Is It Time to Jump on the Mining Bandwagon?

The ‘efficient market’ theory held sway for quite a time in the ’90s, and for some time afterwards. It held that share prices at all times reflect all that can be possibly known about all the factors that determine their value.

When you think about it, that is a pretty sweeping assumption. If there were more than a few ‘unbiased’ and competent analysts following a share all the time and constantly publishing their opinions, and there were enough investors buying and selling based on their own interpretation of those opinions (and who also have the choice and the cash to buy and sell what they want when they want), then, perhaps, you can say there is a fair market.

But these conditions only ever apply to a very small part of the market. A FTSE100 stock might have ten analysts following it. But in the small- and medium-cap sector (including the FTSE350) it is frequently hard to find any analyst at all following a company. Often, shares dawdle along with practically no trading. Even if there is analyst coverage, it will probably be via the ‘in-house’ broker, who, as we all know, exists only to raise money for his clients and, strangely enough, only happens to publish something occasionally but certainly some time before a ‘surprise’ cash raise comes along.

The lack of research for private investors is partly because analysts and brokers don’t get paid these days (blame the FSA and its ‘unbundling’ policy) to produce and disseminate regular unbiased research.

The ‘efficient market’ theory was developed by actuaries as just that: a ‘theory’ which looks sensible on paper in regard to the only shares that actuaries are ever concerned with – i.e. those in the FTSE100. But even for them it always was nonsense, because it depends on the assumption that all analysts are competent and not, as they were in the old days, just out to stimulate trading ideas and hence volumes for the benefit of their brokerage arms.

In the early ’90s, before the “Earnings Guide” came along, its forerunner was a slim volume that listed merely the earnings forecasts from analysts. Initially there was, as you’d expect, a wide variation between them. But after about a year of the more detailed “Earnings Guide” – surprise, surprise – all those ‘forecasts’ began to converge so close to a ‘consensus’ that you could hardly fit a cigarette paper between them. Analyst objectivity?!

And as for that phalanx of analysts now concentrated in the small band of giant brokers focused on the giant companies, the more discriminating institutional investor will tell you that he looks in vain there for anyone thinking ‘out of the collective box’. That is why there are a tiny few firms, away from the brokers, who some institutions will pay well to carry out that ‘out of the box’ thinking for them.

Why am I writing this? The fact is that at any one time it’s not efficient knowledge that drives the markets. It is sentiment (definition: ‘opinion not necessarily backed by fact’) and the weight (or lack) of money. Most investors don’t have the time or ability to check out analysts’ research, let alone do their own. So, not wanting to lose out, they jump onto bandwagons, which usually start to roll slowly but gather more and more (unstoppable) momentum. (The ‘Momentum Investor newsletter’ – no relation – has a good track record by the way.)

And so, after a long period with grass growing around it, the mining bandwagon is creaking into motion. It’s now gathering speed (fairly gently so far) and momentum. Against the growing rumble of the wheels, any lone analyst’s voice is drowned out.

I’m not saying that momentum is wrong. Increasingly strong share buying (or selling) must reflect some sort of change. But what is it and how indiscriminate might it be?

Take Sirius Minerals (LON:SXX). Readers know my reservations about its value ‘now’. Yet its shares are storming away. A sensible investor will ignore me and stick with its bandwagon, although he might do well to be prepared to bail out when the charts and trading volumes turn the wrong way – which might be when the long awaited funding package is agreed.

But look at some of the others. Solomon Gold (LON:SOLG) is being tipped more and more widely, and so is Kefi Minerals (LON:KEFI). Both stocks I believe to be still very cheap even though dilution for the first has merely been deferred. Nevertheless, that dilution is by way of a placing to raise an extremely useful $20 million at a share price that by October when the deal materialises should have been boosted by SOLG’s first resource estimation at Cascabel, where drilling continues to show a bigger and wider series of gold and copper deposits. That is a good dilution deal welcomed by the market, whereas Kefi’s most recent deal is as disappointing as ever. That said, with production at Tulu Kepi now expected by the end of this year, and all the funding except a small equity component almost in place, the margin between the project’s value and Kefi’s market cap is still so large as to keep the shares a very attractive buy for the medium term.

But dilution! The concept that many private investors don’t seem to grasp – if they even realise it is happening – and who fail to realise that mega-dilution renders the historic share price charts and statistics useless as guides to value.

Take Ariana Resources (LON:AAU) – a private investor share if ever there was one. It is now about twice the price and the fair value that I estimated for it back in October, and despite a major spike two weeks ago having been unwound, it is still on an up-trend. But meanwhile, another dilutive share issue (of the many more that I still expect will come along to finance more drilling) at well above its fair value has been slid by to take shares in issue now to a staggering 3.2 times more than four and a half  years ago when I thought it looked attractive.

And, as for spikes, Alecto Minerals (LON:ALO) saw its shares rise on the back of a 0.31p/share broker target (Vs 0.09p now), based on an NPV calculation for its recently acquired Matala gold project in Zambia that, as usual, takes no account of the cost of funding or of any equity dilution before it gets off the ground in 2018. Admittedly, the broker says most funding should be by way of a project loan (which it may – it is not clear – have allowed for) and that the equity element would be ‘small’. But even so, the target is based on a questionable methodology.

P.S. Away from the resources space, have a look at Stanley Gibbons (LON:SGI). Someone has been tipping it – seemingly forgetting that whatever assets it still has (bound to be far, far, less now than when measured for the last balance sheet in June last year) will have been diluted by a share count now nearly four times more than back then.