Richard Karn: Australian Miners Positioned For Success

by: The Gold Report

Sometimes the worst of times brings out the best in people. Such is the case in Australia's mining sector, according to Richard Karn, managing editor of The Emerging Trends Report. While some companies are floundering or failing altogether, Karn has noticed a few shining exceptions. These are names with innovative management teams that have approached project funding in this challenging environment as though it were a high-stakes chess game-and their maneuvers are astonishing. In this interview with The Mining Report, Karn gives his optimistic outlook for the specialty metals sector in Australia.

The Mining Report: Richard, last month you delivered a fairly upbeat presentation on specialty metals at the Mines & Money forum in Melbourne. Why are you so positive on the Australian mining space?

Richard Karn: Well, it wasn't exactly upbeat. What I presented was an overview of the specialty metal sector drivers, which are still quite positive, and the impediments to getting Australian projects funded today.

I then presented three brief case studies of companies that are getting their specialty metal projects into production despite the hostile funding environment.

TMR: Are you predicting an imminent rebound in the Australian specialty metal sector?

RK: No, I am not. The shakeout in the resource sector in general, and the specialty metal sector in particular, does not appear to be over. The sector might be bottoming, but I think there is still more pain to come.

At the conference, Dr. Alex Cowie of livewire markets presented findings that showed 16 resource companies have been delisted from the Australian stock exchange in the last six months, and another 210 resource companies now sport market caps of less than AU$3 million (AU$3M) and on average have less than AU$860,000 (AU$860K) in cash and marketable securities. Without a miracle, many of those companies will go under as well because there is simply too little investor appetite at this time.

TMR: Were there any positive takeaways?

RK: What I was upbeat about was the way opportunistic management teams with good projects were employing a combination of pragmatism, flexibility and sheer determination to move their specialty metal projects toward production, despite the ongoing dearth of commercial project finance and a lingering, somewhat adversarial regulatory environment.

What's happening is a few management teams are quietly excelling while the majority are floundering.

From an investment point of view, being able to differentiate between those specialty metals companies positioning themselves to succeed from those unlikely to survive allows capital to be concentrated where it has the best chance of earning a return.

That is not to say that these companies will be successful and make their shareholders buckets of money-just that they have been able to transition from the "story" stage to the "reality" stage of going into production; whether they can do so profitably remains to be seen.

But most companies in the specialty metal sector have been unable to get beyond the "story" stage, and investors are fed up with the fairy tales.

TMR: What makes Australian specialty metal projects so difficult to finance?

RK: The single biggest obstacle is that many specialty metals do not trade on an exchange, which means the metals are unhedgeable, which in turn means specialty metal projects cannot secure forward sales, which is how commercial banks make sure their loans are repaid. In fact, pricing is purposefully opaque and is often treated as a trade secret because it represents a competitive advantage. This problem is not specific to Australia.

Then there is the complex metallurgy and highly specialized, technical uses that are difficult to understand-even by end users themselves.

All too often, executives want the specialty metal regardless of price, but are unwilling to participate in putting specialty projects into production-despite the fact that such an investment would pay massive dividends going forward, especially in terms of reducing price volatility and improving supply chain security.

Some of these end users have learned a bitter lesson from a misplaced faith in slogans like "market forces will prevail," which is frequently not the case with specialty metals.

We can make the case that many specialty metal projects would be better served by staying private as a JV between producers and end users, which in effect is how one of our brownfield projects has put itself into production.

TMR: Are you fond of brownstone projects?

RK: I confess that I am biased toward a certain kind of brownstone project because I'm partial to overlooked, under-valued assets that have been victimized by circumstance. In cases like those I profiled, these projects represent low risk, high return opportunities.

People tend to forget (and bankers tend to shy away from financing) a large swathe of brownstone projects. Many of these projects were shuttered not because they ran out of ore, or grades deteriorated or they were poorly managed, but because something unforeseen happened to kill the price of the metal they were producing.

In the case of tungsten and graphite, commencing in 1982 when Deng Xiaoping had China "turn outward" in the general direction of a market economy, projects all over the world were closed because they could not compete with the flood of inexpensive supply from China's command economy. That was how China came to control so many specialty metal markets: The government more concerned with amassing foreign currency reserves and seizing control than they were with profit, and as we've seen, now that they have control, they are exercising it by squeezing supply. As a result, western companies are beginning to take security of supply seriously.

TMR: What does it take for companies to defy the odds and may emerge victorious?

RK: In order to get specialty metal projects into production today, management teams need to be flexible and pragmatic in their approach. The defining characteristics are product approval and pre-paid offtake agreements, both of which figure prominently in getting projects financed. Doing so with minimal equity dilution is a much-welcomed change as well.

TMR: Any final comments?

RK: I think there is reason to be somewhat optimistic about the outlook for the specialty metals sector in Australia. Deals are getting done. The best-managed companies are quietly excelling. Specialty metal demand, the crux of the opportunity, is increasing.

But it is more critical than ever to understand what you are investing in: Specialty metal price volatility will not disappear, so investing in the sector is not for the faint of heart, the impatient or those too lazy to do their homework. But for those who get it right, we fully expect outstanding returns.

As managing editor of The Emerging Trends Report, Richard Karn has a broad, multi-disciplinary background and a working knowledge of precious and specialty metals, as well as considerable research, analytical and writing experience. The first nine Emerging Trends Reports have been re-evaluated and updated published in e-book form, as Credit & Credibility. He has written for publications ranging from Barron's, Kitco and Fullermoney to Financial Sense Online.


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