In 2010, rare earth and specialty metals market froth had speculators throwing money at a sector they didn't understand, and opportunistic resource company managers stepped up to take their money. Two years later, so-called zombies, the walking dead companies, lurk on the Toronto Stock and Australian Securities Exchanges, all talk and no product. As Richard Karn of Emerging Trends Report explains in his interview with The Mining Report, anemic cash flows will put many of these zombies to rest in the coming year, while the survivors—the companies that can drop a sample on an end-user's desk for evaluation—will finally see the light of day.
The Mining Report: On the TSX Venture Exchange, there are hundreds of mining companies called "zombies," that is, their market caps and cash balances are so low as to be companies in name only. How many zombie companies are there on the ASX?
Richard Karn: Unfortunately, Australia finds itself in much the same condition.
There are 707 mining and resource companies on the ASX. Of these, more than 400 have a market cap of less than AU$10 million (AU$10M). Furthermore, more than 200 have market caps of less than AU$2M and cash balances of less than AU$850,000 (AU$850K). With the cost of maintaining an ASX listing conservatively estimated to be in the range of AU$650K per year, and the end of the financial year looming (June 30, 2014), a number of companies are verging on insolvency.
TMR: How many of these ASX-listed zombies will disappear before the end of the current fiscal year?
RK: I have no way of knowing that, but I am aware of a number of companies that have cut their payrolls to the bone and are essentially in hibernation mode—barely surviving, with the remaining employees on significantly reduced salaries.
For Australian juniors, for all intents and purposes the commercial finance markets are closed and the fund-raising environment is simply hostile. Too many retail shareholders are trapped in unprofitable positions and are now largely unwilling to participate in capital raisings, not the least because there is little reason to think the situation will improve anytime soon.
Asset sales in this market are similarly brutal: It's a buyer's market and many of these small companies are loathe to let go of assets they have developed for the merest fraction of what they have spent.
TMR: Will this culling of moribund companies be a good thing?
RK: Yes. Whether the commodity boom of the last decade is over or simply correcting, there is little question a considerable amount of froth developed in the specialty metal sector and excesses that were accumulated need to be worked off.
And that is a process, not an event, meaning it takes time.
We attribute the spark for the specialty metal boom that peaked in early to mid-2012 to China's June 2010 announcement that it was curtailing rare earth element (REE) exports and increasing the taxes to do so. That China had done exactly the same thing for the previous two years had not mattered to the market, but suddenly, inexplicably, it mattered to everyone.
Potential supply disruptions for a whole range of specialty metals critical to a wide range of electronic, green and military applications became the topic de jour, spawning Congressional hearings, Department of Defense white papers and World Trade Organization (WTO) actions.
Suddenly, specialty metal projects were on the receiving end of a flood of hot money, and hot money flowing without regard to reality always and everywhere leads to excesses. And the REEs were the poster children, though by no means the only specialty metal projects to attract these speculative capital flows.
At one point, we were aware of more than 720 listed companies globally that were promoting REE projects. We estimated that it would be miraculous if 18 of those projects were in production by 2020 because most of those companies had no idea of what was involved with putting a REE project into production, but that did not stop some opportunistic behavior on the part of both speculators and junior resource company managements.
One example of this suffices to demonstrate the madness of the crowds in this regard. We know of a junior resource company, which shall remain nameless, that was sitting on a tenement they'd acquired a few years before during the uranium boom that, as is often the case, had attendant relatively minor concentrations of REEs. Management flew a geologist out into "the back of beyond" in Western Australia, plunked him down by an outcrop, and took some photos of the geologist hammering a few samples from the rock of its "newest REE discovery." The geologist was so embarrassed by the sham that he kept tilting his head to make sure his face was not identifiable in the photographs—but the share price damn near doubled in the following few days.
This is the type of behavior that is spawned by a speculative boom and must be worked through before the good companies can rise to the top.
Another aspect is simply that people tend to extrapolate good times into perpetuity, and junior resource companies' managements are not immune to this temptation.
It is very common for a small cap, even a micro cap, Australian resource company to have a number of very good projects; the problem is they lack the funds or expertise to develop any of them.
Australia boasts a very rich geology, and Australians exploration companies are very good at finding and conducting early-stage development of projects, typically through the JORC-compliant stage, at which point they try to spin out the asset or try to sell it to a larger company with the financial wherewithal and expertise to develop it.
But if there are no buyers, the costs of maintaining the asset can become fairly onerous—and the more projects a company has, the higher the cost of maintaining them. That is a very real cash drain today.
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 cheaply.
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.