The most disappointing thing that I’ve learned about short selling is that identifying frauds and scams is not as consistently profitable as it “should” be. Identifying frauds actually isn’t the hard part. The real issue is that fraud isn’t symmetrical. While fraud reduces returns on the long side, actually making money by betting against fraud is much harder than it seems. Here are some reasons:
- The wealth isn’t exactly transferred from the longs to the shorts. Short sellers have to pay money to borrow shares. Much of the profit from short selling ends up in the hands of brokers, who earn large fees from lending shares to short sellers.
- Short positions tend to be correlated because of the way they are marketed. The parties lending out shares tend to be institutional investors who fall prey to the marketing tactics of small investment banks. Being unable to ride out market conditions can cause short sellers to lose money.
- Worthless companies often get taken over. There is always some rich person or misguided CEO that will throw money at a fraud.
According to Pretium’s financials published on SEDAR on Thursday evening, the Brucejack mine is generating very strong cash flow.
Cash and cash equivalents increased by $72.5M. This is largely inconsistent with fraud. If Pretium were engaged in Worldcom-style fraudulent accounting where expenses were improperly capitalized into capex, then the capex number would be dramatically higher than $5.771M while the increase in cash would be closer to 0. Given how low capex is (even lower than what the feasibility study anticipated, which is $76.8M over the first four quarters of production)… I think that we can safely conclude that Pretium didn’t engage in Worldcom-style accounting for Q2. The market seems confident that the cash generation is real, sending the stock up 19% following the filing of financials on SEDAR. Needless to say, this development is not good for my short position.
I’m aware that there’s information on mining stocks from guys like Angry Geologist, Exploration Insights (Brent Cook and Joe Mazumdar) and investment bank analysts with mining degrees (P.Geo, P.Eng, etc.). The danger is this: just because they CAN perform due diligence doesn’t mean that they ACTUALLY perform due diligence. I don’t mean to be disrespectful to these people. (*I do understand that I am attacking their credibility.) However, they often come to conclusions without having access to key technical data. For example, Simon Dominy and Strathcona have unique views on Pretium’s Valley of Kings deposit. They had access to all of the sample tower data, including the sample tower data on the Cleo vein. Strathcona had access to the drill core so they could make their own interpretations about the lithology (Wikipedia) of the rocks and therefore the appropriate geological controls. If you don’t have access to accurate lithological information (e.g. pictures of all of the drillcore), then you cannot build a reasonable resource model. Insiders have this information. The investing public doesn’t. When mining professionals make conclusions without access to key technical data, you should take their opinion with a grain of salt.
Secondly, one should question an analyst’s optimism about deposits. With the benefit of hindsight, we can figure out that mineral exploration has been a disaster since 2000. Past optimism about exploration stocks seems quite dubious with the benefit of 20/20 hindsight.
While I haven’t spent the time to piece together all of the data points, it is clear that high-risk mineral exploration stocks have found very few profitable mines since 2000. The only reason why junior exploration stocks haven’t been a complete disaster is because senior miners have thrown away money by acquiring uneconomic projects. The majority of “value creation” in high-risk greenfield exploration can be attributed to poor investment decisions from senior miners rather than the meagre cash flows from mines like Arista, Bloom Lake, and Legacy (potash).
Warning: this post discusses child abuse and may make you uncomfortable…
Our society teaches us that scientists deal with the truth and facts. Scientists’ results are supported by controlled experiments, the scientific method, peer-reviewed journal articles, etc. However, there are charlatans in the world that masquerade as scientists. They do science-ey sounding things without actually doing science.
In the medical field, psychiatry is the worst offender. Conventional psychiatric views are driven by money as the deranged profession ignores very obvious evidence that contradicts their world view. For example, the National Institute of Mental Health website (archive.org, live version) claims that schizophrenia is a “chronic” disease, which means that it is ‘impossible’ for schizophrenia to go away. The reality is that people commonly experience full recoveries from schizophrenia (regardless of medication or treatment). You can see this for yourself on Youtube. Daniel Mackler’s film Take These Broken Wings has interviews with people who recovered from schizophrenia (trailer, full film). One of recovered schizophrenics, Joanne Greenberg, is the bestselling author of “I Never Promised You a Rose Garden” (it has over 26 thousand ratings on GoodReads and became a 1977 film). Despite obvious evidence, the conventional psychiatric field would still like to believe that schizophrenia is a brain disease, lasts for a lifetime, and is something that should be treated by psychiatric drugs (or whatever snake oil therapy is in vogue at the time like lobotomies/psychosurgery, insulin shock, or seizure-inducing ECT).
Pretium has reported excellent grades that are in line with their 2014 feasibility study and subsequent updates to their resource model.
- Q2 feed grade: 14.9 g/t gold
- Year 1 of feasibility study: 15.4 g/t
- Reserve update announced Dec 2016: 14.5 g/t
- H2 2018 guidance:
11.6g/t to 12.82g/t after recovery losses at 2900tpd operation. If recoveries are 97%, guidance implies 12.0g/t to 13.2g/t. 12.9 to 14.2 g/t. (EDIT 7/12/2018: Management stated that the guidance was based on 2700tpd on the conference call, so I should have calculated based on 2700tpd.)
The guidance range is insanely tight as it is roughly ±5% (200,000 to 220,000 ounces). Pretium has gone from complaining about the accuracy of the sample tower data, to saying that it would provide guidance at the end of 2017 and not do so, and now it is saying that it can predict production to within 5%. Simon Dominy’s paper (draft version with working images, final version), especially Table 9, is worth a read as this newfound level of precision is very suspicious to me.
My gut feeling remains the same: this story will not end well. There’s one way to validate or invalidate my short thesis. In the coming quarters, Pretium will release its financial statements. If the mine is the real deal, cash will pile up on the balance sheet. In theory, it’s possible for Pretium to cook the books a little simply by not reporting all of its liabilities. But there’s a limitation to that type of distortion, e.g. I can’t see how it would be possible to understate more than a quarter’s worth of expenses. Over the span of 1-2 years, the financials will paint a reasonably accurate picture as to the mine’s profitability so far. Looking at financials would therefore sidestep the issue as to whether or not the reported grades are real.
The conventional investing wisdom is that owner-operators should outperform since management has a lot of skin in the game. In the case of WWE however, that’s not the case at all. Vince McMahon, the CEO, does what he wants with his company and has left a lot of money on the table by interfering in his own business. WWE’s shows are fairly cringeworthy because Vince McMahon insists on micromanaging the creative, sometimes even writing dialog himself.
But it’s not just Vince McMahon who does this. One reason why Vince ended up with a quasi-monopoly in the wrestling business is because his competitors were even more poorly managed. The lesson is that some (but not all) human beings will interfere in their own success. It’s like hiring a brain surgeon and telling him/her how to do brain surgery. Some people will engage in dangerous meddling rather than stepping aside to let competent people do their job. These behaviours are likely hard-wired (nature rather than nurture). While the detrimental effects of counterproductive micromanagement will eventually become obvious, some owners will repeatedly continue their mismanagement regardless.