Will your gold juniors make it to summer?

By Henry Bonner 

“These are sobering times,” Michael Kosowan told a Cambridge House audience in Vancouver on January 20th. Michael has worked for Rick Rule at Sprott Global Resource Investments Ltd. for 13 years and is now located in Sprott’s Toronto office. Like Rick, he has made a fortune for himself betting on contrarian ideas in bear markets… But Michael has a warning about 2014 in his speech below…

There has been a collective exhale as the mining sector began 2014, marching into the New Year with a strong up move in gold and high hopes of a recovery.

Although there have been a few bright spots as gold reached $1,275 by January 26, the ‘bonfire of the juniors’ has yet to occur. Endangered companies fight tooth and nail merely to survive.

There are just too many companies out there with too little cash. According to John Kaiser, a mining analyst who has been following the sector for over 25 years, 1,025 companies out of a possible 1,770 trade below 10 cents a share while 817 of these companies have less than $200,000 left in capital.1

So What’s Coming?

The big crisis point could come in April and May of this year when the audited financials must be filed with SEDAR. Credit that was extended in 2013 is unlikely to be extended in 2014, forcing management to dig into their own pockets which could precipitate a flurry of de-listings.

The current economic reality has fashioned a quality-control system, albeit somewhat crude and often brutal.  The inherently weak or flawed juniors will likely be removed, leaving a leaner and fitter sector that will be easier to navigate.  The very first to go will be the ones that never should have made it to the party in the first place – those built on dreams of a get rich quick scheme, usually by ambitious but misguided geologists without enough experience.

They will not be easily saved through mergers and acquisitions either. Most seniors have frozen their M&A activity following an abysmal year of heart-wrenching write-downs and impairments.

The seniors remain timid and many will be licking their wounds for a while, even though the damage to their balance sheets is self-inflicted.  Overall, they are not taking advantage of the lower prices to buy juniors; they are cautious and unaggressive this time around and are being decidedly more discerning when it comes to acquisitions.

The New Reality for Exploration

New finds are going to become ever more critical for the industry's future, but exploration is becoming both more complex and costly. A combination of decreased funding and more difficult exploration targets makes it unlikely that we will see many new legitimate discoveries this year.

Should one occur, the resulting localized success will surely serve to baffle and confuse investors, who might interpret one exploration win as a signal that all juniors are moving up. In fact, some companies can be headed higher while most of the remaining companies continue their descent.

Get ‘Something for Nothing’

Nonetheless, some miners have taken advantage of this situation by extracting favorable terms from junior companies at extremely competitive prices. We are seeing acquisitions made ‘at cost’ and not accounting for the expenses, headaches or risks that the company has overcome.

For example, B2Gold Corp. signed an agreement in October of 2013 to acquire Volta Resources Inc.2 The deal valued Volta at $63 million, which is approximately what the company spent on its drilling program that led to the discovery of a significant resource. B2Gold received the value of Volta’s success ‘at cost’ of drilling, not taking into account the risk taken on by Volta’s shareholders prior to the drilling program and the intellectual capital that went into the success.

Because investment in exploration was relatively low over the past two decades, there are few high-grade projects out there to be ‘scooped up’ by a major.  As a result, there are buying opportunities in companies that are not glaringly obvious in terms of grade, size, and ease of extraction.

This also puts a higher premium on the ability to scrutinize and assess these projects. Even the better-looking projects, for that matter, need to be held to stringent scrutiny as to whether they make financial sense!

2014 will be the year of sobriety and bifurcation. The weak will simply not survive; many companies will disappear. These are very sobering times.

The sector is still being culled and a rise in the price of gold will not necessarily save them; do not bet on a high tide floating all ships this time around.

Selectivity is key, which means having the best information and keeping a close eye on developments in the sector. We should expect a lot fewer companies in the space after 2014, and even by the summer, so the months ahead could prove to be a highly determinant period for investors in the sector.

Michael Kosowan has recently moved to Toronto Ontario, where he has joined the Sprott Private Wealth team.  Having worked alongside Rick Rule since 2000, he will now lead the investment advisory initiative for resource equities in the Toronto office.  Michael holds a Master’s Degree in Mining Engineering and is a licensed professional engineer. He is also a registered representative in both Canada and the United States.

With his extensive experience in resource investing, Michael is able to provide insights and knowledge critical in helping clients select and understand their investments.

You will find Michael as a speaker at several natural resource conferences, on webcasts and radio interviews discussing the resource sector.

To contact Michael e-mail him at [email protected] or call 1.866.299.9906.

1 http://resourceworld.uberflip.com/i/229125/31

2 http://www.cbc.ca/news/business/b2gold-to-acquire-volta-resources-in-all-stock-deal-1.2254366