KIM Report

Canaries in the coal mine: resource juniors first to feel effects of slowdown.

Posted by David

As the American market for consumer goods contracts and the greenback devalues, the level of imports to the U.S. greatly reduces. Countries that have economies strongly dependent on manufactured goods to the U.S. (and other troubled countries such as Britain) are affected by this loss of consumer base and start to experience recessions of their own. As the U.S. imports less melamine-enhanced milk and children’s toys with Pb-bearing paint, the world’s most vibrant manufacturer – China, loses jobs. The next dominoes to fall in this depressing little game are the countries with resource-based economies: Canada, Australia, Brazil, South Africa, Chile, etc. With reduced manufacturing, there is less need for raw materials used therein. Also, as the manufacturing countries lose jobs, their own consumer base contracts. Construction in countries like China is reduced as there may not be a demand for homes or office space due to closed wallets.

 

The first sign of dire economic consequences experienced here in Canada is how producing juniors are affected by lower commodity prices. These juniors often have much smaller profit margins than do the seniors and feel the pinch much harder. The most common route of action for these companies when the price for their commodity (metal, potash, oil, gas, etc.) unexpectedly drops is to cease production and put the mine(s) into caretaking mode.

 

This occurred with Blue Note Mining (TSX-BN) when they recently announced they were temporarily halting production at their Pb-Zn-Ag Caribou and Restigouche mines at Bathurst, New Brunswick. This is a far cry from when initial commercial production was achieved last January and its grand opening in June. BN has had excellent technical success in streamlining production at their mines. An example of this was when Caribou exceeded the specifications for maximum tonnage per day milled by 0.2% for August. The have also vastly improved recovery since the start up. The company has also had success in expanding the deposit and thus mine life by further drilling on site.

 

A second example, First Nickel Inc. (TSX-FNI), a Sudbury Ni producer, has also put their Lockerby Ni mine into mothballs as of this week. Acquired from Falconbridge in 2005, this is FNI’s only producing mine. Although they do possess numerous exploration properties in the Sudbury and Timmins areas.

 

So why, in the face of this success, have BN and FNI put their mines on “temporary care and maintenance”? Although it leaves the company in life-support mode and hoping they can remain solvent until metal prices recover, it was the most logical course. Zn has fallen from highs in 2006 at $4000/t back to levels from 2004 at $1100/t. Pb has fallen in a similar fashion from ~$3500/t last autumn to $1300/t levels. Ag is also down from $19/oz to about $10.50/oz in mere months. Ni prices have been reduced from about $8.00/kg to $4.50/kg in just over a month. Price drops of such magnitude will quickly transform a rich deposit into one that is entirely uneconomic. This happened to the deposits at Bathurst and Sudbury and will continue to occur with numerous junior/small-cap producers until people are willing to pay reasonable prices for metals.

 

A company with the potential to go the direction that BN and FNI have gone is Great Panther Resources (TSX-GPR), a silver producer in Mexico. This company has two mines: Topia (Ag-Pb-Zn) and Guanajuato (Ag-Au), and two exploration projects: Mapimi (Ag-Pb-Zn-Au) and San Antonio (Au-Cu). The company has found numerous rich ore zones across their properties and has had success in fine tuning their mining operations to achieve high recoveries. However, GPR has had to cut back on exploration expenditures and had to focus on efforts to reduce cost per ton to process their ore. Their current cost to produce Ag is between $10/oz and $12/oz. As Ag prices flirt with $10/oz, these mines may no longer be profitable to operate in the short term.

 

The individual junior can do nothing to affect world commodity prices. Some may have been lucky or wise enough to hedge a portion of their production at prices from six months ago. However, even those contracts will run out. There may be a slight recovery in metal prices in the short term, but it will take a number of months to years to return to prices seen a short while ago. When metal prices are such that it is economic to return these mines to production, metals like Pb can once again flow from Canada to China and be used in manufactured goods such as children’s toys to be sent back to Canada. Until then, these companies and their investors will have to sit tight and hope that unlike the canary, they can withstand the toxic fumes emanating from the credit market that started this whole mess.

 

Disclaimer: The author holds 1000 shares of BN, 500 shares of FNI, and 500 shares of GPR. This article is in based on the opinion and experience of the author. Please do your own due diligence when investing. To the author’s knowledge, BN ships all of its metal concentrate to Europe.