Is there any hope left for juniors?

There's no surprise that the recent fall in commodity prices and the rise in costs, coupled with shrinking capital have created a recipe for disaster in the junior resource sector. But John McCoach believes better days are ahead for the sector.



There's no surprise that the recent fall in commodity prices and the rise in costs, coupled with shrinking capital have created a recipe for disaster in the junior resource sector. But John McCoach believes better days are ahead for the sector.

"In my view the current market cycle is mostly cyclical but there are definitely some structural issues, and there's some opportunities for us to improve our markets," the president of the TSX Venture Exchange said during a Sept. 12 panel discussion at the Toronto Resource Investment conference.

But panel member John Kaiser appeared less optimistic. "I am willing to concede that if we got a gold bubble … and say gold rocketing to two thousand dollars we will be bailed out of the mess that we are in now," the editor of Kaiser Research Online said. "However, I think it would just temporarily kick the can down the road."

Out of the 1,400 TSX Venture companies that he covers, he said 721 or more than half of them have less than $200,000 in working capital, which is barely enough to last another year. In addition, there are 600 juniors trading below 20¢ with negative working capital.

The shortage of capital has led to the suspension of several juniors for failing to meet the Venture's listing requirements with a few being delisted. "But in August the rollbacks started to go through the roof," Kaiser said, referring to more and more companies consolidating their shares to increase their share prices. Despite this, he stressed that these companies have barely enough to survive.

"There is several things that have frightened me and why I think we face an existential collapse over the entire institution," he continued. These unnerving factors, he said, includes a structural change in the brokerage industry, regulatory restrictions, algorithmic and proprietary trading.

The role of brokers as intermediaries between the companies and public has diminished since the late 1990s with the "deregulation of [brokerage] commissions and the emergence of discount brokers, where the public can go and trade cheaply, and at the same time we got the internet which made a wealth of information available to the investing public," Kaiser explained. Since brokers were not making the same commission on junior companies this resulted in a decline of brokerages participating in the natural resource sector, which has impacted the sector's ability to attract risk capital, he said.

"There's no question that there are challenges in the brokerage industry and that their margins are not what they used to be… and compliance costs are going up," McCoach noted. That said, he argued the shift in the brokerage industry has contributed little to the current troubles in the junior resource sector.

"We were led into this cycle by mostly macro factors, commodity prices, investor sentiment … and opex issues in the mining industry, and I think that is what is going to lead us out of the cycle."

However, he agreed that securing capital for juniors is difficult and suggested a way to increase the availability of funds is to improve the rights offering system in Canada to allow companies to attract money from their existing shareholders. "So that is something we are strongly advocating to fix in Canada," he said.

Kaiser offered that if additional exemptions were made to allow lower net worth investors to buy stocks from discount brokers it would make it easier for juniors in the discovery stage to get capital.

He noted in the last decade brokerages were becoming more "litigation conscious" or afraid of facing lawsuits by their clients if they promoted the potential of a discovery by an exploration company that never took off.

Similarly, juniors face "regulatory overkill" that prevent them from promoting the "speculative possibility" of a discovery and attracting capital to test that anomaly, in case they find nothing, Kaiser added.

Although the newsletter editor clarified that he was not "anti-regulatory" and applauded the National Instrument 43-101 rules that require companies to file technical reports and supporting documents to allow investors to make informed investment decisions, he said the cost of compliance and filing these documents are eating up the little capital that juniors do have.

He further contended that there's a "systematic downward basis" in the sector, explaining that if a company's stock closes up in the last half of the trading day it raises a flag at IIROC, the Investment Industry Regulatory Organization of Canada, whereas if a stock closes down, it doesn't elicit the same type of reaction.

While McCoach agreed that there is a "regulatory burden" in Canada, he pointed out that the rules haven't changed much over the previous bear and bull markets. "It is not the numerator that has changed, it is the denominator. Companies have a smaller amount of capital so that is impacting them more," he commented.

Lastly, Kaiser said algo traders or proprietary traders are "ruining" the junior market by suppressing the share prices of companies by selling positions they don't own through high frequency trades. With the elimination of the uptick rule, short sales are now not being tagged by regulators, he argued.

IIROC made the changes to the short sale rule last year to "harmonize it with capital markets around the world that don't have uptick rules," McCoach responded. But the implications of the change, he said, should be closely examined. However, he added high frequency trades only make up 1 to 4% of the daily trading volume on the TSX Venture.

Given the changes in the brokerage industry and the continuation of regulations and algo trading, Kaiser urged that all stakeholders should examine the "simple solutions" that could make it easier for the stronger juniors to survive and raise capital in these trying times.

"An important role of the Exchange is to talk to fund managers and trading firms outside of Canada to attract capital to this country to support our capital markets," McCoach said.

"We have the right model," McCoach concluded, "and we have to protect that and so when the markets come back people will still see this as a credible junior market."

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