Friday, March 30, 2012

Hidden Strength Showing in Small Mining Shares, Part 2

• Taking Advantage of Long-Period Weakness, Not Easy, but Potentially Rewarding

HOUSTON (Got Gold Report) -- In Part 1 we looked at the relationship of the CDNX to the HUI and noted that the underperformance of the former seemed to be reversing to over-performance although it may not feel like it.  The smaller miners have seen a tremendous amount of liquidity wrung out of them over the past year.  (Part 1 should be read prior to this continuation.)

Just below is the Market Vectors Junior Gold Miner’s Index or GDXJ, showing, in our view, that the popular index of smaller and mid-cap mining shares has been sold back down into a zone of potential support (green on the chart).  We recently concluded a marginally profitable trade with GDXJ and are currently eying it for reentry. Judging by our mail, by the wretched action in The Little Guys and by the pathetic volume for most of the 60 or so issues we track on technical charts, sentiment for the smaller miners and explorers can only be described as abysmal at present.  It is a Vulture Playground deluxe.

20120329-GDXJ-2yr
 
(GDXJ, 2-year, daily)


For some of the extremely low-priced issues we track the stock price has become meaningless, because the market is, once again, in a buyer’s strike.  All markets everywhere need buying enthusiasm (and positive liquidity) to rise, but they can fall just because of a lack of buying.  In any given period there are always people who have to sell. We are of the opinion that buyer’s strike prices cannot be relied on, but it is fun to be a buyer when our “Faves” are getting beaten up by a tired, fearful or apathetic market.  It won’t always be that way, you know. 

 
Part 2 continues…

 
***  

Buyer’s strikes coincide with periods of negative liquidity, when there is more capital or wealth leaving a market than entering it.  Negative liquidity periods are self-curing, however, because they eventually reach a level that encourages bargain hunters and deep value speculators to step in.  More about that in a moment, including what we call that condition. 

SRC Opportunity

If one believes in our thesis, that The Little Guys have seen too much of a liquidity exodus since February of 2011 and are thus primed for a significant reversal back to an extended positive liquidity environment (PLE); if one believes that sooner or later better investor sentiment and enthusiasm will return and therefore the market for the smaller junior miners and explorers probably offers more upside potential than the opposite looking ahead, then the current environment has to rank high on the small resource company (SRC) “opportunity scale.” 

It is the height of irony that we are in a fairly rare period where investor sentiment is rotten while the underlying commodities these companies look for and produce are at prices that will reward execution and success.  It isn’t commodity prices per se affecting the junior miners; they suffer from a sector-wide confidence puncture.  

If one believes that the “animal spirits” will return to this beaten up sub-sector of resource market, then allow us to make the admittedly biased case, once again, that the time to build new positions or to improve existing positions is when they are obviously and strongly out of favor – when it seems that no one wants anything to do with them.  The best time to build a position in an SRC is when they have been trounced, pummeled, marauded, clocked … beaten to a pulp and chunked overboard like so much chum by panicked retail gamers into a buyer’s strike.

 
Sound familiar?     

 


The beauty of these small, thinly traded and risky issues is that they are subject to very high volatility – in both directions.  As our friend, the savvy financier Rick Rule of Global Resource Investments, now part of Sprott Global, often says, most people actually love one side of the volatility story – when an issue moves up strongly, but they can’t stand when volatility heads the other direction. 

Below is one case in point, ATAC Resources (TSX:ATC.V).  ATAC blasted higher during the 2009-2010 positive liquidity event (PLE) for the small miners thanks to a very good series of discoveries in the then red-hot Yukon area play.  High expectations and dramatic investor fury drove ATAC up from pennies in 2009 to as high as $10.34 and a market capitalization of more than $900 million in July of 2011. 

20120329-ATAC

But the negative liquidity event of 2011, combined with souring investor sentiment toward the Yukon took its toll swiftly thereafter.  By Christmas ATAC shares changed hands for as little as $2.22 (-79%), and ATAC’s market cap fell to under $250 million.  // When we say The Little Guys can be volatile both ways, we mean it.  ATAC is an example of it.  An extreme example, but a real one.

Volatility is Our Friend

We Vultures try to keep in mind that once a period of negative liquidity, with its attendant low volume and relentless downward drift runs its course it is almost always replaced by the opposite condition.  Near low extremes it really doesn’t take all that much buying pressure to have high price/percentage impact on our Faves. 

We’ve seen it before, over and over again, and we approach The Little Guys differently than we do all the other markets we trade because of it.  Indeed, because of the way we trade them, we find ourselves welcoming periods of harsh weakness and shareholder fatigue like an old friend.  

At Got Gold Report we have been using this anomalous period of severe weakness to build meaningful positions in a number of guru-recommended smaller resource related companies; tracking them on charts, attempting to add to our positions when they are being fearfully sold off to levels we deem as Stupid Cheap or Ridiculous Cheap (SC or RC on our charts).  We try as best we can to lay in wait at specific targeted zones where we believe the shares of the companies we call our “Faves” may find what we call “Overwhelming Support” (OS on our charts). 

Stupid Cheap, for new readers doesn’t have anything to do with the mentality of the people doing the selling at that time.  SC simply means that we believe that to be a price level we will look back at a year or two hence and say to ourselves, “Man, it was stupid for it to have traded down that low back then.”  RC, being always lower than SC, simply means that we believe that the price has gotten down to levels that when viewed a year or two from now we will be compelled to say, “That price was ridiculous!” 

“Overwhelming Support” (OS) is a theoretical (and actual) zone in periods of negative liquidity for specific issues where the price gets so low that insiders, Vulture bargain hunters and deep value specialists all converge on the bid consistently, each acting in their own self-interest.  At OS the price seems to have difficulty trading any lower, even during market-moving news.  At OS if the issue does trade lower it immediately (within a day or two) snaps back up to above the OS mark.

We call what we do Vulture Bargain Hunting and we only employ this technique with junior and micro-cap issues – as we attempt to game their inherent extreme two-way volatility.  We track the guru-recommended companies on technical charts and keep a running dialog of what we are up to directly in the oversized charts themselves.  Just below is a greatly reduced sample of what one of our “VB” charts looks like.  Vultures (Got Gold Report Subscribers) of course have access to the full-sized, crystal clear linked version on the password protected subscriber pages. 

20120329-NTR
  
We’ve mentioned that particular company before.  It is a promising candidate that has already made a high grade discovery in the far north of Canada in the Yukon, but it has been pummeled by the very market malaise we have described in this two-part offering and because of the ongoing buyer’s strike it trades at a fraction of its pre-discovery potential. The chart is proof of that already.  That blue box is where we would be compelled to add even more shares to our large stake in the company today, ahead of the coming exploration season in the Yukon.  This particular company has seen massive insider buying since December by the CEO, by the way.  Close to a couple million shares at last look.  We like it when the company brass shows confidence in their own company, don’t you?   


We currently comment in and share with Vultures our tracking charts of about 35 different resource related companies, many of which are super-low priced issues that we have dubbed “Cheapies with a Chance” (CWCs).  (With a nod to David Pescod in Canada for the CWC  term.)   They are companies with superior people prospecting and drilling holes in high-potential rocks, in mostly stable areas, nearly all of which share one common attribute. Most are one discovery hole away from a fast multiple of the current share price (just as ATAC was in 2009). 

With time and a little luck from the Drill Gods or the Market Gods the meaningful positions we are accumulating today at SC or RC prices or at OS – with a small portion of our resource gaming line - could make an important difference in our bank accounts.

That is assuming we have the Vulture determination and patience to weather a protracted negative liquidity event like the one that has been in play since February of 2011.

Well, actually, if we are right about the signals we have attempted to point out in this special two-part GGR public offering; if we are right about the CDNX outperformance versus the HUI being a “tell” it could be that the 2011 NLE actually peaked (troughed) in October last year.  Here’s the CDNX chart again for reference.

20120329-CDNX-2yr
  

 
We have made the case in prior buyer’s strike events that even the worst (best?) of them are temporary.  Following a brutal negative liquidity event such as the one that just might have ended (if the ratios we looked at in Part 1 are any guide), The Little Guys reach their nadir at some point(October?), a little more confidence begins to show in that market (CDNX outperforming the HUI?), early birds and bargain hunters sense a little change in attitude and liquidity starts to flow back into the market again (a series of rising lows in the chart above?).  At this point just a hint of optimism returning would make a big difference in the price of the CWCs.  Perhaps in a matter of just a few weeks or months. 

 
We cannot know what the catalyst will be or when it will arrive, however, except in hindsight.  So today we are making the case that perhaps the outperformance of the CDNX relative to the HUI (covered in Part 1) is telling us that some optimism is trying to sneak back in – right now, but it is still hidden, except in ratios we track.  The CDNX outperformance is just one indicator to us, but an important one.  We analysts are always looking for leading indicators.  Some work, some don’t.  That’s analysis. 


For those in the trenches or those who are new to the smaller resource companies it may be hard to believe that they can exhibit high volatility in both directions, not just to the downside.  But it is certainly evident in the charts we review today.  They remind us that it is these times of insidious, pervasive negative liquidity that the best, cheapest positioning can be put on by patient, bargain loving, confident Vultures.

An important point here:  When we speak in terms of patience, we really mean it when talking about the micro-cap issues.  Sometimes the negative liquidity periods we are gaming are over quickly, in just a few months, but sometimes they seem to last for a trading eternity.  We Vultures have to be mentally and financially prepared to build a position and then stay with that position for a long period of time.  Long enough to survive in the trade until a positive liquidity environment returns.  Unless the issue we are gaming does something to destroy our confidence in them, we take the position that our timing is, simply, “as long as it takes.”   

We cannot expect our Faves to reach their speculative potential when there is a negative liquidity event underway.  Oh, once in a while one of them might get a takeover bid (such as happened last year with Trade Winds Ventures, our Vulture Bargain #9), or perhaps one might make a fantastic discovery that might launch it no matter the environment (think ATAC Resources or Kaminak Resources), but for the most part we are all positioning now for when the negative liquidity tide turns strongly positive again ... and it will.        

20120329-Vik
We Vultures dearly love to buy the disgust, pain and panic of others, especially when it involves a company we have done research on and developed confidence in, but don’t get too complacent about that. 

Just about the time we get used to being able to wait for a Ridiculous Cheap price to buy in, the market will undoubtedly quit providing them again – kind of like that PLE in the CDNX chart above. 


Right now we Vultures are still in the position building, position improving stage while we look for signs that the negative liquidity tide is about to turn.  We’ve called attention to a couple of hopeful signs and the CDNX in the above chart may be about to put in its third higher low. 

If it does then we will have another sign to point to.  If it doesn't (this time), then we can use the negative liquidity and downside volatility to improve our positioning even more for when it does.

That is all, carry on. 


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The Original
Vulture Speculator

Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

"I've been a huge fan of Gene and his amazing work for years..."

Brien Lundin, CEO, Jefferson Financial, Host of the annual New Orleans Investment Conference and Publisher of Gold Newsletter


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