Why small cap miners can be far better bets than their larger peers

What conclusions can we draw from the flurry of commentary that followed Glencore’s production results this week.

picture of mining truck
Small can be good in mining

What conclusions can we draw from the flurry of commentary that followed Glencore’s (LON:GLEN)  production results this week?

After short but painful period of vilification it seems that Glencore is now back in demand. HSBC says “buy” and sets a target of 420p, after what it called “a strong quarter.” Canaccord says “buy” and so Credit Suisse, Jeffries and Goldman Sachs.

Liberum takes a more modest stance, rating Glencore a “hold.”

But then Liberum is a seller of Glencore’s major peers Rio Tinto (LON:RIO), Anglo American (LON:AAL) and BHP Billiton (LON:BLT), arguing that Glencore has a better free cash flow yield.

At the smaller end of the broking universe, interest is no less intense. VSA expects the financial results that will follow to be “reasonably good”.

“Lower volumes sold by Glencore have been offset by significant price increases in metals like zinc and oil,” said VSA. “The restraint shown by mining majors such as Glencore in output during 2015-2016 is now showing better market inventory balance globally. Forward outlook appears good.”

But despite all that chatter, the glaring fact is that Glencore’s share price graph has moved in much the same way as the peers that Liberum sets it against, and even in a similar fashion to juniors far lower down the scale, like Anglo Pacific (LON:APF), which this week announced it was doubling down on uranium with an innovative deal with Denison Mines (TSE:DML).

Denison itself, with its single commodity exposure, has remained immune to the recovery, but among the US and Canadian majors the pattern is the same.

Freeport McMoRan (NYSE:FCX), Newmont (NYSE:NEM), Lundin (TSE:LUN), and Vale SA (NYSE:VALE), all turned upwards at the end of 2015 and the beginning of 2016 and the precise differences in the percentage rises those companies enjoyed were not spelled out exactly by analysts in advance.

Indeed, not many of them signalled that recovery was on the way at all. Instead, after years of buying into the idea that the management team at Glencore was somehow smarter than other management teams, as the share price plunged, so Glencore’s stock, psychologically as well as literally, plunged.

What is clear though is that while the leaders of Glencore held firmly to the tiller, rang the changes and brought the business back into a respectable shape after debt appeared to balloon, the market was all along pricing the sector rather than the business.

Thus, when Liberum argues that Glencore’s cash flow yield is likely to “trough” at 10%, it’s invoking a favourite internet mantra – Warren Buffet always says free cash flow is the key to any investment.

But most people have neither Warren Buffet’s investment time horizons, nor his investment portfolio. Does Warren Buffett invest in mining? – not that anybody knows about.

The reasons are straightforward enough – these businesses are notoriously hard to analyse in meaningful ways.

For a start, commodity prices fluctuate on extremely short time scales, rendering formerly profitable operations loss-making overnight, or vice versa. In addition, it’s never clear how much supply there already is in the market, LME stock data notwithstanding, so valuing inventory is a highly subjective business.

In this context, setting appropriate debt levels is certainly not a science and can hardly even be called an art given the balance sheet chaos that most major, and supposedly respectable miners inflicted on themselves at the end of the last cycle.

And finally, given the history of what happened during the last boom, the guys at the top of the industry clearly have no better idea than anybody else as to what’s going to happen next.

For large funds, this is a problem, which is why taking a sector-wide approach is more sensible and also why funding for mining projects dries up periodically, no matter the merits of individual assets.

But for the smaller scale investor there are alternative strategies. Backing people running smaller assets can make far more sense than backing the people running huge organisations in which the individual impact of one man or woman is open to question.

Mark Bristow’s role leading the huge organisation that Randgold (RRS) has become is a case in point. His leadership still commands a premium. But then, Randgold, though a FTSE 100 company now, wasn’t always. There was a time when it was a small cap company too, with refractory ore in Africa and a future that was open to question.

The same is true with Adonis Pourolis, the man who built Petra Diamonds (LON:PDL) into a global player in the diamond market.

With Pouroulis though, there’s a twist. He’s not just a one-trick pony like Bristow. He keeps coming back round for more.

In oil, Chariot Oil & Gas (LON:CHAR) is his.

And in mining the latest public vehicle is Rainbow Rare Earths (LON:RBW), which listed in London this week. There will be others along soon.


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