Many mining executives had a chance to feel like Oliver Twist this year.
They stood humbled and downtrodden in front of the equity markets, cap in hand, saying, ‘Please sir…can I have some more?’
It’s been brutal for them. Plenty of companies with solid projects and great management got a total shellacking from the markets simply for trying to top up the company cash balance.
So I knew things have been pretty bad for some small resources stocks.
But nothing prepared me to see the numbers showing just how tight the equity markets have become in 2012…
The secondary market, which is what companies use to top up the kitty, has fallen from $42 billion last year – to just $17 billion worldwide this year: a stunning drop of 60%.
And the primary market, for listing new companies, has been smashed from $27 billion to just $5 billion globally. A drop of over 80%!
Ouch.
When the taps turn off, the market dries out. This is exactly why exploration companies have been decimated this year – they can’t get funding. And if they can’t get funding, it doesn’t matter how many ounces of gold are in the ground, because that gold will never see the light of day.
Just yesterday I heard about a good mining junior that had $80 million in debt funding lined up to build the mine, but equity markets are so tight it couldn’t get its hands on just $20 million. It’s total madness.
How Do You Invest in this Drought Ridden Market?
It’s essential for investors to make sure explorers have a year (or two) of cash in the bank, or takeover appeal. At the very least they should have backing from a cashed up partner or institution.
As for the developers planning to build mines, they must have funding sorted. In this market they can’t ask for too much or investors will run a mile.
That means until the equity markets loosen the purse-strings, producers with comfortable cashflow are probably the least risky bet.
Seeing just how tight the capital market is now, I’m glad that for this year in Diggers and Drillers I’ve focused far more on producers and funded developers, as well as a few cashed up, well-supported explorers.
For example, the five gold stocks I’ve recently tipped in Diggers and Drillers include two cashed-up producers, two well-funded developers, and just one gold explorer (with plenty of cash, and exceptional takeover prospects).
With funding in such short supply, it’s damn hard for investors to get a result in this market. This means being very careful about which parts of the market to focus on, because which sectors get the funding depends on how much enthusiasm there is for their specific commodity.
Be Patient for When Gold Stocks Payoff
Gold stocks are still an absolute standout, particularly after taking a last week’s body-blow.
After rallying for three months, gold stocks fell hard in a few days between Wednesday and Friday last week.
The fall is still impossible to account for. Fair enough, the stock market had taken a knock, with the S&P down 1.5% in a few days, but gold was pretty stable, losing just 0.7% in the same time.
So when the gold stock indices tanked 7%, and major gold stocks like Newcrest (ASX: NCM) fell 6%, you have to scratch your head a bit.
To explain what I mean, I’ve compiled this table to show some of the moves we saw late last week in gold and some gold stocks, compared to the rest of the market:
I should be clear and point out that none of these are Diggers & Drillers tips. Rather they’re just some large cap gold stocks on the ASX to illustrate the move. Some smaller stocks fared much worse! There was no fundamental reason to explain the drops in these gold stocks that I could see, or have found since. All the prices above are recovering rapidly.
And looking back to the charts in mid July, the gold stock indices had a similar sized smashing. That then set them up for the massive multi-month rally.
So if history repeats itself, the current pullback in gold stocks looks like one of the last opportunities to buy gold stocks on the cheap.
Time to Go Shopping For Gold Stocks
This is what I wrote to Diggers and Drillers readers on Thursday evening. The good news is that since then, many gold stocks have already started recovering strongly. One of my gold tips had fallen from a gain of 55% to a gain of 35% last week, but is already back up to the 51% level again today. There was a great trade in there for those who took it.
Other gold stocks are recovering more slowly, or holding their ground at least. I’d be surprised if all gold stocks rallied uneventfully from here. It’s rare that a steep fall results in a simple bounce. So we may possibly see gold stocks being tested one more time before taking off in earnest.
When they do, they will be rallying from close to historically low prices relative to the gold price.
The important point is that this gives them a lot of space to rise even faster than gold.
So if you believe gold has much higher to go, the right gold stocks could ‘leverage’, or amplify these gains much, much more. For example, our gold tip that is up 51% has made that gain in the time that gold (in $US) gained just 8%.
And right now, with the Fed’s QE3 money yet to filter through into the system, and the Fed already openly talking about increasing the size of the QE3 program (to cater for the end of Operation Twist), it’s hard to argue that gold will fall from here.
This means that the quality gold stocks can be a very profitable investment from here.
But they must have the ‘right stuff’; like being in the right country, having low costs, long life, good management, and exploration potential, amongst many other things.
And of course, in these nightmarish equity markets, they need to be producing cash, or at least be funded to production!
Dr Alex Cowie
Editor, Diggers & Drillers
From the Port Phillip Publishing Library
Special Report:
Retire Rich, Happy and Free From Money Worries
Daily Reckoning:
Australia’s ‘Eggs-in-One-Basket’ Banking Sector
Money Morning:
Picking the Hot Commodity Stocks of 2013
Pursuit of Happiness:
The Biggest Threat to Peace: A State of Warfare or Welfare?
Diggers and Drillers:
Five Reasons Why Gold Stocks Are Set to Rebound
