The Blessing and Curse of Flow-Through Shares

Silver Stock Report

by Jason Hommel, December 5, 2006


If there are forces in the world that make silver prices too low; that is both a blessing and a curse.  It is a blessing, of course, if you recognize it, and if you act on what you know, and become a buyer of silver.  It is a curse, of course, if you don't recognize it, and if you are an owner, or a seller of silver.  

I believe silver is too low for many reasons; most importantly, no nation on earth is using money as money.  I mean, using silver as silver.  I mean, using silver as money.  When silver is not used as money, it is not being valued for its main purpose, and with this lack of demand, it has a low value, and this creates the blessing of an opportunity for investors.  

Flow through shares create something similar in my opinion; this blessing and curse of low Canadian stock prices.

Flow through shares are issued by Canadian exploration companies to Canadian investors in private placements, when the companies issue stock to raise money.  The money raised must be spent on drilling exploration (not underground drilling).  

There are several tax incentives for Canadian investors who buy flow through shares, because the Canadian government is trying to stimulate the mining sector.  But like most things governments do, there is a drawback.  The tax incentives are quite large, and they add up quickly.  If a flow through share costs $1, it really may only cost the Canadian investor about $.41!  

Source:
http://www.goldencapital.com/flowt/traditional.pdf

The reason is that there is a 29% Federal Canadian income tax reduction, plus a 15% tax incentive, plus about a 15% Provincial/Territorial personal income tax reduction.

The flow through share program was designed as a temporary measure in the year 2000 because the mining exploration industry was nearly destroyed through low metals prices.  

As a consequence, the Canadian government decided to motivate Canadians to explore for minerals when it made the least sense to do so; when metals prices were low.  Fortunately for us, we can now buy Canadian exploration stocks at a discount, because of this foolish Government program.

The flow through share program is set to expire in March, 2007.

Source:
http://www.pdac.ca/pdac/advocacy/financial/flow-through.html

Personally, I do not care if the program continues or is terminated.  But since I know how to take particularly strong advantage of it as an American trader, it would not bother me if it continues.

The hold times on flow through shares is typically 4 months, and I know that 4 months after a large flow through financing, we will likely see a dip in share pries.  Why?

The program gives Canadians who buy flow through shares the incentive to buy stock at $1, but sell at anywhere above $.41, and consider it a "profit" -- because otherwise, they would have paid all those taxes.  Thus, the Canadian flow through shares are quickly sold, as they "flow through" directly to the market place, often at a substantial discount.

This is the blessing, and curse, of flow through shares.  They generally create a wonderful buying opportunity.

The big problem is that there is no upward buying pressure when flow through shares are issued.  Big money can buy into a stock without moving the price up.  However, when the shares come free trading, the stock price gets hammered downward.  

Companies who issue flow through shares can thus end up with much lower stock prices as a result.

In essence, the Canadian government is making all Canadian exploration stocks who participate in flow through financings generally much cheaper than they otherwise would be, than without the flow through share program.

Since most of the investors in Canadian mining stocks are Canadians, I wonder if the government is actually doing more harm to Canadians in general than good.  Certainly those who buy flow through shares benefit, but Canadian exploration companies (and shareholders) must be very careful.  

It's almost like hedging with a guaranteed loss in the long run.  The up front money sounds great, but the pain down the road is generally not worth it.

A more free market approach, to replace the temporary flow through share program, would be to lower tax rates to all of Canadians, and to eliminate capital gains on investments in Canadian natural resource stocks.  

If the temporary flow through share program ended, and if capital gains were reduced instead, I'm sure Canadian stocks would go up, and the capital gains tax would be a welcome relief in that event.

But then again, they didn't ask me, did they?  And if they did, it would be to my advantage to tell them to keep it up, since I know how it works for my advantage.

Just watch out for flow through financings, and be careful on how they can affect your investments.  Consider selling your stocks about 2 weeks or a month before any flow through shares become free trading (about 4 months after issuing them), and be ready to buy when they come free trading.  It's always helpful to know why a short-term stock price dip is taking place.  (Thanks to the stupidity of the Canadian government, and short-sightedness of Canadian exploration company managers.)

In conclusion, this is one way to find freedom in an unfree world.  When you recognize that someone else is not doing things the free market way, and when you understand the difference between how things are, and how things should be, it should give you a unique insight into how to best find that hidden treasure in the field.  And this is why the free market will triumph in the end, and why it is continuing to gain strength all throughout the world.  Because those who try to subvert free market principles end up hurting themselves in the long run.

Sincerely,

Jason Hommel