Junior miners on comeback trail

Small resources stocks are set for a good recovery as base metals prices firm.

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The battered and bruised small resources sector could be crowned the “come-back kid” of 2014 as conditions for a significant re-rating of the sector are falling into place.

The focus so far has been on the mining giants, with investment banks scrambling to upgrade their over-pessimistic hard commodity price assumptions over the past few months as the global economy recovers from its “Chicken Little” moment.

The sky didn’t fall, as it turned out, and iron ore is no longer in danger of collapsing to under $US80 a tonne as a number of experts had predicted. The shorter-term price forecast for the steel-making ingredient was raised but is still under the current spot price of around $US123 per tonne, while the longer-term price assumption for copper was increased markedly.

Commodities and mining giants on the upgrade path

Copper is regarded as a lead indicator for hard commodities and that is why it’s noteworthy that sentiment towards the red metal has bounced strongly, with Bloomberg reporting that 45% of traders are feeling bullish towards copper compared with just 31% a week ago.

Equity analysts had no choice but to lift their recommendation on BHP Billiton (BHP) and Rio Tinto (RIO) in recent weeks to account for the improved outlook for metals. Large and mid-tier miners currently attract the most number of “buy” recommendations of all sectors on the S&P/ASX 200 Index.

It’s hard to fathom, but some analysts and strategists were urging investors to dump BHP and Rio only six months ago as they were convinced BHP was going to crash under $30, and that Rio was heading below $50 a share. The stocks bottomed last year at $30.65 and $50.24, respectively. BHP was trading at $37.49, while Rio at $64.96 on Tuesday afternoon ahead of the close.

Buying interest moving to small-end of market

There are early signs that the optimism is spilling over into junior mining stocks as they struggle to emerge from what is perhaps the worst trading period in history, with the ASX Small Resources Index lagging their industrials counterparts by close to 80% over the past three years.

But the mining minnows are stirring back to life as we see some early buying interest in the New Year. Uncapped 100 followers would have been prepared for this, as I identified the potential outperformance of the sector in last year’s article Five small cap trends for 2014.

The fact of the matter is that the upgrade of commodity price forecasts has a bigger positive financial impact on junior miners compared with the majors.

It’s early days yet and a lot can go wrong in the volatile small resources space, but I think the sector has bottomed. This will only become more apparent to sceptics once BHP and Rio break above $40 and $70 a share, respectively. This price action will bolster confidence about the outlook for miners and tempt investors to search for bigger bargains at the riskier small-end of the market.

Best placed junior miners

Tim Treadgold highlighted specific metals and miners that are poised to do well in 2014, and you can add Uncapped 100 stocks Tiger Resources (TGS) and YTC Resources (YTC) to the list.

Tiger has jumped 19% since the start of the year and is up 116% since we rated it an “outperform” on July 3 last year, but the fledging copper producer still has room to climb, particularly after the valuation of its flagship Kipoi project doubled this week.

Management lifted its net present value estimate for the stage two production of its Democratic Republic of Congo project to $US755 million and lifted its mine life by two years to 11 years.

Stage two involves the construction of a solvent extraction electro-winning plant (SXEW), which is now expected to produce 532,000 tonnes of copper cathode over the 11 years. This is 41% above the miner’s previous estimates.

Tiger has a track record of under-promising and over-delivering, and its Kipoi mine will make the company one of the lowest-cost producers of the red metal in the world, as life-of-mine cash operating costs are forecast at $US1.04 a pound. The current copper price is holding above $US3.30 a pound.

In contrast, base metal and gold miner YTC has gone the other way, with the stock falling 10% to 23.5 cents since I recommended it as a “buy” back on October 9.

The stock came under pressure in November on a disappointing exploration result when management said it failed to find a substantial ore body north of its Nymagee copper deposit. There were high hopes following a strong result from an earlier down-hole electro-magnetic test.

While YTC’s fortunes are largely tied to good drill results, the emerging metals producer is one of the better placed junior explorers. Its nearby gold, lead and zinc Hera project in central New South Wales is fully funded, thanks to a funding deal with Swiss mining giant Glencore International.

YTC is close to transitioning from explorer to producer, with first production at Hera expected by the September quarter this year. The miner also has a strong balance sheet, particularly after it raised $14.3 million from Pacific Road Capital in December through a share placement. This was priced at 24.34 cents – a 21.7% premium to its last price before the announcement.

It is also too early to give up on finding the elusive large copper system at Nymagee North. Management is stepping up its drilling campaign this year and is hopeful of finding a deposit that would rival the size and scale of other successful projects in that area.

Glitter for gold?

The remaining “outperform” rating we have in the sector is for gold producer Beadell Resources (BDR). The stock has eased around 3% to 83.5 cents since I recommended it in August, but it has been a volatile ride due to the pessimistic outlook for gold. The precious metal has plunged well over 20% in the last 12 months to around $US1,250 an ounce.

Interestingly, sentiment towards gold has actually improved since the start of the year after the precious metal failed to crash to the $US1,000 an ounce many gold bears had been predicting. Some believers have even braved the chill in the market by proclaiming that gold has found its feet due to strong buying interest from Asia around the current price point.

Clearly, the fundamentals for Beadell play second fiddle to the direction of the gold price, and the gold price is really hard to predict in the current environment because it is not generally impacted by economic cycles but by fear.

The thing is, fear is in short supply right now; credit and equity indicators such as the US volatility index (VIX) and TED spreads (difference between rates on interbank loans and US government bonds) are very subdued.

Further, the market thinks inflation is in a “Goldilocks” period, where it is not expected to come in “too hot” or “too cold”, but just right. Gold tends to do well when inflation gets out of hand, and it tends to perform relatively better than most other assets in a deflationary environment. As Alan Kohler pointed out this week, the deflation risk cannot be ignored.

While it is anyone’s guess where gold will be in six- or 12-months, don’t be too quick to believe the sceptics who claim that it is facing “structural issues” as investor psychology towards the asset has somehow changed. The truth is, gold is behaving like it should.

If you believe gold will hold its own and stay comfortably above $US1,000 an ounce, like consensus estimates on Bloomberg are forecasting, then Beadell is probably heading higher due to its sizable and low-cost mine in Brazil.

Think big, go smalls!

* This article is part of the “It's Time” series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.

Uncapped 100 - Australia's most interesting small cap stocks

Small cap stocks covered by the Uncapped team
CodeNameRationaleMarket cap ($m)Total return 1-year (%)Sector (GICS)
MTU M2 Group Amazing growth story and well run company. High free float and strong insto support.1,133.7155.74Telecommunication Services
NHF NIB HoldingsOnly listed health insurer. Widely held. Good performer.1,117.2721.6Financials
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.989.59113.19Consumer Discretionary
MMS McMillan Shakespeare One of the best performers since the GFC, but ongoing risk of change to FBT rules will hang over the company.906.96-7.1Industrials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.839.331.44Consumer Discretionary
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.820.2445.34Consumer Discretionary
SRX Sirtex Medical A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.793.3721.99Health Care
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.736.87156.18Consumer Staples
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.706.10-19.22Industrials
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.670.3442.89Financials
BDR Beadell Resources Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.666.19-17Materials
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.645.3444.1Consumer Discretionary
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.609.7835.27Consumer Discretionary
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.589.55-10.23Energy
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.551.5261.96Financials
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.508.6846.67Telecommunication Services
TGR Tassal Group Salmon farmer is finally turning a corner with an improved harvest strategy and growing demand for product.480.54114.52Consumer Staples
SEA Sundance Energy Australia Analysts have a favourable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.477.0719.77Energy
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.453.8732.76Telecommunication Services
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?449.7354.37Industrials
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.442.3610.22Industrials
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.432.63-23.4Energy
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.424.63-15.21Health Care
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.424.414.95Industrials
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.422.8138.48Financials
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.412.73118.66Health Care
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.395.45119.1Information Technology
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.374.66-33.93Information Technology
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.371.95-17.75Consumer Discretionary
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.365.1573.22Financials
UXC UXC Company has turned corner and enjoyed re-rating. What's next?362.2218.24Information Technology
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.347.22-31.31Industrials
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.347.05166.23Materials
GID GI Dynamics IncLargely forgotten by investors after poor IPO but could attract attention this year as it looks to gain US approval to use its intestinal liner on diabetics.339.2812.99Health Care
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.328.97242.56Consumer Staples
TGS Tiger Resources Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.327.1019.85Materials
TGA Thorn Group One of few retail stocks that is performing well despite its flat outlook for FY14. The Radio Rentals chain owner is also well supported by instos.321.412.58Consumer Discretionary
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 311.7121.76Financials
GXL Greencross Acquisitive veterinary group that is embarking on new growth phase via merger with pet products retailer309.00139.1Health Care
IMF Bentham IMF Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.295.065.41Financials
BNO Bionomics One of the larger cancer treatment developers in this market.291.9871.74Health Care
NWT Newsat Potential large cap if it can launch its own satellite in 2015.282.42#N/A N/ATelecommunication Services
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.269.02-12.81Information Technology
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered265.7682.62Telecommunication Services
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.261.64-20.86Consumer Staples
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.254.0616.87Financials
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.236.8171.43Health Care
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.235.5134.54Industrials
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage228.19106.9Information Technology
CLH Collection House In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further226.3456.51Industrials
RCG RCG Corp The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.208.5484.9Consumer Discretionary
WBB Wide Bay Australia The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.207.28-9.5Financials
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.207.03-43.39Health Care
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.205.5348.86Information Technology
NEA Nearmap A stellar performer with an Interesting business that offers high quality aerial maps to companies & government.201.98752.11Information Technology
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.196.6984.54Information Technology
CKF Collins Foods One of the few food franchise listed companies.195.3046Consumer Discretionary
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.194.80-8.08Consumer Staples
ACL Alchemia One of the few biotechs with revenue stream. Good pipeline of oncology treatments.193.0280.3Health Care
DWS DWS Will be a big beneficiary if governments start spending on IT again.176.04-4.15Information Technology
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?171.0938.24Consumer Discretionary
CLX CTI Logistics Logistics solution company with good track record of growth and exposure to online retail and large gas projects on West coast.165.7679.77Industrials
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as it undergoes a restructure.160.2219.98Information Technology
MNW Mint Wireless Huge market potential if the mobile card payment solutions provider can gain market traction. Management aiming for $1 billion in transaction value a year.157.512066.67Information Technology
SAR Saracen Mineral Holdings Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.151.79-37.04Materials
MCP McPherson's The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but growing earnings is still a challenge.151.33-20.53Consumer Discretionary
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.149.60-13.2Industrials
GHC Generation Healthcare REITOne of the more interesting REITs. Income is more defensive than typical property stock and its greenfield expansion gives it earnings growth potential.143.9734.24Financials
DTL Data#3 Well respected IT company that receives little press coverage.138.19-27.25Information Technology
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.137.702.86Energy
BGL BigAir Group The wireless small cap has gained strong following over past year or two but is often overlooked by investors and the press.137.0035.1Telecommunication Services
POH Phosphagenics Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.127.56-13.79Health Care
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.123.0384.61Industrials
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.117.86-67.66Materials
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.113.65-6.44Consumer Discretionary
DRM Doray Minerals Widely held by instos. One of the more favoured gold explorers by brokers.110.686.12Materials
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.101.4321.29Industrials
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.99.69-20.61Industrials
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.98.9510.24Industrials
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.92.60-35Industrials
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.92.05-39.66Health Care
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.90.859.85Health Care
AOH Altona Mining Noteworthy copper play with Xstrata pull-out of Roseby project in Australia and the good ramp up of its Finnish project.90.48-30.61Materials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 87.55-15.91Materials
JIN Jumbo Interactive Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.87.51-27.63Consumer Discretionary
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.81.91-21.88Materials
FGE Forge Group Good track record has been marred by a recent shock downgrade and capital raising. How long will it take to redeem itself?80.14-81.52Industrials
EML Emerchants Trying to change way corporates and governments disburse cash with its trackable and controllable debit card offering. If company can get $1 billion in loaded value on cards, the stock will surge.78.54162.5Financials
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.76.8331.58Information Technology
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.71.56-45Energy
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.71.3556.73Materials
TSM ThinkSmart Potential turnaround story worth keeping eye on.70.6089.13Financials
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.68.728.94Consumer Staples
GXY Galaxy Resources Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.65.73-74.33Materials
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year62.29-23.83Health Care
KOV Korvest The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.57.301.4Industrials
OTH Onthehouse Holdings Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a competitive edge against REA.48.07-30.36Consumer Discretionary
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.45.82121.5Consumer Discretionary
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.42.4760.98Information Technology
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.23.3823.33Health Care
Source: Eureka Report, Bloomberg

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