Why mining stocks are so elusive.

In today's article, we highlight why increased caution is advised when investing in mining stocks!

On my desk

This week mining stocks were a focus point of our investment strategy at Mellinckrodt & Cie AG. Thanks to our internal research and our friend Lawrence McDonald - author of the famous "The Bear Traps Report", we were screening a broad variety of stocks. Among them Hecla, Pan American Silver, MAG Silver, Yamana and many others.

However, mining stocks always seem to pose a higher complexity compared to stock classes like consumer goods, entertainment, or automotive manufactoring. But why is that?

The mining insutry

Mining stocks are notoriously difficult to evaluate due to a variety of factors that can impact their prices and profitability. This complexity stems from the unique nature of the mining industry and the inherent risks associated with it.

One of the main challenges in evaluating mining stocks is the unpredictability of commodity prices. Commodities such as gold, copper, and silver are subject to supply and demand dynamics, which can be influenced by a variety of factors such as global economic conditions, geopolitical risks, and technological advancements. As a result, commodity prices can be highly volatile, making it difficult to accurately forecast future prices.

Mining operations are also subject to a wide range of risks that can impact their profitability. Exploration success is crucial for mining companies as it determines the size and quality of their resource base. However, exploration is a risky and expensive process, and success is never guaranteed. This means that mine operators have to make an enormous investment in advance.

In addition, mining operations can be impacted by factors such as labor disputes, natural disasters, and regulatory changes, which can all affect production costs and profitability.

The micro perspective

Another challenge in evaluating mining stocks is the complexity of mining operations themselves. Mining companies must navigate a wide range of operational challenges such as maintaining infrastructure, managing waste, and complying with environmental regulations. These challenges can impact production costs and profitability, making it difficult to accurately predict a company's financial performance.

Technical aids, as well as highly specialized geologists, are supposed to reduce financial losses, but this is easier said than done. In fact, top geologists can earn a small fortune in this field, rather than teaching at universities. However, jobs here are scarce and the profession is anything but easy. Years of research, mountain tours, preliminary investments, expeditions and a process that can end up in the unprofitability of the mine, despite good omens, are no walk in the park.

A classic example of this process are Canadian mining companies - no offense my Canadian friends -. Anyone who watches the relevant stock exchanges knows numerous examples of highly touted mining stocks that disappear into oblivion after years of sideways movement. Either because the mine does not have the hoped-for amount of raw resources, or because the costs have exploded to such an extent that the economic basis has collapsed. I speak from experience, as I myself bought such a very type of share about 10 years ago, with underwhelming results. But as the saying goes, failure is the best teacher.

Fortunately, my good friend, business partner and co-manager Dr. Georg Oehm has received his PhD in economics with the dissertation topic of commodities and is an expert on these topics.

Finally, mining companies often operate in politically and socially complex environments. For example, mining companies may need to navigate complex regulations, deal with local communities, and address environmental concerns. These issues can add to the costs and risks associated with mining operations, further complicating the evaluation of mining stocks.

ESG - Curse or blessing?

ESG means an enormous change for mining operators. On the one hand, the high investments in new technology and equipment result in efficiency gains and improved environmental balances; on the other hand, the investments are enormously capital-intensive. Not ideal conditions when you consider that not every gold or silver vein or mine found is guaranteed to be profitable. High risk usually also means high interest costs with external financiers. A dangerous combination.

This often results in new companies facing high barriers to market entry because, despite a potential technology or efficiency advantage, they simply cannot raise reasonable financing due to the high capital requirements or capital-intensive regulations and certifications, and the business is dominated by the established players.

Furthermore, ESG also carries the risk of institutional investors withdrawing their funds if mine operators cannot comply with the strict ESG regulations. This, in turn, can lead to the money not being used for more efficient and cleaner resource extraction. A vicious circle in such a capital-intensive business.

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That’s it for this week, folks!

Have you invested in mining stocks before?