New Generation of Mid-tiers Could Uplift Mining Sector, Says Sprott’s Luke Smith

How have the reversal in natural resource equities and the slowdown in commodities prices since 2010 affected natural resource companies that bet big on rising natural resource prices?

I asked Luke Smith, an Investment Executive at Sprott Global Resource Investments Ltd. how the industry has changed since the bull market days, and what this means for natural resource investors.

“It means a radical new trend in the mining industry,” says Luke, “that may usher in a new set of companies to complement the enormous ‘seniors’ that alone have been driving the market. More entrepreneurial, creative, and specialized ‘mid-tiers’ will become experts in specific geographical locations and with certain deposit types, and provide opportunity for developers and speculators alike.”

In the mining industry, Luke explains, small, highly speculative exploration companies – “juniors” – take on the risk of exploring for new sources of precious or base metals.

During the bull market days, large mining companies bought these discoveries from the juniors – or took over the juniors themselves; larger companies – “seniors” -- could acquire capital at lower cost, and operate mines more efficiently.

In addition, during that time, the quality mid-sized companies – “mid-tiers” – were bought up and merged into the seniors, leaving a gaping chasm between the small juniors and the major mining firms.

At many large gold mining companies, Luke explains, the management teams are now being “thanked and excused.” The boards of these companies are realizing that these managers took on too much risk during the bull market years. They bought out too many low-quality assets for the sake of increasing their exposure to commodities. The set of leaders who are replacing the old management teams prefer to avoid risky maneuvers and stick to a steady cash-flow generation model.

“The new management teams are corporate ‘suits,’ with very low risk appetite,” Luke explains. “They will raise as little debt and equity as possible to continue running their existing projects, and sell or spin-off their secondary assets or projects that require large capital investments to start generating cash flow. They will not acquire new projects, however, and without acquisitions from seniors, junior mining companies are being starved of exploration capital.”

According to Luke, this gap between juniors and seniors will lead to a new class of companies entering the market: “With a bunch of promising projects not getting built by the majors we have a vacuum in the marketplace. Some of the smaller project companies are amalgamating the money themselves to develop these projects. The smaller companies that successfully bring a mine into production should be sucked into that vacuum. It would make sense that some of the developers would then be entrusted to take on more projects in their region and technical specialty. If this happens, we could see a re-emergence of mid-tier mining companies, providing a bridge between the little guys and the monster majors that the current market lacks.”

“If this investment thesis comes true,” Luke continues, “we could see a much healthier marketplace to auction off successful discoveries. Good projects should attract the best management and capital to develop into the mid-tiers this sector lacks. Speculators could make out on that move!”