THH – We Are so Lucky: Why Worrying About Downside is Irrational

Like I discussed the previous post today I think the average, high-quality junior is around 200% undervalued right now. Yet I believe that a majority of people are worried about the downside…

“Gold could go lower!… Miners have not bottomed yet!” etc.

But this worry makes little sense from a game theory perspective. During peaks in sentiment one can easily see ounces in the ground trading for >$100/oz. If many of the de-risked, cashed up, high-quality juniors out there would drop 50% from here then some would be trading for less than $10/oz. In other words one could expect 1,000% returns from those lows if one is patient enough. Some juniors would trade close to the cash in the bank along with projects totally for free. This of course makes absolutely no sense and would be totally unsustainable. Therefore this would not be a PERMANENT loss except if one is stupid enough to actually sell.

So in a sense the “rational upside” from here is around 200% and there is no “rational downside” on average. Make no mistake, things can go wrong for any one company but I am talking about risk adjusted fair value.

• If you are buying something cheap and unlevered you do not have a problem unless you make it so.
• If you are buying something expensive and/or levered then you have a problem

Compare the junior sector to the broader stock market. You have people buying companies at lets say PE of 40 in hopes that growth will “bail them out” in a few years. In other words they are paying a premium today for what a company might do in the future. There is nothing wrong with this since investing is all about the future. However, in the junior mining space we do not have said problems since we are not even paying fair value for what is already known, let alone pay for any future potential that has yet to materialize. As a buyer one could not ask for a better environment to invest in. I am loving the current environment simply because a) It’s almost impossible to be making a mistake in terms of overpaying, and b) The wider the Price-to-Value gaps become the higher my Expected Returns are. A dollar invested today will have a much higher ROI than a dollar invested in this space 18 months ago.

Never forget that a widening Price-to-Value gap goes up exponentially since RISKS go down while UPSIDE goes up all else equal.

How this looks in practice:

There are companies I would be willing to put X amount of money in, Y% of my portfolio in while getting Z% of the company 18 months ago when PRICES were a lot higher.

Fast forward 18 months when these companies might have gone up 50% in VALUE but down 50% in PRICE. At this point in time I might be willing to put 4X the amount of money, up the portfolio stake by 4X, and up my personal ownership of the company by 4X. Why? Because less is priced in (Lower RISK), less banked value and potential is priced in (More upside), and every dollar invested gets me double the amount of shares.

We are truly blessed to be aware of this sector at this point in time. Truly blessed…

In the broader stock market there has not been a fire sale since 2009 when some quality companies hit single digit PE ratios. If one bought the DOW when it was selling at fire sale prices at the bottom then one would be sitting on a 436% return 13 years later. If one did NOT buy the fire sale prices and instead waited a year to get in then the return would be 215% which is around 50% worse:

I mean think about that for a minute. In 13 years there has only been one short period of time when the broader US stock markets were trading at fire sale prices. In the mining sector we have are now well into the fourth time that miners can be bought at fire sale priced since 2015. The thing about fire sales is that it takes down even the high quality names that have little business going down. When Mr Market is depressed and handing out gifts do not reject them. How does anyone expect to have great future returns if one is not able to buy but rather sell cheap? And make no mistake about it this sector is dirt cheap right now. That does not mean it cannot get cheaper before it gets expensive. However, something cheap becoming cheaper is frustrating but not a problem. It is an irritation but at the same time it is also an opportunity to buy even more for even less.

Personally I am very stressed about the fact that one of these days the juniors will not be brain dead cheap and my invested dollars will not have Expected Returns of 200%. I don’t know when these opportunities will go away. I don’t know if we will see even better opportunities soon. All I know is that especially the gold juniors are beyond dirt cheap. In fact they are way cheaper than the 2015/2016 bottom and any other period of fire sales since that time when you factor in the price of gold and the value of the gold business.

Buy cheap, sell expensive, rise and repeat:

Mr Market is not efficient. Mr Market does not “know something”. Mr Market’s mood swings is what we as investors have a job to take advantage of.

1. We will never allow ourselves to sell cheap
2. We will always buy cheap regardless if 95% of people who do not beat an index tell us we are wrong
3. We know that Mr Market always, always, always goes from Depression to Euphoria and back again
4. We are front running a time when Mr Market wants to buy our shares for a premium
5. We will be patient
6. We will be even more patient
7. We bet on the inevitable
8. We understand that juniors are cheap even if gold was trading at $1,500/oz today
9. We understand that gold could fall hundreds of dollars in price and we would still not be overpaying for juniors today
10. We understand how wrong the market is

Best regards,

The Hedgeless Horseman