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Oct 2002 - Reduced Liquidity

The Benefits of Reduced Liquidity

In the fifth extension to its bid for AurionGold, Placer Dome has again trotted out the remark under the heading “Risk of Lower Liquidity…There is a significant risk that the liquidity of AurionGold will fall further if Placer Dome's shareholding increases and if the Offer closes, causing further downward pressure on the share price”. This remark is cited so many times along the lines that a company is expected to experience reduced liquidity due to a takeover or a major parent holding, that in the shareholder’s interest the major will take it over and you the shareholder can invest in something else.

The inference is that reduced liquidity results in lower share prices, whereas the reverse is often true. Just ask the recent IPO’s of Vulcan and Universal Resources which were both down by about 20% to 25% within days of listing due to excess liquidity. In fact, one of the reasons that Independence Gold’s share price held up so well after listing was the loyalty options that it issued after about 3 months and which limited the liquidity of the stock.

Weakness in a stock due to reduced liquidity is often due to the quality of the stock’s assets. Take North Flinders (NFM), Normandy failed to acquire 90% of the shares when it tried to take it over in January 1996 for 4.25 times a NDY share. NFM was producing about 220,000ozpa of gold and had upside potential to 350 to 400,000ozpa with Callie growing beyond 3moz or 4moz. NDY continued to creep on NFM at the 3% every 6 months, reducing liquidity even further. Callie is now an estimated 11moz or so orebody (still open at depth), and with its Groundrush mine, NFM (or Newmont NFM) is producing at about 600,000ozpa. There are only 78m shares on issue and within the past year NFM has almost doubled to trade at nearly A$20 per share.

A more recent example is Harmony’s acquisition of Hill 50 Gold from December 2001, Colonial did not take up the initial offer, and it went towards closure with only a few shareholders and Colonial’s holding. Liquidity was heading for minimality, and yet Harmony then increased its bid by another 5c and Colonial then accepted. A pity because in our opinion, Hill 50 was worth more, particularly given the resulting squeeze in available Australian gold stocks that can now be invested in, and showing that Harmony astutely acquired the company at a bargain price.

Durban Deep trades very poorly in Australia relying on the shares that remained from the Hargraves and Dome takeovers, but yet its share price has traded daily and moved according to what its price has traded at in ADR from in the US on the previous night. That has resulted in DRD increasing by about 30% to 40% since the end of August 2002, despite its “poor” liquidity. Anglogold and Newmont similarly trade daily in Australia and although they trade in significantly lower quantities and at low liquidity, they do still trade in accord with their US share price closes of the previous night.

Less liquidity usually results in higher share prices. It is from an Australian perspective that the high volumes of shares on issue is common. Implats only has about 1521 shareholders, of which individuals are 1317 holding only 440,000 shares out of the 66.35m shares in issue, 8 shareholders hold 94.8% of the company or 62.9m shares – now that is what can be described as reduced liquidity, but yet it does still trade at about US$55 per share (ADR) in the United States.

We can recall visiting a Canadian precious metals funds manager some years ago, who stated that they would not invest in Australian golds because the share prices were too low at less than US$5.00/share. He classified anything less than US$5.00/share as a rubbish stock from a North American perspective. In his opinion, the best suggestion we should make to Australian gold companies was to consolidate their shares in issue, say 1-for-10, which would reduce liquidity, but result in higher share prices.

However, there is that caveat in that it depends on the quality of the asset. We can also recall one of the Mercury fund managers calling a number of gold stocks “lobster-pot companies” where you would buy them for the tasty morsel and once you got in found that liquidity suddenly dried up and you could not get out of the stock again.

The liquidity argument does appear when a seller is forced to sell due to their needs and the spread between buyers and sellers can be large. However, those situations are usually one-offs unless the market or the particular stock’s share price is collapsing for whatever reason.

So liquidity can be an issue and it certainly used to have an effect, but time has moved on. Instead, if the market perceives that the stock has underlying quality assets or has future potential, then reduced liquidity should not infer that share prices have to fall, instead they could in fact rise and appreciate even further.

Returning to our original example, being the Placer Dome takeover of AurionGold and whether the market perceives AurionGold’s assets to have quality. Well, Placer certainly must, otherwise it would not be making this fifth extension to its bid. Placer has already stated that the closure of Porgera should have a greater effect on AOR than on Placer, so it is not taking over AOR to increase its holding in Porgera, and AOR has divested one of its non-core assets (Zimplats) and there are other sleepers such as Zimbabwean and Solomon Islands gold, but they are not likely to be the current focus.

However, AOR does have 40% of what has to be Placer’s best asset (Granny Smith, now mining Wallaby), its 100% of Kanowna Belle (post re-interpretation of the orebody) could continue for more than one decade, Henty has been extended at depth / along strike and then there is the rest of the Kalgoorlie region and the significant land package aside from Kundana and Raleigh. Only last quarter (June 2002), AOR was mining at about 50,000tpm at 8g/t from the underground mine at Quarters that it rapidly established after recently taking it over, and reported intersections at Quarters of 2m at 1700g/t. Now those are the sort of intersections (at 50oz/t or so) that make gold companies salivate.

Consequently, it comes down to the market’s perception of the quality of the underlying assets, and the reduced liquidity in say AOR could instead result in higher share prices, NOT lower ones.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, who has a Proper Authority with State One Equities, and with his associates, either has or expects to have interests in most of the stocks in this article, This e-mail address is being protected from spambots. You need JavaScript enabled to view it . The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

  • Written by: Keith Goode
  • Tuesday, 01 October 2002