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Financial markets have become more and more correlated. Everything seems to be trading up or down based on what the overall market is doing.
The current market connectivity is bad for junior mining stocks. Copper risk/reward used to be separated from aluminum, but today aluminum, copper, and Greek credit default swaps move up or down together. Investors currently have many more liquid options to buy volatility, so money is flowing to other investments.
I have spent a lot of time with senior bankers in the last month or so, and I have learned of their bias towards junior mining companies. Senior bankers do not like an economic model where 95-98 out of 100 company projects will not result in a mine, and the remaining 2-5 companies will not have the capital to build a mine for a good project.
At the $100 million to $1 billion level of check writing, banker types dislike the fat tail distribution of the junior sector. Many bankers finance mining companies without dropping down into the junior space.
China is going to start scrapping lots of things built before 1995. The first wave of Chinese construction went up quickly and cheaply, and many buildings will be torn down to make way for new, perhaps more tasteful buildings one to three times the size.
The old building only had one electric outlet per room, and the new one will have three. The old one had painted steel, but the new one will use stainless or galvanized steel. What can be recycled from the old will be recycled. The Chinese did not build the old to last forever, but the new one will be built with a 50-year life in mind, as long as the building manager does not take a bribe or three and go cheap on the rebar or electrical wire gauge.
When an economic winter starts in springtime, it is impossible to determine when it will end. What one must remember is all winters end, but I expect the current one to be different. I expect many of the juniors that held through the last down trough with grit and drive to crumble. I also expect many banking teams will break up and regroup. Law firms will have to rethink how they bill clients, and do clients really want to pay for coffee? My bet is they would be happy to bring their own from Starbucks.
The fact is the 2008-2009 economic dip was horrible, but people had savings, lack of shock, and drive to survive it. The 2012-2013 recession is going to kill lots of companies because it will involve China ending the first round of its super cycle with a break and a consolidation. Plus we will see the end of the Euro as we know it.
When you buy shares of Vale, BHP, or Freeport, you're buying direct production exposure to their mines. When you buy shares of Stornoway or Selwyn, you're buying option exposure to possible future production.
This derivative of possible future production is an option where the company will go into production if the project is good, the commodity stays strong, and the world doesn't end by the end of 2012. Owning junior equity shares creates cheap exposure to the commodity.
Vancouver, Washington-based Oreninc, has compiled a comprehensive database of Toronto Stock Exchange and TSX Venture Exchange junior resource-company financings. Each issue FCW displays a list of uranium-related fundraisings that have opened and closed over the course of the week, as tracked by the Oreninc Deal Log (see p. 7).
A great mining project possesses a large, high-grade, easy-to-access resource. However, we have used up most of the world’s largest resources, and now we’re left with seconds.
The question is whether we want high-grade and small or low-grade and huge at the top of the menu. An example is Northern Dynasty’s Pebble Mine versus Oracle’s Oracle Ridge Copper Mine in Arizona. Pebble could be a material mine to a major mining company, but it is so huge and moves so much dirt versus metal produced that it is very expensive to permit, develop, and monetize.
When Zimbabwean-style inflation comes ashore in North America, the value of any hard asset will go up. Fiat currency will weaken, and metals such as gold and copper will increase in value relative to the US dollar.
However, we have a hard time measuring the price of gold in US dollar terms. We cringe every time we hear gold is going to hit $10,000/oz. If this happens, we expect the cost of a loaf of bread to hit $20, and it will cost $500 to fill up the average car. In relative value, we expect gold’s purchasing power in terms of real goods to remain steady or even decrease.
As the overall market swings, basic skills such as picking stocks become less important.
Beta is traditionally defined as market volatility that every stock has some exposure to, whereas alpha is individual stock-specific risk and reward.
Over the last 10 years, the overall market has shifted from a market where people trade on alpha-based bets to a market where a significant amount of trading is aimed at capturing beta inefficiencies.
