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- Advanced Market Knowledge - Part 1
If you do not know exactly what you are doing, it is not always easy making money in the natural resources micro cap markets and often preconceptions can get in the way. There are many books on investing and trading, but few that realistically address the actual peculiarities of these markets. General stock market investment books are quite useless in, since investment techniques suitable for main markets and large companies are not appropriate for natural resources micro cap companies. Most of those that try to apply these techniques lose, often a lot. It is a completely different game.
There is not actually much useful information out there about trading these companies, hence I decided to write this. I shall be covering everything you will not read elsewhere, particularly subjects which others either do not understand or even know about, or even if they do, are unwilling to talk about openly, including shorting and the various forms of market abuse. I shall set out exactly how all this works in detail. Exactly how the insiders make their profits. And how you can profit too. I shall explain all the things that no one else will, all the secrets the insiders do not want you to know. A large amount of money can be made if you know how it all actually works and what goes on behind the scenes may be completely different to what you think. I believe most will find it eye opening.
I have been involved in the markets for a long time. I bought my first shares in the 1970s and I have worked in the financial sector since the early 1980s. My particular knowledge is of the stock markets and I have been actively involved in these, both in the UK and the US, from both sides of the fence, for over 40 years. My main focus is on the oil and gas industry, where I have significant experience, but I also understand fully how the game is played in all the other sectors, whether it is mining, pharmaceuticals, technology, or any other area. The modus operandi with them all is just the same. To succeed, you need to understand exactly what everyone is doing and precisely what their agendas are
It is important to accept reality, understanding from the outset is that very few of these companies succeed. Many rotate through a series of different managements and projects, with their share prices declining year after year. Even the ones that do appear to “succeed” often do not do so from the perspective of longer-term shareholders, the value of whose investments constantly erode away with continual dilutive financings. While the very occasional one will actually deliver for shareholders, broadly these micro cap companies should not be viewed as investments. Anyone with doubts about that just needs to review a few longer term price charts to see the endless declines.
What these type of shares are good for though is trading, since they can move very fast, often by multiples, in a short space of time. To succeed, it is necessary to understand why and when they do this, and how to avoid the numerous pitfalls and traps that can ruin people who get involved.
The first things to put to one side are fundamental and technical analysis. They are simply not applicable to small, speculative companies in continuous fundraising cycles. Of course, the company has to have an exciting project, that is essential and, yes, they all will have resource reports and/or financial projections, but that all is best taken with a pinch of salt. What is assumed in these is rarely delivered. Key if there is going to be short-term share price performance is a compelling, highly promotable story, with big headline numbers.
Technical analysis is equally inapplicable when large numbers of new shares are being issued into the market at new price points. Previous support and resistance levels lose any significance with the large scale dilution that takes place in these companies.
Those who see themselves as investors wanting to invest in great projects and profit thereby may question all this, but it does not matter how great the project is if the company is going to fund it with multiple placements at ever decreasing prices.
As perhaps is becoming clear, the key points are financing and promotion.
Small cap speculative companies generally exist to enrich their insiders, not their public investors, and everything they do is for their own benefit, not yours. The vast majority lose with these companies, but for the scheme to work, some have to profit and you want to be one of those.
So let us go through the various stages when a “deal” is put together. Whether they are using a shell or floating a new public company, the operation is basically the same, although a shell is often easier since many of the necessary elements (trusted brokers, attorneys, auditors and of course the key point, a listing) already are in place.
First, they need a project and I shall focus on oil and gas, although the principles are the same for all companies. It does not necessarily need to be a good project, the main requirement is large potential numbers. Failure generally is on the cards anyway. Best from a promotional point of view are projects that are drill ready.
There are two main options (other deal types will be discussed in relation to company structures and share issues later): acquire or farm-in to a permit or license, where all the preliminary work such as seismic is done and the next stage is drilling, or acquire an old oil field with possible undeveloped locations and deeper exploration potential. The latter is quite popular since such fields can often be acquired for very little; indeed, if there are decommissioning liabilities, they might even get paid to take them over. Often they are acquired by an offshore company and the public company does its deal with that, with the organisers effectively flipping the asset into the public company for a several million upfront profit. It can also be done for no or little cash with the public company agreeing to do certain work and the organisers’ offshore company retaining a carried interest. Many deals are more sophisticated and the transaction is done in stages, but the principles are the same. Of course, some companies are genuine with real projects. Sadly, they do not necessarily always perform that well. There are a few stars every decade, but very few of the companies we will encounter are actually like these ones and commercial failure is the most likely option.
Remember, most projects are not economic and will never even cover the public company costs, let alone provide any return to shareholders. Indeed, many projects only exist because they are necessary for the CEO and/or organiser to hustle the money. Reality is the good projects get acquired by the large companies; small companies rarely get their hands on them.
With a vehicle and a project, the organiser, whether the CEO or someone behind the scenes (as often is the case), will address financing and promotion. These are the two most important matters if you want to make money trading these companies and, with the advent of social media, they have started to merge together. As I said before, much of this is done in stages, but it is the main financing for which we need to watch.
The key is always to be heading for an event, fully financed. You do not want to be in at an earlier stage, with the main financing still to be done, or be in after the event, when the development finance will need to be done, but without the original excitement.
I am going to be addressing all of this and more in much greater detail, with clear explanations of how such knowledge can be applied for advantage. There are some truly bad companies that never offer any long-term profit opportunity, but many do for a certain period of time and that is what the “game” really is all about. Yes, there is the very odd one that could make a good investment, but the vast majority do not, which is why most micro cap investors’ portfolios show losses, often extremely large ones. It is about trading them over relatively short periods of time. That is where the money is made in this market.
Essentially, you need to know where the company is in its operational, financing and promotional cycle. Understanding that unlocks the door to market success, since by entering at the right point you will always be buying into upward moves. And this is the key.
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The vast majority of speculative micro cap companies are loss making, many with heavy capital expenditures and generous salaries. Thus, most need cash constantly. Very few have assets which offer adequate security to a lender, so financing has to be equity based. Broadly, there are two ways to do this. First, sell shares directly to investors who believe the company is a good proposition and actually want to buy the stock, even if they intend to flip it at a profit. Second, finance through the market.
The first is a quite straightforward proposition. The company's broker, or brokers, will contact investors on its list, or through others, and stock will be placed at a discount to the market price. These contacts are made on a confidential basis and until the placement is announced to the market, the investors are in possession of “inside information” which they are not meant to disclose or act upon. Obviously, they do and the market prices generally decline before placing announcements indicating this. In some cases, the information leaks widely and is even published leading to large price declines, which can require the placement price to be reset downwards. A good indication of the “quality” of the placement can be discerned from the level of the discount and the level of the leaks.
The shares issued in these placings are not necessarily paid for immediately. Settlement can be several weeks later when the shares are actually issued. During this time shares in certain markets which do not impose holding periods are often forward sold and this can be a time of intense promotion on social media as those looking to flip extol the attractions of the shares they want to sell to you. It is not necessarily guaranteed profit for those taking the placement or the would be flippers though, since the poorer quality companies can often rapidly go to a discount to the placing price. Some feel they have “joined the club” when they enter this circle and take placements, but in reality they are often just marks.
The second, financing through the market, is a far from straightforward proposition and there are three main ways in which it is done. First within this category is naked shorting, whereby a trader or “institution” (more on them later) sells shares they do not own and simply fails to deliver them. They then approach the company saying they want to invest a large amount and cover their short via a direct issuance of stock from the company at a discount. Their selling also will have forced the share price down already and a good profit can be made without actually laying out any cash. Clearly, a lot of this is done on a nod and a wink and they sell knowing that they will be able to cover later on. The share price is damaged, but the company gets the cash and the directors’ salaries get paid, which to them is the most important thing.
Second is convertible loan notes. These represent loans made to the company, which are either repayable in cash, usually at a premium, or can be converted into shares at a discount. For cosmetic reasons, they generally have clauses prohibiting short selling by the holders, but these can be got around and are intended to be got around. The holder then simply sells shares short, which generally moves the price down, then converts the loan note into shares at a further discount to cover the short. It is virtually guaranteed profit for the loan note holder and often the only way that some companies can obtain finance.
Third is investor sharing agreements. These are for the “institutions” that do not want to put up any cash at all and essentially are just a present by the directors to friends and associates. Under an investor sharing agreement, the company issues shares to the “investor” who sells them and then pays over a percentage of the share price to the company. It is money for nothing with zero risk for the “investor” who just sells shares they did not even have to pay for and keeps around 25% of the sale proceeds. They are only used by the very worst of companies.
Clearly, existing shareholders are greatly disadvantaged by the above financing methods and some countries prohibit them, but not all. Hence the continued popularity with some companies for markets such as the UK.
Naked shorting, referred to above, also can be done on a large scale pre-placement in connection with a ramp. Indeed, it is much easier to sell large volumes on rising prices rather than falling ones. People buy a lot more when they see the share price going up. Vastly increased promotional activity often is an indication that a placement is on the way: why would someone pay for it other than to sell stock? Trading long on this basis is highly risky, though, since the placement, often at a large discount could be announced any day.
Some pre-placement ramps are primarily to get the share price up, so the placement can be done at a higher level than present, but the key tell-tale is the promotional activity by the less than reputable (more on this in a while).
It is quite easy to guess whether a placement is coming up simply by looking at the company’s accounts and working out when they are going to run out of cash. If you combine this with the monitoring of promotional activity, you will rarely be wrong with your placement forecasting.
Avoiding holding shares over a placement possibly is one of the most important keys to success with micro cap companies, which is why understanding the promotional side is so important.
Companies with convertible loan notes outstanding are best avoided, since the share price is very much more than likely to decline. Companies with investor sharing agreements in place almost certainly should be avoided, since their share prices are virtually guaranteed to decline.
One mystery for many is that whereas some companies do have promise, others have little and people ask why do they keep these worthless, purposeless companies going. The answer is simple: salaries for directors, fees for brokers, lawyers and auditors, trading profits for insiders with the shares. It is a pure exercise in cynicism. But with abusive promotional and financing techniques, even these types of companies can be kept alive.
Not all are deliberately dishonest, many are simply run by incompetents with a tendency towards pomposity. They engage in failed project after failed project, yet will never accept that perhaps they do not really understand the business. They actually believe they are serious business people, despite racking up seven figure losses year after year after year, and genuinely believe they deserve six figure salaries, large expense accounts and pension plans. None of the professional advisers say any different, because as long as the CEO can keep fundraising, they can keep earning too. Fees is what it is all about. Do not be fooled by implied endorsements from what may appear to be respectable associations. The names are only there because they are being paid.
Why do people buy shares in these types of companies? Possibly because they are foolish, with little knowledge and believe the story that the company is currently promoting or, more often, simply because they think or have been told that the share price will go up. Indeed, that is basically how the micro cap markets work. The majority of people simply do not care about any underlying “fundamentals,” their investment or trading decision is based solely on a belief that they can sell the shares at a profit later that day, week, month or year. And that is how these often quite nonsensical companies keep going. Investing in them is simply a game of pass the parcel, but with the odds very much rigged against the investor.
In this situation, since the shareholders do not really care about what is going on, the directors can do whatever they want. Every so often there may be some shareholder activism, but generally very few investors turn up at company meetings, other than for free food and drinks, and hardly any vote. The asset for the insiders is not anything on the balance sheet, it is the public quote.
The reality is that with control of the board of a quoted public company, you can do anything you want. In the right hands, it is a licence to print money.
We are then back to the deal process outlined earlier, with the “asset” being a necessary nuisance to raise funds and promote. The reality is that virtually anything can be dressed up and, for a good fee, a professional will come up with a report endowing the asset with the necessary promise.
I mentioned earlier that there were acquisition deal types for the company other than paying cash. The consideration paid by the public company for the asset can, of course, be shares issued at a ground floor price. The identity of the counter party can readily be disguised through the use of an offshore company, itself with multiple shareholders who will each receive less than the disclosure level of the public company’s enlarged capital. They can all in reality be the same person using entities with no recorded beneficial ownership, such as funds, foundations and companies with bearer shares. The offshore company owns the asset, the public company acquires the offshore company (something like an Isle of Man incorporated one can give it a more respectable look) and the public company shares are issued in consideration to the offshore company shareholder names, each of which will own less than the disclosable level.
All that is needed to effect the above is cooperative professional advisors, since the purchase and sale agreement often in some jurisdictions does not need to be publicly disclosed, since those undertaking such an exercise will of course ensure that the transaction will not be classed as a reverse takeover, where a prospectus or new admission document would be required.
Like some of the financing techniques I described previously, corporate abusers can not get away with such a transaction in certain jurisdictions in the same blatant manner, since the purchase and sale agreement would need to be exhibited to a regulatory filing and the nature of the shareholders would become apparent. In other jurisdictions such as the UK, however, it is all fine, or at least it is not found out, or examined.
All these essentially free shares are going to be sold into the market, though, depressing the value of shares which the public will have paid for. It is important to understand these matters, to see why shares can trade so far below their notional issue prices. It is simply because insiders secretly were given very large numbers of shares for nothing. The asset acquired by the company in such a situation equally will be worth nothing, regardless of the professional endorsements and valuations that come with it.
At the same time, it would be wrong not to say that not all companies and directors are the same as those described above. The problem, though, is that many are, hence the need to be aware. At the end of the day, directors are in it for themselves and, notwithstanding what they may say, the interests of investors are very low down their list of priorities. Investors only get considered when they need money. They are not regarded as the legal owners of the business, rather just as a necessary evil. Only when directors need, or feel they will need them, will the investors interests be considered.
Remember, you have to look out for your own interests and understand that the key to a promising stock play is always to be heading for an event, fully financed. This is the point in time when most share price rises take place. As I said before, you do not want to be in at an earlier stage, with the main financing still to be done, or be in long after the event, when the development finance will have to be done, but without the original excitement.
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The whole of the micro cap game works only because of promotion. This is the most important ingredient and it is essential to understand this.
Historically, micro caps were promoted by financial writers in the newspapers and tip sheets and by brokers either face-to-face with clients or in telephone conversations. The writers and brokers usually were informally compensated, often quid-pro-quo, and that tradition continues today, the only difference now being the participants. Financial writers and brokers are still actively promoting shares, but others now have equal if not greater importance.
The big change is that previously there was a certain quality filter on the information being communicated, since the writers and brokers would not have been employed without them having a certain level of knowledge. Now anyone can have an audience for their opinions, regardless of their ability. And how can someone with no knowledge themselves know the difference?
Most people now obtain their information from the Internet and a new world has opened up in which investors can interact. The earliest forms of electronic investor communication were the bulletin boards, which continue today. If everything is in balance, they should display alternative views and provide investors with a reasonable perspective of other investors’ opinions. Unfortunately, dissenting, and often truthful, voices tend to be suppressed, either by being shouted down by other posters, perhaps just other accounts, or by being removed by the administrators or moderators due to complaints from those other posters and/or accounts. Sometimes, the companies being discussed are PR clients of the platform, in which case it is possible that the administrators and moderators are less than independent. Commentary on these boards essentially is worthless, but it does have a huge impact on many investors. Much is PR often being posted by the company or those retained either directly or indirectly. A significant part of the information being posted is deliberately false or misleading and often there is little or no counter to that.
The bulletin boards have to a certain extent now been superseded by the social media platforms, of which the most important for shares is Twitter, although the boards do remain extremely popular. A similar situation to the bulletin boards does prevail on Twitter, with promoters trying to shout down or bully those posting opposing views, however, this is less effective, since on Twitter the administrators and moderators will not come to their rescue and take down the posts they do not like and/or ban the truthful posters.
In all these venues, the idea of the promoter(s) is to create interest and excitement, leading to buying by investors. Ideally, these investors once they have bought the shares will in turn promote the stock. Whenever the price falls, those touting it claim to be topping up and a club or team like feeling is encouraged amongst investors, particularly via groups, to discourage any selling. Messaging services such as Telegram also are used for this purpose. The most powerful emotion being exploited is FOMO (fear of missing out) and people succumb to this time and time again. Like the bulletin boards, the majority of the information posted by promoters on social media is false or misleading.
Another major source of information for investors to which they afford much credence is interviews. Unfortunately, since they invariably are paid for, virtually all of these are staged, with pre-agreed questions and the company reviewing and editing the interview prior to broadcast and distribution. The information contained in these interviews often is misleading. They also provide further material for the bulletin board and social media promoters to use, misinterpret or distort.
In similar vein, many of these types of companies also word news announcements in a way that can be deliberately misinterpreted by promoters. It is very important to read the whole announcement, word by work, looking for any ambiguities. If you can spot them, then you can readily see what the real story is. I shall give examples of these later.
Investor evenings, presentations and lunches also belong to the same category as interviews. They can build up a false trust between investors and directors, who for the main are essentially professional salesmen. Investors can feel privileged and often think they are privy to advance information as a result, but this is rarely the case.
Officially, public issuers use and directly engage IR companies and PR web sites, but the meaningful impacts on price and volume are achieved in other ways. These companies and web sites often interrelate to commentators, who profile themselves as independent and uncompensated, even though they are paid. They are self styled stock market experts who purport to provide informed opinion, although the only criteria for qualification as one of their stock selections is a cash payment. Nevertheless, they do have influence and reinforce their credibility between themselves, even interviewing each other. I am sure you will be able to spot them.
Most powerful, although usually only used in North America, are large email blasts, which can create millions of dollars of volume a day for micro cap stocks. Some promoters can not bring themselves to stomach the several hundred thousand dollar cost for an effective one, although this method has significant impact.
Disclosure of compensation is rigorously enforced i some countries, the regulatory view being it is important for investors to know whether the opinion is genuine or paid for. In others such as the UK, no one appears to care.
The reality is that micro cap companies frequently are promoted on the basis of mistruths. The companies rarely lie in their news announcements, but they can write them in a way that allows people to mislead themselves, or leave ambiguity to allow for alternative, more positive, interpretations by promoters.
Most of the time, it is best not to believe any of it and not allow yourself to be persuaded of the merits of a company to the extent that you believe it is a long term hold. These companies are for buying and selling, rarely for holding beyond the short to medium term.
For an investors point of view, though, it is better to see strong and effective PR engaged. The poorer companies, which are the majority, often can not generate the necessary impact to ensure the required excitement and get the share price moving. The level of the people involved is a fair indication of the level of the promotional quality of the company’s management and project.
Incentives for the promoters usually are in the form of cash and often warrants. Normal payments to official IR and PR outfits will be made directly by the public companies, but cash and warrants for the unofficial, non-disclosed, PR will usually come from the party controlling the company, often working in tandem with one of the brokers.
As a side note, it is very much worth keeping an eye on promoters’ activities, since their activities can often flag up a forthcoming placement, which as detailed previously can usually be confirmed by a quick review of the company’s cash position. It is essential to avoid these.
There are two main public audiences for these people: those who believe in fundamentals and look for what they think are good investments; and those who are only interested in whether the price is going to go up, preferably in the shortest possible time scale.
Looking at the first group, they are easy to manipulate. The company can only publish facts, but the promoters can do “research” and since 99.9% of their audience is clueless regarding petroleum geology / mining geology / pharmaceutical research, etc., they can as good as make it up. One of the favourite techniques with oil projects is “closeology,” which essentially is used to “prove” the merits of the company’s acreage by its proximity to producing tracts, or other acreage owned by well known companies. There will be good reasons why the prospect being promoted has not been drilled or permitted/leased by other companies, but this inconvenient point is ignored.
It is important to understand that even within an oil field, some parts are productive and some are not. Oil and gas generally is contained in undulating sands of varying thickness. The geologist aims to map these with structure and isopach maps. These will show both the prospective and non-prospective areas. Prospective areas are leased or permitted by real oil companies, non-prospective areas are not. Therefore, it is quite easy for a charlatan to acquire a large land tract, surrounded by production or well known names - and equally easy for their promoters to “research” it and extrapolate estimated “production” or “reserve” numbers.
The next step often will be for the promoters to speculate on the possibility of a takeover by a major oil company and huge possible numbers for that will be touted. The company can cooperate with this by issuing meaningless statements that it is in discussion with other parties regarding the project (it could simply be for the supply of everyday services) and the promoters can twist these statements to fuel their take over theories. “Credibility” is added by other paid commentators and posters espousing and endorsing the idea.
It is also important to understand that Government issued oil and gas licences and permits can cost very little to obtain, and in some cases they can actually be a liability due to work programme commitments. The process to obtain one is relatively easy and in many cases quite straightforward. The United States has the simplest process, where Government or State departments offer leases for sale by auction. Alaska is particularly popular, due to its large perceived hydrocarbon resources. The minimum bid there, which is sufficient to acquire many tracts, is just $5 an acre.
Outside North America, it is generally necessary to submit a geological report and a work programme, however, extremely large tracts can be obtained for very little cash. There are a number of geologists who specialise in obtaining licences and permits and their fee to prepare an application can be as little as $5,000.
As outlined previously, these leases, licences or permits can be flipped into the public company at a price which then gives the asset a multi-million pound valuation on the books of the company. This often is the “fundamental” value upon which some investors are focussing.
Back to the promoters and the second main audience who are only interested in whether the price is going to go up, preferably in the shortest possible time, this is an even easier group to convince. All that is needed is repetition of a simple message from as many sources or accounts as possible. You will see groups regularly switch on and switch off with these types of posts like a machine. It can either be done by a number of paid posters or just by one individual with a number of accounts. The catalyst to creating buying then is simply placing a few buy trades to start the price moving up and the advertisement of that move via the paid posters. Once underway, it can be accelerated by interviews and paid commentators.
It is very easy for people to get lured into these momentum plays and, as always, FOMO (fear of missing out) is what has to be avoided. It is very important to resist these, since getting involved destroys trading discipline.
If you understand what these promoters are up to, it is easy to spot them and avoid getting involved. Yes, you could make some money on one or two of their trades, but overall you will lose, big time if you get hit with a placement, which is usually what happens. In any case, relying on promoters for trading ideas is not the route to success, in fact quite the opposite.
Part 2 follows…