Calling the bottom of any market is always impossible. I leave that to cleverer, if illiterate, folk than me. i.e. chartists like my good pal Zak Mir. But it strikes me that those who regard now as an opportune time to get back into mining (and plausibly oil) stocks are getting ahead of themselves. Yes, the sectors have performed abjectly. But I sense that there is far worse to come.
The story starts a few years ago when gold was racing ahead, folks were convinced that China would consume 120% of every tonne of base metals produced and that it would do the same for oil. Extrapolating these macro trends into a super cycle allowed an awful lot of marginal project,s or even non-projects, and arguably just dreams, to gain a stock market listing and secure equity finance. In the four or five years that have followed a few things have changed.
Firstly, it has become abundantly clear to investors that management teams across the resources sectors live the life of riley, awarding themselves huge pay packages and jetting here there and everywhere at vast expense. Generally having a great old time.
Secondly, very few of these management teams have delivered anything in terms of value creation. There are actually more mining companies in the world than there are projects to work on. And the best projects are snapped up by those with the deepest pockets, viz NOT mining juniors. Those promoting stock on the basis of marginal projects (often rehashed mines from the 1970s) have struggled to show why a project that was marginal before is anything other than marginal now.
Thirdly, investors have lost a packet. Generalist funds which were sucked in to an area formerly the preserve of specialist funds, are now exiting with their tails between their legs. Private investors have done their conkers and are selling both units in specialist funds (so forcing them to liquidate stock) and also selling ordinary shares. These folks are NOT coming back in a hurry. They are furious that management has been so greedy and incompetent. They are livid that companies published statements saying that an asset has a NPV of x only to see it sold for a fraction of x a few months later. Most investors are now convinced that Mark Twain was bang on the money.
Fourthly the macro picture looks less rosy. Look at Chinese Steel inventories and you must fear for base metals. Gold has pulled back. It will recover, but folks cannot now simply extrapolate an uptrend.
And just to add to this perfect storm a capital intensive industry needs cash. Banks are not backing projects and the quoted sector on Aim and the TSX is running out of money.ย It is estimated that 800 of the 3500 mining juniors on the TSX will be bust or cash shells by Christmas. On AIM I reckon that 120 of 260 resource stocks could also be toast.
Is there blood on the streets yet? Well a trickle. But it will turn into a torrent. On a daily basis you now see resource companies on AIM publish full year numbers with the auditors stating that the company is only a going concern if it can raise equity and that the directors express confidence that they can do just that. Why the hell are they confident? Raising equity now for a junior is well-nigh impossible. If a company is lucky it can do so but at a cost of mega dilution. But many will not be that lucky.
Given that backdrop, even companies valued on cashflow multiples of 2, with net cash and generating cash do not look that attractive. Funds facing redemptions will have to sell stock in the good companies because there are just no buyers at all for the bad stocks they own. At some stage the good companies will be a buy so compelling will be the value but that will only be when there is blood on the streets. And the checklist for that includes:
1. 500 companies on the TSX going bust/declaring themselves shells
2. 50 AIM resource companies going the same way
3. London investors seeing a raft of high profile AIM resource stocks either failing to get a fund raising away at all or having to do so on terms that are appalling.
4. A good number of AIM Bulletin Board darlings that were once valued at ยฃ100 million plus going under.
We are nowhere near blood on the streets yet but the process is underway.