The double edged sword of junior company financings Dr Richard Appel December 29, 2003 After suffering from a long, exhausting correction that ended in July, 2002, the exploration stock sector staged an incredible price explosion. The past several months witnessed the share prices of company after company advancing 100%, 200%, 300% or even more. These breathtaking, wealth-building increases created a euphoric condition and quickly dispelled the frustration and despair that had earlier consumed those that had invested in this tiny segment within the universe of equity investments. The earlier, discouraging time frame began in June, 2002, when gold's new Bull Market first rose to the $325 area. This occurred after the yellow metal had ended its long, tedious and trying Bear Market that had been in place since its $875 high in 1980. The ensuing 20 year period saw the noble metal, after first plunging into the low-$280 range, stage various rallies and declines until its ultimate $252 low was posted in August, 1999. By June, 2002, gold had arduously climbed a wall of questions, disbelief and wonder until it had attacked an important milestone in the $325 range. Despite the junior gold market's initial expression of strength which accompanied gold's climb from its Bear Market nadir, those who invested in these companies were forced to withstand yet another period of consternation. Investors were left wondering whether a new gold Bull Market had truly arrived while they endured yet another long, testing period when gold soared higher in price, and both the juniors and even the major gold producers were left largely behind. During the period between June, 2002 and July 2003, gold trended higher and even briefly tested $390. While witnessing the advances in gold, these steadfast gold share investors questioned whether the junior gold exploration companies would ever again exhibit renewed strength. In fact, as if to confirm their fears, by early July, 2003, numerous exploration companies had actually retreated to price ranges that approximated their earlier Bear Market lows. After enduring this difficult period many investors were besides themselves and wondered why both the major gold and their favorite junior companies had not benefited from a rising gold price. Their quandary was dispelled in July, 2003, but many of those who did not maintain their confidence, their composure and their patience, were separated from their share holdings only a fleeting moment before the inception of the recent explosive price advances. Beginning in July, 2003, one by one, the junior explorers rose skyward out of their depressed trading ranges. Company after company saw their share prices rise 30% to 50% or more in a matter of a few weeks. It was interesting for this observer how one could actually witness the spreading, gradual wave of price increases. As I stated earlier, the past five months have been an incredible time for the junior mineral exploration companies. This was a period when the vast majority of notable companies soared from their earlier, July nadirs. By early October, if a company reported exciting news of an important acquisition, or exploration success, they saw their shares double or even triple in price within a matter of a few weeks. It was as though new life had been breathed into the industry! However, after their rocketing stock prices quickly made up for lost time, an important event occurred. It was the influx of capital that was directed towards financing the various companies. The money was to be used by the juniors in their quest for mineral wealth and to the benefit of their shareholders. An incredible amount of money entered the funding pipeline for the junior companies. The higher stock prices caused numerous funds and venture capitalists to offer working capital to their favorite exploration or developing enterprises. This, so that they too could participate in the profits that they were confident, would be generated by future junior successes. When a small company offers a financing they typically perform a unit offering. A unit normally consists of one share plus one share purchase warrant. For companies traded on the Toronto or Toronto Venture Exchange, the share is fully paid and can normally be traded after a mandatory four-month hold period. The warrant on the other hand, gives the acquirer the right to purchase an additional share at a fixed price within a given timeframe. This is typically for one or two years. The price of the unit is usually set at or below the current market price of the company's shares, and the warrant is priced slightly higher. For example, if XYZ's stock is trading at $0.50 C. it may offer a unit at $0.45 C. with the warrant at $0.55 C. with a one-year life. The warrant acts as a sweetener to attract investment capital; it offers the acquirer the added benefit of locking in the price of the warrant share. In fact, in some cases it can double the profit potential for the investor. In this example, if the price of the stock rises to $1.00 C. the unit purchaser not only garners a $0.55 C. profit from his share ($1.00 C. minus his $0.45 C. cost), but also an additional $0.45 C. by exchanging his warrant and $0.55 C. ($1.00 C. minus $0.55 C. cost). Thus, his initial $0.45 C. investment will yield a total of $1.00 C. in profit ($0.55 C. plus $0.45 C.) if the stock merely advances to $1.00. If it moves still higher in price during the one year life of the warrant, it will benefit him to a greater amount. How Can the Influx of Junior Financings Influence the Overall Exploration Market? Under normal circumstances a financing will only affect the issuing company. This results from a series of events. First, when an equity offering is announced those who participate may already be holders of the company's stock. If this is the case, some of these individuals will sell currently owned shares in order to pay for their financing commitments. Later, if the warrants are in the money, they may sell additional shares in the company, possibly from their then free trading unit shares, in order to exercise them. Finally, after spending additional capital to acquire the warrant shares, they may sell some or all of these newly issued shares to lock in their profit. In each of these instances stock of the company is sold into the market. In the case of the newly tradable shares and warrant shares an increase in the available supply of stock results, as well as a dilution in the total issued and outstanding shares. All of these conditions act to dampen price increases for the company. Or, it may even foster a temporary lowering in the company's share price. The large number of companies that have either closed or will soon close important capital raising activities will be presented with both a blessing and a potential curse. It has favored the companies with a generous amount of working capital. This will allow them to advance their favorite projects or to acquire additional ones. However, this may occur at the expense of their stock prices when shares of stock are sold to pay for the various financing stages described above. Further, this potential problem is amplified by the combined total number and amount of these equity financings. I am not aware of an accurate estimate of the total capital that has already been committed to finance the Canadian junior companies during the past several months. However, I would be surprised if it is not already approaching $2 C. billion. This represents an enormous amount of money dedicate to finding and making a mine for these nascent companies. Further, it will result in an incredible amount of new "paper" that is destined to one day enter the market. As I earlier chronicled, due to a major financing a company's price may suffer from the increased supply of its stock entering the market. If you extend the ramifications of this effect from one individual to that of several hundred companies, there will be a different result. In this scenario we can have a plethora of funds and venture capitalists selling positions in a widespread number of companies, in order to either fund their financing commitments or for profit-taking. This can place downward pressure upon a large number of stocks, which in turn may spread to other companies within this small market. The result may be to lower overall prices for the entire market, and a major secondary correction. A Major Constant Of The Junior Exploration Sector An important recurring condition exists in the junior resource market that all investors must understand, and for which they should be prepared. When this market weakens those stocks that have waiting bids typically find a great deal of their stock being offered. This is due to the relatively illiquid nature of these small companies. When this market corrects there are always individuals, funds or others that will always require cash. They typically refrain from initially selling their weaker stocks because they recognize that they will force these shares lower and will sell little stock in the process. They therefore search for those companies with strong bids where they can sell stock with the least damaging affect upon their share prices. If they possess a large position and sell a small quantity of stock in a weakly bid company, they will ultimately drive its share price lower and damage themselves in the process. If I am correct, by February or March 2004, the vast majority of the new financings will be free-trading. If the market is not flush with new buying capital at that time we may suffer a period of decline across the junior sector, as a stream of newly issued shares will becomes available to enter the market. I am addressing this issue for two reasons. First, to help new investors better understand the ramifications of junior company financing. Second, I desire to make you aware of a potential short-term set-back that it may generate. It may not occur, but the potential does exist. I continue to believe that both gold and gold equities are in secular Bull Markets. Further, I anticipate that they will last for several more years. While the timing of the next major correction is unknown it will likely appear when the current up-leg ends. It may begin after gold posts a temporary peak, which I am confident has not yet been seen. Or, for the juniors, it may be precipitated if an insufficient amount of buying soon enters the market to absorb the potential entrance of the newly free-trading financing shares. On a positive cord, the great amount of capital that the juniors have been able to raise will likely be rewarded by one or more major mineral discoveries by this time next year. This will cause the share price of the fortunate company to soar to multiples of its pre-discovery level. Further, it will be taken by the entire exploration sector as a confirmation of the reason why we have all become involved in this industry. The rocketing stock price will generate great excitement and share chasing, and will vindicate our belief that fortunes can be made in this presently obscure market sector. Additionally, it will act to attract a renewed and likely enormous influx of capital into the market! Investors will be given tangible evidence that this industry can indeed generate stock market fortunes. This will enhance the share prices across the entire industry. All stocks will again benefit from the newly injected money inflow, and new record highs will punctuate the junior stock tables. The above was excerpted from the January 2004 issue of Financial Insights © December 21, 2003. Dr Richard Appel Financial Insights December 26, 2003 Financial Insights is a monthly newsletter in which I discuss gold, the financial markets, as well as various junior resource stocks that I believe offer great price appreciation potential. Please visit my website where you will be able to view previous issues of Financial Insights, as well as the companies that I am presently following. You will also be able to learn about me and about a special subscription offer. CAVEAT I expect to have positions in many of the stocks that I discuss in these letters, and I will always disclose them to you. In essence, I will be putting my money where my mouth is! However, if this troubles you please avoid those that I own! I will attempt wherever possible, to offer stocks that I believe will allow my subscribers to participate without unduly affecting the stock price. It is my desire for my subscribers to purchase their stock as cheaply as possible. I would also suggest to beginning purchasers of these stocks, the following: always place limit orders when making purchases. If you don't, you run the risk of paying too much because you may inadvertently and unnecessarily raise the price. It may take a little patience, but in the long run you will save yourself a significant sum of money. In order to have a chance for success in this market, you must spread your risk among several companies. To that end, you should divide your available risk money into equal increments. These are all specula-tions! Never invest any money in these stocks that you could not afford to lose all of. Please call the companies regularly. They are controlling your investments. FINANCIAL INSIGHTS is written and published by Dr. Richard Appel and is made available for informational purposes only. Dr. Appel pledges to disclose if he directly or indirectly has a position in any of the securities mentioned. He will make every effort to obtain information from sources believed to be reliable, but its accuracy and completeness cannot be guaranteed. Dr. Appel encourages your letters and emails, but cannot respond personally. Be assured that all letters will be read and considered for response in future letters. It is in your best interest to contact any company in which you consider investing, regarding their financial statements and corporate information. Further, you should thoroughly research and consult with a professional investment advisor before making any equity investments. Use of any information contained herein is at the risk of the reader without responsibility on our part. Past performance does not guarantee future results. © 2003 by Dr. Richard S. Appel. All rights are reserved. Parts of this newsletter may be reproduced in context, for inclusion in other publications if the publisher's name and address are also included for credit. _______________ 321gold Inc