Time to Get Selective: Rebuild Mining Portfolio in 2024 by Targeting Quality Over Hype

• The number of companies marketing and raising funds significantly dropped in H2 2023 as sentiment soured, indicating which firms were struggling
• Discoveries can deliver outsized returns even in weak markets (e.g. Snowline +10x, Azure Minerals +20x) but most exploration fails
• Commodity price performance varies widely year-to-year based on supply and demand dynamics (uranium +86% in 2023, lithium -81%)
• 4 key attributes for companies are: value, momentum, independence, and management; investors should evaluate on all 4
• After a tough period, investors should review portfolios, cut losers, and redeploy into quality companies leveraging positive market shifts in 2024

Investor Sentiment Drop-Off Indicative of Struggling Companies

Merlin Marr-Johnson highlighted in a recent interview how the capital markets environment for natural resources changed markedly throughout 2023. Specifically, he explained that the number of mining and exploration companies actively marketing themselves and raising funds dropped precipitously in the second half of 2023 relative to the first half, based on the number of investor interviews conducted.

In the first quarter of 2023, Marr-Johnson hosted 15-20 companies per month for interviews. However, by the fourth quarter that number had declined to just 10 total interviews for the 3 months. He attributed this fall off to deteriorating sentiment in commodities like copper and gold, despite relatively resilient metal prices. Weakness in equities led to substantial declines in market capitalizations and cash balances across the sector. This dynamic revealed mining firms and developers that were struggling to sustain operations and maintain investor enthusiasm.

As Marr-Johnson stated, "It was just phenomenal. I was seeing 15 to 20 companies a month at the start of the year, and I've done 10 in the last quarter. So I did eight in October, one in November, and one in December."

While lower marketing spend when capital is tight can be prudent, the drop also reflects how difficult it became for marginal companies to attract interest when market enthusiasm waned. Companies actively saying 'We want to market but whatever we do doesn't make any difference and investors are not investing'. This sentiment change also provided some clarity on which mining firms had viable plans and assets versus those that did not.

The Power of Discoveries to Drive Returns

Despite broad weakness in mining stocks through 2023, some standout discoveries still managed to drive tremendous upside. As Marr-Johnson explained, major discoveries can "kick through a downturn" even when sector sentiment sours.

He highlighted 3 prime examples that delivered exponential returns for investors in 2023, defying the bearish backdrop:

• Snowline Gold – shares are up over 10 times or 1,000% based on a major gold discovery in the Yukon
• Azure Minerals – stock is up over 20 times on large, high-grade lithium results in Australia
• Hercules Silver – shares are up over 7 times or 700% after the blind discovery of copper in Idaho

As Marr-Johnson emphasized, capital flowing into the right exploration stories can still generate huge wins. When discussing Azure Minerals' lithium discovery driving its valuation from A$20 million to over A$1.7 billion he stated, "We saw that with Snowline Gold, the first whole share price response; then it comes down and then gradually it builds and builds and builds."

However, while discoveries provide exciting upside, early-stage natural resource investing remains extremely high-risk. The vast majority of exploration projects fail to develop into an economic deposit. One major discovery occurs only once every few thousand attempts. So while the returns can be staggering on occasion, investors need to size exploration bets appropriately relative to the low odds.

Marr-Johnson explained, "That's why we invest in this space, is because you get these 'off the charts wind', so to speak. You get these outsized performances from the discovery process."

Champion Iron - Canadian iron ore producer operating the Bloom Lake mine in Quebec. Has about a $3 billion market capitalization. Delivered returns of around 8% in 2023, slightly outperforming larger iron ore miners.

Atalaya Mining - Copper producer based in southern Spain. Market cap under $500 million. Generated returns of approximately 7% in 2023 despite relatively flat copper prices.

Snowline Gold - Gold exploration company focused on the Yukon territory. Stock prices increased over 10 times in 2023 after a major discovery of high-grade gold mineralization.

Azure Minerals - Nickel and lithium explorer in Australia. Share price rose over 20 times after drilling intercepted long intervals of over 1% lithium at a project in Argentina. The market cap is now over A$1.7 billion.

Benton Resources - Canadian project generator focused on base and precious metals exploration. Has made multiple discoveries over the past few decades but is unable to substantially grow beyond its current ~$30 million market capitalization.

Divergence in 2023 Commodity Price Performance

One of the keys Marr-Johnson highlighted from 2023 was the divergence in price performance between different natural resource commodities. While the general narrative focused on broad weakness, some commodities like uranium registered huge gains over the period.

Notable moves included:

• Uranium – up 86%
• Iron Ore – up 21%
• Gold – up 13%
• Copper – up 3%
• Oil – down 7%
• Coal – down a substantial 62%

This variance highlights the importance of evaluating the unique supply and demand dynamics facing individual commodities rather than lumping them together. For instance, the major decline in seaborne coal prices stemmed from China resuming some imports from Australia, alleviating the supply squeeze.

Meanwhile, uranium continued its price recovery thanks to structural supply deficits and growing demand from the shift towards nuclear power. But this divergence also shows the difficulty of predicting market movements. Coming into 2023, expectations for continued strength in commodities like copper and oil did not play out.

Four Keys: Value, Momentum, Independence, Management

In terms of advice for investors looking ahead to 2024, Marr-Johnson emphasized evaluating mining companies across four key factors:

1. Value – assessing quality of the asset(s)
2. Momentum – work programs, catalysts, news flow
3. Independence – barriers like permitting, infrastructure
4. Management – track record, capital allocation

Evaluate the current state of operations and the pipeline of upcoming milestones. Specifically, investors want to see properties capable of driving substantial value. Combined with catalysts stemming from exploration, resource updates, and engineering studies, this momentum indicates advancing prospects.

However, Marr-Johnson also highlighted that external dependencies can derail even promising companies. Permitting delays, power access, port facilities, and other infrastructure needs outside miner control present risks. Argentina was cited as a jurisdiction where government actions hamper independence frequently.

Lastly, management competency constitutes a critical success factor. Their geological interpretations, engineering decisions, drilling targets, financial administration, and capital allocation ultimately determine outcomes. Less quantifiable attributes like open communications and accountability are also a factor for investors.

As Marr-Johnson explained, assessing all four areas provides a framework for determining the most promising mining investment opportunities entering 2024.

Time to Refocus, and Reassess Portfolios After Difficult Period

In closing, Marr-Johnson reiterated that after an extended downturn across mining equities, now represents an opportunity for investors to refocus their portfolios. The temptation after a difficult period is to avoid realizing losses or admitting mistakes. However, rationally reviewing holdings, selling poorer positions, and redeploying that capital into higher conviction names often proves prudent.

Rather than chasing extreme speculative upside, investors should emphasize understanding project fundamentals and seeking asymmetric risk/reward opportunities. For instance, Marr-Johnson highlighted quality developers advancing studies on promising mineral deposits as neglected currently, despite favorable long-term supply/demand outlooks. After massive underperformance, these companies can offer substantial upside if the cycle shifts more positively.

Overall, while segments of the mining space like uranium and lithium outperformed in 2023, the prevailing weakness has left much of the industry undervalued fundamentally. This disconnect signals the chance to selectively rebuild positions in promising copper and gold vehicles at discounted levels as the cycle rebounds.

Key Takeaways

• Struggling miners revealed – Drop off in macro environment and financing separates strong from weak
• Discoveries still lucrative – Major exploration wins generate huge returns, though risks remain high
• Commodities diverged – Performance differed drastically between resources based on unique dynamics
• Assess 4 key factors – Value, momentum, independence, and management indicate winners
• Refocus portfolios – Rebuild positions in oversold, fundamentally strong miners after reckoning

Here are some bullet points focused on actionable investment advice

• Eliminate exploration plays or junior miners that do not realistically have funding available for at least 2 years of operations in this environment
• Be selective on any new exploration bets; only companies with top technical teams, proven jurisdictions, compelling targets
• Research developers advancing studies towards BFS/construction decisions; well-run projects can get funded
• For risk tolerance, stocks with quality production/cash flows should outperform on the upside in indices and commodity prices
• In an M&A environment, cashed-up mid/seniors acquiring assets could represent opportunities if acquired at reasonable valuations
• Consider commodity-focused ETFs as a diversified way to gain exposure during periods of positive cyclical trajectory

In closing, 2023 proved an exceptionally challenging year for mining equities in the face of relatively resilient metal prices. However, the pressures forced a needed reckoning, revealing the sector’s overblown speculative excesses built up during years of loose funding conditions. Investors must now critically re-evaluate holdings based on asset quality, management execution, and risk-adjusted upside. The current period of capitulation offers the chance to redeploy judiciously into fundamentally robust miners at discounted valuations ahead of an expected cyclical recovery. Companies able to demonstrate funding access, execution ability, and strategic vision stand to benefit greatly from the ongoing Industry consolidation and rotation back toward quality.