November Fund Performance & Market Commentary

The Delbrook Resource Opportunities Fund returned +3.4% in the month of November vs. a return of +0.9% for the SPDR S&P Metals and Mining ETF, the Fund’s closest benchmark. Year-to-date the Fund has returned +10.3%, approximately twice the performance of the benchmark, while maintaining a Sharpe ratio of approximately 1.1.

The Fund has begun to unwind its short positions within the precious metals space in anticipation of a rebound in gold prices after the US Federal Reserve meeting scheduled for December 13th.  With 98.3% probability of a 25-basis point hike currently priced into the bond market, we see limited downside to precious metals equites in the short term, barring a dramatic hawkish shift in “fed-speak” – something we see as low probability given recent economic data and new Fed leadership scheduled for early 2018.


We’ve been asked recently to comment on some of our higher conviction ideas.  One company we are very excited about is Barksdale (BRO-t) -- a base metals focused exploration company. BRO holds approximately 5,200 acres of land bordering Arizona Mining’s (AZ-t) Taylor deposit. Historic drilling on BRO's property identified a possible extension of the Taylor deposit, which may lead to the geologic resource. South32 (S32-asx) recently exercising their top up right in Arizona and other majors have acquired land in the surrounding area. Therefore, we believe BRO is substantially undervalued at $35mm market capitalization. The Company will initiate a drill program in 2018 intended to confirm historic drill intercepts and further define mineralization.

Market Commentary: Bullish on Nickel

As we’ve written before, the commodity cycle for mining over the next decade will be different from the Chinese driven “super-cycle." Our recurring theme is that technological innovation will spur demand growth for certain commodities, while other commodities will be losers. As an example, this month we describe our outlook for nickel.

The global supply of nickel is currently about 2 million tonnes per year. That supply is almost evenly divided between high purity or Class I (99.98% nickel) and lower purity or so-called Class II, such as ferro nickel (15-30% nickel) or nickel pig iron (2-12% nickel).

Generic stainless-steel manufactures are currently the largest consumers of nickel at around 70% of global production. They do not require high purity nickel. In contrast, nickel used for batteries accounts for only 3% of consumption in 2017, but does require high purity nickel. 

Class I nickel is mostly produced from sulphide nickel ore bodies - this represented the majority of historical nickel production up until the last ten years. The exhaustion of sulphide deposits in the early years of the "super-cycle" caused the nickel price to exceed $22 per pound.
The lateritic nickel deposits have since been substituted as the primary source for nickel used in generic stainless steel manufacturing over the last decade (given the depletion of the nickel sulphide deposits). This is the reason for the decline in nickel prices since 2008. The laterite deposits are divided into limonites and the saprolites. The limonites can be exploited via the high-pressure acid leaching route (HPAL) to produce Class I nickel, but there are much higher capital costs. On the other hand, the saprolites are the primary source for cheap production of ferro-nickel or nickel pig iron, which are unsuitable for use in batteries.

Nickel and cobalt are key ingredients in the manufacture of lithium ion batteries for electric vehicles (EV’s). The topic du jour in the commodity space is the question of when electric vehicles will gain mass adoption and their potential impact on the demand for materials used in batteries. Based on the respective predictions for EV penetration rates, Goldman Sachs and Merrill Lynch have forecast incremental annual Class I nickel consumption ranging from 200K to 700K by 2025, with most of that demand gaining momentum after 2020. More staggering, both suggest the possibility that the incremental demand for battery grade nickel could increase to 1-2 million tons in 2030. Given that high purity nickel production is currently less than 1 million tons per annum and the majority of that is already used by specialty steel makers who are relatively price insensitive, an enormous production response would be required to satisfy potential Class I nickel demand growth for electric car batteries. 
It is very difficult to know when EV’s will gain mass adoption or what type of battery mixture will prevail. Nevertheless, the trends suggest that the demand for battery materials could exceed most expectations. The pertinent question is “when”, not “if.” The key issue when it comes to nickel is that only the sulphide deposits or laterite deposits amendable to high pressure acid leaching (HPAL) and are suitable for battery materials. 

In our opinion, the mining sector is not cognizant of the potential looming shortages of Class I nickel supply. The sector as of late neglected nickel exploration and new project development, while rightly focusing on debt reduction and returning capital to shareholders via increased dividends. We must also recognize that this is an industry that requires very long lead times to bring new projects on line. Therefore, we see the likelihood for much higher nickel prices over the next several years.

As always, please contact our office at 604.229.1450 with any questions you might have

Matthew Zabloski