Are you interested in investing in commodities or mining companies but aren’t quite sure where to start?
Rudenno is an industry veteran and expert and literally wrote the book on valuation in the resources industry.
Announcer: Live from the Internet, it’s Tradestreaming Radio with your host, Tradestreaming.com’s own Zack Miller.
Zack: Hi, this is Zack Miller, and you’re joining us on Tradestreaming Radio, our resource online where investors can learn directly from experts in their field. Have you ever thought about investing in commodity companies or mining companies but weren’t quite sure exactly how the industry works or how to value companies or resources? I invited Dr. Victor Rudenno, our guest for this week’s podcast, onto our show. He is the author of a book entitled “The Mining Valuation Handbook: Mining and Energy Valuation for Investors and Management”. He spent his entire career dealing with this issue, and I invited him onto our program to help us learn exactly how the industry works, how certain influences make prices go up and down, what investors want to look for in mining investments, whether they’re public market or private market.
I hope you find this useful. I thought it was useful enough that I invited Victor back to do a more comprehensive type course for you guys. I hope you will enjoy that as well. Look for that in the future.
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Victor: Okay. By the way of background, I’m a mining engineer, and I started off as an academic, but then some 25 years ago, I went into the stock brokering and investment banking industry.
Zack: In Australia?
Victor: In Australia, yes. Working for a number of major banking groups, such as Merrill Lynch and CIBC and others. I worked initially as an analyst. I didn’t specialize in any particular area. I covered all the different aspects and resources, although I suppose I became more of an energy analyst towards the end. Then about ten years ago, I moved across to the investment banking side of things, spending more time, obviously, on doing valuation work and IPOs and capital raising and advisory work to mining companies. Then started my own little investment bank, and more recently have just been consulting on my own for mining companies again, specifically in valuation work.
I suppose over those years, I was often asked by people, “Is there a good book I can read to understand mining,” which is quite different from industrial stocks in many ways. There were a few books around, but they’re all rather specialist and really narrow. So I thought, why not do a handbook and try to cover all of the aspects of mining and mining valuation? So the book covers not only valuation techniques, but also the basics of mining, what it’s all about, as well as energy, so oil and gas is included as well.
Zack: I’ve seen in the book there’s a lot of tactical information on Australian mining companies. Was the purpose of the book though really just a handbook in general for any market?
Victor: Yes. It is for any market, and each edition I’ve tried to make it a little bit more general. As you’ll see, it covers more aspects, like all the tax regimes and royalty regimes around the world. When the next edition comes out, which might be towards the end of next year, I’m hoping that I’ll put more international studies. There are some tables there that help people work out operating costs and capital costs and so forth for mining companies on some 90 projects over some 20, 30 different countries around the world. I hope to expand that to something over 400 companies in over 30 countries around the world. Also, the examples which are basically Australian focused, because that sort of evolved when I first sold the first edition, but I hope in the next edition to have a lot more international projects so it won’t look so Australian. But in terms of the concepts, they’re the same, and the details are really to show the reader how to work it out or to see what the particular issues are.
Zack: So, why do we need a handbook for mining valuation? What’s different about the mining industry, as you said before, from other industrial sectors?
Victor: Probably two specific aspects. One is that commodity prices are a lot more volatile. You buy food products or industrial stocks and so forth, most commodity prices tend to rise with inflation and then modestly volatile. Whereas when you look at commodity stocks, you can just see the huge volatility that occurs. Even now, in the last week or so, the commodity prices have been falling fairly significantly after a very strong rise over the last 6 to 12 months. So, the commodity prices are very volatile, and that’s both a positive and a negative for resource stocks.
The second thing is that mining companies have finite lives. The resources that they develop and produce product from have a finite life, and that’s quite different too. You can have a major mine, and within 10 or 15 years, it might run out of ore and then have to close down, whereas obviously an industrial factory could go on indefinitely.
Actually there is a third aspect, and that relates to the finite life, and that is that mining companies have to explore to find replacement resources, whereas industrials don’t. That exploration obviously adds risk to the mining company, because if they fail to find that replacement ore, then of course, they may go out of business. But, of course, that’s the positive side as well, because mining companies can make discoveries and have phenomenal improvements in their share price, which industrial stocks just can’t match. So a mining company that makes a major discovery can increase in share price many times. So, they’re the three critical parameters that make mining companies quite different from industrial stocks.
Zack: For me as an investor, it’s that third piece that I liken to biotechnology companies. This binary event, either they find it or they don’t, and the money’s running out or they have to continuously raise money to explore. So, how does somebody get their hands around that piece for an exploratory company? Where do you begin to gauge the risk there?
Victor: That’s of course the hardest aspect of looking at resources by far, because you can never foretell if a company is going to be successful, because in the end there’s a large element of chance. I think the important thing is, one, if you can follow companies that have a good track record. That means that they perhaps have the people in place, and that can sometimes help. You should look to see whether they’ve got adequate exploration funds, as you’ve just mentioned. If they’re coming down and have very little funds left, that of course increases the risk. So you’re looking for companies that have a good track record, have sufficient funds available, and have also good acreage, relatively large amounts, because that gives them a greater chance of success, and preferably acreage which is situated where other successes have been achieved. That’s not to say that if you’re next door, you automatically will have success, but at least you want to have a company that’s got perhaps all of those aspects, and that perhaps will improve your chances. But in the end, yes, no one can really foretell what’s going to happen.
Zack: So, Australia, the U.S., Canada, first world countries, I would say regulatory risk doesn’t play a huge role, but whenever you’re extracting resources, it does. If you’re a mining or resource investor outside of first world countries, doesn’t the government risk also play a big role in your investing returns?
Victor: Yeah, and even in places like Australia. You can say it’s safe from a legislative point of view. We’re just introducing a new mining tax. The U.K. has changed the taxation rates on oil and gas a number of times in the North Sea. So, even in first world countries, you can never be certain that things won’t change. So yeah, there are political risks, but that seems to be changing. I’ve noticed that there was a time when it was unheard of for at least Australian mining companies to do any exploration work outside of Australia. Now, the majority of Australian mining companies explore outside of Australia, anywhere from the Middle East to Africa to Russia. They’re all over the world now, because it’s getting harder to find those larger deposits, and people are more understanding of the political risk, and that’s just one more aspect of resource stocks.
Zack: Your book is finitely detailed and is clearly the work of a professional. In my practice as a financial advisor, people come in, they own mining stocks, and it’s clear to me they don’t really understand what they own. Are mining stocks the purview of retail investors, or is the type of thing that institutional guys should stick with?
Victor: There are a lot of retail investors who invest in resource stocks and do extremely well out of it. I don’t think people should be too frightened with resource stocks. As I say, they’re a bit different from industrial stocks, but I think people can find a lot of good return, and it only takes a little bit of practice and reading the releases that companies put out and then perhaps using a book like mine to try to understand some of the terminology. In any sector, bio or any other sector, there’s always going to be terminology that you have to learn and get used to so that you understand what the directive and the company is saying.
Zack: Can you walk me through the process? Say I’m a retail investor and I want to get exposure. I buy your book. I read about what I need to know. Can you take me a few steps into that process? Do you recommend using stock screeners and looking for particular criteria to start narrowing down stock selection?
Victor: What do you mean by stock screeners?
Zack: I mean some type of technology that you can input a variety of criteria that you preset and look for just those stocks that fulfill that criteria before you start to drill down on looking at individual securities.
Victor: Well, to be honest, I’m not familiar with it, unless you mean just performance related criteria and returns.
Zack: Fundamental. You’re looking for a certain return on assets or something from a company. I guess what I’m asking is what are those criteria that we should be looking for?
Victor: That’s sort of more from the industrial side. It’s a little bit harder with resource stocks. I think with resource stocks, one thing you should be looking at is really your exposure to the commodity. So first of all, you need to decide which commodities that you’re interested in getting exposure to. So you might be keen on gold at the moment, or you might decide you want to get into iron ore, because that’s quite strong at the moment. I think the first part is to select the commodity that you’re interested in.
The next thing to do is decide whether you want to be with the stocks that are already in production or those that have projects that are not yet in production, the explorers. Each one of those has a different risk and a different return. If they’re already in production, obviously the risk is low, but the returns will be lower. If you go into the exploration side, obviously the returns can be much higher, but the risks are the highest. In between, which is not a bad area I think for people to look at if they’re not that familiar, is to look for companies that already have the resource discovered, but they’re not yet in production. There’s construction and production risk still there, but once they get into production, there’s usually a good increase in the share price. So that’s just the fact that they’ve gone from a non-producer with no cash flow to cash flow. Then you can get significant returns there.
So I think that’s what people should be looking at. Commodity, and they’re looking for those companies that have found the commodity and are looking to get into production.
Zack: Where would people begin to find those companies? What resources do you use online or offline that you stay on top of your game to help you stay abreast of the industry or to bubble up some of those ideas?
Victor: If you get some of the news services, they’re mining news services that provide some recent releases by companies. They’re not very expensive. Here in Australia, for a few hundred dollars, you can get a daily news release that lists all of the companies and summarizes what their releases are. That’s a great way to at least know what’s going on and to see stocks that announce that they’ve got an amazing resource for a project, and they’re just about to start their prefeasibility or bankable feasibility study. Those sort of signals, so you can watch companies that way. And then, of course, you’ve got to go and look at the company websites and download the actual releases that they put out, have a read of those to see what sort of results.
Now, the key then is if you find those companies that are in the commodity and have got resources, then you’re looking for the ones that can get the best profits, and that in the end comes down, more often than not, to the grade of the deposit. So typically for a gold company, they’ll say they’ve got so many billion of tons of ore, which contain gold. Then they’ll tell you how much gold is in each ton of ore, and they’ll talk about grams per ton. Now the higher that grade, everything else being equal, the higher the profit they’ll get per ton. So what you’re searching for are those companies that have got deposits that are high grade, because they’re the ones that are going to have the biggest margin and therefore the lowest risk of getting into production and provide the highest return.
Zack: What is the terminology when somebody looks for that? They’re looking for the term highest grade, or is there some type of classification system?
Victor: Grade is a word that will commonly be used, but for each commodity, it’ll be a little bit different. For base metals, they’ll usually talk about percent of copper or percent of lead, so they talk about percentages. So you’re looking for percentages that are going to be half a percent or above for copper. Then for gold, it’ll be either ounces per ton or grams per ton. On the American side, it’ll be more ounces per ton. For the big iron ore and coal, it’ll really generally be how many tons they’ve got, but they will also talk about the quality of the iron ore and the coal. So with iron ore, they’ll talk about percentage of iron content. Coal, they’ll usually either tell you whether it’s steaming coking coal and then a little bit about the quality of the coal. So the coal tends to be more quality driven, whereas the others it’s a percentage or an ounce per ton.
Zack: Interesting. I want to talk quickly about trends. You mentioned already on the call that you’re seeing Australian companies getting much more active globally. Can you talk about other high level trends that occurring in the industry right now?
Victor: I suppose there’s always slight improvement in the technology that’s being used in exploration. Perhaps there have been no major developments, but certainly there have been some improvements in terms of remote sensing and so forth. But on the production side of the oil and gas, of course things like horizontal drilling have been a major technological boost and have meant that a lot of deposits of oil and gas, particularly oil that weren’t viable before have become viable, particularly in the onshore U.S. Also in Australia, onshore gas from coal and oil from shale, these sorts of developments have been a very big technological change for the oil and gas industry. For mining companies, I suppose it’s always a volume business. So, for many companies and the industry as a whole have been trending towards getting bigger mines and bigger tonnages. We’re also, of course, seeing globally the impact of developing countries, particularly China in terms of demand, as being the ones that have been the catalysts for getting the significant increases in commodity prices.
Zack: Are we going to see the Chinese companies as well as investment destinations, not just on the demand side, but are we going to be looking to those companies that are going to the far reaches of the world to fulfill their demand? Are those going to be investing opportunities in the future, or are we still talking about Australian, US, and Canadian firms mostly owning that industry?
Victor: Certainly the Chinese and the Indians have been very active in acquiring assets, but I think in most cases, those entities tend to be state owned or privately owned. So I don’t think at this stage it’s as common, but certainly that seems to be a trend where you see more of the state owned, privately owned companies in China going onto the Hong Kong Board and so forth. So I think years over time, you will see more of it, because they’ll look to raise capital elsewhere. But at the moment, it does tend to be more the Canadians, Australians, and to a lesser extent US companies are the ones out there doing most of the work.
Zack: So you really get global exposure by investing through those companies, because those companies themselves have very long tentacles, right?
Victor: Yeah. Especially the big ones, they’re virtually everywhere these days. The world has become very small in many ways including resources.
Zack: So, last question, and I appreciate your time. Are there any common misconceptions that you have when you speak to investors that they have about the resources industry that are commonly held that you can put your finger on?
Victor: I think people [inaudible 19:22] big caverns of oil sloshing around underground, when in reality, it’s just really small amounts of oil in sandstone. It’s those technical issues that they’re not that familiar with. I suppose, also, they don’t appreciate just how much rock has to be mined and processed to produce a relatively small amount of metal. Particularly in the case of gold, I don’t think they would appreciate that three grams of gold is the equivalent of a three parts per million. In a ton of ore, there’s a very small amount of gold to be found, so a lot of tons have to be processed. I think people just don’t appreciate those aspects. And of course, I suppose most people have never seen a mine, so they don’t even know what they look like.
Zack: Great. This was very helpful. Thank you very much for your participation and your time.
Victor: It’s a pleasure.