Discoveries And Bear Markets: Uncommon Common Sense
A lot of people are tempted to sell juniors because they think gold/silver will head lower.
Even though the juniors are cheap relative to especially the current price of gold there is of course a high likelihood that said juniors would get even cheaper if gold dropped a lot.
However, if something is cheap it is cheap…
Scenario 1:
The gold sector is hot and in a fully fledged rally.
Investors are happy because every gold stock has been going up and the precious metal portfolio has been doing great.
Now, grassroot explorer A is trading at a MCAP of $50 M and makes a significant discovery which will end up being worth $400
That’s an 8X return
Scenario 2:
The gold sector is in the toilet after a year long correction.
No one is happy and no one wants to buy.
As a result grassroot explorer A is trading at MCAP of $16 M since everyone and their mother is in “risk off” mode and assume that the miners will go down forever.
Said explorer makes the same discovery as in scenario 1 and will be worth $400 in the future.
Given that the sector had been obliterated the revaluation now starts from $16 M in MCAP instead of $50.
That’s a 25X return instead of 8X.
Discussion
Same company. Same target. Same discovery…
Totally different returns simply due to the stock being a lot cheaper due to valuation differences as a result of materially different sector sentiment levels.
Conclusions
I refuse to believe that buying disgustingly cheap stocks with disgustingly good Risk/Reward will ever be bad regardless of how shitty the sentiment is or how bleak the chart looks for gold.
If something is cheap, like now, you will often get paid more in the future.
The reward for being disciplined and not selling stuff when it becomes CHEAPER is that the REWARD side and the RISK/REWARD equation goes up EXPONENTIALLY.
This is really simple concepts that the VAST MAJORITY (95%) for some reason have a big problem to understand.
I sell shares when I think they are expensive not when I think they are cheap and might get cheaper…
But that’s me.
Best regards,
The Hedgeless Horseman
Thanks for your advice, I came to mining stocks spring 2020, and reading this reignited my enthusiasm & confidence. It’s been a bad Monday 9 August. bless you
All the above is true, except that the one thing to consider for an exploration company during a medium/longer-term bear market for gold is the cost of capital to survive said downturn. If the gold price is “too low” and capital in the sector is scarce, then it would be a lot more difficult for an exploration company to raise the capital necessary to prove a deposit or sustain ongoing operations. Without cash to drill, employ knowledgeable geologists and management, and fund ongoing costs, a company could go bankrupt, be forced to sell all or part of the land at a cheap price, and result in a negative return for shareholders. History is littered with examples of good prospective discovery stories that never made it, or made it in the hands of someone else, because of a lack of sector capital and “bad timing.”
Fortunately, it does not appear that gold is entering a medium or longer-term bear market, and junior mining companies have been able to raise capital (as a sector) over the past year. However, if the gold price were to continue to fall and drag out over a couple of years (not my personal view), then many exploration companies, because of their lack of internal cash flow and heavy reliance on the capital markets, would suffer, and potentially go out of business. So while investors can take a “long-term view” on gold and gold mining, it’s critical to understand how certain juniors would manage a 2-year+ bear market in gold (i.e. would they make it? would they make it only with massive equity dilution, thus eating away at the potential upside in a bull market?). That would be part of my “margin of safety” requirement for investing in any exploration stage company that does not have producing mines and the ability to harvest internal cash flow.
Hi Tyler,
You are of course right. I thought about including discussion about that or at least reflect it by success at scenario 2 being worth say $300 M instead of $400 M to reflect added dilution. However, after a real discovery hole things change a lot and access to capital will be like night and day compared to pre-discovery.
You also point out the many reasons why I prefer to buy juniors with a) Good cash on hand that will last a field season or two and/or b) Have loyal backers that will probably provide continued access to capital on at least decent terms.
The financial context was something I did not factor in much when I started out but has been going up in priority a lot along the way.
Thanks for the contribution!
/Erik