(From THE WALL STREET JOURNAL ASIA)
By Patrick Barta
Kalgoorlie, Australia -- READY FOR SOME wild prospecting on the fringes of the worlds mining sector? Dig no deeper than Western Australia, where shares of mining companies that dont even produce any ore are soaring like dot-com stocks, circa 1999.
Western Australia is the base for much of the worlds speculative mining activity. The vast, sparsely populated region has some of the earths biggest reserves of mined commodities, including iron ore and gold, making it highly attractive for exploration start-ups. Also, Australias stable economy and well-developed financial markets make the country a good incubator for mining ventures, including companies digging mostly elsewhere, like in Africa and Asia.
Many -- if not most -- of the start-up outfits will come to nothing. Like dot-com highfliers, some are built on little more than hype and a hunch. Some promise to unlock riches from mine sites that were picked over years ago. Others are drilling in areas where most miners have never gone -- like the ocean floor.
The Australian and Canadian stock exchanges are favored listing sites for many fledgling companies that dont have a long track record of profitability. The obvious problem for investors is that most of these companies dont yet have large producing assets, so cash flows are hard to predict, and the chances of failure are often high.
In extreme cases, some speculative miners have turned out to be outright frauds. Global mining investors are still smarting from the fantastic flameout of Bre-X Minerals, a Toronto-and Nasdaq-listed Canadian company whose stock value hit $4.5 billion after it claimed to have discovered the worlds biggest gold find in Indonesia in the 1990s. The discovery was a hoax and Bre-X went bust.
Despite all the risks, even serious money managers concede that some speculative mining companies could hit pay-dirt, especially given todays high commodity prices and intense demand for resources. For investors with a high risk tolerance, it might be worth a flier on a few of them -- so long as it is part of a broader strategy including blue-chip mining stocks as well, analysts say.
In exploration, "sometimes the moose pasture turns out to be nothing more than moose pasture," says Neil Boyd-Clark, a portfolio manager at ABN Amro Asset Management in Sydney. Even so, "you dismiss [these companies] at your own peril," he says. "You dont have to be a big company to discover a vast mineral reserve." Indeed, shares in Western Australias mining companies have outperformed their peers in many other industries in recent years, according to a study by accounting firm Deloitte Touche Tohmatsu.
In the year ended June 30, Deloittes index of Western Australia-based mining stocks rose 92%; since May 2000, the index was up 390%. Among the contributors: relatively little-known outfits like Anvil Mining and Equinox Minerals, both of which have projects in Africa. Both companies are listed on the Australian and Toronto stock exchanges.
By contrast, the Australian Stock Exchanges "All Ordinaries" index, made up of blue-chip Australian companies, rose 19% during the past year and 66% since May 2000. The U.S. S&P 500 rose 6% in the 12 months that ended June 30 and fell 10% since May 2000.
High-risk mining companies "pose more upside that you cant get in the mainstream sector," says Keith Jones, a managing partner in Deloittes Perth office.
Mr. Jones argues that interest is spreading beyond the usual market for these stocks -- average retail "punters" who play penny mining stocks like casino bets. Now, he says, large institutional investors are buying, helping boost the overall market capitalization of Western Australian mining companies 92%, or A$16 billion (US$12.3 billion), in the past year.
Equinox, for instance, saw its market capitalization increase more than tenfold in the past year to A$610 million. Australia-listed Fortescue Metals Group, which plans to mine iron ore in Australias Pilbara region, had a market capitalization of $2.3 billion at the end of June -- up from $632 million a year earlier.
Of course, this activity leads skeptics to conclude a financial bubble is forming. If conditions do change, and commodity prices fall, many small mining companies will likely fail, leaving investors with nothing. Indeed, many speculative ventures are predicated on projects that might not make economic sense with lower commodity prices.
Exploration stocks can "do very well for a while, and then the music stops, and it gets a lot tougher," says Shane Oliver, an analyst at AMP Capital Investors Ltd., an Australian fund manager.
But he, too, acknowledges "there is money to be made" in small mining stocks, at least in the short run. This is partly because commodity prices appear set to remain high for a relatively long period of time, as the industry has moved slowly to develop new supply. If prices do stay high, it could give some of the smaller companies more time to get their projects up and running.
Fortunately for investors, the Australia-listed companies have to follow minimum standards of financial disclosure that can help weed out truly unreliable ventures. Among other things, companies must follow standardized procedures for reporting the size of their estimated reserves.
Investors should pay close attention to those filings, as well as any cost estimates from the companies, as that information could help determine whether potential mines will remain profitable in a downturn.
Unfortunately, many high-risk mining stocks arent analyzed by major brokerages, meaning it isnt easy to get additional reliable research on them. Instead, investors often must rely on word-of-mouth.
There was a lot of that at this weeks Diggers & Dealers conference, an annual showcase of start-up mining ventures in Kalgoorlie, a historic Western Australia town.
One company many people were talking about: Bendigo Mining, which has been promising to produce gold from underneath its namesake town, near Melbourne, for years. In July, the company finally poured its first gold bar and plans to launch full-scale mining operations in October.Another extremely speculative venture is Nautilus Minerals, a Vancouver-based company aiming to become the first major producer of copper and other metals from the oceans floor off the coast of Papua New Guinea. The company is listed on the Toronto Stock Exchange.
At Diggers & Dealers, analysts of Patersons Securities, an Australian brokerage that does follow small mining stocks, recommended a handful of "speculative" buys, including Avoca Resources and Navigator Resources .
Avoca is developing a gold deposit in southwestern Australia. Navigator is drilling for gold and nickel in Australia. Both companies could benefit from high gold prices.
Patersons has managed share placements for both companies.
(END) Dow Jones Newswires
-PR-