Summer 2019 Resource Sector Outlook from Sam Broom of Sprott Global

In this interview, Sam Broom, Investment Executive with Sprott Global, shares his current outlook on the resource sector.  Because Sam spent his early career as an engineering geologist in both New Zealand and Australia, he offers a unique and informative perspective particularly for North American resource investors.  Sam also has a keen interest in charting and technical analysis and that focus comes through in his commentary.

0:05 Introduction

1:24 Discussing private placements

5:48 How much cash should explorers have in the treasury before you invest?

7:37 Most bullish chart based only on technical analysis

10:02 Current thoughts on cobalt and nickel

12:14 Australian mining markets

18:15 How can one profit from the trade war?

21:16 Discussing change of control fees

TRANSCRIPT:

Bill: You work with individual clients, you’re a full service broker. Regarding private placements, I’d like to start by getting your perspective on what you’re seeing with private placements in the mining sector right now.

Sam: Yeah, sure. Private placements are quite an interesting way to play, in particular, the junior exploration and development space. For those of you that aren’t as familiar with the private placement market, you have to be an accredited investor to participate, so in the US that means having $1 million net worth excluding the family home, or over $200,000 in annual income. There are a bunch of other rules, but those are the two main ones that people usually qualify by.

Right now it’s quite an interesting time to be considering private placements. In general, we’ve seen a strong lull in private placement activity over the last six to 12 months, it’s been pretty quiet out there. For any of you that have been investing in the junior space will have noticed how slow the junior markets have been. As a consequence of that, the private placement activity slows right down, but for a buyer if you’re an allocator of capital during these times, it’s actually the time you want to be considering being the most active. The reason being is, there’s just not the capital out there to fund these juniors through these private placements, which means that the ball is in your court when it comes to dictating the terms for these placements.

Oftentimes, you look at the warrant terms, so the warrant is sort of a “freebie” that not always, but often comes with these placements. The best one you can get is usually a tradable five-year full warrant, and those are quite rare but you’ll only really see those at market bottoms, where there’s really very little interest. Now is the time to keep an eye out for those kind of placements, because you just don’t get those coming along when things are hot. I do think what we’ll see in the next six to 12 months, particularly in the gold space if this breakout in the gold price holds up, is we will start to see a whole host of companies sort of coming out from the darkness, so to speak, and out of hibernation, and raising a bunch of capital.

You do want to be selective, because what that also does is it increases the supply of stock in those juniors in the sector, so it often puts a little bit of a cap on the sector in the short term, as that glut of refinancings and recapitalizations occurs. If you can pick out the very best ones, and you do have to be very selective, there’s a lot of crap out there in the junior market, to put it nicely, so you really have to know what you’re doing, and even if you know what you’re doing, the junior market is an extremely high risk, high reward proposition.

If you’re able to effectively play that junior market through the private placement game, by building a big warrant bank over time and high quality expression companies. The goal is that, let’s say you’ve had 10 to 15 private placements and you accumulate these warrants, you’ll have a couple of them which will really hit a home run, and you end up getting paid twice with these warrants. Right now is a really good time to be starting to take notice of the private placement market, if you’re an accredited investor.

I do think we’re about to emerge from a fairly dark time for the junior financings for the junior sector, so it’s definitely time to keep your eyes peeled for really good deals. If you are an accredited investor and you haven’t thought about playing in the junior space, it’s definitely a time to take note. If you do want to chat more about it, I’d obviously be more than happy to give you more information about how you can go about doing that.

Bill: When you’re surveying the investment scene for explorers and you’re advising your clients, what are you looking for in terms of what the explorers have in their treasuries right now? Things are very tough, I just read today a company announced, “We closed our private placement,” and then I clicked on it and read it, and it was like for $250,000. I’m thinking to myself, “I don’t even think that’s going to get you through the year, with all the listing fees.” What are the minimum requirements in the treasury that you’d like to see?

Sam: Well, it depends. You really want them to be raising enough to make a material difference, and to steal a Rick Rule-ism, to answer an unanswered question. I want to see that they don’t have to raise money for at least another 12 months, ideally, and that’ll give them enough money to undertake an exploration program that’s really going to provide an answer. Let’s say they’ve developed a decent target, they’ve got geophysics that has a robust anomaly that’s supported by soil sampling, the mapping, you’ve got a drill-ready target that requires probably two to 5,000 meters to test the concept.

You want to make sure they’ve got enough money to drill that out, and then have enough in the bank to cover G&A, so they’re not going to be able to tap the market again for at least another nine to 12 months. If they’re just doing a “keep the lights on” raise, like you said, $250,000 to pay the listing fees and keep the office and management salaries ticking over, it’s a clearer void for me. You really have to make sure that you’re getting some bang for your buck, because that’s what you’re there for. You’re not there to pay director’s fees and management salaries.

Bill: You have a keen interest in charting and other forms of technical analysis. From purely a technical analysis, throwing out the fundamentals of supply and demand, what commodity are you most bullish on, just from a charting perspective?

Sam: Look Bill, it’s pretty hard to look past the precious metals space right now. For a couple of years now, I’ve been posting to my clients’, and I believe I’ve even posted it with you on one of these podcasts before, the precious metals, well the gold price in particular has been building a five to six-year basing pattern that looks extremely powerful. I thought it was going to break back in 2017, it didn’t, it teased us one last time, we had a big sell off through the early to mid-last year, through until about October. We have finally now broken out above that level that everyone was waiting to break, at 1,375, we’ve even broke through 1,400 momentarily.

Things are pulling back a little bit now, but I can’t look past the gold chart at the moment, it looks fairly, fairly enticing. I don’t say these things lightly, because you never know in this space. No matter how good the chart looks, no matter how good the fundamentals look, things change overnight, money flows reverse and you can be whip-sawed, we all know the precious metals investors, how quickly things can change. On a purely technical basis, I haven’t felt this excited about the technical, and the fundamental as well, but we’re talking technicals here.

To me, the precious metals space, with gold in particular, looks extremely interesting here. It wouldn’t surprise me if we consolidate, in fact I’d almost prefer if we consolidated and went sideways for a few weeks to a few months, even down to 1,350 on a purely technical basis would be fine by me. If we can hold those levels and we can go sideways for a few months, and build a base for the next move, the chart is one of the better-looking charts not just in the commodity space, but of all the indexes and ETFs and sectors that I follow. It’s hard for me to look past the precious metals space right now.

Bill: I’m looking at the cobalt price, cobalt, this chart tells me, is $13.38 US per pound. A year ago, it was about $35 a pound, and a few years ago, you were one of the first on the internet, at least on YouTube, to produce a video in which you talked about the bullish outlook for cobalt. What’s your perspective on cobalt right now?

Sam: I sort of went a little bit colder on cobalt, there was a reasonable supply response out of the artisanal miners out of the DRC to the price spike that we saw, so we saw a glut of dark pool, if you want to call it, cobalt coming out of the DRC. We also, in hindsight, we probably saw a little bit of euphoric buying, you saw a lot of big transactions, you saw the big stream that wheat and precious did on the cobalt space, we saw the cobalt 27 company come into existence. There was a lot of, and with the benefit of hindsight, probably over-excitement and euphoria in the cobalt space that has now since reversed, and it’s been a complete popcorn trade.

To be honest, I’m far more interested in it again now on a purely theoretical basis, because it is right back almost back at the starting point, and it is going to be a critical element in all the electrification technologies, assuming lithium ion batteries continue to remain the main energy source for electric vehicles. I probably have, there’s not a whole lot of high quality ways to play it, there are a few speculative avenues to play it. Again, I focus on those, the cobalt in safe jurisdictions, mainly Australia, but all the players that I’m aware of are firmly optionality, and they’re really nickel deposits with a decent side of cobalt. On a different note, I am far more interested these days in the nickel side of things, and if I can get a little bit of cobalt for free on the side, that’s kind of the way I’m playing the cobalt theme these days.

Bill: You mentioned the Aussie market, as North American investors, what should we know about what’s occurring in the Aussie mining markets right now?

Sam: I was looking back through some of our old emails, Bill, and I’ve been a huge fan of the Aussie market for a number of years now, for a whole host of reasons. It continues to be, particularly in the precious metals space, but in general, I would argue the premier mining market in the world. Which is strange, because most North Americans wouldn’t be able to name you a single Aussie mining company, but it continues to go from strength to strength.

I’m just looking at some numbers now, year-to-date, I’m looking at the Australian All Ordinaries Gold Index, which is kind of like the prime index that tracks I think it’s about 20-something Australian gold miners. It has handily outperformed the newest dollar terms, its international brethren. I’m looking year-to-date, it’s up 28% versus 21% on the GDX, 19% on the GDX, I’d say 15% on the GDXJ, the Tier Six Global Gold Index is up 19. Given the Aussie dollar and the Canadian dollar have been relatively similar, you’ve seen literally a 50% outperformance from the Aussie index this year in terms of the gains they’ve had.

There’s one key thing that’s driving the Aussie gold mining market, and that is margins and robust balance sheets. They’re a very little bet on the Aussie producers relative to the North American markets, which makes it far more institutionally investible. Their margins are fantastic, I mean if you go and look at the ore and sustaining costs in US dollar terms, for most of these Aussie miners, most of them are definitely sub-800, some are even sub-$700 US ore and sustaining costs.

There’ve been a conservative way to play the gold space for the last few years, during a time when the gold space has been a really tough place to be. It’s a completely different business model, but if you look at the North American space, the only ones that have done well have been … Well, not the only ones, but the bulk of the names that have actually done well in a tough market have been the royalty streaming companies. Different business model, but similar reason why they’re doing well, in my opinion, that they’re proven to be businesses that have been able to prosper and make money and generate decent return on invested capital during the full range of the cycle prices.

That’s why I continue to like the Aussie space, especially the precious metals space, less of an Aussie dominance in my client portfolios outside. In the base metals, I tend to have more North American exposure in the base metals space, but if you’re looking at the precious metals space in particular, if you don’t have a handful of the better Aussies in your portfolio, you really are missing out, and you really should take a close look at it and consider the best ones and adding them to your portfolio.

Bill: Some of those well-capitalized Aussie miners such as South 32 and St. Barbara have been shopping for mineral deposits in North America, haven’t they?

Sam: Yeah, we’ve seen a fair decent whack of the Aussie takeover, or however you want to term it. I think that may continue, I think there’s been a little bit of over-exuberance. I’ve seen a lot of speculation trying to find the next takeover target, particularly in the gold space following the Santa Barbara thing with Atlantic Gold. Kudos to Steven Dean and his team, that was an absolutely fantastic deal for them. What we’ve seen is, in the gold space anyway, the miners that have been taken out by the Aussies have been producing assets. I think a lot of people have rushed to the next development stage project, thinking that it’s going to be a takeout target for an Aussie.

I could be wrong, and you might see that happen, but I think that the trend of buying producing assets is going to continue. I’m also cognizant of the fact that the Barrick’s and the Newmont’s are going to be spinning out a lot of assets, non-core assets soon, in the next 12 to 18 months. I think a lot of those are going to be prime targets for these cashed-up Aussies, so I’m not 100% sure that we’re going to see a huge glut of juniors continue to get taken out, or sort of smaller to mid-cap producers. There are a couple I’ve got my eye on that I think might be in the works, but in general, I don’t think we’re going to see a dozen or so takeovers in the next 12 to 18 months. I think it might be one or two, if that. Look more at the asset quality and where it is in terms of being in production, versus development, I think that’s where you need to focus.

Bill: Sam, what’s your take on the US/China trade war, and how should speculators play this?

Sam: It’s a tough one. We’re starting, I was looking at some economic data today, the PMI indexes and the ISM and things like that, mostly for my industrial metal themes that I look at. Some of the data is pretty scary-looking, so we’ve got this dichotomy in the industrial metal space at the moment where you look at zinc, for example, you’ve got near record low inventory levels in the LME. Nickel, for example, you’ve got inventory levels falling off a clip, and that’s only starting to happen at an even accelerating rate.

On the supply side of things, things look tight. We’re looking at TCRC rates and smelter costs going through the floor, which in the copper space which signifies that the copper markets is apparently tight, and yet we’ve got continued weakness in the copper space. We’re getting this real conflicting information, with things looking tight on the one hand, but prices still staying weak or even getting worse. I’m a little bit cautious at the moment.

What I am doing personally and for clients is continuing to slowly average into my very highest quality picks. I think the time, the thing to do right now is to accumulate quality on dips. Every time things dip, you want to be buying your quality names. I’m not worrying too much about trying to speculate on the next 20-bagger lead/zinc discovery, although to be fair, not one of my largest speculative position at the moment is actually a zinc play, but that’s more to do with the deposit quality rather than it being a zinc play.

What I think you should do is, you should be looking to average over many tranches into your best industrial metal plays while this trade narrative is in place and driving weakness in those markets. Don’t do it all at once though, because things could get worse before they get better. If I had to bet, I would say the industrial space may get worse before it gets better, but in the long run, the supply side is looking extremely bullish. For if and when, we know it’s going to happen, the demand side of the equation, China stimulates next or heaven forbid, we have a major reset and the governments all come in with these infrastructure stimulus programs and things like that, which I’m almost certain is going to happen eventually. You want to have your quality portfolio accumulated and ready to go on these weaknesses.

Bill: One thing that you and I have talked about and that I have observed, some questionable things, in my opinion, with some companies is change of control fees. What are your thoughts on change of control fees in this sector, and for those of us that are based in North America, can you give us an idea of what different mining markets across the world do with these things?

Sam: Yeah, sure. It’s obviously a big topic at the moment, and I think rightfully so. I think some of the payouts that management and directors have received from essentially completely destroying shareholder value during their tenure, it’s a slight on our industry. I know it’s not just our industry, but it seems to be rather prevalent in our industry. This is another reason why I strongly prefer … Well, I shouldn’t say “strongly prefer”, but I have a soft spot for the Aussie market, and it’s that they have an extremely strict set of rules on what companies can pay out in terms of a golden handshake or a change of control clause payment.

For example, directors can only receive 12 months’ base salary as a change of control clause before shareholders have to approve it, so it’s basically the wild west over here in North America, they can get paid whatever they want, and it’s up to shareholders to revolt if they want to make change. Another thing is, and Aussie is not directly linked to the change of control situation, but they have this thing called a two strikes rule, where if any compensation report gets more than 25% no votes at the AGM for two years running, then all non-executive directors are up for re-election.

It basically holds management directors’ feet to the fire and makes sure they’re not basically hooking themselves up at the expense of shareholders, it gives shareholders a lot more power. I think I would love to see more regulation, and I’m not usually a fan of regulation but in this instance, I would love to see some sort of changes put in place to make the situation more tenable over here, and help shareholders hold management accountable here in North America too.

Bill: Is part of your due diligence process researching what the change of control fees are? Before you invest in a company, do you analyze all that?

Sam: Absolutely. I personally do it, we’ve got a really, really good group of people here at Sprott, we got one guy in particular, who’s fantastic at, he’s just got an interest for finding the nitty gritty details of contracts and things like that. We always go in and look for the minute details that most people don’t even bother looking through, the 20 or 30-page document to find who’s going to get paid what if a change of control happens, or the various forms of compensation or kickbacks that management or directors are getting. It really, really is important to dig deep when you’re making an investment and make sure you know what you’re getting yourself into, and know what the incentives … Because that’s what it all comes down to, right?

Bill: Right.

Sam: You want to know what the incentives management have to make the company succeed, and you want to make sure you’re investing in companies where the management team have exactly the same motivation and incentives as you, the shareholder. There are always exceptions to the rule, but more often than not, you’ll find the best-performing companies are companies where the shareholders and management have the same incentives.

Bill: It seems like there could be some guiding principles about not having these excessive control fees, if executives at the helm of the company have basically destroyed share price valuation over the last, let’s say, two years. If there was just some guideline that if the share price is down more than 45% in the last two years, it negates the $15 million change of control fee. I’m just kind of thinking out loud, but it seems like something like that could be implemented.

Sam: Totally. I mean, you’d have to have a hard think about exactly how you’d do that. As it stands at the moment, I mean if you have a management team that owns very little to no shares, but they’re going to make out like a bandit and claim millions of dollars if the company gets bought out, in a perverse way they’re incentivized to destroy the company’s value, to the point where it becomes more attractive to an acquirer. Because that management team then, the change of control clause is triggered, they make out with their giant fee, while shareholders are left with 20, 40, 50, 70% loss or whatever it is.

I never like to see that, I always like to see management making out either handsomely or poorly, just like us shareholders. Looking at what their compensation is, looking at what their change of control clauses are, and looking how much stock they own is a hugely important part of our investment thesis.

Bill: You’ve been listening to Sam Broom, an investment executive with Sprottt Global. Sam’s email is [email protected], and Sam advises and can help you if you’re interested in a full service broker. There’s a team there at Sprottt, as Sam referenced, that does the due diligence and their research on the companies that Sam recommends to his clients. Sam, is there anything else you’d like to say about how people can contact you?

Sam: Yeah, just if you do want any more information, contact me at that email. You can also look me up on the website and click on my link in “our people” link, I’d be always more than happy to talk to you. I know Rick always offers to give a complimentary ranking of people’s stock portfolios, so I’m always happy to do that as well, I’d be more than happy to look at your portfolio and give you an obligations ranking as well. If that interests you, please feel free to reach out to me.

Bill: Excellent, and don’t forget, the Sprott Conference is coming up in just a few weeks, and if you go, I’m sure you’ll be able to see Sam there in person. Well Sam, as always, it’s great chatting with you, and I’ll be seeing you in a few weeks at the conference.

Sam: Sounds good, Bill. I’m on a panel with Brent Cooke on Tuesday afternoon, so come and have a listen.