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Mining Debt and Investing in Miners generally


netnet
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Let me start this out by saying that I never in my life invested in resources stocks before this board brought Altius to my attention, (H/T to Dazel now departed). My mental model had been Mark Twain’s description of mining companies:  a hole in the ground with a liar on top. Commodity sectors seemed to me to be incredibly fraught, and not having a geology degree, I figured that it was well outside of my competence.

 

With Altius, I do understand, a CEO outsider, a capital light model, a long runway, a history of success, and royalties. So, I feel that Altius is within my circle of competence, and because of this company, I have been paying way more attention to the mining sector.

 

Mining, geez, It’s f^%king incredible.  Assets that sold for 3 billion at the top, being sold off at the bottom for 12 million(Champion Iron’s purchase). 

 

Another mental model: In mining only buy during a downturn and follow the smart money, buy when they buy.

 

I now realize my purchase of Altius, was totally untimely. I know better now! Am I saying time the mining market? Well actually yes, but that is just waiting for the fat pitch!

 

Also, on buying during the downturns: It is interesting that there were no posts on mining company debt during the downturn.  There have been several posts on Oil and Gas debt, but none on mining company debt. The highest quality mining company debt was trading at ridiculous yields in December 2016

  • Anglo-American at 10%, now 3%
  • Glencore at 19%, now at 4%

Now this has the benefit of hindsight and one could not expect catch the bottom tick, but Anglo was pretty sure, as was Glencore once it announced its delevering plans, were high probability investments. 

 

One of the benefits of mining investments to me are that the cycles are pretty apparent and not 1:1 correlated with the rest of the market.  When the S&P is down 30%, it is hard to be calm and composed, because it feels like the whole world may crashing on you, although buying BRK at the downturn was easy, Wells less so, and Amazon, I passed.

 

Basically, the model  in mining is: every seven years or so, follow the smart money in, hold tight for 3 to 6 years and sell. It also seems as if the debt rebound lags price increases, by a few months. Nor should one expect another super cycle, but the wheel will most certainly turn.

 

(here is a link to an article on Mining company debt: http://www.globalminingobserver.com/fred-jones-mining-bonds-169,

and here is a link to a more general article on cycles. http://bigthink.com/videos/how-to-find-certainty-in-an-uncertain-world)

 

So, I’m long Altius-flat and Champion up 3X. I missed the mining distressed debt.

 

Thoughts?

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I definitely look at distressed bonds on a situation by situation basis and mining and energy debt investments were very fruitful last year.

 

I wrote up Gran Colombia on the site (link below) and although the numbers have changed a bit (production higher, gold price lower), their senior secured convertible debt (GCM.DB.V-TSX) trades at 82 and can be created at less than 1.5x EBITDA.

 

They just proposed increasing the coupon from 6% to 8% and extending the maturity from 2020 to 2024. They also have a buyback in place for these debs as there is a sinking fund for free cash flow and management owns a ton of them.

 

It's rare to find a piece of debt with so many favourable characteristics at this price point but they ran into problems and overextended themselves previously when the gold price was high and got squeezed by a low gold price and a strong Colombian peso. Those operational issues and problems in Colombia with locals (gangs, artisanal miners) is what is causing the discount but the discount seems too big.

 

To be clear the trade here is for a multibagger not to get to par in 3 or 7 years!

 

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/gcm-to-gran-colombia-gold-corp/

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It's not as simple as you make it to be IMO.

 

Similarly to oil/gas: what worked as 10 baggers in 2008-2009 yielded zeros or near zeros in 2014-2016. After 2008-2009 one could have felt genius in oil/gas space. After investing similarly in 2014-2016 not so much. (My results are pretty much like that: multibaggers in 2008-2009 oil/gas, ~50% loss with no future recovery expected in 2014-2016. And that 50% loss includes couple multibaggers on a few stocks/bonds from the bottom to now.)

 

I would guess this is the same or similar in mining sector.

 

Well, you would say "wait for bottom, follow smart money, etc.". Maybe it will work for you. Or maybe next downturn will be different than this one and results will be different too.

 

Good luck

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Miners are a good place for value investing, there is a huge chance of price/value discrepancies (both ways, naturally) since it is so far out of meta that even the majority of value guys don't go there. Gotta be careful and picky to select low risk high return situations and you can make lots of money.

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Most investors hate mining, because it's not straight forward to analyse.

You have to do work (versus just follow), you have to be willing to pick up dimes in front of the steam-roller (not buy and hold), & most everyone has lost a fortune to it at some point (easy to find negative stories).

 

It is helpful to have some geologist friends.

They will give you an idea as to what concentrations are commercial in the various mineral belts, and some idea as to the processing limitations. To most folks, all rocks look the same when they are covered in dirt.

 

In most cases you will be dealing with 3 cycles, that are not mutually exclusive - or in sync. Supply/demand for the mineral itself that will generally be a function of the macro economy. The M&A/Capital cycle which is industry specific (debt offerings, IPO proceeds, new investment, divestment, sales and bankruptcy) and the investment cycle which is market specific (value to growth to momentum to value investment). The cycles are correlated, but the coefficients change each go around (hence this time it is different (correct), and the more things change the more they stay the same (also correct)). At any one time, one cycle will typically dominate.

 

A thick skin, deafness, and a hairy arse - go a long way.

You are investing against the market wisdom of the financial press (buy GS, not GS marketing). You have a life (& do other things than listen to the press every day - deafness). And you are quite warm and toasty, walking around in a Yeti overcoat (do not need adoration).

 

If XYZ is not listed on a major exchange, walk away; 95% of the universe just got eliminated.

Thereafter it is a pretty short list, and the differences are mostly company specific. 

 

Key to mining is that when the band strikes up; you take the girls for a few turns on the dance floor, then give them back. Its a lot of fun, a great time is had by all, and manners go a long way - but you are not married to them. A hard lesson to learn.

 

Obviously you can do very well, but make sure that you know what you are doing.

 

SD

 

 

 

 

 

       

 

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A mining company is very similar to a desirable expensive house in an overheated real estate market.

 

As long as the music keeps playing (liquidity) the house will continue to appreciate; but when the music stops the house goes onto a market with no buyers. If there is mass selling, the price of the house plummets; but if some of those desirable houses are held off the market - the fall is less than it should be.

 

As the magnate with the 20M house is better able to hold the house off the market than the wannabe with the 1M house - the 20M house declines only 15-20%, versus the 40% of the 1M house. The decider is how badly, and how quickly, do you need to sell?

 

The Glencores, Rio Tintos, Anglos etc. had to sell to repay debt, but the size of the mines largely meant sales to their existing investors via royalty agreements. Investors bought the company debt at 10% yield, & the company royalty; the company used the proceeds to pay down credit lines, & the debt yield fell to 4% (now its way less risky); investors then sold the debt (at a profit), paid off the cost of the royalty, & invested the difference in dirt cheap company stock. It is rinse and repeat at very little real risk - but it is only possible if you are a 'name', and have big institutional shareholders.

 

If you are just a dog-sh1te company, you get liquidated - and your assets sold into a newly created entity, funded by those institutional investors in the Glencores. At a later date the entity gets sold to the major at an inflated price, with part of the proceeds (via purchase of a new debt issue) funding the acquisition. The capital market cycle; whether it be mining, oil/gas, brewing, or even tech.

 

Hence, play in the deep end of the pool only.

 

SD

 

 

 

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A mining company is very similar to a desirable expensive house in an overheated real estate market.

 

As long as the music keeps playing (liquidity) the house will continue to appreciate; but when the music stops the house goes onto a market with no buyers. If there is mass selling, the price of the house plummets; but if some of those desirable houses are held off the market - the fall is less than it should be.

 

As the magnate with the 20M house is better able to hold the house off the market than the wannabe with the 1M house - the 20M house declines only 15-20%, versus the 40% of the 1M house. The decider is how badly, and how quickly, do you need to sell?

 

The Glencores, Rio Tintos, Anglos etc. had to sell to repay debt, but the size of the mines largely meant sales to their existing investors via royalty agreements. Investors bought the company debt at 10% yield, & the company royalty; the company used the proceeds to pay down credit lines, & the debt yield fell to 4% (now its way less risky); investors then sold the debt (at a profit), paid off the cost of the royalty, & invested the difference in dirt cheap company stock. It is rinse and repeat at very little real risk - but it is only possible if you are a 'name', and have big institutional shareholders.

 

If you are just a dog-sh1te company, you get liquidated - and your assets sold into a newly created entity, funded by those institutional investors in the Glencores. At a later date the entity gets sold to the major at an inflated price, with part of the proceeds (via purchase of a new debt issue) funding the acquisition. The capital market cycle; whether it be mining, oil/gas, brewing, or even tech.

 

Hence, play in the deep end of the pool only.

 

SD

 

There is another way to counter this...

 

Simply buy smaller companies that are profitable, have little or no debt, and have no need to access the capital markets.  These companies will have operational mines that require NO or little capital expansion.  Add on to that companies that pay dividends and have management that is committed to paying a dividend.

 

Of course, this is easier said than done...and these are a very, very small fraction of traded companies, but they are out there.

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A mining company is very similar to a desirable expensive house in an overheated real estate market.

 

As long as the music keeps playing (liquidity) the house will continue to appreciate; but when the music stops the house goes onto a market with no buyers. If there is mass selling, the price of the house plummets; but if some of those desirable houses are held off the market - the fall is less than it should be.

 

As the magnate with the 20M house is better able to hold the house off the market than the wannabe with the 1M house - the 20M house declines only 15-20%, versus the 40% of the 1M house. The decider is how badly, and how quickly, do you need to sell?

 

The Glencores, Rio Tintos, Anglos etc. had to sell to repay debt, but the size of the mines largely meant sales to their existing investors via royalty agreements. Investors bought the company debt at 10% yield, & the company royalty; the company used the proceeds to pay down credit lines, & the debt yield fell to 4% (now its way less risky); investors then sold the debt (at a profit), paid off the cost of the royalty, & invested the difference in dirt cheap company stock. It is rinse and repeat at very little real risk - but it is only possible if you are a 'name', and have big institutional shareholders.

 

If you are just a dog-sh1te company, you get liquidated - and your assets sold into a newly created entity, funded by those institutional investors in the Glencores. At a later date the entity gets sold to the major at an inflated price, with part of the proceeds (via purchase of a new debt issue) funding the acquisition. The capital market cycle; whether it be mining, oil/gas, brewing, or even tech.

 

Hence, play in the deep end of the pool only.

 

SD

 

There is another way to counter this...

 

Simply buy smaller companies that are profitable, have little or no debt, and have no need to access the capital markets.  These companies will have operational mines that require NO or little capital expansion.  Add on to that companies that pay dividends and have management that is committed to paying a dividend.

 

Of course, this is easier said than done...and these are a very, very small fraction of traded companies, but they are out there.

 

Not so sure ....

 

When the cycle turns down, as it will ... that very good independent comes under enormous pressure to sell itself to a major. Price is falling, capital markets are dry, only the majors have the ability, and most would prefer to hold the shares of a major (with an active option market) going into the trough - especially if there is also the usual price premium for taking stock versus all cash. To NOT get acquired you really have to have very tight ownership; which does occur - but not very often.

 

It's just the capital market cycle, but it's a big steamroller.

The sellers management usually ends up in other small but listed firms, with sizeable equity stakes (ALS).

Repeating the magic.

 

SD

 

 

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