TSX - Resource Boom Part III

TSX - Resource Boom Part III
By James West

The TSX Venture dropped in August by a few hundred points, which frightened a lot of investors away from that market for the time being. Volumes are returning to post-summer levels, but there is still a high level of uncertainty out there that is preventing big players from jumping in.

This is a major opportunity for those with the stomach for contrarian investing. With some company valuations off by as much as 50% from their pre-August prices, there are some solid bargains out there that are going to provide triple-digit gains for savvy shoppers.

Contrarian investing is essentially doing what the majority of investors aren't. And it often inspires foolhardy forays into sectors that are taboo for good reason.

But the resource sector is showing all the hallmarks of a resumption of boom activity.

TSX mining companies raised almost $6.4 billion (CAD) in the second quarter of 2007, above last year's $5.4 billion and more than double the $2.9 billion raised in Q2 2005.

Gold companies continue to be the largest recipients of financing, accounting for 53% of the total funds raised in Q2. Uranium continued to increase to all-time high prices; the metal was priced at $136 per pound (USD) at the end of the quarter.

Several other metals continue to trade at or near all-time highs, including nickel, molybdenum, silver and copper.

Northern explorers appear to be benefiting from an unusually long exploration season, particularly in the Thelon Basin, which is demonstrating early potential to be similar in scope to the Athabasca Basin in Saskatchewan.

TSX -listed oil and gas companies raised over $5.5 billion (CAD) in the second quarter of 2007, nearly double last year's $3.0 billion and far more than the $4.3 billion raised in Q2 2005. Energy trusts led the sector, with four of the ten largest financings being from that quarter. Continued upward pressure on the price of oil, with further geopolitical instability and lower-than-expected European production, forced the price of crude back over $70/barrel at quarter-end.

The oil sands will be significant beneficiaries of the current pricing environment, with established miners planning further production increases. Vancouver-based Teck Cominco seeks to increase its presence in this sector with large acquisitions and partnerships. This activity is a positive signal for juniors that may become takeover targets or recipients of joint venture investment in future.

While some companies have re-priced or even cancelled financings, hindsight will show them to be trigger-happy, and their management skills will be called into question.

Just in the last two days, $85 million in mining finance has closed. That's $42.5 million dollars per day entering the junior exploration sector. If you don't see the inevitable outcome of so much money directed towards new exploration, go back to sleep.

The problem with the investing public is that it reacts to the headlines rather than hard data.

Headlines are by nature designed to accomplish one thing--get you to read the article. So, typically, headlines are sensational and bombastic, and are often way out of context relative to the data that inspire them.

The reach of Toronto Stock Exchange and TSX Venture Exchange extends internationally, providing access to capital for more than 3,800 companies. $1.8 trillion USD in global market capitalization and leading-edge trading technology make TSX Group a dynamic source of North American capital.

TSX Value and Volume

Why does capital funding of junior mining companies continue strongly while the rest of the financing markets have slowed to a crawl?

The answer is simple.

Looking at the investing landscape now, the superior returns offered by the private equity business were only feasible while the credit bubble was still inflating. Now that it has popped once and for all, the value of all things leveraged is under scrutiny and suspicion.

Junior mining share valuations are reverse-leveraged to 10% of the value of any mineral asset they have discovered in the ground.

That means if you have $1 billion in gold on a piece of ground that you have managed to describe to the satisfaction of National Instrument 43-101, analysts will rate your company's NPV at $100 million, and not a penny more.

This makes sense, as there are all kinds of things that could go wrong in the process leading up to the actual start of mining. The price of a metal could theoretically decline. Competing mines could be brought onstream that are more cost-efficient. Metallurgical, geophysical, and or infrastructural problems may develop that only come to light in the construction phase and that could derail or delay a mining project.

But compare these factors to the credit and mortgage industry. The unpaid loans backed by dubious assets have been forward leveraged. In other words, the bank is counting a debt as paid in full and then using its value to issue yet more worthless paper.

That practice has come to an end. And now that real estate, private equity, and the credit business itself are subject to the same rules of risk assessment as the rest of us, there will be a large shift in the amount of capital directed to those markets.

Institutional investors have to keep that money working, and when they look around, the resource sector is one of the few places where value can be stored and leveraged to a rising share price. This is going to make resources increasingly attractive, especially since a lot of the larger financial institutions are not yet able to determine what the extent of the damage has been from the ongoing deterioration of credit.

Presently, the market is not rationally valuing mining stocks, for two reasons:

1. The funds that have had to cover obligations to private equity buyout participation have had to come up with money somewhere else, since all of their asset backed commercial paper is more or less frozen in limbo pending revaluation. That means they have had to liquidate large holdings of junior public companies at any price, resulting in companies that now are trading, as I said before, for as low as half their pre-August valuations.

1. That in itself has caused the rest of the market to pause, and in some cases conclude that the bull has left the building and the bear has set up shop for a prolonged stay. But that is simply wrong, and when the rest of the investor herd understands that, these companies will return to their prior levels, and then some.

There are bargains galore . . . I can't say it enough. The TSX and resource companies around the world are on the verge of becoming the global market's new shooting stars, and smart cookies who load up now will be laughing all the way to the bank.

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