1. Higher gold price: There is a tendency to value gold in USD terms because for traders commodities are denominated in USD terms. The USD is however not a fixed, tangible value like commodities. We can see from the gold price has gone up in real terms from the following chart, but the increase in the USD price is mostly because of a weaker USD. In terms of pounds, yen, the gold price has moved less significantly. But rest assured its going higher.
2. Project delays: The spec end of the market tends to rely more on outsourced consultants to get their projects prepared, so they need to sit in queues whilst their contractors deal with other clients. Consider the fact that a lot of geologists become traders, fund managers, investors in times like these because they have wives who don’t like to work in the bush, and certainly not PNG. Others go off and set up their own companies. Same for consultants, so labour markets are tight. Large companies have the capacity to pay more, offer higher benefits because they have the cashflows and larger projects. They are more inclined to have their own drilling rigs on-site.
3. Fund manager criteria: Fund managers tend to have minimum criteria in terms of liquidity (trading volumes), market capitalization, project diversification, which eliminates a lot of the smaller stocks. They want to hold a ‘significant amount’ of stock, and a great many specs have disappointed, eg. Gleneagle, Highlands, Perseverence, Lafayette, Bendigo just to name a few.
4. Role of commodities trading: Two years ago I attended a commodities trading seminar in Tokyo. At the time I heard very little criticism of commodities trading. Why? The market is volatile, so its easy to make large gains quickly (or lose). There is no project risk. It is a new market for fund managers, but in the current market, the ‘China factor’ and weak USD, this activity is booming. They can trade options, futures, CFDs (contracts for difference) and spot indices as well. The implication is that this trading is dwarfing trading activity in the physical market, even in the more liquid markets like gold, silver and copper. Lastly, commodities trading allows you to get the same volatility as specs using leverage. No project risk, and less specific information. Its very easy for a fund to set up, without the huge research department filled with analysts to cover stocks, let alone small spec stocks. In that context its easy to understand the lack of interest.
5. Investors: The spec investor has disappeared to some extent. Increasingly moms and dads are taking the low-risk, low maintenance route to wealth/asset management, and are placing their funds with investment funds. Banks & financial planning are huge growth industries.
6. Stock valuations: I don’t think you can simply say that stocks are cheap because they are trading at discounts to cash backing, if you consider where the funds are going….that is exploration, which is unlikely to see some value for years, and given the risk, its more likely to turn to nothing. It is not a good idea to invest in specs without a good understanding of the project merit. For 1st phase exploration I would only invest if their first hole gave >50-metre intersection of 5g/t, as I might then expect further excitement in the stock. But only if it was close to the surface, and I would tend to trade the stock. A narrow, high grade intersection might also appeal, but I want to see >40g/t and proof of continuity, or a series of such lodes. More likely I will want to see more evidence. I am going to feel more secure if they have indicated reserves, because we are closer to financial closure. There are a great many cheap stocks like that. But yes, quality specs are cheap, which is why I recommend buying.
Andrew Sheldon www.sheldonthinks.com