When Will the Juniors Finally
Begin to Rally?
Boris Sobolev
Jan 14, 2008
The Large Cap Party
With gold knocking on $900
per ounce, most gold stock indices are making large advances
despite an overly bearish sentiment on the broad equity markets.
Large inflows into gold and silver ETFs are highlighting the
point that there is major demand for stagflation insurance, namely
gold and silver.
Institutionals seem to have
a voracious appetite for large gold producers in early 2008.
Barrick Gold, Newmont Mining, Goldcorp and Gold Fields make up
around 60% of the S&P/TSX Global Gold Index ($SPTGD on the
chart below), as well as other highly followed indices such as
the Gold Bugs Index ($HUI) and Philadelphia Gold & Silver
Index ($XAU). All have made impressive gains on large volume
and a ton of block trading, which are signs of major institutional
involvement.
In today's markets, it is becoming
increasingly difficult to find companies with solid earnings
growth. With the earnings reporting season just around the corner,
precious metals producers are expected to report large improvements
in profits. Sharply rising gold price is more than compensating
for the increases in mining costs and decreases in production.
No Evidence of Gold Rally on Small
Caps
The picture for the small /
micro cap gold and silver stocks is much less rosy. The main
index for these speculative exploration and development companies
is the S&P/TSX Venture Composite Index ($CDNX). The ratio
between $CDNX and $SPTGD is now falling to a low set in 2004
as investors seem to be repulsed by these leveraged gold plays.
What are the reasons behind this disparity between producers
and junior exploration companies?
- While producers are expected
to report soaring profits, the exploration and development plays
are expected to report more losses. Projected mining costs are
going to be revised upward; capital expenditures for bringing
projects into production will increase as well. The question
is not if the costs will rise, but by how much. Additional delays
in project development schedule will be commonplace as engineering
firms and assay labs are unable to keep up with soaring demand
for their services.
a
- Investors continue to be wary
of the volatility in the juniors after a bloody washout in August
and another in December. Volume has fallen on many small caps
and a number of trades per day can often be counted on one hand.
a
- Sentiment exhibited by retail
investors is at the most depressed level in years. In the American
Association of Individual Investors survey (AAII), only 26% of
investors expressed bullish views, while 55% expressed bearish
views. With such negative views of the market, the last thing
investors want to do is lose more money in the volatile development
and exploration shares.
Even the "blue chip"
exploration and development companies, which have been combined
by Resource Stock Guide into a World
Class Deposit Index, are not performing up to par. Stocks
included in this index have the largest undeveloped gold, silver
and uranium deposits in the world. They are prime targets for
acquisition by major companies, yet they have underperformed
the $HUI index by a wide margin since last summer.
Turnaround on the Way
The factors enumerated above
are preventing investors from jumping on the exploration and
development value plays. But this will change:
- Both general investor sentiment
and the sentiment of exploration and development stock investors
is so low today that it not likely to get any worse. What this
means is that another washout is unlikely.
a
- Tax selling, a negative force
in the latter part of 2007, is no longer a factor.
a
- Crisis of credibility prompted
by Novagold and Southwestern Resources disasters has almost run
its course, and junior exploration companies are reacting with
better reporting and disclosure.
a
- The Securities and Exchange
Commission (SEC) is relaxing its rules for investments in foreign
stock markets by US investors. Under a proposal being prepared
by the SEC, stock exchanges outside the US will be able to provide
direct trading access to US investors through US-based brokers
for the first time. This will greatly improve appeal, exposure
and liquidity for many junior exploration and development companies
traded on the Canadian stock exchanges.
a
- In the past several months,
valuation levels for large and mid-size producers have increased.
On the contrary, junior exploration and development companies
have actually gotten cheaper in this time period. The valuation
gap between producers and junior exploration companies is the
widest it has been in years. Capital-rich but resource-hungry
producers will not miss this opportunity.
A takeover frenzy is coming
and it will push exploration and development stocks much higher.
Boris Sobolev
Denver, Colorado
email: Contact@ResourceStockGuide.com
website: www.ResourceStockGuide.com
321gold Ltd
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