Investor employs robust technical analysis on junior mining stock charts.
Summary: Gold majors appear lower, along with some juniors, while others rebounded off major lows for several days last week. We review why there have been some miscues on early calls for bottoms in precious metal mining shares this year.
The March 2008 takedown in the precious metals sector had barely begun before calls for bottoms in bullion and precious metal mining shares began going out. On March 24, 2008, a grand full week after major selling began, one analyst wrote a piece entitled “All In.” Another tossed out a recycled “Buy With Both Hands” alert. The same day, we also wrote a small note entitled, “Silver Stocks All in Multiyear Rolling Tops,” predicting further lows and potential washouts into 2006 trading ranges for PM stocks. (I've tried not to name names of the other guys just to keep the tone reasonable, but you can search those links up pretty easily.)
Last week after the July 25 close, we saw more attempts at calling bottoms. Eventually such calls might be right, but there will be no rebate on the 40% losses many stocks have seen since March. In fact, if one has even mildly diverse investments, the widely divergent trading in various commodities and stock subsectors can make such generalized market calls futile and counterproductive.
We have been strongly bearish the major gold companies as they topped out in mid-July. They are down another 10% since the last bottoms were called. We had already projected targets for Agnico-Eagle Mines (TSX: T.AEM, Stock Forum) at $45 and Yamana Gold (TSX: T.YRI, Stock Forum) at $9.30 before that. The majors are simply repeating the pattern of many of their junior cousins. We also continue to see breathtaking new lows in a number of juniors.
On the other hand, we appeared to have significant short covering for several days at the end of the week in others that have had major washouts. Markets are a very mixed bag of moving targets, which require more detailed and individualized attention than our media mavens can provide.
Hopefully, we can help readers recalibrate and develop realistic expectations as we proceed beyond the initial “easy-money” stage of this PM bull. To lay a background for how we evaluate stock direction, we need to build a context of fundamental valuation, along with a study of stock price and volume movement the past few years.
The mania that was
We’ve all heard the stories of worthless 50 cent stocks going to $50 in the late stages of the 80s gold mania. Predictions of similar gains abound in this cycle, though we are supposedly in the second stage before the wild mania to come. Unfortunately, we feel the mania has already happened for many companies, with little hope of recovery. Of course, illegal short-selling probably isn’t helping matters any in some cases.
To evaluate this, we have guesstimated the resources levels and attendant market caps the junior companies have traded at in this cycle. Let’s use five stages, starting from the hundreds that have gone public, to the relative few that have reached commercial production on a well-defined two-to-three million oz gold equivalent project:
Stage 1. $500,000 to $7 million private “angel investing” to cover acquisition, mapping, drill targeting
Stage 2. $10-$40 million after spin-off into the public markets
Stage 3. $50-$100 million after getting to drill stage on a decent property, no defined resource necessary
Stage 4. $200-$300 million after several phases of high-grade drill results, initial multimillion oz resource estimate
Stage 5. $500-$700 million with two-to-three million oz. P/P, discounted at 8%, 7-10 year mine, with $300 profit margin
Mining stock promoters and media-friendly fund managers often have financial involvement at Stages 1 and 2. These individuals are, at best, always conflicted, often careless, and, at worst, disreputable in their discussion of these companies. Someone who paid nickels and dimes for something and is telling us to pay dollars does not have our best interests at heart, or they would have told us when the price was a dime.
Let’s look at Esperanza Silver (TSX: V.EPZ, Stock Forum) over the past three years of trading. It is one of a number of “quality” companies that one popular media source has suggested people accumulate all the way down - about 70% down the past 18 months.
EPZ fundamentals
EPZ is representative of dozens of junior PM stocks we could reference, which experienced mammoth gains from the major May, 2005, bottom. At that point, many juniors were at Stage 2 market cap levels with valuations of $20-40 million. At the top in November, 2006, the forward market cap (we must always discount known options and likely future financings) was well over $200 million. At that price level, a reasonable valuation would need to have been backed by at least a feasibility stage, two million oz gold equivalent project, which they most certainly did not have.
Currently, EPZ has about $10 million in cash, at least that much more if they have a chance to monetize their portion (100,000 oz. gold equivalent) of their San Luis project, a second scoping study-stage project (Cerro Jumil), and several other promising early stage projects. In the hands of successful explorers, surely these projects deserve some modest speculative value in a raging PM bull market. Yet they currently trade for about $40 million.
Thus, in 18 months, pricing has gone from near dotcom speculation levels to near value/takeover levels. This is why, with so many market variables, differing opinions from conflicted sources, and price swings of an order of magnitude, the only opinion that matters is those of market participants. And they aren’t going to come out and tell you when and what they’re doing until it’s too late to be of any value to you. The only place to get timely information is in the price and volume movement of the stock chart.
Let’s look at a chart of Esperanza Silver and a few so-called “technical” sell and buy signals:
Valuation review - We start in 2005, with little resource definition, but speculative value. At the top in 2007, we have 1500% gains, and a stock price that would reasonably be argued is years ahead of itself. At the very least, from the perspective of clever people in this market early on, holding a stock with 1500% gains for, at best, another 100% in two-to-three years is not a particularly savory prospect. That’s certainly enough mania for us! Moreover, at those prices, it is a thoroughly rational decision for market movers to take the short side in a fair or manipulated market.
Price and volume action - When you see major increases in volume at price highs and lows, alarm bells should go off if price no longer follows the existing trend. We can see the climactic volume right at the highs in November 2006. If that much volume is not going to move price, nothing will.
Relative strength - When a stock is not moving up in concert with its peers or with other underlying drivers such as the bullion price, the stock is being sold, usually with the express purpose of taking your money if you’re still long. EPZ has been internally weak, never besting old highs or major moving averages and trendlines, and comparatively weak vs. peers and the bullion. There has been no reason to hold this stock since $3.00.
We could go on, and do, in our blog. But, in cutting to the chase on where we think EPZ is going, we will point out one other technical indicator. Trendlines and curve-fitting tools, especially those using higher-order polynomials, are useful in pointing to areas where price movements are simply unsustainable. While the pure fundamentalists have long ago thrown up their hands protesting that EPZ is “undervalued,” there has been little in the price action to suggest lows are in, until very recently.
On the right of the chart, we’ve illustrated that a four-point curve, through the lows of the last 12 months, projects to new lows of only 81 cents four weeks from now. That is a mathematical certainty as much as this pattern can predict, which would suggest selling is thoroughly exhausted, given EPZ hit 82 cents last week. In contrast, we do not see such exhaustion in the volume action. But with what appears to be thoroughly manipulated, low-volume selling in the junior sector this month, we may not get large volume into the absolute lows. Further, there appeared to be short-covering the last four days of last week in many PM juniors. EPZ did not participate in that, and still has a 15 cent gap above it, which looks like free money. We see an EPZ short-term range from 82 cents to $1.18, with the next level of support down at 69 cents.
We think this is a fairly thoroughly developed rationale for direction in this stock and readily identifiable profit and loss targets. There are, at least short-term, countervailing themes elsewhere in the sector that may affect microcaps like EPZ. As past history has shown, we do not think multiyear time investment horizons for individual stocks are wise choices. Calling yourself a “long-term investor” can easily become an excuse for lack of oversight. We do not think relinquishing 50%-70% of your capital, while it may work out, is a particularly wise way to attain financial freedom.
Disclosure: Author has no position in Esperanza Silver.
This article was written by a member of the Stockhouse community.
Visit cmunny on the blog Master Resource Trader for more stock price analysis.
