Does the vaccine mean it’s time to sell?
23 Nov 2020