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Equity Update: Opportunity in the Junior Resource Sector

Posted by nexvucapital on March 30, 2013

The Miners (both precious and base metals) have been hurt by rising operating costs which have wiped out any benefit from the rise in metal prices.

TSX Mines

In the case of copper the global supply has a cash cost of ~$1.50 to $2.00 per pound. Hence a copper price holding stable north of $3.00 is required to keep supply forthcoming relative to current demand. We are calling for a robust US economy (GDP at more like 3.5% versus the consensus of +2%) and China levelling in at +/-8% GDP growth (with a two-headed focus on both industrialization/urbanization and creating a sustainable consumption based economy/middle class which is a recipe for higher copper density per capita).

Copper

Gold

In a world of stable metal prices and muted earnings growth, we are also in a period of minimal CAPEX expenditure such that the mines currently scheduled for near-term production will generally come on stream to offset demand but NEW CAPEX for production growth from the Majors and from Institutional investment into the inventory of advanced-stage junior projects will generally stay extremely low. This creates a new reality for those junior companies sitting on advanced-stage projects that require better economics (higher metal prices) or projects that are too small to warrant acquisition. Under these conditions, we see an ongoing shift in the junior resource sector away from resource feasibility and toward discovery exploration as investors focus on juniors that may bring forward new discoveries that would be economic at current or even better – at lower metal prices.

CDNX

The current environment is perfect for asset-based mergers and acquisitions with the initial focus being on companies with known large economic assets on the books. We have seen our first major deal already in FM.TSX taking out IMN.TSX and we will see more of this activity going forward as the equity prices of the targets are substantially down from their highs of just a couple of years ago and the cost of debt financing is at secular lows. We recently featured one of our favourites in this category – Lumina Copper (LCC.TSXV).

https://nexvucapital.wordpress.com/2013/03/27/equity-update-lumina-copper-corp-lcc-tsxv/

THE KEY: the dominant purpose of the Junior Resource Exchange in Canada through its history has been the discovery and resource development (proving up size) of new resource assets which are then acquired by the Majors and Mids. This has also been the most rewarding investment strategy for those who historically invest in the Junior Resource Sector. As can be seen below this type of investment strategy takes considerable patience as contrary to the “overnight” success chart patterns that we see upon discovery the truth is that to be pre-positioned requires patience. The general timeline can be seen below where it takes on average 4 to 5 years to have a discovery post the conceptual phase.

Life Cycle of a Junior Explorer1

WHY? Because new discoveries are hidden from view generally and require a systematic process:

  • Concept Generation:
    • where is the best location for a potential asset discovery
    • ground acquisition while dealing with multiple “owners”
  • Pre-Discovery:
    • surface geology and geophysics to target where to drill
    • discovery drilling to determine the location of the targeted asset
  • Discovery:
    • confirming the existence of the targeted asset
    • delineation drilling to determine the general economics of the discovery

We can suggest a Junior Resource Exploration Risk Reduction Strategy:

  • Known districts – proven assets with proven infrastructure economics
  • Multiple targets – diversification within a single company
  • Large targets – the type that can be sold to the Majors and Mids.
  • Work to date – targets that are deep into the pre-discovery phase – drilling
  • Financing – a management/support team that has a history of raising funds in tough markets for exploration. In good times technically competent management teams raise capital from investment bankers and institutional investors but in lean times it requires access to a network of retail brokers and retail investors.

Conclusion: with exploration juniors trading at their lows the timing is optimal for an entry point on a risk/reward basis.

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