Neil Adshead is constantly scouring the field of junior exploration stocks as an analyst at Sprott Asset Management LP. I took advantage of his visit to our San Diego office to ask him a few questions.
Neil looks at companies with market caps below $500 million, so he’s looking for companies with a big upside to justify the risk: “an extra $100 million to $200 million [above the market’s current value of a project]. That’s the kind of ‘uplift’ that we’re looking for,” he said.
It’s also about avoiding big popular stocks that are getting ready to fall: “Sometimes, you’ll see these valuations go to the moon. But digging into the data we might find that a $500 million company is really only worth $50 million.”
Neil also commented on platinum’s disappointing run last year, although it was well-liked by many analysts: “I think a lot of analysts like to be first to call a trend. So they make a compelling case and then other people jump on the story too. When it comes to the platinum shortage — same as with the zinc and uranium shortages — it may take months or years to actually play out for various reasons.”
Henry: Neil, can you explain for our listeners and for our readers what you do for Sprott as an economic geologist?
Neil: I joined Sprott in early 2012 after spending the seven years prior with an investment firm in San Francisco called Passport Capital. I worked in a role analyzing mining opportunities for Passport. Before I joined Passport in 2004, I worked as an exploration geologist for Placer Dome, which was a very large Canadian company (which was merged into Barrick Gold in 2006). I worked for Placer for 10 years.
Since I joined Sprott I’ve worked across the Sprott platform looking at various equity and debt opportunities for Sprott entities.
How did you decide to join the investment side of the mineral exploration sector as opposed to ‘in-the-field’ ground work searching for new deposits?
Sure. I did a PhD in Australia in Economic Geology in the early 90’s which involved some field work in Western Queensland and after I finished the PhD, I worked on a project involving mineral exploration for gold and silver in Papua New Guinea.
From that, I learned a lot about the mining business and the exploration business. I then moved into a corporate role. The subsidiary I was working for was part of Placer Dome. That moved me to Vancouver. I worked in a corporate role there for three years in various capacities, one of which was looking at opportunities in gold and silver and copper across Europe.
So I had quite a broad experience with that major mining company. After a while, an opportunity arose to join the hedge fund Passport Capital as an analyst. I haven’t looked back since.
So you do a similar type of exploration and mining analysis for Sprott?
Yes, I do analysis mainly of junior mining companies, say from a market cap of close to zero up to maybe $500 million. The analysis involves financial statements, looking at all the technical sides of the projects, the geology and the metallurgy in the mining, along with all the ‘softer’ issues like the social issues. This involves the government and the fiscal regime, too. So I really look at everything relating to smaller cap mining investments for Sprott’s equity and debt arms.
Within the discovery and development chain, what aspect of that industry do you focus on the most? Is it the early-stage deposits? Or deposits that are being brought into production? Where do you see the most value currently?
I think that we have the greatest capability to find a ‘valuation mismatch,’ which is what we’re always looking for in the market, in post-discovery exploration projects (meaning that an initial discovery has been made, but further exploration is needed to expand its size).
Once you’ve drilled holes on a new prospect and made a new mineral discovery, then you can start to analyze the geology, the drill results, and the geophysical data to assess how big that project may ultimately become. Then, after spending maybe another $10 million or $20 million on a drill program, you can start to forecast whether that project could be worth an extra $100 million to $200 million. That’s the sort of ‘uplift’ that we’re looking for.
When you look at other people who are investing in these companies, what do you think about the market’s ability to properly analyze these stocks and price the risks and value that can arise?
I think the market’s ability has improved over the years. I would put that down to the rise of the internet and the amazing amount of information that everybody in the world can get. For instance, we have the SEDAR system where all filings are available to the public and the NI 43-101 system whereby every Canadian issuer now has to write what’s called a ‘technical report’ and provide various pieces of information in a standard format.
So for us, as analysts, if you what you’re looking at and you have got some experience in what you’re doing, access to that information on your fingertips in a matter of seconds is very good. If everybody is looking at that data and acting appropriately, then the market should be pricing opportunities more accurately than they were 10 to 20 years ago.
Given the fact that more people have access to that information, do you still feel that you can gain on edge over the market in valuing companies?
Definitely. Really, our job is to try to forecast the future given the information that we have. Whether by looking at geologic maps, technical data, geochemical, or geophysical surveys, we are trying to predict what that project will turn into. There’s also a jurisdiction involved and we look at countries to determine whether the trajectory of the country is positive or negative. In certain countries, the decisions that the governments make can greatly impact the valuation of opportunities in the future.
From the technical side, as a geologist anyway, we are well-qualified to dig into a story which the market has overvalued. Some stories do get hyped up for various reasons. Some of it is over-promotion or some ill-informed shareholders buying shares in the company based on a recommendation from somebody who maybe doesn’t know exactly what they’re looking at.
Sometimes, you’ll see these valuations go to the moon. But digging into the data we might find that a $500 million company is really only worth $50 million. Obviously that’s beneficial to know.
So there are different ways we look at the same data. I think the market is more efficient on the more liquid stocks than what it used to be, but there’s still plenty of scope to find mismatches between value and price.
What do you make of recent interest in the exploration sector from private equity groups that are supposedly more sophisticated investors? Do you think that they add something to the sector? Are they really the ‘smart money,’ as some suggest?
I wouldn’t say they’re not smart. After seeing how they have behaved in their investments over the last 12 months, my view today is that ‘private equity’ is really just another source of money in the sector – not much different from other kinds of investors, but with a different name.
I think that private equity is actually a good thing because it has created a new avenue for capital to come into the exploration sector which means higher valuations for companies in the sector. It’s good for issuers because all of a sudden there’s a new source of capital. It’s good for existing shareholders because the companies they own might receive higher valuations. Companies retain access to capital which then allows them to drill holes and to add value.
So some of the private equity is acting like true private equity in the way that people think that private equity should. But I see some private equity groups that are really just acting like mining funds. They’re just a replica of what Sprott has done for years or Dundee or other longstanding mining equity buyers in the sector.
So it’s being touted as this new wave — this paradigm shift in the way stuff is getting financed in the junior mining game. I don’t really see it. At the end of the day, a dollar is a dollar. It’s just being directed into the sector in a slightly different way.
What do you make of the overall directions of the commodities markets and how do you think that they’re going to affect exploration in the next two to three years?
Personally, I think if you’re trying to predict a commodity price or a market more than 12 months out, you are probably kidding yourself. Things change very quickly. Certain commodities, copper and gold for example, are some of the biggest commodities and have multiple drivers on the demand side and the supply side which change in influence over time.
Trying to predict the relative importance of each of those is very, very difficult. I think if you actually believe your forecast too greatly, you are going to end up making investment mistakes. So I just try and look out 12 months.
Being a geologist, we tend to focus a bit more on the supply side. The demand side is made up of the customers. You have to delve into the very different dynamic of what the consumers use the products for.
Instead, we tend to focus on the supply side because that’s what we deal in. We deal in mines. We deal in scrap markets.
We do try to make commodity forecasts, and what we look for is more of a trend rather than just saying “OK, copper in 12 months is going to be $3.” We look at the macro and we think, “from this point of view, the trend over the next 12 months in copper is probably going to be positive,” or we think there’s a higher likelihood it’s going to be negative and then we try and make investments where that outlook is a component of the equation.
Do you base those trends on the amount of new supply that you see coming into the market?
Yes, primarily on supply. Again, as a geologist, I tend to look on the mining side of it more, but I do read as much as I can on demand.
Take copper. What’s happening in the electricity market in China is a big driver because aluminum is getting substituted for copper in certain scenarios. But there are lots and lots of data points. You just have to constantly keep reading it and you just almost get a bit of a temperature and you see swings in sentiment as to what’s happening in the market.
Now we’re not trying to trade those swings. We’re just looking out 12 months or so and asking “what do the trends look like in copper, gold, or platinum?”
Platinum gets a lot of analyst interest and there was a lot speculation about a potential supply squeeze in platinum and palladium last year. It looked like the consensus was for platinum prices to go higher. Yet there was no breakout.
I think a lot of analysts like to be first to call a trend. So they make a compelling case and then other people jump on the story too. When it comes to the platinum shortage — same as with the zinc and uranium shortages — it may take months or years to actually play out for various reasons.
For instance, there have been hidden inventories of metals (such as Russia’s secret palladium supplies) and certain commodities have encountered substitution. Platinum, for instance, can be substituted by palladium. I’m now hearing stories about zinc being substituted by another metal for galvanizing in certain applications.
So people often call these trends too early and sometimes they can take years to play out. Still, they generally do play out because on the supply side, the pipeline of projects is actually quite easy to forecast. But it’s often on the demand side where the customers are using the metals that unexpected changes occur — for instance, substitution or sales from hidden inventories. It often takes longer for the thesis to play out.
Henry: Thanks a lot for joining me Neil.
Courtesy: Henry Bonner
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