SPAC attack: what happens when hot IPO's and financings hit the market in tech and gold
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Initial Public Offering’s (or IPO for short) are riding high right now.
You might’ve heard about the Snowflake IPO making headlines.
It’s a company with a special type of deal structure that most investors might not have heard of before.
And leading the charge and fury in the IPO markets are SPAC’s, short for Special Purpose Acquisition Companies.
SPAC’s start as a shell company and sell shares to investors. It doesn’t have any operations or business of its own. The purpose is to acquire one that does.
It’s like a backdoor route for large sums of money (think $100 million, or more) to get into the stock market.
Investors and the private equity funds behind these SPAC’s love it because there is much less underwriting.
And the paper pushing process through the SEC is easier.
Much like private placements in the red-hot mining space – which we’ll get to in a moment – SPAC’s have rules.
However, you can make money with SPAC’s – and quickly.
Anyone that invested in the VectoIQ SPAC before or during its acquisition of Nikola Motors (NKLA) could’ve made 10x returns.
We recently alerted subscribers to a SPAC in the Katusa’s Resource Opportunities newsletter portfolio.
You would expect with all the headlines that IPO’s are flooding the market.
In fact, in the next chart you’ll see that YTD in 2020 we’ve seen the 2nd lowest number of IPO’s (113) in 6 years.
But the return of those IPO’s through the lens of the Renaissance IPO index is much higher than the last 6 years.
What Happens When New Paper Shares are Created?
Capital flows are one of the least understood, most closely guarded secrets in the resource sector.
Bull and bear markets are driven by expansions and contractions in capital flows.
This capital comes from everyone, like retail investors all the way to trillion-dollar sovereign wealth funds.
Knowing how to profit from these tidal changes in the market is incredibly important for the contrarian investor.
We have all heard a few marquee lines related to trading:
I want to talk about the last one…
Being a good seller is as important as being a good buyer and stock picker.
Realizing a profit is important. But selling is a lot more than placing a market sell order for your entire position and moving on.
Selling should be just like your alligator buying: Slow. Methodical. Strategic.
Always use limit orders.
Let the buyers come to you.
Discipline is required on both the buying and selling of shares.
And here’s why…
How to Prepare for Amateur Hour…
I want to use my points above to help you understand how fund managers (who get redemptions) and amateur investors sell and put pressure on a stock.
And my expertise is in finding and getting my subscribers and myself into resource deals like gold, oil, copper, uranium and silver.
We are coming into the last four months of a year that has seen the share prices of both good and bad gold deals soar because of the rise in the gold price.
Throw in a U.S. Presidential election…
And I believe we are going to see pressure on many resource stocks.
Now, this could be a major opportunity for us.
Let’s start with how much capital has been raised in the metals and mining sector.
2019’s spike was due in large part to Katanga Mining’s CAD$7.6 billion rights offering.
If you remove that…
It was a very tough year for many companies.
2020 will be an improvement. Gold has performed well, and financings are already approaching CAD$4 billion.
What’s more important is what these financings represented versus the sector’s market capitalization.
How Much Money Really Went into the Precious Metals Sector?
In the next chart, you will see equity financings as a percentage of sector market capitalization.
Historically, financings represented between 3.5% and up to 8% of the sector’s market capitalization. Over the past 5 years, financings have cratered.
Again, if you remove Katanga’s rights offering, financings in 2019 would have represented just 1.7% of the sector’s market cap (red dot).
Even with the precious metals market rocking, thus far in 2020, financings have represented just 1% of the sector’s market cap—the lowest representation since at least 2008.
This means that although mining stock prices are rising, financings are not increasing at the same rate.
You can attribute this trend to 3 different factors:
Number 3 is where I believe the significant change is.
But with all the new IPO’s, listing, financings, deals that are hitting the markets… what happens to all those new shares once they start trading?
The Great Flood: Free Trading Stock Will Flood the Market This Fall
Yes, we are data nerds and we compile incredible amounts of data that others do not.
Ironically if you used each data terminal individually you would get 3 different numbers for financings this year and every other year.
As you know, a large portion of equity financings are conducted through private placements.
For every seller of shares, there needs to be a buyer of those shares.
It’s not rocket science to expect that the stocks that have financings coming “free trading” will trade lower.
The expiration of the restrictions can create significant selling pressure as investors look to recoup their capital—all at the same time.
The Gold and Silver Paper Wall
You’ll want to pay attention to this.
The chart below combines the data sets and encompasses 95%+ of the equity financings in the last 12 months—certainly any equity financing over CAD$5 million.
From this new data set, we’ve calculated the dollar amount of upcoming free trading stock.
This is where the flood of paper will enter the market…
You’ll see that the next 4 months have significantly more free trading stock than the previous 8 months.
The majority are gold and silver stocks.
This is an enormous amount of capital for the mining sector to be able to absorb.
To put it in perspective…
Now extrapolate my situation to the entire market and its CAD$2.5 billion dollars which is coming free trading.
This creates a serious problem for relatively illiquid listed mining companies.
I highly doubt there is CAD$3-4 billion in new capital ready to step in and absorb those shares in the open market at the current prices—which are much higher than the financing prices.
A Real-Life Example
Here’s a real-life example of a situation likely to experience major havoc sometime this fall:
A small junior whose management team I have never heard of and that has never been involved in mining before raised $2 million in May.
Share prices since the private placement are up 800%, not including the warrants. The company trades 225,000 shares a day right now.
The private placement was for just under 30 million shares. Again, the math doesn’t lie. Converting “paper” profits to realized profits will be nearly impossible for those investors.
The list of these types of deals is pages long.
Most of the companies are doing financings to keep the lights on or to fund a promotion to raise the price higher so they can unload stock.
I’ve always avoided those types of pie-in-the-sky burning matches and I’ll continue to avoid them for my entire career.
The risk/reward is horrible.
However, many good companies also financed earlier this year. And most certainly there will be investors looking to recoup some principal.
And we’ve run the numbers on a handful of companies we want to own. They are on our alligator watchlist.
As the newly created shares come free trading, there will be pressure on many gold and silver stocks.
It could be your last ticket to pick up shares of some great gold and silver stocks on the cheap.