An epiphany of sorts the other day while dreaming in a jet-lagged state.
I remember a colleague showing me an article back when I first got involved in the sector. It was an interview with Peter Munk IIRC and discussed the valuation of projects from the exploration stage through to production. The graph looked something like this.
The first part--the discovery--is marked by volatile and big swings in price. Once the decision was made to take it to production, there was a drop in value--maybe as the various difficulties of production were sorted out. Eventually money is spent, and the mine is built, and it again increases in value into production (assuming no major problems arise).
I remember thinking that the big drop in value between the production decision and building the mine was some sort of market inefficiency.
In retrospect, I think that at the time of the article, the retail market controlled the share price of the exploreco during the exploration/discovery phase (if a bunch of kittens chasing a ball of yarn could be said to be in control of anything). What I think has happened since then (certainly since about 2008) is that the institutions are now in control throughout the life cycle of the discovery and development--and they don't like that drop in value after the production decision. It looks bad on their quarterly statements.
So now the valuation curve looks more like this:
Most of the fun and good times at the exploration stage are now gone and the value of the project increases as money is committed toward development. I have to admit that this looks like a more reasonable trajectory for the development of an ongoing business.
If this is the case, then investing in explorecos has become a high-risk, low-reward scenario. In fact, the only possibility of a reward is if the company has a plan to achieve production that doesn't involve selling hundreds of millions of shares at a nickel.
I remember a colleague showing me an article back when I first got involved in the sector. It was an interview with Peter Munk IIRC and discussed the valuation of projects from the exploration stage through to production. The graph looked something like this.
The first part--the discovery--is marked by volatile and big swings in price. Once the decision was made to take it to production, there was a drop in value--maybe as the various difficulties of production were sorted out. Eventually money is spent, and the mine is built, and it again increases in value into production (assuming no major problems arise).
I remember thinking that the big drop in value between the production decision and building the mine was some sort of market inefficiency.
In retrospect, I think that at the time of the article, the retail market controlled the share price of the exploreco during the exploration/discovery phase (if a bunch of kittens chasing a ball of yarn could be said to be in control of anything). What I think has happened since then (certainly since about 2008) is that the institutions are now in control throughout the life cycle of the discovery and development--and they don't like that drop in value after the production decision. It looks bad on their quarterly statements.
So now the valuation curve looks more like this:
Most of the fun and good times at the exploration stage are now gone and the value of the project increases as money is committed toward development. I have to admit that this looks like a more reasonable trajectory for the development of an ongoing business.
If this is the case, then investing in explorecos has become a high-risk, low-reward scenario. In fact, the only possibility of a reward is if the company has a plan to achieve production that doesn't involve selling hundreds of millions of shares at a nickel.
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