http://www.midasletter.com/index.php/bracing-for-the-extinction-of-500-juniors-or-an-entire-institution/

 

The real gains of 53% for gold and 26% for copper defined as the difference between the CPI inflated price from the 1980 base and the current spot price vanish when we apply the higher mining sector inflation rate. This, coupled with concern that the cost escalation is not done, partly explains why resource equities have fared so poorly since April 2011 despite metal prices in most cases holding near all time highs.

Most of the existing copper supply has a cash cost in the $1.50-$2.00 per lb range as shown by the Brook Hunt cost curve above. The chart below plots 47 copper deposits as operating cost per tonne, as defined by the most recent PEA, PFS or BFS, against the copper grade, with the bubble size reflecting the mine plan projected annual copper output. The colored straight lines reflect the operating cost per tonne equal to the revenue per tonne generated by the grade at the indicated copper price, with grade adjusted 15% to reflect royalties and smelter fees. In simple terms, for a copper deposit to be economic it needs to plot to the right of a cost-grade curve for a particular copper price. The bulk of the copper deposits plot to the right of the $3/lb curve, implying that if the copper price can stay above $3/lb, 4.3 million tones of new annual copper supply could come on stream during the next five years, easily matching the Brook Hunt demand projection of about 20 million tonnes for 2017. These 47 deposits reflect only those owned by Canadian resource juniors, many of which were bought out by majors since 2005.

Assuming the anxiety about a looming global recession or depression disappears after the United States has wandered over the “fiscal cliff” and discovers that there is no kaboom, the Republicans and Democrats finally get serious about negotiating away the worst aspects of the fiscal cliff, and the pent up desire among Americans to put four years of deleveraging behind them and start feeling good about the future again gets unleashed, we could expect copper to be stable in the $3-$4 range over the next few years. Once the mining industry gets comfortable that the world is not going into a depression, it will launch a round of mergers and acquisitions that will clean out the best of the remaining copper projects owned by the juniors. We will see something similar happen to the advanced gold deposits once the market accepts that $1,500-$2,000 per oz is the new reality for gold.

But what will not follow is the expectation that significantly higher real prices for gold or copper are around the corner. Such expectations will not become realistic until 2015 or later. Normally when a round of M&A cleans out the inventory of advanced deposits owned by the resource juniors one would expect the industry to dredge up a whole new batch of deposits from the private sector and stuff them into any one of the many shells listed on the TSXV. However, the inventory that is available will be of an even lower grade than the “exploration failures” resurrected during the last decade. In the absence of higher real metal price expectations there will be no appetite among institutional investors for projects that require positive macroeconomic developments in order to pay off. The abundance of undeveloped inventory coupled with expectations for stable metal prices are key reasons why I think the junior resource sector will shift from resource feasibility demonstration, which is in effect a speculation on higher future metal prices, to discovery exploration, which is a speculation that new deposits will be discovered that are very economic at current prices and even at considerably lower metal prices.

Unfortunately, this shift from resource feasibility demonstration to discovery exploration will pose a real problem for the Canadian junior resource sector. The 632 companies with less than $200,000 working capital have barely enough money to stay listed for another year while doing nothing to advance project fundamentals except in the case where the project is under option to another party. Filtering for companies that have Negative Working Capital generates 499 hits, close to the widely circulated number of 500 juniors on the extinction list. Many of these companies have more issued stock than the median for their price range, making it difficult to raise additional capital through equity financings. There are 409 companies trading below $0.20 with no money; who will finance them so that they can limp along for another year doing nothing? During 2013 there will be hundreds of rollbacks (reverse splits) followed by price retreats back below a dime. In a few cases these juniors will own advanced projects, “diamonds in the rough” that have some value, perhaps to be reinterpreted for brownfields exploration targeting a Big Anomaly. But the rest will join the 116 juniors with more than $200,0000 we classify as shells because they do not have a discernible flagship project worthy of additional exploration dollars. Because these shells will end up trading below a dime, insiders will have the opportunity to refinance so that the core group owns 90% of the paper at cheap prices, the traditional “tight shell” regarded as essential for a proper promotion and funding cycle.

The TSX/TSXV, however, is not the same as the OTCBB pump and dump machine. The potential audience for the resource juniors is small and sophisticated, even among retail investors. Liquidity is more valuable that illiquidity when it comes to place bets on real fundamental outcomes. Companies where the insiders own all the cheap paper will be shunned by the market. And when the corporate administrators discover that there is no need for shells, hundreds of them will simply disappear, either through the suspension-delisting cycle or by merging redundant members of a management stable into a single junior. The departure of 500 resource juniors would be a healthy development for the sector because when the retail investor does return to this sector, we want the field of choices not to be diluted with worthless distractions.

The group to watch during 2013 will be the 428 juniors with advanced projects undergoing feasibility demonstration. These may benefit from a slingshot effect if the market decides the macroeconomic glass is half full rather than half empty, rapidly boosting prices 100%-200% as M&A fever kicks in. But the really interesting companies to investigate will be the 506 juniors that have more than $200,000 working capital and have projects that could deliver a major discovery that provides 10, 20, 30-fold price gains from their current depressed levels. These are the ones which could attract the retail investor, but to attract the retail investor an antidote to the predatory spiders must be created, an antidote in the form of a system that facilitates visualization of the potential outcome in both physical and monetary terms, and externalizes it into a public forum through a wisdom of crowds process. Such a dynamic consensus outcome visualization will allow a resource junior to bend like a reed when the hurricane blows, snapping back to the equilibrium price as fundamentals oriented speculators rush in to take advantage of the temporary good speculative value created by the volatility traders. No longer will the resource junior be a fragile sapling easily broken by a destructive trading culture devoid of legitimate purpose. There will still be plenty of volatility, but it will revolve around competing visualizations of the potential outcome, making the Canadian junior resource sector stronger, perhaps “antifragile” in the sense intended by Nassim Taleb. I have developed a plan for how this can be done; its seeds are in the rational speculation model.