The problem with mining and in particular junior exploration right now, at least from an investor’s standpoint, is that no significant new money seems to be coming into the trade. Some stocks are being bought … but mostly with money taken out of other stocks. And thus the sector as a whole — amply demonstrated by the middling performance during the past year of various mining indices and diversified investment funds — is churning. It doesn’t help the situation when we have huge opportunistic grabs the likes of NovaGold’s (AMEX/TSE: NG) monster equity placement of almost $400 million (including overallotment option). Or that NovaGold in its infinite wisdom has decided to create yet another company in an already overcrowded space by spinning off a NovaCopper. I’m not trying to pick on NovaGold, just making a point. They do have some valuable assets if only they could do something with them other than dangling hopes and prayers in front of big New York hedge fund guys who are too lazy to properly research the sector.
Fortunately it appears that the tide may finally be turning from a short-term speculative market of fools to one where strategic positioning and building true shareholder value are appreciated. A possible shift is indicated by the sudden slew of smart-ish mergers and rollups that we are witnessing at both the producer and junior level. We already have four of these examples from our own portfolios: Pan American & Minefinders, Panoramic & Magma Metals, Macusani Yellowcake & Southern Andes and Smash Minerals & Prosperity Goldfields. In a different market, having such a high concentration of buyouts would probably make us look like geniuses but the truth is that nobody is getting rich on these deals because valuations still suck. Yet it is a big positive that some transactions are being driven by rationalization of purpose (building assets with productive value instead of blue sky “in situ” promotional value) and strategic considerations. Also quite relevant is that these mergers and rollups are reducing the huge number of companies that investors have to consider and spend their money on.
The thing is that the market is made up almost entirely of “Greater Fool” trades and traders. By that I mean that most investors have the purported tactic of buying low and selling high with no intention of holding a particular stock for its organic growth or dividend/income potential. One reason for this is simply the dearth of legitimate companies with such potential especially in the junior resource market. As a consequence of this, the market is presently populated by fools (including us by necessity) … not fools in the sense of intelligence but rather intent. Yet we can’t all possibly buy low and sell high and succeed. In fact only a few do. It’s the classic pyramid scheme quandary: eventually you run out of even greater fools than yourself.
As already noted, there is some hope for a shift away from such a denouement in the resource market but in the meantime there is the very real risk that the investing world and in particularly the junior resource market simply runs of out fools. As it did (hopefully temporarily) last year. That development came somewhat as a surprise and probably doesn’t represent a secular shift but we need to be aware of the different possibilities and alternatives going forward. We need to be prepared to act based on whatever we see happening and not what we would like to see happen.
Here’s a strange analogy but apt in my experience at least: Comic Books. You see like many kids growing up in the United States during the 1960s through the 1990s, I started reading comics (not the “funnies” but serious stuff like X-Men, Spiderman, Dark Knight, etc.) in elementary school and my growing collection eventually became a valuable “investment” asset as the ranks of collectors swelled. Some popular titles became highly prized as more and more collectors started following a particular story line and sought to complete the series by acquiring all the back issues. By high school, I was buying multiples of “important” first issues and “appearances” and later selling the extra copies back to the local comic book shops at a profit.
But then at some point everybody caught on to the (small but still exciting for a teenager) profit potential of comic book “investing” and started doing the same thing. Seeing the higher demand, the publishers started printing much larger runs of the issues they expected to be very popular … so called “key issues”. Not to mention that they also started publishing reprints, which for some collectors who primarily wanted to just read the storyline from the start, was enough.
By the time Todd McFarlane’s Spiderman came out in 1990, my comic book “hobby fund” was thousands of dollars in the black and thus I made my largest purchase yet (by then a college student): several hundred of the #1 issue of Spiderman in various permutations (green cover, silver cover, bagged, unbagged, platinum edition, etc.). I was hoping to make a killing … unfortunately so were thousands of others like me … and not to mention the publisher itself: Marvel Comics, anticipating the demand, had printed probably the largest run of any comic book ever issued up to that point (a year later, the new X-Men series had an even bigger first printing of over 7 million copies). Despite countless buyers greedily rubbing their hands together in anticipation of buying multiple copies of the first Spiderman issue, there was still such a huge oversupply that Marvel had to come up with special gimmicks like different cover colors and pre-bagging. Serious collectors always put their comics in plastic bags to keep them in pristine shape, but a comic book sold in sealed bags is basically meant for “investment” and not reading.
So when comic books are being pre-bagged by the publisher, thereby ensuring that they will not actually be read, we have a situation called jumping the shark. I didn’t recognize the phenomenon at the time (it wouldn’t even be named for another decade) but I knew innately that I didn’t like what was happening. I wonder what might be the equivalent of that in the junior exploration or mining sector? I don’t know, but one thing for sure is that we at Metal Augmentor like to be cautiously observant and so we are always on the lookout for stuff like this.
Recognizing any future “shark jump” should be easy if we allow ourselves to admit and say: “Now that really is ridiculous!” We did see some troubling signs last year like Stillwater Mining buying Peregrine Metals or Golden Minerals buying ECU Silver but those weren’t really ridiculous deals … ridiculous would have been Freeport-McMoran buying the former and First Majestic Silver the latter. If you don’t catch my drift then you might be a greater if not greatest fool and proceed accordingly.
Getting back to my comic book exploits, needless to say the secondary market for Spiderman #1 did not go very well. Patient selling did eventually allow me to make my money back on a couple hundred of these cursed Spiderman #1′s but a few years later the back issue market had become so oversupplied (not just for McFarland’s surfeited works but all comic books with the exception of the truly rare issues) that I ended up dumping thousands of previously valuable titles (including hundreds of Spiderman #1) in front of a community center in East Oakland. I hope the kids who ended up with them tore those ridiculous pre-sealed bags open to read those cursed books! I’m sure there are still several boxes of Spiderman #1 somewhere in my garage … just contact me if you’d like a genuine silverax copy real cheap! In any case, Spiderman #1 ended my career as a comic book speculator. Let’s hope all of our junior resource speculating careers don’t end in a similar manner … say, due to the insatiable desire of Bay, Howe and Wall Street to keep putting together “pre-bagged” companies with moose pasture projects until the point is reached when all of us fools can no longer bear the weight of the crap.
I should note that besides comic books, baseball cards (and later basketball, football, hockey and even car racing cards — do you see a pattern?) also had a similar run from the 1960s to the 1990s, teaching several generations of kids the finer art and pitfalls of speculative collecting. With beanie babies (introducing girls to the arcane art) being the last great money-making fad to die out during the 1990s, I wonder how much the experience of the “collecting” generation had to do with the real estate and stock market, and in particular dotcom, booms that came a few years later. Sure, the proximal causes were easy credit and excess liquidity but it seems to me that cultural preparation might have played an important part as well.
And it wasn’t all bad in the same sense that the Amish don’t have it all bad. Yes, speculative bubbles are obviously bad things and excessive risk-taking is not a productive enterprise, but let’s consider the possibility that entrepreneurialism and innovation themselves spring from speculation. Moreover, an appetite for speculation may be something that requires conditioning and experience. If so, then perhaps societies that are economically dynamic should thank their cultural habit of wheeling and dealing to which their children get exposed during their formative years.
On a positive note (for the prospects of an enduring supply of fools at least in the U.S.), the “collecting generation” is still very much out there and could be the driver for whatever fool mania is yet to come in gold, silver, commodities and resource stocks. A stacking and stashing phenomenon (collecting silver or gold coins bit by bit) has already taken off during the past couple of years thanks to online discussion camps at Zero Hedge, Max Keiser, TF Metals Report and the like. Maybe the next generation of kids will get an early lesson in speculation after all … from silver and gold?!? Quick, somebody needs to come up with a collectible format that is affordable to them (I suggest about a dollar per item so that would be something with about 1/50th of an ounce of silver or 1/1000th of an ounce of gold). Such a fad would then supply a whole new batch of speculators that fool-inspired markets like the present one will desperately need in order to succeed in the future.
But beyond that, it seems to me that the real money to be made in precious metals and natural resources over the long term is not from studious application of the Greater Fool Theory or speculation itself but from the productive deployment of capital … building businesses that will generate substantial return on capital over the long term. Everything else — including owning gold and silver beyond 10-25% allocation for wealth protection — relies in part on someone more foolish (again in the sense of speculative intent and not intelligence) eventually finding something to be more valuable than you originally found it.
Importantly, building a mining company that will generate organic growth and a solid return on principal cannot be done in a nilly willy manner but must be accomplished using all of the strategic tools and discipline that entrepreneurialism and capitalism can muster. Getting it right is measured by the amount of enterprise value created, which is particularly difficult in a business like mining where the assets by definition are depleted over time. Spinning off a supposedly valuable project for short-term gains is the antithesis of such an approach and a sure sign that fools are dominating the market. The spinoff is merely a satiation of the foolish appetite for instant reward. On the other hand, strategic mergers and rollups (including by juniors whose management recognizes that a multi-project pipeline is important for mitigating risk and creating the pre-conditions for organic growth) are a sign that fools are losing their influence. Let’s hope so before we completely run out of them!