This Downturn is Different: Investors should realize the recovery will differ too, says Lawrence Roulston
No sugar-coating here—this market’s “probably the worst I’ve ever seen and I’ve seen a lot of cycles in my three-plus decades in this industry,” said Lawrence Roulston. “But this one is different from previous cycles.” Speaking on May 26 at Vancouver’s World Resource Investment Conference 2013, the editor of Resource Opportunities emphasized that “it’s really important to understand why this is different in order to understand what to do moving forward.”
By long-term standards, metal prices remain strong. With “irrational” stock prices, Roulston maintained, investors face the challenge of distinguishing the “grossly undervalued” companies from their “grossly overvalued” peers. Even so, opportunity awaits buyers who are more discerning than sellers.
To offer some perspective, Roulston went over some history. In 2008 “everything around the world was hit at the same time,” he said. “The Venture index lost 75% of its value in a matter of weeks. But that sell-off was driven by external factors.” Recovery started “almost immediately,” in early 2009. “Over the next few years the Venture index tripled.”
Looking back to the years between 1999 and 2001, “the nuclear winter of the resource industry,” Roulston said “mines were built whenever metal prices were high, new supply came onstream at the top of the market, there was an oversupply, the prices collapsed and the market went into a down cycle. These cycles had been going on for decades and decades in the mining industry and a lot of people still see the mining industry in that sense.”
But, he insisted, “we’re no longer in that era. It’s very different this time around.”
In 2001 copper went for about 60 cents a pound, “which is in real terms the lowest price copper has ever traded at.” Gold was $252, “the lowest price in over two decades.” In the midst of that despair “nobody dreamed that China, India, the rest of the developing world were about to take off. They were still just looking at the Western world.”
Over the next decade that nuclear winter transformed into “the biggest bull market in the mining industry ever.”
If anything, today’s malady could be worse than that of 1999 to 2001. Yet demand for metals “is still strong.” Although short-term prices have dropped, “all the metal prices are well above their long-term average prices. And the mining companies are generating big operating profits at the current prices. The industry has prospered, at least on the operating level. You don’t have to be a visionary at this time to understand that there’s outstanding value in these junior companies. Most of the valuations on these companies were done at prices well below the current metal prices. And they still look like attractive valuations, even if those valuations aren’t reflected in the current share prices.”
Roulston has strong words for some companies, though. “The real reason that the mining industry is so beaten up, the real reason investors hate the mining industry so much at this moment, is the industry itself.” He pointed to majors writing off about $60 billion over the past few years and sacking at least seven CEOs last year. “And the operating performance of the juniors has been even more appalling.” From 2010 to 2013 companies listed on the TSX Venture got $26 billion from shareholders but “most of that money was spent without generating much value. People who made those investments want out of the mining industry.
“A lot of this money came from people like you and I. But a lot of it came from institutional investors—hedge funds and various other investment funds. And those guys want out. They want to sell their shares, they want to get them off the books, they don’t care what price they get, they want to forget they have even ever heard of the mining industry.”
It’s an across-the-board sell-off. Institutions “don’t care if the companies are good, bad or indifferent.”
Therein lies the opportunity, he maintained—as long as buyers are a lot more discerning than sellers. “If you buy the right companies at the right time, the reward potential is huge.”
Furthermore, not all large investors have abandoned the sector entirely. Roulston said there’s private equity “collectively holding hundreds of billions” looking at producers with cash flow but hoping to pay the prices of earlier-stage projects. “It’s only a matter of time that they realize they’re not going to get huge discounts on cash flow,” he said. Eventually they’ll consider projects at the feasibility or pre-feas level. When that “massive amount of money” moves in that direction, “you’ll start to see a big, big recovery.”
Big miners might be cutting back on acquisitions but “there are hundreds of hundreds of other entities around the world that are capable of making these multi-hundred-million-dollar takeovers, that will be buying these companies and will be generating huge returns for the owners of those companies.”
As for the best way to find companies “in this wreckage,” Roulston offered some advice.
He prefers those with deposits. While companies trading below their cash value might appear attractive, “cash in the bank has value only to the extent that the company is going to spend it wisely.”
Many companies are trading at huge discounts from their highs. But buying companies that failed to find much in the ground “can be like buying a lottery ticket after the draw…. In some cases the best value are companies that are trading near their highs because these companies have been able to hold their values because they have good, strong assets and are getting recognition.”
His conclusion tinges optimism with caution. “There are lots of bargains out there but you have to be very selective—and more selective than at any time I’ve ever seen.”