The Return of the Big Anomaly
During the Cambridge Vancouver World Investment Conference on June 3-4, 2012 I gave two very important presentations that signal a shift in my narrative regarding the Canadian junior resource sector. Both my Workshop: Searching for Bottom-Fish presented on June 3 and Keynote: The Return of the Big Anomaly presented on June 4 argued that the junior resource sector is about to undergo a shift from the cash flow speculation that dominated the past decade to the traditional exploration discovery speculation that dominated the junior resource sector from the Hemlo discovery in the bottom of the 1982 recession to the Bre-X Betrayal in 1997. I presented some of the disturbing trends necessitating such a shift in my May 23 blog post Staving off Mass Extinction with the Big Anomaly.
To accommodate my view that market conditions favor a return to old-fashioned discovery speculation which does not require one to monitor Bloomberg headlines about the latest eurozone disaster or fret about $100 swings in the price of gold, I am introducing the Big Anomaly Club (this link, which uses the KRO Search Engine to generate all Big Anomaly Club members along with their flagship and secondary projects, requires active KRO Members to be logged in). The Big Anomaly Club is a special list featuring resource juniors with a flagship or secondary project still at the exploration stage which in my opinion has the potential to deliver a discovery whose potential value exceeds the valuation assigned by the market before a drill results confirmed discovery by more than 1,000%. I've already declared Peregrine Diamonds Ltd and Uravan Minerals Inc as members of this club, and I'll soon assign other existing Spec Value Hunter picks to the Big Anomaly Club. My goal during the next month is to fill the club with additional Big Anomaly plays so risky I would rather just own them myself than recommend them.
Membership in the Big Anomaly Club does not constitute a recommendation; it simply means that we think the project merits watching for signs that drilling is delivering a discovery that could send the stock price on a trajectory toward 1,000% plus gains from the pre-discovery equilibrium price. In special circumstances we will turn a new Big Anomaly junior into a simultaneous formal Spec Value Hunter recommendation, but in general we would wait to make a recommendation when results indicate that a Big Anomaly is on its way to becoming a Big Discovery. By that time the stock may have appreciated 200%-500%, but that is the price paid if one wishes removal of the very high probability that drilling turns a Big Anomaly into a Big Nothing.
The policy at Kaiser Research Online is that KRO employees are free to trade Big Anomaly Club members unless they are made the subject of a formal Spec Value Hunter recommendation, at which point we are stuck holding while a buy recommendation remains in place or selling after a closeout or demotion to "poor speculative value" has demolished the stock price.
Identifying a Big Anomaly play and visualizing its potential is labor intensive - smart use of the KRO Search Engine will only highlight juniors with a good chance of having a project that qualifies as a Big Anomaly - appreciating how and why an exploration play qualifies as a Big Anomaly requires quite a bit of background work and discussions with company representatives, not all of whom understand what their exploration team is trying to accomplish. So if discovering a Big Anomaly play is something like extracting teeth, why don't we just do this work, place our bets, and go to the beach while we await the outcome of the truth machine?
The truth is, our business model involves collecting fees from subscribers in exchange for handicapping the betting opportunities in the junior resource sector. One day after we have institutionalized the rational speculation model as a vast "wisdom of crowds" system that visualizes potential outcomes of exploration plays we will retreat into the woodwork and just privately place our bets. But for now we do this work to educate our audience and put ourselves in a position to evaluate an emerging discovery as a recommendation candidate. For the real value lies in recognizing the early stages of a Big Anomaly erupting into a world class discovery play.
We share the results of our labor with KRO members through Special Interest comments with the assumption they are sophisticated enough to understand the extreme loss risk associated with Big Anomaly plays, and have the common sense to stay away from the Big Anomaly Club if total loss risk is not an option. For this reason Big Anomaly related comments are restricted to KRO members for 3 months, usually enough time to make or break the Big Anomaly (see the General Release Schedule to find out what will become unrestricted when).
It is not our intent to document the rise and fall of every Big Anomaly Club member; we merely want to point out and explain what these lottery ticket draws are all about, and leave it to KRO members to place their own speculative bets. At the same time we are eager to educate our audience about how to apply the "rational speculation model" to projects still at the early stage of the exploration cycle.
I am overdue with regard to providing an up-to-date tutorial of how the rational speculation model works, but this PDAC Diamond Technical Talk given in March 2009 demonstrates how it applies to the diamond sector, whose Big Anomaly boom in 1992-1996 was a key inspiration for the development of my approach to quantifying the speculative value of potential exploration outcomes relative to how the market is pricing them. Also, this 49 minute Mining Interactive College Video done in June 2009 is a very good introduction, especially since the example it uses, Brett Resources Inc, played out exactly as predicted. Here is the link to the Powerpoint Presentation that I refer to in the video.
Membership in the Big Anomaly Club is different from membership in a Bottom-Fish Edition. The Big Anomaly Club will include juniors with way too much paper outstanding, barely enough money to fund a "hail mary pass" drill test of the Big Anomaly, and in danger of a stiff rollback if drilling does not deliver a discovery hole. These are all or nothing juniors which do not belong in a Bottom-Fish Edition which is reserved for juniors with the capacity to survive an extended bear market. The Big Anomaly Club can also include solid juniors whose survival does not hinge on the outcome of a Big Anomaly's test. Such resource juniors can also qualify as members of a Bottom-Fish Edition.
As of June 14, 2012 there is no open Bottom-Fish Edition. I closed out the 2009 and 2010 editions at the end of 2011 because it was clear that the junior resource sector was descending into a bear market. However, I have created a Stocks to Watch list to which I add companies that are bottom-fish candidates when they appear to be bottoming. The market has turned south in a big way since the start of May, and I have not yet had a chance to add the resulting bounty and purge the those earlier candidates which in the gathering gloom are destined for the dead-fish fertilizer pile.
The general negativity would suggest that I have plenty of time to publish a new Bottom-Fish edition at the end of 2012 at rock bottom prices, but my contrarian instincts cause me to worry that the junior resource sector may be back in an upswing by Q4 of 2012, so my plan for the moment is to publish a new Bottom-Fish edition during the dog days of summer. For now, however, I am focused on this new concept of the Big Anomaly Club.
By creating a Big Anomaly Club we are trying to spotlight an aspect of the junior resource sector that lost its retail audience in the wake of the Bre-X Betrayal in 1997, and which was overshadowed by the rise of real metal prices during the past decade which shifted the market's focus onto the development of deposits which were the failures of past exploration cycles when lower metal prices prevailed. This phase of speculation on the economic implications of higher metal prices for existing deposits started to subside in 2011 as the global macroeconomic outlook in the wake of the 2008 Crash failed to develop a convincing recovery. As of mid 2012 advanced projects with both base and precious metals were trending lower despite the surprising resilience of metal prices near the upper end of their historical range. The institutional and hedge fund capital that dominated the "super cycle" window is withdrawing from the junior resource sector, and is unlikely to return until macroeconomic conditions signal that the emerging market super cycle remains intact.
Meanwhile, retail investors, who never fully embraced the number-crunching, geopolitical risk analysis and macroeconomic prognostication required for intelligent investing in mine development plays, and who have not participated in a discovery play since the Bre-X Betrayal, remain on the sidelines. This has created a funding vacuum within the junior resource sector which threatens its existence as an institution because of the expensive nature of its support and regulatory infrastructure.
Although a convincing gold rally above $2,000 not accompanied by systemic financial collapse which wipes out appetite for dollar denominated speculative equities is indeed possible during the next six months, a broader turnaround in the global economic outlook that restores faith in the super cycle is very unlikely before 2013, and even then only possible through a scenario that defies the doomsday narrative of the resource sector's pundits and financial backers. The drawback of this outcome is that the prophets of doom who dominate the junior resource sector would suffer massive enfeeblement, leaving this industry to flounder around in search of new voices.
I'm taking the view that the panel of experts who drew a standing room crowd on June 4 in Speaker Hall South for an hour long debate on the "Global Impact On Your Portfolio", namely Doug Casey, Peter Schiff, Frank Holmes and Mike Berry, while I drew a two-thirds full audience in Speaker Hall North to hear my talk on "The Return of the Big Anomaly", will during the course of the next 12 months be talking to a sparse audience of diehards who somehow have not tired of macroeconomic drivel and ideological preaching while the crowds will be packing talks where the discussion is about wealth creating exploration discovery plays rather than wealth transferring artifices.
In my view the only near term potential source of capital for the junior resource sector is the retail investor, who will only be coaxed from the sidelines by the arrival of a major discovery that switches the glass from half empty to half full.
A single discovery success story, however, is insufficient to switch the glass half full and pull speculative capital from retail investors into the junior resource sector. The success story needs to enrich a large and diverse shareholder base that ranges from widows and orphans to stock brokers all hopelessly buried in what appears to be a doomed stock. And it needs to do so as a result of efforts by management to do exactly what it is their mandate to do, namely deploy their geological creativity in conjunction with sound exploration methodology to generate a Big Anomaly presented as such to the public, and then tested with a drill which turns the Big Anomaly into a major new discovery which in retrospect will have been so obviously a winner.
The junior resource sector is currently unhealthy because the approach of a critical test of a Big Anomaly does not generate anticipative speculative buying despite considerable efforts by management to make the nature and scale of the Big Anomaly very visible through diagrams and graphics. This "last minute" speculative buying which drives the stock above the level of the last financing round is essential for the health of the resource sector because it provides earlier investors an opportunity to recover some of their capital which they can recycle into other juniors developing a Big Anomaly target. Unfortunately, this anticipatory after-market no longer exists, which means that in the absence of a major grassroots discovery there will soon be no risk capital available for the junior resource sector.
Turning a Big Anomaly into a new wealth creating deposit discovery is a probability game, with most Big Anomalies eventually turning into duds. However, unless management is geologically incompetent, or the Big Anomaly is a very high risk high reward target, most initial drill programs do not deliver definitively bad results. In fact, most deliver "encouraging results", which in a healthy junior resource sector market stimulate further speculative buying that enables the junior to secure additional funding at a premium to the earlier round's price that enables it to fund additional exploration of the target and allocate funds to other targets still at the incubation stage. This dynamic is absent from the junior resource sector in 2012, which implies rapid depletion of existing exploration capital in corporate treasuries or its conversion into subsistence capital that pays for administrative overhead while reducing the probability of wealth creation to zero.
Not only is there no anticipatory speculative buildup ahead of a Big Anomaly test these days, fueled by what used to be derisively called "promotion", but there is almost a zero response to results unless they qualify as a "barn-burner" whose deposit implications are so self-evident that a maximum valuation is almost instantly attained. Aurelian's Frutta del Norte gold discovery in 2006 was an example of a grassroots discovery which suffered very little market anxiety before followup results confirmed the scope of the discovery. Frutta del Norte was in fact the result of a "hail mary pass" directed at a blind conceptual target with faint supporting data which received very little advance public arm waving from a chagrined management team which had chewed through a $20 million exploration warchest with very little to show for the effort. It functioned like an unexpected bailout rather than fulfillment of the wildest dreams.
For a great discovery arising from a Big Anomaly to achieve a collective market switch from glass half empty to half full it must require of its investors a leap of faith besieged by skepticism, a leap of faith pinned to the Big Anomaly outlined by management as the road to shareholder enrichment. When certitude rather than qualified faith accompanies the eruption of a discovery play, it paradoxically frightens rather than emboldens the shareholders because they intuitively recognize that they simply got lucky, and so they withdraw from the market with their winnings. What we need is a Big Anomaly score which sends the winners as well as the bystanders on a rampaging quest for similar Big Anomalies just begging for a drill hole to confirm them as new discoveries.
In the rare event that buyers materialize in response to "encouraging results" that inch the Big Anomaly closer to fruition, existing shareholders must these days compete with an army of traders who spend their day looking for surges of liquidity into which they can sell paper they do not have, which they have an intention to borrow or deliver that need never be fulfilled because the short position will be closed out by the end of the day. And should the inflow of Big Anomaly fundamentals focused buying prove stronger than expected, the elimination of the uptick rule for short sales makes it possible to mobilize bigger guns to flood the bid side of the order book with sells until the upwards momentum has been exhausted, and discouraged existing bona fide shareholders turn into sellers that enable the traders' short positions to be neutralized. In this manner new speculative capital that flows into the junior resource sector gets systematically harvested by a trading culture supported not just by a predictably myopic brokerage industry, but a pathologically stupid stock exchange beholden to a shareholder base with an appetite for geese that lay golden eggs.
Kaiser Research Online has been part of the junior resource sector since 1994, and we are very worried that the TSXV is wandering towards an extinction threshold, which would not at all be good for our business model of collecting membership fees in exchange for equipping KRO members with the tools needed to engage in profitable "rational speculation". Our Big Anomaly Club is our own form of a "hail mary pass" we hope will save the day by making visible the Big Anomalies severely stressed but legitimate juniors are generating, and steering the market's perception back to a form of resource sector speculation that went out of vogue after the Bre-X Betrayal and the rise of the super cycle.
The regulators have very much constrained the ability of the resource juniors to graphically "visualize" the value of the potential outcome the truth machines testing their Big Anomalies might generate. The rules of qualified professional reporting and the mine engineering profession also limit the range of metal prices that can be plugged into discounted cash flow models. This embeds a pessimistic bias into the technical evaluation system which is required to use trailing average prices if they are lower, but never if they are higher courtesy of a recent price spike such as nickel underwent in 2007. But the 43-101 reporting rules as well as prohibitions against selective disclosure encourage companies to make available in reasonably organized form an unprecedented abundance of exploration data.
Sophisticated software for the production of graphics that make datasets intelligible give companies plenty of room to "help" the market understand the Big Anomaly without explicitly describing it. That is a good thing because all geology is subjective thanks to its fourth dimension called time of which we see only the present, with the history a best efforts reconstruction on the part of the observer. We are entering an era where the retail investor will learn the rules of geological-economic visualization and apply them to the information provided by the juniors under the tough "what you see is what you get" requirements of the Canadian 43-101 system. We are not there yet, but we are moving in that direction. For an example of how geology is being made accessible to investors, check out the Ore Deposits 101 produced by Sprott Global, in particular the more recent video on Carlin deposits.
But for the moment we are still in a vacuum where the retail investors watch uncomprehendingly from the sidelines, while the fund managers keep their distance from the wild and wooly world of Big Anomaly visualization. And this represents an opportunity on a par with the bottom-fishing window that opened up at the end of 2008. Back in 2008 the crash wiped out valuations of juniors engaged midstream in the advancement of deposits that appeared to work very well at super-cycle metal prices. The bottom-fisher's risk was that the global economy in the wake of the 2008 Crash would fade away into a long term depression that sapped demand for raw materials, resulting in a commodity price bust that rendered these juniors with advanced projects into Very Long Sleepers that would eventually be mopped up by others at rock bottom prices. This scenario did in fact not happen, though now there is concern that the V-shaped recovery was an artificial interlude created by two rounds of quantitative easing that have made the eventual consequences even worse.
From the junior perspective the situation today is different than at the end of 2008, because during the past 3 years we have seen many of the advanced projects get absorbed through takeover bids by larger companies. What is left is arguably the dregs of the deposits rolled out from the closet during the super cycle boom, the deposits still owned by the juniors because they are more marginal than the deposits the bigger companies did acquire and have yet to fully put into production. The owners of these projects will have to count on the capital markets to fund their advancement through the development cycle to production, a very expensive proposal crippled by the departure of institutional money from the resource sector until the macroeconomic outlook signals the super cycle is back on track. (To review advanced projects with resource estimates for gold, copper, silver, nickel, zinc, tungsten, uranium, and molybdenum, projects already taken over as well as ones still owned by listed juniors, check out our KRO Resource Tables.)
Not every junior has been involved with proving the economic feasibility of an existing deposit. Many have engaged in old-fashioned discovery exploration despite a relatively unreceptive market. These juniors have been punished by bloated share structures and cheap prices which assign almost zero speculative premium to their exploration projects. This is the new window of opportunity for resource sector speculators, and it is one we at KRO intend to dress up so that everybody can see what is still going on at a fundamental level, and place highly leveraged bets on Big Anomaly plays that offer very good speculative value as defined by the rational speculation model.
Historically we have offered lists of bottom-fish that KRO members can pick and choose from during bear markets. We are screening our universe of resource juniors for candidates that qualify for inclusion in the Bottom-Fish 2012 Edition to be published later this year. By selecting the Stocks to Watch link in the special parameters box of the KRO Search Engine KRO members can preview juniors that made the cut during Q 1 of 2012; since then the market has substantially deteriorated and we will soon add a new batch of qualifiers while purging some that look like lost causes in the current environment. But our immediate priority is to establish the Big Anomaly Club, because this will consist of desperate ninth inning juniors swinging for the fence in the final game of the World Series, or throwing long bombs into the endzone during the final moments of the Super Bowl. The metaphor is a bit of a stretch because in the discovery exploration game victory is never instantly attained, with completion playing out in slow motion. We will privately place our bets on Big Anomaly plays, but for our KRO members we will be looking for those slow-motion completion plays to make Spec Value Hunter recommendations.
KRO members need to distinguish between Big Anomaly and Bottom-Fish portfolios. A diversified Bottom-Fish portfolio should be constructed with the expectation that at worst the portfolio will do nothing while a general bear market runs its course, but when the cycle turns bullish again, the Bottom-Fish portfolio will lead the junior resource sector indices and deliver overall 500% plus gains before the general market cycle turns negative again. A good Bottom-Fish portfolio is difficult to accumulate, and suffers from timing risk because it is difficult to predict the duration of a bear market. Cash rich, well structured juniors with good management teams belong in Bottom-Fish portfolios, as do juniors with Big Sleeper assets or a prospect-generator-farmout exploration strategy that enables new plays to be generated and tested with somebody else's capital in a manner that minimizes equity dilution. A good Bottom-Fish portfolio requires minimal attention until we are back in a confirmed bull cycle.
In contrast a Big Anomaly portfolio requires constant attention because it consists of juniors on the threshold or in the midst of making or breaking a Big Anomaly target. To qualify for the Big Anomaly Club the junior must have a drill-ready target or group of targets which individually or collectively lend themselves to concrete visualization in both physical and economic terms based on extrapolation of geological data or invocation by analogy with an existing orebody. The target can be outlined through exploration tools such as geophysics, geochemistry, remote sensing, trenching and prior drilling that failed to result in a 43-101 resource estimate robust enough to justify a preliminary economic assessment, or it can be a conceptual target based on contextualized geology. We exclude projects which have advanced to the stage of economic quantification, but we do include projects that host a resource deemed to be sub-economic if exploration has shifted to a new Big Anomaly target.
A Big Anomaly play needs to deliver results with size and grade implications that can handle a reversion to historical metal price averages of the sort dreaded by the market during mid 2012. By its nature an exploration discovery play is one where speculators need not know anything about prevailing macroeconomic factors as is the case with advanced projects where "exploration" is focused on discovering the cost structure of the optimal mining scenario while funding decisions are based on speculations about long term metal prices. All they need to worry about is what is happening to grade, tonnage and geometry as drilling delineates the discovery. Speculative economic analysis is still required to establish the valuation limit, but this task is much easier after the publication of more than 500 technical reports by TSX and TSXV juniors since 2008 presenting preliminary economic assessments (PEA), prefeasibility studies (PFS), and definitive or bankable feasibility studies (DFS or BFS) as well as just plain feasibility studies (FS).
The reason we treat the Big Anomaly Club as a free-for-all gambling arena that KRO members must track on their own unless we adopt the junior as a Spec Value Hunter recommendation is because many of the Big Anomaly Club members will have only one chance to complete their hail mary pass, and in most cases we are stuck with an incomplete outcome that spells a rollback for the junior. None of these plays qualify as investments; they are speculations distinct from gambling because they do have a chance of creating new wealth. We do yearn for the days when conferences used to be fun, when we spent our time homing in on buzz about a hot exploration play, trying to separate bogus from real rumors, and understand what sort of results were needed to make a stock go higher. When nobody packed a hall to listen to macroeconomic drivel from know-nothings and moral admonishments from preachers you knew amassed their wealth through utterly different means.