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Emerging Trends in Critical Metals: Richard Karn
Source: Brian Sylvester of The Critical Metals Report (4/3/12)
While markets do not always reward every deserving company, quality deposits carry an intrinsic value. That's why Richard Karn, managing editor of The Emerging Trends Report, advises investors to "buy the resource" over the stock. In this exclusive Critical Metals Report interview, Karn shares some companies with deposits worth their salt.
Richard Karn: Nationalization risk has crept higher over the last 4–5 years. It led the risk list last year and probably will again this year and going forward. We see this theme as part of what we call the global "pandemic of corruption." Nationalization is simply corruption run amok. You have the recent military coup in Mali. Zimbabwe and Namibia are but two of a number of countries in the southern part of Africa that have changed their royalty and taxation regime in ways that disadvantage miners. Indonesia is getting interesting, too.
We made the decision to stop investing anywhere except North America and Australia five or six years ago; mining projects are easy targets for corrupt politicians intent on enriching themselves and their cronies by cloaking their greed behind nationalist rhetoric about how mining projects "exploit the people's resources." We just decided we do not need the aggravation.
TCMR: But Australia just passed a "super profits" tax, which taxes any profit made by mining companies that exceeds 6% of its capital investment at 40%.
RK: I think you are describing the Resources Super Profits Tax (RSPT). That was Labor Prime Minister Kevin Rudd's brainchild that promptly got him booted from office. The more recent tax is the Minerals Resource Rent Tax (MMRT). It applies to oil and gas, coal and iron, not specialty or precious metals.
The MMRT is unlikely to survive the next election. Even without a change in government, the MMRT will be subject to a constitutional challenge in the courts because the federal government does not have the power to tax resources; that power resides solely with the states.
Many people in Australia see the MRRT as another example of over-reach and intrusive government on the part of the left-leaning Labor Party. And it is interesting to note that the Labor Party just suffered a massive, historic defeat in Queensland because of policies like this. But in any case, even if the MMRT were to stand, it still applies only to oil, gas, coal and iron, not precious or specialty metals.
TCMR: Could it be expanded to cover those metals?
RK: I suppose that is always possible, but I would submit that the extent of the defeat of the Labor Party in Queensland, which is a mining and agriculture state by the way, reflects, amongst other things, a general antipathy toward the MMRT. The Liberals will do their utmost to get rid of it because they, as well as a growing segment of the population, understand that mining is the cash cow that is driving the Australian economy.
TCMR: But at the same time, in your interview for The Gold Report, you said mining companies are having a hard time getting financing.
RK: Difficulty arranging financing is not a new development. It has been an issue for small companies since at least 2006 or 2007 and was exacerbated by the global financial crisis and its aftermath. What complicates the financing picture considerably for specialty metals companies is that many specialty metals are not traded on an exchange. That means that these metals cannot be hedged by selling production forward. From a commercial point of view, if you cannot hedge your production to protect the bank, your terms—if you can get them—will be very onerous.
TCMR: Would you invest in a hedge producer anyway?
RK: Yes, if that were the only way a specialty metal company could get into production. I'd prefer a company to hedge about 15–20% of its production to guarantee its mine goes into production, especially if the alternative is massive equity dilution, which has frequently been the case in Australia.
In the specialty metals sector, we expect prepaid offtake agreements to accelerate as a financing trend. In this situation, an end-user of graphite or tungsten or antimony, for example, will agree to finance a project through production as a partner in exchange for a first call on the first 15–20% of production.
These prepaid offtake agreements also serve to protect the secrecy of specialty metal prices. Many specialty metal prices we see quoted are really just a "best guess." This is because the price and terms of purchase agreements between the specialty metal producer and the end-user may well amount to a competitive advantage for the end-user and is a tightly held secret. Prepaid offtake agreements are the cost of financing. And, the price will be discounted to whatever the parties agree to in order to make the deal work. However, the miner will sell the un-hedged remainder at the best price they can get.
TCMR: We have seen prepaid off-take agreements in the rare earth element (REE) space.
RK: That is true. I'd say it's critical because these plants run to hundreds of millions of dollars and their products must be tailored to their customers' specifications.
Speaking of REEs, I would advise your readers to take a long, hard look at Alkane Resources Ltd. (ALK:ASX). It is a dark horse in the REE sector because its primary focus is not rare earths. Alkane is extracting three different mineral groups economically and will have at least five different product streams: zirconium compounds/hafnium, niobium/tantalum and REEs. The company has sold its first five years' production of both its zirconium compounds and its niobium and tantalum products. I expect an announcement regarding its REE offtake soon. Alkane is putting an 820 thousand ounce (Koz) gold project into production, too.
Alkane may well be the single best company you can buy as an index of Australian specialty metal projects because it gives you exposure to 22 of the 49 specialty metals we follow—in addition to gold.
TCMR: Last fall, The Emerging Trends Report examined how what you called the "finanicialization of commodities" is changing the way commodities are traded and how their equities are priced. Can you tell us more about that?
RK: The invention of index funds and exchange-traded funds (ETFs) have changed the investment landscape—but we see it as a specious development we do not subscribe to or indulge in. Look at indexing. On the surface, an index of gold miners might comprise 50 stocks, obviously reducing your exposure to any one company, which may indeed be a good thing. By the same token, when you also hold a gold or oil ETF, for example, you eliminate mining risk entirely. So the financialization of the gold or ETFs give people the opportunity to buy a paper vehicle with no mining or drilling risk because it is based on the price of the commodity itself.
So far, so good. But we believe things have been increasingly running amok because these vehicles also enable rapid, erratic movements in entire commodity sectors and industry segments, which undermines the price discovery mechanism as well as the fundamental roles of the equity and commodity markets. Worse, it has enabled high-frequency trading, which we cannot escape viewing as government-sanctioned front-running, to infiltrate and undermine the role of the commodity markets.
The commodity market evolved as a way for producers and consumers to stabilize their financial relationship and to help the market maintain price visibility over the long term. Even the idea of holding contracts for milliseconds utterly distorts the price discovery mechanism. We anticipate a move toward the equivalent of pre-paid offtake agreements, for example in the agricultural commodities, especially in the aftermath of the MF Global debacle.
TCMR: What makes Australia an appealing mining jurisdiction for specialty metals?
RK: As I mentioned earlier, we see what sovereign risk the Labor Party has generated over the last few years dissipating going forward. Then there is Australia's unique geology, which is a consequence of it being so tectonically stable for so long—literally billions of years. This has allowed nature to do a significant amount of concentrating of Australia's ores through prolonged natural weathering. Of the 49 precious and specialty metals we follow, 40 will be produced in Australia, which makes it kind of the motherlode in that regard.
And the sweet spot is Western Australia (WA), which is where we will be spending the majority of the next 18 months. WA is probably the best place in the world for massive-scale open pit operations, and Australians are arguably the best in the world at it. The WA government is very mining friendly. In fact, it has been leading the charge against the MRRT.
TCMR: At the Gold Symposium in Sydney last November, you said that specialty metal stocks were one way to grow wealth in a negative real-interest-rate environment. Can you run through some of the specialty metals you are bullish on?
RK: As mentioned, we follow 49 metals, at least 40 of which are or will be produced in Australia. To qualify for our list, a specialty metal or metal group has to experience two or more of five significant threats to supply: sovereign risk, scarcity, no substitute in a primary application, byproduct sourcing, and dissipative use, meaning that a metal is not recycled or recycling protocols are either non-existent or not in effect.
We call the transition group between base and high-tech specialty metals "industrial specialty metals," which includes tungsten, manganese, magnesium, molybdenum and vanadium, among others. These metals are highly leveraged to a base metal, so where iron ore prices have gone up nearly 200% over the last decade, the prices of these specialty metals have risen 400–500% or more.
Then there are what we call the "specialty alloy metals," used almost exclusively in high technology, such as the REEs, tellurium, graphite, gallium, germanium and indium, as well as specialty metals with a broader range of applications, such as the platinum group metals (PGMs): silver, tin, gold, antimony, etc. Their gains have been simply stunning over the last decade, with many of them up well over 1,000%.
It is important to remember that demand for these metals is not correlated to gross domestic product (GDP). It is driven by discovery. When you look at specialty metals, remember that it is technology itself that is powering demand.
Metallurgists and material scientists can do more research in a shorter period of time today than ever before in history. And this trend is not slowing down—it is exploding. Take mobile phones, for example. There are 35 to 60 specialty metals in your mobile phone. Despite the global financial crisis in 2008 and 2009, sales of mobile phones increased worldwide and demand for those specialty metals went up as a result. That is an example of resource demand being driven by discovery, not correlated to GDP.
TCMR: What are some of the investment themes in these metals that investors should know about?
RK: In 2010 and early 2011, people were making more money in specialty metals than you could shake a stick at. REE companies were the poster children, but the appreciation was sector wide. Then in April 2011, the Australian specialty metal stocks started getting sold down—they were just too frothy. We believe they have been sold down about as far as they can go, and a large number of companies have become takeover candidates.
A trend we see is for larger companies to use their company scrip, the corporate equivalent of fiat currency, to buy good specialty metal deposits at depressed prices. What investors should do is buy the resource, not necessarily the company because regardless of management, global demand is such that good deposits will get developed.
It should also be noted that though the U.S., European and Brazil, Russia, India and China, economies are slowing; another group coming up behind the BRICs has been experiencing torrid growth for some time. These are the so-called 'N-11': Indonesia, Egypt, Mexico, Turkey, Pakistan, Bangladesh, Vietnam, South Korea, Philippians, Nigeria and Iran. These countries have large populations and a large and growing demand for infrastructure to support their burgeoning industries. These countries also have emerging middle classes that desire consumer goods and home electronics and the like—all of which will drive demand for specialty metals.
TCMR: Let's talk about specific names. Tell us about your graphite recommendation, Strategic Energy Resources Ltd. (SER:ASX).
RK: Interestingly enough, when China made its announcement to curtail the export of REEs in the summer of 2010, which hadn't mattered for the three previous years but then suddenly did, we had been expecting a market-moving announcement regarding either graphite, antimony or tungsten—three other metals the Chinese control. So in the course of focusing on projects that would produce these specialty metals, we visited Strategic Energy's historic Uley project at the very tip the Eyre Peninsula in South Australia that September, and I was amazed someone hadn't picked up the project.
The Uley project consists of seven identified ore bodies covering an area of more than 75 square kilometers, with a historical deposit quoted at 387 million tons (Mt). The current focus of the project is the Main Road large-flake graphite deposit, which has a JORC-compliant Indicated and Inferred resource of 6.6 Mt grading 8.7% carbon.
This is not a greenfield project years from production but a historic producer with a processing plant on care and maintenance as well as the requisite infrastructure, more than 80,000 tons (t) of stockpiled large-flake ore. With the work undertaken recently, it could be put back into production within as little as two months.
Frankly, I was so amazed by the project that I left convinced I must have missed something. So I went back in mid-November and spent three more days tramping around the property, and there was simply outcropping graphite and bowling ball-sized clumps of graphite everywhere. We recommended Strategic Energy in December of 2010; they promptly ran up about 400%, and over the last eight months of so have drifted down with the rest of the market to where we find them to be a compelling buy again.
Interestingly, Strategic Energy Resources, which has a number of oil and gas interests as well, has recently spun off the Uley graphite project into another entity called Tacoola. Shareholders on the Strategic Energy Resources register as of April 17, 2012 will receive an entitlement of Tacoola shares on a 1:1 basis. Obviously, time is an issue here, but it is also important that potential investors who are not Australian or New Zealand residents confirm that their brokerage is acting through an Australian nominee company.
TCMR: What attracted you to Platina Resources Ltd. (PGM:ASX)?
RK: We were initially interested in Platina out of concern over the political situation in South Africa, which controls 80% of the platinum industry and a very big hunk of the entire platinum group metals complex.
Platina is dedicated to developing platinum resources outside of South Africa. They've been looking for and finding platinum and other metals in Greenland and Australia.
As far as Australia is concerned, because its project here is much closer to fruition than Greenland is, at the turn of the 20th century, 20–30 Koz alluvial platinum was found in the vicinity of its Owendale project site in New South Wales.
They've developed a 270 Koz platinum resource that is largely in particulate form, and what they are hunting for is the source of all that platinum.
In addition, intermixed within the deposit is the highest-grade scandium in Australia: a JORC-compliant resource of 4.6 Mt grading 344 grams per ton (g/t) scandium. The results of a second drilling program are due soon.
By comparison, the Jervois Mining Ltd. (JVR:ASX)-EMC Metals Corp. (EMC:TSX) joint venture has roughly 12 Mt grading 261 g/t scandium, and Metallica Minerals Ltd. (MLM:ASX) has roughly 15 Mt grading 133 g/t scandium.
Platina's scandium is a significant development that supports our contention that you have to buy the resource as much as the company controlling it; the company may fail, but the resource will still be in the ground—and in the case of scandium, we are utterly convinced these resources will be developed.
Globally, scandium occurs at about 20-25 g/t. Conventional wisdom says that to be economically viable, scandium must be found with other economic minerals, such as uranium or REEs, or exceed concentrations of 100 g/t. The interesting thing about Australia and scandium is that with these three nickel-laterite deposits, natural weathering has essentially stripped away all the other elements, leaving the scandium without the attendant REEs, yttrium and other minerals it is normally found with.
In theory, this should render scandium easier to process, and the race is on to see who will be first to market. We don't know who will win the race, but we know someone will, so we bought all three companies.
TCMR: What is scandium used for, apart from high-end bicycle parts?
RK: Scandium is the most potent grain-refining element for aluminum alloys known to man. When you add roughly 0.5% scandium to aluminum, the aluminum can be welded without heat cracking.
Scandium coming to market in large amounts would reshape a number of industries, including the aerospace industry. Studies show savings of 10% or more in both weight and operational costs when aluminum-scandium alloys are used in place of traditional aluminum and standard construction methods. For instance, the 'skin' of an aircraft could be thinner and welded together, making it more 'slippery' through the air and eliminating the need for rivets entirely, which in the case of an Airbus A380, for example, would mean not using literally millions of rivets.
It could also play a role in solid oxide fuel cells, such as those made by Bloom Energy (private). Right now, yttrium and zirconium comprise the electrolyte in these devices. Bloom Energy has filed a number of patents substituting scandium for yttrium. This would, as I understand it, lower the fuel cell's operating temperature, which in turn extends the life of the fuel cell, thereby improving the economics.
We estimate that Australia currently has the potential to produce 300 tons per annum (tpa) of scandium over a visible horizon of at least 20 years—and we are confident there is much more scandium to be found. The current scandium supply mostly comes from ex-Soviet stockpiles or as a byproduct of REE processing, mostly from China. These sources combined usually amount to a mere 2–8 tpa; you can get an idea of the potential.
We would also like to remind readers that specialty metal markets are small and prices are high for a very good reason; there is not much available. Consider, for example, that in 2010 global indium production was 525 t, germanium production was 140 t, or that the tellurium market was less than 130 t.
We are talking about a market that is virtually non-existent today growing to 300 tpa within a relatively short timeframe and having a considerable economic impact on a range of industries.
TCMR: Richard, thank you for your time.
RK: My pleasure.
Richard Karn, managing editor of The Emerging Trends Report, has a broad, multi-disciplinary background, industry contacts, and a working knowledge of these metals as well as considerable research, analytical and writing experience pertaining to them. His firm has published nine Emerging Trends Reports, which were updated in the aftermath of the global financial crisis and published in the form of an eBook, Credit & Credibility. For more than two years, The Emerging Trends Report has been conducting a boots-on-the-ground survey of Australian precious and specialty metal projects. If you would be interested in participating in the exciting venture, please contact Mr. Karn at [email protected].
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1) Brian Sylvester of The Critical Metals Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Critical Metals Report: Strategic Energy Resources Ltd. Streetwise Reports does not accept stock in exchange for services.
3) Richard Karn: I personally and/or my family own shares of the following companies mentioned in this interview: Alkane Resources Ltd., EMC Metals Corp., Metallica Minerals Ltd., and Platina Resources Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports to do this interview.