A wounded bear
market, like the animal it represents, is one that should be handled with extreme
caution. And the cause of this injury can be, perhaps, best summed up by Gravitas
Financial’s Vishy Karamadam in a speech at the 2014 Cambridge House International Conference in Toronto this
past week, when he said, “In Canada, our problem is a decline in the resource
sector in terms of global demand. China, a big consumer of resources, is a big
reason for this decline.”
It is a sentiment
shares by others. In a presentation at the conference, analyst John Kaiser asserted,
“It will be hard to raise capital for several years. There are around 700
mining companies on the TSX Venture Exchange with negative working capital, and
the total number of small miners is shrinking. They are starting to disappear.”
Lack of capital
seems to be on the minds of every junior miner these days. And why not? Given these
trying market conditions, numerous companies have decided to bundle their cash
and either (A) invest it elsewhere; or (B) hold it until more opportune market
conditions arise. The latter option is the one most explorers seem to be taking,
but there have been numerous cases of industry shifts. Some are going into the
medical marijuana business. On the other end of the spectrum, there are some
who are against the notion of sitting on cash. For instance, Bill Fisher of
Gold Quest Mining Corp. believes activity is the key to survival in the junior
resource business. “If companies cannot afford to drill, they should be doing
geophysical work and other things that cost less money. Merging smaller
companies can also reduce overhead costs. This is happening over the last
couple of years,” he claims. Given these three opinions, how should a junior
resource investor play this market?
During the
Cambridge House Conference, Mr. Karamadam presented the audience with some
advice on how to invest in resource juniors during these difficult times. The
first step, he says, is finding the appropriate target. Primarily, one would
want to look at investing in a company with higher grade deposits and
resources. Having the necessary funds is vital. Profits are scarce while debt can
be rapidly accumulated. When it comes to developing a resource project, the
initial steps can be cumbersome. There is a list of surveying involved,
followed by an extensive planning stage, construction, and finally production
and closing. Construction alone is costly and capital intensive. Production can
also vary depending on the resource at hand. It can take anywhere between 1-100
years for extractions. Thus, it is essential to look at a company with a
substantial cost plan. “Looking at a company with cash for the next 1-2 years
to survive without much further dilution is key,” said Mr. Karamadam. One
should also look at investing in companies with an experienced management team.
Having good management is absolutely crucial. There are very few companies that
get smaller after being big for a certain period of time. Usually companies
start off small and become larger over time. Those that get smaller are usually
the product of bad management. A competent CEO, for instance, can change
the mindset of investors altogether, albeit a turbulent market. Once an
investor completes their due diligence then it is appropriate to stagger their
investment purchases. It is never a good idea to enter the market all at once.
It is better to be patient and adapt to the current market conditions.
Greater risk can
bring bigger rewards. There are external factors, though, that must be
considered, especially that of the overall economic conditions. Let’s say you
want to invest in mining stocks. The first step would be to go with a company
with a good deposit. As Gravitas Financial analyst Stefan Muchal said in a
recent Ask the Analyst segment, “without a deposit, you really
don’t have anything.” The next query naturally becomes what one would
consider as an economic deposit. Mr. Muchal explained that there are a number
of factors that make a deposit economic. These factors can be found in a Feasibility
Study, which a bank uses to fund a project. “Initially, you want to look at the
location, being in a jungle versus being in good grassland can make a lot of
difference,” says Mr. Muchal. This ties in with the earlier assertions of Mr.
Karamadam. Clearly having the appropriate resource is an essential building
block of a successful junior mining stock. As an analyst, the fundamental
element you want to look at is the strip ratio and the Net Asset Value. “The
higher the strip ratio, the more rock you will have to move, and the lower the
economics of the deposit will be. This is what will ultimately constraint the
depth of the mine,” explained Mr. Muchal. “Net Asset ratio will give you a good
idea of what money will be worth in the future versus what it is worth
now.”
Gold was another
underlying theme of the Cambridge House Conference. Many agreed that this is
not the prime time for gold. Mr. Karamadam believes there is no urgency to hold
gold at this point in time. The $US is strengthening and global political
conditions seem to be in control. Perhaps Mr. Buffett put it best in a recent
shareholder letter, “Gold gets dug out of the ground in Africa or someplace.
Then we melt it down, dig another hole, bury it again and pay people to stand
around guarding it. It has no utility. Anyone watching from Mars would be
scratching their head.”
Disclaimer: This article was posted with the
permission of a third-party contributor and the opinions contained therein
do not necessarily reflect those of Smallcappower. Smallcappower does not
endorse any investment advice provided by these third-party contributors.
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