With the action in the metals markets the last couple of days I felt compelled to comment. It should be apparent by now that Chris and I are both fans of the precious metals. I wouldn’t go so far as to call either of us “Gold Bugs,” but more fittingly, realists. The appreciation in gold and silver has been nothing short of spectacular over the past few years. The reasons are obvious: Inflation of the money supply, increasing national debts (globally), supply demand issues, etc.
Gold and silver have been used as money for time eternal. As Doug Casey likes to say, “Gold is the only only financial asset that’s not simultaneously someone else’s liability.” We’ve been suggesting purchasing gold and silver for the last several years, and although you should have loaded up a long time ago, pullbacks like the one occuring now give us another chance to add to our positions.
If you’ve missed the gold bullion/silver bullion runs, or you just don’t want to add on the dips (for whatever reason) you may want to check out select mining shares. The gold and silver miners have not performed nearly as well as the metals themselves. There are a lot of opinions as to why they’ve lagged, but I don’t much care about the why, I only care about the fundamentals. Most mining companies are terrible investments (as our other friend Kuppy says time and time again). They lose money consistently, and if they do find something it takes years, and costs a fortune to build a mine.
When I buy mining stocks I usually turn to the experts. However, sometimes I’ll come across a gem on my own. What do they say; sometimes even a blind squirrel finds a nut!
A couple years ago I put some shekels into a little company called Sandstorm Gold. I liked the company then (and like it just as much now) because of who created it. You know what we say all the time here at CapitalistExploits – MANAGEMENT. Sandstorm Gold is the brainchild of ex-Silver Wheaton wunderkind Nolan Watson.
Watson was CFO at Silver Wheaton, an uber successful mining company listed on both the TSE and the NYSE. I believe he was the youngest person ever to fill the CFO role in a NYSE-listed company. He was instrumental in Silver Wheaton’s meteoric growth, helping to raise over US$1 billion in debt and equity for the company. I recommended the stock to friends and family around $4 last time we had a big smackdown. It’s risen over 10 times since then. With Sandstorm I think he’ll do it again.
To give you a good overview of the company’s business model I suggest reading this Seeking Alpha column. It’s concise and to the point. The gist of it is that Sandstorm is a royalty company, not a gold mining company. It functions similar to a bank that only lends to mining companies, providing large upfront cash payments in exchange for a locked-in price per ounce of gold and a percentage of future production.
There’s none of the operational risk that comes with miners (although there is miner risk, as that is where there streams come from…), no cost overruns, no miners to employ, no politics to deal with… yet they are exposed to all of the upside if the price of gold continues to rise. Watson and team are creating a dynamic portfolio of properties with an average cost per ounce of gold of $425. I like what’s going on here.
How do I want to play Sandstorm? I could buy the stock, which would be just fine. However, if I want a little more leverage I could buy the warrants (which I have). Sandstorm Gold has two different warrants trading on the Vancouver exchange. Both give us PLENTY of time for Watson to build his business and to let gold continue with its trend. I’ll talk about each in a moment, but first, for those that aren’t familiar with warrants they are similar to an option.
The warrant buyer has the right but not the obligation to buy the underlying stock at a pre-determined price, quantity and future time. It is unlike an option in that a warrant is issued by a company, whereas an option is an instrument of the stock exchange. The security represented in the warrant is delivered by the issuing company instead of by an investor holding the shares. Warrants are often issued as part of a capital raise to “sweeten” the deal, especially in tougher markets.
Sandstorm has issued two series of warrants. The first, symbol: SSL.WT gives the warrant holder the right to buy Sandstorm Gold at .60 until expiration, which is April of 2014. The second, symbol: SSL.WT.A gives the warrant holder the right to buy Sandstorm Gold at 1.00 until expiration, which is October 2015. You can get a full review of the economics of these warrants at Canadianwarrants.com. They give you a nice little spreadsheet-like rundown on all Canadian listed warrants. (update – unfortunately, as of February 3rd, 2012 that site has not been updated)
I like warrants because of the leverage they offer. A great real-life example of this was Sulliden Gold. My friend Carlos Andres pointed Sulliden out when the stock was in the mid .50′s. Meanwhile the warrants were trading for about .15. I liked the story, and I liked that I could get additional upside exposure by purchasing a warrant, which is what I did. The stock went on to rise over 300% before the warrants were called (warrants can sometimes be called, check with the company to see if a call feature is part of the deal before you purchase a warrant. It’s not always a bad thing, but it is another variable to consider).
The warrant appreciated by over 1000%. It was a sweet deal. I sold the warrants a happy camper. Remember, you don’t have to, nor should you, exercise a warrant. In almost every case you should simply sell your warrants prior to expiration.
With Sandstorm let’s do some theoretical math. Right now the SSL.WT is trading at about .76, with the stock at 1.26. That means the inherent value of the warrant right now is .50. There is .26 of premium with over 2 1/2 years left before expiration. The SSL.WT.A is trading at .61, with .35 of premium and over 4 years left before expiration. In my opinion either warrant offers exceptional appreciation potential.
Let’s compare the theoretical return of the warrants if Sandstorm stock were to double in price from today’s 1.26 to 2.50. At 2.50 the SSL.WT will have an inherent value of 1.90, which is a gain of 1.14, or 150%. The SSL.WT.A would have an inherent value of 1.50, or a 146% gain. That’s a nice boost from the 100% the stock would give us. However, if you ratchet up the stock gain, the warrant gains become exponential. At 3.75, or a 200% gain for the stock, the SSL.WT gains 314% and the SSL.WT.A gains 351%. Now, if the gains in the stock happen long before expiration the premiums in the warrant will add to these prices.
The point is that we can get a LOT of leverage by buying the warrants here instead of the stock. The warrants carry some risk, but the combination of strong underlying fundamentals and outstanding management gives me confidence in this speculation.
Let me know what you think.
“A speculator is a man who observes the future, and acts before it occurs.” – Bernard M. Baruch