In this Mines and Money interview, I discuss why mergers and acquisitions can offer some of the best risk-adjusted opportunities in the mining sector.

The interview was originally published by Mines and Money on 30 June 2014. The original publisher link is no longer available, so I am reproducing the interview in full below from my archive.

Originally published by Mines and Money on 30 June 2014

In his role at Anarcho Capital, Jayant Bhandari advises institutional investors on opportunities in the junior mining sector. Before this, he worked for 6 years at US Global Investors (San Antonio, USA), a boutique natural resource investment firm, and for 1 year at Casey Research (an investment publication). Before emigrating from India, he started and ran Indian subsidiaries of two European companies. He still travels to India multiple times a year and takes a very active interest in understanding and writing about the Indian economy and culture. He has an MBA from Manchester Business School (UK) and a B.Eng. (Computer Engineering) from SGSITS (India).

Following his appearance at Mines and Money Hong Kong earlier in the year, Jayant was kind enough to take the time to answer our questions on the state of the mining sector, offer his tips for natural resources investors, and share his advice for mining companies looking to attract investment.

Jayant Bhandari will be speaking at Mines and Money London 2014, 1-5th December at the Business Design Centre, London.

Mines and Money: Jayant, you have been a critic of some of the exaggerated promotions within the mining sector. Can you explain?

Jayant Bhandari: Mining companies as a group—particularly the gold sector—have been a value-destructive sector. It consumes more investor cash than it distributes in capital gains and dividends. Were mining the only sector in the economy, we would all be living in caves, at best. Of course, a large responsibility lies with investors who approach this sector with a gambler’s mentality.  They invest based on hunches. They deify management and value projects on mythical yardsticks rather than on cash-flow-generating capacity. On top of this, they “value” projects using a gold price that is much, much higher than the spot price. The incentives these investors provide create fissures for the wrong kind of people who are great promoters rather than value-creators to rise. Such investors often get what a lottery ticket offers: nothing. But then these investors are operating in an easy-money ecosystem in which banks offer negative real interest. Savers have mostly no choice but to divert their money to high-risk or over-priced or, in some cases, promotional companies with moose pastures, to have a hope of getting some yield.

MM: Have mining companies improved their behavior, or is there still some way to go?

JB: In my view, it has become extremely difficult for mining companies to raise money in the market. Investors have understood that when commodity prices rise, costs often follow, increasing faster. The result has been that, despite the gold price rising many times over the last 15 years, the stock prices of most gold mining companies have fallen sharply, even though they raised capital when stock prices were higher and distributed negligible dividends. There has recently been a lot of talk about such companies trying to rein in their costs, and indeed, some of them have shown improvement, but you must eventually see a structural change in their thinking. The management must change its culture from lifestyle-for-management to mining, from producing glorious ounces to generating real cash flow. The recent acquisition of Osisko Mining by Agnico-Eagle and Yamana, who, in my view, overpaid, suggests the culture shift has yet to occur. I am not sure if a change at this fundamental level will come unless they go through more pain, unless there has been creative destruction. Entrenched interests don’t change that easily.

MM: What’s the one key piece of advice you’d give to an investor looking at allocating to a junior mining company?   

JB: Be rational. Do a risk-reward analysis and invest only if a company offers a probability-adjusted upside. Invest for cash-flow, not for some mythical rules of thumb like ounces-in-the-ground. If you cannot see value, wait for other opportunities. Focus on preserving your capital. What I am speaking about in this conversation is not because I have avoided these pitfalls, but because I have learned the hard way.

MM: For 2014 and going into 2015, which areas of the mining industry do you expect to see recover?

JB: When the market falls, all companies fall. In this correction, good companies have fallen as well, crystallizing value for investors. These good companies are likely to offer upside given their current position, and they might be able to opportunistically acquire new projects cheaply, adding more value. I prefer junior mining, which can avoid incurring too many expenses by hibernating if the commodity market does not recover. I would be very careful about companies that operate gold mines, for most of them have little or no profit, slowly eroding their value.

MM: You’ve spoken recently about the upturn in the M&A market and the opportunities for investors as a result. Do you expect this to continue into 2015?

JB: M&A is likely the best aspect of this industry today. This is the trade of the year, and perhaps for the next few years. Many cash-rich juniors are trading at a discount to their cash value, as the market believes they cannot find projects to deploy their cash and that it will slowly be eroded by inflation and general corporate overheads. At the same time, many companies are trading at far below their projects’ worth because the market believes they will fail to raise money. In an ideal world, they would have married much earlier, but egoes and personal aspirations of management make this an uphill task. The reality of the market today is forcing such marriages, unlocking value from both cash and projects for early investors. In fact, quite surprisingly, arbitrage can persist even after an official announcement. I see M&A activity as the key theme of this year and maybe next, providing profit opportunities to those who can anticipate. Gold mining companies must undergo similar reorganization.

MM: At Mines and Money Hong Kong, you were concerned about the prospects of the gold mining industry. Has anything happened since then to make you change your mind?

JB: Gold stocks tend to correlate positively with the gold price, as has happened in the recent weeks in the aftermath of the crisis in Iraq. Alas, an increase in gold prices might not translate into improved profit performance—oil prices have risen along with gold, which will likely largely negate any increased profit expectations. Analyst reports still value companies based on multiples of NPVs, using a higher-than-spot gold price and a very low to no discount rate—I find all this quite irrational and certainly something that fails the first test of investing: protect your capital.

MM: What do you see as the key developments for the gold market over the next year or so?

JB: I continue to expect news of low profitability from gold mining companies. This will sustain pressure on their market valuation and continue to push them to reorganize significantly. This will make stock prices more volatile, potentially providing opportunities to profit from share price volatility, corporate reorganizations, and M&A. Some people comment that I am wrong in believing that a new breed of suckers won’t join the fray. As the aphorism goes, maybe this time it isn’t different, but even then, I prefer a margin of safety. Moreover, this time it can indeed be different: over the last decade or so, with the advent of the internet, access to corporate information has matured. Investors are much better informed, which is affecting the conduct of those trading at the margin.   

MM: What advice would you give to mining companies looking to attract investment?

JB: Focus on the bottom line, not so much on the top line. People might no longer invest merely for ounces in the ground.

This interview was originally published by Mines and Money on 30 June 2014.