What Will Jumpstart the Juniors?
The Gold Report caught up with Neil MacDonald, CEO and Director of NovaDX, an investment firm that provides capital investment, investment banking, financial and business advisory services to early-stage natural resource exploration companies. NovaDX has a growing portfolio of early-stage companies focused on the discovery of new mineral deposits and petroleum reserves. NovaDx's wholly-owned subsidiary, Canadian Small Cap Resource Funds (www.cscrf.ca), creates and distributes limited partnerships that invest in flow-through shares of Canadian junior mining and energy companies.
TGR: Let's start with the juniors. Why aren't they participating in this cycle as they have in the past?
NM: People are rethinking their portfolios and speculative capital is one of the first casualties during a credit crisis such as the subprime mortgage situation in the US. The liquidity has gone out of the junior markets. That's why juniors are finding it much more difficult than they did even six months ago to raise capital for their exploration programs. So you’re seeing quite a disconnect between the buoyant commodity prices and the value of the exploration companies.
TGR: Is it mostly individual capital that has disappeared from the speculative market or is it the funded capital too?
NM: It's a combination. Capital from both individuals and institutional investors has declined in the last six months.
TGR: Has money that would normally have gone into juniors shifted over to the ETFs?
NM: That’s definitely a factor, although we don’t see as much of that here in Vancouver.
TGR: What is it going to take to get the juniors to reconnect?
NM: A fundamental confidence has to return to the markets first but I don’t think we’ve seen the end of this mortgage debt crisis. Speculative capital won't come back until investors are comfortable again. That being said, a new discovery of substantial size could accelerate the entry of speculative capital back into this market.
TGR: Many believe that this recession/depression will be limited to the U.S. and China will take up the slack. Do you think that's a valid perspective?
NM: There are roughly 300 million people in China who are in the process of becoming affluent. That burgeoning consumerism will continue to drive demand. It is, however, unrealistic to expect the same rate of growth we've experienced over the last three to four years. Nonetheless I don't see Asian markets sliding into a recession. At the same time, I don't expect to see near-term growth here in the U.S. Debt on a per capita basis has reached historic proportions and something has to change.
TGR: So the Asian markets will be the source of continuing demand for some of these commodities?
NM: Definitely. South Korea, the world's largest shipbuilder, is a good example. It has a very large industrial base and imports all of its raw materials. There’s very little domestic production. To offset concerns about rising commodity prices, the South Koreans are starting to stockpile inventories to hedge against future price increases.
You've got to look at the supply side too. Although there are new copper, zinc, and moly mines planned to come into production, there's still a gap between projected supply and demand. That shortfall will support commodity prices at current levels. We won't be seeing the low commodity prices of the not-too-distant past anytime soon. We're not going back to $40 a barrel for oil.
TGR: I know you said earlier that in China you wouldn’t be expecting the rate of growth that we've seen over the last two years; growth will continue but at a slower pace. And we see the U.S. going into a recession, or at least to a period of flat growth. If that's true, why wouldn't commodity prices level out now?
NM: Looking at the numbers—China’s growing "middle class" now has a population equivalent to the entire U.S. that is just starting to consume the kind of goods that support its newly emerging affluent lifestyle.
TGR: Over the last several years, we've seen exponential growth, now it’s starting to slow down. Is this out pricing the market already?
NM: That’s a good question. I don’t believe it is. The demand will continue to be there but not the growth in demand. Again you have to consider the supply side. Let’s face it—new deposits are taking longer and costing a lot more to bring into production.
TGR: You’re a value investor. . .does it matter as much if copper goes to $8 or gold goes to $2,000?
NM: We are a value investor and we look for unique opportunities. Copper is one commodity we believe will have sustainable demand. Again, this is reinforced by supply constraints.
Gold's a more interesting one. Supply and demand are obviously drivers but the economy plays a huge role too. People use gold more as a hedge against currencies, but I do believe the outlook for gold is favorable and will likely drag silver along with it.
TGR: So, when you say the outlook is favorable for gold and copper, can we extrapolate that to mean higher prices?
NM: I certainly think copper has some room to rise, as does gold. Some see $2,000 gold. I am not as bullish as that, but I don’t see it falling back to $600 either.
TGR: Can you give us some background on what you look for in particular companies?
NM: We look for situations that allow us to mitigate the controllable risks such as those related to management, finance, and general corporate risks. What we can’t control, of course, is the risk at the end of the drill bit. Only Mother Nature does that.
We select companies whose management teams have a demonstrated track record. Our companies have projects with an above-average opportunity for making a new discovery. Too many junior exploration companies hang their hats on a single project, and spend too much time exploring that one project before they give it up.
We look for companies with a pipeline of projects, experienced management, and innovative strategies for raising capital. Right now there's something like 1,300 or so exploration company listings on the TSX Venture Exchange and a very large number of them have issued a lot of paper to raise capital. They are up to capitalizations of 70, 80, 100 million plus shares. Unfortunately, they haven’t been that successful in finding very much. That kind of share structure, particularly in this market, makes it extremely difficult to attract additional investment because the leverage simply isn’t there.
A new discovery, unless it’s quite large with a very attractive valuation isn’t going to do much for the share price when there are 100 million shares outstanding. When good news does come from some of these companies it tends to be more about liquidity than value building. But I think that’s a sign of the times.
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