When the contrarians join in the herd, a turning point is fast approaching. Sentiment across the junior resource sector is dismal. It is shaking the steadfast dedication of even the gold bugs – some of the most resilient and loyal followers that exist. When their confidence shakes, something is afoot.
This week I received a call from a mining entrepreneur. He is independently quite wealthy and in fact, not too long ago sold a junior resource company for nine-figures. This is not a destitute retail investor who has burned through his last dollar betting on a dying penny stock. Yet, he relayed to me the same fears I have been hearing more and more of late – the junior resource market is broken, traditional avenues of financing are gone for good, this bear market could last for another five or ten years, and the key statement – things are different this time.
I provided him with a pep talk I have given countless times over the past couple months, my thesis to which is that contrary to public sentiment, things are going to be exactly the same this time.
First there will be a move off the lows (what causes this is unknown, but also irrelevant). Then investors with an eye on resource stocks will start to move in, wondering if this is the beginning of a real move. Pretty quickly, brokers and bankers will begin to pick up the phone and call their clients, talking about the next big mining deal. And before long, retail investors will be buying stocks like hot cakes.
News that previously was yawned over and created selling, will not just catch a bid, but in many cases cause frenzy. Recycled mining projects will be re-housed and renamed, and once again sold as the next big discovery. Five and ten cent stocks will head towards a dollar. Non-brokered unit financings with full warrants will shed their warrants and eventually turn into bought deals. Unsightly and unkempt promoters, without a hope in the bear market will emerge from the shadows. And the revival of the Vancouver machine will be complete.
Investors have trouble seeing this picture because the junior resource market at the moment is so depressed.
Just recently, the Toronto Venture Exchange ($CDNX) breached its December 2018 low and is just 8% away from reaching its 2015 low. Relative to the price of gold, the $CDNX is cheaper now than it was in 2015 or anytime since its inception in 2006. The $CDNX acts as a strong proxy for junior resource equities, comprising of 56% mining related companies. For those blaming the recent sell off on cannabis, cannabis related stocks make up around 5% of the exchange.
It is common for junior resources to experience a trickle down effect. Money that flows first into gold, moves to the majors and mid-tiers, eventually making its way down to the juniors. The trickle down has not occurred this time – not yet that is.
What has created this disparity in prices? After all, gold is up around $250 (18%) in the past 12 months.
The advent of passive funds certainly has been a major contributor – ETFs such as the GDX and GDXJ are an easy way for investors to get exposure to gold stocks. The GDXJ or the Junior Gold Miners ETF is a misnomer; the ETF has swelled to such a size that it no longer owns a single junior company due to liquidity restraints. This is starving the sector of capital.
The top ten holdings of the GDXJ and this “junior misnomer” I speak of can become quite apparent by looking at the top 10 holdings of the index. What should be a basket of juniors actually includes:
|Kinross Gold Corp.||$5.4B||5.49%|
|Pan American Silver Corp.||$5.2B||4.91%|
|Evolution Mining Ltd.||$6.6B||4.77%|
|Gold Fields Ltd.||$4.4B||4.41%|
|Yamana Gold Inc.||$3.4B||4.17%|
|Northern Star Resources Ltd.||$5.9B||4.08%|
|Companie de Minas Buenaventura||$3.8B||3.84%|
Banker and broker financings have also dried up. Many of the top banks have fired their research analysts and cut their mining divisions. Certain brokerage houses have dissolved entirely. This is a reflection of market conditions. Brokers are merely a conduit for product between companies and investors; rarely do brokers influence investor sentiment or decision-making. Instead they rush to the point of least resistance in pursuit of fees, which necessarily means avoiding depressed segments of the market.
The recent pop in the cannabis bubble has been purported to drain speculative capital from the markets. Ironically the cannabis bubble itself was at one time blamed for the lack of capital in mining. I do not agree with either. If anything, the wild moves in cannabis were reminiscent of a junior mining frenzy and should play well in the minds of investors’ greed when mining begins its move.
It is important to remember that many of these same circumstances existed at the end of 2015 as the $CDNX continued its dismal decline. Pessimism was extreme and nobody was calling for an imminent turn around. And then all of a sudden, the market reversed course and took off. Money came in and within a matter of 8 months, the entire exchange rallied by 60%!
The advent of passive ETFs and the lack of broker and banker participation have created an ultra depressed junior sector. But, those very same factors will ultimately create powerful forces in the opposite direction. The ETFs, which are currently too big to invest in the juniors, are providing tremendous amounts of money into the gold sector. That money is still stuck with the majors, but it will find its way down. And as liquidity improves and junior market caps grow, new ETFs will emerge that will begin buying the smaller companies.
And yes, brokers and bankers will rush back into the sector with a vengeance.
Above all, it is important to remember that gold creates the perfect storm for a bull market. It is one of the few investments that can benefit from both fear and greed. Additionally, investors do not realize it but gold is quoted everywhere – on TV in the morning, on every financial website, and in every newspaper. As soon as prices begin to rise, investors can’t escape witnessing the frenzy build.
The fundamentals for gold today are truly spectacular. The metal is negatively correlated to the Nasdaq and S&P; days of stock market weakness translate into gold price strength. Negative yielding debt continues to grow at an astonishing rate. The Fed is stuck having to lower interest rates, even in an environment of high equity prices. And QE has resumed under the term ‘Repo Operations.’ Nobody knows why, but it can’t be good. Liquidity is everywhere and it won’t take much to spark a rally in the juniors.
As my call with the mining entrepreneur wrapped up, I couldn’t help but sense that we were both optimistic. He heeded to many of my points and his pessimism subsided. For myself, further confirmation of the maximum pessimism environment that we are mired in only goes to feed my excitement – this is the perfect set up for a generational move in junior mining stocks, one that everyone refuses to see coming.
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