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A FOURTEEN-YEAR "OVERNIGHT" SUCCESS

Today’s market wrap deals with some of the pitfalls of investing in cyclical stocks and specifically the juniors, whose namesake – coincidentally – puts a fence around the vast majority of companies represented at the PDAC Convention in Toronto.

As commodities cycle in [bull] and out [bear] of favor, the fortunes of the companies who prospect and produce - all the way up the food chain to distribution and/or retailing these goods can change with the wind. In the case of a junior exploration company this becomes even more of an issue, since, by their very nature they spend money “looking for” resources. So, not only are there issues concerning whether or not an economically viable resource is found; this can also be problematic from the standpoint of lag times between discovery and such time as the project is either joint ventured or brought online by a producer. Everyone should understand that two very different skill sets differentiate exploration [geology] from mining or production.

The Prospecting and Development Food Chain

While both pursuits require capital – and in the case of mine development a great deal of it typically “up front” – producing a resource implicitly infers that one is receiving ongoing income from sales which means one might think of the exercise as management of margins, costs etc along with the ‘race to replace’ reserves as they are exhausted.

Exploration, on the other hand, entails the constant draw down on cash reserves [colloquially referred to in the industry as “burn”] which puts the enterprise in the perpetually awkward position as to whether or not they have enough cash in the bank to continue funding their current exploration budget. Few explorers actually build mines – for a host of reasons including capital requirements and required skill set – but some do, very well.

Sometimes, major producers possess the requisite exploration skills “in house” to replace their eroding reserve bases – others rely on the “juniors” to do the heavy lifting in this area – acquiring promising prospects at a ‘relative premium’ once they have shown economic viability or promise.

A Real World Case Study

Last night at the PDAC welcome reception, I bumped into Gregory A. Hahn – President and CEO of Colorado based Constellation Copper Corporation [TSX: CCU] and here is his story:

Constellation is one of those “juniors” that has not only prospected for and discovered a resource – they’ve decided to develop it themselves. The project that the company was founded on is its Lisbon Valley copper project, located in southeastern Utah. It was the promise in this potential resource that initially attracted the attention of Mr. Hahn some 14 years ago.

At the company’s inception, they became a TSX Venture Exchange [the old Vancouver Stock Exchange] listed company. Way back in the early 1990’s copper was selling for 1.10 – 1.20 per pound. With copper trading at this price, prospects for Constellation looked good – but work still needed to be done. A move to the more senior TSX Exchange followed in 1995 giving Constellation a higher profile and still better access to the capital markets. Through the early stages of the development the size of the resource was being defined and enlarged to the point of economic viability.

Then, in the late 1990s a copper scandal involving a large Japanese Bank [Sumitomo] exploded in the marketplace and the price of copper collapsed to the .60 - .70 per pound region. With copper at this depressed price – attracting equity capital became a much more expensive or dilutive proposition.

As a result of this negative development, a decision was taken to hopefully avoid the capital markets with Hahn plowing his own personal funds in to the company hoping to ride the downturn in world copper prices out.

The Market Takes No Prisoners

After a small financing in the year 2000, Constellation’s prospects continued to sour in the face of persistent low world copper prices to the point where Hahn – by 2002 – was forced to lay off his staff and take a major pay cut himself. Hahn admits he was close to closing the doors and raising the white flag.

But Then Something Happened

The layoffs at Constellation were in effect for roughly three months before the price of copper began rising, largely due to supply shortages brought on by voracious Chinese demand. With suddenly improving prospects, it was game on again and as Hahn said, “they [the staff] were nice enough to have me back”. A much needed financing occurred in the fall of 2003 and as you can see by the graph below – so has the company’s share price since then.

As this story was being related to me last evening, much of the staff of Constellation was on hand for the convention – soaking it all up and “pinching themselves” – with the company due to harvest their first commercial amounts of copper in the next two weeks. Now, if Constellation can manage their growth as a producer as well as they navigated the tricky waters of prospecting and development – they should be a company to keep an eye on in the coming months and years.

Isn’t it amazing how stories like this tend to get told at conventions like this one?

Today's Market

Overseas equity markets began the week on a positive note with Japan’s Nikkei Index gaining 237 to close at 15,901. Meanwhile, North American markets fared worse with the DOW dropping 62.70 to close at 10,958.91 and the NASDAQ giving up 16.60 to close at 2,286.03. NYMEX crude oil futures fell 1.26 ending the day at 62.41 per barrel.

The U.S. Dollar Index gained .25 – closing at 89.88.

Precious metals fared poorly today with COMEX gold futures falling 10.60 to 555.90 and COMEX silver futures also dropped - .20 to10.00. The XAU gold bug’s index dropped 4.58 to 132.57 while the HUI lost 12.50 to close at 306.53.

On tap for tomorrow at 8:30 a.m., the Bureau of Labor Statistics [BLS] is due to release revised Q4 [05] Productivity data – expected -.1 vs. prior -.6. Then at 3:00 p.m., the Fed is due to release Jan. Consumer Credit data – expected 10.0 B vs. prior 3.3B.

Wishing you all a pleasant evening and prosperous tomorrow - reporting from the PDAC Convention in Toronto!

Rob Kirby

Read more: Rob Kirby's PDAC 2006 Report

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