A Conversation with Justin Tolman, Economic Geologist at Sprott Global Resource Investments

NOTE: This Interview was completed at the end of January 2020 and was published for Subscribers on Feb.18/2020. Become a Premium subscriber today and save 40% until March.31st using the Promo Code – PREMIUM

Your decision making ability will ultimately determine the course of your life.

Personally, I believe everyone needs to be anchored in a core set of principles or rules that shape their decision making process.

Without the anchoring, emotion or outside influences can take over and could ultimately steer you in the wrong direction.

So what’s my point?

It goes without saying that those who choose to invest in the stock market, especially those who invest in the junior resource sector, are continually tested by the decisions they make.

Very quickly, bad decisions will lose you money.

Understand yourself and form a set of rules or principles to invest by. Additionally, when given the opportunity, learn everything you can because applied knowledge is power and profitable.

Today is one of those great learning opportunities, as I bring you an interview with Justin Tolman. Tolman is an economic geologist and is a part of a world-class technical evaluation team at Sprott Global Resource Investments.

In our conversation, we cover a number of topics including his view on the current gold equities market, where the next big mining innovation will come from, how to avoid value traps and much more.

Enjoy!

Brian: 2019 was a great year for the gold price with it hitting a high above US$1500 per ounce for the first time since 2013. Many headlines throughout the media equate the strong gold price with the beginning of a new bull cycle in the junior equities.

However, for those who watch the junior gold equity market closely, you will see that the equities have lagged the metal prices.

What is your view on the current junior gold equity market?

Justin: Before I opine on this, I should say from the outset that we have a wealth of professionals within the Sprott group who spend much more time than I do thinking about our industry from a macro view and broad market trends. I get a lot of value from what they say and people could sign up for that information for free – Sprott’s Thoughts.

That being said, I will opine; I do think that junior equities are lagging the gold price and there’s good reasons for that, following the excesses of the last bull market.  The onus is on us in the industry to close that gap and show that we’re responsible stewards of invested capital. Now, sustained higher gold prices are always better than the alternative, and should be a good leading indicator for a recovery in gold equities.

I don’t think all junior gold equities will necessarily appreciate in value at the same rate, if at all.  There’s a spectrum of both quality and risk across that universe of issuers, and personally I am most interested in those projects that have potential to go on and become profitable mines.

 In that context, there are some compelling opportunities we’re actively allocating towards now.

Brian: Protecting my downside risk is a major part of my investment strategy. For companies with existing discoveries or outlined deposits, it’s fairly straightforward in how to construct a valuation model and compare against the company’s current MCAP.

However, as of late, I have had a hard time deciding how to construct a fair valuation for exploration projects and, on a grander scale, the value of an exploration company.

Generally speaking, how do you calculate the fair value of an exploration project or company that, for all intents and purposes, has nothing of quantitative value – excluding cash? Please explain.

Justin: That’s the trick, isn’t it? We’re always dealing with incomplete information and we’re always trying to quantify intangibles.  Especially with early-stage exploration companies where often the short answer is, it depends.

One of the metrics I see used a lot by junior explorers is to compare themselves to their peers in a nice bar graph and it inevitably leads to the conclusion that the company in question is woefully undervalued. Now, this obviously has potential to be a very flawed way of doing this, especially if you’re gonna let the company hand pick its own peers.

If you have some knowledge of the inputs and the nuances and pick the peer comparison yourself it can work better. 

A couple of petroleum industry guys, Paul Newendorp and John Schuyler, pioneered some really good work on decision making for exploration, I’ve got their text books on my shelf in front of me here. I’ve used some of their principles before to help deal with risk applied to hard rock exploration – using decision trees and some other tools.  But to make it work you need to understand the exploration process and be prepared to make some assumptions about the probability of different outcomes.

 At the end of the day, though, as I’m thinking about this, part of any exploreco’s valuation comes from the team; some groups are just going to be better at coming up with well-thought ideas, testing them efficiently, and when it doesn’t work, moving on.

When you can identify those people or teams that demonstrate competence in execution, both in the field and the boardroom; who experience in a given geography and deposit style; who show integrity in looking after shareholders, those guys out-perform over time and command a premium.

Brian: Most of the major innovations within the mining industry occurred many years ago. First, in the late 1800s, with major advancements in mineral processing, and then the birth of geophysics in the mid 1900s.

It would seem to me that the mining industry is due for another major step forward.

In your opinion, where will the next major innovation in mining be?

Justin: Due for a step forward, I’d love that. It’s been a while since we had a step change in the tool box available to us. In fact, it’s been a while since we had a step change in our understanding of ore deposit controls, but just because it’s due, doesn’t mean it has to happen.

It’s a bit fashionable now to talk about the machine assisted learning, artificial intelligence in exploration, I see that popping up in the vernacular of junior press releases. I don’t tend to put too much emphasis in them except for very special cases.  Those sorts of systems tend to work best in data-rich environments and they certainly don’t tell you when to stop spending money.

On the exploration side, I think in the future we’re going to see more discoveries made at depth, beyond the range of what we can directly detect from the surface using traditional tools, so that implies an increasing reliance on the drill bit and vectoring from there.

There’s a bunch of neat down-hole applications which are evolving from this. Short wave infrared scanning of core and increased sensitivity of down hole geophysics are getting gradually more sensitive and affordable every year.

On the mining front, I see an increasing role for equipment automation using combinations of existing technology. Not just to incrementally improve productivity or lower costs, but to drastically improve site safety and working conditions.

I’m seeing more and more adoption of this picking up globally, it enables mine equipment to operates in extreme temperatures, confined spaces and other hazardous work environments autonomously or remotely.  Meanwhile people can oversee the operations from somewhere comfortable and safe. 

Brian: In our conversation earlier this year, I asked you about jurisdictional risk and how it fits into your investment analysis. One comment, in particular, that caught my attention was,

“You need to be quite judicious in applying broad risk categories to entire jurisdictions, whether it’s countries or provinces, the reality is that often it depends. Some superficially low risk places for mining investment, like Peru, in actuality can be a very complex patchwork of attractiveness depending on local community attitudes, legacy issues, and a host of other things. That’s one of the things that we like to think differentiates us at Sprott we get out on the ground in these areas early and develop a deeper understanding for this aspect. A big part of my job is spending time on the ground at lots of these projects first-hand.†~ A Conversation with Justin Tolman, Economic Geologist at Sprott Global Investments

I completely agree and think that it’s vital that investors heed your advice in looking as deep as possible into the jurisdiction they are planning to invest in.

With that in mind, I think it’s a great opportunity to discuss a country that you most recently visited, Brazil.  Brazil, on a whole, I think, has been painted with a high-risk brush.

In terms of mining investment attractiveness, how do you view Brazil?

Justin: Well, if you remember the last interview, you’ve kind of done exactly what I advocated against.  You just asked for a comment on risk regarding the 5th largest country in the world.  On balance, I am pro Brazil as an investment jurisdiction, but it’s always going to carry the caveat of “under the right circumstancesâ€. Given the mineral endowment,  there’s plenty of opportunity across the country for groups who can execute on the ground.  My recent trip that we were talking about, I visited a number of projects in Para, Bahia and Maranhão  states. All of them had some mining history and some exposure to large-scale mining operations. At the time, I was looking at gold, copper, and nickel projects.  Some we own in house, others we were considering investing in.  None were large-scale iron ore operations which obviously have come under increased scrutiny in the wake of the tragic tailings dam collapse last January at Brumadinho.

Brian: Executive compensation within the junior mining industry is an interesting topic, as I have heard a variety of opinions on what is appropriate and what isn’t.

As an investor, of course, I would rather see low executive wages and their compensation focused on share price appreciation – options, etc. However, I do see the other side of the coin, when it comes to attracting and keeping top talent.

So, it begs the question, where is the appropriate balance between the interest of the shareholders and the adequate amount and type of compensation for the team which is running the company?

Justin: Those two things don’t have to be diametrically opposed. Why can’t it be both? The goal perhaps should be to structure incentives to align between investors and executives. Maybe that’s a bit utopian but it’s a worthwhile discussion. I can tell you that how a management team is incentivised is absolutely something that we are conscious of, look at and factor that into our investment decisions and recommendations internally.

Fundamentally, what gets measured and rewarded drives decision making and outcomes.  So consider if somebody is financially motivated to sell their company via a generous change of control clause, does a higher share price help or hinder that outcome for them?

Striking the right balance of short and long-term performance incentives is important, what’s the criteria for determining their short-term bonus pay outs?  How much stock does an executive own and what price did they acquire it for?

These are questions that we ask routinely, and investors should ask more.  One way to encourage an aligned compensation package is having independent directors on the compensation committee that are actually independent.  

Certainly, we love it when company executives eat their own cooking, buying shares alongside us in the market.

Brian: During university and the days of +US$100 per barrel oil,  I can remember one of my professors stating that he thought peak oil was one of the biggest concerns for humanity moving forward, and that the price was only headed up because of it.

Today, with the use of horizontal drilling and other factors, the oil price has plummeted and the talk of peak oil seems to be a thing of the past.

 Moving to the hard rock sector of the mining industry, much of the ‘peak’ talk I have heard has focused on gold, with a few pundits suggesting that we are in peak gold – we will never again reach the production or new discovery numbers seen in the past.

In your opinion, is peak gold legit?

Justin: I don’t know? There’s lots of variables that go into peak gold and some of them are beyond my ken and I don’t really pretend to have an opinion.  Wasn’t US peak oil originally supposed to be in the seventies and then hydraulic fracturing came along and that all changed? I subscribed more to the necessity-is-the-mother-of-invention type philosophy for these things.

With that said, we do work in a cyclical business, and if we’re willing to shorten the time horizon for peak gold to something shorter than forever I happy to comment.  Certainly in the last few years it’s apparent that mining companies have underinvested in Greenfield exploration, and have been ruthlessly squeezing the existing operations for additional, increasingly marginal production.

This has led to declining discovery rates. The very attractive tier 1 deposits, that are so sought after are increasingly scarce, and when you couple this with the increased timelines to permit new operations, future global production is under a lot of pressure.

So, barring a paradigm shift in technology, like you asked about before, this obvious implication is that the demand for quality deposits and genuine new discoveries is only going to increase.  Which makes me kind of happy. It’s the reason I get up in the morning and come into the office.

Brian: In my view, to be a consistently successful investor in the junior resource sector you need to buy companies with good management teams, and that are selling at a price which is less than their intrinsic value.

In saying this, investors do have to be wary of value traps, which I define as companies that have the potential to never escape the market discount.

First, do you agree that value traps exist or it is just a matter of the investor getting the thesis wrong?

Secondly, if you do agree that value traps are out there, do you have any advice for steering clear of them?

Justin:

Great Question.  It dovetails nicely with your earlier one on trying to calculate fair value for exploration companies.  There no question value traps exist, in face our industry is littered with them. 

Just because something is cheap on whatever metric you happen to be using, doesn’t mean it has to go up.  One clue that a stock might be a value trap is that it will appear to have been cheap for an extended period of time.   What changed to make it appear cheap?

When you suspect you are dealing with a value trap the think about stress testing your assumptions and valuation metrics.  Is the asset in an inherently risker part of the world demanding a higher cost of capital?  Is there an issue with the orebody not immediately apparent that might prevent the asset from being mined profitably?  Like a remote location or a lack of water or community support for example.

Next you need to see a way forward for the project, some measurable catalyst that will work to unlock value.  Permitting a road, changing the mining/processing method, or in some cases rebooting the corporate structure.   

Then think about to what extent the outcome of that catalyst in in the control of the company.  If not at all then I fear your plan is based on hope.  Which tends to be unpredictable.

Brian: Sprott USA offers a wide range of the best services and products in the natural resources market. From full-service brokerage accounts to private placement opportunities and exchange traded products and bullion trusts.

Can you give us an overview of what is new at Sprott and what opportunities are available for interested investors?

Justin:  You’re right, there is lots going on at the moment. We just completed our acquisition of Tocqueville earlier this month, which was really exciting for us adding an additional $2 billion or so in assets under management.

The bit that I get excited about however is that it consolidates and build on our in house technical and sector expertise in the gold business. 

Here at Sprott Global , we’ve got some really exciting actively managed products available; the Rule Managed Account has been running for a year now as resource portfolio and gives participants a chance to participate in investment themes that Rick [Rule] is tactically trading in.

One of our most experienced advisors Jason Stevens has been running the Sprott Real Asset Value+ Strategy which has put together some really impressive returns which is great for long-term alternative investment exposure.  Jason pays a lot of attention to balance sheets and the business’ value drivers to identify core positions.

Personally, I’m as busy as I’ve ever been working with our teams and PM’s to identify undervalued high quality projects and new discoveries that we can get out in the market and support.  

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Until next time,

Brian Leni  P.Eng

Founder – Junior Stock Review