http://www.theaureport.com/pub/na/15015?utm_source=delivra&utm_medium=email&utm_campaign=Gold+final+streetwise-reports+02%2F15%2F2013+15%3A02%3A32

TGR: How does this create a structural inefficiency in the junior resource market?

JK: The current setup makes it possible for traders to strip out money flowing into the system without contributing any offsetting value. The rationale for accommodating algo and human prop trading is that this creates liquidity. Perversely, some of these trading systems even pay for these day trading orders while penalizing real investors putting on longer-term positions based on fundamentals. The trouble for the resource juniors is that the day traders are not interested in project fundamentals; they are focused only on volatility and capital flows. By being able to sell short stock without tagging it as such they can intercept money moving into the stock from fundamental investors. Obviously to profit they need to unwind the short position. This is just a matter of waiting for the inflow of new money to end, and then pounding the bid side of the order books with further short sale orders until the failed rally triggers a cascade of selling by despairing long shareholders, which allows the day trader's short positions to be covered the same day.

When fundamental speculators, that is, people who are betting on the fundamental outcome of whatever the company is trying to do, have to compete against such traders, the fundamental speculators disappear. This makes it difficult for the resource juniors to establish a higher trading price in response to positive fundamental developments and fund further work at those higher prices. Include the regulatory efforts to curtail the flow of private placement funding in the name of protecting investors, and you end up with the junior stuck on a dilution treadmill, issuing more stock to a shrinking pool of "accredited investors" at the same or lower prices despite making fundamental progress. Because ongoing equity financing is the key to delivering a definitive fundamental success in the form of a deposit that can be turned into a profitable mine, this "structural inefficiency" further skews the playing field in favor of traders. Allowing these supposed liquidity creators into the system has actually caused liquidity to evaporate.

The end game for this situation is that eventually fundamentals-oriented investors will withdraw entirely from the junior resource sector, leaving only the algo and human prop traders to battle each other. That may create the appearance of a thriving market for a while, but none of the capital in play flows into corporate treasuries. If the companies cannot produce fundamental successes, there is no reason for investors seeking winning bets on fundamental outcomes to pay attention to the junior resource sector. Furthermore, these day traders have become pretty good at recognizing when they are battling each other. Once it becomes apparent that they are cannibalizing each other rather than preying on real investors, they flee. Then there will be only very large spreads with little stock on either the bid or offer side, in effect a dead market. This is the institutional failure of the Canadian junior resource market that I fear.