Is there any hope for Venture-listed juniors?

It’s no surprise that the fall in commodity prices, the rise in mining and development costs and shrinking available capital have created a recipe for disaster in the junior resource sector. But John McCoach believes better days are ahead. 

“In my view the current market cycle is mostly cyclical, but there are definitely structural issues, and there are some opportunities for us to improve our markets,” the president of the TSX Venture Exchange said during a Sept. 12 panel discussion at the Toronto Resource Investment Conference.

But panel member John Kaiser seemed less optimistic. “I am willing to concede that if we got a gold bubble . . . say, gold rocketing to US$2,000, we would be bailed out of the mess that we are in now,” the editor of Kaiser Research Online said. “However, I think it would just temporarily kick the can down the road.”

Out of the 1,400 TSX Venture companies that he covers, he said that 721 have less than $200,000 in working capital, which is barely enough for more than half of the companies to last another year. There are also 600 juniors trading below 20¢, with negative working capital. 

The shortage of capital has led to the suspension of several juniors for failing to meet the Venture’s listing requirements, with a few being delisted. “But in August the rollbacks started to go through the roof,” Kaiser said, referring to more companies consolidating their shares to increase their share prices. Despite this, he stressed that these companies have barely enough money to survive.

“There are several things that have frightened me,” he said, adding that he thinks “we face an existential collapse over the entire institution” because of structural change in the brokerage industry, regulatory restrictions and algorithmic and proprietary trading.

The role of brokers as intermediaries between the companies and public has diminished since the late 1990s, with the “deregulation of [brokerage] commissions and the emergence of discount brokers, where the public can go and trade cheaply, and at the same time we have the Internet, which made a wealth of information available to the investing public,” Kaiser explained. Since brokers were not making the same commission on junior companies, the amount of brokerages participating in the natural resource sector declined, which has impacted the sector’s ability to attract risk capital, he said.

“There’s no question that there are challenges in the brokerage industry and that their margins are not what they used to be . . . and compliance costs are going up,” McCoach noted. But he argued the shift in the brokerage industry has contributed little to the troubles in the junior resource sector.

“We were led into this cycle by mostly macro factors, commodity prices, investor sentiment . . . and operating-expense issues in the mining industry — and I think that is what is going to lead us out of the cycle.”

However, he agreed that securing capital for juniors is difficult and suggested one solution could be to improve the rights-offering system in Canada to allow companies to attract money from their existing shareholders. “That is something we are strongly advocating to fix in Canada,” he said.

Kaiser offered that if more exemptions were made to let lower net-worth investors buy stocks from discount brokers, it would be easier for juniors in the discovery stage to get capital.

He noted that in the last decade brokerages have become more “litigation conscious,” or afraid of facing lawsuits by their clients if they promoted the potential of a discovery by an exploration company that never took off.  

Similarly, juniors face “regulatory overkill” that prevents them from promoting the “speculative possibility” of a discovery and attracting capital to test an anomaly, in case they find nothing, Kaiser added.

Although the newsletter editor clarified that he was not “anti-regulatory” and applauded the National Instrument 43-101 rules that require companies to file technical reports and supporting documents so that investors can make informed investment decisions, he said the cost of compliance and filing these documents are eating up the little capital that juniors do have.

He added that because of a “systematic downward basis” in the sector, a company’s stock closes up in the last half of the trading day and raises a flag at the Investment Industry Regulatory Organization of Canada (IIROC), whereas if a stock closes down, it doesn’t elicit the same reaction.

While McCoach agreed that there is a “regulatory burden” in Canada, he pointed out that the rules haven’t changed much over the previous bear and bull markets. “It is not the numerator that has changed, it is the denominator. Companies have a smaller amount of capital, so that is impacting them more,” he commented.

Lastly, Kaiser said algorithmic traders, or proprietary traders, are “ruining” the junior market by suppressing the share prices of companies by selling positions they don’t own through high-frequency trades. With the elimination of the uptick rule, short sales are not being tagged by regulators, he argued.

IIROC made the changes to the short-sale rule last year to “harmonize it with capital markets around the world that don’t have uptick rules,” McCoach responded. But the implications of the change, he said, should be closely examined. He added that high-frequency trades make up 1–4% of the daily trading volume on the TSX Venture Exchange.  

Given the changes in the brokerage industry and continued regulations and algorithmic trading, Kaiser urged that all stakeholders examine the “simple solutions” that could make it easier for the stronger juniors to survive and raise capital. 

“An important role of the Exchange is to talk to fund managers and trading firms outside of Canada to attract capital to this country and support our capital markets,” McCoach said. “We have the right model, and we have to protect that. And so when the markets come back, people will still see this as a credible junior market.”