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A Fancy Contrarian Opportunity

Source: James Kwantes for Streetwise Reports   03/01/2021

James Kwantes of Resource Opportunities discusses North Arrow Minerals and explains why he believes the stage is set for a diamond rebound.Tulips were introduced to the Netherlands…

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This article was originally published by The Gold Report

Source: James Kwantes for Streetwise Reports   03/01/2021

James Kwantes of Resource Opportunities discusses North Arrow Minerals and explains why he believes the stage is set for a diamond rebound.

Tulips were introduced to the Netherlands in the late 1500s and the country soon fell in love with the brightly colored flowers. Their arrival coincided with the Dutch Golden Age, when control of lucrative trading routes to the Far East made the Netherlands a marine superpower and one of the world's wealthiest nations.


Trade and the resulting prosperity set the stage for the tulip bulb mania of the 1630s. Businessmen who became wealthy buying shares in the Dutch East India Company would decorate their estates with lavish flower gardens of tulips, which had been introduced from Turkey. The rarest and most valuable tulips were the ones with genetic impurities, which produced vibrant colors and unique patterns. Human beings love natural beauty.

In diamonds as in tulips, the rarest and most beautiful are the most valuable. Lucara Diamond Corp. (LUC-T) has been demonstrating it for years, pulling spectacular stones out of its Botswana diamond mine and selling them for prices as high as US$63 million. That price-tag, for the 813-carat Constellation, was more than Lucara paid for a controlling interest in the Karowe project before it became a mine. Fancy pink diamonds from Rio Tinto's recently closed Argyle diamond mine in Western Australia also command high prices.

Human beings love natural beauty. It's something of a counterpoint to the narrative that De Beers created the demand for diamonds with its legendary "A Diamond Is Forever" advertising campaign in the late 1940s. That branding certainly introduced diamonds to new markets, such as Japan, and established mass market appeal for diamond engagement rings. Natural diamonds, of course, have been objects of desire for thousands of years.

According to legend, a single Semper Augustus tulip bulb sold for the price of a fine Amsterdam canal house at the peak of the Dutch tulip bubble. Centuries later, it was determined that a virus had produced the vibrant colors and unique patterns of the Semper Augustus. The tulip bubble quickly collapsed. Almost 400 years later, though, the Netherlands remains a flower powerhouse globally.

In diamonds as in tulips, chemical impurities create the vibrancy and color. Fancy diamonds fetch higher prices because the stones are rare and because they are beautiful. The presence of nitrogen, for example, is what gives a population of diamonds from North Arrow Minerals Inc. (NAR:TSX.V) Naujaat project in Nunavut their vibrant orangey-yellow hue.

STAGE SET FOR A DIAMOND REBOUND

The staying power of natural diamonds has been challenged by everything from lab-grown stones to changing demographic trends to COVID-19. It's been a rough ride for investors in Canadian diamond stories, too—Dominion Diamond Corp. and Stornoway Diamond Corp., operators of two of Canada's diamond mines, were both forced into bankruptcy protection.

North Arrow has not been spared. The stock has mostly been in the penalty box since a disappointing 2015 valuation of a 383.55-carat parcel of Naujaat diamonds. The primary conclusion of the valuation was that results and modelled values should be treated with considerable caution because of the small size of the sample. North Arrow has cost-effectively advanced Naujaat and its other Canadian diamond projects since, with successes including the discovery of new diamondiferous kimberlite fields at Pikoo (Saskatchewan) and Mel (Nunavut). While other diamond explorecos went bust or switched commodities, North Arrow shed non-core assets, sold small royalties on secondary projects and did modest raises with help from its billionaire backers.

As the world slowly emerges from the pandemic's grip and consumers from their homes, natural diamond prices and sales are bouncing back strongly. Rough diamond prices have rebounded and recently eclipsed pre-pandemic levels, reports New York diamond analyst Paul Zimnisky in the February 2021 edition of his State of the Diamond Market. De Beers just raised prices at its third consecutive sale, according to Bloomberg.

The pandemic appears to have created pent-up demand for jewelry and diamonds. Tiffany & Co., the world's largest jeweler, reported record sales for the November 1 through December 31 holiday period. China is leading the way, as the growing consumer powerhouse leaves COVID-19 in the rear-view mirror. Tiffany's Chinese sales rose 50% during the holiday period. Richemont, the world's second largest luxury conglomerate, said Q4 sales in China surged 80% year-over-year (Richemont is the parent company of Cartier and Van Cleef & Arpels). Chinese jeweler Chow Tai Fook opened 286 net new stores in the country in the fourth quarter of 2020.

From an investment perspective, diamonds may be one of the last contrarian bets left within the commodity complex. Base metals, battery metals, precious metals—prices of each have surged in the past year as inflation looms. Diamonds have lagged until recently, despite favorable supply-demand dynamics coming out of a long bear market that saw global diamond exploration screech to a virtual halt.


Large diamonds and rare colored diamonds are leading the way. Last year Louis Vuitton, the world's most powerful luxury brand and the recent acquirer of Tiffany & Co., purchased two of Lucara's most prized diamonds—the 1,758-carat Sewelo and the 549-carat Sethunya (above)—with plans to turn them into brilliant centerpieces. The Sewelo is the second largest rough diamond ever mined. A 59.6-carat fancy pink diamond, the "Pink Star," sold for a record US$71.2 million in 2017.

ENTER THE AUSSIES

Smart contrarian investors are taking notice. One is Michael O'Keeffe, an Australian entrepreneur who has made shareholders lots of money in coking coal and iron ore. A metallurgist by training, O'Keeffe got his start at Mt. Isa Mines and Glencore Australia before launching his own ventures. O'Keeffe took Riversdale Mining, a $7-million Australian coal junior with assets in Mozambique, to a $3.7-billion buyout by Rio Tinto in 2011.

These days, O'Keeffe runs Champion Iron Mines (CIA-T). In 2015, Champion bought the Bloom Lake iron ore mine in Quebec's Labrador Trough out of bankruptcy for $10.5 million and assumed about $43 million in liabilities. O'Keeffe has turned the operation around, developing Champion into an exporter of premium iron ore concentrate to markets in China, Japan, Europe and elsewhere. Champion shares bottomed at $1.10 at the end of March and now trade at $5.40, for a $2.6 billion market capitalization.

O'Keeffe (above) settled on diamonds after scouring the investment landscape for contrarian opportunities. He teamed up with diamond veteran Peter Ravenscroft, who was independently forming a strategy to consolidate the diamond project development space. They formed Australia-listed Burgundy Diamond Mines (BDM-AX), which plans to become a mid-cap diamond producer by developing premium projects that have been overlooked and/or under-funded.

In June, Burgundy signed a JV deal with North Arrow Minerals (NAR) that will see Burgundy earn a 40% stake in Q1-4 by funding a $5.6-million bulk sample of 1,500 to 2,000 tonnes at Naujaat, North Arrow's colored-diamond project in Nunavut. Burgundy advanced $300,000 of that last year so North Arrow could ship fuel and sampling supplies to Naujaat on the annual sealift. The objective of the bulk sample is to confirm that the more valuable colored diamonds occur in larger sizes throughout the deposit.

The favorable JV deal allows North Arrow to retain majority control of Naujaat on a partner-financed path and established timeline. It undoubtedly helped that North Arrow CEO Ken Armstrong cemented a relationship with Peter Ravenscroft, Burgundy's managing director and CEO, while the latter was in charge of resource delineation at the Diavik diamond mine in NWT. Ravenscroft is a diamond veteran with 40 years in the industry including with De Beers, Anglo American and Rio Tinto.

So what is Burgundy buying into? Naujaat's Q1-4 kimberlite hosts Canada's largest undeveloped diamond resource 100% held by a junior. The deposit hosts an estimated 26.1 million carats (Inferred) from surface to a depth of 205 meters; 2017 drilling showed Q1-4 extends below 300 meters depth. The outcropping kimberlite has a distinct population of rare orangey-yellow diamonds that could drive the value proposition and make the deposit economic. The Q1-4 deposit is seven kilometers from tidewater, near the community of Naujaat.

If this summer's bulk sample is successful, Burgundy could earn an additional 20% interest in Q1-4 (60% total). North Arrow and Burgundy have a non-binding letter of intent to negotiate a second option agreement giving Burgundy the right to earn the additional 20% interest by paying for collection of a subsequent 10,000-tonne bulk sample.

The purpose of that exercise would be to definitely answer the diamond value question. The price tag for that bulk sample would be much higher, too—in the order of roughly $20 million.

SIZE MATTERS. SO DOES SATURATION

Intriguingly, the fancy orangey-yellow diamonds tend to be larger than the other diamonds in Q1-4. The colored diamonds are a distinct, younger population of stones. In earlier samples taken by North Arrow, they made up between 9% and 12% of the stones but as high as 21% to 30% by carat weight. Establishing the size-frequency distribution of that fancy diamond population is the main objective of this summer's 1,500 to 2,000-tonne bulk sample.

High-quality diamonds that are saturated in color can sell for multiples of the price of white diamonds, but the mines producing them are shutting down. The latest is Rio Tinto's Argyle mine in Australia, the world's primary source of fancy pink stones. Argyle closed last year. The Ellendale mine, also in Australia, produced 50% of the world's fancy yellow diamonds and was Tiffany's primary supplier for those stones. Ellendale closed in 2015 (although another company is attempting to revive the project).

There were some initial doubts that the Naujaat fancy colored diamonds would cut and polish well. North Arrow addressed those concerns with its cutting and polishing exercise that yielded beautiful, valuable stones. The polished diamonds received favorable certifications by the GIA (Gemological Institute of America). The diamonds were certified by GIA as fancy vivid orangey yellow—fancy vivid diamonds have the highest color saturation and command premium valuations.

TOP TEAM, LOW PRICE

In the notoriously risky junior mining sector, investing with people who have track records of making investors money greatly increases the odds of success. Gren Thomas, North Arrow's chairman and a Canadian diamond pioneer, fits the bill.

On the heels of Chuck Fipke's September 1991 diamond discovery, Thomas and South African diamond expert Chris Jennings (now a North Arrow director) headed north on a cloak-and-dagger staking mission. They flew into Yellowknife and split up at the airport, staying at different cheap hotels as they systematically staked as much prospective ground as possible.

"We got the feeling that the town was just trembling on the verge of a staking rush," Thomas recalls. "At any minute, the whole place could blow wide open."

That winter staking adventure eventually yielded the Diavik diamond discovery and Thomas's Aber Diamond Corp. (40% owner) saw the rich mine through to production. That worked out rather well for shareholders.

Thomas owns 11.1% of North Arrow's shares and recently increased his position by loaning the company $400,000. Jennings, his old staking partner, owns a 5.3% stake in North Arrow. Gren's daughter Eira Thomas led the field exploration team that made the Diavik discovery leading to Canada's second diamond mine. She co-founded both Stornoway Diamonds and Lucara Diamond Corp. and now runs Lucara, the world's premier producer of large, high-quality diamonds. Eira is a North Arrow advisor and large shareholder who was key to securing Naujaat for the company. CEO Ken Armstrong is a 25-year veteran of the diamond space and has been involved in the discovery of 10 diamond-bearing kimberlites in Canada and Greenland.

Through Burgundy, O'Keeffe joins three billionaire backers who are involved with North Arrow. Mining tycoons Lukas Lundin (through Zebra) and Thomas Kaplan (Electrum) each own 10.3% stakes in North Arrow; Ross Beaty owns 8.8% of shares. All three put money into North Arrow's last financing; insiders and key shareholders hold more than 53% of North Arrow's shares.

A VALUATION GAP

There aren't many active junior exploration companies backed by the likes of Lundin, Beaty and Electrum that trade below a $15-million market cap. And that's not the only metric that suggests North Arrow shares are fundamentally undervalued at these levels.


Eira Thomas (left) and Gren Thomas (right) at the Diavik mine opening.

Consider the discrepancy in market capitalization between North Arrow and its JV partner, ASX-listed Burgundy Diamonds. The Naujaat diamond project is the recognized flagship for both companies; after this summer's bulk sample, North Arrow will own a 60% interest in Naujaat and Burgundy a 40% interest. Yet consider the market cap comparison between joint venture partners:

North Arrow Minerals
60% stake in Naujaat (flagship)
Canada's best portfolio of advanced diamond exploration projects
100% share in Hope Bay Oro, a gold project adjacent to Agnico Eagle's Hope Bay mine
Market cap: C$12.2 million

Burgundy Diamond Mines
40% stake in Naujaat (flagship)
Exploration alliance in Botswana
Nanuk, an early-stage diamond project in northern Quebec
Legacy Peruvian gold/silver asset (25%)
Market cap: C$76.9 million

A GOLDEN CALL OPTION

Buried in the property portfolio is a gold asset that just moved up in relevance: the Hope Bay Oro property in Nunavut. Hope Bay Oro is directly north of Agnico Eagle's Hope Bay gold mine, recently acquired for $287 million from TMAC Resources. Prior to the purchase, Agnico Eagle had already upped its exploration budget. In subsequent interviews, Agnico CEO Sean Boyd has emphasized exploration as a key focus at Hope Bay as the miner seeks ounces to build annual production levels.


North Arrow's 4,103-hectare Hope Bay Oro property is three kilometers north of the Doris gold mine—the first to go into production at Hope Bay—and adjacent to Agnico ground. Oro hosts the same rocks, the same structural setting and the same mineralization style as Doris, where gold grades are about 10 g/t Au.

A 1,225-meter drill program completed by North Arrow in 2011 confirmed near-surface, high-grade gold mineralization over 300 meters of strike.

Ten of the 11 drill holes along the Elu shear hit significant gold grades, including:

  • 7.55 meters grading 4.91 g/t Au from 38.4m, including 4.2 meters grading 8 g/t Au;
  • 2 meters grading 20.22 g/t Au from 125m;
  • 4 meters grading 7.04 g/t Au from 42.6m;
  • 1.45 meters grading 31.92 g/t Au from 43.55m.

Acquiring Hope Bay Oro seems to be a logical bolt-on for Agnico, especially given the gold miner's renewed focus on exploration. Selling it could provide North Arrow with a non-dilutive source of funds. North Arrow CEO Armstrong is evaluating next steps at the property, including a potential drill program.

A BEAUTIFUL FUTURE?

The bet on North Arrow is that 60% or even 40% of a diamond mine that produces valuable fancy diamonds would be worth multiples of the current market capitalization. North Arrow has a partner-funded path to determine if Naujaat hosts an economic diamond deposit sweetened by a population of valuable fancy orangey-yellow diamonds. The JV partner is top-shelf, with the financial backing to fast-track a mine into production.

A final word on tulips and diamonds. Contrary to popular belief, the speculative tulip bubble occurred primarily among a small number of Amsterdam businessmen who had grown wealthy from maritime trade. The tulip bulb trade was considered too speculative for the Amsterdam stock exchange, which was well established by that time. As spectacular as the 1636–37 tulip price collapse was, it did not affect many Dutch citizens or even have ramifications for that small country's economy, let alone the world. This was a niche phenomenon.

The appeal of diamonds, on the other hand, spans the globe. While America remains the dominant market, fast-growing and populous countries such as China and India are taking their place on the diamond center stage. Rising tides of prosperity have brought luxury consumer purchases within reach.

Human beings still love natural beauty. That bodes well for fancy colored diamonds and the companies that can bring deposits hosting those stones into production. The quality of the Naujaat fancy diamonds, the strength of the North Arrow and Burgundy teams, and the recent rebound in diamond sales says North Arrow may be closer to that objective than its market capitalization suggests.

North Arrow Minerals (NAR-V)
Price: 0.11
Shares outstanding: 111.68 million (166.4M fully diluted)
Market cap: $12.17 million

James Kwantes is the editor of Resource Opportunities, a subscriber supported junior mining investment publication. Kwantes has two decades of journalism experience and was the mining reporter at Vancouver Sun, the city's paper of record.

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Disclosure: James Kwantes owns North Arrow shares and was compensated by North Arrow Minerals for the writing and distribution of this article. This article is presented for informational purposes and is not financial advice. All investors need to do their own due diligence or consult an investment advisor.

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Economics

Just How Big Is China’s Property Sector, And Two Key Questions On Policy And Tail Risks

Just How Big Is China’s Property Sector, And Two Key Questions On Policy And Tail Risks

While the broader US stock market was giddily melting…

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Just How Big Is China's Property Sector, And Two Key Questions On Policy And Tail Risks

While the broader US stock market was giddily melting up in the past week, things in China were going from bad to worse with Evergrande set to officially be in default on Oct 23 when the grace period on its first nonpayment ends, and with contagion rocking the local property market - which as we explained last week just saw the most "catastrophic" property sales numbers since the global financial crisis - sending dollar-denominated Chinese junk bonds to all time high yields.

So even though it is now conventional wisdom that China's property crisis is contained (just as its concurrent energy crisis is also somehow contained), we beg to differ, and suggest that the crisis hitting the world's largest asset class is only just starting and is about to drag China into a "hard landing", with the world set to follow.

And yes, with a total asset value of $62 trillion representing 62% of household wealth, the Chinese real estate sector is not only 30 times bigger than the market cap of all cryptos and also bigger than both the US bond and stock market, but is the key "asset" that backstops China's entire financial system whose deposits at last check were more than double those of the US. In other words, if China's property sector wobbles, the world is facing a guaranteed depression.

So given the escalating weakness in China’s property sector, which has been in focus given intense regulatory pressure on developers’ leverage and banks’ mortgage exposure, and consequent contraction in sales and construction activity, it is natural to ask how significant a hit this could pose to both China's and the global economy. To help people get a sense of scale, below we excerpts some of the key findings from a recent note from Goldman showing just how big China's property sector is.

  1. A wide range of estimates for the scale of China’s property sector — up to about 30% of GDP — have been reported in the media and by other analysts. Different definitions of the scope of the sector largely account for the disparity.
  2. The most important distinctions are what types of building are included (residential, nonresidential, or all construction including infrastructure), what economic activity is included (only the construction itself, or all the value-added embedded in the finished residence e.g. domestically produced materials), and whether related real estate services are also included.
  3. A narrow definition of “residential construction activity as a share of GDP” could be as low as 3.6% of GDP. Expanding this to include all related domestic activities - e.g. materials like metals, wood, and stone produced domestically and used in housing construction, as well as services like financial activities and business services used directly or indirectly by the housing sector - would account for 12.4% of GDP. Adding nonresidential building construction and its associated activity would take it to 17.7%. Finally, including real estate services—which show a high correlation with broader property trends—would take the number to 23.3%. (All these numbers are based on detailed 2018 data, and exclude infrastructure spending not directly related to residential and nonresidential buildings.)
  4. The property sector’s share of the Chinese economy has grown fairly steadily over the past decade, after surging in the stimulus-fueled recovery just after the 2008 financial crisis.

Digging into the definition of the “property sector”, there are three main questions that need to be kept in mind:

1. What types of construction? One important difference is in what types of construction activities are included. Construction broadly consists of three categories: residential housing, nonresidential buildings, and infrastructure-related construction. In China, residential construction appears to be about half of total construction—the rest is either non-residential building construction or civil engineering works, plus a small amount of installation/decoration activity. Specifically, residential and nonresidential buildings represent around 70% of total construction, and residential floor space under construction is typically about 70% of total floor space under construction.

Note that this ~50% share for residential share of total construction is not unusual in international perspective. For example, the residential share is similar in the United States—though it reached into the 60-70% range during the peak years of the housing bubble—and has been about 40-50% in South Korea for some time.

2. What types of economic activity (only construction, or everything necessary to complete the finished building)? An even more important distinction is what types of activities one counts. Strictly speaking, the construction industry itself represents about 7% of China’s GDP. This represents wages, profits, and taxes from the construction sector (regardless of what type of construction or what end users). This is the value added of the construction sector itself, or the narrowly defined activity of building things.

However, the construction industry uses a lot of output from other sectors – both materials (cement, wood, steel, etc.) and services (transportation of materials, financial services) to create finished buildings. Put another way, there are a lot of “backward linkages” from the construction sector: a home purchase requires not just the value added from construction industry, but also the value added from the “upstream” industries that provided the materials and were otherwise involved in the completion of the finished product.

To gain some intuition for this, in the chart below, Goldman shows how much of each industry’s domestic value added ultimately goes into “final demand” of the construction industry (purchases of property by consumers or investment in property by businesses). For example, about one-third of value added in “wood products” goes into construction, about one-half of basic metals value added goes into construction, and essentially all of construction’s value added goes into construction final demand. (Note that this includes direct and indirect requirements—for example, basic metal output that is sold to firms in the metal fabrication industry that then sell to the construction sector would be counted as part of final demand for construction.)

The next chart shows what fraction of the final demand for construction is provided by each sector. Roughly speaking, if we think about this as “the total domestic value added embedded in an apartment”, almost 30% of this is provided by construction activity, 8% from nonmetallic mineral products, etc.

From the perspective of total domestic value added from all industries embedded in the final demand of the construction industry, the overall construction industry’s final demand accounts for roughly one-quarter of China’s GDP. This estimate is based on China’s most recent (2018) “input-output” table—which indicates the final output of each industry, as well as how much input is used from every other.

3. Should real estate services be included. Some analysts focus on property construction only, while others add the “real estate services” sector e.g. the leasing and maintenance of buildings when estimating the impact of the housing sector of the economy. These activities contribute roughly 6-7% of GDP in China. In many countries, real estate services are somewhat less volatile than housing construction. The likely reason is that real estate services relate in part to the stock of existing buildings than the flow of new building construction. Even if there were a housing crash and building construction stopped, most real estate services could theoretically continue.  As evidence of this, in the US housing crash, construction sector GDP fell by ~30% peak to trough but real estate services never declined. That said, in China the “real estate services” sector has been significantly more volatile, almost as volatile as the construction sector itself.

Contributions by type of demand and activity

Taking these three factors into consideration, Goldman next shows estimated shares of China’s activity in the next chart, and breaks down construction into its main components while showing the share attributable to real estate services. The “sector activity” column shows the share of GDP accounted for directly by activities of that sector. In other words, companies and workers engaged in all types of construction activity accounted for 7.1% of China’s GDP in 2018. The “final demand” column shows the share of GDP accounted for by all the domestic economic activities embodied in final demand for that sector. In other words, the demand for buildings and other construction also generates demand for materials and other types of services — and adding the value added in construction and all of these “upstream” sectors together gives the numbers in the right column

Putting the above together, the size of China’s property sector therefore depends on the question we want to answer:

  • What share of Chinese economic activity do workers/companies involved in residential construction represent? Here, one should look at domestic value-added (the left column). This is 7.1% for overall construction and just 3.6% for residential construction only.
  • How much economic activity is driven by demand for residential property construction? Residential property demand drives 12.4% of GDP (right column, second row in table), because in addition to the construction activity it creates demand for all the materials and other services involved in building construction.
  • What about the impact of total demand for property construction? Including non-residental buildings as well as residential, and the total upstream requirements of both, we want to look at the “domestic value added in final demand” of construction of residential + nonresidential buildings. This is 17.7% of GDP (12.4%+5.3%).
  • How much of the economy is at risk from a property downturn? Here, we could potentially add end demand for real estate services to the above calculation. This would be another 5.6% of GDP, suggesting 23.3% of the economy—nearly a quarter—would be affected.

Finally, if one adds all construction and all real estate and all their associated activities, we get just over 30% of the economy (24.5%+5.6%), although it is worth caveating that this may be an overly broad definition for the property sector, as it includes infrastructure-related activity, which if anything is likely to be ramped up by policymakers in the event of severe property sector weakness.

* * *

Yet even a nice big, round 30% estimate for how much China's property sector contributes to GDP, does not encompass all the potential spillovers from a construction sector downturn. There are at least three others:

  1. Second-round effects. A shock to construction (or any other sector) implies a drop in wages and company profits in that sector. This in turn implies lower income for the household and business sectors — and incrementally lower consumption and investment respectively. Such “second-round” or “multiplier” effects aren’t included in the estimates above.
  2. Fiscal spillovers. Land sales represent an important part of local government revenues in China (roughly 1/3 in gross revenue terms). Governments acquire land usage rights from rural occupants and sell them at a premium via auctions to developers. If land sales revenues fall because of a housing downturn (through some combination of fewer successful auctions and/or lower land prices), budgets will be squeezed, which could limit local governments’ spending and investment.
  3. Spillovers abroad via imports. As the world’s largest trading nation, China does not get all of its construction materials and other intermediate inputs domestically. In addition to the estimates above, which focus on domestic value-added, about 11% of the total value added embedded in China’s construction final demand is from foreign sources. (This is about 3% of China’s GDP, although it makes more sense to look at each trading partner’s exposure relative to the size of its own economy.) So, if we wanted to look at the total size of China’s construction sector in terms of driving economic activity, regardless of where that economic activity occurs (perhaps to compare China’s construction sector to other countries with different levels of import intensity) the figure in the top right cell in Exhibit 3 would be 3% larger.

Putting it all together, and China's property sector emerges as the mother of all ticking financial time bombs.

* * *

Which brings us to what is Beijing's latest policy action (if any) to prevent this potential financial nuke from going off, and what are any additional tail risks to be considered.

Well, as noted above, China's property sector began the week with sharp price falls across the board, with China's junk bonds cratering to near all time lows and with signs that the concerns are spilling over to the broader China credit market with spreads widening across the board. Some key updates:

  • Recent news suggest China property stresses are building up. A number of China property HY developers have made announcements over recent weeks regarding their upcoming bond maturities.
  • On 11 Oct, Modern Land launched a consent solicitation to extend the maturity on its USD 250mn bond due on 25 Oct by 3 months
  • Xinyuan Real Estate announced on 14 Oct that the majority of holders of its USD 229mn bond due on 15 Oct have agreed to an exchange offer. Note that Fitch considers both transactions to be distressed exchanges.
  • Furthermore, Sinic announced on 11 Oct that they are not expecting to make the principal and interest payments on its USD 250mn bond due on 18 Oct. These indicate that stresses amongst developers are building.

Meanwhile, the grace period on Evergrande's missed coupon payments is ending soon. Evergrande missed coupon payments of USD 148MM on 11 Oct. This came after missing an earlier coupon payment on 23 Sep. The earlier missed coupon has a 30-day grace period, which ends on 23 Oct, and should that not be remedied in the coming week, the company will be in default on this bond. With Evergrande USD bonds priced at around 20, a potential default is unlikely to have large market impact, though if the company is able to remedy the earlier default, this could provide a positive surprise for the market.

Despite these mounting risks, the market staged a sharp rebound at the end of the week, with news emerging that policymakers are seeking to speed up mortgage approvals (if not followed by much more aggressive easing, this step will do nothing but delay the inevitable by a few days).

And while Goldman's China credit strateigst Kenneth Ho writes overnight that valuation is cheap across the lower rated segments within China property HY, market direction hinges on whether they will be able to refinance and avoid defaults. In particular, he notes that with $6.2bn of China property HY bonds maturing in Jan 2022, policy direction in the coming two months will be key. And since Goldman remains in the dark as to what Beijing will do next, as it remains "difficult to foresee how policy developments will play out in the coming weeks", Goldman prefers to wait for clearer signs of policy turn before shifting lower down the credit spectrum.

* * *

This brings us to what Goldman calls two key questions on China property - policy and tail risks, which will dictate the direction of the China property HY market.

As discussed in depth in recent days, Beijing's tight regulatory stance is increasingly affecting a broader set of developers, as slowing activity levels are adding to worries across China property HY. For the period from early August to the first week of October, the volume of land transactions cratered by 42.5% compared with the same period last year, and for property transaction volume, this fell by 27.0%.

Difficult credit conditions and weak presales add pressure to developers’ cash flows, and these factors are what led to the pick up in defaults and stresses in China property HY. Therefore, unless there are clear signs of an easing in policy direction, Goldman warns that tail risks concerns are unlikely to subside, and these will dictate the direction of China property HY market. As noted by Goldman's China economics team, credit supply holds the key to China’s housing outlook in the near term, emphasizing the need for policy adjustments in order to stabilize the housing market. Incidentally, the latest monthly Chinese credit creation numbers showed a modest miss to expectations, as total TSF flows came in at 2.928TN, just below the 3.050TN consensus, and up 10.1% Y/Y, lower than the 10.3% in August (the silver lining is that M2 rose 8.3%, up from 8.2% in August and above the 8.2% consensus).

That said, given the sharp slowdown in residential property activity levels over the past two months, policy stance appears to have relaxed over the past two weeks if somewhat more slowly than most had expected. The table below summarizes a number of policy announcements and news reports that suggest some easing of policies are taking place.

That said, the announcements and policymakers’ statements do not signal a large shift in overall policy direction yet. For example, the more concrete measures such as home buyer subsidies and the reduction in home loan interest rates are conducted at a city, and not national, level. And whilst Bloomberg reported that the financial regulators have informed a number of major banks to accelerate mortgage approvals, the precise details are lacking. The recent actions are therefore mostly in line with the overall policy stance. On one hand, policymakers remain focused on the medium term goal of deleveraging, and will want to avoid over-stimulating and reflating the property sector; on the other hand, policymakers have stated that they want a stable property market and to avoid systemic risks from emerging, suggesting that they would seek to avoid over-tightening. The problem is that they can't have both, and one will eventually have to crack.

Goldman is somewhat more optimistic and writes that finding a balance will take time, adding that "given the need to balance the competing policy objectives, further measures could continue to emerge piecemeal, and visibility on the timing and the type of policy actions are limited." Furthermore, there may need to be further downside risk towards the property sector before we see a more decisive change in direction in the policy stance. This means that tail risks concerns are unlikely to subside, despite signs that policy direction is gradually shifting.

* * *

Assuming help does not come on time, the next key question is how fat is the tail as large amounts of bonds trading at stressed levels. Currently, the China property market is pricing in elevated levels of stress. Their price distribution is shown below indicating that 38% of bonds (by notional outstanding and excluding defaulted bonds) are trading at a price below 70, and 49% of bonds are below a price of 80.

Are market prices overly bearish on tail risk, or are they accurately reflecting the stresses amongst property developers? With policymakers likely to maintain their medium term goal to delever the property sector, it is unlikely that tail risk concerns for higher levered developers will not subside. However, how “fat” the tail is will depend on the policy stance over the next two months.

A big challenge going forward is that there are sizeable bond maturities in the next year, which will heavily influence tail risk. As noted above, a number of developers have conducted or are seeking to complete distressed buybacks, and defaults rates amongst China property HY companies are soaring. As such, the policy stance in the next two months will be critical.

As shown in Exhibit 2, China property HY bond maturities are relatively light for the remainder of 2021, but pick up substantially in 2022, with USD 6.3bn of bonds maturing in January alone!

A full list of bond maturities from now to February 2022, is shown below.

It goes without saying, that should policy easing over the next two months be insufficient to ease the financial conditions amongst developers, there could potentially be a meaningful pick up in credit stresses at the start of 2022 just as the Fed launches its taper and just as a cold winter sends energy costs to unprecedented levels.

Finally, for any investors seeking some exposure to China's HY market assuming that the worst is now over, Goldman agrees that while valuation is cheap across the lower rated segments within China property HY, the key determinant on market direction won't be valuation, but rather hinges on whether developers will be able to refinance and avoid defaults - i.e., can the Ponzi scheme continue.

Tyler Durden Sat, 10/16/2021 - 18:00
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Precious Metals

Eagle Plains Resources releases Donna drill results, provides Knife Lake update

 
Eagle Plains Resources (EPL.V) has released the assay results from the 12 hole drill program completed at the Donna project in British Columbia. The…

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Eagle Plains Resources (EPL.V) has released the assay results from the 12 hole drill program completed at the Donna project in British Columbia. The drill program was completed in the first few weeks of the summer period but the labs are still slow so it took a while for the company to see the assay results. As a reminder, the summer drill program was directly following up on the exploration activities in 2020 when the Donna activities had to be suspended due to bad weather.

The summary of the more important drill holes can be found above. The best interval was actually hole DO19001 which encountered 1.5 meters of 9.41 g/t gold. That hole was the deepening of a previous drill hole that was completed in 2019. Hole DO21002 was drilled from the same drill pad and targeted the hanging wall and footwall ones. Some gold was detected (with 0.77 meters containing 4.46 g/t gold and 2 meters of 1.33 g/t gold as main features) but the other intervals were less intriguing. Holes 3 to 12 were all drilled at and around the past producing Morgan mine area and while the holes intersected limestone and metavolcanics, and we hope the data from the drill core will help the Eagle Plains geologists to further refine and re-define the exploration targets on the property.

Also keep in mind the surface exploration activities at Donna just continued throughout 2021 and the company’s field team collected in excess of 1,200 soil samples, 84 silt samples and 92 rock samples from the main zones of importance at Donna. All the data from the drill program and field exploration program is being analyzed and the results will be used to put together a 2022 exploration program.

Eagle Plains also provided an update on the Knife Lake project in Saskatchewan,  where partner Rockridge Resources (ROCK.V) has just completed its geophysical program. That summer program included an airborne electromagnetic survey, conducted over 610 line kilometers over the Gilbert Lake area, where no modern exploration activities have taken place.


Disclosure: The author has a long position in Eagle Plains Resources. Eagle Plains is not a sponsor of the website, but related company Taiga Gold is. Please read our disclaimer.

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Precious Metals

Mountain Boy Minerals awaits assay results on seven holes drilled at American Creek, surface sampling returns high grades

2021.10.16
Drilling at Mountain Boy Minerals Ltd.’s (TSXV: MTB) (OTCQB: MBYMF) (Frankfurt: M9U) flagship American Creek property in British Columbia…

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2021.10.16

Drilling at Mountain Boy Minerals Ltd.’s (TSXV: MTB) (OTCQB: MBYMF) (Frankfurt: M9U) flagship American Creek property in British Columbia is progressing well so far, with a total of seven holes completed from two drill pads.

Five of the holes were completed in the High-Grade zone, with the remaining two on the High-Grade extension. Core samples have been shipped to the lab, with assays pending.

The drill has since been mobilized to the third pad at the Maybee zone, where drilling is currently underway.

Results from surface sampling of the property earlier this season have also been received, with assays of up to 3,444 ppm Ag (Maybee zone), 6.166% Cu (High-Grade zone), 15.26% Pb (Mann zone) and 17.57% Zn (High-Grade zone).

The recent work by MTB included mapping and sampling along the cliffs north of the old mine, an area that had not previously been examined due to the difficult access.

Geologists skilled in rock climbing traced the structure hosting the High-Grade mineralization approximately 400 m to the north, identifying an area now referred to as the High-Grade extension, where the initial two holes were completed.

Geological work is continuing, focusing on the area between the High-Grade zone and the Maybee zone, a 2 km long corridor within the 33 sqkm property. Multiple veins in that area remain underexplored to this day.

The intent of the current program is to improve the geological context with the intent of identifying further drill targets.

“Silver and base metal mineralization has been identified over multiple kilometers and includes some exceptional grades. We are working systematically toward an understanding of this extensive and robust mineralizing system which we firmly believe has the potential to host the kind of deposit for which the Golden Triangle is renowned,” Mountain Boy CEO Lawrence Roulston commented in a news release dated August 16.

American Creek Overview

The American Creek project is centered on the past-producing Mountain Boy silver mine, located 20 km north of Stewart in BC’s Golden Triangle.

The property has favourable host stratigraphy, including rocks from the Lower to Middle Jurassic Mount Dilworth formation and Lower Jurassic Hazelton Group. Recent geochronology also confirmed the presence of Early Jurassic intrusions on the property.

Geology of American Creek

There is abundant evidence pointing to large, continuous regional and property scale faults, folds and shear zones, which are often related to mineralization in the region. Significant alteration and mineralization have already been observed along these structures forming the American Creek corridor.

Therefore, Mountain Boy Minerals considers the area to have “real potential to host one or more deposits.” While it holds a significant land package, with a variety of targets identified, much of the project area remains underexplored.

Mapping and prospecting on the project so far have already led to multiple discoveries, including a new area of gold-silver-base metal mineralization on Bear River Ridge, a silver and base metal intermediate epithermal system along an approximate 2 km trend, and — more importantly — an Early Jurassic latite porphyry intrusion below the epithermal system.

This previously unrecognized intrusion is similar in age to the many Jurassic Intrusions that are related to several deposits in the area, including the Premier porphyry, which is directly related to what was once considered North America’s largest gold mine.

Ascot Resources is currently focused on restarting the historic Premier mine, which has produced over 2 million ounces of gold and 45 million ounces of silver.

The Stewart mining camp — where American Creek and many other MTB projects are found — is part of the larger Stikinia Golden Triangle and is known to contain well over 200 mineral occurrences.

“The presence of numerous nearby past producers, an evolving understanding of the geology and encouraging results and discoveries in the region all support the highly prospective nature of the area,” the company commented on its flagship asset.

2021 Exploration Program

For this year’s program, detailed structural mapping has concentrated around the many mineralized showings on the American Creek project, including the High-Grade zone.

Results from this mapping suggest that the High-Grade zone mineralization is related to an interpreted shallow westward dipping thrust fault and east-west steeply dipping cross-cutting structures.

It is postulated that the best mineralization occurs at the intersection of these two structures, and this year’s drilling will test this hypothesis.

Geologists have been working with a mountain guide mapping the cliffs around the historic silver mine. This has resulted in the discovery of several new mineralized showings to the north. The mineralization appears to be within the same stratigraphic horizon as the High-Grade zone and is cut by similar steeply dipping cross structures.

Drilling last year demonstrated that the shallow structures intersected in drill holes are rich in base metals and likely represent one of several mineralizing pulses in the epithermal system.

Guided by additional mapping results, the company has turned to steeper cross structures and localized ore shoots during this season’s drilling.

The 2021 drill program is specifically targeting four areas: the High-Grade zone, the newly discovered extension of the High-Grade zone, the Four Bees zone and the Maybee zone to the north.

Drilling of the High-Grade zone occurs at a different azimuth with the intent of testing the intersection of the shallow westward dipping thrust fault and the east-west cutting cross structures.

In 1999-2000, 51.6 tonnes of material were extracted from the High-Grade vein and sent to the Cominco smelter in Trail, BC. The documented grades of 13.6 tonnes of this material were 18.854 kg/t Ag, 1.1% Zn and 2.5% Pb.

These exceptional grades demonstrated why this is still such a compelling target to drill.

BA Project Update

Elsewhere in the Golden Triangle, Mountain Boy is also moving forward with a drill program on the BA silver-lead-zinc VMS project, located 18 km northeast of Stewart.

The 10,658-hectare BA property was acquired by Mountain Boy in 2006 following the discovery of the Barbara zone, where initial sampling yielded assays of 5.24% Zn, 0.66% Pb and 55.2 g/t Ag over 1.7 m, and 2.17% Zn, 0.41% Pb and 13.5 g/t Ag over 1.2 m.

Drilling continued at the Barbara zone over a three-year period, with a total of 13,570 m in 93 holes completed from 55 different drill pads. Significant silver, lead and zinc mineralization was encountered both in drilling and on surface.

A joint venture was later formed with Great Bear Resources to conduct an aggressive exploration program of the Barbara zone and its surroundings, which brought the total drill count to 178 holes (28,484 m).

A preliminary resource (2016) of the Barbara zone on all the drilling (excluding surface trenching was) showed 8.93 million tonnes of ore at 0.96% Zn, 0.017% Cu, 0.30% Pb and 36.77 g/t Ag, for a total of 188.6 million pounds of zinc equivalent (1.96% zinc equivalent).

The current drill program is designed to target the northern extension of the mineralized horizon at the Barbara discovery that was drilled between 2007 and 2010.

The historic drilling delineated substantial near-surface silver-lead-zinc mineralization extending over 610 m, striking north-northeast. Since then, receding glaciers at the northern end of the zone have exposed further mineralization at surface.

This mineralization has subsequently been sampled in three channel sampling campaigns extending the zone of mineralization to at least 700 m. Assays of up to 601 g/t Ag, 1.98 g/t Au, 3.31% Pb and 9.96% Zn have been returned from these programs.

Silver Rebound

Mountain Boy’s drilling of two highly prospective silver properties comes just as the precious market is experiencing a rebound due to re-emerging inflation concerns around the global economy.

For the month of September, the US consumer price index rose by more than forecast, which underscored the mounting inflation pressures in the world’s #1 economy. This in turn has driven up investor demand for assets that serve as inflation hedges such as gold and silver.

Source: Kitco

Coming off a record year, silver prices have somewhat pulled back in recent months, but the latest economic indicators are suggesting another rally is in the works, especially with the US Federal Reserve looking to tighten its stimulus measures very soon.

Daniel Briesemann, an analyst at Commerzbank AG, wrote in a Bloomberg note that he expects the tapering to be announced at the next meeting early in November, he said.

“The market is now seeing a major pivot here as far as how inflation is showing more signs of being persistent than transitory, and that’s likely to force the Fed’s hand to deliver a rate hike well in advance of what people were anticipating,” Oanda’s senior market analyst Edward Moya told Reuters this week.

The anticipated Fed tapering has so far led to a retreat in 10-year Treasuries and the greenback, both of which are traditionally investment alternatives to safe-haven metals.

In silver’s case, the outlook is particularly bright given its strong industrial demand on top of the monetary driver. In fact, much of silver’s value is derived from industrial demand and supply fundamentals. It’s estimated around 60% of the metal is utilized in industrial applications such as solar panels and electronics, leaving only 40% for investing.

A report by BMO Capital Markets shows that silver consumption by the solar industry alone could grow by 85% to about 185 million ounces within a decade.

In addition, silver demand for “printed and flexible electronics” is forecast to increase 54% over the next nine years, rising from 48Moz in 2021 to 74Moz in 2030.

Then there are the automotive and 5G sectors, which are likely to become even bigger demand drivers in the future. A comprehensive report by Sprott titled ‘Silver’s Clean Energy Future’ found that three areas of growing demand for silver — solar, automotive and 5G — potentially account for more than 125 million ounces in 10 years.

The question is whether the world will have enough supply of the metal by then.

According to the 2021 World Silver Survey, global demand for silver in 2021 is expected to outpace supply by 7% (+8% supply vs +15% demand), at which rate a significant market deficit will begin to surface.

Conclusion

In an article earlier this year, we showed the world has already reached peak mined silver. At the moment, there are simply not enough projects in development to generate the kind of production to match an accelerating demand.

When it comes to mining precious metals, the prolific Golden Triangle of British Columbia has never disappointed. Having consolidated a large property position within the region and integrated a wealth of exploration results, Mountain Boy Minerals could be well on its way to making an important silver discovery.

At American Creek, which is centered on a past-producing high-grade silver mine, work to date has supported the hypothesis of a large mineralized system capable of hosting deposits of the same scale as many others in the Triangle.

This year’s drilling at American Creek will test the true extent of this geological system, which, by the end of the program, could be demonstrated to extend over a 2 km length, containing several areas of silver-rich mineralization.

The fact that MTB compares this geological setting to the Premier camp, an important historic gold-silver producer, is also encouraging.

Mountain Boy Minerals Ltd. (TSXV: MTB) (OTCQB: MBYMF) (FSE: M9UA)
Cdn$0.16, 2021.10.14
Shares Outstanding 54m
Market cap Cdn$8.64m
MTB website

Richard (Rick) Mills
aheadoftheherd.com
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