Small cap mining: why the land banking in 2023?

Small cap companies are spending their money on pre-drilling exploration to conserve cash. But they’re still buying up land. Why?

Picture the scene. It’s 1 January 2023 and your favourite small cap mining stock is facing sky-high interest rates, an illiquid market, and investors gripped by fear more than FOMO. Over the next 12 months, there’s a grim understanding in the market that generating solid results — in most cases — will be an uphill struggle.

And nothing you do is going to make a lot of difference because when rates are rising, you’re always swimming upstream. Got some decent geophysical results? How are you going to fund some drilling?

Oh, you managed to get some solid drilling results? How are you going to pay for a Scoping Study? Managed to release that Scoping Study? — well, now you need to pay for a Pre-Feasibility Study, then a Definitive Feasibility Study — and at some point, hope that a major (Rio Tinto, Glencore, Anglo American, China et al) take interest and either buy some shares, enter a Joint Venture, or if you’re super lucky buy out the asset at a premium.

Now the problem is that paying for every stage of proving an asset requires cash. If you manage to swing a JV, offtake agreement or investment with a major — KOD, ARCM, TYM, PREM, SVML, GGP etc — then much of this expense is taken care of. But often you still need to raise some cash yourself, and if you are on your own, then this usually involves placing shares.

In a bull market, this isn’t a problem. The general idea is that each stage of exploration creates more market value than the subsequent dilution — looking a little like this:

• Share price 1p: preliminary survey ongoing
• Preliminary survey success, share price increases to 1.4p
• Company places at 1.2p, funds to be used for initial drilling
• Initial drilling success, share price increases to 1.8p
• Company places at 1.6p, funds to be used for infill holes and resource expansion
• Detailed results come in including grades, true width, share price increases to 2.5p
• Company places at 2.2p, funds to be used for Scoping Study or PFS…

In 2023, this model hasn’t really worked. The retail investor base is now far more generally aware of generic timelines, the Lassonde Curve, and also the difference between theory and practice when companies talk timescales and costs.

Or in other words, this market has created much more savvy investors, ones who can figure out roughly when a placing will occur (or who are in for a long wait before any substantive news) and get out before the placing happens. This depresses the share price, which then necessitates placing more shares than if investors had stayed in — and the problem is that FOMO of a buyout or being out when a major steps in, is simply not strong enough to keep investors in.

Once the placing is over, investors then buy shares for the run up to news before selling on the news — again in anticipation of a placing — and this leaves company CEOs in a bit of a bind. If they place shares, this reinforces trader-like behaviour and also dilutes loyal shareholders at a low value — and if they don’t place, they can’t fund the activities that drive value over the longer term.

Now, I am of the opinion that it’s likely interest rates have peaked; most analysts consider that they will start to fall through 2024. This macroeconomic scale is important because it means that institutional investment and HNW investors will start pouring back into risk assets — as while many junior resources sector companies have been hit hard this year, they are not worth nothing.

Once you start to see share prices lift, the retail investor base will pour back in, copying the larger fish. And then the placing & proving model once again becomes sustainable.

But in 2023, companies have had to focus on cost-conscious exploration, or else find creative solutions to financing which may or may not have long-term repercussions for asset values. Because no CEO wants to dilute at the ridiculous prices we are at now unless they are either close to finalizing a study OR close to production OR have completely run out of cash.

Let’s consider a few recent creative ideas:

• Marula Mining — funding through Q Global
• First Class Metals — share loan agreement
• ECR Minerals — selling non-core assets
• Greatland Gold — Wyloo AU$50 million cash
• Power Metal — selling Kavango shares

There are dozens of other examples, including royalties and warrants, but the point is that 2023 has seen companies needing cash to fund exploration doing what they can to avoid placing in this market. Of course, this has seen share prices continue to slide because — in a classic catch-22 — you need the funding from placings to create further value. If there’s no drilling, there’s limited catalysts, and therefore not even a flicker of FOMO.

So, what have company CEOs been doing in 2023? The competent ones have been setting up for the bull run in 2024. While some have done a little initial drilling, any company without a major backing them have been engaged in cost-conscious exploration at surface, looking for the best possible targets, so that when cash comes back to the market, they have a series of catalysts lined up ready to get drilling in the most prospective areas of their licences immediately.

The second widespread bull market preparation that I’ve seen is companies increasing land footprint of prospective tenure. This is fairly easy to understand:

• A company has seen promising signs in its assets that point to mineralisation extension beyond their asset boundary.

• Staking costs are extremely low because they usually come with spending commitments within a certain timeframe.

• If a third party has the rights to an extension, they often sell it cheaply because they can’t afford to finance exploration spending commitments.

So, companies buy more land, and then investors scratch their heads, wondering why small cap businesses continue to buy up rights to prospective tenure adjoining or near to their current projects — even if, presently, they can’t finance their current flagship already.

But this ignores market cycles. If you’re in charge of a small cap mining company, you know that 2024 onwards will see money pour into the sector. Those staking costs will rise sharply, buying assets will increase from a nominal fee to significant expense, and the moment you drill an asset and come up with the goods every piece of land around you will be boosted by nearology.

The plan, then, is to get your hands on every bit of prospective tenure you possibly can — because when the market improves to the point where you can get the cash together to start drilling, that tenure will become exponentially more valuable, and you can then highlight further potential upside to investors. Further, you expect to be able to meet staking expenditure commitments over the next two years as the bull market returns.

In other words, investors should be considering buying junior resource shares at the bottom of the market — and these companies themselves are buying assets at the bottom of the market.

If you’re looking on bewildered at your company spending precious cash on asset expansion, then there’s a simple fact to understand — and it doesn’t matter whether you’re an AQSE-listed Marula or AIM great Greatland — prospective land values are currently at rock bottom prices. Below rock bottom. Because over much of 2022 and 2023, it’s been impossible to materially develop assets from a financial perspective, and so there is little competition for tenure.

But as the market returns this will change rapidly; and those investments in tenure will make your company far more attractive to the majors looking to splash the cash.

This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.

Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.