Life Lessons: Why Jr Precious Metal Emerging Producers Have Been Underperforming

On the message boards there have been quite a few frustrated posts by fellow investors wondering why their already undervalued Precious Metal Emerging Producers have been so underperforming the underlying gold and silver metals. A Precious Metal Emerging Producer is a smaller-scale precious metal mining company that is either opening a new mine (either their first or second) or is substantially scaling up the production from existing mines. From my viewpoint, a Jr graduates from an advanced development explorer to an emerging producer when it has all the financing needed to go into production.

I've been wondering the same thing myself, but am not too worried because the ones I'm holding are so undervalued. If the price of gold and silver hold up, they should be producing such good earnings that eventually the market will "get it" and push up their stock prices substantially.

But still, what is the explanation for this underperformance? Here's some explanations I've heard:

1. Big-Boy Naked Shorting - The "big boys" (hedge funds?) are shorting Jrs (perhaps with illegal Naked Shorts) and going long the precious metals themselves. I've heard this claimed, but have never seen any actual evidence given to back up these claims. I've seen heavy shorting of Minefinders (MFN/MFL.TO) and maybe Golden Star Resources(GSS/GSC.TO), but this does not seem to be an explanation that covers most of my emerging producers. Most of my producers whom have little or no shorting according to the TSX venture exchange. Those stocks where it is happening should get quite a nice short-covering stock pop if they actually execute according to their plan.  
2. Moose Pasture Dilution - this goes something like:
   • Most of the money in the TSX Venture is in the form of index funds which invest in all of the index's stocks (good and bad). I'd love to get some facts and figures and determine how significant TSX Venture index investing is. 
   • The TSX Venture has been bloated by a multitude of "moose pasture" exploration companies. They are refered to as moose pasture stocks because they don't have any real mineral resources proved up, just moose pasture that could possibly some day be something. A small fraction of these someday may prove up a resource that is worth money, but until then they don't have much value.
   • As moose pasture stocks are added to the TSX Venture, index funds have to sell part of their holdings of existing stocks to buy the new stocks. This selling reduces the prices of the existing stocks (bad for emerging producers) bringing down the value of the index funds.
   • The addition of these stocks has the net effect of lowering the stock prices of existing stocks (and the index as a whole). The addition of moose pasture stocks is alot like the end of the dot-com bubble where tons of Pets.com and their ilk soaked up the sucker money. In this case it may be the conscious smart-money gaming of the fashionable index investing craze. This is a reminder of how Index investors can suckered by smart money who, when they know where the index investing money has to go, figure out a way to exploit this foreknowledge. Index investing only makes sense in areas where markets are efficient and that implies that there is enough actively managed money to allow index investors to benefit the actively managed money keeping the entire index valued equivalently. I don't think the TSX Venture exchange meets these criteria. 
   • When index fund investors see that they are losing money, they flee their current index for another "hotter" index. This results in the index funds selling the stock of all the companies in the index causing the prices of individual stocks and the index as a whole to lose value. This is a positive feed-back cycle and should continue until there is little index money left in the TSX Venture exchange or until a significant wave of new money buys into the exchange's stocks. Falling Nickel, Zinc and Lead base metal prices further depress the index by trashing the associated Venture base metal stocks pulling down the index as a whole. This furthers the flight from the TSX Venture of index fund money.
   • I believe this moose pasture dilution is a significant factor and that the main hope for a Jr escaping it is to either "grow up" to the point where institutional money would consider buying the individual stock for its worth (having achieved mid-tier production levels and having left the Venture exchange for the TSX or the AMEX exchanges) or to have a resource big enough and valuable enough to be a major's takeover target. For production I reckon this to be more than 100K oz gold / year or 5 million oz / silver per year. I reckon 2 million gold oz is a "big enough" resource to be a takeover target. I don't know how big a resource of silver would be necessary to be a takeover target. In any case, its not my opinion that counts, but its the "fund" money that determines what "big enough" is.
3. The Fear Factor - When the price of precious metals are rising because of fear, money leaves Jr mining stocks of all forms for safety reasons. This makes sense for stocks which still require financing (which may not be available during some kind of systemic upset), but doesn't really make sense for those which don't need financing as their outlook benefits from the rising precious metal prices. But they all get taken down anyway in the flight to safety. Again, there is the momentum effect where once Jrs start falling, they continue to fall as money exits looking for a safer place or at least one that is not down-trending. I believe that this is the case with Jr emerging producers. The antidote of the fear factor is the "Value Factor" which causes the buying of selected Jrs when they are clearly undervalued, supporting their prices. The converse of the fear factor is the "Greed Factor" where Jrs soar when the price of precious metals are rising because of greed not fear. This greed can come from sheer price rise momentum or from inflation driving precious metal prices and Jrs appearing way undervalued. Smart money may be at this point doing value investing, but this fall, as precious metals follow their seaonal rise, I'm expecting to see the Greed Factor kick in. 

To summarize, I'm rather dubious of the "Big-Boy Naked Shorting" explanation, but pretty much accept the "Moose Pasture Dilution" and "Fear Factor" explanations.

So, the life lessons I've been getting from Jr precious metal investing are:

1. Wait for the "greed phase" to invest heavily in Jrs. This year its too late for me to follow this advice because I've been long and strong all year and Jrs are so illiquid you just can't trade in and out with the money I'm swinging.
2. Only buy Jrs that you expect will "grow up" (see above). I don't care how undervalued a Jr stock seems (well, I guess I have one exception), if it doesn't have a good likelihood of growing up I'm not holding it.
3. Be on the look out for a genuine end to the precious metal bull market and be ready to exit should that occur. This life lesson comes not from the recent precious metals Jr under performance, but from the collapse of zinc, lead and nickel Jr base metal emerging producers. Its pretty clear that the price of mining stocks (and Jrs in particular) get creamed when the underlying metal price is descending rather than rising. This is the case regardless of how much money the stock may be making (or be poised to make) at anywhere near current prices. This is because there is no telling, once a metal's price starts falling, how far it will fall. A falling metal price provokes a flight for safety even if the stock is set to make big money at the current price. I believe it applies to precious metal mining stocks as well, should an exit should be taken regardless of whether one is above or under water, should there be a clear indication that the precious metal bull market is truly over.

With all of the above in mind, I believe I'm pretty well positioned with the Jr miners I have. I think I know what I'm doing with each one and have good reason to expect success with each. Of course, it all depends on them executing their plans (or something reasonably close to their plans) and the price of gold and silver holding up or, better still, advancing). The payoff should be quite substantial (easy double at least) for each if this turns out to be the case.

Here's the miners I'm holding:
o Gold Resource Corp, GORO.OB - the only one I'm green on. My life lesson from this one is that you are better off with high-quality management whose interests are aligned with the investor's.
o Aurcana, AUN.V - in less than two years will have 3 silver mines running and be producing mid-tier level silver. Has shown itself to be competent by opening one mine. Competence has been vouched for by SLW giving them 25 million cash for a silver stream.
o First Majestic Silver, FR.TO - has held up really nicely. This would be my top low-risk rec right now. This thing is really already a mid-tier and expects to more than double production in two years. Has been consistently fulfilling its guidance.
o Metanor, MTO.V - producing gold in politically safe Quebec with a mine reopener. Undervalued at the current production level with lots of good news on exploration due. Could grow up to be mid-tier while generating lots of cash flow.
o New Guinea Gold, NGG.V - after a long time (ala ROK.V, uh-oh) is now in production at 30K oz/year at one mine while proving up a 2 million oz, very high-grade open pit gold mine nearby. Its this other deposit that makes them a takeover target.
o ATW Corportation, ATW.V - reopening two gold mines in Australia. A value play in that the market cap is less than what the two mills are worth. Depends on exploration turning up more oz nearby. Highly respected management.
o Minefinders, MFN/MFL.TO - may sell this to make room for other ideas. Not as undervalued as the rest, but big enough project going into production this month (gold and some silver) to be a takeover target.
o Golden Star Resources, GSS - ok, at this point I feel like Charlie Brown with Lucy holding the football, but if these guys would just execute, GSS could really be a major winner for me. I'm giving them one more try with the earnings coming out this week.
o Silverstone Resources, SST.V - a way undervalued relative to Silver Wheaton silver stream licenser with the same management as the respected copper miner, Capstone (CS.TO). Has not the same growth profile in acquiring silver streams as SLW, but is way under valued on a  cash / flow, annual oz and resource oz basis, so they don't really need any additional silver streams to be a quite nice cash generators.

So in parting, leave me a comment:

1. What do you think best explains the underperformance of Jr precious metal emerging producers?
2. What life lessons have you learned about Jrs from this trying period?
3. Which do you like and why? 
4. What do you think will signal a good entry point for Jr precious metal emerging producers?

MontyHigh

 

Comments

[B.J. Potter]

patience and keep buying as the juniors and mid-tiers get hammered...eventually people will realize the dollar is worthless and big money will shift into the gold and silver mining sector as physical
and paper is bought in a big way...gold and silver are real money and I don't see the U.S. keeping our economy together without a major wreck that wakes everyone up to reality...hoping for silver and gold to go to new highs by early 2009...NXG pulls 400,000 ounces of gold per annum out of the ground and has a P/E just under 10 with a forward P/E under 5 (something has to give on these realities)...patience
long Hecla Mining (HL), Northgate Minerals (NXG), Canadian Zinc (CZICF), Coeur D'alene (CDE), Western Goldfields (WGW), Endeavour Silver (EXK) and
Minera Minerals (MNEAF)

[rick]

most juniors don't have great land. that's it. and they don't care, they just want a paycheck.
as per the .com like comment, look at the last 2yrs venture IPO's and even the ones post sept 2007- they seem like good properties and decent companies. its the old 2002-2005 companies that stink.

[Public Heel]

4. What do you think will signal a good entry point for Jr precious metal emerging producers?

When they drop no faster than their metal (au or ag). Then, you can short the metal and go long the miner.

[thewanderer]

Some years ago I bought SSRI from $1.50 to $2.00 range due to hard circumstances I had to sell, ( sold my winners SSRI,held my Winstar,worldcom huge mistake) I feel like I'm getting a second chance with GRC . Good management, little dilution , Production suppose to begin this year. Goal of 1/3 divedends, 1/3 for taxes and 1/3 build up the mines

Do you know the Reids personaly?
If I had the bucks I'd like to go visit them and get a better feel about wether I've made the correct decision or not.

[roberto]

'2: What life lessons have you learned about Jrs from this trying period?'

Forgot to respond to this one. I've learned nothing. Every year, I say I'm going to sell in March, or April at the latest because I know what's going to happen, but I get sucked in again because I don't believe it will happen this time. This has been going on for many years. There seems to be no cure except: Don't Sell!

[roberto]

Well, I hold AUN 50k and I hold AXR 35k, and a bunch of others, but those two are my main focus; SLW and others I trade in and out of in the 5 or 6 digit range; I have a small stable of stocks that I feel I have a feel for, and I 'farm' them. I must say that AXR has been a very frustrating hold; I've made a lot by trading it in the past, but the recent small-cap market disaster has made everything more difficult. We have a world financial crisis, and money is hard to find. AXR seems to be boxed in by iceberg orders (is Casey a suspect? They admit to big holdings in this one before, and they went from Best Buy to buy under 4 dollars to buy under 3 dollars, etc; is anyone going to bid higher if they go from Best Buy to buy under 3 dollars?); this is good in a way - it stops the big drops, but it also inhibits the breakouts. The downside? The stock has been ground down from 5.50 to 3 bucks. My current observations: SLW could be a candidate to target AXR; also, PAA is making some noises about acquiring near-producers, I assume in relatively 'safe' territory (nothing is really safe!) - they're the silver guys, and I can't imagine them not considering AXR. Nova of course, if they get the loot together is a natural as well.
AUN I consider in these terms: Why is EDR 3 bucks, and AUN 50 cents? AUN has MORE than EDR. Just that the market is crazy, I suppose. But AUN will have its day; it hit 2 bucks before and I think it's a 5 buck stock.

[I-Man]

What I've learned is that I was too early getting into Metanor and too late to get into Sangold. Looks like they are taking down SGR today on good drill results, could be a time to finnaly pick some up. Hopefully by the end of the year these jr. prices will seem like a small bump in the road.

The prices are volitale, that's for sure, as Jay Taylor always says you can sell half when your Jr stock doulbes and then you own it for free, you 'playing with the house money'

[Bruno in TX]

I think the credit crisis has had a large effect on mining juniors. That plus the rising costs to operate or build a mine. The two are related. If it costs more to build a mine and the money is harder to get, the chances that the mine will get built are much lower. Case in point is Nova Gold and Galore Creek project. When they announced they were putting the project on hold because costs had risen too much, the stock tanked. Copper Fox and others in the neighborhood tanked with it. The disease has spread through the whole sector. People don't want to assume the risk that despite good drilling results etc. the mine will not get built or that if it does they won't make any money because of higher costs to operate the mine. This is what is dragging down even some of the mining majors.

[MontyHigh]

David,

You and I have a lot in common.

I own a lot of NRDS. I used to own a lot of SRZ and First Nickel and have owned GlobeStar.

I jumped out of base metals last fall when it was clear the US was going into a recession.

I went into precious metals for safety. Its been pretty frustrating to have made the right Macro call, right sector call and then be in the whole for making the wrong investment vehicle call.

I've been playing with futures some. I expect that going forward that I'll be shifting my trading from stocks to Futures.

I'd like to stay in touch. What message boards do you post on and what's your handle.

Monty

[mike tracy]

What do you think best explains the underperformance of Jr precious metal emerging producers?
A. OK, here goes, fundamentally I think humans prefer or trust investing in products of human minds, intellectual property, versus product of mother nature i.e. natural resources and raw materials. People sense more value in a new mortgage back derivitive security, or the latest gigahertz quad core 128 bit multi-processor, or in a genetically engineered medicine. It just seems smarter to invest there versus a pile of zinc ore (or a moose pasture). It's just not sexy. Tech is sexy.

What life lessons have you learned about Jrs from this trying period?
A. Don't live or work in a high rise building.

Which do you like and why?
A. I don't invest much in PM, more industrial metals. I have been continuously green on Capstone until today's 13% fall to $3.00. I like copper plays where costs can be held at about $1/lb by the sale of Zn, Ag, Pb, Ni, AU, Ga, whatever. I like SRZ for that purpose. I prefer North American based assets. Mexico, US, Canada. NRDS is one I own too. Oh yes, and First Nickel because of the copper/nickel combination. Nickel will be back. Oh, and GlobeStar because there are no Moose in the Domenican Republic.

What do you think will signal a good entry point for Jr precious metal emerging producers?
A. No help there Monty. I have been burned with GSS, AUR, etc. I prefer an industrial metal producer with a PM or rare earth offset.

[David]

Regarding GSS, I held this stock back in 2003 and made some money on it. But I finally got tired of the constant dilution and private placement pattern, so I sold and have never been back. Looking at the chart today, the stock WAY below where I sold it.

I'm personally suffering badly with Minera Andes MNEAF.OB. The stock has fallen from $2 to $0.88 in about 5 months. Other than a Canadian private placement at $1.50, not much negative has happened with the stock and yet it has been punished badly. So, I'm in the same boat with you.

My other holdings are MFN, MRB (merged with NGD), and AZK.

Dave