The Art of Betting on Maybe, Junior Miners as an Options Trade
No one really ever owns a mining stock, THEY RENT THEM
I’ve been involved in debt and equity financings totaling more than US$2 billion.
I’ve sat at the table in strategic private placements, equity and debt financings, M&A transactions, structured notes, and streams and royalties; I’ve collaborated closely with the largest global investment banks, law firms, and advisors, with deals spanning both public and private markets across North America, Europe, Asia, and Australia.
And now I’m sharing my experience — for greed and glory.
After kicking around the commodity sector for almost twenty years it still makes me laugh when I meet some guy running a small hedge fund (usually a fresh face kid out of New York or Connecticut) telling me he is a “value investor” looking at the mining space. The only thing I can tell you for sure is that these guys are an odds-on favorite to get smoked out!
No one really ever owns a mining stock, THEY RENT THEM
The same goes for many of the folks on forums like MINTWIT, CEO.CA and Hotcopper.com.au. These sites are littered with angry investors who lost money in part because they didn’t understand what they were buying and how they should assess risk.
Recall Warren Buffett who said “risk comes from not knowing what you are doing.”
Not appreciating what you are buying or using the wrong framework when thinking about your investment is setting yourself up for disappointment.
Earlier in my career I was the head of origination at one of the largest mining funds in the world. It afforded me the opportunity to look at countless deals. The number one input in every mining company I have ever looked at, and there have been tens of thousands over the years, is the commodity of their project. No other factor can ever eclipse the commodity price for a given project. At some commodity price every project is viable. The inverse is also true, at a certain commodity price no project is viable.
How can we use this knowledge to make money?!?
Take a moment and think about some of the biggest wins in our sector. Do you recall the legendary story of Uramin? A handful of investors raised a few million dollars and purchased historic drilling data on a uranium project in Africa. Eighteen months later the company sold for nearly USD 2.5 billion dollars without drilling a hole. Or more recently take lithium. Left for dead, lithium stocks couldn’t raise a penny and then almost overnight billions of market capitalization was created. Ditto for uranium.
It’s cliche but TIMING IS EVERYTHING!!
Today’s low grade will become tomorrow’s high grade
To make money by trading junior mining stocks you must first understand what it is that you are trading. You cannot think about these stocks like a NYSE or NASDAQ listed company. Trading junior mining companies is like trading options. Having the discipline to make AND lose money this way has always been helpful once you start to think like an options trader.
One way to make money in junior mining companies is to start to think about them as options. Yes, you heard me right – options.
Think about it, there are two basic types of options: calls, which allow the purchase of the underlying stock, and puts, which allow its sale. The price of an option (the premium) is influenced by factors like the stock's current price, the strike price, time until expiration, and market volatility. A key aspect of an option is "theta” otherwise known as time decay. Theta is the idea that over time as you near the expiration of the option it becomes worth less money. I think about junior mining stocks as “call options” on large out of the money deposits. Just like options, you need to manage your holding period… or you may likely get diluted into oblivion.
How does this strategy translate to the junior mining space?
Roughly one-in-three-thousand exploration projects will ever become a mine. Spoiler Alert! For all the CEO-of-your-favorite-investment’s talk of building a mine… he isn’t going to do it! No, he isn’t a liar… or even delusional… he is just doing his job. Selling a dream!!! This is where discipline comes in. DON’T FALL IN LOVE. See the stock for what it is, an option that it is likely heading towards zero or 20x and nowhere in between.
Buy the dream, stay for the commodity move, sell on volume!
How is a junior stock an option? There are almost zero junior mining stocks that have cash flow, only slightly more than zero ever will... Remember that scene from Silicon Valley: “If you show revenue, people will ask “how much” and it will never be enough…if you have no revenue you can say you are “pre-revenue” and be a pureplay.” That basically sums up junior mining. I am sure everyone can point to the outlier but, in reality, the stock you are buying is going to need to raise money again – and sooner than management is prepared to tell us. Hence the theta. The very nature of every junior mining stock is their time decay due to the future need to raise money. This isn’t a bad thing, it is just worth acknowledging and accepting it.
If you buy a stock and hold it through a period where the underlying commodity of the stock’s project doesn’t appreciate you can just about be guaranteed to suffer massive dilution. BUT…if you buy a stock at the right point in the cycle and have the commodity price come your way, you can see unfathomable returns.
How are options priced?
Certainly, theta as described above is part of the equation but, in my opinion, leverage to a commodity price move is key! There are a bunch of different ways you could think about this framework — personally, I prefer large “low grade” unloved deposits. Robert Friedland, one of mining’s most recognizable figures, has famously said that grade doesn’t matter. He is right! It is just as hard to permit and build a small project as it is a big project, and so, if you are going to be long a project, it may as well be a large one.
Across nearly every commodity that I can think of there are large low grade “world class” deposits that are trading at a fraction of the NPV or any other metric just waiting to transition to high grade. These are the HIDDEN GEMS that can generate vast sums of wealth in a small amount of time. Nearly all the big scores I have ever had personally have been in part related to a commodity move and leverage to the commodity move through a large project.
So how do we think about pricing the options?
Actually pricing the option has much to do with timing the commodity price cycle. If you buy in too early, you will be crushed by theta – or future capital raises – but as the underlying commodity moves, the share price can move in a matter of trading periods. In short, once you have identified a company with an asset you like, you have to make up your own mind about where we are in the commodity cycle for the relevant company and their underlying projects.
Our team is constantly evaluating these types of opportunities and at some point in the future we will let you know when we identify interesting opportunities. We will always focus on the commodity first and foremost, and then look for good companies with good leverage to that commodity.
Anthony
Stay tuned for next month!
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That is a very interest thesis, guess the low grade is overcome by high price so extraction is ROI positive eventually and therefore the large deposit makes it attractive assuming commodity move is sustained. Great article. Lets see if i can find some in the precious metals space.
I can relate to everything you wrote. Curious to what is coming.