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If I had a crystal ball in 2002 and could clearly see the price of commodities in 2015, I would be shocked at the state of the venture resource stocks, and would probably assume the crystal ball is defective. Back then gold averaged $280, copper $0.75 and Brent $20 – today gold averages $1,150, copper $2.33 and Brent $46.
Sure, commodity prices are depressed compared to their highs but, put in context, they are still trading far higher than in 2002. The story is very different for junior venture exchanges like the Toronto Venture Exchange (TSXV) and London AIM exchange, which are anaemic at best. Venture mining and exploration stocks have endured a five year bear market followed over the last 16 months by oil & gas.
The TSXV index, which is about to enter its sixth straight bear market year, is a good measure of the resource exploration sector, as about seventy percent of its make-up is mining and oil & gas companies. The TSXV index peaked in 2011 at just over 2400. Today the index trades just above 500 and is expected to close lower on the year; average losses have been about 27% per annum over the last five years.
The question constantly asked by investors that follow the venture markets is ‘when will the market turn,’ when the question should be ‘how do I invest and position myself for a slow grinding turn around’? Below are a few simple questions that you should ask about potential investments.
Does the company have cash? Cash is king in this environment. Companies that were able to raise money during better times and have cash on hand do not need to go back to an illiquid market and try to raise funds at much lower prices, thereby diluting present shareholders.
What is the company’s cash burn ratio? How much are their monthly expenses? Dividing monthly expenses against their cash balance will give you a good idea of how long until they need to raise cash again…in this environment the longer the better.
Is the company’s general & administrative expense (G&A) reasonable and spent on increasing value? If most of the money is spent on maintaining over-priced offices or consultants it is probably not a good bet; any money that is not going into improving or proving out resource (in the ground) or infrastructure is generally money that is not well spent.
Does management have skin in the game? Far too often you see management paid hefty salaries; I would rather see managements’ fortune tied to the success of a company and aligned with investors by holding a large equity position instead of an inflated salary that has no correlation to the success of a company.
Is management capable and experienced? This is a bit of a subjective measure but important as I have seen bad management take a great resource and destroy shareholder value, and good management working with a reasonable resource and build fantastic shareholder value.
Are there any future contractual commitments or balloon payments the company may need to meet to maintain a resource, and does the company have reserves set aside to cover the payment? A company may have a great resource but if they cannot meet obligations they will be forced to raise funds at a low price (diluting shareholders), or give up the property.
Focus on companies that have resources in politically stable jurisdictions – with junior stock prices so depressed there is no need to take on additional political risk investing in riskier countries. Look for companies with assets in countries with strong rule of law and history of mining and exploration.
Diversify within the sector by investing in 5-10 companies to hedge your investments, and keep a long term mind set. The nature of the commodities market is cyclical and the one rule that has constantly rang true is that ‘nothing cures low commodity prices like low commodity prices’.
The information contained in this article is for information purposes only, and represent the views of the author. It is not intended as specific investment or financial advice, or a recommendation or solicitation to buy or sell any security. Any investments or strategies listed in this article may not be suitable for all investors. Past performance is not indicative of future performance, and as with any investment, prices may fluctuate. It is recommended that advice is sought from a qualified investment professional prior to implementing any financial plan. LOM has made every effort to ensure that the contents herein have been compiled from sources believed reliable, however LOM does not warrant the accuracy, adequacy, timeliness, or completeness of this information expressly disclaims liability for errors or omissions in this information.
