Hot Commodities! The Only Game Left in Town

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 |  Includes: DIA, QQQ, SPY
by: James West

My, my! How the mighty are falling!

The collapse of the U.S. economy continued apace on Friday, with selloffs in Lehman Brothers (LEH), Citigroup (NYSE:C), Bank of America (NYSE:BAC), Wachovia (NASDAQ:WB), Fannie Mae (FNM) and Freddie Mac (FRE) leading the plunge.

At the same time, gold surged to $964 an ounce and oil topped $146 a barrel.

The correlation between the weak U.S. dollar and the strong price of gold is confirmed on such volatile days, but what is the broader implication for emerging exploration companies going forward? As these metrics unfold, the TSX Venture is off 5 points, while the TSX senior board is up 75 points led by gold miners Goldcorp (NYSE:GG) and Kinross (NYSE:KGC).

Fannie Mae and Freddie Mac are on the ropes. Ambac’s (ABK) share price is crumbling, though its sure looks like they’ve got enough in ‘em to go a few more rounds. Lehman Brothers is wounded and bleeding…but IndyMac Bank (IMB) of California is out cold, ko’ed by a run on the bank reminiscent of the Northern Rock debacle in England.

IndyMac had 32 billion dollars in assets, but on Friday, all of its 33 branches closed 3 hours early to stave off a bloodletting that has essentially eviscerated the country’s second largest savings bank. The financial magnitude of this “thrift” bank’s demise is historically topped only by the 1984 toppling of Continental Illinois National Bank and Trust.

In the case of Fannie Mae or Freddie Mac, any terminal meltdown in those companies' ability to service ongoing obligations would collectively vaporize $5 trillion in mortgage obligations, which is over half the mortgages in America.

Carnage everywhere! Where can we invest our dough with a sufficient level of risk that we can at least hope to eak out a few ducats more than the growing rate of inflation threatens to devour?

Once again, we in the trenches of the commodities business can only shout out about the merits of owning gold, silver, oil, copper, zinc and nickel, potash, wheat and soy!

But never mind trading in just the actual commodities. If you can’t read the writing on the wall, which is admittedly faint from all the whitewashing going on in the broader market, let me read it to you.

When the dust settles from all the collapsing, and when the smoke clears from the burned backsides of millions of investors around the globe, and when the writedowns and bailouts and foreclosures finally reach an end (which they surely must), there’s going to be one place and one place only for investors to put their money where its value can be trusted to outperform the Dow, the S&P 500, and NASDAQ combined.

And that place, my friends, is in emerging resource stocks.

That’s right, folks. Step right up to the TSX Venture Exchange, the one place where companies exploring for and developing deposits of gold and silver, oil and gas, nickel and copper and zinc, are all boot-strapped and incubated, lovingly nurtured until ready for consumption by major producers.

Consider the chart below, with lines representative of TSX Venture, S&P500, and Dow Jones and NYSE relative performance respectively over the last 10 months.



While the Venture has been dragged down along with the other major indices, the relative performance within certain timeframes has clearly demonstrated the opportunity for investors nimble enough to act decisively to reap superior gains and limit losses relative to the other indices.

Interpretively speaking, one could argue that this is meaningless for future performance; an interesting observation that must be considered is that the only index with zero representation of anything to do with housing, credit and banking is the Venture.

So whereas the other indices are directly affected by the destabilized real estate, lending and banking companies, the Venture’s accompanying downward performance curve is a result of the diminished liquidity caused by these other sectors' underperformance.

Once liquidity stabilizes, the fragrant odour emanating from the mortgage and financials industries is going to be a long time in remediation, while the bull market for commodities and the companies that develop those resources will continue only slightly less exuberantly for the reduced purchasing power of beleaguered U.S. consumers. And the newly de-leveraged and in all probability, freshly regulated investment dollars of the remaining so-called “investment” banks will be forced to deal in tangible products with real markets.

That means an unprecedented amount of capital directed towards the Venture Exchange and its 2,800 odd emerging companies. The effect will be a very substantial and dramatic lifting of all boats by a freshly stimulated financial tide.

Last year, the combined TSX Group, which includes the TSX Venture, TSX, and NEX exchanges traded in excess of $1 Trillion in transaction value.

One of the greatest realities about the TSX Venture Exchange is its incompatibility with the requirements of huge institutional brokerage firms, who regularly compete with their clientele to extract profit from the equities they recommend.

    TSX Venture issuers typically have two things in common:
  1. Low share issuance:
    Since most of these companies are funded and organized as start-ups, they don’t come out of the chute with two or three hundred million shares. This means that the big banks can’t acquire a sufficiently large position to redistribute to their thousands of account holders, charging a commission for each transaction. This means that you, the individual investor, armed merely with an online discount brokerage account and a good advisory newsletter, can sidestep the marketing ballyhoo and misleading grand sweeping generalizations of the major brokerages, and trade for yourself. It's not only profitable (when done correctly), but it’s a hell of a lot of fun.
  2. Low share price:
    The massive public relations and “perception management” machine that is the mainstream media is controlled by its shareholders – the major investment banks and financial institutions. That’s why there is so much negative publicity around about “penny” stocks, and it is also why many major brokerage firms (Edward Jones, for example) prohibit their brokers from buying or selling any stock under 5$ for their clients. They cite the “high risk” and “unsuitability” of these low price companies in their literature, and instead put their clients’ money into blue chip corporations like Enron and Tyco.

The major brokerages work on commission structures. That means a percentage of each transaction value. So if MEGAcorp wants to raise $200 million at $25 a share, and VENTUREcorp wants to raise $5 Million at $0.50 a share, guess which company is a more suitable risk for the Investment Bank’s clients?

It certainly won’t be VENTUREcorp, whose total commission yield, (assuming a 7% commission) is only $350,000. Why bother with VENTUREcorp when MEGAcorp’s transaction will deliver (even assuming a reduced commission in view of the sheer size of the transaction of 5%) $10,000,000?

Plus, what about the commission when the shares are redistributed to their clients' accounts?

There’s far more to be made from the distribution of 8 million $25 dollar shares than there is from the distribution of 10 million shares at $0.50 a share.

So you can see why the major investment banks have a very strong incentive to find “penny” stocks “dangerous” and “high risk”.

Let's face it – any investing is high risk. Especially if they’re rated triple “A”.