PDAC 2015: John Kaiser on retail investors, systemic flaws PDAC 2015: John Kaiser on retail investors, systemic flaws
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2015-03-19
Retail investors, historically the “life blood” of the junior sector, are largely gone from the picture, but need to return for the sector to survive the current downturn, says John Kaiser.
The editor of Kaiser Research Online notes in the 1980s that retail investors depended largely on brokers to access information to invest in juniors. “To a large degree, it was a momentum driven market, and the focus in the ’80s was largely on gold exploration,” he said in early March at the Prospectors & Developers Association of Canada (PDAC) conference.
In the 1990s, the sector uncovered several large discoveries, including the Voisey’s Bay nickel deposit and the Ekati diamond deposit, attracting institutional investors through private placements, Kaiser said. “That period was all about discovery exploration.” It also coincided with the deregulation of brokerage industry and the emergence of the Internet, which minimized the role of brokers as intermediaries between juniors and investors.
That discovery exploration phase came to a halt in 1997 following the Bre-X scandal, “when the greatest gold deposit ever turned out to be a fraud,” Kaiser says. Consequently, the sector sank into a five-year bear market.
But on a positive note, the fallout led to the introduction of the National Instrument 43-101 that required companies to backup their findings with technical reports, identifying project risks. This injected new life into the Canadian exploration industry and “set the stage for the biggest bull market we have ever had,” Kaiser says. The commodities super-cycle lasted from 2003 to 2011.
This led majors to invest $140 billion in buying out 263 juniors on the Toronto Stock Exchange and TSX Venture Exchange in the past decade, Kaiser says. While institutional investors were largely part of that, he notes retail investors were marginalized, as it required “a lot of number crunching” and cash flow analysis that they were not used to.
“Now that has ended, and we are in the worst bear market of the decade, and the retail investor has completely left the room.”
The narratives that attract capital sources in the industry are currently not working, the analyst says. The commodity cycle, based on the belief metal prices will go higher because of macroeconomic reasons, is a narrative that institutional but not retail investors follow closely, Kaiser says. He predicts the current commodities downturn will continue for another year or two.
The two narratives involving gold bugs and discovery exploration that retail investors traditionally enjoy are both stalled because the price of gold didn’t go up as expected, and juniors currently lack the capital necessary to make big new discoveries.
“Because of the circumstances— structural changes in the industry— we are no longer seeing the capital go into these companies that enables them to drill the holes that deliver that Voisey’s Bay, which turns the glass half full again. We have a worse than half empty glass and the retail audience has nothing to inspire them to come back,” Kaiser says, pointing out discovery exploration is too risky for institutions.
The fourth relatively new narrative— security of supply— driven by rare earth elements and crucial metals is one Kaiser suggests retail investors should learn more about, as the capital costs for such projects are generally lower than that for large base metals projects. But he cautions even this has lost some appeal after the boom and bust of the rare earth market in 2010 to 2012.
Structural flaws and fixes
Overall, the junior sector is in bad shape, and may not be able to withstand the continuing bear market, Kaiser says. Out of the 1,649 junior companies that he follows, 717 currently have negative working capital; 291 have between $0 and $500,000 in working capital; while 554 firms have between $500,000 to $20 million. Only 77 firms have more than $20 million in working capital. The companies in the last two categories are likely to survive, while the rest are on the brink of disappearing.
The analyst stresses the accredited investor restriction is one of the many reasons the capital market is broken. To become accredited, investors must be worth $1 million, excluding their primary residency, or earn at least $200,000 a year in the last two years, to participate in private placements.
Kaiser argues for the elimination of the restriction, as wealth does not dictate intelligence and prevents the average investor from investing in junior companies. “Why should the 1% be the only ones entitled to buy stock from [a company’s] treasury? Why shouldn’t an ordinary person that does his or her homework be able to give their money directly to a junior?”
For those who do qualify, Kaiser says U.S. regulators are looking to push the net worth requirement to $2.5 million, cautioning Canadian regulators may follow suit, further diminishing the capital pool.
Other structural problems include the client relationship model that limits a financial advisor’s ability to suggest risky investments such as junior mining stocks to certain clients based on suitability factors such as a client’s age.
Kaiser, who predicts the downfall of financial advisors, proposes financial institutions should allow investors to open two account types, one that is 100% robo-advised and another for risky investments that are 100% the client’s responsibility.
Meanwhile, proprietary day trading coupled with the elimination of the short sale uptick rule has created a downward bias in the junior sector as it makes it difficult for juniors to trade higher on positive developments, compromising the price discovery mechanism in the sector, Kaiser says. “So there is now this capital harvesting stripping system in place, which is sucking away the after-market money that retail investors could potentially inject into the market.”
Adding to that is limitations juniors have in promoting their story, with the introduction of the NI 43-101, which prevents them for saying what they think a project might look like before a technical report or economic study is out. The companies are “allowed to publish all kinds of dots and details, but they are not allowed to connect the dots for the public. We need to build something that facilitates the dot connecting,” Kaiser says.
He suggests an online interface that enables investors to visualize a project as a mine by applying a discounted cash flow valuation model to that project, by using different variables, to help assess the project’s potential. Users, staying anonymous, could share the possible outcomes of their deposit model with other investors online.
“It is the wisdoms of crowds being collected in one space and aggregated to create a consensus outlook, which becomes a reference point in the market in deciding if a stock is overvalued or undervalued,” Kaiser says, adding it will also be educational for a younger audience of retail investors in learning how the sector works.