Tax Loss Buying Part II
We are in a holding pattern. Take the uncertainty around the Federal Reserve's pending decision, add in tax loss selling pressures, mix in a rising US dollar, and add in end-of-year fatigue and you get a market moving as much on self protection and exhaustion as on technicals or fundamentals.
One example of that: I met with a uranium junior today and, after catching up on corporate news, we talked shop for a while. Tax loss selling came up. That's a normal seasonal occurrence but this year-end there is another kind of pressure. Portfolio managers and institutional traders with mining exposure are in such need of gains that they are selling up stocks, even if they still like the story, to have a closed-out win in their books. They might be planning to re-enter the stock in the New Year, but the reality right now is extra selling pressure not only on tax loss candidates but on stock success stories.
Consistent metal price weakness is not helping. The 30-day copper price chart is looking almost as bad as the 6-month chart.
Gold is down too (though it jumped to end today, not yet sure why). Zinc is weak, as are nickel, platinum, palladium, uranium, and silver. In the absence of strong reasons to believe this situation will reverse anytime soon, metals investors are exhausted.
In my attempt to balance realism and optimism, I still see opportunities but I also see a huge number of Steer Clear signs. Further downside in gold is definitely possible, especially immediately following a decision to raise rates. A surprising number of weak projects are still being promoted. End of year pressures could continue to hurt equities for several more weeks.
Come January, mining's strong season should provide some positive opportunities - but get in too early and you limit your chances. Patience and realistic expectations are the name of the game.
With that in mind, I took subscribers through Part II of my Tax Loss Buying strategy in last week's letter. We still haven't made any moves, but we are preparing. The sector looks set for another year of sideways stumbles, which to me means it's important to play for 20 or 30% gains where possible.
For today's Maven Monday, I've packaged up one news bite and most of that Tax Loss Buying article. This week subscribers will get a list of candidates that meet the criteria I outline, along with actionable advice on timing and price. If things work out, the letter will also offer a new recommendation. If you'd like to see,sign up for a free trial subscription.
The Metals Investor Forum approaches!
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And now for this week's Maven Letter selections. Hope you enjoy!
In The News…
First Mining Finance (TSXV: FF) has eaten up another junior. The company, which brands itself as a mineral bank focused on acquiring assets that will see much higher valuations in time, took over Goldrush Resources (TSXV: GOD).
Goldrush has five properties in Burkina Faso. More important, though, is its bank account. The company has $3.5 million in the bank and expects another US$750,000 to come in over the next two years from previous deals. That means First Mining is really using its shares to buy $3-$3.5 million right now (depending how much gets spent on lawyers to close the deal) plus roughly $1 million (Canadian) later.
Goldrush also offers two royalties: a 1.5% net smelter royalty on the Pompoi permit, which is near Semafo’s Siou gold mine, and a 1% NSR on two permits hosting a gold zone near Nord Gold’s Bissa gold mine. First Mining would look to sell these royalties to raise additional funds.
The deal will see First Mining provide 0.0714 shares for each Goldrush share, giving GOD shares an implied value of $0.026. That represents a 52% premium based on each company’s 30-day volume-weighted average prices.
First Mining will issue almost 12 million shares to get the job done. Taking only the cash into account and assuming it totals only $4 million, the deal raises money for FF at $0.33 per share issued. If it’s $4.5 million, the raise is at $0.375.
First Mining is trading at $0.355 today, so it’s a raise at market terms.
However, First Mining’s VP Derek Iwanaka pointed out the advantages.
“Sure, it’s about on market terms – but there’s no commissions, no warrants, and this deal was easier than it would have been to raise $4 million in the market right now. Plus selling the royalties could add some value.”
My next question was a familiar one for him: what about share count? The Goldrush deal will bring First Mining’s count to 305 million. That’s not small, especially given that First Mining only came into existence in April.
But First Mining is using the kind of capital that is available – shares – to buy undervalued assets that will be worth more down the road.
“As long as we’re building good ounces per share, we’re still adding accretive value,” Iwanaka said. “We started out in April with $5 million, 74 million shares outstanding, and zero ounces in the ground. By July we had almost a million ounces and 100 million shares out, which is 0.01 ounces per share. Given today’s news we have – or soon will have - $4 million with just over 300 million shares out and 7.5 million ounces of gold equivalent, which is 0.025 ounces per share and almost the same amount of cash as we started with. That’s value accretion.”
As for investors in Goldrush, company president and CEO Len Brownlie said his team spent the last year trying to put their bank account to work, but none of the 90 projects reviewed worked. By taking this deal with First Mining, Goldrush is providing shareholders with a premium to the current share price plus ongoing exposure to gold assets, through a larger, more diversified company.
On The Macro: Tax Loss Buying, Part II
Metals are getting hammered again.
I wish I could point to reasons for near-term optimism, but I cannot. The only light I see on the horizon comes from seasonality, which is why I will continue last week’s look at Tax Loss Buying with the second instalment: How To Place Your Bets.
I mentioned last week Canaccord’s assessment that in the last five years, stocks on the TSX Composite Index down more than 15% year-to-date as of mid-November have underperformed the index by almost 4% over the month to mid-December and then, in the subsequent month (mid-Dec to mid-Jan) these same stocks have outperformed the index by 3.6%.
Importantly, that outperformance is on top of gains the TSX reliably generates in the metals space over that time frame
So there’s a starting point: look for stocks that are down more the 15% year-to-date.
But I chose my examples last week – Tahoe Resources (TSX: THO) andPrimero Mining (TSX: P) – because they offered more than chart arguments. Each struggled with specific headwinds in 2015 that looked to be nearing resolution. That is the kind of change that can amplify the upside in what is otherwise a trading argument.
Then there’s the commodity question. What metals do you think offer the best chance of a New Years rally? For me, the answer is gold. Gold’s January strength is reliable and all the questions swirling around rates and debt and dollar strength provide as much lift to gold as pressure on it.
Silver, platinum, and palladium are usually proxies to gold, but I wouldn’t trust platinum this time around – too many demand questions, too much ETF outflow, and too much supply. Palladium is no better: 70% of global palladium goes into cars and the slowdown in China, the world’s biggest car market, has the market very worried about demand.
If you like silver, it offers good odds of a New Years rally as well, as it moves in tandem with gold (until it starts outperforming – but we’re not there yet).
The metals I like in the medium term are zinc and uranium. However, I don’t expect any near-term moves with those prices, so tax loss buying opportunities are limited. Copper holds no near-term hope, in my opinion.
Once you’ve homed in on commodity, the next question is stage. Exploration? Development? Production? My preference is for production. What we’re looking for here is stocks that will provide the best leverage to gold’s January gains. Explorers offer a bit of leverage, developers a bit more, but producers offer the most. The reason is straightforward: set costs mean a rising gold price multiplies profits.
So the criteria are:
- Gold or silver miners
- Stocks that have declined more than 15% year to date
- Companies that have faced particular struggles, on which progress or resolution is on the horizon
I have quite a list of candidates, but in this instalment I’ll got through just one. The point is to illustrate how to think about entry and exit points – because remember, this is a short-term trade concept. This is not about buying deep value stories that you believe will multiply in time. That is important too, but the tax loss buying angle is about figuring out how to use January’s rally to bank 20 to 30% gains, and then get out.
The example I will use today is Mandalay Resources (TSX: MND). Mandalay operates three mines: the Costerfield gold-antimony mine in Australia, the Cerro Bayo silver-gold mine in Chile, and the Bjorkdal gold mine in Sweden.
Here is the company’s 52-week chart:
The stock lost 25% from start of January to mid-November and is down 31% compared to its mid-January high.
So MND is a gold and silver miner that is down more than 15% year to date. So far, so good.
As for the third criterion, Mandalay has faced its share of specific struggles this year. Costerfield operated well, in general, but a strike impacted production at Cerro Bayo as did the need to transition from one mining area to another. Meanwhile, Bjorkdal is still being transformed from the marginal producer Mandalay acquired last year to an efficient, low cost operation.
Let’s start with Bjorkdal, because it is a perfect example of what Mandalay is trying to do. Mandalay was formed by a team of seasoned mine operators. They all retired from major mining companies and then got together specifically to buy and improve mines they know from experience were good assets that hadn’t gotten the attention they deserved.
Bjorkdal is their most recent acquisition, bought in September 2014. The team bought Bjorkdal precisely because they saw so many opportunities to improve the mine. Those improvements have been the focus for the last year.
For example, the gold at Bjorkdal is nugget-y. To process nugget-y ore effectively requires careful grade control and customised sorting techniques, neither of which had been implemented. Mandalay started with customised orebody mapping, drilling, sampling, and modelling. With a better model on hand, Mandalay was able to implement more selective mining techniques, supported by a local assay lab.
On the sorting side, Mandalay is testing optical techniques to separate black wallrock from gold-bearing quartz vein material. Results suggest 40% of the black waste rock can be isolated out, boosting mill head grades significantly.
All this work meant Bjorkdal was mostly effort (and cost) this year, rather than returns. The mine produced gold at an all-in sustaining cost of US$1,110 per oz., which certainly doesn’t leave a lot of room for profit. But the improvements underway are now starting to pay off.
Trials of mining selectivity methods went very well, which means the entire mine is now incorporating these methods. Same goes for the sorting systems. As a result, Bjorkdal should generate better results in the fourth quarter – lower costs and higher output – which would tie in nicely with a seasonal share price rise in January.
Over at Cerro Bayo Mandalay faced other challenges. Miners went on strike for several weeks in late June/early July. That disruption happened just as the operation was transitioning from the Fabiola and Dagny mines to the Delia SE and Coyita mines.
Such transitions are necessary, as Cerro Bayo is comprised of multiple underground mines feeding into a single flotation plant. Now that it is done, the higher grades at Delia SE should boost average mill head grades.
Between Bjorkdal and Cerro Bayo, Mandalay faced specific challenges that look set to resolve in the near term. As they do, Mandalay’s financial performance and operational successes should start to shine.
Importantly, this is a fundamentally good company. Mandalay posted a US$17.6-million profit for 2014 and has posted positive profits every quarter this year. The corporate bank account generally contains about US$47 million. And with mines in Australia, Chile, and Sweden, Mandalay is really benefitting from weakness in local currencies versus the US dollar.
The experienced management continues to prove their value. These guys took ‘old’ mines and gave them new life. Exploration had been limited at all three assets until Mandalay stepped in, but now MND adds more reserves each year than it mines.
Looking ahead, costs should fall at Bjorkdal and Cerro Bayo. Meanwhile Mandalay expects to spend about 25% less on capital projects in 2016 than it did this year, while producing more gold.
The company’s financial care comes through in its dividend policy, which sees Mandalay pay 6% of the trailing-quarter gross revenue out to shareholders. The latest instalment saw investors receive $0.0083 per share, which represents a 4.6% dividend yield. As gold investors continue to wait for a real mining rally, yield is attractive.
OK, so Mandalay meets the criteria. How then should an investor interested in MND as a tax loss buying trade come up with a plan?
It all comes from its 52-week chart. Let’s take another look.
What we need to establish are entry and exit points. In terms of entry: MND is already essentially at its 52-week low. That being said, the stock could well lose more ground over the next three weeks, as tax loss sellers hit down-on-the-year stocks. A decision by the Federal Reserve to raise rates would add more pain.
An entry below $0.70 looks likely.
As for an exit, there are two levels of support/resistance on MND’s chart, which I’ve drawn in. A January gold rally could easily lift MND to the first line, at $0.82. That would represent a gain of approximately 22%, depending on your exact entry point.
Should Mandalay announce strong fourth quarter results amidst gold’s seasonal rally, MND might well regain the upper level, at $0.92. That would represent a ~37% gain.
I would take either! In these markets, it’s about picking up profits where you can. But locking in those gains requires discipline. For each tax loss trade, you have to assess the company and its chart and figure out a game plan: entry and exit points that are achievable and provide enough return to make the trade worth your time.
And then you have to STICK TO YOUR PLAN! Gold falls back in February or March as reliably as it gains in January, so don’t let a rising tide tempt you.
Gwen, you are truly a beacon of sound thinking and honest insight in a market sector full of charlatans.
BTW - I really enjoy reading your newsletter - very comprehensive and you do an excellent job of integrating a macro perspective into your analysis.