-- Posted Tuesday, 16 September 2008 | Digg This Article
| Source: GoldSeek.com
By Tom Szabo
www.metalaugmentor.com
A major objective of many investors active in the natural resources sector is to diversify away from the fiat-based world of finance and credit-dominated sectors such as banking, insurance and retail. These investors want exposure to hard assets, not soft ones. Today, they desperately hope that commodity prices will soon recover given the large losses just about every natural resource portfolio has incurred over the past few months, the last two in particular.
The fall in commodity prices has created an environment that has made it very challenging for natural resource companies—mining equities in particular—to obtain financing for exploration and project development. It seems cash, not metal in the ground, is king. How ironic that the one asset natural resource investors are trying to diversify away from—the U.S. dollar and its troubled competitors—is the very asset that mining equities need the most right now. It turns out that drilling contractors, engineers, geologists and miners all still prefer to be paid in paper money.
Due to the simultaneous reduction in market liquidity and commodity prices, metal exploration and mining companies that need to raise funds to finance their activities are facing the prospect of substantial share dilution or the possibility of losing their property interests if they cannot meet contractual spending commitments. We believe there has to be a very compelling reason to own cash-strapped companies in this market.
Conversely, companies that are not in need of financing have an important margin of safety in the current environment. Should metal and commodity prices stay weak for a long period of time—something that is not impossible during a bull market as the historical example of the mid-1970s demonstrates— such a margin of safety could turn into a major advantage.
Indeed, if the markets were efficient and logical, we should expect that mining equities with lots of cash and other liquid assets would trade at significant premiums to their cash-strapped peers. But that doesn’t appear to be the case at the moment.
In early August of this year, things didn’t look quite as bad, but nevertheless we had already started to notice that the market capitalizations of several mining equities were approaching their cash positions. This situation piqued our curiosity so we placed these companies on our radar. To our surprise, their prices continued to fall so that now in many case they are trading at a steep discount to their breakup value (the estimated amount of cash that could be distributed to shareholders if all assets and liabilities are liquidated and the company is broken up). Compellingly, many of these companies have attractive property holdings—some joint ventured with majors—that are currently being assigned a zero value by the market.
Thus was born the idea for our inaugural research report on Mining Equities, the title of which—“Cash is King?”—reflects the strange contradiction that the one asset in greatest need, cash, seems to actually be more of a burden (an asset to be deeply discounted) than an advantage for some mining equities.
One example of a company that probably deserves closer examination is Mega Silver (TSX-V: MSR). The company has a market capitalization of about C$8.1 million while holding nearly C$15.0 million in cash and short-term investments. That means the company itself is being valued by the market at negative C$6.6 million despite the fact that it is earning an interest in several prospective silver and gold projects located in Mexico and Canada where a combined 6,500m drill program is currently under way. The market seems to be telling Mega Silver that it likes neither its cash nor any of its properties. Short of being a very profitable producer (which the market doesn’t seem to like either), what else can a mining equity offer?
Many similar examples abound in this strange resource sector of 2008. In fact, our research has uncovered more than 30 companies like Mega Silver (excluding oil and gas). Yet ultimately our research did not answer the underlying question: Cash is King? Only time will do that. We believe, however, there is a reasonable basis to conclude that many companies trading today below their cash value are positioned to benefit, relative to other mining equities, regardless of where the markets head next: up, down, or sideways.
About The Metal Augmentor
The Metal Augmentor is a new service being launched in the next few weeks at www.metalaugmentor.com. The main purpose of The Metal Augmentor is to aid both new and experienced investors in navigating the fascinating, dangerous, and rewarding world of investing in physical metals and mining equities. Our focus will be on gold and silver, but we will also provide in-depth coverage of the other major metals. When you purchase our report on companies trading near or below their cash values at www.metalaugmentor.com/mer.php, you will also receive a one year subscription to The Metal Augmentor.
-- Posted Tuesday, 16 September 2008 | Digg This Article | Source: GoldSeek.com
