Dave Forest: How to Play the Looming Platinum Supply Crisis The Metals Report COMPANIES MENTIONED Anglo American Platinum Ltd. Energizer Resources Inc. Impala Platinum Holdings Ltd. Ivanplats Ltd. Largo Resources Ltd. Lonmin Plc Reunion Gold Corp. Zimplats Holdings Ltd. 09/03/2013 South Africa, platinum mining giant, is about to fall off the investment map, says Dave Forest of Pierce Points. Until the country sorts out its labor politics, there is a real need to establish alternative sources of platinum group metals, vanadium and manganese. In other words, while it's a bad time to be a miner in South Africa, it's a good time to hold in-ground reserves. In this interview with The Metals Report , Forest names deposits in the Americas and elsewhere in Africa with the potential to meet global platinum needs. But he's choosing carefully, because even in times of scarcity, Forest argues, it just won't do to develop anything other than the best, most economic mining projects. Source: Kevin Michael Grace of The Metals Report The Metals Report: You recently wrote, "Many of the global threads in the minerals industry are today running through South Africa." How crucial is South Africa to commodities and, especially, the so-called strategic minerals? David Forest Pierce Points Tel.: (604) 417-2960 dforest@piercepoints.com Streetwise Reports LLC 101 Second St., Suite 110 Petaluma, CA 94952 Tel.: (707) 981-8999 x311 Fax: (707) 981-8998 jluther@streetwisereports.com THE ENERGY REPORT THE GOLD REPORT THE LIFE SCIENCES REPORT THE METALS REPORT Dave Forest: There may be no other country that is as important to the mineral industry as South Africa in terms of across-the-board production share. It produces about 70% of the world's platinum. There is no other major commodity that is so geographically concentrated. South Africa also produces a lot of the world's strategic minerals, such as vanadium, manganese and titanium. TMR: Nelson Mandela was close to death recently. Many have worried that his death will result in a civil crisis. What do you think? DF: South Africa has so many unresolved systemic and structural issues. Mandela's death could serve as a flashpoint. It could be a number of other things. TMR: When you read about the president of the African National Congress (ANC) singing "Umshini Wami (Bring Me My Machine Gun)," this suggests a high possibility of political turmoil. DF: Absolutely. The labor unions have been incredibly militant. The difference between what they're asking for and what the companies are offering them is 150% compared to 5%. That's a very big disconnect. TMR: What is the significance of possible changes to South Africa's Mineral and Petroleum Resources Development Act? DF: The old minerals code has always been faulted for being vague. The government issued a new draft code last year. Mining companies raised somewhere in the neighborhood of 80 objections to different parts of the act and submitted them to the government. The revised draft released this summer ignored almost all of these objections. TMR: When can we expect government action? DF: Pretty soon. The government is taking comments on the revised act until Sept. 6. So we could see action this year. TMR: How strong is resource nationalism in South Africa, particularly in government circles? DF: South Africa has one of the highest electric-power costs on earth. So there is a lot of talk about coal, which is used to generate a good portion of this power, being declared a strategic material, if not outright nationalized. This would have a major effect on the global thermal market because South Africa is a pretty significant swing supplier, especially in the Indian Ocean and Asian spheres. TMR: The National Union of Mine Workers (NUM) has announced a vote on possible strike action. How important would such a strike be? DF: We had strikes over the last year. They had a material impact on the balance sheets of all the mining companies involved. You're talking about losing a month or two of production. This is especially worrisome in South Africa because it has a lot of older, deeper mines. Once you turn off the switch, it gets harder to turn it back on. These mines need constant maintenance. If they don't get that, you run a real risk of permanent operational damage. TMR: Is South Africa on the verge of killing the goose that lays the golden eggs? DF: The question is, how long until South African mining companies can operate profitably with the incentive to make the capital expenditures needed to maintain existing mines and develop new ones? In the long term, South Africa is going to be a very rich place. In the short term, we could see some significant dislocations. TMR: How would you rate the prospects of South Africa's various platinum group metals (PGM) companies? DF: I think you can put most of the existing producers into the same basket. South Africa is a pretty high-capital place to operate. We're talking deep mines to exploit fairly restricted layers, with high labor and energy costs. The only reason that conditions aren't even tighter is that miners got a boost from the depreciation of the rand. PGM producers are going to have a tough time for at least the next year and possibly longer. I'm a little more bullish on development stories. Now is a good time to hold inground reserves. I like Ivanplats Ltd. (IVP:TSX), which has a significant in-ground platinum reserves but isn't being forced to spend the capital to develop and operate it now. TMR: Any other examples of this? DF: Zimbabwe, which was a country a lot of investors had written off, seems to be doing better than many South African operations now. And a company like Zimplats Holdings Ltd. (ZIM:ASE) (a subsidiary of Impala Platinum Holdings Ltd. [IMP:JSE]) might be better insulated as a result. TMR: Do major producers such as Anglo American Platinum Ltd. (AMS:JSE) and Lonmin Plc (LMI:LSE) have escape routes? DF: Their only option would be diversification outside South Africa. Right now, they don't have that, and that's as much a function of geology as of politics. TMR: What is your advice for investors in South African PGM companies? DF: I think if you're a value investor, and you look at the margins that the sector as a whole is making—which translates into cash flows versus valuation—you probably wouldn't want to be in the majority of those companies right now. TMR: Should South African PGM mining become unproductive, where else in the world will we see major efforts to find PGMs? DF: This is where it starts to get really interesting. You would expect to see a large demand for exploration prospects outside South Africa. But the known alternatives are Russia and Zimbabwe, not the most attractive destinations for capital. Beyond that, we know of a few places where lower-grade platinum is found, and we're talking an order of magnitude lower. There's a real need for exploration teams that can come up with new ideas about where richer platinum reserves might be found. TMR: What about PGMs produced as byproducts from mining of other metals? DF: The platinum produced as byproducts by companies in Ontario's Sudbury district are probably the best prospects. But they are less likely to have a material impact on the supply balance because the amounts of PGMs you're talking about are relatively small. TMR: There is quite a divergence of opinion about Ontario's potential, in places like the Ring of Fire district. Some say it will be a huge development for decades to come, while others say it's hype. What do you think? DF: Ontario has some of the more interesting magmatic-sulphide deposits on the planet. It has potential. But you're talking about a system that's more linked to the fates of metals such as chromite and nickel. I don't see it being a significant player in terms of platinum group elements (PGEs). TMR: If South African production of vanadium and manganese becomes unproductive, which regions will step up as replacements? DF: Three countries—South Africa, China and India—produce most of the world's vanadium. Unlike platinum, we do know of a few places on earth where we have South African-like deposits of vanadium. A company like Largo Resources Ltd. (LGO:TSX.V) in Brazil is probably in a good position. It is developing a magmatic iron-vanadium-titanium deposit, which, interestingly, also has some PGMs. This is a near-term producer in a geological terrain similar to that which has been proven around the world. That's a pretty interesting combination. And Brazil has a very well-developed mining sector, which means it also has pretty well-developed infrastructure, which adds to the economic viability of the project. TMR: What about Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCQX) and its vanadium project in Madagascar, just east of South Africa in the Indian Ocean? DF: Energizer's Manga Vanadium project is a different type of deposit, but the grade and size look like they would be comparable economically. The biggest question there is the economics of the infrastructure, and we haven't seen the scale of development yet that would give us a complete indication of what that's going to look like. But, certainly, if that aspect of the project can be managed, Energizer could be a very viable source of vanadium supply. TMR: What about alternative sources of manganese? DF: None of the alternative areas are as proven as South Africa. That doesn't mean they won't work, but it means we don't have a full understanding of what their production economics would look like. I would probably lean more toward Guyana and Reunion Gold Corp. (RGD:TSX.V), as the geology is similar to South Africa's, and the costs are quite a bit lower than in North America. TMR: Do you believe that the U.S., Canada and other western countries need to further the development of home-grown strategic minerals so that high-tech and emerging technologies are not so dependent on countries such as South Africa, China and the Democratic Republic of the Congo (DRC)? DF: I think the market actually does a pretty good job of ensuring supplies of strategic metals. We may get short-term dislocations, but as an investor in mining companies, I would rather see higher prices for metals that are in short supply benefit companies that are developing the best new projects in the world. What tends to happen when you declare something "strategic" is that governments invest money in projects that are often very marginal. So you tend to reward people who are not developing the best projects in the world. I'd rather see capital go where we're going to get the most supply, rather than to projects that will shuffle along for a couple of years and then shut down. TMR: Mineral production everywhere is afflicted with rapidly rising costs. Do you think that anything can be done about this? DF: For a while, the fad was to invest in sectors like mining. So we had a lot of often indiscriminate investment, a lot of capital going to a large variety of projects, some good, some not so good. All that new money bid up prices for mining services pretty significantly. What should happen and what is starting to happen now is that the less well-conceived projects are dying off, being put on hold or just not being developed. That's easing some of the cost pressure. I think if we get back to developing only the best projects, only the projects that make sense, we will see less money being spent on services, and we'll see less cost pressure, which would be good for the people left to develop the best projects. TMR: If the production prices of industrial commodities can't be controlled, doesn't this suggest a possible significant decrease in production, which would have significant consequences economically? DF: Yes, and we might be at that juncture right now. Look at the gold sector. We went from a focus on rapid expansion a few years ago to the reverse, which we're seeing now. Investors are now asking companies to end their development capital spending, rationalize existing operations and focus on cash-flow projects. That will probably translate into a smaller gold development pipeline, which means less gold being taken out of the ground for the next couple of years. That should stabilize prices and stabilize the industry. TMR: Dave, thank you for your time and insights. Dave Forest is chief operating officer of Condoto Platinum NL and managing geologist of Pierce Points, a free weekly e-letter covering the natural resource sector and commodities markets. A geologist, he has worked for over a decade in the oil and gas, mining, and environmental sectors. Want to read more Metals Report interviews like this? Sign up for our free enewsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Metals Report homepage. If you would like to comment on the content of this interview, engage with the interviewee or any of the companies discussed in this interview, or if you would like to be interviewed by The Gold Report, please contact Judy Luther of The Gold Report, at jluther@streetwisereports.com, (707) 981-8999 x311. 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