Visibility

From the June 28, 2015 HRA Journal: Issue 235

As I’m sure most of you figured out long ago I write this sidebar last.  Quite a bit has happened in the past 24 hours only some of which is dealt with in the issue.

Greece is obviously a big deal in Greece but I still think the damage is containable and largely contained already.  I don’t expect markets to be happy if Grexit happens in the next week or two but I’m not convinced its crash material either.  Indeed, unless some markets trade substantially worse in coming days it should be clear even to the Syzira caucus that they badly overplayed their hand.  The simple truth is that the Greek economy is not that important, something that should have been factored into the game theory a bit better.

Gold still isn’t getting a lot of love but its early days in the latest Greek drama, not to mention what looks like an unfolding bear market in Shanghai.  The Euro is behaving as I (and few others) expected.  If that continues it should help bullion once traders stop being confused about it.  Likewise, if the selling gets deeper in Shanghai we could see more return to that most accepted of value stores in Asia.  Things are moving fast so I plan another issue once we get past the Greek referendum day.  Stay tuned.

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There has been a lot of talk about private equity in the mining sector.  There are many stories floating around about this or that private group that wants to put millions (or billions) into the sector.

So far, few deals have come to pass, at least ones with a public company component that we have heard about.  It’s possible there are lots of private deals we’re not hearing about but I’m skeptical about that.  Mining is a relatively small and very incestuous business.  There would be gossip and while I have heard about a few deals its hardly been a tidal wave of investments.

That’s not to say that I think there are not a group of large private investors (individual or corporate) interested in the mining sector.  There are, but the few groups I have talked to are very much of the vulture variety.  

These vulture equity funds are interested in mining precisely because its been beaten down so hard.  They are hoping to get top flight assets for pennies on the dollar or, better yet, for no money down at all.  Some of them may succeed but most that I have talked to expect deals that are unattainable, even in a market like this.

There is a limit to how much you can grind companies down and still be left with something worth pursuing.  The cheapest assets are often the cheapest for a reason. There is some permitting, metallurgical, access or other issue that makes a deposit difficult or perhaps impossible to mine. 

Some of these private equity groups will lock up assets for a better market but I think quite a few will fail to make much progress.  Mining projects are not fungible—each is an individual and without people who can unlock the value in each situation the project may well end in tears.

I bring up private equity because many in the sector (me included) hoped the arrival of these groups marked a bottom in the market.  That wasn’t to be or at least it hasn’t been yet.   I hope private equity is part of the solution but after two years (in many cases) of hunting for projects it’s clear they won’t help fast.

In the past month or so we’ve seen another source of potential funding show up.  This one interests me more because of the background and credentials of the people involved.  It also interests be because the participants made a conscious decision to build public vehicles.  That tells me these groups expect the shares of these vehicles to be currency in and of themselves. 

These are groups that could have pulled the money together privately and not had to deal with the many and varied regulatory demands that go with a public vehicle.  Nonetheless they chose to go the public route.  Let’s look at two recent examples.

Electrum Special Acquisition Corp listed on NASDAQ in mid-June.  The IPO was 17.5 million shares priced at $10 and the brokers ended up taking the full Greenshoe overallotment so the company raised $200 million in its IPO and is trading just above the IPO price.  The IPO includes 10 million warrants with an $11 exercise price.

Electrum is backed and operated by a number of successful mining entrepreneurs who haven’t been noticeably active for a few years.  The company is effectively a high level cashed up shell in search of mining projects and/or companies to acquire.  It states that its target acquisitions will be in the $200-800 million size range and that it will use either cash, its shares or some combination of the two to pay for deals.  

The core management of Electrum has been quiet for the past 3-4 years.  They have decided it’s time to act and don’t seem to have had any trouble finding $200 million to get the ball rolling.  Keep in mind they are just in the deal targeting stage now.  There wasn’t a specific company or project that was the basis for the raise.  It’s a hunting trip.

I take news like this as a positive sign that groups that most would agree are “smart money” are finally stepping up.  That doesn’t mean the market bottoms tomorrow. I’m sure if you asked the backers of Electrum when the bottom was in they would insist they haven’t got a clue when the bottom is.  That’s the only sensible answer. 

Nonetheless, the fact they are moving on this tells me they don’t think project prices will get much cheaper.  It takes time to find and negotiate on deals and this is a sector where prices for good assets can move up quickly once traders decide a bottom is in.  The timing also implies management of Electrum expects their shares to be as good or better currency for closing a deal than cash.  That’s only going to be true if the market is improving for the sector.

The second deal is the multi-company merger and financing by Osisko Royalties that I’m sure most of you heard about.  The merger brings together Oban Mining, Corona Gold, Ryan Gold, Temex Resources and Eagle Hill Exploration.  The resulting company will control Eagle Hill’s Windfall Lake high grade project and have a $65 million cash balance. While Oban is the surviving company this is very much an Osisko and Dundee Capital deal.  Osisko gets just under 20% for its money and first rights on future royalty streams and Dundee gets a big shareholding and thanks to its interests in some of the cash-rich participants of the deal.

While Windfall Lake is the official reason for the deal, and Eagle Hill shareholders got the best premium it looks like there is a longer term plan here.  This deal really only makes good sense for the cash rich merger companies if it becomes a multi-mine deal.

Whether added projects come out of existing holdings of the merger partners or are something new remains to be seen but I can only assume Osisko has a plan.  If OR just wanted in on Windfall lake they could have dealt with Eagle Hill alone. The backers chose to clean up five share floats and leave themselves with an equity holding.  Again, it looks like some “smart money” players decided it’s time to start cutting deals in earnest.  

These two deals aren’t going to turn the market by themselves.  Coming out of a 4.5 year bear market is still bound to be a slow and halting process.  As I noted in the past issue my experience is that this kind of market ends with a whimper, not a bang.  Things start to turn as smart money selectively enters and supports a small number of deals and most traders only see the bottom in the rear view mirror. 

I don’t think this time will be any different unless there is some sort of crash in the New York.   That would also be a bottom signal but a much uglier one.  Probably more V shaped too, much like 2009.

I’m still on the fence when it comes to the idea of a 2015 crash.  I think at least a correction would be a healthy thing for NY.  We may see that when the Fed actually pulls the trigger.  Its mind boggling to think traders are unprepared for that after trading the Fed for two years but the heads of several Wall St firms insist they are not.   That may just be Wall St talking its book.

Markets can roll over without reference to the economy if they get too overextended but a true crash usually has some external event (like the subprime crisis) as a driver.  I don’t see what would be that driver right now.  The US economy is strengthening and so is the EU (Greek mess or not). Shanghai will probably crash or at least correct severely but that won’t have much effect on NY.  Yes, interest rates will get lifted at some point but the moves will be slow and heavily foreshadowed. The Fed will not be surprising anyone.

Unless there is a black swan event I have trouble seeing what would generate a true crash on the major indices. I still don’t expect NY markets to gain much this year but I’m not seeing a washout event on the horizon for it or, by extension, the resource sector.  Let’s hope there’s no fall melodrama.

Comments about a possible ending for a resource bear market have been echoed when it comes to the gold market. There is still a large camp of gold traders, particularly those that favor technical analysis, that insist the bear has to end with a bang. 

Like the equity markets I don’t see what the driver for that would be.  Granted, there was no real driver for the 2013 takedown either other than a massive bear raid.  Perhaps we see another. 

From the perspective of market sentiment I can see the logic for expecting a crash ending.  After over four years of bear, it gets harder and harder to believe a bottom is “the” bottom.  A cataclysmic event—logical explanation or not— is far more likely to leave traders saying “ok, that HAD to be it”.

Most of those that expect one more takedown seem to expect it soon.   By the end of 2015 certainly and probably this quarter.  Summer is an odd time spectacular market moves (they call them the doldrums for a reason) but cycle timers largely agree that is when it should happen.  Can’t say I’m looking forward to them being right but if it finally puts the last nail in the coffin of this bear market I can live with it.

That brings me to the closing topic of this essay which is gold seasonality.  If that is the dominant factor this year we may be about to get a little relief.

The table at the top of the next page shows the duration and size of the gold market’s annual “summer” rally. These rallies represent some of the stronger buying periods for bullion based on Muslim and Indian festivals as well as jewelers stocking up for Christmas in the West and pre-Lunar New Year in the East. 

The average percentage price gain during the annual fall rally is 14.9%, though you should note that the smallest gain and shortest rally was last year. 

The chart below tells a similar story though it ends in 2013.  While the size and exact form of the fall rally differs from year to year the timing of the start of it (late June to late July) has been fairly dependable. 

The bottom line is that, if there isn’t some cataclysmic short term selling event there should be a rally in bullion lasting anywhere from 2-4 months, then a pullback then another rally as Lunar New Year buying really ramps up.   We do have to beware of that selling event but it’s not predictable while the fall rally in bullion seems to be about as dependable as a seasonal factor ever gets.  

Most traders still won’t care in the summer so there is no reason to chase anything.  But if you’ve been looking for an opening that at least reduces downside risk at a sectorial level, it’s just arrived

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