Mining Industry Outlook

After a really dismal year for the resource industry, there are finally signs that the market is at the bottom.

Before looking at where the markets are headed from here, let’s have a quick look at a couple of indicators of the junior resource market to show just how bad the destruction has been.

The Toronto Stock Exchange Venture Index is not a perfect measure, with junior resources roughly two thirds of the index, but is probably the best indicator available of the overall junior resource market. The VIXJ declined 66% from its high in early 2011 to the low point in late June.

Another indicator is the Market Vectors Junior Gold Miners ETF, which is based on replicating the Market Vectors Global Junior Gold Miners Index. This index involves gold and minor silver, with a focus on small producing companies, but including a range of development stage and exploration companies. That index lost 82% of its value from the high in 2011 before a small rebound over the past couple of weeks.

Enough has been said here and by others about how bad the resource markets have been over the past year and the reasons for the annihilation of the sector.

Everybody wants to know when the market will turn. The little upticks at the end of both of those charts provide some cause for optimism. Those charts and others like them have shown false starts over the past year. That might be the case here again, but there are a number of factors suggesting an upturn in the not too distant future.

I’m not expecting a sharp upturn, like we saw in early 2009. The resource market at this time is very different than we have ever seen before. There is a huge and growing divergence between those junior resource companies that have real assets versus the thousands of other companies which have good intentions of making a discovery in the future but at this time, they have neither a discovery nor the cash to fund a discovery.

In 2008, share prices and commodity prices across the board fell hard, but then rebounded quickly and pretty much in tandem. Somebody could have rung a bell on January 2, 2009 to signal the bottom of the market.

Within two weeks, the venture index was up nearly 30%. It went on to triple in just over two years. Investors who came into the market in late 2008, when the negative sentiment was at its peak, on average, tripled their money in 26 months.

There was a huge influx of new money during 2009 and 2010. Quite frankly, many of those investors were pretty naïve with regard to the junior resource markets. Investors who bought companies on the basis of an expected discovery have been sorely disappointed in all but a very few cases.

Many investors are continuing their efforts to unload the shares that were bought during that period of euphoria.

The share prices of those companies which do not hold anything of value and are out of cash are destined to fall further, even though they may be down 90 percent or more from the highs.

The investors who are buyers in the junior resource market at this time are pretty savvy and they are highly selective. They are buying shares in the higher quality companies. Until recently, they just kept bids under the market price, waiting for the market to come to them, which it did.

Perhaps sensing that the prices for those quality companies have bottomed, investors have begun to push the prices higher.

Many high quality companies will double or more before there is a consensus that the market is at the bottom. A bottom to the overall market may not come for some time yet, as

investors are still trying to unload shares of companies that they simply want to be rid of. Many of those companies are still trading well above their fundamental values.

There is certainly further downside risk in the overall resource markets. But, for the higher quality companies, there is a great deal more upside potential than downside risk at this time.

Resource Market Sentiment

The big gold mining companies have taken yet another round of multi-billion dollar write-downs in the latest quarter, leading some people to believe that they will not be buying any new gold deposits (and therefore junior companies) for a long time. It may well be true that the big Western mining companies will not be buying more metal deposits in the near future. But, that does not signal a lack to takeovers of junior companies.

In the past month, Alamos Gold (AGI-TSX) offered to buy two juniors, both for cash, at prices well above the recent market prices. The bid for Esperanza Resources (EPZ-TSXV), which we follow in Resource Opportunities, was 38% above the average trading price.

The mid-tier producers, for the most part, have strong balance sheets and are looking to expand. There are also hundreds of international mining companies, many based in emerging countries like China and Brazil, which have cash and are actively evaluating the many bargains available at this time.

The sudden collapse of metal prices this year caught many companies off guard, slashing or eliminating profits. As a result, some companies are now facing serious financial distress, which is very unfortunate for shareholders of those companies. The flip side is that companies in a strong financial position are able to acquire assets at bargain prices.

There is a lot of money to be made at this time in the resource markets, for companies and for investors. Share prices and asset prices are at bargain levels, making this a good time to be buying shares or shopping for mining industry assets.

Fortunes were made in this industry by those who loaded up in late 2008 or in 2001, times when market sentiment was at rock bottom levels.