The Commodity Investor Q&A
With Matt Badiali
August 27, 2008
Q: Mining companies are getting cheap, and I know you like gold and silver. Is it time to buy yet? – A.J.
A: Not yet. Here's why.
Late last month, I met with 22 natural-resource companies in Vancouver. Every meeting was the same... The mood is kind of a forced optimism. It reminded me of Kevin Bacon's character at the end of Animal House, yelling "Remain calm. All is well..." as he gets trampled by a panicked crowd.
I'd go into the meetings and we'd smile at each other. Then we'd discuss the projects. Nothing makes geologists happier than talking about rocks – especially rocks with gold in them. We'd laugh, and I'd slap their backs. The rocks look great.
It wouldn't get ugly until I asked about burn-rates (that's the amount of cash the company goes through to keep the lights on and the drill rigs turning). Mining companies live or die by the money they raise in the market. That's because they have ZERO cash flow and fewer assets. They get cash by selling shares, and today those shares are worth half or a third of what they were a year ago.
Worse yet, many of these companies will need funding in the next six months or they'll go under. That's when the bear market will really hit.
The main market for junior mining stocks is the Toronto Stock Exchange's Venture Exchange. The TSX V peaked at 3,361 in April 2007. It bottomed at 1,901 on August 19, a 43% decline. The majority of that decline (28%) occurred since July 1.
Investors – both retail and institutional – are fleeing the market. But the funds are the real culprit. Even in a good market, these small-cap miners are thinly traded companies. Trying to dump 10,000 or 20,000 shares into this bear causes catastrophic falls in share price. That's why the funds wait for good news. They are selling off the best stuff, because it's liquid.
You can see that by looking at the charts of companies like Hathor, Canplats, and Keegan Resources. These companies all have legitimate discoveries. In any other market, these stocks would be triple their current value.
The sense in Vancouver and Toronto (the hubs of mining and finance in Canada) is fear. Brokers won't touch deals. Companies looking to raise cash among the traditional banks and brokerage houses are getting the brushoff. There is neither the will to lend nor the source of funds for risky projects.
That leaves quite a few companies in dire straits.
If a company with cash flow and a real business can't get funding, how will an exploration company get it? The answer is, many won't. That means the TSX V will see another leg down, as many of these companies fail for lack of funding.
In addition, commodity guru Rick Rule, of Global Resource Investors, believes Canadians will sell even more ahead of the new year, to take advantage of a tax loophole.
A lopsided trade with too many buyers or sellers is like putting everybody on one side of the boat. In this case, share prices will fall ridiculously far before anyone will buy.
So here's what you should do: Make a short list of companies you want to own. Then wait. By mid-December, you should start seeing those stocks begin to bottom out. That will be your window of opportunity.
Good investing,
Matt Badiali
Editor's Note: Thanks to all of you who have sent questions in to the Commodity Q&A. For the rest: If you'd like to see your natural-resource question answered next Wednesday, let me know.
