Normally, I spend a great deal of time and energy in finding investments that have lost most of their value and are terribly out of favor — like the junior gold shares which, on average, have fallen more than 50% since the beginning of 1989. Yet despite this devastating price drop, I can’t convince myself that there is much value here. Many investors who bought junior gold stocks in the late 1980s find this viewpoint difficult to accept. After all, even producing gold mines like Breakwater, Canamax, Granges, MinVen or Nevada Goldfields have all lost more than 65% of their share value since 1988 alone.
Nor are they the worst casualties. What about companies like Augmitto or Pioneer, which have dropped more than 95% during the same period? Surely, there must be an end to such declines, one might argue, a point where additional investment is justified.
That there is an end to any decline is clear. In some cases, the end comes when the company can no longer produce profitably and runs out of cash. Then, the share value drops to zero, as what recently happened to producers Golden Shield and LynnGold.
In many other cases, stock prices will stabilize when the financial and operating environment improves. That, as I will demonstrate, may take a long time. And finally, in only a few companies, major gains in gold production or the discovery of new orebodies will get the stock moving.
Why is it that the junior golds have done so poorly, often at times when the bullion price and the values of senior gold shares advanced? There are a number of key factors that have contributed to their demise, some of which are linked to developments in the investment sector, others to the operating environment in which the gold mining industry finds itself. Changing Investor Profile
Most brokers will tell you that junior gold equities are suffering because the retail investor is now absent. What they mean by that is that shares of the less established producers, the development and exploration companies were typically bought by small, private investors. And up to that point, their theory is sound.
But because brokers are losing more and more of these clients, they mistakenly conclude that no retail business is being transacted. This is where they are wrong. The retail investor is very much alive and well, but now transacts most of his business through specialized gold mutual funds. During the past five years, North American gold mutual funds have more than tripled their assets — my latest count shows that 28 such funds with combined assets of more than $4.2 billion operated in the United States alone.
This development does not bode well for the junior gold companies, because “big money” cannot effectively invest in this sector.
Let’s assume you were to manage a gold mutual fund with $100 million in assets. Would you be able to invest in Muscocho at nine cents or in Pioneer Metals at 26 cents a share? The answer is probably no. Liquidity is Everything
To start with, institutional managers have to assess an investment according to the same basic criteria that apply to your personal investment decisions. One key aspect is liquidity: if you can’t buy and sell it when you need to there isn’t much point in owning it. Having said that, let’s assume you want to buy a 1/2% position, or $500,000, in a typical junior gold stock. A transaction like that takes five minutes when it comes to established producers like American Barrick or Placer Dome Gold, but to convert $500,000 into a junior gold holding takes days. What’s even worse, selling that same stock may take weeks.
In short, for mutual funds the only way to invest in the less established gold market is to pick one of the most liquid juniors. And because mutual funds make up so much of the demand for gold related shares, only those equities which can achieve reasonable liquidity will succeed. High Risk Proposition
That is not to say, however, that juniors with good liquidity will automatically be sound and safe. Far from that. Everyone considering investing in gold shares should know that junior issues are a high risk proposition. Even the most seasoned analysts have had to learn over and over again that an unusually high dependence on capital, mining uncertainties and lack of diversification make for an extremely treacherous environment.
Occasionally these lessons are forgotten, even by myself. Last year, for instance, I thought companies like Muscocho Explorations and Hope Brook Gold had a better chance to succeed because none less than Echo Bay Mines and BP Minerals held substantial ownership stakes. Obviously, I was wrong, along with many other mutual fund managers who held positions. Echo Bay, one of North America’s most experienced gold producers, recently withdrew from the Muscocho venture after taking a $74 million loss, while BP is still trying to turn the Hope Brook situation around. Both companies’ stock prices, of course, have been caught in a free fall.
How can it be that even the most eminent mining companies can be so wrong in their assessment? The short answer is that mining is a business of many uncertainties. Bets are made by investors on a company’s ability to identify, exploit and expand ore reserves.
This doesn’t sound overly complicated, but anyone who analyses the process, quickly realizes that the largest risk factor resides at the front end. After all, finding a mine is far more complicated than exploiting it; financing the development of a new property is more difficult than getting money for increasing production at an operating mine. Money Shortage, Low Gold Price
At this time, a number of factors make for even greater uncertainty than was the case a few years ago. First of all, the juniors are confronted with a serious shortage of capital. For roughly 15 years, an almost endless stream of exploration and development funds was available. This has now suddenly dried up.
Much had to do with the tremendous excess liquidity which benefitted financial markets throughout the world until late 1987. Another, even greater boost to the juniors came in the form of “flow-through” financing, which gave investors the ability to combine mining investments with attractive tax breaks. Flow-through schemes provided junior gold companies with hundreds of millions of dollars which would otherwise not have been available.
As we all know, world liquidity is now in decline and flow-through financing is no longer. That’s why hundreds of exploration companies who own potentially profitable properties can no longer find the money to drill for gold. Seniors More Aggressive
Another aspect is that the junior companies are no longer seen as the most productive finders of gold. In the seventies and the early 1980s, many market participants subscribed to the view that exploration had best be left to companies specializing in that fields. Whether this viewpoint was justified or not is vigorously disputed, but that it has changed, is a fact.
Although every one accepts that some major gold discoveries were made by relatively obscure companies, many other finds of equal importance were pioneered by senior producers like Newmont, Placer Dome and American Barrick. That gives institutional managers like myself some confidence that an investment in a senior gold company can provide not only an ongoing stream of production with diversification from several different orebodies, but also significant growth.
I suspect that in the future, almost all of the growth will come from the established producing firms. Not only are they the only ones with the money to carry out large- scale exploration work, but they are also under immense pressure to constantly replenish their reserves to make up for current production.
This means that many more small gold companies in the junior sector will disappear. As the industry continues to consolidate, those firms which lack a first-rate property or the money to exploit it will become take-over or merger candidates. Only a few of the junior companies will do well and make it on their own.006 Peter C. Cavelti
is President of Cavelti Capital Management Ltd. of Toronto, which specializes in gold related money management services. In addition, Cavelti Capital manages several gold funds in Canada and the United States.
Normally, I spend a great deal of time and energy in finding investments that have lost most of their value and are terribly out of favor — like the junior gold shares which, on average, have fallen more than 50% since the beginning of 1989. Yet despite this devastating price drop, I can’t convince myself that there is much value here. Many investors who bought junior gold stocks in the late 1980s find this viewpoint difficult to accept. After all, even producing gold mines like Breakwater, Canamax, Granges, MinVen or Nevada Goldfields have all lost more than 65% of their share value since 1988 alone.
Nor are they the worst casualties. What about companies like Augmitto or Pioneer, which have dropped more than 95% during the same period? Surely, there must be an end to such declines, one might argue, a point where additional investment is justified.
That there is an end to any decline is clear. In some cases, the end comes when the company can no longer produce profitably and runs out of cash. Then, the share value drops to zero, as what recently happened to producers Golden Shield and LynnGold.
In many other cases, stock prices will stabilize when the financial and operating environment improves. That, as I will demonstrate, may take a long time. And finally, in only a few companies, major gains in gold production or the discovery of new orebodies will get the stock moving.
Why is it that the junior golds have done so poorly, often at times when the bullion price and the values of senior gold shares advanced? There are a number of key factors that have contributed to their demise, some of which are linked to developments in the investment sector, others to the operating environment in which the gold mining industry finds itself. Changing Investor Profile
Most brokers will tell you that junior gold equities are suffering because the retail investor is now absent. What they mean by that is that shares of the less established producers, the development and exploration companies were typically bought by small, private investors. And up to that point, their theory is sound.
But because brokers are losing more and more of these clients, they mistakenly conclude that no retail business is being transacted. This is where they are wrong. The retail investor is very much alive and well, but now transacts most of his business through specialized gold mutual funds. During the past five years, North American gold mutual funds have more than tripled their assets — my latest count shows that 28 such funds with combined assets of more than $4.2 billion operated in the United States alone.
This development does not bode well for the junior gold companies, because “big money” cannot effectively invest in this sector.
Let’s assume you were to manage a gold mutual fund with $100 million in assets. Would you be able to invest in Muscocho at nine cents or in Pioneer Metals at 26 cents a share? The answer is probably no. Liquidity is Everything
To start with, institutional managers have to assess an investment according to the same basic criteria that apply to your personal investment decisions. One key aspect is liquidity: if you can’t buy and sell it when you need to there isn’t much point in owning it. Having said that, let’s assume you want to buy a 1/2% position, or $500,000, in a typical junior gold stock. A transaction like that takes five minutes when it comes to established producers like American Barrick or Placer Dome Gold, but to convert $500,000 into a junior gold holding takes days. What’s even worse, selling that same stock may take weeks.
In short, for mutual funds the only way to invest in the less established gold market is to pick one of the most liquid juniors. And because mutual funds make up so much of the demand for gold related shares, only those equities which can achieve reasonable liquidity will succeed. High Risk Proposition
That is not to say, however, that juniors with good liquidity will automatically be sound and safe. Far from that. Everyone considering investing in gold shares should know that junior issues are a high risk proposition. Even the most seasoned analysts have had to learn over and over again that an unusually high dependence on capital, mining uncertainties and lack of diversification make for an extremely treacherous environment.
Occasionally these lessons are forgotten, even by myself. Last year, for instance, I thought companies like Muscocho Explorations and Hope Brook Gold had a better chance to succeed because none less than Echo Bay Mines and BP Minerals held substantial ownership stakes. Obviously, I was wrong, along with many other mutual fund managers who held positions. Echo Bay, one of North America’s most experienced gold producers, recently withdrew from the Muscocho venture after taking a $74 million loss, while BP is still trying to turn the Hope Brook situation around. Both companies’ stock prices, of course, have been caught in a free fall.
How can it be that even the most eminent mining companies can be so wrong in their assessment? The short answer is that mining is a business of many uncertainties. Bets are made by investors on a company’s ability to identify, exploit and expand ore reserves.
This doesn’t sound overly complicated, but anyone who analyses the process, quickly realizes that the largest risk factor resides at the front end. After all, finding a mine is far more complicated than exploiting it; financing the development of a new property is more difficult than getting money for increasing production at an operating mine. Money Shortage, Low Gold Price
At this time, a number of factors make for even greater uncertainty than was the case a few years ago. First of all, the juniors are confronted with a serious shortage of capital. For roughly 15 years, an almost endless stream of exploration and development funds was available. This has now suddenly dried up.
Much had to do with the tremendous excess liquidity which benefitted financial markets throughout the world until late 1987. Another, even greater boost to the juniors came in the form of “flow-through” financing, which gave investors the ability to combine mining investments with attractive tax breaks. Flow-through schemes provided junior gold companies with hundreds of millions of dollars which would otherwise not have been available.
As we all know, world liquidity is now in decline and flow-through financing is no longer. That’s why hundreds of exploration companies who own potentially profitable properties can no longer find the money to drill for gold. Seniors More Aggressive
Another aspect is that the junior companies are no longer seen as the most productive finders of gold. In the seventies and the early 1980s, many market participants subscribed to the view that exploration had best be left to companies specializing in that fields. Whether this viewpoint was justified or not is vigorously disputed, but that it has changed, is a fact.
Although every one accepts that some major gold discoveries were made by relatively obscure companies, many other finds of equal importance were pioneered by senior producers like Newmont, Placer Dome and American Barrick. That gives institutional managers like myself some confidence that an investment in a senior gold company can provide not only an ongoing stream of production with diversification from several different orebodies, but also significant growth.
I suspect that in the future, almost all of the growth will come from the established producing firms. Not only are they the only ones with the money to carry out large- scale exploration work, but they are also under immense pressure to constantly replenish their reserves to make up for current production.
This means that many more small gold companies in the junior sector will disappear. As the industry continues to consolidate, those firms which lack a first-rate property or the money to exploit it will become take-over or merger candidates. Only a few of the junior companies will do well and make it on their own.006 Peter C. Cavelti is President of Cavelti Ca
pital Management Ltd. of Toronto, which specializes in gold related money management services. In addition, Cavelti Capital manages several gold funds in Canada and the United States.
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