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With the price of gold having risen from its low of 255 us$/oz in 1999
to its level today, it is an interesting time to have a look at Precious
Metal Stocks (PMs).
The volatility in this sector, particularly among the juniors, is
legendary.
As Bill Bonner of the Daily Reckoning has identified in his best seller,
"Financial Reckoning Day,"
there is a certain rythym measured in decades as to
what sector one should be investing in per decade, as evidenced by the last
30 years.
From this perspective, the PMs had a good run in the late 70s
and again from 1993 to 96,( as in this chart of the XAU Gold and
Silver index), parallel to the rise in price of gold and other precious
metals.
The PMs appear again to have started a secular bull market in the
last 4 years, (as seen in the HUI, the more
recently created gold bugs index).
Financial historians may search in vain to trace some of the PM
companies, (especially the juniors) from one PM Bull Market to the next.
Why is this?
One way to explain this phenomenon is to compare these Junior
Mining companies(JMs) to the world of butterflies
(and moths).
The laws of Darwinian survival of the fittest and the strategies for
survival have some remarkable parallels!
1) Birth
Many butterflies lay large batches of eggs for
survival of their species in an effort to avoid total liquidation by
predators.
Similarly, there always seems to be a great number of new JM companies
being founded, probably because of the high number of predators, and failure
rate through lack of finance!
2) The hungry Caterpillar
The young caterpillars need masses of food, and the ones who survive,
have massive growth, often shedding and renewing their skins to accomodate their new girth several times, in the spring
and summer time.
JM companies that survive this growth phase,
are the ones that do numerous financings mainly through Private Placements,
giving exponential growth, and an increasing number of fully diluted shares
issued. The summer/ winter analogy corresponds to bull/bear market conditions
for the PM markets.
3) Surviving the winter
Depending on species, butterflies can survive the winter with
different strategies, some as caterpillars, some as pupae, and some as adult
butterflies... until the sun rises again sufficiently to reactivate them.
Junior mining companies likewise. Some shut down exploration and
hibernate with zero costs... until the metal prices rise again. Others
transformed into dot.com high tech companies during the last period of
depressed metal prices, only to re-emerge as PM companies again when the
sector revived.
The lucky PM companies, who survived the winter as butterflies, went
on to another bull market, provided their wings were strong and undamaged
enough to enable them to fly.
4) Mating
Of course for the species to survive, reproduction is necessary. Some
male moths have antenna that enable them to smell the pheromones of an
interested female at a distance of several kilometers.
With the number of species of moths running into the tens of thousands, and
finding your mate in the dark, this is perhaps a fortuitous Darwinian
attribute.
Here the pheromones
represent resources in the ground measured in millions of Gold ozs, and it takes first of all clever geologists to find
it, and later on good management with the right antenna to secure it in the
form of staking claims, joint ventures or similar deals.
5) Aesthetics
Butterflies are
among the most beautiful of all insects; the Peacock, Swallowtail, Red
Admiral, Fritillaries, to name but a few.
JM companies are also one of the most exciting of all sectors of
stocks. In a PM bull market, there are always several JMs that are
"10 baggers," ( a stock that increases 10
times in value), and occasional 100 baggers!
Extreme leverage to the gold price combined with rerating of the gold ounzes in the ground, as a junior drills its way towards
increasing ounzes, (and moving the ounzes from the resource to reserve category), are the
rocket fuel for the share price. Typical valuations range from us$ 10/oz Gold
at exploration debut to 100 $/oz at bankable feasability study stage and even higher as production
gets under way in a 7 year process.
However the process is reversable,
particularly with a downward maniuplated gold
price, as argued by Gata and
more recently in the Sprott report.
But this is one of the very factors that produce the 10 and 100 baggers, the
fact that the JM share prices can lose most of their value in a PM bear market.
The few survivors plus the next generation of new juniors relaunch at the
beginning of the next bull market.
Facit: Timing (and DD) are very important keys to success in the JM market.
6)Defense Mechanisms
Caterpillars, pupae, and butterflies have developed various ways to
discourage predators, such as bright warning colours or eye shaped patterns.
Similarly small (JM) companies often try to develop poison pill or
other defense mechanisms against take over by a
major.
So now let's leave butterflies for a moment and have a closer
look at another aspect of mining companies.
Proximity or Area Plays
A classic form for junior mining stock speculation is to piggy back
onto an exisiting successful mine or major prospect
discovery. Claims are staked all round the hot property and sometimes
promoters attempt to run up the stock with claims that they are just about to
make the big strike.
Most large mining areas are usually shared between many companies. For
example Newmont is only one of several companies with land positions and gold
mines in the Carlin Trend.
Occasionally a junior manages to gain control of a whole district, area or
very large mine, by various methods, including staking claims, joint
ventures, or takeovers or buyouts.
This is a classic route for a junior to grow into a major, and in so doing
increase its market cap by a factor of several times.
Historical examples with reference to diamonds, nickel, gold, and copper
include:
- Cecil
Rhodes Consolidated de Beers mine,
which bought out from 1871 onwards all the other claims to the
"big hole" diamond mine at Kimberley,
SA
.
- Chuck Fipke's Ekati mine where
the The great
Canadian diamond rush was on...
On Nov. 5th 1991 the JV had to go public with a news release on the
finds. Yellowknife went wild. Helicopters were buzzing in from all over the country.
By spring 1992 de Beers alone was operating 26 helicopters for staking. Chuck
had claimed 1 million acres, all prime targets. De Beers soon surpassed that
and claimed 10 mill acres, all on the off chance something might be there. END
- Robert Friedland's Diamond Filed Resources
Voisey Bay.
When RF began to realise that VB could turn out to be one of the largest
Nickel deposits in the world, he is quoted as saying... "I don't
care how much money it costs, stake the whole of Labrador" Friedland quote 1995.
.
- Freeport McMoran's
Grasberg copper and gold mine.
Summary
PM companies and in particular Juniors are among the most attractive
stocks to invest in, when the market fundamentals are favourable, as
currently in a secular gold and silver bull market.
Many of the JM stocks do not survive from one PM bull market to the
next. Some fail financially, others leave the sector, some return, others are
taken over.
A small minority survive to become majors.
The winners often increase in market cap by multiple factors of 10 or more.
What criteria can we use to try and spot the winners in the JM gold
market?
Your antenna should be sniffing through the
darkness for the following pheromones.
Search for companies with:
1. good (track record) management
2. no debt
3. well financed
4. unhedged, (ie no
forward sales of Gold through futures or derivatives)
5. good portfolio of properties, (exploration
and/or production)
6. in politically stable countries
7. focused on environmental issues
8. plans for enhancing local employment,
access roads, electric power structures
9. area plays
Most important of all Do Your Own Due Dilligence:
Study the official company filings on all news releases, feasability studies, of their principle projects to
ensure they are economically, environmentally, and otherwise viable, without
hedging of the gold price.
Alan Leishman
Alan Leishman is now
retired in Switzerland following a career in international commerce
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