Editorial Blame it on flow through

The exact wording might change from time to time, but essentially it boils down to this — “flow-through made me do it.”

That’s right, the very investment incentive that was hailed as having saved the junior exploration industry a short two years ago is now being invoked to explain the myriad of failures that have resulted since then.

Failures may seem like too strong a word, for some of these projects. But there have been an awful lot of projects that have fallen well short of expectations, expectations that were fostered by studies, analyses and “dog-and-pony shows” ad nauseum when companies were trying to raise money. By the very standards set for them by the companies involved these projects haven’t met their objectives and “failure” is the only way to describe them.

We’ve listed some of the more prominent in the past; it serves no purpose to list them again. Most readers know several projects that fit the description. But even without specific examples, one would have to be totally oblivious to Canada’s mining scene over the past couple of years not to be aware that many projects have fallen by the wayside on the road to profitability.

There have been many success stories, to be sure. But they don’t grab the investor’s imagination the way a “disaster” story does. Besides, the success stories — which, by the way, far outnumber the failures during the 1980s — is another story.

When a project turns sour there is bound to be a lot of finger pointing. Now, however, there’s a ready-made excuse. Flow-through funds were so plentiful companies felt compelled to make the most of them. And because there was a time limit on when the money could be spent, many were hard pressed to spend the money on work that was truly warranted. They had promised their investors that the money would be spent, so spend it they must.

Then, after the investors took possession of their “cheap” flow-through shares, the companies were under more pressure to come up with favorable results so that the stock wouldn’t be immediately dumped on the market thereby depressing the stock price.

With the stock market crash of 1987 and a declining gold price during 1988, those pressures intensified. The consultants who were called on to evaluate the property and perhaps recommend a production decision might well be the same consultant called upon for further work should the project proceed — clearly a potential conflict of interest.

In fact, in the flow-through heyday it was not inconceivable that a mining engineer or geologist could establish an exploration company, then have that company raise flow-through funds to hire himself as a consultant. It was a type of make-work project. The value of the project was secondary, but it had to be kept going to each subsequent stage in order to keep the money coming in.

Many of those projects couldn’t live up to expectations because expectations were inflated to begin with.

Flow-through financing had its place, and an important place it was. During the dark days of the early- and mid-1980s, it did keep the exploration industry alive. And it served its purpose well.

But flow-through proved to be almost too good. It raised the level of “normal” activity to such a frenzied pace that anything less seemed like the doldrums. One fund manager uses the term “flow-through junkies.” What started out as a shot in the arm for the industry became a habit that is proving very difficult to break.

Now, it seems, we must go through a painful period of withdrawal while investors reassess the risk-reward ratio of junior mining stocks.

Flow-through shares may have clouded that decision-making process. For a while investors pumped up the market because of the tax benefits available from the flow-through mechanism. That raised expectations unreasonably high. Then, when the market crashed, the inevitable stock dilution kicked in and investors’ returns were knocked down unreasonably low.

The true value of exploration mining stocks is somewhere in between. It may take a while yet before investors rediscover the true value of mining shares, but eventually we have to return to reality.

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