Analysts’ ideas of the week – what triggered this depressing junior resource market?

Walking Howe Street in Vancouver is depressing these days. Those not familiar with Vancouver, Howe Street is has traditionally been the financial district of Vancouver, like Bay Street in Toronto. Howe Street, the Mecca of junior resources, includes thousands of junior resource companies employing thousands of people. It is hard to come across a cheerful face these days – the culprit being the disastrous junior resource market. The TSX Venture is down 31% YOY, and 63% in the past 5 years. This is illustrated below.

According to the TSX, total financings were down 70% YOY in February 2013; the total number of financings was 33 in that month, down from 71 in February 2012. According to PwC, there was not even one IPO on the TSX or the TSX Venture in Q1-2013 – the first time in a decade! In comparison, Q1-2012 had 13 IPOs (Initial Public Offerings) for all Canadian Exchanges, 12 of them were in mining.

Gold and copper are the two most dominating commodities in the resource sector. Gold did give us a scare two weeks ago, but has since crawled up to $1,470 per oz (from the low $1,300s). Gold is up 67% over the past five years; copper is down by 13% – but this drop does not justify the 63% drop in the TSX Venture over the past 5 years.

The primary reason for the drop is the over ambitious plans by mining companies in the 2000s – everyone was after big deposits. Raising capital then was not an issue; in fact, anyone who felt “I would like to get into the mining sector” could raise money in the mid 2000s. Companies (and investors) were not concerned then about the economics of projects – they all felt that one ‘bonanza’ hole could make them richer. Therefore, when base metal prices eventually dropped, those high CAPEX projects started to become not feasible.

A very common trait of junior resource companies, and their investors, is that they get so focused on the positives that they never consider the negatives. This phenomenon resonates very well with a book I am reading now called the “The Black Swan”. In the book, the author, Nassim Nicholas Taleb, a mathematician, trader, philosopher etc, discusses/stresses the impact of highly improbable and rare events on our daily lives – which he calls the ‘Black Swans’- an extremely rare bird. One of the best examples he gives is about a turkey that is fed every day. People observing the turkey would think that humans are looking out for the best interest of the turkey. However, on Thanksgiving day, something totally unexpected happens to the turkey. This is an event that none of our analysts/forecasts/economists would have predicted, as everyone makes their predictions based on events in the past. A similar example of a black swan event is the 9/11 incident – these incidents have had a huge impact on our lives, and have completely changed the dynamics of the environment we are in. The takeaway here is that we all should consider the worst-case scenarios before making any significant move.

Investors are now highly skeptical about high CAPEX projects. However, I believe, we are soon going to see everyone starting to talk about the drop in exploration expenses, and the impact it is going to have on the supply of essential commodities – which is when I think the mining sector will wake up. We investors have a very short-memory – one or two positive events will bring most of the investors back in the market. Therefore, in order to take advantage of this behavior, we should now be invested in companies with strong fundamentals. No one can predict the bottom, and I certainly do feel that this is the time to park some of your capital on some good stories out there.

Over the next few weeks, we will be doing a survey of the CEOs /senior management of juniors to get an idea on their plans for the next 6 months. This survey will give us lot of insights on when the market is going to pick up, as ultimately, it is they who decide the markets. Do look for the results in a future edition of this publication!

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