Beware Bears Everywhere

In my previous blog http://icebergshares.blogspot.co.uk/2015/07/new-pumping-and-dumping-sentiment.html I talked about a few aspects of life on AIM and briefly touched upon the bear market.

Some won’t believe me, but the last 18 months has seen some fantastic gains in a favourable market on AIM. This has not lasted for the last 6 months and will only become worse…..

It’s difficult for invstors to grasp this, they will always think if they pick the right stocks they will make amazing gains. They will blame poor entry points. They will bemoan the timing of external factors. They will point to the time of year. Everything except realise the truth.

The truth is that the AIM market is on a Bear run. Now I have to quantify this statement, for my own purposes I am looking unapologetically at the exploration and resource sectors.

It’s on a bear run thanks to:

• Global Macro-economic factors.
• Massive withdrawal of AIM funds.
• Rising exploration costs.
• Falling commodity prices.

It will continue to worsen because of:

•          The lowering of potential profits.
•           An exponential rise in failed/delisted companies.
•           Short term continual lack of governance in AIM.
•           Crippling costs of capital.
•           Further degradation in the first 4 factors.

It will still be possible, I am sure investors will have it forced in their face, that some companies will make large gains. Where this happened 12 months ago though, it might only happen in 25% of cases now. In other words a guess from me might be that it becomes 4 times more difficult to make a substantial profit in in the next 12 months.

The only way is (down).

As an appendix at the bottom of this blog I’ve included 3 graphs from Infomine, they show the prices of Gold, Copper and Silver over the last 5 years. It doesn’t take an expert to see that prices are at 5 year lows. WTI oil has fallen back to below $50 a barrel. There are a string of experts claiming that the bottom has been hit in commodity prices and the only way is up. Please pardon my scepticism but I’ve been hearing this for the last 2-3 years. Every few months we get told that production is due to decline and China is going to hoover up all the resources. 

It simple doesn’t happen.

China is growing its internal production capacity rapidly and its demand is slowing down. BRIC’s in general are seeing only small real increases in demand. Coupled with this production is being increased due to a glut of projects(particularly copper) that started life 2-4 years ago in response to the higher prices.

Supply is also increasing due the declining commodity price. This might seem strange, when prices started to fall a few years ago, many projects were put on hold, producers stockpiled ore thinking that prices would rebound. Around 12 months ago Rio Tinto, stopped this strategy and decided to keep cash flow (to allow a share buy back) steady by increasing commodity tonnages.

This has been taken to another level by the likes of Unity Mining that have increased gold ouput by 50%, reducing cost per oz and keeping cashflow growth. This has been achieved by mining the higher grade areas (looking at 8g/tonne).

Oz Minerals another Aussie miner has increased copper production to maintain cash flow. This means that supply will only increase further as commodity prices decline, we have a bit of a dog chasing its tail scenario.

The market won’t price in any kind of rise in commodity prices in the next 12 months and so potential profits and NPV values will be hit.

This will have a consequence for the AIM, particularly within the mid-sized exploration production sector.

Oz minerals also shows the more problematic side of the fall in commodity prices. At its main copper/gold mine, as well as increasing copper production it’s suspended its gold production as it is no longer economical to mine gold.

Wood Mackenzie have recently commented that 10% of gold mines are now operating at a loss with gold at $1100 an oz.  Personally with stable demand and higher supply I think $1000 could fall and a low of $950 or so could be seen. This would put many miners in to a negative cash flow position.

Life is hard for any wanabe explorers turned miners and it’s getting harder and harder.

Good commodity companies can adapt, particularly those without debt. AIM however is dotted with many, far too many, lazy, hyped up companies and it will get ugly.

So what for AIM?

The consequences will be felt by private investors.

I mentioned that the decline set in 6 month ago, around this time the institutional investors started to leave AIM, funding was becoming scarce. Cornhill and a few others stepped up and started to offer more and more placements to private investors for companies that institutional investors would no longer touch with a barge pole. We all know the reputational damage this has caused, so I won’t go over it all again here. It did however help keep a bubble of “normality” for share prices of commodity companies across AIM.

The disparity of AIM over the other major alternative, commodity exchanges such as TSX and ASX grew and grew. Currently a company with a good current explorational asset might we worth $1m on TSX, if it were on AIM and with some pumping as much as $12m. A shell company on the look out to buy assets $350k on TSX and $5m on AIM.

This level of disparity cannot continue.

AIM will always be easier to raise money on than TSX etc , however it’s to the likes of TSX that the larger commodity companies  have come looking recently for good quality JV deals, as its simply far cheaper.

The last couple of months have seen even the private investor funded placements start to become unsustainable. Larger and larger discounts to the SP are more than evident along with higher and higher fee’s charged by the company’s brokers.  Private investors taking part in the placings are making less money, or indeed making a bigger loss.

Over the next 6-12 months, even this method of financing will become difficult for companies. Another problem, along with reducing liquidity in AIM, falling NPV’s, falling commodity prices and falling confidence.

So where does all this leave us?

Most, if not all commodity companies are overvalued by between 20-80%.

Explorers are buying assets, which I freely admit are very cheap at the moment, but these assets require considerable money to develop or prove up, that money will not be raised cheaply and will only get more expensive over the next 12 months.

Some small producers without flexibility and with debt will go under.

Companies will need to be innovative when exploring, they will need JV’s with deep pockets, they will need to costs to production with other companies, when producing they will need to share mill’s, processing, infrastructure all with other companies to gain economies of scale and reduce costs.

Having a world class asset is not enough. It needs to be scalable, easy and cheap to mine, low risk, high grade. The company needs to be professional enough to raise money and frugal with the money raised. Maybe with a bit of luck folks will continue to make some money, particularly if they remember to steer clear of the ramped stocks. Buy after de-risking news, not before.