Junior Sector 'Primed for Consolidation'


"Though metal prices remain high, Haywood noted, investors continue to avoid the junior market. But Haywood concluded its junior market précis reasoning increased M&A activity may be on the horizon."

An alternative title to Haywood Securities' latest overview of the junior sector might have reverse-scrambled the wording of a classic American Western film starring Clint Eastwood to "The Ugly, the Bad and the Good." And perhaps added the qualifier "Almost." As it is, Haywood chose, "Adrift in a Sea of Negative Sentiment" for its recent report on juniors, a research offering that respectively followed Haywood's "2011: Junior Exploration's Annus Horribilis. 2012: Reasons to Be Hopeful" and "Signs of a Bottom?"

The title substitution works as Haywood started with a long list of nasty reminders of how ugly things have been on the market, but then ended on a—somewhat—elevated note. The harsh landscape Haywood described at the outset of its report will not surprise market watchers nor lift their hearts. "Just when we thought things were looking better—wham!—the lukewarm investor sentiment for speculative mining and exploration-focused equities that we began to see in Q1/12 evaporated and sent the S&P/TSX Venture Composite Index (YTD Performance -6%) back to the Q3 lows last witnessed in 2010 and 2011," Haywood wrote.

Though metal prices remain high, Haywood noted, investors continue to avoid the junior market. "So, simply put, investor sentiment today is as bad as it was in mid-2010, after resurrecting itself from the 2008 market crash, but metal prices (gold, silver, copper, iron, and uranium) are significantly higher. Trading volumes and risk appetite for speculative mining and exploration-focused equities have vanished."

Haywood reasoned that juniors have turned investors off for non-metal reasons, particularly such items as rising taxes, royalties and inflating capital costs. With that in mind, Haywood said that now "We find ourselves in a new paradigm (last seen before the 2008 market crash) driven by the threat of shrinking operating margins from miners and the nagging sabre rattling from a number of geologically prospective and prominent jurisdictions (Africa, South America) for mining and exploration."

This was the Ugly and the Bad. Haywood, however, still sounded off on a hopeful tone, though not quite with surefire hero stuff (i.e. winning the belle, besting the evil sheriff and riding off into the sunset. But neither was it a final disturbing image, the body-strewn thoroughfare after some shootout from which nobody walked away.) Haywood concluded its junior market précis reasoning increased M&A activity may be on the horizon. The Haywood analysts began with a caveat, that metal price volatility and an uncertain global economic outlook "still dampen the appetite for mergers and acquisitions." But then they turned to good that may come, especially given the amount of cash some miners are piling up thanks to fat margins.

"Nevertheless, we are hopeful that potential exists for M&A activity, underpinned—one hopes—in the near term by a clearer global macroeconomic picture and stability in the financial and commodity markets. The realization of this potential, we feel, will breathe new life into the sector for speculative mining and exploration-focused equities. The timing of this reawakening is unknown, but judging from the operating margins still being employed by many miners and the inability of many explorers and developers to fund the development of their projects, the sector is primed for consolidation."

On that score Haywood Securities analysts are not alone in pointing to miners as a source of hope for equities. Frank Holmes, who heads up US Global Investors, has been beating the drum loudly especially on gold and has suggested in recent commentary published in these pages that mergers and acquisitions will be strong this year. "Another big buyer has been the miners themselves. Mergers and acquisitions in the mining sector have been at an all-time high over the past two years. Large gold miners such as Barrick, Goldcorp and Kinross have been taking advantage of these cheap valuations by snatching up small miners with proven deposits." That trend should continue, Holmes argued, given growing cash in the hands of miners despite rising inflation.

Still, it's anybody's guess when—or if—the junior market will make a resounding return. For that you would need a copy of the script. Mickey Fulp, of the Mercenary Geologist, guessed at the coming plot for gold equities in a recent commentary. While Fulp noted there will be some bargains to be had in gold equities, he remained bearish on the underlying equities in the nearterm. "The real question in front of (us) cannot be answered at this time: Could this game be over or is it just in an extended rain-delay? That said, at some point valuations for the small minority of fundamentally strong gold companies will make for some no-brainer buys. Until then, I prefer to sit on the sidelines and simply watch the carnage continue."

Kip Keen

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