An Insider's Guide to the Mining Sector: An in-depth study of gold and mining shares

Publishing details

HARRIMAN HOUSE LTD

3A Penns Road

Petersfield

Hampshire

GU32 2EW

GREAT BRITAIN

Tel: +44 (0)1730 233870

Fax: +44 (0)1730 233880

Email: [email protected]

Website: www.harriman-house.com

First edition published in Great Britain in 2004 by Harriman House.

This eBook edition 2011.

Copyright © Harriman House Ltd.

ISBN: 978-0-85719-119-9

The right of Michael Coulson to be identified as the author has been asserted

in accordance with the Copyright, Design and Patents Act 1988.

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of the Publisher. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published without the prior written consent of the Publisher.

No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in this book can be accepted by the Publisher, by the Author, or by the employer of the Author.

Designated trademarks and brands are the property of their respective owners.

About the author

Born in 1945, Michael Coulson has been associated with the mining sector for over thirty years, although his university background is in economics where he holds a BSc from the University of London. He first worked as a graduate trainee on the legendary mining desk at James Capel in 1970, for many years the leading mining stockbroker in the City. After that he became a mining salesman at Sterling & Co and also developed the firm’s research coverage of the sector. In 1973 he joined Fielding Newson-Smith (later to become NatWest Markets) as a gold mining analyst where he began a long association with the South African gold mining industry. Two years later he became senior mining analyst at L Messel (latterly Lehman Bros) where he started to produce an annual gold review which he published every year until 1991. In 1979 he moved to Panmure Gordon and in 1982 he left and joined Phillips & Drew (UBS) with the task of establishing the firm in the mining market.

After a successful four years there, where two years running he was voted No 2 gold analyst in the Extel Analysts Survey, he moved to Kitcat & Aitken where he set up a highly regarded integrated mining desk. In 1990 the firm’s Canadian owners closed the firm and he was briefly with County NatWest. The following year he set up a small mining team at Durlacher, but in 1992 was back in the mainstream at Credit Lyonnais Laing where he was a salesman/analyst on the firm’s specialist mining team and established an expertise in African shares. He was then approached by South African bank, Nedcor, to join a start-up broking operation the bank was establishing in London. This operation was closed in 1997 and the following year he joined Paribas to head its Global Mining Team.

He left Paribas in 2000 following the completion of the merger with BNP. Since then he has been doing independent research, mainly on a commissioned basis, primarily for small UK brokers lacking mining expertise. He is currently a non-executive director of City Natural Resources High Yield Trust and of Canadian exploration junior Moneta Porcupine.

He lives in Wandsworth with his wife and has three daughters. He has a lifelong passion for cricket and football and also enjoys a glass or two of wine sitting in his moderately well cultivated garden listening to music from another age!

Acknowledgements

This book is the result of over thirty years of following the mining sector and investing in it, both directly and for others. I have drawn upon a large number of personal experiences in describing the workings of the global mining industry and share market. Having worked at a large number of stockbrokers I have observed the sector from many different angles and worked in often quite different environments – experiencing both the often structured world of Phillips & Drew and Paribas and the far more entrepreneurial approach of Kitcat & Aitken and Credit Lyonnais Laing. Unknown to them, colleagues and friends from these days have played a key part in the writing of this book, for truly the mining sector is a global village where, whether it be London or Johannesburg, Toronto or Sydney, we participants and observers cannot help but have an impact on each others actions and attitudes both on and off the ‘field’.

I would like to pay particular thanks to two people for their role in both editions of this book. My editor Stephen Eckett whose enthusiasm for the project has kept the whole show on the road. With such a wide ranging subject as mining it is easy to get sidetracked with a consequent unravelling of the narrative. Stephen’s comments and advice have been invaluable in moulding the book into a coherent entity that hopefully readers will find both interesting and helpful, and his nose for data sources has led to the inclusion of more tables and charts than I had thought possible when starting out. In this particular area I would also like to thank my old colleague and friend Charles Kernot, now of Evolution, who provided invaluable help in locating many of the charts used.

Foreword to the second edition

When I wrote the foreword to the first edition of the Insider’s Guide back in late 2003, I was confident that we were on the brink of a major bull market in both metals and mining shares after years in the doldrums. Michael Coulson’s book was therefore extremely well timed, and also a valuable guide for investors new to the mining sector at a time when expertise in the industry amongst brokers and other investment advisers was at a very low ebb.

Since then we have witnessed a huge bull market in metals and a remarkable recovery in interest in mining shares amongst both large and small investors. Despite this, mining shares have often performed raggedly with the more speculative exploration and development sector having peaked in early 2006. Since then it has failed to match the progress made by the majors who have benefited from both soaring earnings and vigorous takeover activity. This suggests to me that the current bull market may have considerably further to run, particularly as demand for commodities from the so-called BRIC nations remains so strong.

However, the fact that major mining shares continue to sell on relatively low PE ratings and that junior mining shares struggle to attract investor interest, certainly in the UK, can only be down to a continuing lack of knowledge about the sector amongst professional advisers and their retail clients. For this reason the second edition of Michael Coulson’s book is as important as the first.

One encouraging thing that I have noticed over the last year or so has been the re-building of mining coverage amongst the investment banking and broking community and we have even begun to see the reintroduction of integrated mining research/sales/trading teams, much on the lines established years ago by the mining sector’s doyen, the late Julian Baring. However, it is important to note that due to the increasingly regulated securities industry little of this coverage trickles down to many investors. For them Michael’s book remains a very useful tool to use when evaluating the sector and making stock choices, and his grasp of and interest in mining history provides an invaluable context to that decision making.

Adam Fleming

Chairman, Wits Gold [JSE: WGR]

www.witsgold.com

Preface

What the book covers

The first edition of this book covered those subjects that I believed were fundamental to acquiring sufficient knowledge about the mining sector to invest in it with confidence. In doing this I dipped into a wide number of subjects and tried to extract the points and issues most relevant to successful investing. Since then the mining and metals sector has experienced a massive bull market and this has led to a number of new or enhanced influences for the sector arising.

The key subjects looked at in the first edition covered the main mining countries which have listed mining companies, metals both great and small with a separate section for gold, the listed mining companies themselves from the giant diversified groups to the minnows of the exploration sector, the main mining stock markets, and some history (always important in analysing mining markets where lightening often does strike twice) including a view on the Bre-X disaster and the 60s Australian nickel boom.

This new edition brings all the above up to date, and also expands the scope of the book by looking at the growing influence of China, India and environmental concerns on the mining and consumption of metals. In terms of share markets the position of AIM versus the Canadian and Australian markets is examined in some detail and I also take a close look at the alternative investment areas of ETFs, etc. Lastly, I put the current mining bull market into context and speculate on whether we are in a super cycle for metals and therefore for miners.

The book finishes with an updated section on the main issues relating to dealing, settlement and information sources.

A word of warning

Comments and statements about such a fast moving sector as mining are often overtaken by events. It is possible that readers may spot something in the text that they think is incorrect. It may well be that when the book was published that fact/comment was correct but has been overtaken by subsequent events. The most common differences would likely be issues dealing with share prices, like market capitalisation; these figures are changing all the time and often the change is significant. The acceleration in consolidation within the mining sector can also create problems, with companies losing their independence between printing and publication.

Who the book is for

The book continues to be aimed at anyone interested in mining, and particularly mining as an investment sector. Whilst I think that the book contains material which will be useful to experienced followers of the mining sector, its main target is those who are interested in mining but perhaps not particularly familiar with the sector, and would like to know more. This means private investors, non-specialist institutional investors, generalist stockbrokers, financial advisers, and mining industry professionals.

Mining has been out of favour for many years, which has led to a sharp fall in coverage as attention has shifted to the growth sectors of technology/media/telecommunications. Over the last few years we have seen quite a sea change again, with interest in mining rising once more. However, for the moment information distribution continues to lag behind, with many brokers still not particularly familiar or comfortable with the sector. Investors will have to continue, therefore, to fall back on their own devices, surfing the net in pursuit of value enhancing information in many cases.

I hope this book will provide useful background for investors, enabling them more accurately to focus their information search and enhance their subsequent investment decisions.

How the book is structured

Whilst the book is compartmentalised to some extent:

the first part covering mining countries and metals in a general sense,

the second part companies, how they are valued and where they fit in the overall industry, and

ending with the subjects of dealing, and information sources

there is some overlap and even repetition which is unavoidable.

The mining industry is large but at the same time compact in that it concentrates on a fairly limited number of influences. Thus the key issues facing a mining company cover:

the demand and price of metals,

the search for these metals and

the economics of developing and running a mine.

It is thus difficult to write about and analyse mining without jumping about between these three key elements. The base structure of the book, however, is logical and is intended to lead the reader naturally from the subject of where mining is carried on and the key metals mined, to the main markets where mining shares are traded and the kind of companies that make up the global mining share sector and how it is valued, to the final section on information sources and dealing in mining shares.

A note on currencies and metals prices

Most metals are priced in US dollars which is also often the currency of corporate earnings reports even if the reporting company is not a US company. The reader, however, should be aware that particularly where we are looking at historic events other currencies creep into the text. This is deliberate and is often as a result of the way historic information has come to me. The dollars referred to in the text are usually US, but keep an eye out for the Australian and Canadian versions. Sterling is often used in keeping with the UK’s position at the centre of international mining, but the euro does not intrude very much in these pages.

As to weights and measurements, the book reflects the real world, not the bureaucrats’ version, so imperial/American and metric are both used and often in the same breath. Thus, a gold mine’s reserves are measured in grams per metric ton (tonne) but the gold in those reserves is valued on the basis of troy ounces. Similar examples of mixing measurements can be found with base metals such as copper, nickel and zinc.

Supporting web site

The web site supporting this book can be found at:

www.harriman-house.com/mining

Introduction

Give us the boy

It was a bright morning in early 1971. I had been seconded as part of my graduate training course at London stockbrokers James Capel to assist on the mining desk, having expressed an interest in becoming involved in international securities rather than the domestic share market. As the Jesuits say, give us the boy and we will have him for life. My lifetime addiction to mining began that spring day.

As a trainee I was not expected to arrive at the same time as the department, trainees have a way of getting under everyone’s feet and their absence is seldom regretted. As I opened the mining department door that morning I was met by a scene of pandemonium. The mining desk stretched across the institutional equities department, and was open on one side to the desks of the UK institutional salesmen. On the other side there was a floor to ceiling partition, on which the mining share prices and dealing boards were fixed, separating the mining sales desk from the specialist mining research group who beavered away behind the partition. I looked down the desk at gesticulating arms and waving telephones as the mining sales team urged their clients into action.

At the end of the desk on the left against the window which overlooked the eastern end of London Wall sat Shane Norman, assistant to the Mining Partner, Julian Baring, who was on his right. Latterly, Baring was to become the City’s leading gold guru, first as a broker and then as a fund manager. Next to him sat Andrew Malim and next to Malim was Peter Bugge. On the other side of the desk was David Dugdale, part-time mining dealer later to become managing director of James Capel following its big bang takeover by HSBC. Next to him sat Mike Bevan, senior mining dealer, who, that morning, had yet to go down to the Stock Exchange floor, so frenetic was the dealing on the desk. Next to him was Alan Robinson booking the deals. My seat was next to Alan in the corner opposite Shane Norman and Julian Baring. Behind the partition, analysts Bill Anderson and Harry Hake beavered away. In those very early days of specialist sector coverage in London, James Capel’s mining team was a large and formidable entity.

That morning Ashley Down, the Australian Partner, was on the mining desk as well, for what I was witnessing was the announcement of the Agnew nickel find in Western Australia by UK mining groups, Selection Trust and CAST. Agnew turned out to be the last lash in the tail of the Australian mining boom which had started with the discovery of nickel at Kambalda in Western Australia in 1966 and peaked with the Poseidon nickel discovery in 1969. Unfortunately, due to then tight Australian exchange controls, Australian investors were frozen out of Agnew, but UK and Continental investors were having a ball that morning.

For a relatively young and certainly impressionable trainee on the first rung of a stock exchange career the Agnew discovery was heady stuff and confirmed the attractions, albeit it in a superficial way, of the mining sector. Overnight the prospects of two mining groups had been potentially transformed by a major minerals discovery. Of course the effect of such a discovery on Selection Trust and CAST, who already had significant sources of mining earnings, would have been less than say its effect on a ‘penny’ stock like Poseidon, whose earlier nickel discovery had propelled its share price from 6 old pence (2.5p) in 1968 to over £120 in early 1970. However, the excitement of mining with its hope of instant riches was addictive.

Beyond speculation

But if the prospect of instant riches gave the mining sector obvious glamour, I rapidly discovered that it had other attractions, and pitfalls, as well. Attitudes towards investment in industrial equities can change markedly over time, the bulls of the late 60s were followed by the bears of the mid 70s, who in due course were followed by the bulls of the late 90s replaced in their turn by the post-IT boom bears of the new millennium. Against this background the mining sector can provide some counter cyclical relief, the major boom in South African gold shares in the 70s followed on nicely from the nickel boom and gave some protection from the ravaging of world equity markets in the wake of the 1973 oil price shock. Here the attraction was less in the discovery of new mineral deposits and much more in the prolonged surge of the gold price, which transformed the outlook for the gold mining industry and its earnings and dividends.

Whilst the speculative attractions of mining share markets are, therefore, easy to appreciate, the size and importance of the worldwide mining industry should not be ignored either as that gives the sector its underpinning. Although there are still a number of state mining companies the industry is heavily in private hands, and many producers are publicly quoted. The industry itself is widely spread round the world and no continent or island, however small, is without a minerals operation even if it is only a basic small stone quarry.

However, mines also are controversial due to their impact on the environment; a deep level mine may be inherently dangerous to work in and an opencast mine may be viewed as an unacceptable scar on the landscape. The degree of disapproval will also vary, with Africa less likely than the western USA to create difficulties for new mine developments.

The current mining boom

There were those who believed that mining was an old industry with limited attractions, if any at all, for the modern investor. A widespread view as the twenty-first century dawned, and the TMT boom reached its peak. Indeed, mining has often been written off as a sunset industry; it hardly rated a mention in the early 60s as a previous high technology boom unfolded. Yet, as we saw above, that decade ended with one of the century’s greatest stock market booms, in Australian mining shares.

It is, however, true that mining struggled with the technological revolution, and metals, as a component of economic growth, have lost ground as the knowledge based economy has overtaken the raw material based economy, particularly in the advanced world. Having said that, the rising economic power of China and India and the still relative poverty of their people is changing all that, raw materials, the bedrock of both basic industry and social infrastructure, have clearly not had their day even though the real price of metals has tended over the longer term to fall, although this is not a straight line process, as the inflationary 70s showed.

As an investment proposition the mining sector has waxed and waned with regularity. It is interesting to note that institutional portfolio weightings for mining shares in mining countries such as South Africa, Australia and Canada can still be below their correct weighting in market capitalisation terms, although the China story and the rise of tracker funds may be slowly changing this. In the UK some general stockbrokers see the sector as difficult to understand, both on a macro and a micro level, although the rising importance of mining companies in the FTSE 100 is having some effect on their attitude. The fact that some of the best mining shares are foreign listed and have to be dealt and settled overseas is another check on their enthusiasm. However, dealing in overseas mining stocks did not trouble Julian Baring and the James Capel mining team, or indeed rival mining teams, in the 70s and 80s, and foreign dealing to this day remains relatively straightforward despite reductions in settlement periods.

A global business

Whatever reluctance stockbrokers may have in dealing in overseas mining shares, it is important for investors to see mining shares as inhabiting a truly global sector. Much is made today of looking at market sectors on a regional basis rather than just a narrow national one. The phenomenon of Europe-wide sector research and dealing is well established, but the imperatives of national economic trends have an irritating way of reasserting themselves. For mining the global picture is paramount – a gold mining company may have operations in half a dozen countries but the market and price for its product is international, homogenous and largely unaffected by local considerations. Even those other great international leviathans, the oil majors, can find downstream profitability materially affected by local conditions.

Mining, then, is an industry which requires an international outlook from investors. An open and enquiring mind is essential and in order to make informed judgements about investment possibilities a wide body of knowledge about the world is essential. Many people make the mistake of thinking that the mining sector is difficult because it requires technical knowledge of the industry itself, and unless one is familiar and comfortable with engineering and geological concepts one is bound to flounder. Although it is true that some knowledge of the mechanics of mining is needed in reviewing mining investment ideas, understanding of both macro and micro economic trends which drive the demand for, and price of, metals is equally important.

Perhaps one of the most compelling things about mining is that it forces us to open our eyes to the world. It is rewarding to specialise in one country’s mining industry as I did with South Africa, and in doing so become familiar with a country that in my youth I had had no contact with and knew very little about. But mining is a global business and to engage successfully with it, investors and analysts must acquire a catholic attitude. That is why, certainly in the past, UK mining analysts and investors were held in such high esteem, their global outlook and understanding being in often stark contrast to the parochial attitudes of many of their overseas peers. But if the mining sector’s global focus has been educational and rewarding, on a more basic level the sector has been (indeed still is) enormous fun to follow and invest in. I hope this second edition reflects that and also provides some thoughts as to how this fun can be turned to profit.

1. Industry Background

We start the book with a broad look at the worldwide mining industry, looking first at those countries that historically have always had a substantial private mining sector and listed mining companies.

Whilst the leading mining groups are still to be found in the old ‘English speaking’ markets, recent years have seen the flotation and/or listing of mining companies from Kazakhstan, China and Russia. In the case of Kazakhstan many of the listings have been in London and the companies have incorporated in the UK, a phenomenon I will be looking at in more detail later. China and Russia have also part privatised a number of their larger mining companies which have their primary listings in their home market, and in the case of China in Hong Kong also; smaller mining companies active in the two countries tend to be foreign registered and foreign listed.

Mining countries

As I have said there is scarcely a country in the world that does not have some semblance of a mining industry, even if it is no more than a chalk quarry or a sand and gravel pit. However, the number of countries with substantial mining industries is more limited, and not all of those would be considered ideal environments for investors.

From the perspective of the investor familiarity is a good starting point, and that can cover a number of issues including language, legal integrity, environmental constraints, economic policy and political prejudices. If one looked at the portfolios of the bigger specialised mining investment funds one would find that the majority of stocks held still come from a very limited number of countries, primarily:

Australia

Canada

South Africa

UK

US

The question of location

Here, we define the country of origin as where the mining company has legally incorporated itself. Following the demise of its coal industry the UK is no longer an important mining country, but four of the world’s largest mining groups (Anglo American, BHP Billiton, Rio Tinto and Xstrata) are incorporated in the UK.

Part of the reason why the majority of mining stocks came from a very limited number of countries is the historic structure of many mining industries which were formerly owned and run by the state, and have only recently entered the public domain following privatisation in the last ten years or so.

Of course a mine is where you find a mineral deposit, unlike a factory which can be put up in the most beneficial location. This means that many mining companies from, let us call them, the big five countries, operate outside their geographical incorporation. Although Chile is a large producer of copper, few funds would buy a Chilean mining stock direct even if they could. Rather, they are exposed through holdings in major groups such as Antofagasta and Rio Tinto which have substantial operations there. This is repeated in other Latin American countries, in Eastern Europe and in the old Soviet Union countries.

Having said that, locally incorporated stocks such as Buenaventura in Peru, Grupo Mexico, Vale (the former CVRD) in Brazil, KGHM in Poland and Norilsk in Russia are frequently to be found in foreign portfolios. It is likely that this trend will continue as local stock exchanges and capital markets gain both financial strength and recognition. This could well lead to mining companies in these markets using their own paper to make overseas acquisitions, rather than as at present paying cash – CVRD’s takeover for cash of INCO for example. As the number of large mining companies in the major markets shrinks under the current and continuing wave of bids and mergers, investors may in any case find themselves looking at these less well established exchanges for opportunities.

Australia

For many older investors Australia, as far as mining is concerned, conjures up the image of free booting entrepreneurs pushing prospects and projects at unsuspecting punters, an image heavily influenced by the nickel boom of 35 years ago. Even in today’s heavily regulated markets, the Australian mining industry still creates larger than life characters – Canada has also done well in this regard in recent years.