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March 15, 2006

The Underworld of Sub-penny Gold Stocks
by Roland Watson

"Abandon every hope, ye who enter here."

Whilst watching the current correction in gold and silver prices, I decided to hold back on further precious metals investments. This is quite a normal action to take but in my quest to decide which strategy to enact on prices bottoming out, I found myself propelled into a dark and unfamiliar domain. It was a domain where the rules of engagement seemed to be different and was populated by a different set of investment creatures altogether.

I am talking about that dominion where gold stocks mutate into sub penny stocks, a world where nimbleness of foot is required lest you are consumed without mercy and it does not seem to matter one whit whether a company has one ounce or one million ounces of gold under the ground.

It seemed like a journey down into an equity version of Dante's nine circles of the Inferno from which nothing seems fated to ever emerge from perpetual darkness. From above we took our journey, past the main producers down to mid-tier companies, onto juniors newly producing and onto promising exploratory companies foraging for the next big find. But below we descended into an otherworldly haze beholding companies that seemed to wander like zombies in a state between life and death. They gave the impression of having no purpose whatsoever having nothing to speak of in the way of riches or even a semblance of such a hope in them.

Their eternal destiny seemed to be one in which they would forever remain frozen at absolute zero prices. It was also a world that had an atmosphere of deception and intrigue as demons lay behind every pile of Fools Gold trying to pump up comatose stocks to the detriment of the gullible. Yet in amongst these do-nothings and rotting corpses lay one or two gems that would somehow arise in resurrection destined to join the respectable ranks of shares ranked in dollars rather than fractions of cents.

As I stumbled around this murky region, I came across two companies that caught my attention and made me question and finally re-affirm the raison d'etre of the gold stock investor.

The first was Great West Gold that was trading at the ludicrous price of $0.0004 per share or four hundredths of one cent. It had been previously trading at a low of $0.0001 that is so low that it was displayed as zero on my chart summary and I suspect this is a price that cannot go lower for trading purposes. Moreover, the number of outstanding shares was of the order of 20 billion not including however many warrants and options had been granted.

Welcome to the underworld of confetti shares at vanishingly small prices. I paused and examined this small gold entity. They did not appear to be producing an ounce of gold and they were in the throes of a restructuring that aimed to purchase some old deposits by further dilution of stocks. I walked on past them wondering whether a small investment should be aimed in their direction. I reminded myself of the philosophy of the gold investor - valuations and a long-term perspective - and moved on.

Almost immediately after that, Great West Gold exploded in price to a peak of $0.003 in early March before settling down to $0.001. That was a 30-fold increase from their low of $0.0001 and no doubt someone was a little richer for that. I thought to myself that in the lower reaches of the penny stock inferno, we could expect volcanic behaviour as speculative forces unleash strange pent-up energies.

Did I regret not buying? In some sense, yes, but it did not seem the way of the seasoned gold investor which I shall explain shortly.

Good luck to Great West Gold, they may yet achieve equity resurrection and escape the sub-penny inferno. But as I reached the lowest circle of this equity inferno, I came across the strangest case yet and one which bore watching before moving back up to the world of light.

This denizen of the equity deeps is called Pearl Asian Mining and once again we find a stock that is barely above the lowest of the low price at $0.0002 - one million shares would cost you $200. As I continued to observe, I noticed some strange species of investors excitedly jumping around this inert creature willing it to get up. In their imaginations, they were fighting against another group of creatures called the naked short sellers.

Now this latter class of being we know about having watched them run against the price of gold and silver for a considerable amount of time. The problem though was whether these fellows were actually moving in this twilight situation. I listened to these sub-penny investors excitedly talking amongst themselves (on certain internet forums) about a coming short squeeze redemption against these demonic market makers who continually shorted the price of Pearl Asian Mining.

The most fascinating thing about this was a phenomenon I had not witnessed and do not expect to witness in the equity world above. In their attempt to cause these alleged naked shorts to run for cover, Pearl Asian Mining is taking the extraordinary step of declaring a dividend of 1000 preferred shares for every one common share held by investors before the ex-dividend date this week.

With 30 billion shares outstanding, this would imply an issue of 30 trillion shares! Something sounded almost surreal about this, but then again I was in an almost surreal world. As I listened to these sub-penny investors, I realised that a lot of them cared not for the gold fundamentals of the company but where rather obsessed with the vulcanism of volatility.

As we noted, Great West Gold rocketed 3,000% in about two weeks. Such a move is unheard of in the equity world above. But in this volcanic world of volatility, spots around you erupt in fury only to die down as quickly again. It is a world divorced from valuations and one devoted to the rapid momentum trader who rides a stock for mere days in the search for quick profits.

Against this backdrop of extreme volatility, the game was afoot. Pearl Asian Mining (and Great West Gold) believes they are held in their zombie state by evil market makers selling shares they do not have. Pearl Asian has decided to call any bluffs out there by forcing them to create an extra 1000 shares per non-existent common shares. They believe this will end the naked short selling and propel their share price up a few circles.

As I write, the game is still on and the price remains in a tight range of $0.0002 to $0.0004. The sub-penny forums await the outcome of March 31st when these trillions of preferred shares have to be created and delivered ex nihilo. I stood by somewhat incredulous of their doctrine. Why would market makers continuously short a stock that is about as low as it can go? Surely there are fatter victims to capture?

A visit to Pearl Asian Mining's press releases brought me closer to the truth. A recent press release trumpeted this headline:

"Pearl Asian Mining Industries 'Operation Gold Finger' April, 2005 Reports: XYZ Gold Project Showed an Estimated Ore Reserve of over 2.4 Million Metric Tons of Gold & Silver Tuesday March 7, 6:00 am ET US $60,285 Per Day X 360 Days Per Year Operation = $21,702,600.00 Estimated Annual Gross Revenue"

One has to be careful with headlines lest one thinks that they are implying they have 2.4 million tonnes or 7.7 billion ounces of gold and 69 billion ounces of silver (at a 10:1 ratio). Their assay results are also optimistic, but I won't go further since all information is in the public domain. Moreover, this seemingly good news failed to budge the share price out of its tight range. It seems that in the world of sub-penny stocks, one is not so easily believed.

I was in a world of rapid momentum traders waiting for a geyser to erupt. That was not the way of the traditional gold stock investor who buys and holds based on proven reserves and excellent future production prospects. I asked myself why any company down here in the ninth circle of $0.0001 stocks should have anything like a promising future? I looked at the promising juniors who are now doing well. They were born in the full light of day and not in the deepest equity hell. Perhaps I am wrong; perhaps not all stocks down in the hundredths of a cent inferno are there because that is what they are worth. Perhaps a few of them such as Great West Gold and Pearl Asian Mining will rise to the skies above playing their golden harps.

In the meantime, I continue to watch and observe the great game of hyper-volatility and when the game is done, it is back to the world above where the light of valuations penetrates much more readily and there is a greater degree of certainty about the affairs of men and mines.

Roland Watson writes the investment newsletter The New Era Investor that can be purchased for an annual subscription of $99.

To view a sample copy of the New Era Investor newsletter, please go to www.newerainvestor.com and click on the "View Sample Issue Here" link to the right. Comments are invited by emailing the author at newerainvestor@yahoo.co.uk.

Roland Watson
http://silveranalyst.blogspot.com

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