In light of a few recent outcomes particularly in the mining sector I thought it was a good time to discuss divergence in Fundamental Analysis (FA) and Technical Analysis (TA).
I am going to use DCN as a real life example of discussing this divergence and how it can be used as an early warning signal.
Let’s go back to February this year. DCN released an investor presentation announcing expected All In Sustaining Costs (AISC) of ~A$1,000/oz
They also announced that Westralia was performing at steady state in line with DFS expectations and ore reconciliation progressing well
Despite this in early March in the weeks following this presentation the share price fell from $2.80 to $2.40 with many thinking it was offering a good opportunity to buy in at a lower level before quarterly results and the show kicked off
However on 25th March, just 5 days out from the end of the quarter (and 4 weeks after the investor presentation) they release updated guidance as below
This was a pretty big miss and the chart showed the hit as you can see
So was the chart telling us something before this announcement?
The stock did bounce back over the next few days on the upbeat parts of the revised guidance. June quarter was expected to be a bumper quarter in terms of ounces at the top end of expected output from the DFS at 50-55koz and costs coming back down closer to where they were expected.
The market was told there had been issues but they had been resolved and things would look better moving forward.
As expected some trust was lost over the way things played out across February and March but the market was being told fundamentally nothing major had changed and it was just the typical hiccup in commissioning that is far from uncommon.
However the price started a sustained decline after this initial bounce back over the coming few months despite gold priced in AUD was making new highs on a regular basis and the majors moving in the opposite direction. We saw a slide from $2.60 to $1.55 or a 40% decline.
Despite some uncertainty many people retained the view that this stock was getting cheaper and cheaper for the fundamentals behind it and too much risk had been priced in.
Then today we find out that the situation is much more problematic than originally anticipated.
Guidance is reduced from 200koz p.a to 150-170koz p.a for the next 5 years, AISC increased from the targeted steady state $1,000 announced in Feb to $1,350-1,450/oz and reconciled ore grade 15% below that calculated in the reserve.
As you can imagine the price effect has been extremely damaging.
So what we can see here is that on two occasions with this company there has been a clear divergence between TA and the expected fundamentals on the company.
This article isn’t a witch hunt into the practices of the ASX but I will say that in my opinion you can assume on most occasions there are people who know more than you do.
I know there are a lot of investors out there with a strong FA bias but sometimes it pays to listen to the TA as when these divergences occur it can be a strong early warning system of red flags.
It’s at this point that one needs to consider their risk/reward requirements. Take the inflection point of the TH this week for DCN as an example. If they had reaffirmed guidance the stock might have gapped 10-20% to the upside but would have likely left plenty on the table for price to fill into where FA is.
The opposite case was what we saw today with a 60% decline (30% opening gap) on missed guidance. Where possible it is best not to take on the situations that have asymmetric downside risk in possible outcomes.
If playing events with limited outcomes you want to look for the ones that have asymmetric risk to the upside. Let TA be an early warning indicator and think before entering event driven strategies.
Sorry to any DCN holders, and I hope this helps some in the future.