Pros and Cons of Investing in Mining and Natural Resources

By
William Hughes
·
December 3, 2020

The mining industry can be one of the most volatile to invest in, but with high risk also comes high reward. So, is mining investment a good fit for you?

Why should I Invest in Mining?

Almost every product that you use on a daily basis has elements that started off buried underneath the ground.

So whether you like it or not, mining is here to stay.  

What are the pros and cons of investing in the mining industry?

The Pros of Investing in Mining

Mining provides a resource that humans can’t live without

Think of all the other possible industries you can invest in: Bitcoin, Real Estate, Healthcare, Cannabis... the list is endless. 

The one thing that connects all of those industries is natural resources. 

Bitcoin could not be possible without the battery metals that build the computer its mined on, houses could not be built without steel, healthcare would struggle to function without the antiseptic properties of silver and cannabis could not be grown without the fertilising properties of potash. 

Natural resources are the backbone of all industries on earth, and the demand is only increasing as supply becomes scarce. 

The Pros and Cons of Investing in Mining - Why should i invest in mining?

There is a clear longevity to investing in mining: we are using resources today that we were using 3,000 years ago, just in a different way.

We can predict that gold will always be desirable, steel will always be necessary and there will always be some level of demand for oil and gas. 

However, with the need for a more sustainable future, comes the progression of Electric Vehicles using battery metals (Nickel, Cobalt, Lithium, Graphite, Copper) and the rise of carbon neutral energy from Uranium. 

Well-established industry

Mining is one of the most established industries in the world, dating back 40,000 years to the first known records of coal mining - with industrial mining originating 10,000 years ago.

This means that the industry has developed well-established trends and patterns, that can be forecast and predicted (major economic crises aside). This allows juniors to predict the potential profits of an orebody before they go into production, giving investors and the company confidence to move forward.

The Pros and Cons of Investing in Mining - Why should I invest in mining?

Dwindling supply = increased profit

Demand for natural resources is exponentially increasing as a consequence of the increase in world population: more people = more demand.

As economies grow and evolve, consumption of natural resources per capita increases. The average individual in the US uses 8x more natural resources in their day-to-day life than the average individual in India - but India is catching up.

However, with all resources that are mined underground, there is a finite supply (until we learn to artificially recreate them or recycle them).   

Increased demand and finite supplies only leads to one thing: increased prices.

Palladium has recently become the most desired of the 4 precious metals (gold, silver, platinum) due to its acute supply and increased demand. 

Palladium is 30x rarer than Gold and also surpassed the price of gold in 2019 for the first time since 2001.

As the demand for diesel cars (which uses platinum) decreases, the demand for petroleum-powered (palladium) cars increased. With 85% of total palladium consumption used in catalytic converters, helping to turn harmful pollutants into carbon-dioxide and water.

And it looks like the demand for palladium is going to increase in the near-term, with experts saying that the the electrification of the majority of the world’s automotive fleet is years into the future.

Lack of demand = plummeting prices

In the same way that a finite supply can lead to increased prices, a lack of commodity demand can also result in decreased prices. 

The BP Statistical Review of World Energy in June predicted that if the industry demand for oil continued at the current rate then there is only enough oil left to last us the next 46.2 years. 

In theory, this should result in oil prices increasing due to limited supply. However, the exact opposite happened. 

In 2020, oil prices collapsed to the lowest point since 1999 due to lack of demand as a result of the Coronavirus crisis with a global lockdown grounding planes, docking boats and halting traffic.

Simple process to understand... if you do your research

Although complicated at first, the mining industry is relatively easy to understand and invest in. All mining companies generally follow the same lifecycle from the exploration stage through to production. 

Once you have a clear understanding of the process, it is easy to apply that knowledge to different companies.

For example, all companies must complete feasibility studies to determine the size of the orebody and associated economics of mining it - so, if you can understand the variables that affect a mining companies ability to get into production economically, you've got a very good chance of making a return on your investment.

There are also many different sources you can use to understand mining terminology or spot the things you should be looking at when analysing a company: red flags and green lights.

The Pros and Cons of Investing in Mining - Why should i invest in mining?

Offers different levels of risk that suit the individual

Mining companies are split into two categories: junior and major mining companies.

The difference between juniors and majors is the market capitalization. 

Junior mining companies

Juniors tend to have a market cap. sub $1 billion. A junior mining company can then run the gamut of explorer, developer and producer - each requiring a different set of management skills to deliver effectively. 

Junior companies also tend to vary in risk-profile and therefore return. Higher risk, higher potential return. 

Major mining companies

Majors tend to have a market cap. over $1 billion. A major mining company tends to be further along the lifecycle and is a heavily de-risked producer.

They operate multi-jurisdictionally (different countries) and produce meaningful quantities of cash which invariably need to be reinvested back in the ground to continue to make themselves sustaining, tis also means significaltny lower leverage therefore lower returns. 

Investors need to evaluate which they are better suited to. Are you a... 

Thrill seeker: Junior mining companies offer high leveraged returns on investment when investing at the exploration stage, but only a small percentage will succeed through to the development or production phase.

Investment in explorers and developers require more research and due diligence as many variable are yet to be proven.  You need to be able to answer questions honestly before making an investment. 

Play it safe: Major mining companies offer a more stable and steady investment, with smaller returns but the possibility of earning dividends (a distribution of profits by a corporation to its shareholders). 

Can't decide? Some investors choose to split their investments between the two, offering both risk and stability. With a blended risk approach to their portfolio. 

The Pros and Cons of Investing in Mining - Why should i invest in mining?

The Cons of Investing in Mining

The mining process can be complicated

The mining industry is full of complicated jargon that can feel very daunting at first, especially when trying to understand PFS vs DFS, downdip, updip NI-43 101 reports...  

Don't let this put you off though - with a bit of time and focus, you'll be able to understand enough to do your own due diligence. 

Here is a simple checklist of how to get started with investing in mining:

  1. Decide if you want to invest in mining
  2. Be clear about your own investment strategy and stick to it, write it down
  3. Work out what your risk appetite is. 
  4. Study the markets and see which commodity you think shows the most potential. Where in the cycle is the commodity? 
  5. Identify a handful of companies to study and follow.
  6. Take your time - there are always more deals looking for your money. 
  7. Decide your method of analysis.
  8. Research that company until you've got a thorough understanding.
  9. Listen to the companies explanation of the business plan, does it make sense to you? Has the company continually done what they promised to do?
  10. Invest a little initially, and see if you're comfortable and add more over time. 
  11. Remember the way you make money is by selling shares at a profit. They are spending your money, they report to you and the ONLY way you make money is if you sell your shares at a profit. You're not investing in a friend, company or the individual. 

Take the emotion out of investing. You're here to make money.

The Pros and Cons of Investing in Mining - Why should i invest in mining?

Lack of information available to retail investors

Retail investors often do not have access to the types of company reports that are paid for by institutional investors, costing up to $100,000. Research companies and brokers are restricted by regulators in regards to sharing that information with retail investors, which puts retail investors at an immediate disadvantage. 

Less information available = worse investment decisions.

We are looking to change this by providing unbiased, unpaid for company research specifically and exclusively for retail investors - closing the gap between institutions and individuals. Get started with Crux Investor today.

The Pros and Cons of Investing in Mining - Why should i invest in mining?

Don't be fooled by brokers 

The investing industry is comprised of many different types of investors, from hedge funds to accredited investors to insurance companies (collectively institutional investors) all the way down to retail investors at the very bottom of the investing food chain. 

Retail/individual investors are thought to be less knowledgeable, less disciplined and less skillful than institutional investors (fewer sources available) so they are often presented with more risky investment opportunities.

Another fear for retail investors is that their naivety is preyed upon by larger brokerage firms who often tend to practise The Greater Fool Theory. 

The Greater Fool Theory

The idea that, regardless of the value of the stock, it will always sell as there will always be someone (a greater fool) who is willing to pay a higher price. 

In this case, the greater fool tends to be the retail investors who don't know any better. Brokers can trick new/naive investors into buying stocks that the broker needs to sell, for a very high over-inflated price.

Take the emotion out of investing. You're here to make money.

The Pros and Cons of Investing in Mining - Why should i invest in mining?

Don't be fooled by promotional language

A growing concern for both the industry and investors is the type of promotional language used by companies when trying to persuade people to invest in their company.

It’s all in the interpretation: Tier One; world-class; spectacular results; ore; Capex…different companies are choosing to report these in different ways using different metrics, creating an imbalance in reporting. 

This imbalance is only heightened by companies increased desperation to survive: there are more companies needing financing than there is money being invested. Some companies tend to exaggerate their positions in a bid to 'win' the investors and their cash. 

There's a lot of white noise in the industry: companies with different quality assess and different likelihood of success all say the same thing, making it extremely difficult to decide where to invest your money.  

What you should look at when analysing a company: 

  1. Company managements relevant experience
  2. Attractiveness of the geology and economics
  3. Financing available
  4. The permitting and licensing process
  5. Potential mergers and acquisitions.
  6. Jurisdictional risk
  7. Corporate structure 

Take the emotion out of investing. You're here to make money.

Don't be fooled by confirmation bias

Confirmation bias kills profit - don't fool yourself. 

There's also a lot of biased information online, paid-for by the company that is intentionally skewing the facts of the company its promoting. 

Make sure to look at a writer's position in a company before reading the information, and discount all or most of what has been written. 

Whilst an article written by the company you're invested in can be very useful, don't give-in to confirmation bias (the process of reading and absorbing information that positively affirms your investment decision.)

For example, if I am invested in X company and read reports/information only endorsed by that same company - how do I know that information is accurate?

Instead, focus on un-biased and in-depth analysis from multiple sources and validate all facts independently. Do your homework and seek honest answers to the right questions, because many fall into the confirmation bias trap and you're just kidding yourself out of profits. 

Take the emotion out of investing. You're here to make money.

Extreme volatility 

There are more than 3,000 junior mining companies listed on exchanges globally, with new ones constantly appearing - some good, some bad. So how can all of them survive and make money? They can’t and they won't. 

Worldwide there are less than 50 major mining companies, so clearly not all juniors can progress to this stage - some must fail, some will be bought up and most will wander aimlessly or reincarnate themselves. 

Between 2010 and 2011, out of 500 Uranium exploration companies, only 2 got into production.

Juniors require substantial capital to get into production and can take 10-20 years to do so, during which time a lot of things can go wrong:

  1. Choice of jurisdiction
  2. Poor exploration drill results 
  3. The technical limitations of the orebody
  4. Mining permits not granted
  5. Running out of cash 
  6. Change in the commodity price. 
  7. Social and environmental conflict
  8. Poor Management decisions
The Pros and Cons of Investing in Mining - Why should i invest in mining?

In conclusion, there is money to be made in investing in mining and 2020 has been a spectacular year in terms of returns.

2021 is looking to follow the same pattern with massive quantitative easing globally resulting in precious metal investors being reinvigorated.

Supply and demand for battery metals is only increasing, following government subsidies and regulatory changes. Lithium, nickel, copper, cobalt all continue to rise. 

Uranium investors are speculating a meteoric return and rare earths continues to be the geo-politcal hotcake as countries are buying them in a bid for resource independence, continuing to build up their own ecosystems, defending them robustly. 

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