Smallcap Discoveries: Weekly Update: March 6

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Subject: Smallcap Discoveries: Weekly Update: March 6 - 10

February 27 - March 3

Market Commentary

Markets

Late this past week we may have witnessed a financial earthquake and the epicentre was Silicon Valley. Late in the week, news broke that SVB Financial (Silicon Valley Bank) (SIVB.Q) was in deep trouble. Fear amongst their depositors (mostly VC funded companies) and the subsequent rapid withdrawing of their funds caused the bank to halt withdrawals and ultimately caused a 1930 style run on the bank. This is the largest U.S. bank failure since the 2008 global financial crisis and has left clients scrambling for the money needed to pay employees this week. It looks like US regulators and the FDIC have moved to control the situation and help return funds to depositors.

The overall banking sector was hit, with several regional banks like First Republic Bank of San Francisco (FRC.Q) and PacWest Bancorp (PACW.Q) being hit the hardest. Concerns of bank runs on other banks or contagion has concerned investors.

This situation obviously sent shivers through the markets. The DOW finished the week down 4.4%, Nasdaq was down 4.7% and the TSX fell 3.9%. Weakness was predominately driven by financials and tech.

There is a lot to unwrap here and since I’m not a banking expert I will leave it to others to explain the circumstances. For this, I highly recommend you view this video for an explanation and possible outcome to these events: https://www.youtube.com/watch?v=vU1g7ZUQkWI

All that said, I see no reason for any kind of panic. If anything, I view this as a potential capitulation event. This may even be the “breaking” event that causes the US Fed to alter its tightening stance. More on this thought later.

In the meantime, I’m sure we will see and learn a lot more by market open. We’ll know what this financial earthquake measures on the Richter scale on late Sunday or early Monday morning.

Energy

It looks energy may have to take a bit more of a back seat over the next little while as banking issues take center stage for the time being. WTI oil had a softer week and continues to bounce up and down in a tighter and tighter trading range.

Nymex natural gas was weaker pulling back from its sharp bounce higher the past few weeks.

Energy services companies had a rough week after testing their 52-week highs.

On Friday we saw the weekly Baker Hughes drill rig data and we continue to see a drop in rig count and an especially big drop in Canadian rigs. In the US active rigs dropped by 3 rigs while in Canada we saw a 23 rig drop. It’s not unusual to see Canadian rig counts drop as weather related road bans cause a slowdown but I’m not watching the prairie weather close enough to know if that is the cause.

Commodities

The late week US banking crisis sent treasury yields lower and drove some selling of the US greenback. The potential for a more accommodating Fed likely weakens the US dollar further and could set up a very strong rally in commodities especially precious metals.

Gold did have a bounce going into the weekend and may be a short term hedge against uncertainty. If the Fed does change its tightening stance, gold should be benefit longer term too.

This could be a very interesting week for a host of different commodities. Let’s see what Monday brings.

Stocks

This past week and the coming week will likely be looked back on as historic moments in the financial markets. There are a few different ways things can play out, and the news seems to be changing every moment as I write this. I’ve just seen that another bank has been taken over by the US regulators. Signature Bank (SBNY.Q) has been shut down. The Feds have stated that all depositors will be made whole. So now we have 2 banks that have been shut down and several others being closely monitored. The US Fed is stuck, and I think we just witnessed the Fed “pivot” as they have moved to convince all depositors in the US banking system that their funds will be honored regardless if they are in excess of the $250,000 guarantee limit.

I find it hard to imagine the Fed can now continue tightening financial conditions in an attempt to fight inflation. Just look what the 2 year treasuries did late Friday:

I think equities stand to rally if we see more evidence of the Fed backing off like we are starting to see.

There is potential for some tech weakness as I think we’ve seen a bit of instability in the sector and perhaps an Achilles heel to the Silicon Valley tech infrastructure. There is likely to be some collateral damage in the tech space from this. It will be another reason that I doubt we see tech as the leader of the next bull market. In Canada, it was learned late Friday that Canadian tech company Acuity Ads had US$55 million in deposits with SIVB and Shopify has some small exposure as well. Does this instill confidence in these companies?

This banking shakeout is another reminder to me why I don’t like the financial/banking sector, the leverage in the space can wipe out a company literally within hours, as we have just witnessed with SIVB and SBNY.

It will be interesting to see what happens in the venture capital funding sector. How much cash will be floating around that ecosystem now? Funding likely gets harder, as SIVB was a big lubricator of Silicon Valley innovation. Just another reason to stay away from hig- priced tech stocks.

It’s early and things are changing very rapidly, but I can’t help but find this very bullish and confirms the investing trends and thesis that I have been suggesting for over a year now. If I’m right and this IS the Fed pivot, we could be in for a strong, potentially new bull market. But it will be vitally important that we stick to the right stocks. Chaos brings opportunity, and I think this is it.

Other Stuff

In late December,we wrote an article on the potential for an increase in microcap takeovers and management take-outs. We highlighted 9 companies that we felt had a good chance of this. On Thursday, we saw one of those companies get a takeover offer. Circa Enterprises, (CTO.V) announced that it had entered into an amalgamation agreement with Sicame Canada Holdings. In essence, selling its business for roughly $2.10-$2.20 per share. You can read the full press release here: https://finance.yahoo.com/news/circa-enters-amalgamation-agreement-sicame-235400909.html?fr=yhssrp_catchall

This is roughly a 40% premium to the previous day’s trading price and up 86% from our December 28, 2022 highlight. Hopefully, many of you were able to profit by this result.

We anxiously await to see who the next company on the list might be to see this happen. Here’s the list:

Some interesting things that need highlighting in our microcap world…

We saw some more big block trading in Zedcor (ZDC.V) at recent highs in price. I view this as bullish as likely more funds become involved.

McCoy Global (MCB.T) had very good year end numbers. Investors liked what they heard and drove the stock to new multi-year highs.

Imaflex (IFX.V) spiked to a new multi-year high. I couldn’t find any news to drive this action so it could be new investors finding out about the story. It’s a name that we have highlighted in the past and we’ve interviewed management a few times.

Kits Eyecare (KITS.T) also hit a new 52-week high on the back of financial results. Q4 revenues climbed by 29% to $26.2 million.

Hammond Manufacturing (HMM.A.T) which made our takeover list also hit a new 52-week high after announcing their year end numbers.

This company makes and sells similar products as one of my long time favorites Inventronics (IVX.V). Its sister company Hammond Power (HPS.T) release very strong results.

HPS makes the equipment that goes in the metal boxes that both HMM and IVX makes so the strong results should bode well for IVX when they announce over the next few weeks.

So, there you go. Some great action in some of our names this past week while the big markets shook. The coming week will not be short of headlines that might cause concern but there are many spots that won’t be subject to the chaos. I see no need for any panic, stay focussed and be prepared for opportunities.

Fortuna audaces iuvat - Fortune favors the bold!

To your wealth,

Paul and Trevor

Buys and Sells This Week

Sold Circa Enterprises (CTO.V) @ $2.06

Smallcap Discoveries

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