|Kaiser Watch March 17, 2023: Will the bank run scare help resource juniors?
|Jim (0:00:00): How will the banking crisis affect resource juniors?
The failure of Silicon Valley Bank last Friday has shone a light on a problem created by the Federal Reserve's determination to subdue persistent inflation by rapidly reversing the ultra low interest rates of the past decade. When the covid pandemic hit in 2020 the Federal Reserve flooded the system with liquidity to prevent a serious recession arising from the disruption of business activity and consumption. The result was that savings deposits climbed, but because of the economic uncertainty the depositors' money was not lent out to support businesses and real estate purchases, but was instead parked in low yielding government bonds whose yield was slightly better than what the banks were paying the depositors. When interest rates rose sharply the value of the banks' bond assets dropped, but the value of customer deposits stayed the same, which meant that the difference had to be accounted for by the bank's capital which belongs to the equity shareholders of the bank. Normally this should not be a problem, but Silicon Valley Bank was unique in that it specialized as the preferred banker for the countless startups that the west coast venture capitalists had funded until the tech bubble ended in 2022.
Many of these startups remain private and some achieved "unicorn" status which means that based on the price of the most recent financing round, the private company had a market capitalization in excess of $1 billion. Most of these startups are simply spending machines as they develop whatever fin-tech or other concept that supposedly will eventually conquer the world. Even when they have revenues these are dwarfed by "market development" costs, which became acceptable with the original dot-com bubble that ended in 2000. The end of ultra low interest rates in 2022 put a lid on valuation increases because when government bond risk free rates are 4% that translates into a Price-Earnings ratio of 25 rather than 200 as was the case when yields were 0.5%. The prospect of even higher interest rates would further reduce the value of future success. Investor interest in funding these unicorns in danger of losing their horns dried up in 2022, which disrupted the assumption that the startup world could continually replenish its treasury with new funding.
Much of the money spent by tech sector startups goes toward human labor, with payrolls being met on a semi-monthly basis. Because the west coast venture capitalists encouraged the startups they were backing to bank their cash at the Silicon Valley Bank, that bank had an excessive concentration of deposits which in 2022 were being depleted by the ongoing payroll expenses that the venture capitalists were having a hard replenishing with new funding. This was a de facto run on the bank whose bond assets were suddenly worth less and represented losses if liquidated to generate the cash to meet withdrawals. It was different from a more typical bank run where ordinary depositors start withdrawing their money to chase better yields elsewhere and not caring that they forfeit the tiny interest that was being paid on their ultra low yielding term deposits.
The startups were not like ordinary depositors who at most leave $250,000 in bank deposits because that is the maximum amount insured by the FDIC (we have since learned that super-libertarian Peter Thiel left an enormous amount of his capital in SVB even as he urged his fund to sneak out the back door). But when you are a business you have to maintain a much larger cash balance to fund ongoing expenses. Venture capitalists like Peter Thiel became aware of SVB's vulnerability and started alerting the startups they were backing about the risk of a bank run that could wipe out their remaining cash which was becoming increasingly difficult to replenish with new funding, especially at prices higher than the last round. Making payroll is a sacrosanct rule, so the recognition of a payroll catastrophe risk would have unleashed panic within a startup's management. This created a classic prisoner's dilemma well known from game theory. The venture capitalists were watching this with horror from the sidelines, because if the startups they are backing blow up because their capital has vanished and the brain trust that underpins the development story disperses when payroll is no longer being met and their options and RSUs are worthless, the VC's investment is down the toilet. Unfortunately, many of these VCs are chest-thumping full of merit libertarians who celebrate the superiority of the individual rather than the collective, so it was natural that some chose to bolt before their competitors did the same. And once that was underway, the Silicon Valley Bank was dead in the water and had to be seized by the government.
The equity of the Silicon Valley Bank's shareholders has been wiped out and there is no way of getting that back, which is why bank stocks in general tumbled last week and continue to be under pressure. Instead of letting SVB depositors take a haircut on their deposits above $250,000, the government decided to guarantee the full amounts. This has been widely criticized as creating absolute moral hazard of the sort that created the savings and loan fiasco of the 1980s because it is assumed the government will now guarantee everybody's bank deposits. While plenty of individuals may have had deposits in excess of $250,000 at SVB, most of them likely have much of their wealth stashed directly in treasury notes, mutual funds or equities held by a brokerage firm where they are segregated from the firm. So bailing them out would not have been a priority for the government, but preventing the collapse of the entire west coast startup eco-system, putting tens of thousands workers on the street and effectively destroying whatever concept they were developing, would be a different matter. Seeing some of these fin-tech (aka crypto) startups vanish might not be a bad thing, but killing the rest would be.
Unfortunately the consequence of the Silicon Valley Bank failure is that it has awakened everybody to the structural risk created for the banking sector by the monetary fight against inflation unleashed by Jerome Powell in 2022 which is only a quarter so far of what Paul Volcker needed to do in 1981 to subdue inflation. The inflation back then was difficult to subdue because the rapid increase in oil prices had created a wage-cost push spiral (COLA clauses - cost of living adjustment) which was not unwound until the mid eighties. Today's inflation has two different drivers which are likely immune to monetary policy.
One is that demographic change is shifting pricing power into the hands of Millennials and Gen Z as the Boomer generation drifts into retirement and plans to live off its concentrated wealth until the sun sets on them around 2040-2050. The Boomers, the most selfish generation ever, have exhibited reluctance to sacrifice any of its wealth for the energy transition goal of preventing global warming from ruining the future of their children and grand-children. It is easy for a Boomer to be a climate change skeptic and argue that the planet may fix the problem all on its own because very few Boomers will be around to find out if they were right or wrong. Whereas past generations all bought into the idea of family formation and enduring mid-life sacrifice that guarantees success for their children, after which the parents can enjoy retirement, today's younger generations are to a fair degree embracing the same End Timer mentality as their elders by refusing to work on terms that guarantee their survival in what is shaping up to be a terrible future without miraculous intervention. The only way the economy can fight this attitude is by rushing to deploy automation and AI to substitute for a shortfall of workers, a path that Japan and China are now aggressively pursuing because they have a terrible demographic problem. But the automation-AI replacement will not happen overnight, so wage based inflation pressure will be difficult to eradicate without plunging the economy into a deep recession or depression, which will have the consequence of radicalizing the younger generations.
The other inflationary pressure is the reversal of the deflation created by the globalization of the past two decades which enabled China to become a great power rival to the United States. China's embrace of autocracy and decision to have state owned entities reach deeper into all aspects of the Chinese economy is creating geopolitical tensions and wiping out the multinational dream of selling goods and services to the Chinese population. Western businesses are now withdrawing from China, and while they initially looked at relocating production capacity to China's neighbors in southeast Asia, the clear signs that China sees this as its turf is forcing them to look at India with its complicated bureaucracy or reshoring to home bases like the United States where higher environmental and human costs prevail. Reshoring production capacity will involve higher CapEx and OpEx than businesses have enjoyed in a globalized economy. In addition, the geopolitical fracturing of the global economy threatens to disrupt raw material supply from environmental shit-holes like China and Russia who together dominate 40% or more of the supply of most metals. Sourcing new metal supply not subsidized by autocracy which leaves downstream victims powerless to protest will be a source of raw material input cost inflation.
Jamming interest rates through the roof will not make these structural inflationary pressures go away. But doing so will deflate the value of the assets in which banks have parked their customers' deposits. Almost everybody now understands this and containing the rising panic will be difficult to do while continuing to jack up interest rates. Bitcoin has rallied 20% since Monday when it became clear that the west coast crypto startups would not be allowed to die. People are buying Bitcoin because they see only price risk in its ownership, not evaporation risk as they now see with their bank deposits. But Bitcoin is a Ponzi scheme and could overnight suffer its own monster "bank" run.
The biggest beneficiary of the bank run scare will likely be gold, because gold is energy stored in a physical form, not in the sense that gold can be burned to make the wheels turn, but to extract it from the ground and concentrate it into a gold bar requires energy. Although the world adds about 100 million ounces annually to the gold stock, the incremental addition is a declining percentage of the total above ground gold stock. Without a higher real price this trend cannot be reversed. Unlike Bitcoin, you cannot make gold disappear by pulling the plug on it. Bitcoin is an ongoing energy liability whereas gold is stored energy. Inflation will not go away, keeping investors fearful of additional haircuts to the value of their bonds and equities if the Federal Reserve resumes raising interest rates. Gold's price theoretically will track inflation, which means owning gold should allow one's purchasing power to remain stable, except for the inconvenient fact that countries like the United States treat gold as a "collectible" whose nominal value gain is subject to an onerous capital gains tax. Owning gold as an inflation hedge is thus a stupid strategy. But gold's real role is to hedge against uncertainty, the risk of massive dislocations. The era characterized as the "end of history" has come to an end, and gold's role as a hedge against uncertainty is now ascendant. There is now a solid reason to shift some of one's wealth into gold, which, combined with growing demand from autocracy central banks eager to escape a weaponized US dollar, could allow gold to break through $2,000 and finally establish $2,000-$3,000 as its new trading range.
The resource juniors will benefit from the banking crisis because gold will once again be topical if $2,000 becomes the new base. One could worry that the banking crisis and high interest rates will negatively impact macro-economic demand for metals, which should result in lower prices and thus chill investor interest in juniors exploring for or developing non-gold metal deposits, making gold the only game in town. But that worry is offset by the fact that the need to replace metal supply that currently comes from increasingly unfriendly autocracies is only going to worsen, even if America becomes an autocracy which I guarantee you will not make America best buds with China and Russia, regardless what Tucker Carlson and Donald Trump think. And there is the fact that the car makers are now hopelessly committed to the energy transition as far as electric vehicles are concerned, and the IEA has made it clear how much additional supply of copper, nickel, lithium and rare earths beyond macroeconomic consumption are needed to make those EV deployment goals reality. Naturally investors in resource juniors cowered in fear this week as they watched the global banking sector, according to the Financial Times, see $450 billion in equity value vanish. But on Friday while the general equity market trembled further, the GLD ETF gained ounces and the traded value of TSXV resource listings jumped dramatically.
Daily Gold Holding Change for GLD ETF
TSXV Trade Value Split between Resource & Non-Resource Listings
|Jim (0:14:23): What's next for Patriot Battery Metals?
Patriot Battery Metals was halted on Tuesday to allow completion of a $50 million charity flow-through financing and did not resume until Thursday. The financing was done in the form of 2,215,000 shares at $22.57 and gives PMET working capital in the $60-$70 million range depending on how much has been spent at Corvette since the start of the year. The entire financing was actually bought by Australian entities. After Peartree stripped the flow-through benefits from the stock all of the shares were sold through Australian brokerage firms or the subsidiaries of Canadian firms to Australian investors in the form of 22,150,000 shares so called Chess depositary interests (CDI) at AUD $1.20. Just as British and Australian listed companies trade on North American exchanges on a 10:1 rollback basis (ie Piedmont Lithium), stocks with a primary listing on North American exchanges trade on a 10:1 split basis on the ASX. So whenever you see the PMT price on the ASX, multiply by 10 and adjust by the AUD-CAD exchange rate to calculate what the TSXV equivalent price will be. The stock is down from its $14-$15 range during PDAC week in part due to overall market weakness as the banking crisis began to emerge, but also to reflect the discount needed to place the stock in Australia.
The big question is whether or not PMET will bounce back after loading its treasury with an extra $50 million. The timing of the halt during a week when conservative investors watched the banking sector lose nearly a half trillion dollars in equity value, stocks that are supposed to be safe and boring, has injected a new dynamic into the PMET market structure. The stock will likely come under pressure from the exercise of 4,038,409 warrants at $0.25 that expire June 30, 2023, and 26,850,727 warrants at $0.75 that expire mostly at the end of the year. Normally a warrant overhang is a problem for a junior when the exercise price is above the market price because the holders will short against the warrants every time the stock rallies through the exercise price. An then cover the stock in the market when the stock price sags, sucking up incoming new risk capital. PMET has a different problem in the $0.75 warrants represent a paper gain of $286 million at, say, $11.41 per share where it was trading mid day Friday. If the holders wanted to collect their profit by exercising and selling their stock, the market would need to eat about $300 million worth of stock. That is not chump change.
The warrant holders may until last week have been happy to wait for a potential buyout later this year, but during the two days while the stock was halted to complete the financing and the general market was shuddering from the bank run crisis, they probably experienced a considerable amount of fear that their paper profits might evaporate. The premise behind PMET's recent $2 billion valuation is the idea that the world is determined to go through with the energy transition in order to ensure an inhabitable future for the children and grandchildren of the Boomers. One plank in the energy transition strategy involves electric vehicle replacement of internal combustion engine vehicles. The IEA projects that the for the 2030 EV goals to be achieved the world will need to expand its lithium supply by 600%. But none of that will happen if the world descends into an apocalyptic End Times mentality. So what happens on the global stage matters to shareholders of PMET.
Then there is also the recent financing reality in the resource sector where major financings are done at major discounts to the market. Nobody knew what the term structure would be for a financing most knew was coming, so existing shareholders likely weren't happy to see in effect a bought deal at AUD $1.20 or $12 which, because $1.00 AUD is worth about $0.91 CAD, implied a $10.92 CAD price for PMET. During the past year we have seen a spate of bought deals at 20% or more discounts to the market price, which resulted in an instant haircut for existing shareholders that was not rewarded with a rebound after the financing was completed. So although PMET post-financing has $60-$70 million working capital to finish delineating the CV5 lithium deposit and proceed with an economic study, spooked warrant holders will likely start exercising the warrants and banking the profit.
The good news about the Australian purchase is that the stock went into strong hands which apparently included Mineral Resources and Pilbara Minerals, two $14-$16 billion market cap ASX listed lithium producers with apparent ambitions to dominate a future $100-$200 billion market while established majors like Rio Tinto, BHP, Vale and Anglo American pick their noses. Earlier this year there were unconfirmed rumors that Mineral Resources was accumulating PMET in the open market, which raised hopes that it might launch a hostile bid for PMET, perhaps ahead of a maiden resource estimate expected in late Q2. Since nobody has disclosed passing the 9.9% insider threshold, all this is largely rumor, though the paperwork for the Australian purchase would make clear who bought what in the current financing. If it is true that Mineral Resources and Pilbara bought toeholds, this bodes well for the stability of the PMET market as it digests stock from the warrant exericse.
Changing the subject, while updating the PMET financials for my KRO database I noticed a peculiar entry in the balance sheet of a kind I had noticed last year in the case of another junior whose CEO suggested I talk to the CFO for an explanation. The Dec 31, 2022 balance sheet shows current assets of $20,990,581 and current liabilities of $10,537,259. A standard measure of a junior's financial health is working capital, which is current assets minus current liabilities. On this metric PMET had only $10.6 million working capital at the end of 2022. But one of the current liabilities items is called "flow-through premium liability" and it is $8,553,172. This is an accounting fiction which new regulations now require companies to include in current liabilities. The amount represents what the company would be liable for to Canada Revenue Agency (ie the Canadian equivalent of the IRS) if an audit determines that the flow-thru funds were not spent properly. There have been cases in the past were flakey life-style juniors raised flow-through money and failed to spend it on qualifying exploration, which resulted in the flow-thru benefits of the placees being reversed by CRA. This resulted in a huge mess for the junior and the investors, especially for the investors if the junior has effectively blown all its capital and the pump and dumpers behind the junior have walked away.
While the intent is to alert investors that the company has an obligation to spend flow-thru money properly, it does cause the working capital number to understate the financial health of a company that has flow-thru funds in the bank. When it is confirmed that the money has been spent properly, this line item vanishes via "amortization" recorded as an inflow rather than outflow. Of course the cash by then has also vanished because it needs to be spent by the end of the year subsequent to the one in which it was raised. In the case of PMET's Dec 31 financials the FT premium liability is linked to the $20 million charity FT financing PMET did in September at $13.27 when the stock was trading at half the price. If you trust the junior as being run by competent management trying to create real value through exploration, this line item is not necessary, and potentially misleading. We will have to watch for this distortion of a junior's financial health, just as we have to do with an expense line item called stock option compensation which is also an accounting fiction that must be stripped out to reveal the true burn rate of a junior. It is unfortunate that the more regulators try to achieve transparency, the more they achieve obfuscation.
|Patriot Battery Metals Corp (PMET-V)
Unrated Spec Value
|Canada - Quebec
PMET Balance Sheet, Expenses, and Warrant Table
PMET Financial Snapshot within KRO Profile
KRO Search Engine Working Capital Parameter
|Jim (0:23:54): What is the status of Eagle Plains royalty spinout?
Eagle Plains created some confusion last week with an update that declared March 17 to be the day of record without making clear what that day of record referred to. This led some to conclude that March 17 was the day of record to get the 1:3 Eagle Plains royalty spin out. With 2 day settlement that meant March 15 was the last day to buy Eagle Plains to get the spinout. The date is important because the stock will likely drop somewhat to reflect the absence of the royalty portfolio. On Thursday morning Eagle Plains put out an emergency news release clarifying that March 17 is the record date for being eligible to vote at the April 26 special meeting to approve the spinout. That makes sense because how do you declare a record date for a dividend in specie spinout before you have shareholder approval? Eagle Plains management went to great effort to poll its shareholders about their views on the spinout before it formalized the spinout deal, but none of that guarantees slam dunk approval. Just consider that a week ago everybody though the banks were solid after the post 2008 reforms, and now everybody is freaking out.
I'm not sure how this slipped past the lawyers, but if March 17 were truly the record date for the spinout, but anybody buying Eagle Plains after March 17 wouldn't know if they still get the spinout or not. In any case, this confusion is now fixed. The record date will be declared after the April 26 meeting approves the spinout, and this usually comes in the form of an official TSXV notice. Eagle Plains continues to be a KRO Favorite which is now up 50% to reflect the $0.10 implied value of the spinout, but the stock has potential to go a lot higher in Q2 when drilling gets underway at the Vulcan project. In addition, on March 2 EPL announced that it had staked 2 lithium prospects in British Columbia and 4 in Saskatchewan. It has not disclosed claim locations or sizes because it is busy staking additional lithium pegmatite plays and does not want to tip its hands. Saskatchewan is now shaping up as a hot lithium province.
One of my year end bottom-fish stocking stuffers, Searchlight Resources, tripped up in late January when it optioned 100% of the Hanson and Jan Lake lithium prospects to Brunswick Exploration for $35,000 up front. Brunswick's Bob Wares couldn't believe his good fortune. While the LCT-type potential of the Jan Lake pegmatites is at this stage unknown because nobody ever checked, the Hanson Lake pegmatites to the south are confirmed LCT-type pegmatites. I was surprised during the recent Toronto MIF Backstage Interview when Bob mentioned that after drilling the Anatacau target in James Bay and Hearst target in Ontario Brunswick will be drilling the Hanson Lake pegmatites, possibly by June. Searchlight's Alf Stewart and Stephen Wallace, who were quite pleased to have quadrupled their $8,500 staking expense in less than 3 months, were taken aback by the shareholder blowback they received. Searchlight is supposed to be about the Kulyk Lake rare earth play, and secondarily the high grade Bootleg Lake gold play not so far from the Tartan Lake gold play of Satori which Rob McEwen thinks might be his next Red Lake. For god's sake, lithium is Plan C!
Wallace was not pleased by the blowback, mumbled a string of expletives, rolled up his sleeves, and burnt the midnight oil rummaging through Saskatchewan's archives. On February 27 Searchlight announced the acquisition of 7 new staked claim groups, one of which, Davin Lake, at 27,632 ha, is a substantial land package. Stephen, what can you tell me about it? Sorry, you will have to wait a bit. It seems that Saskatchewan may be an unsung lithium hero which smart groups like Eagle Plains and Searchlight are now intensely parsing, hence all the secrecy. That is why neither Eagle Plains nor Searchlight are publicly revealing the locations of their new lithium claims, though of course as experienced users of Saskatchewan's MARS system they know exactly where each other's claims are located unless obscure numbered companies are being used to do the staking.
The market has not rewarded Searchlight for its replacement lithium claim package, but that is due to an overhang of 19,040,000 warrants at $0.05 that expire May 26, 2023. Searchlight had $1.8 million working capital at the end of December 2022, so is not desperate to raise money. This situation is a special opportunity to bottom-fish for Searchlight (yeah, I want to prove this stocking was not stuffed with coal). Over the next two months lots of disgruntled stock can be accumulated by nailing a nickel bid to the wall. As the warrant expiry approaches and the supply at a nickel dries up, smart bottom-fishers can post a bid at $0.055 to coax warrant holders to capture a short term 10% gain by exercising their $0.05 warrants and selling the stock at $0.055. In a climate where ultra sophisticated investors are losing 10%-15% on their ultra conservative portfolios, who will sneeze at a fast 10% gain? But everything is a matter of context. KRO members know why Searchlight is a multi-pronged bottom-fish whose missing piece in the form of a structural problem will vanish in two months. If Brunswick, with its $16 million treasury, makes Hanson Lake rather than breaks it in early Q3 of 2023, Stephen Wallace and Alf Stewart may yet have the last laugh as the market has a "Saskatchewan WTF" reaction. And you can count on the Eagle Plains team to also be tethered to the Saskatchewan lithium rocket launch.
|Eagle Plains Resources Ltd (EPL-V)
Fair Spec Value
|Canada - British Columbia
|Zn Pb Ag
|Searchlight Resources Inc (SCLT-V)
Bottom-Fish Spec Value
|Canada - Saskatchewan
|Disclosure: JK owns shares of Brunswick and Eagle Plains; Brunswick and Eagle Plains are Fair Spec Value rated Favorites; Searchlight is Bottom-Fish Spec Value rated