Edmond Jackson's Stockwatch: GCM spike "pump and dump" or reality check?

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Was last week's spike in the shares of prospective coal miner GCM Resources - up to 45p on 5 February, then right back below 18p - telling as to whether there is any real prospect of the value-transforming project in Bangladesh going ahead?

The rise was initially mooted as informed speculation as the Bangladesh media reported that governmental coal policy was being finalised; indeed someone appeared to buy 193,000 shares at about 40p.

If you follow technical analysis of price and volume then you might have been tempted in, but anyone who has followed the fundamentals since this company listed on the Alternative Investment Market (AIM) in 2004 (known then as Asia Energy) knows the government has kept prevaricating.

Despite the country's dire need to address its energy crises, the open-pit mining proposed in the Phulbari coal basin in northwest Bangladesh appears to remain contentious.

Project approval

You could have avoided getting whip-sawed as a hopeful in this share's numerous spikes; or instead, cynically traded them (also going short) with an attitude that no Bangladesh government is willing finally to approve the project because it fears public reaction after three people were shot dead in riots in August 2006.

Since then the company has kept in dialogue with the government and evolved a theme of "local support for the project improving" - but sellers clipped the shares instantly when it was reported the Bangladesh prime minister had said: "We will decide on coal extraction... in the future... we are waiting for a new technology... the first priority is the land of farmers."

There has been talk of influence moving in GCM's favour but with the price back below 18p the best the stock is saying is that this remains a long haul.

Frustration among shareholders led to changes in GCM's board last year with the executive chairman of AIM-listed Polo Resources becoming executive chairman of GCM.

Polo saw its stake slightly diluted from 29.8% to 27.8% while supporting a £2.3 million placement at 19.8p last August, as the subsidiary of a Singapore-listed energy group bought in. These specialist investors have replaced various hedge-fund hopefuls who played the shares, especially in 2005 when the price entertained £10 as brokers targeted nearly £30.

Profit from Phulbari project

GCM made a small profit in 2011 when it was using funds raised for the Phulbari project towards investing elsewhere in the resources sector; otherwise the table shows a record of ongoing losses, mainly capital expenditure where the latest interim results for the second half of 2013 cite a £518,000 loss against £2.072 million balance sheet cash at end-December.

Whether or not Bangledesh finally approves the project before this latest capital injection runs out, the professional investors involved should be wise enough to realise GCM shares are effectively a call option - if a very long-dated one considering the project's contract terms of a 30-year mining lease from 2004, which may be renewed for further periods of 10 years each.

This gives the owners a very long time horizon to see if Bangladesh acts in support of its development needs. In the meantime the coal won't go away; it is all down to politics.

A high risk/reward gamble is therefore to accumulate GCM during times of despair - in the hope that the government eventually gives its final approval. An idea that has been long in the background is for the company to seek to enforce its sovereign contract via an international court.

Whether or not Bangledesh finally approves the project before this latest capital injection runs out, the professional investors involved should be wise enough to realise GCM shares are effectively a call option."

It was originally made in August 1994 with BHP (now BHP Billiton) giving it the right to "explore, develop and mine" in respect of licence areas near the town of Phulbari; then assigned to Asia Energy in 1998.

When Asia Energy listed, BHP's divestment was explained as due to restructuring rather than reflecting the likelihood of project success, although events imply it is worth paying attention to where the likes of BHP decide not to stay.

The problem with litigation is that it can poison the relations essential to make a project successful; and would be a gift to activists against it; and so de facto GCM has been left in limbo.

A less risky means of exposure is via Polo, which is more diversified with interests also in oil and gas, gold, iron ore and vanadium. Its prelims for the year to end-June 2013, cited a net asset value (NAV) of about 32.3p per share as at 17 December, versus a market price currently of about 19p after a bounce from 16p on a volatile chart.

Such a discount to NAV is something of a "margin of safety" although figures like these only get proven in a trade sale, so need a pinch of salt.

In a commodities bull market a premium to NAV is possible for dynamic company shares, but in the current cautious environment a discount is more realistic - especially for a less liquid share capitalised at about £50 million. Also Polo's financial record is lumpy: a $16.2 million (£9.9 million) loss in its last financial year compared with a disposal in the previous year raising over $160 million.

Prospects for natural resources groups are effectively geared to whether China can manage its way through debt woes, as I described in my January macro piece; there being serious downside risk in shares if it can't, yet this could lead to exceptional buying opportunities.

So while last week's events in GCM may look just a narrow example of "pump & dump", they ought to prompt a broader view of the realities for investing in developing countries and how their risks can be mitigated.

For more information see gcmplc.com and poloresources.com.