Are junior players just leveraged gold plays? – Eric Angeli

Eric says that his daily conversations with companies’ CEOs and clients have shown him that most people get into junior mining companies because they expect precious metals prices to go up. That’s what is called “directional investing” or the “top-down” approach. You begin with the notion that a particular asset class will rise or fall. Then you buy into the sector.

That would make sense for most asset classes – after all, if people are willing to pay more for a product, the company that makes it stands to see greater profits, right? But Eric says this view just isn’t adapted to the small-cap natural resource space. If your investment in a small gold exploration or mining company depends solely on higher gold prices you won’t have success in this market, he says.

The direction gold will take is paramount to the success of the top-down investors’ portfolios, says Eric.

You have to take the opposite approach, eliminating gold or other precious metals price movements as the crux of you investment decisions. The gold price is a “piece of the puzzle,” but not the only driver.

Instead of being a “top-down investor,” you want to be a “bottom-up investor,”– also known as a “fundamental investor”

Why hasn’t the top-down approach worked?

You might say: because the price of gold hasn’t gone up! That’s true, but there’s more to the story.

“Until quite recently, gold has continued to rise, though not at the same clip we enjoyed after 2008. The problem is that miners’ operating costs rose faster than the price of gold. Investors didn’t expect that.

“Nor did they factor in other cost increases. Sure, the value of a deposit rises every day the gold price rises. But did oil jump at the same time, making trucking the goods out more expensive? Did your laborers start demanding higher wages? Did energy costs increase? Did the federal government demand a bigger slice of the pie?”

As Eric explains, it wasn’t enough to be right about the gold price. You had to do your homework on the stocks you owned because many of these companies’ high costs outstripped the gold price.

“Mining companies have a fiduciary responsibility to make shareholders money,” says Eric, “so they can’t help but paint a rosy picture for potential investors. That’s why you need to have a disciplined and impartial eye. Most companies are, frankly, not worthy of your hard-earned capital.”

Gold stocks may offer leverage to gold or other metals, but in order to be successful in this space, you have to think of a rise in the price of gold or another precious metal as ‘icing on the cake’ rather than your fundamental thesis for investing. As Rick Rule has publicly advised, if you believe the price of a metal will rise, buy the metal. Buy the equity of a company because you believe there is something intrinsic to that stock that may take it higher.

P.S.: Our Natural Resource Investing Guide gives investors 10 simple questions to ask before investing in any junior mining stock. Click here to download your free copy.

Eric’s comments were originally published by Casey Research on October 23, 2013. You can read his full comments – and other experts’ investment advice every day in their free e-letter, Casey Daily Dispatch.

Eric Angeli has been with Sprott since 2006, when he moved from major Wall Street firms Morgan Stanley and Bear Stearns to work under the tutelage of Rick Rule in the natural resource space. Eric takes a concerted interest in the education of his clients and is an avid proponent of the value-based investing strategies of Benjamin Graham. Eric holds a double major in finance and international business from New York University’s Stern School of Business. To contact Eric, e-mail him at [email protected] or call 1.800.477.7853.