Will Canadian regulators be able to avoid the final fatal crash of the TSX Venture Exchange?

Justice is needed, as well as transparency. And a hard-nosed special sheriff in town as well.

A good initial step would be to go aggressively after all fraudulent asset statements or deceptive claims made by junior companies and their promoters. Some serious convictions might be just what is needed to restore order and investor confidence in a market gone wild (again). Articles in the Vancouver Sun once in a while naming the perpetrators have proven to be as ineffective as useless.

Regulatory authorities are clearly understaffed, and understandably have a difficult time to keep pace with the significant number of fraudulent deals.

It is not an understatement describing the business model of a remarkable number of junior companies as a premeditated scheme to raise money for paying the personal monthly bills of the company founders.

Where are the CEOs who work for a 1$ salary? There are none on the TSX-V. Instead hefty fees paid out to CEOs, company founders and others from investors’ hard earned money are not the exception but the rule. This has to change. I encourage lawmakers to address the issue of personal fees and salaries in the junior sector. Just a zero-salary-and-zero-fee rule for the key promoters or key founders would reduce the number of fraudulent lifestyle companies significantly.

What regulators can’t do because of lack of adequate resources and staffing in their department, investors should do even if it at the expense of significant time, which is to thoroughly investigate their investment target.

Investors don’t need a degree in finance or geosciences in order to validate the business model of an interesting company. Some good old common sense would go a long way. But greed is a powerful driver.

While investors know that the high risk can bring huge rewards, the risk—along with a lot of hype and misinformation about new resource projects —has become so large in the perception of the investors that none but the most fearless of them is willing to give it a try. This is the core problem of the junior sector today and it is not unreasonable to assume that the next fatality will be the TSX-V itself. Its current constitution and form can’t possibly survive.

It seems that for whatever reason the TSX-V is not able to recognize the scale of the problem and act on it. Investors certainly did and are re-routing their hard earned dollars to more trustworthy market places. Canada is losing jobs, business opportunities and tax revenue because of this situation, and Canada’s good standing in the world’s resource and energy sector is at limbo. Currently approximately 2350 companies are listed on the TSX-V. Wouldn’t it be helpful to mercilessly delist those who do not fulfill even basic minimum moral, ethical, legal, professional and financial requirements for running a business, and be satisfied with less than half the number of listed companies? It surely would assure investors and restart the bitterly needed confidence required for moving funds into the resource sector.

The news of the ruthlessness of certain stock promoters and their foul plays has made it even into remote African countries. I travel regularly to Africa and astonishingly in 2013 for the first time ever I was confronted in two remote West-African countries in the respective legal advisory department of the mining ministries with complaints about “Canadian stock market speculators, who just need any project to play their pump-and-dump games”. The officials in each case complained that Canadian juniors would sign up a project and after having obtained the signature on the exploration license they would stop paying taxes and fulfilling their property work commitments, and just disappear. Obviously shareholders 10,000 kms further to the west are not aware of the lack of project compliance nor are they being properly informed in many cases. I guess it’s a bit unfair to offload all the bad reputation on some Canadian players, as German and US speculators and other nations contribute significantly to the number of foul plays. The “open market” of the German stock exchange comes to my mind and I mentioned the Pink Sheets in the US before. This needs to change. But investors should not give up.

Graph 2 of the TSX Venture Exchange: The spread between bid and ask is consistently above 3%. This large spread puts the TSX-V on the same level with the risky options markets just without the potential benefits of the options. Clearly something has to change here.

Investors could contribute to a highly overdue culture change of the TSX-V by actively demanding transparency on the use of funds and projects from the junior companies.

A good test also is to research the exit strategy for a certain project. The widespread “let’s drill and see” attitude ain’t no good! Investors have a right to know what the exit plan is. Too many junior companies are drilling in areas where it is clear from the beginning that a production license will never be obtained on that site in the first place. This just is another typical symptom of a cancerous disease called “lifestyle company syndrome”. These are companies, pretending to have a viable project, but in reality have been set up for the mere purpose of funding the antics and daily bills of its founders and promoters. The diagnosis is clear, the treatment in the absence of any law enforcement would be for investors to apply common sense.

Again, investors should back out of if they can’t get clear answers and convincing concepts that comply with the most basic rules of common sense.

Among all this doom I would like to bust one myth about the resource market. Yes, it can make investors rich. As a fund manager I have been always a contrarian. The entire resource and energy sector currently is at historic (inflation adjusted) lows and I can see tremendous buying opportunities and upside potential across the entire resource and energy sector. While the TSX Venture Exchange may not survive the downturn in its current constitution, the savvy investor (equipped with more than the average dose of common sense) may profit from outstanding buying opportunities if the proper research is done.

It sounds trivial but investors need to do their due diligence and in the process should not limit themselves to the projects advertised by the company but as well as and above all to the character traits of the company founder(s) and promoters, their CV, their track record, a clean criminal background check, bank references and other usual professional references. Don’t be shy to ask from the company CEO and other key company managers a criminal background check or a bank reference. If you don’t get this basic information, don’t invest. It’s a simple as this.

Investors also should be mindful about technical analysis. The TSX Venture Exchange is way too illiquid for technical analysis to be of any use. Technical patterns known from the large stock exchanges don’t work with TSX-V companies. Even TSX-V securities that have above average volume suffer from the distortions caused by the notorious illiquidity of the exchange. Thorough fundamental analysis is the only way to go.

And this leads me to the next myth, which is that financial statements are difficult to read and understand. They are not. Every speculator and investor should take a crash course in reading and understanding financial statements. These are few hours to invest and will pay off nicely. Abundant literature is available as well. Or ask a friend to give you a helping hand.

I love resources and I believe in it. The world’s population will grow to 15 billion by the end of this century—and the world’s energy and resource requirements will grow exponentially. Regardless of the poverty level in the developing countries, the BRICS, or the lifestyle in the Western world, people will consume more of everything and will need many more resources. Resources will be needed to manufacture all those goods required by billions of people, and energy will be need to ship those goods to their buyers.

There couldn’t be a better case for a long-term uptrend in any economic sector than resources and energy. I do hope that Canada keeps its leading role in this sector and that lawmakers address the obvious problems of the TSX-V rather sooner than later. It should not deter investors from carefully selecting great opportunities.