The buy side: digging for disclosures

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Corporate reporting in the precious metals mining sector has improved over the past 20 years, according to Florian Siegfried, manager of the Precious Capital Global Mining and Metals fund. But investors would still like more information.

In 1997, Canadian company Bre-X Minerals was at the center of the biggest mining scandal in history. Two years earlier, it had fraudulently reported large gold deposits in one of its mines in Indonesia, as a result of which its stock price had soared. When the fraud was exposed, the company collapsed and its shares became worthless. Among the victims, three large Canadian pension funds each lost millions of dollars.

Since the Bre-X scandal, standard setters have worked to improve disclosure in the sector. Today, local standards such as NI 43-101 in Canada and the JORC Code in Australia require companies to provide far greater financial and technical information for each project, with independent verification.

Florian Siegfried, Manager of the Precious Capital Global Mining and Metals Fund, agrees that corporate reporting in the sector has greatly improved, pointing to criticism from investors as well as increased regulation as the drivers for this trend. But, though mining companies now provide a lot of useful information, more is still needed.

Finding the next mine is tough and takes years to develop.
  • Operational metrics

    When reading reports, Siegfried starts by looking at operational metrics, such as whether the company has higher- or lower-grade deposits in its mines, as these will drive the financial figures.

    He compares these metrics with prior quarters to see if there is a trend and, if so, how steady that trend is. Then he compares them with the assumed metrics, for example in the project’s feasibility studies. “This is to see if predictions are bearing out in the real world,” he explains. “There is often a big difference, and feasibility studies can be wrong by plus or minus 20%.”

    Even if a project is financed and built on time and budget, the reality check still only comes in production. If a company bases its project on incorrect fundamentals – for example, if its recovery rates are too optimistic – it will not make any cash, and that can kill a project. If it has bank financing, this could even send it into receivership if the technical and financial covenants are breached. Siegfried says this scenario has been all too common, especially during the recent mining downturn.
  • Independent verification

    Siegfried welcomes the new levels of independent verification, for example, in calculating metal resources and reserves, mined grades or operating costs in each mine. But, he says, “by using different assumptions, companies can still play with how they calculate that,” leading to significant variation in reporting.

    He would like to see additional metrics relating to individual projects being reported, so that investors can understand such assumptions. “We don’t necessarily just want to see what the company earns in its bottom line; we also want to find out whether each mine is generating cash and how it is using that cash,” he says. “For example, is it funding another project that might make no money? Not every company provides this degree of asset-by-asset transparency.”

    Forward-looking statements are much more helpful, he adds, because mining is not just about cash generation. Companies are in a highly capital-intensive but depleting business and have to find ways to replace their reserves constantly.

    “Finding the next mine is tough and takes years to develop,” says Siegfried. “In the corporate report, I want to see a statement about how management will continuously reinvent the business and replace what it has mined out – and be reassured that it has the financial and operational ability to do that.”
  • Dangerous assumptions

    Assumptions that companies use to calculate net present value or internal rate of return can also be controversial, says Siegfried. Some use three-year trailing average metal prices, which is fine if the gold price keeps rising, as it did from 2009-12. But when prices fall by 30% or 40%, as they subsequently did, those numbers may become worthless.

    “I would rather they were highly conservative and used a fixed price below the actual price,” says Siegfried. “Price volatility makes mining a high-risk business, and companies have to keep costs as low as possible to operate effectively,” he adds, “so the way they report costs and the ability to reduce them are fundamental.”

    Now that metal prices are recovering, Siegfried wants to see that cost-cutting measures are sustainable and driven by operational experience. “It’s important to compare this quarter by quarter,” he says. “In the past, large companies have struggled with this. Today you have to be smaller and more profitable. That’s what I’m looking for.

    “The risk now is that management [gets over-excited] again, for example in overpaying for acquisitions or salaries. Investors have to watch carefully to make sure that miners avoid the mistakes of the past.”
  • Counting the cost

    Despite the improvements in reporting from gold mining companies, criticisms about lack of transparency continue, including in the area of cost reporting.

    Siegfried says investors are still not able to understand completely whether the costs that companies report are accurate. “The metrics are not robust enough and many projects still do not make it in reality,” he says. “This has caused a lot of frustration among investors, particularly when they suffered big losses in the mining downturn.

    “Some companies are doing a fantastic job now in the details they provide in their reports,” he continues, “but the market is pushing for more from others, and financial transparency as a whole has to increase overall.”

    In the past, companies disclosed what it cost to generate one ounce of gold on a cash basis. But that number excluded many items, including corporate general and administrative costs and reclamation costs, as well as capital expenditure to sustain the business. “This means the market could get the inaccurate impression that they had a healthy cash position,” Siegfried explains.

    The World Gold Council introduced more accurate reporting guidance in 2013 and the industry started reporting the all-in sustaining costs (AISC) calculation in an attempt to give more accurate information on total production costs per ounce. But, Siegfried says, “AISC still doesn’t include the whole bottom line of what it costs to produce an ounce of gold – and companies can play around with that number. For example, non-sustaining capital expenditure and exploration costs are excluded.

    “I think that AISC will disappear and that we will move to a fully-fledged, all-in costs basis for accounting and reporting,” he concludes. “I don’t mind whether this is as a result of regulation or whether the industry does this itself, but I would like to see more transparency in that area.”
  • Gold: a hedge against political uncertainty?

    The surprise UK referendum vote to leave the European Union (EU) has substantially raised the price of gold. “Talking to family offices and other high-net-worth individuals lately, I’ve found that their rationale for holding gold is that the metal provides some sort of a hedge against political uncertainty,” says Florian Siegfried.

    He adds that, after the vote, the sterling price of gold rose close to its all-time high. “In other words, gold has provided an effective protection against this kind of politically-driven currency devaluation and political uncertainty,” he says.

    “As the socio-economic environment in the EU becomes more fragile, I think investors will continue to increase their allocations to gold,” he continues. “In an increasingly risky economic and political environment, the investment community is starting to reconsider gold as a hedge, not an investment.”

August 2016


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