Why are small caps going down and new lithium commentary

It’s that time of the year again...

May.

The old market saying is “sell in May and go away”.

The saying originates from London’s financial district when aristocrats, bankers, and merchants would sell all their stocks in May, escape the city heat for the summer, then return just in time for the annual St. Leger’s Day Stakes horse race in September.

For some reason, the saying caught on and now it's part of the market's DNA around the world.

In Australian small cap stocks, the saying has morphed to the expectation that June will be full of tax loss selling where investors look to crystalise paper losses to offset any tax payable on gains.

Instead of suffering through expected depressed share prices in June, the saying “sell in May and go away” has been adapted for those that try and get ahead of the June tax loss selling phenomenon.

“Sell in May” and “June tax loss selling” are generally more prevalent during bull markets like 2020 and 2021, where people are sitting on capital gains (remember those?) that they need to offset by selling some of their losers.

We doubt many people are enjoying many capital gains right now after the shocking last 12 months we have seen on the markets.

Also, having closely watched the small cap market (as we always do) it feels like most people who had an itchy trigger finger on the sell button have already exited sometime over the last 6 months while the market was in a slump.

Either way, our observation over the years has been that the investments we make during the market downturn are the ones that generally show the best returns over the long term.

So as counter-intuitive as it feels to transfer cash for placements into beaten up stocks while in the depths of a bear market May/June selling season - this is exactly what we have been doing.

This week we have participated in the TMR cap raise, the IVZ SPP and the DXB rights issue.

And we will be participating in most cap raises in our portfolio stocks as and if they come up in the next few months because we are long term investors.

As long term investors we believe that weak points in the market are a good time to top up and average down on our Initial Entry Price - because the market always (eventually) comes back.

This is not personal financial advice, but how we are treating the current market conditions which works for our circumstances.

We will report back in a few months on how each of the capital raisings we participated in during May/June play out...

If the market rips upwards in July like it did last year we will feel like geniuses, or there might be many more months of pain and face-palming as companies pass the hat around again at possibly even lower prices - nobody knows.

But why exactly do markets expect June to be rough?

June is the notorious “tax loss selling” month.

June marks the last month before the end of the Australian “financial year” - meaning it gives investors 30 days to start thinking about what their tax returns are going to look like come the 30th of June.

For investors who were lucky enough to have a few wins over the course of the financial year (hello LRS, ONE and ALA), it means they could be staring down the barrel of a “capital gains tax bill”.

Almost always those same investors also have a few investments that didn’t go so well and are sitting on paper losses - paper losses are on-screen losses that haven't yet been crystalised by selling the position.

Some investors may look to “offset” that capital gains tax bill and start selling those losses, booking them and then using the tax rule that allows losses to offset gains made in the financial year.

Like clockwork, this happens every year...

Investors wait until the last few weeks of the financial year, hoping that one of the companies delivers a material piece of news, but finally give in and book the losses as the company’s share price continues going lower.

Usually the more investors that sell, the lower the price goes and this spooks more investors into selling too, creating the infamous June tax loss selling spiral.

This year may look a little different with the markets generally being pretty rough for many months already.

Investors will likely have more losses than gains and may not have anything to offset them against.

This might mean less than usual selling as we approach the end of June.

It also means the late June bargain hunters who usually appear might even start buying earlier as currently depressed prices don’t fall as far as expected.

The good (and annoying) thing about small cap markets is that you can never predict what will happen, especially not based on past performance.

Knowing how the small cap market gods behave when we try to find any patterns or repeatable events in the markets can be a challenge.

June might even end up being a positive month if too many investors decide to try and start picking up June bargains early and end up front running each other into a little rally.

We are long term holders and don’t try to get clever by ducking in and out of positions over the short term - our plan is to just take the placements, rights issues and SPPs as they come during the rough patches, hold and wait for the bounceback.

What about July?

Last year the market shot up in the first couple of weeks of July after most beaten up small caps were oversold, and bargain hunters swooped in.

Sometimes this can even happen in the last few days of June as investors and traders try to pick the June bottom.

A bounce back is usually seen on the most beaten up small caps that suffered most in May and June.

Ironically, in July sometimes it can be the winners that cop a bit of selling, instead of the losers.

Investors sitting on big paper gains (currently a rare beast) and want to take some off the table to lock in some profits might decide to hold through May and June in order to lock in those gains early in the new financial year.

By waiting to sell in the first few weeks of July (which is the start of the new financial year), the investors have all of that capital available to re-invest in other opportunities without having to worry about the tax bill of the sale for at least another ~11-12 months.

Maybe they will cycle that capital into some of the beaten up stocks that copped it in June?

The problem with these predictions is that small cap stocks have thousands of individual investors, each with different circumstances, different paper losses and gains and a different selling strategy - which makes it impossible to accurately predict what might happen.

In summary, here is what we expect to see based on some assumptions around the general circumstances of thousands of small cap investors in the current market conditions:

1. In May - sellers outweigh buyers in anticipation of what MIGHT be coming in June.
2. In June - more sellers in the companies where share prices are trading near 12-month lows as investors look to book in tax losses, BUT not as much as the market expects, leading to an earlier than expected bounce back in the last few weeks of June.
3. In July - some sellers in the companies where share prices are trading near 12-month highs as investors look to lock in gains early in the financial year. Bounce back in the majority of (decent) small caps that have had a bad 3 to 12 months.

We have been Investing in small caps for 20 years and have seen these dynamics play out year in year out - each year is a bit different depending on general market sentiment and collective investor circumstances.

Our view is that these months aren't a time to put the cue in the rack. Instead, we see it as a time to adapt our approach to the type of market in front of us.

There are always opportunities that present themselves for traders looking to pick up tax loss selling bargains, as the true value of the company doesn’t always reflect the price staring back on the screen - particularly in tax loss season.

Here are some of the companies in our Portfolio that we think are being unfairly oversold on the behavioural change in markets during May:

Kuniko (ASX:KNI)

KNI has been busy drilling out a number of its European battery metals projects.

In the past month, the company has released assays from its copper and nickel projects (which you can read our coverage of here, and here).

KNI had a blistering run when it IPO’d, and some investors who chased the share price will be sitting on losses, which could be weighing on the share price over the last few months.

However, we think most of the tax loss selling on KNI was done in June last year so we expect this one to have a run into the new year.

Los Cerros (ASX:LCL)

LCL just hit a 52m intercept with gold grades of 3.65g/t together with some copper mineralisation at its PNG gold/copper project.

Despite what are potentially company-making drill results, the company’s share price went up briefly and has since come off (but settled higher than pre-result).

Pre-drill results, LCL’s share price was ~3.2c per share, on the day of the result the share price went to a high of ~5c per share - a ~56% move on huge volume.

LCL ended the week at 3.7c per share - a ~15% move from its pre-drill share price.

Our view is that at a different time of the year, in a different market, the re-rate to results like LCL’s would have been stronger and likely a lot more sustained.

Instead, many investors who were likely in LCL for the Colombia story may be using the liquidity to exit and crystallise their losses - on the day of the announcement nearly ~81M million shares changed hands which is nearly 10.5% of the share register.

This is a healthy reset where LCL’s share price starts to form a new base from which to re-rate on the next announcement, which will hopefully be another great assay result on hole 5 (expected in a few weeks) followed by 13 more holes in this drilling campaign.

We took part in the LCL rights issue at 3c back in March (when the market was awful).

Tyranna Resources (ASX: TYX)

Another company in our portfolio was met with a similar style of selling.

TYX had a great run and traded above 4c for a few months back in September, October and November, in anticipation of their maiden lithium drill campaign in Angola.

TYX made a discovery albeit with some drilling issues that are expected to be solved in the next drill campaign.

The key issue was TYX was low on cash post drill campaign, and the market was selling in anticipation of a cap raise.

TYX surprised everyone by signing a funding and offtake deal with ~$9BN capped Sinomine worth up to $31M, giving TYX’s project a read-through valuation of ~$100M.

Off the back of that news, TYX hit a high of 3.3c per share but has since come off and is trading just below where the share price was before the deal was announced - possibly investors that entered above 4c taking the chance to exit on liquidity.

TYX is now trading at 2.4c per share and is capped at ~$58M (below the $100M read-through valuation of its project from the Sinomine investment ).

We note that TYX went into a trading halt yesterday pending an announcement relating to its prospecting licence - the transfer of the licence is the key precondition of the Sinomine investment.

As part of the funding deal with Sinomine, TYX needed to register the transfer of the licence into the new Joint Venture company so we are hoping (and praying) for positive news related to this:

The Sinomine deal is expected to close within 30 days of being announced on the 2nd of June, after which $4.5M will plonk into TYX’s bank account and $10M into the project joint venture company.

After this TYX plans to commence a new drilling program.

Noble Helium (ASX: NHE)

Noble Helium (ASX: NHE) is gearing up to drill its helium project in Tanzania in Q3 this year.

This month NHE announced a preferred bidder has been selected for a two well farm out who will be paying for the full cost of the drilling campaign and some back costs (up to a cap of $20M).

Next, we are looking out for the completion of the farm out deal ahead of drilling.

NHE came flying out of the blocks on its IPO just over 12 months ago, hitting a high of nearly 40c but has been trading at or just below the 20c IPO price for most of the financial year.

NHE looked like it was on its way back up over the last 2 months, but in the last few days, the NHE share price has taken a hit for no apparent reason, on very low volumes.

We can only assume its early tax loss selling and hopefully whoever is picking them up has picked the lows - especially with the finalisation of the farm out deal imminent and drilling expected to start next quarter.

Note that this is not financial advice or recommendations to do anything, but rather our observations of the share price movements of some of our Investments that may have been affected by the current market conditions and tax loss selling period.

Our take on the lithium market right now

One of the hottest sectors across markets for the past five or so years has been battery materials - particularly the lithium sector.

We have 8 different lithium Investments across our Portfolios and it is one of the best performing macro themes over the past few years.

With lithium spot prices down ~67% from the start of 2023 we thought it was time to weigh in on the sector wide debate and lay out what we think is happening in the sector right now.

In our note, we touch on:

• Why the lithium spot price is down.
• What the major lithium producers are actually selling their lithium for.
• The medium-long term demand/supply outlook.
• How the major lithium producers are spending all of their cash.
• What we are doing right now.

Must read: What is going on in the lithium market right now?

What we wrote about this week 🧬 🦉 🏹

Elixir Energy (ASX:EXR)

Our energy Investment, EXR, sold off sharply on an update on its Mongolian CBM project, then announced that the Government may fund nearly half of the well costs for its upcoming gas drilling program in Queensland. We break down what happened and what we expect next.

📰 See our full Note: What happened to EXR's this week?

Los Cerros Limited (ASX:LCL)

Half a soccer field of gold - 52m at 3.65g/t gold assay on hole 4 from the PNG project. LCL is awaiting assays from hole 5 where the visuals on hole 5 have prompted LCL to “re-assess the potential”.

📰 See our full Note: LCL delivers 52m at 3.65g/tonne gold - “spectacular” result

Euro Manganese (ASX:EMN)

Some of the biggest companies in the world are descending on Becancour in Canada, intent on building out a major battery hub. We’re betting that EMN can get in on the ground floor of this North American battery boom by providing secure supply of a high purity manganese.

📰 See our full Note: EMN’s North American manganese ambitions - crucial on spec product to come

Quick Takes 🗣️

KNI: Kuniko releases high grade nickel assays in Norway

IVZ: IVZ completes environmental permitting - drilling on track

EMH: Czech Prime Minister on site at EMH’s lithium project

IVZ: IVZ 2D seismic contract awarded - Drilling set for Q3 this year

PUR: PUR's largest lithium permit now granted

EV1: EV1 to build its downstream plant in the USA

MEG: MEG firming up lithium targets before drilling in James Bay

TMR: TMR completes $2.5M capital raise - Maiden resource next.

MAN: MAN identifies cost effective wells for lithium exploration

TEE: TEE latest investor presentation

Macro News - What we are reading 📰

Battery Metals

Koreans pour doubt on Albanese’s domestic manufacturing dream (AFR)

LG Chem outlines ambitious new battery materials strategy (Armchair Trader)

Why Australia is behind Canada and the US on critical minerals (AFR)

Lithium

Mining Giants Have Underestimated the Lithium Wave (Bloomberg)

ETF heads talk up lithium investment opportunities (AFR)

Lithium: Driving the EV Revolution Forward (Srott ETFs)

Uranium

Russia Uranium Deal Caused Manager Exodus at Kazakh Mining Giant (Bloomberg)

Nuclear power not an option for Australia, says Chris Bowen (The Australian

Gold

Newmont Seals $19 Billion Newcrest Takeover in Top Gold Deal (Bloomberg)

Gold miner Newmont seals $19bn deal for Australia’s Newcrest (FT)

Oil & Gas

‘We have to fight back’: Santos CEO (AFR)

Cannabis

How New York and California Botched Marijuana Legalization (WSJ)

‘More acceptable now’: Medicinal cannabis use rising, passes 1 million prescriptions (The Age)

Biotech

Drug Companies Are Minting Billions on Unproven Treatments With FDA Shortcut (Bloomberg)

Hydrogen

Danish firm Copenhagen Infrastructure Partners unveils $30bn green energy plan in SA (The Australian)

Andrew Forrest doubles down on Fortescue’s Norway bet (AFR)

⏲️ Upcoming potential share price catalysts

Updates this week:

• IVZ: Drilling oil & gas target in Zimbabwe, Myuku-2 (Q3, 2023).
  • IVZ appointed a contractor for its 2023 2D seismic program & had its environmental permits renewed. See our Quick Take on the news here.
• LCL: Maiden drilling underway at primary PNG copper-gold target.
  • LCL hit a 52m gold intercept with grades of 3.65g/t - potential company making hits if the company can continue delivering similar results. See our note on the news here.
• TMR: Maiden JORC resource estimate for its Canadian gold project.
  • TMR raised $2.5M at 4c per share, we increased our Investment in the company in the placement. See our Quick Take on the news here.
• KNI: Drilling 3/3 of its Norwegian battery metals projects in Europe.
  • KNI put out nickel/copper and cobalt assay results from its nickel project in Norway. See our Quick Take on the news here.

No material news this week:

• GAL: Drilling at its Callisto PGE discovery in WA.
• NHE: Scheduled to drill two targets at its helium project in Tanzania (Q3 2023).
• LNR: >10,000m drill program at rare earth’s project in WA.
• DXB: Interim Analysis of Phase III Clinical Trial on FSGS (Q4 2023).
• TG1: Drilling at its NSW gold project in May.
• TTM: Drilling campaign at flagship Dynasty gold project.
• GTR: Maiden resource estimates across two of its uranium projects in Wyoming, USA.
• BOD: Phase III clinical trial for CBD insomnia treatment.

Have a great weekend,

Next Investors