Finding The Ups In A Down Market

Canadian resource sector juniors are a special breed of speculative securities whose market pricing is dictated by six key cycles: the seasonal cycle, the story speculation cycle, the company life cycle, the market cycle, the commodity cycle, and the economic cycle. In late 2008 a seventh "institutional" cycle with dangerous implications for bottom-fishers became a factor as the six normal cycles converged into a simultaneous low.

We are now experiencing a perfect storm of cyclical lows coupled with a risk of institutional collapse. That is why stock prices are so cheap.

What follows is an outline of several scenarios that bottom-fishers should consider during these unusual times. Bottom-fishers should either focus on bottom-fish with a story that fits one of these scenarios, or take a blended approach.

Spiralling Deflation

One scenario is that the world will succumb to a deflationary spiral reminiscent of the 1930s that paralyzes the global economy. This scenario promises weak commodity prices that discourage speculation in the ounces-and-pounds-in-the-ground juniors, and produces a shortage of speculative capital for discovery exploration-oriented juniors.

Because it is impossible to predict how long it will take for the economic cycle to emerge from this kind of funk, this scenario risks the institutional collapse of the Canadian junior resource sector.

The best bottom-fishing strategy for this scenario is to focus on cash-rich juniors that are firmly under the control of experienced management teams who can be trusted to generate a story that could launch a speculation cycle. One example would be Kobex Resources (KBX-V), which has about $18 million in working capital left after permitting problems prompted it to give up on its Lucky Jack molybdenum project in April.

Kobex is headed by Roman Shklanka who has two major buyouts under his belt: Sutton Resources' Bulyanhulu gold project in Tanzania, and Canico Resource's Onca Puma nickel project in Brazil. In both cases, management was able to generate takeovers in quiet markets.

Kobex management owns about 14% of the 34.3 million issued shares, which trade at a discount (20 cents apiece at presstime) to the $0.52 cash breakup value.

In this situation the bottom-fishing strategy focuses on the ability of the junior to survive in the long run and be in a position to come alive when conditions are ideal.

Spiralling Inflation

Another scenario is that the lessons of the Great Depression have not been lost on central bankers and government leaders, with the end result being that efforts to combat deflation will lead to substantial inflation, which propels the gold price through US$1,000 per oz. into a new trading range.

In this scenario a rise in the price of gold is not caused by a sharp decline in the exchange rate of the U. S. dollar against other currencies, which would boost the prices of all commodities. In this scenario gold rises against all currencies while other metal prices tied to the economic cycle languish. Such a development would generate broad enthusiasm for juniors with gold ounces in the ground, and spur a scramble by the juniors to acquire projects with existing gold zones once thought to be marginal. It would mirror the "race to production" psychology that characterized base metals projects during the boom spanning 2003-2008.

An ideal bottom-fish for this scenario would be Brett Resources (BBR-V), which owns 100% of the 4.8-million-ounce Hammond Reef gold deposit in Ontario. Brett is not cash-rich, but does have a strong management team headed by Ron Netolitzky whose most recent success was the buyout of Viceroy and its Gualcamayo gold deposit.

The Hammond Reef gold resource is a low-grade deposit that could be mined by open-pit methods. It's an asset that would benefit dramatically from a gold price above US$1,000.

Stagnation

Another scenario could be one of an extended global recession during which precious and base metals prices stay at current levels, further discouraging market interest in the inventory of ounces and pounds in the ground.

In this situation, the current downtrend in real estate and equity prices stabilizes, but a Japanese-style stagnation afflicts the world economy.

One would expect the Canadian junior resource sector to shift its attention back to discovery exploration-oriented stories where the goal is to make a world-class discovery whose economics are not dependent on higher commodity prices.

Because it is all too often difficult to predict which junior will make such a discovery, one must bottom-fish for companies that either have an under-appreciated discovery in the making or a strategy uniquely suited to making a major discovery.

A good bottom-fish for this scenario would be Eric Friedland's Peregrine Diamonds (PGD-T),whose new Chidliak diamond project in south Baffin Island is showing early signs of a diamond field comparable to the Ekati discovery Dia Met Minerals unveiled in late 1991.

Inside three months, Peregrine has revealed good regional diamond indicator mineral chemistry, identified 170 geophysical targets, and confirmed three kimberlites as diamondiferous, one of which has micro diamond results suggestive of a high macro grade. In addition, several large diamonds -including a 2.01-carat gem-quality colourless stone -have been recovered from very small samples.

BHP Billiton (BHP-N),which bankrolled exploration of Ekati and eventually bought Dia Met at a price that valued Ekati at $2.1 billion, has elected to back into Chidliak to earn a 51% interest by funding the next $22 million in exploration, after which it can increase its stake to 58% by funding a feasibility study.

Another intriguing bottom-fish with a discovery exploration focus is Nevada Exploration (NGE-V),whose management has spent the past decade developing a new explora- tion tool based on gold in groundwater chemistry.

Nevada is host to multi-million-ounce gold deposits that formed long before its "basin and range" topography was shaped. The outcropping ranges have been hit hard by previous exploration but the bedrock in the basins buried by gravel has remained invisible to low-cost exploration methods.

NGE management digitized 47,000 groundwater chemistry measurements recorded by Nevada state, developed a proprietary technique for collecting and measuring gold in groundwater samples, and collected 3,000 such samples from basin areas that the digitized database had highlighted as "dirty" with marker elements. Through this program NGE has identified 33 basin prospects with gold groundwater anomalies. It staked 11 of those. The company spent most of its money drilling two prospects in an effort to confirm the model, and is now at a stage where it can offer its prospects as farm-in opportunities for juniors seeking a shot at making a major gold discovery.

By virtue of its systematic and innovative data gathering approach, NGE has a vision of Nevada's hidden gold potential that no other company has. The market wants proof of the concept, but NGE does not have enough capital to drill the numerous holes needed to confirm its theory. But there are 275 capital pools with money in their treasuries and time running out to complete their qualifying transactions.

Insider stock in a capital pool is escrowed until a qualifying transaction

is done, after which the escrowed shares get released in stages over a three-year period. If it becomes apparent that it will be several years before a commodity cycle is back in an upswing, NGE's longshot basin plays may be the ideal property for capital pools.

Infrastructure Renewal

Another picture that may develop is a transformative infrastructure renewal campaign launched by president-elect Barack Obama as a form of fiscal stimulus that not only creates a legacy for future generations, but does it with a green-economy spin that doubles as a long-term strategy to shift away from economic dependency on oil.

Infrastructure renewal will eventually boost demand for raw materials in general, but the desire to make things more durable and efficient will boost immediate interest in specialty metals such as tungsten and rare earth oxides, whose supply is now dominated by China.

Many technologies linked to the renewable energy sector such as hybrid cars cannot be commercialized on a large scale unless significant new supplies from reliable jurisdictions are developed.

A bottom-fish well suited for this scenario is Avalon Ventures (AVL-T), which is conducting infill drilling and metallurgical studies on its 100%-owned Thor Lake rare earth elements (REEs) deposit in the Northwest Territories.

Avalon will publish a resource estimate in early 2009, followed by results of a metallurgical study. At that point it will still have $8 million in working capital left to fund the next stage of work.

Thor Lake has a world-class concentration of rare earth elements, in particular the valuable heavier elements used in super magnets. One of this project's obstacles has been a social licence from surrounding aboriginal communities, but company management seems to be making progress. Avalon's story could attract market attention even though the short to medium outlook for the global economy remains uncertain.

--The Author Is A California based Newsletter Writer. Visit His Website At www.kaiserbottomfish.comfor Further Information.