Lesson #3: The Value of Time-Arbitrage

An additional lesson I learned in 2017 that I think is one of the best ways to beat the market:

…That the market is impatient and that time-arbitrage seems very profitable especially in a bad market, when people gladly sell a good stock just because it might be an additional month or two until the next catalyst.

This one is simple, yet the fact that time-arbitrage appears to be present in a lot of good names suggest that investors aren’t as rational as they hope and/or think they are. At this point in time I would say that sentiment is quite poor and the few real success stories (stock performance wise) have been a few exploration stocks. Since we humans probably put too much focus on what has happened in the recent past, it’s not that hard to understand why a lot of investors seem to be “exploration catalyst hunters”, which means a lot of money has been flowing into exploration stocks with near drill results coming in the near term.

This preference has lead to exploration stocks in particular with no near term potential “blue sky” catalyst being sold off while stocks with near term catalysts may see increased buying pressure. This is of course irrational since the Risk/Reward calculation more than often haven’t changed a bit for either “type”. The buying frenzy in almost any exploration junior with a project in the Golden Triangle earlier this year is a good example of this. When drill results drew near, the junior stocks could be trading 200%-300% higher than just one or two months back. When the same stocks were done drilling for the season, they sold off hard.

A theoretical example:

Let’s say that a company “should” be valued at $0.80/share based on a theoretical true NPV based on the risk and potential reward and that this company has no exciting catalyst coming up for at least 3 months and thus get no love from the market since it is considered “boring” relative to say an identical company with drill cores currently in the lab.  Say the “boring” stock might get sold off down to $0.60 due to hot money leaving and the latter stock get bid up to $1.00 because of the same hot money.

In this highly theoretical example, an investor could buy the company during the “boring” phase for $0.60 and sell it 3 months later for $1.00, without the fundamentals or Risk/Reward having changed one bit. That’s theoretically a 66% return based simply on time-arbitrage and getting a 66% return simply by being patient for 3 months is nothing less of spectacular.

For this scenario to be true alpha, the chances of any material change to the company’s fundamentals must be very low during the 3 month wait period. Basically this strategy is based on human psychology (impatience and greed) providing alpha opportunities for the patient investor, while not really taking on much risk (if at all)

Aston Bay Holdings (BAY) is a stock which I currently own a decent amount of for several reasons. One of the main reason’s is time-arbitrage. I think that come summer, this stock will probably trade a lot higher due to the “drill hype” that usually goes hand in hand with a micro cap junior drilling elephant targets, and I actually think the rise will start sooner than that. I have even read comments along the lines of “Oh, they won’t be drilling until summer. I’ll come back then”. I think this mentality is very common in the exploration space today. Investors seem to discount mere months to an irrationally high degree, and they don’t seem to realize that they are in fact part of the herd. Discovery Metals (DSV) is my other decent sized exploration company holding where I think we are in the “boring phase”.

So what is the fair value of Aston Bay for example? I have no idea, no one does. All I know is that with a market cap of $10 M the market seem to be pricing in a microscopic probability that they will hit something even close to what they are after. If they would find what they are looking for, then the stock could theoretically be a 100-bagger from this level. If they don’t, well then don’t expect to walk away with much.

And if that Isn’t enough, we all know what could happen to exploration stocks when drill results are drawing closer, especially when the sector is impatient and investors are looking for “quick riches”. We have seen countless stocks run up hundreds of percent before the first assays were even announced. Garibaldi Resources was valued at over $300 M before any drill results were out. Arizona Silver which was “only” targeting a silver deposit was valued to over $60 M pretty much on hype alone. Novo Resources also had a huge run up without much data to back it up.

Big potential prizes usually attract a lot of hot money. Just look what is happening in the crypto space. Ordinary people dreaming of life changing gains are willing to go all in and even borrow money for the shot of becoming rich. Should it come as a surprise that investors are willing to bid up junior exploration stocks when there is a theoretical potential for life changing gains?

So, what is the best way to get alpha and out-sized returns if most investors (the herd) in this sector are impatient and greedy…?

• Buy early
  • Buy when the stock is irrationally cheap (undervalued) due to the impatience of investors.
• Ride a portion of the hype
  • The stock will potentially go from irrationally undervalued to irrationally overvalued during the “drill hype” greed phase.

Those two factors is why I think patience, rationality and discipline can and has been used by a select few investors to get alpha and out-sized returns. You get alpha through the re-rating of the stock as the drill results draw closer. You are also able to ride the greedy speculative phase in the days or weeks before the first assays are expected.

Bottom line: Take advantage of the pendulum that is human investing psychology that incorporates impatience and greed.

let’s end with a chart of Garibaldi Resources, one of the best examples of how profitable time-arbitrage can be if you get in early and there are elephant targets on the table (at least theoretically):

GGI (Daily).

Note! I own shares of Aston Bay Resources and Discovery Metals. I am thus biased. This is not investment advice. Always do your own due diligence. Both are somewhat illiquid stocks and can be very volatile.