Why Smaller Is Better
Jeff Nielson: Having invested in mining 
companies for quite a few years now; one of the first lessons I learned was to never touch the large-cap miners. However, before I explain my own reasoning, I want to quote a Bloomberg articl e from this morning which attempted to cover the same subject:
New Gold Inc. (NYSE:NGD) Executive Chairman Randall Oliphaunt, who helped build Barrick Gold Corp. (NYSE:ABX) into the world’s largest producer of the precious metal, says he prefers running a smaller gold miner than a big one.
Companies that produce fewer than 2 million ounces annually have more opportunities to increase output, said Oliphaunt, who was chief executive officer of Toronto-based Barrick from 1999 to 2003 and joined Vancouver-based New Gold six years later. It’s “very challenging” to expand a large, established gold company, he said…
The problem with this Bloomberg article is that while it goes to great lengths to document the fact that large-cap gold miners are gross under-achievers while the junior and mid-cap gold miners have provided very attractive rates of return, it never explains why.
Why do smaller gold miners “have more opportunities to increase output”? Why is it “very challenging” for the senior gold miners to grow? It’s very simple: because large-cap gold miners (and large mining companies , in general) have the world’s most-idiotic business model.
All large-cap mining companies have a very simple “rule” they live by: they only want to develop/produce large mining projects. Let’s assume that it is not purely the egos of the suit-stuffers who run these companies which prevents them from getting involved in smaller projects. Why are most large-cap mining companies not interested in developing smaller mining projects – no matter how high the profit margins will be ?
There can only be one answer to this question: they focus purely on larger projects in order to have the greatest total output while managing the fewest number of mines. This, in turn, implies a corresponding belief: that the more mines these large-cap miners have to manage, the more things which can go wrong.
The rebuttal of shareholders to this attitude should be automatic: “if you can’t stand the heat, get out of the kitchen.” These companies chose to be large-cap corporations. It’s especially easy for mining corporations to spin-off mines – either through outright sales, or simply setting up independent operations. When a corporation decides to become very large, this presumes administrative competence . A competent management team should not tremble in fear at the idea of running twenty, small, very profitable mines rather than five, huge inefficient ones.
This leads us to yet another question: why do smaller mining operations tend to be more profitable and/or efficient? We can answer this question simply by taking a closer look at the development of the mining mega-projects which these large-cap miners covet/demand.
It’s certainly true in mining (as in any other business) that the more outlets you operate, the more things which can go wrong. However, more unique to mining is the reality that as these projects grow in size individually , the number of things “which can go wrong” increases nearly exponentially.
We can start with the environmental/permitting issues. Very large mining operations tend to be “dirty”, thus they impact a much larger geographical radius (even in proportion to their size). Depending on the location, the permitting process ranges from difficult to impossible, and is usually much longer than the permitting process for smaller projects – delaying return on capital investment.
A parallel but different problem are the aboriginal land-claims which often exist in the regions in which these mining companies explore. Again, with these mega-projects impacting a much larger radius; this makes it much more likely that these land-claims will add further costs, further delays, or sometimes prevent development altogether.
Assuming that a large-cap mining company eventually completes the permitting/land-claims obstacle course and actually gets the “green light” to develop a project, we then get to mine construction. Here we start with the fact that given the previously-mentioned hurdles these projects face, construction usually begins behind schedule.
With our banker-produced inflation causing construction costs to soar, the “feasibility study” which produced the cost-estimates for construction is often obsolete before the first piece of construction equipment arrives on site. Similarly, large projects take longer to complete. Not only does this delay the return on capital further, but it generally guarantees even more cost-overruns.
While this does not provide a complete picture of all the additional headaches which come with attempting to develop a mining mega-project (I haven’t even touched on the issues of financing such projects), by now readers should have a pretty good picture of the nightmares involved. Given that these are the only projects which large-cap (gold) mining companies seek to develop, is it any wonder they are among the world’s worst corporate under-achievers: resource-producers who are floundering in a resource-starved world?
While this paradigm affects the entire mining industry, it is especially acute with respect to gold and silver miners. This is simple economics. Many of my previous commentaries have documented the relentless suppression (by the banking cabal) of gold and silver prices.
For newer readers still unfamiliar with this serial conspiracy, the basic premise is relatively simple. As the world’s best “money” for nearly 5,000 years; gold and silver prices are our ‘canaries in the coal mine.’ When the bankers relentlessly dilute their paper currencies with excessive money-printing, the prices for gold and silver (expressed in that depreciating paper) should soar .
By suppressing those prices, it helps to hide this inflation from the Sheep, by allowing our governments to lie about that inflation without any obvious “smoking gun” to expose those lies. We see absurdities such as in July: where the U.S. government reported (literally) 0% inflation in the U.S., with its supposedly broader measurement of inflation. Meanwhile, at the same time, World Bank reported that global food prices were rising at an annualized rate of approximately 120%, and Asian governments were simultaneously meeting to discuss the “global food-price crisis.”
Because of the serial suppression of gold and silver prices, this makes economical gold and silver deposits less common in general – and the large (high-grade) projects which the large-cap precious metals miners covet are even more rare. As a result, these large-cap “gold” miners (in particular) are morphing into polymetallic mining companies (generally copper/gold); as the only projects which have enough total ounces to meet their lust for size now often contain more base metals (by value) than gold.
The mutation of these senior gold-producers leads to even further erosion of the return to shareholders. “Pure” gold-producers (i.e. single-commodity producers) tend to be valued at higher multiples in our markets than polymetallic producers; thus the obsession with size ultimately dampens investor returns even further.
It’s no wonder that most of these senior gold producers have been reporting flat, or even declining gold production; while smaller gold miners steadily/consistently ramp-up production year after year. It leads to a very simple equation for precious metals miners: smaller is better.
Where do investors find these smaller miners with their superior growth profiles? Canada’s markets (the TSX and “Venture” exchange) are the global capital for junior and mid-tier mining companies. For U.S. investors with no access to Canadian exchanges, most of these companies have either “pink sheets” listings, or are even listed on larger U.S. exchanges (most often the Amex).
Having recently been driven down to multi-year lows in their valuations, these mining companies are currently priced at absurdly cheap levels. However, because of the greater volatility inherent with smaller companies; it’s essential that investors in junior miners hold a “basket” of such companies to provide a safe level of diversification.
Research these smaller miners carefully (since they’re not all “winners”), spread out your investor dollars, and wait. With prudence and patience, even most small investors should be able to prosper through investing in these smaller miners.
[Disclosure: I hold no interest in Barrick Gold, I hold a small position in New Gold]
Written By Jeff Nielson From Bullion Bulls Canada
Jeff Nielson is from Canada and is a writer/editor for Bullion Bulls Canada www.bullionbullscanada.com . He has a personal background in law and economics. Bullion Bulls Canada provides general macro-economic and political commentary, since the precious metals markets are among the most complex (and misunderstood) in the world.
Bullion Bulls Canada also provides basic coverage of Canadian precious metals mining companies. Canada is the global leader in mining exploration, and Canadian-listed mining companies (on the Toronto Stock Exchange and Venture Exchange) are responsible for the majority of the world’s most-promising discoveries.
