Mining Sector at a Crossroads: Strong Earnings Meet Rising Risks

0:03 [music] >> All right. Welcome back to the compass. Um my name is Derek McPherson. I'm the executive chairman of Olive Resource Capital. And with me as always is Sam Poulos, uh president, uh CEO, and CIO of of Olive. Um and we're here to talk about mining stocks as always. Um you know, it's right about May 13th, so the vast majority of Uh it is May 13th at 11:11 a.m., so um I'm I'm going to point that I'm going to point that out as always like timestamp these things um cuz you never know what happens um in the hours intervening between when we recorded and and and and who's bombing what. I mean, as we speak today, Trump is in China.

0:45 Um so that is going to have major economic impact whatever comes out of there um and will have impact on the markets for sure. But I think you know, it it cuz it is May 13th, we are mostly the way through Q1 reporting for probably all the significant producers both gold and and and base metals. Um and so cuz we often do, we we spend a lot of time going through those quarters um and looking at what the trends and what's coming out of them. Um we tend not to trade quarters, it's not our our business model. But what we like here what we want to see is the commentary, what CEOs are identifying as risks, what the opportunities are. Maybe someone who had a bad quarter that creates an opportunity to step in.

1:26 Um which is something that we did uh at the end of Q4 on the Q4 quarter with with a name that we're now out of. We could we could talk about that uh a little bit later, but uh I think you know, as we look through Q1 um especially for the gold companies, uh record production, record cash flows. So it's another good quarter. It's good to be a gold company. Yes, uh the you know, we see a continuation of what happened last year. Uh the commodity price was up over 10% for the quarter on average.

1:57 I think Q's floor was 4,200-ish. Q1, even in spite of the reset in March for the Iran Iran conflict, it it would have been closer to 4,900, 4,800, but closer to 4,900. So, you know, big big big difference there, you know, quite 15% increase on the gold price. Um also, quite interestingly, a lot of the large producers reported record quarterly production. Or at the very least, in some cases, um record for the past few years. Um so, that translates into very very strong free cash flow. Um lots of cash being built up on the balance sheets. Barrick announced a $3 buyback.

2:41 So, you know, we're seeing um one, the cash build-up, two, um the companies start to disclose what the uses of cash are going to be. Um in the case of Barrick, funding up, you know, $3 is a pretty sizeable um buyback for for a mining company. Well, or or they're using the cash in the case of Agnico and buying things. In the case of Agnico, I mean >> [clears throat] >> Yes, that was it that was April's news, but yes.

3:09 The month of April, just as a reminder, Agnico made a a three-cornered deal, or four, you know, four-pronged deal when you really think about like they also involved B2Gold, but you know, consolidating uh all of the area around Carrie in Finland. Uh if I remember correctly, it's about all $3 all in, or three or I might be wrong. >> Yeah, but but but you know, but but some of that was shares and then, you know, six 700 million dollars in cash. They they kicked out another 100 million dollars in cash to buy Fox River.

3:40 Um and uh and then so, you put all that together and they were still uh cash flow positive in the month of April. So, Absolutely. And you know, we took a lot about a generalist look at uh sectors that, you know, as generalists and a lot of that is driven by revenue growth, revenue per share growth, all these growth metrics and profitability metrics. So, that trend continues for, I want to say, fifth quarter in a row. We've been talking about this for feels like ages now, but certainly these companies continue to post pretty aggressive growth metrics that will attract more and more generalists into the space. Now, I think the the caveat to that is, you know, Q2 is only halfway halfway through, but halfway through, we've already lost, on average, about $200 worth of gold price average, uh call it 4 to 4 and 1/2%. And now we're also facing, you know, uh cost increases as a result of the, you know, the increasing cost of of fuel and the and the availability of fuel. One thing that a lot of market participants that I talked to are not aware of is that crude prices have gone from 70 to 100, you know, I'll call it 40% increase, 30% increase. Uh jet fuel, diesel, and refined products have gone up 50 to 100% depending on the jurisdiction where you where you're at. So, the the impact is going to be quite substantial, uh especially for certain types of miners.

5:15 Predominantly, you know, different mines have different intensity of use of fuel, you know, fly-in fly-out mines obviously takes less jet fuel, but more broadly, open-pit mines, you know, more operational leverage, more use of fuel per unit of product at the end. So, that's something that we also need to keep in mind for Q2 as we're going to see, potentially, things continue margin compression from both the commodity price being lower and also the cost basis coming higher as a result of the increasing industry prices. I think that's a key point. I think this is um we might Q1 might be peak earnings for gold for gold producers where we get the peak margin peak peak earnings.

5:58 And and the reason and for all the reasons Sam just outlined, right? You've got the one of your input costs and we talk a little bit about kind of what how that affects different companies more or less. But your input costs are going up, the quality's come down a little bit. Now the quality could cover between now and the end of the quarter you know, we got we're like I said we're halfway through so you know, we could get all that back but but there you know, the soft outlook for Q2 is not is not awesome if that makes sense or it's not as good. It's still going to be great quarter. Don't like don't the sky isn't falling by any stretch of the imagination. You know, Agnico will still make 13 or 14 million dollars in free cash flow a day. It isn't going to be the end of the world. Um but you know, I think that the the that aspect of it, you know, that might give pause or create an opportunity. You know, that might be where generalists start to come in because they see this pause in the in the in the in the metric growth and people people come in or it might give people pause.

6:58 An area that's you know, but the exposure on fuel and I think this is is a point we were talking about before we came on but I I it's really important. It really matters what kind of mine you have. Um if you are in northern Ontario connected to the grid and running an underground mine you are not getting you know, your your your exposure to diesel might be four or five uh percent of your overall cost stack, right? And so a 50% increase is a couple percentage in costs. You're not going to might not even see it, right? Um if you are running a large-scale open pit operation in the jungle that has you know, using heavy fuel oil for gensets and has diesel and diesel trucks that you are flying into a into a jurisdiction where you don't have easy access.

7:46 Let's call it Africa. Um, then your cost structure is going up. Um, and now all of a sudden you're 30 to 40% exposed in your cost structure um, to uh, to fuel prices and and you're going to see a heck. So, you know, if you're looking at that, like who's going to have the worst margin compression? Um, you know, I think you're probably look at uh, large if you have large-scale remote open pit operations. Uh, those are going to get impacted. Um, so I, you know, uh, not to, you know, someone like Anglo, um, large-scale remote open pit. Someone like, uh, Kinross has got a lot of large-scale open pit um, mines.

8:27 Um, they have really moved a lot of tons. Uh, Agnico to a lesser extent. Um, they have large-scale open pit mines, but they're also grid connected in a lot of the places. So, they're they're they're less so, but they're stuff and none of it's going to be really exposed. Um, and uh, and and and and actually probably the one that's probably got the you know, and obviously Newmont and Barrick. Um, not so much for the Nevada assets, but they're, you know, every everywhere else in the world that they operate is going to is going to have a negative impact. Um, the ones where we I I you know, I I I kind of hinted this at the at the beginning where we've actually made some decisions about our portfolio, um, is in Australia. Uh, we've looking, you know, we've talked about this in different episodes, um, that we're, you know, the market feels like it's pricing in, um, a quick resolution to the Iran conflict. Um, and that we probably haven't seen the the follow-on impacts.

9:22 And I think one of the most energy we think one of the most energy exposed countries is is Australia. And Australia is a lot of open pit mines, a lot of fly-in, fly-out operations, a lot of very remote operations. And Australia is a net importer of energy. And so, they run the risk of of seeing probably the largest sort of uh price spike. So, we've actually reduced our our Aussie exposure on that basis. Yeah, so I I was going to say when you were talking about the scale of the operations, I think you end up touching here, but it's like also the location of those sites. Yeah.

9:57 Uh some places have greater access to fuel, like Nevada, of course, you know, the US, the largest producer of oil in the world. Uh I'm not sure if it's the largest refiner, maybe first or second with China, I don't know, but anyway, you know, quite self-sufficient. Yes, the prices are going to increase, but there is abundant product in country for these mines. There's going to be other parts of the world that may not be as lucky. Um but I think there's obviously a sequence of, you know, the underprivileged ones. Uh and obviously, we will start I would, you know, the the most exposed ones are the smaller nations.

10:35 Uh smaller landlocked nations, all them in Africa, you know, Malawi comes to mind. They're selling their gold to buy to buy diesel. Um there were a few smaller mines in Malawi. I think the the one of greatest importance is a is a is a uranium mine. Um but you start with those countries, but out of the major, you know, sort of like dominant mining jurisdictions, Australia is definitely the most exposed. Australia imports slightly 1% of their refined product consumption.

11:03 They don't have refining capacity or any capacity. Um they need to bring in everything. Now, being a wealthy nation, um I suspect they'll be able to attract product by paying more. Uh and they will not run into any severe issues with shortages and and and so. Obviously, it's a, you know, government priority right now to avoid that because that would kill any government. Um but, you know, you'll face pretty pretty steep uh price uh premiums.

11:34 Um especially in, you know, Asia-Pacific is generally the part of the world where people have to pay the most for fuel and gas. This is only going to exacerbate that. So, yes, in our view, um, we like the Australian companies, we like the operators there. We just think this exogenous variable right now, it's out of their control. And frankly, the stocks, in our view, are not really pricing in, um, that risk. So, we've we've reduced our exposure.

12:02 And, um, um, you know, perhaps only temporarily. Uh, we'll obviously have to see how this plays out. Back to your point, uh, Donald Trump is sleeping in Beijing tonight. So, we'll see what tomorrow brings. Yeah, I think that's the I think that's the I think that's a big thing, right? And and and I was, um, I was listening to the on on what tomorrow brings. I was listening when I was listening to a podcast on the on the way into work today.

12:26 Um, they were talking about the fact that also, uh, there was a senior Chinese official that went to Iran, uh, this this month this the last couple days as well. Um, so maybe there's China's going to try to be the adult in the room and get Iran [clears throat] and the US to stop shooting at each other. Um, China, who is a massive net importer of energy, as well, uh, is needs that. You know, we we we kind of focused this Q1 conversation along gold miners. And and it's probably worth mentioning, uh, probably more exposed than the gold miners, cuz you have these underground you have you have gold miners and things like that that are are less that have a lower impact on the energy stack, um, is the base metal mines.

13:09 Um, you know, base metal, iron ore, these are large-scale open, like, you know, a big gold mine is I sorry, one of the biggest one of the biggest mines in Canada, the biggest gold mines is is Detour Lake. And it's what I I think it's 80 80 to 100,000 tons a day. I don't remember the exact number now that the new eco has expanded it. Uh the biggest, you know, the biggest copper mine in Canada is Highland Valley, which is like 180,000 tons a day. Dwarfs it.

13:39 Um and there are large-scale mines in Chile, etc., where you've got um where where a lot of this copper where a lot of this copper comes from, where a lot of these copper miners are exposed to. Um and ones in Africa that are remote. And so, I think that like as you look at that kind of that stack, if you will, of of energy, I think we'll see and again, Q1, none of none of these guys are really going to have that impact, right?

14:02 Q1 ended March 31st. The price of was just was just starting to go up. That you've got supplies on site, so there's a lag effect on that on that fuel cost. Now, you're going to see it. Now, the advantage the copper miners have in particular is that the copper price is is at all-time highs, right? They're they're getting margin on the top side. And it's because of a couple of shutdowns, you got Grasberg, you've got a downgrade price on Kamoto Copper and got some um you got some And so, I think benefit there, but I think that overall, this is is actually the price a consequence of the supply risk because of the fuel.

14:41 Because now that you're saying that obviously copper is much more exposed than gold to a supply constraint that you're driven by this um you know, oil and gas price hike or or, you know, uh reduction in supply. And to your point, you know, I think two of the fourth largest uh two of the four largest copper mines in the world are in Chile. Uh Chile's a net importer of oil and and fuel, massively so. Uh historically, you know, it's close to Brazil. If you go south around the that passage, but like Australia, it's in the Asia Pacific uh sort of context, which is sort of the more complicated part of the world in terms of getting, you know, stability of supply for fuel imports. Uh Peru, which is the third largest copper producer in the world after Chile and the DRC, imports 50% of its fuel uh needs. So, you know, these are countries that are also exposed to the situation. The DRC, as well. Right? A lot of large group large-scale remote operations there, as well. And so The DRC has a benefit that has plenty of hydro, but they do get their fuel from South Africa, typically. Uh I'm sure there's other routes, but typically comes from South Africa. South Africa is a net importer, as well. So, you'll imagine that by definition you're third largest because South Africa is first, and then that has to go through the I suppose that goes through Zambia.

16:08 Uh so, they'll be number two, and then eventually in the Congo will be number three. So, yes, definitely. Um and we're not even touching into the sulfur situation, which Well, and and and that's another one, right? third factor on the on the copper supply side. So, the month of May has been particularly strong for the copper market, um uniquely. Um not in the context of most major commodities. And I'm starting to wonder that maybe it's a response to this very tangible risk of further supply shocks. And during the month of May, during the last 2 weeks, uh Freeport also announced uh further delays into the the the not the restart, but the ramping up of Grasberg back to its nameplate capacity. So, um definitely a market to watch, and you know, a market where we have some significant exposure. Yeah, I I think you know, so as we're as we're looking at it, you know, if you taking all that into account on on on on on copper in particular, right? If you're looking at copper names, supply and you want your mind that's a a net ex- a net in an area with that that has secure energy supply.

17:12 Um and you want to be uh and and you certainly remind and you know, expect that there's going to be some margin compression on these guys. And and the sulfuric acid thing is is not to be I think flippantly out of hand ignored. There are there we they you know, there are reports of increasing sulfuric acid prices. There's a nickel smelter in Indonesia that shut down on the on as a result of of that. Um, now nickel prices haven't been all that great, so they probably just probably became part of an excuse. They are probably a marginal refiner, but I think the key point is there is that there is Um, you know, we're starting to see this trickle in, right?

17:50 We're not seeing significant impacts, we're seeing on the margin. If you will, we're seeing impacts, but I think I think this plays out much more so in Q2 reporting. Right? Cuz I think that's where you'll start to see, you know, whether there's there's legitimate shortages reported or whatever. Everyone I mean everyone identified it I I mean, I didn't read everybody's quarter, but I'm fairly certain that without fail everybody identified it as a risk. And on every analyst's call, someone asked about, you know, what's the impact of the cost of fuel going forward. And so, that is and that is a given and and what we I think people will have to you know, that's what that's that's what we're going to see.

18:31 So, everyone's warned on it. Everyone said there's a there's risks out there. You know, there you know, there's a few very sophisticated uh, energy research analysts or traders, participants, uh, and I think they've all agreed. There was a there was the the Financial Times Commodity Summit, uh, last week or the week before. So, you had all the big traders and all you know, all the big oil companies. Even Robert Friedland was there. But, I think there was a panel where all the major kind of like market analysts from from the investment banks, the consultancy groups, the risk management groups, they've all agreed that the level of disruption of this situation is unprecedented.

19:17 It doesn't even equate to 1973, doesn't equate to 2020 when we had a pandemic. This is an unprecedented amount of supply that's been taken off the market. And somehow we've all fortunately, at least in these parts of the world, we've continued to live our lives somewhat normally. But there is you know, analytical and analytically um the thought that you know, these shortages are going to come to bite at some point. We're not going to wake up tomorrow. Hopefully we wake up tomorrow and Donald Trump and Xi Jinping are hugging each other.

19:49 But even if that happens, there will still be shortages in parts of the world for sustained period of time, meaning weeks to months. And those I appear to have been gone unaddressed by market participants. So, you know, we're still waiting for kind of like the aha moment when major company has to scale down operations, has to genuinely, materially alter their plans to address the situation. Yeah, that's in my mind that's going to be the catalyst. So, for the market probably to pull back, but we'll see.

20:26 Um All right. And I guess you know, we're I think that covers Q1 and kind of what the risks are going into Q2 and talk a little bit about the copper market and it it being kind of it has risk of supply shock in it. So, I think there's there's partly pushing the price in the short term. Uh last thing is is that obviously this morning we woke up. There was another merger in the mining space. And this was a merger, not a takeout.

20:51 You've got basically I mean it's I think it's a couple percent premium for Orla shareholders, but it's an at market deal where you know, Orla and Equinox are being or are are joining forces. And looks like a merger for scale um almost exclusively. I don't know. Sam, if you had uh any comments on that. I have I have some market impact comments, but not on on the merger itself. I think it's logical uh that we see more of these. They're going to be just over a million ounces on their way to over 1 and 1/2. That puts them squarely in the second bracket um of the market.

21:28 And uh they did put on the press release something that shocked me, which is that they will be the the second largest gold producer in Canada after I mean from a Canadian source after Agnico. Oh, that's quite interesting and I think that's the angle they're playing is, you know, resemble Agnico, build on that sort of like safe jurisdiction production centers um and try to use this platform to get a premium valuation that would allow them to profit uh from further acquisitions um as as as it will market progresses.

21:59 Uh not to forget, you know, Orla was backed initially by Pierre Lassonde and Equinox is a God, I'm forgetting his name. Save me here. Um Ross Beaty I mean Ross Beaty company, so you know, two incredibly successful billionaire mining investors um joining forces. Um so, it's definitely going to be a name to watch. Like this is a graduation from these two stories into, you know, maybe not the leading of the mid-tier, but you know, the upper part of the mid-tier of companies.

22:28 And I I expect there'll be some asset disposals. Uh obviously there are some assets in the platform that don't fit uh exactly this scale where they are now. But at the same time, I also would expect that this is not the last merger or acquisition that they'll do as a group. I think if they can get this premium valuation, they will they can they can be very active and and aggressive uh to to you know, to try to build a tier one uh mining gold mining company. But that's sorry, to your point and just to finish this, uh it is certainly the greatest benefit is scale. Um it propels you into being more attractive to uh you know generalist investors to broad broad broad market index ETFs not not not gold specialty mining specialty ETFs. So there's definitely a you know benefit from that and from the synergies point you know other than G&A and management I don't really see any meaningful synergies and I also didn't see any mentioned squarely on the press release.

23:27 But but I am you know I'm positive on the outcome and I think we probably going to see a lot more you know transactions on this type. >> I think it's an interesting I don't think we'll see a lot of transactions I actually I disagree there. I don't think there's a lot of transactions of this type because there isn't that much or that many companies to jam together that have significant assets, right? So now you know Equinox kind of already was there Orla now is is there as as part of Equinox, you know.

23:54 They're they're unicorn hunting, right? They're looking for you know quarterly and annual see your production. You know obviously everyone wants first first quartile cash cost but you don't always get that in good jurisdictions, right? And so their growth opportunities are much more difficult. Generally speaking but that also you know Orla was one of those buyers was one of those companies out there that would buy or had the potential to buy kind of 100 150,000 oz a year assets and that would move the needle, right? Now they're they're not in that game anymore. So there's one less buyer for these smaller assets. And I think it kind of plays to what we think about a lot when we look at you know exploration and development companies is to what scale can it be?

24:42 How big is this thing going to get? And and so I you know I think again it highlights our kind of view that you know kind of 200 250,000 oz a year type assets reinforces our view that 200 250,000 oz a year assets are kind of the minimum. Uh uh uh I have to check for the scripts yet. >> Yeah. Now, but you know, like on on on the flip side of that, you know, like do we get more consolidation of like the 2 to 400,000 oz producers to create more million oz producers, right?

25:16 Is there a chance that Wesdome marries someone or Centera getting together with someone else? Centera should have bought something 5 years ago. Um Uh, yeah. Uh, sorry, I said that out loud. Um, the uh um but yeah, I think that there's uh I you know, maybe maybe there is, but I I I think that development assets are going to start coming off the table more so. I think you're going to see the more likely scenario is not these kind of jammed-together mergers like like Equinox and Orla, but more uh developers getting taken out and these guys trying to grow. Um, cuz I the reality the reality is is that there's a lot more value creation for my as a in my mind for a in building things, right? I was talking to somebody last night and like doing the hard thing is how you create value, right? The thing that is people don't want to do and in North America it's build mines, right? In Australia, you have 12 oz and three guys and, you know, we're putting a 2,000-ton-a-day mining operation up, right? Like it's it's it happens. Um, in North America we don't build things, right? The the North American market doesn't reward um single-asset companies building. Uh, and so I think that you know, these companies that can build things that have the ability, they are and can operate are going to get rewarded. Um, uh the there's an opportunity to grow into the scale that they're they're after um with via M&A. Um, and so I I see that as more likely to occur just because they're and maybe I'm completely wrong and you know, we wake up tomorrow morning and SSR and Saturna have merged.

27:00 Right? And and that's and that's what's happened. But I think that it's I I think that more it's more on the development side that you're seeing. I mean, there's there there are still, you know, several kind of large-scale development assets out there that are that are very attractive. We discussed it on the when we talked about G2 being taken out. Um how many of those quality development assets um that are advanced enough on technical studies and permitting are available right now?

27:33 The answer is five or less. Right. So, at the same time, you know, like for you know, it's possible that for some reason none of the five take your board's mandate or your your jurisdiction or whatever. And then, okay, well, let's just, you know, grow a different way. Right? But there's only two but but but but but but but but but but at the same point, there's only two or three Orlans out there. Right? There's only two or three companies the size of Orlan out there. Kind of half million dollar half million ounce a year producers um with growth and and decent pipeline.

28:05 So, I it's it here, maybe four um or five. And often times, you know, I look at like um I look at the example of uh of of Torex, right? They're who are doing a good job, by the way, but they are in a very tough jurisdiction. And a lot of people no one's really attracted to those assets uh because of the their their location in Mexico. Um that area is very difficult. Uh they've made it work, good [clears throat] on them, but there's there's a there's a I guess a pushback.

28:37 And so, I look at Wes Lunding Gold. Lunding Gold isn't really acquirable. They're they're more likely a buyer. Just cuz of scale and the cash flow profile, etc. Um they are the unicorn. Um you've got um SSR Sandstorm and you know good I tossed the idea out there for some investment bankers to go uh to go pitch it. Um you have uh you know but you know Sandstorm doesn't really have you know neither of those companies you know and have really an asset that somebody really wants, right?

29:14 Um and then uh and then the last one is uh and so I think >> no we have we have other things like Artemis. Art- yeah Artemis is is from our valuation perspective pretty high, right? So it's a little difficult to get to get your your head around that as a as a producer. Maybe maybe you're right. Maybe you get a merger of equals where you jam a couple things together. Um but the other one I mean the the one the the sort of the obvious one is uh is what uh Iamgold absolutely. Um that's that's one where I think M&A possibility but I think the you know if I was uh putting my guessing hat on uh I think it the the the the ticker of the buyer on that one starts with an A and it the second letter isn't a B. Um >> [laughter] >> uh and and just because they want to control the that type of asset in in Canada they want to control cap scale. Uh it's around a lot of their other assets. Uh But you know I think I guess this is the point like you know there there are there are options on both sides. Yeah.

30:20 There are fewer than there were 3 months ago and 12 months ago. So And frankly to to the point on scarcity, right? And and this is I think this is the point we're getting to is that like it's scarcity, right? That like you know Rupert got taken out. There isn't the you know the world with no one has found another 200,000 oz a year 2 g you know, two you know, 2 g open pit deposit in the last, you know, what?

30:50 Right. And so, there isn't a new one that just cropped up that can backfill that pipeline, right? So, these things have scarcity value. These are the things that that big companies want. And all those names we mentioned are both potential targets and potential acquirers, right? Of assets. Um And so, I think that's where it that's where it becomes very, I don't know, interesting or or the where a lot of opportunity exists for um for investors, right? Is that like, you know, so our our our niche is we're buying, you know, we're we're looking at these these development assets that are um are high-quality development assets.

31:28 Um and so, that's our that's our niche. Yeah, I've obviously we've talked a lot about Omai, we own Troilus, we own a few other um companies that are in that in that bucket. And we think that's where we're going to get the most torque. Being taken out in a merger of equals is not does not feel awesome. I can tell you that. All right. I think we should just wrap it up here. >> And so, I think Yeah, I think that's enough. Um thank you very much for tuning in again.

31:51 Um hopefully uh we, I don't know, as we we babbled on for 33 minutes, you guys uh learned something from it. I know we did. Um so, uh when you have a few, you know, let us know if you're if you have anything that we'd like us to talk about. Uh we're coming into the summer season, so maybe news slows down or M&A picks up, one or the other. Um and so, we'll we'll keep doing it. We'll talk to you all next week. Thank you.