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Richard Karn's Advice for Avoiding the Walking Dead


 -- Published: Wednesday, 24 September 2014 | Print  | Disqus 

Source: Special to The Gold Report  

 

Starved of cash, nearly 150 mining companies listed on the Australian Stock Exchange went into bankruptcy during the fiscal year that ended June 30, and another 23 have gone under since then. Richard Karn, managing editor of the Emerging Trends Report, believes a fresh wave of failures is expected when the quarter ends September 30, and a major shakeout at some point appears likely. But the situation isn't grim for all the specialty metal companies down under. In this interview with The Gold Report, Karn shares insight on how companies may survive the onslaught.

 

The Gold Report: When we interviewed you in April, you said the pending demise of zombie companies on the Australian Stock Exchange (ASX) was a good thing because there were too many deadbeats in the specialty metal sector. Has that process worked its way through the system or are there still some "walking dead" making it difficult for investors to pick out the promising companies?

 

Richard Karn: Unfortunately, the latter is still the case. According to the Australian Securities & Investment Commission (ASIC), 146 companies in the mining sector went into administration (bankruptcy) during the fiscal year ending June 30, 2014. As Luke Smith pointed out last month in your publication, yet another 226 resource companies did not have sufficient cash to meet their anticipated expenditures for this quarter.

 

Since then another 23 resource companies have failed, and as of Aug. 25, 2014, 17 more had not paid their listing fees and were suspended from trading on the ASX.

 

So, no, we do not think the process is over.

 

TGR: How are companies accessing capital today?

 

RK: By and large, they're not. We've been picking up on some positive activity in the base and precious metal sectors, but that mostly has yet to trickle through to the specialty metal sector.

 

In the case of specialty metal companies, most are unable to raise money either from the capital markets or from their shareholders. Failed or abysmal uptake of rights issues and the like continue to be common. Many companies are literally being starved of cash.

 

TGR: Can companies sell some of their assets to cover costs on other projects?

 

RK: Asset sales are difficult in the current environment because so many companies are now so desperate to sell that it has become a buyers' market. That being said, the Chinese have been stepping in to snap up the occasional bargain.

 

TGR: If companies have no more options, how long can they keep the lights on?

 

RK: Not long. The end of the quarter is September 30, and companies will have to disclose their financial situations. We expect a fresh wave of failures within the next six to eight weeks as more resource companies become insolvent.

 

We don't know what the catalyst will be, but for some time we've been expecting a final selling frenzy that will mark at least an intermediate-term bottom in the specialty metal sector.

 

Some assets are so mispriced that the market appears to be pricing in failure well before the fact. In fact, so sure is the market that a number of these companies will fail that they are trading for less than the cash they have on hand, literally placing no value whatsoever on their resource projects.

 

Final washouts often occur when markets are oversold, and the specialty metal sector remains oversold. The spark for the selloff could be another failed rights issue or poor uptake on an option scheme, either of which would reflect a fundamental lack of confidence in management.

 

It could be some unknown—perhaps an otherwise meaningless threshold event—that "spooks the herd," and shareholders just start selling everything indiscriminately to ensure they recover some of the money they've invested.

 

It could be that it finally dawns on investors that a number of these junior resource companies hold a lot of each other's stock, which they are carrying on their balance sheets at par as a liquid asset when in actuality those shares are so illiquid they could not be sold except at a steep discount—and could well crash the share price in any case.

 

As I said, we do not know what will spark the selloff—just that it is coming.

 

And when the selling has been exhausted, it will constitute at least an intermediate bottom in the specialty metal sector.

 

In the final shakeout, we are anticipating a number of mismanaged companies will deservedly go under—as, unfortunately, will some quite good companies—and some very good projects will be picked up very inexpensively.

 

And being able to pick up outstanding assets for very little money always marks the bottom of the cycle, because it increases the odds of success as the cycle turns up again.

 

TGR: What characteristics should investors look for to avoid these doomed ventures?

 

RK: At the moment I would avoid small-cap specialty metal companies that are carrying any debt, especially if they are not cash-flow positive. If or when their ability to service that debt is called into question, it will likely be too late to get out.

 

In addition to reading financial statements to get a grasp of their financial situations and those circumstances just mentioned, I would look at what managements are actively doing to help their long-suffering shareholders.

 

For example, have they reduced staff, cut expenditures and taken a cut in salary themselves or are they still maintaining a "resource boom" lifestyle at their shareholders' expense?

 

Most important, I would look for either positive cash flow from operations or sufficient cash on hand to sustain operations through to some pivotal event the market has been waiting for, such as commencing production, receiving project funding, permits or approvals, or receiving the results of a bankable feasibility study, etc.—something that will demonstrate management is delivering on its promises.

 

TGR: Could the recent repeal of the mining tax in Australia help all of these companies, or will it only impact large operators?

 

RK: The Minerals Resource Rent Tax (MRRT) did not apply to the specialty metal end of the resource sector in Australia, so its repeal will have little direct impact on these companies.

 

Indirectly, however, repealing the tax serves returns Australia to the ranks of the safest, most mining-friendly jurisdictions in the world, and at some point that will indeed lead to increased investment flows into the specialty metal sector.

 

What markets fail to fully appreciate is that many, and arguably most, of the technological advances we enjoy today, whether found in consumer electronics or transportation or renewable energy sources or military hardware, rely on secure, uninterrupted supply of a range of specialty metals.

 

With military conflict raging across the Middle East and North Africa; a full-fledged arms race between the countries with claims to the South China Sea, notably China and Japan; and the numerous potential conflicts brewing throughout the world, now more than ever secure supply of these specialty metals should be a very high priority. Should a war erupt, common sense, as well as history, dictates the first victims will be the very notion of globalization, free market economics and "just in time" delivery.

 

If it were in China's strategic interests to stop exporting rare earth elements or tungsten or antimony or graphite, to name just a few of the specialty metal markets China controls, all of which are crucial to a range of military applications, there is absolutely nothing anyone could do about it.

 

Of the 50 specialty metals we track, more than 40 could be mined economically in Australia alone, thanks to its unique geology.

 

We've been writing about this trend for more than six years now, but except for a relatively brief period from mid-2010 through late 2011, in the panicked response to China cutting off supply of REEs to Japan, the aftermath of the global financial crisis has squelched the market's appetite for mining projects in general and specialty metal projects in particular. They require the long-term commitment of capital and a sustained effort to put into profitable production.

 

The flood of liquidity sloshing around the planet since 2008 in search of a return appears to have such a short investment horizon that mining projects are largely off the radar.

 

So nothing has been done. There's been a lot of talk, a lot of bureaucratic posturing and comic sputtering as World Trade Organization complaints are ignored or unfair business practices perpetuated, but nothing has been done. And the longer this continues, the more vulnerable the West becomes.

 

The specialty metal price spike the West suffered in 2010–2011 in panicked response to the Chinese curtailing exports of REEs will be nothing compared to what a "shooting war" would provoke.

 

Thinking otherwise is the height of naiveté.

 

TGR: Thank you for your insights.

 

As managing editor of The Emerging Trends Report, Richard Karn has a broad, multidisciplinary background and a working knowledge of precious and specialty metals, as well as considerable research, analytical and writing experience. The first nine Emerging Trends Reports have been reevaluated and updated published in e-book form, as Credit & Credibility. He has written for publications ranging from Barron's, Kitco and Fullermoney to Financial Sense Online.

 

DISCLOSURE: 
1) Richard Karn: I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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Streetwise - The Gold Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

 

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 -- Published: Wednesday, 24 September 2014 | E-Mail  | Print  | Source: GoldSeek.com

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