For junior exploration this is the 2008 financial collapse all over again

Small stocks hit 2008 lows as junior golds collapse to $29/oz - Algorithmic trading is fueling TSX Venture destruction

Pinetree Capital I have used for years as a benchmark of investor sentiment. They hold a large portfolio of micro and small cap public companies across various sectors worth almost $200 million. Approximately 70% is weighted toward base and precious metals and 15% uranium and other specialty metals and minerals.

This five-year chart on Pinetree sums it up very well – we are currently back to the devastating lows hit in Q4/08following the global economic collapse.

At that point, the level of pessimism hit an all-time low and the discussions centered on the 1930’s depression. The difference today, the Dow is near a five-year high and it is only the small, higher risk companies that are being subjected to these incredibly low valuation levels.

Junior golds collapse to $29 per gold ounce

To back this “post economic collapse” valuation scenario, we can also take a look at the junior gold stocks. I track 50 with a minimum one million ounces (43-101 compliant) and have been doing so since I noticed cracks in the foundation March 2011.

I use this to try and benchmark fair value for the sector overall, but also when researching individual companies and trying to determine their growth potential and risks. View my comments below on Victoria Gold and you will understand why this is important.

As the following chart will show, we hit what appeared to be a low in June 2012. At that time, we were all devastated that valuations could have fallen to these levels.

That basket of junior golds hit $29 per ounce this past week!

Algorithmic traders helping destroy our market

Defined: http://en.wikipedia.org/wiki/Algorithmic_trading

In “normal” times issuing news was a positive event that both companies and shareholders looked forward to. Now it is a liquidity event. If news is moderate to good – it creates enough buying for shareholders to liquidate.

If it is good enough to generate a substantial amount of buying – the algorithmic traders identify the liquidity, jump on it like maggots – and butcher it for a penny or two. Then they move on after a couple days to the next play and leave the company in the dust.

The Canadian junior markets are too small for these algorithmic traders. This works fine on larger companies or exchanges, but it is destroying our small Canadian market and the Venture Exchange. No doubt they introduced it (and continue to allow it) because of the fees the exchange generates.

But when we have a weak investment environment to begin with (for micro and small caps in Canada), we will be left with a barren wasteland within the next couple years.

More than just financial destruction

If something isn’t done in 2013 to address this, we will have a very serious problem and the reputation (that took the past decade to repair) of Canada being the best place on the planet to raise exploration capital – will be wiped out.

Right now more than 500 small companies on the TSX Venture are at risk of disappearing. They will soon run out of money with few options to tap into capital. To an extent you can view this as survival of the fittest.

However, at the same time, this has destroyed the speculative portfolios of tens of thousands of investors in the TSX and TSX Venture who have traded (quite successfully) these markets for decades. Now in a matter of two years we are at risk of losing those investors (speculators). Many will never return because they are in, or approaching, retirement age. Others will slowly dip their toe back into the market, but only after a period of years.

Cash- rich companies are also struggling

And the situation isn’t much better for the companies with cash. Through my Virtual Vulture Fund we track 80 TSX and TSX.V listed companies with a minimum of $10 million and a maximum of $190 million. They are not fairing any better.

Most trade at or well below cash value and many are just sitting on their cash doing nothing with it – creating long term retirement projects for senior management and the board (Phoscan at 27 cents with $60 million is one good example).

Others like Victoria Gold have more than $30 million in the bank and six million gold ounces in the Yukon - that appears economic. What is the market currently valuing that gold at?

An incredibly low $5 per gold ounce. And this is one of the most stable regions of the world.

On February 19, Victoria Gold announced critical environmental approval that took two years to obtain. This should have produced some decent gains considering the low valuation of the gold and the fact they traded rock bottom on their chart.

Instead, the stock cycled 3.6 million shares and went nowhere. Thanks primarily to short term traders and in particular, the algorithmic traders who had their computer programs skim off half a penny or so every few seconds of decent activity.

What should have been market moving news – was an event that did nothing to change the valuation of the company. And this is supposed to be an “Efficient” Market? It isn’t even close. In fact – this is a huge mess for small Canadian companies and retail investors.

If the stock exchange, regulators, and brokerage firms don’t put their heads together in 2013 to arrive at a solution, we are going to see billions of dollars in speculative capital leave this venture market permanently.

And with so many investors approaching retirement age, now is not the time for them to bury their head in the sand and think it will fix itself. I am not convinced it will this time.