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Message: Natural Selection

"Natural Selection" at Work in Exploration Sector: Steven Poulton, Altus Strategies

By Henry Bonner ([email protected])
Sprott Global Resource Investments Ltd.

As the mining sector makes its way through a prolonged period of attrition, both individual and institutional investors in the sector continue to suffer losses to their natural resources portfolio.

I recently spoke with Steven Poulton, Chief Executive of ALTUS Strategies in the UK. ALTUS is the investment manager to London listed Altus Resource Capital, which invests in junior resource equities while Altus Global Gold focuses on the mid cap producers. Altus also incubates and manages its own exploration deals across Africa.

“While there is fantastic value out there we have to remain incredibly discerning in terms of which companies we invest in right now” Steven begins. With tumbling prices for mining shares over the past 18 months, he believes we’re now looking at a scenario where a market capitulation is playing out, which will lead to a general decline in the number of investors and companies operating in the sector.

“It is natural selection – amongst both companies and shareholders. Generally, we expect that those investors who had unrealistic valuation methods to choose companies – or those who simply bought the momentum of the bull market years – will simply give up, if not already.” Fewer market participants mean less money in the sector, but also a stronger base from which to begin the recovery. “This is unpleasant to witness but ultimately very healthy for the sector” he states.

What kinds of companies should you invest in?

“The viable companies in the space are those where board and management has the greatest stake in the game,” says Steven. “The sell-off in gold and other metals has exposed mismanagement for what it is, but the sell-off in the stocks has been indiscriminate and this creates a stunning opportunity as the underlying themes which drove metal prices since the turn of the century, including gold, remain firmly intact.”

Steven’s reasoning is that the bad practices that took over the mining industry during the bull market which broadly lasted from 2002 through 2010, are already coming to an end. During that period, many companies became a mere means of providing a lifestyle to their management and advisors, he explains. Instead of spending their shareholders’ money creating value, much was spent inflating salaries as well as consultant and advisors fees – plus a heavy General & Administration overhead. “Cash was splurged, seemingly encouraged by the market to ‘make it big’, regardless of the absurd capex implications, juniors drilled with abandon and even new graduates expected almost rock-star treatment.”

“Shareholders weren’t necessarily opposed to this arrangement. It didn’t matter if companies were not actually creating value with the money they received because most share prices went up regardless, on the mantra of ‘growth is good’.”

Now, Steven says, “that party’s over.” The rules of the game have changed. With the sector having given back most of its gains, almost to 2002 levels, the trend following speculators have “largely left the market for now, to chase the blue chips being powered by central bank money printing”.

The remaining market participants, he expects, will be far more demanding in terms of how efficiently companies run their operations, less swayed by the big, unrealistic promises and focused on how the directors look after their greatest asset – their share capital.

“Investors in the space will understand the kinds of questions and answers they should be getting, and how to interrogate the premises of management teams. So this period is a ‘cleansing’ period rather than a mass extinction, which is a natural occurrence in the resources sector. You will have a cleaned-up market with a more questioning investor base even amongst the generalists.”

In turn, the companies that survive should be those who behave more efficiently: “The amount of money spent on activities besides taking samples, drilling, growing resources, or building mines must become far smaller. This will be deflationary for the cost of mining and exploring for new ones. We’re re-booting the sector a little bit right now.”

“In addition to an overall rebound that we would expect based on previous experience in bear markets, there is also the fact that due to the lack of success in discovering world class deposits over the last 35 years, the true high-quality, economic deposits that are discovered by juniors will be of tremendous value to the producers going forward.” So, Steven expects that buying good projects with disciplined management will start to pay off.

Should we hold onto our cash and wait for prices to fall further?

“It’s rarely wise to try and call the bottom,” says Steven, “but we’re seeing tremendous value right now. We are currently buying up the best opportunities that we see, and holding some cash plus exposure to the metals too, allowing us to invest aggressively if prices fall still further. Dripping money into these markets when participants are so disaffected – and this is especially the case during the summer months – is an intelligent strategy in the current volatile market.”

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