Morning Musing from Mickey the Mercenary Geologist
“Gold stocks suck,” said fellow
newsletter writer Eric Coffin in a presentation at the recent Cambridge House
Investment Conference in Calgary. I could not agree more.
Let’s review the fundamentals to understand
why his words ring true.
Most micro-cap resource stocks were immersed and
have stayed underwater since a sector-wide high in early March 2011. The
Toronto Venture Exchange Index, which serves as a good proxy, is down 43%
from that period of time. Weakness in the resource sector has occurred
despite record or near-record prices for most commodities in 2011 and
continuing high prices into the second quarter of 2012.
Reasons for the decline in junior exploration and
mining stocks are many:
- The Japan earthquake and tsunami in
mid-March 2011 resulted in a significant downturn of the world’s
third largest economy and substantial damage not only to the uranium
industry but to the entire resource sector. Some mining operations have
been substantially affected by delays in delivery of heavy equipment
from Japanese manufacturers.
- Private placements in Q4 2010 and Q1 2011
became free-trading and began hitting the market four months before the
summer doldrums started. Professional investors and speculators
essentially front-ran the old adage, “Sell in May and go away.”
- The usual seasonal weakness in the summer
of 2011 was followed by a 30% correction in commodities in the early
fall that devastated resource equity markets.
- Many investors sitting on significant
capital gains from early in 2011 balanced them with massive tax-loss
selling near year’s-end.
- Continuing economic worries in Europe
related to the bad debts of Greece, Portugal, Spain, and now Italy have
led to general risk aversion among investors and speculators.
- The continuing high price of oil has
inflated exploration and development costs and resulted in less work
being accomplished at higher expenditures than advertised.
- Environmental opposition and bureaucratic
regulation have led to the delay of many projects with most
juniors’ timelines not being met at their budgeted cost.
- A slowdown of growth in China from higher
interest rates and stricter bank leverage requirements in late 2010 and
2011 has reduced overall demand for industrial commodities.
- Reluctance of financial institutions to
bankroll large mine projects because of sharply escalating capital
expenditures and operating costs has trickled down to a tight market for
equity funding of junior company projects.
- The US Federal Reserve’s
postponement of a third round of quantitative easing, at least until
after the November elections, has resulted in range-bound and stagnant
prices for precious metals.
The ten factors listed above have contributed to an
on-going bear market for junior resource stocks.
However, in my opinion the main reason that
speculators have lost interest in the high risk / high reward micro-cap sector is the overall poor performance of
these equities since January of 2011. Simply put, a legion of juniors has
consistently over-promised and under-delivered for several years now and
investors finally have grown weary of the charade.
Daily trading volumes and the value of the Toronto
Venture Exchange show the disinterest and resulting downturns:
of MSN Money
This chart shows that:
- More than 200 million shares were traded
daily for most of the first quarter of 2011.
- There were only three days with trading
volumes greater than 200 million shares in April 2011.
- There have been two days with trading
volumes greater than 150 million shares since May 2011.
- Average daily volumes have been less than
100 million shares since July 2011.
Seasoned investors know that trading volume and
market capitalization are strongly correlated. The lack of liquidity in the
junior resource sector is shown by the on-going downtick of the Venture
According to my friend Glen Jones at Intierra Resource Intelligence,
nearly 80% of the1716 micro-cap (herein defined as <$500 million market
value) exploration and/or mining companies listed on the Toronto Stock
Exchange and Toronto Venture Exchange have a property with gold as a primary
or secondary commodity. A little less than half of those reported news on the
property in the past 12 months.
Since January 4, 2011, the performance of junior
gold stocks has been dismal compared to the price of gold.
- Gold has risen from $1389/oz to $1642/oz for an 18%
- The Toronto Venture index has a 39%
decline from 2275 to 1398:
- The abyssmal performance
of junior resource gold stocks is best illustrated by a ratio of the
Toronto Venture Index to gold, which has dropped from 1.64 to 0.84 for a
The junior gold sector boomed post-global financial
crisis from Q2 2009 thru Q1 2011 because commodity prices rebounded to new
highs and venture capital was readily available for all comers. Many gold
stocks lacking the necessary criteria of a tight share structure, an
experienced and successful management, and a robust flagship project were
financed with “itchy money” during this period.
Many low-grade projects with marginal to bad
economics were promoted, company managers consistently over-promised and under-delivered, and repeated equity financings, often at
lower and lower prices, led to massive dilution and obliterated the gains of
longer-term committed shareholders.
In classic bull markets, greed rules and investors
become speculators. Fearful of missing the next big thing, they
indiscriminately throw money at each and every opportunity.
It’s especially important at these times to
try and separate the few contenders from the many pretenders, find a few good
companies that have a chance to become miners, and disregard the majority who
exist solely to “mine the stock market” (Mercenary Musing, October 20, 2008).
In late January 2011 I sensed that gold stocks had became overbought and, made a conscious decision to
lighten my exposure. At that time I ceased coverage on two advanced explorers
from which we had taken our doubles in less than 12 months. Four months later
I exited a typically underachieving gold explorer and subsequently took a
tax-loss on it at year’s end (Mercenary Musing, September 12, 2011).
As market valuations have dwindled over the past 14
months, it has become increasingly apparent to me that the Toronto Venture
Exchange is overloaded with and burdened by a plethora of junior gold
explorers that will never be successful and reward shareholders.
Little wonder the investing public has become
disillusioned, disinterested, and disgusted.
Now that we are in a bear market for juniors, most
stocks, whether good or bad or ugly, will suffer in a like manner. Some
writers, mavens, gurus, and pundits have recently called the bottom or
surmised that the bottom is near and now is the time to buy.
We are coming into May when selling is normally
expected to pickup, and that will be followed by
the dog-day doldrums of July and August. The economic outlook in Europe is no
better, China continues to slow its economy, the US Fed, partisan
policymakers, and politicos will do
nothing of import before the November elections, the price of oil remains
high, and metals prices are stagnant. Markets are skittish and subject to a
whim within an undercurrent of trepidation. None of the above factors will
inspire the confidence of risk capital in the short term.
Although I am a contrarian by nature, I do not
foresee a catalyst for improvement before Labor Day at the very earliest, and
I do not intend to participate as a wholesale buyer at this juncture.
The real question in front of cannot be answered at
this time: Could this game be over or is it just in an extended rain-delay?
That said, at some point valuations for the small
minority of fundamentally strong gold companies will make for some no-brainer
buys. Until then, I prefer to sit on the sidelines and simply watch the
Despite my bearish bent, I remain a committed
shareholder of two gold companies currently covered via Mercenary Alerts for free email subscribers only.
These two issuers have the requisite three key criteria listed above and have
maintained strong share prices even in this down market.
In addition, those who follow me know that all is
never lost and I can always find something to go long on. Currently my cash
is looking for graphite explorers and developers and oil companies with
upside production stories and low debt. As always, I continue to search for
compelling copper oxide and uranium plays.
Anybody out there got a hot tip? You know how to
Ciao for now,
The Mercenary Geologist
The Mercenary Geologist Michael S. “Mickey” Fulp
is a Certified Professional Geologist with a B.Sc. Earth Sciences with honor
from the University of Tulsa, and M.Sc. Geology from the University of New
Mexico. Mickey has 30 years experience as an
exploration geologist searching for economic deposits of base and precious
metals, industrial minerals, coal, uranium, and water in North and South
America and China.
Mickey has worked for junior explorers, major mining companies, private
companies, and investors as a consulting economic geologist for the past 22
years, specializing in geological mapping and property evaluation. In
addition to Mickey’s professional credentials and experience, he is
high-altitude proficient and is bilingual in English and Spanish. From 2003
to 2006, Mickey made four outcrop ore discoveries in Peru, Nevada, Chile, and
Mickey is well known throughout the mining and exploration community for his
ongoing work as an analyst for public and private companies, investment
funds, newsletter and website writers, private investors, and brokers.