Juniors for Seniors
Saturday, 3/22/2014 18:09
Young, older or retired, we're all speculators now. Junior mining stocks might suit...
I HAD the.privilege of interviewing Louis James, chief metals & mining investment strategist here at Casey Research,
writes Dennis Miller, editor of Miller's Money Forever.
Louis is the editor of
Casey International Speculator, the first subscription newsletter I ever bought, and I am holding a good number of his recommendations. Personally, I've really been looking forward to this interview, as it sort of brings my own investment journey full circle.
Louis is quite the globetrotter, visiting mines all over the world. I am glad we were finally able to corral him long enough to share his expertise with our readers...
Dennis Miller: Louis, thanks for taking a few minutes to join us.
Louis James: You're very welcome – I'm happy to help.
Dennis Miller: I want to start with the big picture before we get into specifics. Most of my readers are on either side of the retirement cusp – making conservative investing paramount – but if 5-10% of your portfolio is in a speculative pick and it doubles, that relieves pressure from the rest of your portfolio. Can you explain how the mining sector and how some of your picks might fit into the speculative portion?
Louis James: I've got two answers for that question. First, if Doug Casey is right about the Greater Depression, there is no such thing as a safe investment. You have to remember that at the peak of the crisis in 2008, we were told that checks came within 48 hours of not clearing banks. General Motors filed for bankruptcy. American Airlines filed for bankruptcy. In the post-Lehman Brothers world, absolutely nothing is safe.
We are all speculators now. The only difference is whether we recognize that or not, and act accordingly. So while it may seem like the kind of speculation I recommend is too high risk for someone nearing retirement, someone who may not have time to start over again has all the more reason to offset the omnipresent risk with some allocation in high-yield speculations.
As Doug says, it's better to risk 10% of your portfolio on high-risk, high-reward speculation than to risk 100% of your portfolio on so-called safe investments that may not even keep up with inflation.
Furthermore, if Doug is right about the Greater Depression, even people with considerable assets accumulated may find themselves with liquidity problems and even cash-flow deficits. If, for example, a high-net-worth individual's wealth is tied up in real estate, and the real estate market seizes up, he or she might not be able to liquidate assets, even if that became necessary to replace lost income.
In a world where no financial institution of any kind can be relied upon absolutely, even a "solid as bedrock" annuity is vulnerable to some risk. Simply put, no one can afford to rest on their laurels.
The second line of reasoning may challenge some of your readers, and may contradict my first point slightly, but not if you consider the long term. Forgive me for being blunt, but I don't know any polite way to put this: no one who is not on death's door should plan on dying any time soon.
There are new medical technologies under development now – some quite close to market – that have radical implications for human longevity. Soon it will make no sense to think of anyone who is not over 100 as old. And by the way, I don't just mean surviving hooked to all kinds of machines in a hospital room, but living in better health than we may have now.
Sure, misfortunes may befall us before we get to enjoy the benefits of these technologies – I'm not promising eternal life next week. What I am saying is that everyone who is not facing a certain and short life expectancy should plan for the future. And they should not assume that they won't need money after a few more years.
Everyone in their 60s should have a financial plan that, at least conceptually, covers the next 50 years. The world will be vastly different in 10 or 15 years, of course, so clearly plans can't be too detailed, but they should exist. People should not assume their financial needs will zero out any time soon.
Given these factors, it is more crucial than ever for retirees to use their accumulated capital to generate more capital, and not focus exclusively on protecting the nest egg. They worked hard for their money; now it's time for that money to work hard for them.
The best way we've found for money to generate not just a trickle of income but substantial new wealth is to speculate on what we admittedly call "the most volatile stocks on earth": junior resource stocks.
Dennis Miller: In the old days, I would fill out retirement planner worksheets that predicted how long my money would last. On the conservative side, if the computer said you were covered until age 120, you were fine. I always figured if I ran out at 119, the hell with it. You're saying 120 years old is a lot more relevant than I thought when I was filling out those worksheets in my 50s.
Louis James: Absolutely! No one wants to run out of money at any age, which is why they should always use their capital to generate more capital.
Dennis Miller: When we looked at technology stocks, Alex recommended a company that was developing several new medical tests. I got the impression that it was basically doing the research and development, but once the tests were perfected and had the necessary approvals, they would be purchased by a larger company.
Are junior mining companies similar? Are they, in effect, like research and development for the mining industry?
Louis James: That's a very good analogy. The major mining companies look at the juniors as a source of Other People's Money – we call it "OPM". It's a good symbiosis. The big companies tend to be bureaucratic – and we can't really blame them because they have tens of thousands of employees all around the world. But mineral exploration is a high-risk venture, not very compatible with a bureaucratic mindset. The big companies are happy to buy quality assets that have been studied and de-risked, even if it means paying many times what it cost the junior company to make its discovery.
The situation is highly analogous to Alex's technology companies, where the outcome tends to be binary. If a company developing a new drug gets FDA approval, it goes from having nothing but a very expensive dream to having something with a potential multibillion-Dollar market.
Similarly, a junior exploration company goes from having nothing but a geologist's dream to having Probable and Proven mining reserves in the ground that even bankers will lend money on. The consequences for shareholders who buy in early can be staggering – life-changing, in fact.
Dennis Miller: Why wouldn't a person just invest in a junior mining ETF or something? That would give them real diversification, wouldn't it?
Louis James: It would, but it would also put someone else's judgment in charge of the speculation, not their own. Furthermore, when funds take significant positions in small companies that don't trade a lot of shares daily, they face liquidity problems entering and exiting at good prices. An individual investor can often get their orders filled at better prices on both the buy and sell sides, and can take better advantage of market volatility to achieve lower cost bases. Even if the fund includes a big winner, that upside is diluted across the average portfolio performance of every company in the fund.
Truth be told, we would never bet on the sector as a whole. Junior mineral companies as a group are a lousy speculation. You have to be able to pick out the diamonds in the rough – speculate only on the best of the best.
Many fund managers approach this in a highly quantitative way. They have their spreadsheets, their models, and their parameters. They make their picks based on what fits the numbers they're looking for best. In my experience, this actually does help identify companies selling cheap, but often fails to identify the reasons why a company is selling cheap.
Dennis Miller: Earlier we discussed the similarity of junior mining stocks to pharmaceutical stocks. One of the major differences I see in the two sectors is this: If a pharmaceutical stock hits a winner with FDA approval, there will probably be multiple bidders for the patents, regardless of how the sector is performing at the time. But in the case of junior mining stocks, say gold jumps a couple hundred Dollars an ounce: wouldn't your entire sector move in tandem and benefit a lot?
Louis James: Yes, that's true about the sector. However, not all companies are equal, nor do they all benefit equally.
First, and somewhat ironically, a miner with a very high profit margin benefits proportionally less from an increase in the price of the metal being mined.
Say you're a gold miner, producing for $500 an ounce. If gold goes from $1600 to $1700, your profit increases from $1100 to $1200, or less than 10%. But if you're producing for $1500 an ounce, and gold rises by the same amount, your profit increases from $100 to $200 Dollars per ounce, or 100%.
That's no reason not to buy a highly profitable producer. You just play things differently if you want to speculate on changes in the price of gold vs. buying a great company. Second, when you speculate on a junior exploration company making a discovery, it doesn't – or shouldn't – make any difference how the price of gold fluctuates. The company has no gold yet; changes in the price of something it has none of should not matter.
We don't buy these stocks because we think gold is going up; we buy them because we think their chances of making a significant discovery are excellent. When this happens, they can go from having nothing to having something of great value. The change in value is substantial, and the consequences for shareholders can be spectacular.
Successful smaller companies can be bought out by the bigger players in the field, just as with those pharmaceuticals you mentioned. This is actually one of our preferred exit strategies; it can be hard to get a good price on a large block of shares in a lightly traded stock, but that's not a problem if a larger company buys us all out – often at a nice premium to market.
Dennis Miller: Louis, on behalf of all of my readers, I'd like to thank you for taking the time to teach us about a very important sector.
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