“WHY ARE MINING SHARES LAGGING?”

Leonard Melman

 

Note:  For readers not familiar with the concept of our “Melmania” section, this is where your editor can take any subject and develop arguments regarding some ultimate conclusions.  Since some of those conclusions might sound extremely radical, the name of “Melmania” seems appropriate.

 

April 30, 2008

 

Please cast yourself back into the time frame between 2001 and 2002 and imagine you were having conversations regarding the potential of mining share investments. In your wildest imagination, during such conversations could you have envisioned an era where the price of the metals would explode upward - almost beyond your wildest dreams - and yet the price of many quality junior mining shares would gain little or not at all? Yet, that is the world we are actually living with, particularly during the past year.

Metals have indeed performed spectacularly. We would ask you to take a look at three representative charts to illustrate just how dramatic have been the upward moves in gold, copper and platinum during the past seven years.
 

Gold is an excellent example. From lows in the $250 - $260 zone (all prices US$) in 1999-2001, gold has soared dramatically, exceeding the $1,000 level by early 2008. However, many junior gold mining shares peaked more than a year ago and have actually declined in the face of the latest rally.
 

The same is true with copper. After languishing near 60 cents until early 2003, copper exploded upward, reaching over $4.00 per pound by early 2006. A sizeable correction ensued, but copper has regained virtually all of the lost ground and now stands close to its record high.
 

 

Platinum has been even more spectacular, soaring from $400 per ounce in late 2001 to an astonishing $2,200 per ounce in early 2008.

However, despite moves such as these in gold, copper and platinum as well as equally spectacular moves in such metals as nickel, molybdenum, zinc and lead, the overall performance of the junior mining shares during the past year has been moderate at best and severely disappointing at worst.

During an interview with Al Korelin on his radio network taped during the recent Cambridge House Calgary Conference, we had an opportunity to address this issue at some depth. Here are some of the ideas expressed during that interview, as well as additional information we have been researching.

First, the mining share investing public is highly aware that all manner of mining costs are escalating rapidly. Estimates for the cost of bringing new projects into production are rising so fast that properties and projects once forecast to become highly profitable mining operations are now being shelved, either temporarily or permanently. One most notable example is the Galore Creek Mining Project in northern British Columbia where the estimated cost of bringing the property into production rose from an earlier estimate of near C$ two billion to more than C$ five billion by late 2007. Partners Teck Cominco and NovaGold then suspended the project until new and more favorable estimates could be obtained.

Some of the sharpest cost increases have involved energy costs, fuels, professional and management personnel, transportation, regulatory and real estate prices. All of those trends toward rising expenses remain intact as this is written in late April, 2008 - and investors are becoming wary regarding the eventual profitability of many projects.

Second, the time span involved in bringing a project from early prospecting until successful production continues to lengthen on average. Combined with rapidly rising costs, this is also bringing into question the viability of many projects. During our early years in the mining share brokerage world in the late 1970’s, it was not unusual for a project to move swiftly through exploration, resource development, feasibility studies, final permitting and construction financing. In the present time frame, ‘swiftness’ is a seldom-used term in descriptions of progress regarding the development of projects.

Third, we have the growing difficulty of raising capital, for two primary reasons. One is the reality that the world’s credit markets are being stretched thinner and thinner and less money is available for financing the junior mining industry and, next, there are so many potential objections to mining projects from environmentalists, aboriginals and numerous governmental regulatory agencies that potential sources of mining capital are growing more cautious.

Fourth, there is a growing fear of interference by government action. One country after another in locations such as Venezuela, Mongolia, Chile, Ecuador, Bolivia, Eritrea and the Democratic Republic of Congo (DRC) has taken actions which have been harmful to mining prospects, ranging from increasing levels of taxation, breaking of previously negotiated contracts or even outright threats of nationalization.

These are some of the major reasons why the group has been under-performing of late in relation to what might have been anticipated, given the price actions in the metals themselves.

It is up to the mining share investor, in consultation with his registered investment professional, to determine whether the recent declines in average mining share prices represents a true investment opportunity, or whether continuation of a cautious stance is in order.
 

Leonard