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.
- Mark
“A speculator is a man who observes the future, and acts before it occurs.” – Bernard M. Baruch
Hi Mark. Good analysis on the warrants. I’ve seen them used quite a bit in the private placement arena for startup companies as sweeteners, as you also pointed out. The earlier the phase that the startup was in, generally the higher the ratio of warrants offered per share purchased in the seed round.
In your experience, have you seen companies offer warrants with a condition such as you have the warrant to purchase at x strike price, for each regular share you purchase in the next round of financing? In other words, a kind of inducement for the investor to purchase again in the subsequent round of equity raising.
Keep up the good work, you two.
Best,
Martin
Martin,
Thanks for your input. I have not seen companies use warrants in that way. I don’t know if that means it couldn’t be done, I’ve just never seen it. Lately, meaning in the last 6-8 months, I’ve seen a lot of deals getting done without warrants, or maybe a half warrant. This just means that the companies are not having as difficult a time raising the capital they need. A few years ago I was seeing deals with 2 warrants attached. I guess it’s not 2008/2009, although from looking around it seems that it should be…
Mark
Thank you for the post.
I’ve been running the numbers on Sandstorm using the Seeking Alpha projections to 2021 plus taking account of corporate costs, which I’ve put in at $1.5m growing at $0.1m per year. DCF’ing these at a sensible WACC of 10% means that the gold price needs to be c.$3,000 per ounce, before the NPV of the cash flows exceeds the market cap. I’m assuming tax is a flat 26% per year and no working capital movements.
Am I missing something here? It doesn’t feel all that cheap to me. Apologies in advance if I’ve made a howler of an error!
Cheers
Matt,
Thanks for the comments. I started buying the warrants a couple years ago, so my cost basis is much lower than today’s price. That being said, I plan to keep buying. I like the management, and although your analysis seems to be accurate (BTW, I don’t recall saying it was undervalued) I’m still comfortable buying alongside these guys (management – who have a disproportionate amount of their wealth in Sandstorm). It may not have the massive upside of an explorer, but I think the growth will be solid, and these guys will continue, in my opinion, to do good deals. I don’t want to comment on how high gold could trade over the next few years, but I could see it over $3k very easily if things continue the way they are, maybe much higher. If that’s the case I like the leverage Sandstorm, and the warrants in particular, offer me.
I don’t know if that answer helps, but that’s my story and I’m sticking to it
I definitely encourage you to call the company and get it from the horse’s mouth. Don’t listen to me, I’m just a guy with an opinion, and you know what they say about that, LOL.
All fair comments. Plus as you state, you didn’t say it was cheap!
I was running the sliderule over it and couldn’t quite understand the result.
I totally buy in to the upside of gold, the leverage a royalty company has on that price, the quality of the management team and the leverage that warrants give. But I like a value cushion too.
I’ll put the company on my watch list in case the share price drifts down.
Thank you for your help.
Thanks Matt! Let us know if you have any other thoughts on this, or any other topic.
Thanks for the Sandstorm ideas, interesting, but even though I am bullish on gold, this one is not for me.
There is a lot here I just don’t like. I’ll stick with DGP. I get 2x the move in gold futures. It’s simple and clean. No worries about a company’s valuation or all the internal issues that come with owning stock.
Sandstorm may be a streamer but its a company with their own set of issues that you need to stay on top of. Management spreadsheets of contracts are just that and nothing more. How can you do due diligence without access to every deal and access to what’s happening at every mine they have an interest in? I realize you trust management. I get that.
I was surprised you did not talk more about the risks. You say “there are none of the operational risks that come with miners…” but there are. If the miners fail to produce or meet production benchmarks (for operational, technical or other reasons including higher costs leading to cash flow problems) there will be less royalty money for Sandstorm. This is a regular occurance with jr. miners.
Investing with famous managers often means you are paying a stiff premium for their prior success because everyone bids up the stock price of their new venture right from the start. That seams to be the case here. The valuation looks rich to me. The share count is already up to $321M with a market cap ot $418M and it is purely based on mgmt projections of future cash flow.
You say “they are exposed to all of the upside if the price of gold continues to rise…” but that’s not right. Gold prices and Sandstorm’s stock price do not track together. Since Sandstorm’s inception 3 years ago its stock price has underperformed gold and way underperformed DGP. Sandstorm’s royalty stream, not their stock price, is what is linked to future gold prices assuming no major production problems at their contract mines. Huge difference.
I was also surprised you did not emphasise the downside of owning warrants vs stock. With warrants things need to work out in the near term so timing is everything. One of the most important investing lessons I’ve learned is to make time your friend not your foe. If you own stock in a great company and they have a big setback you have the option of waiting for a recovery — not so with warrants or options.
Leo Tolstoi: “The strongest of all warriors are these two; time and patience.”
So why add the timing risks on top of other risks of owning an expensive stock linked to gold miners?
P.S. Regarding your intro, to better understand why (and the reason deos matter) mining shares have underperformed gold, I suggest reading the May 5th edition of The High-Tech Strategist by Fred Hickey.
Keep the ideas coming, I really enjoy the material that you and Chris share with your readers!
Mark S.
Hi Mark,
Thanks for the analysis, you make some great points. Regarding DGP, ETF’s and ETN’s are tough pills for me to swallow. With an ETN you have counter-party risk, contango risk, etc. and in today’s environment that is a big factor. You’re right about not having the miner risk, but there are other risks. In general ETF’s and ETN’s often don’t perform as promised. DGP has delivered so far, but there are risks.
You are correct that there is mining risk with Sandstorm. I should have been more clear on this. It’s true that the individual mining companies Sandstorm strikes a deal with will face operational risks, and assessing those risks is difficult. I pointed out that mining was a terrible business, yet I didn’t mention operational risks could affect Sandstorm. Again, that’s why I chose this particular royalty play – management. They are not infallible, but I like their track record and believe they can assess and manage the operational risks.
The comment on valuation is fair, and as I pointed out in the last comment, I never said Sandstorm was undervalued. There may be a “management premium” at this point. As you stated, success often comes with a premium. Just because Mr. Watson and his crew “hit it out of the park” in the past, doesn’t mean they can do it again. Anything can happen. Valuation is always forward-looking, so although it may be fairly valued, or even slightly over-valued, I’m betting they’ll just keep adding to that value over time. As they continue to do deals where they can lock in streams at significant discounts to the price of gold it will have a positive impact on future cash flows. Am I wrong there? The “wildcard” is their ability to make good deals happen. As more and more deals are consummated the results will be multiplied.
Regarding the downside of warrants, you are right that timing is everything. That’s why I like Sandstorm’s warrants. We have a lot of time, especially with the “A” series warrant, to let them develop their business. There isn’t much premium in the warrants if you believe the stock is fairly valued here, and lots of time to add value. Warrants are not stocks, they expire at some point in the future, and warrants can, and often do, end up being worthless. I don’t think that will happen here, but it is possible.
Finally, I didn’t mean to imply that it wasn’t important that mining shares were under-performing gold. Going into the reasons for that under-performance wasn’t appropriate for this post. Gold is a commodity, a mining company is a business, fraught with all the risks that being in the mining business entails. Input costs, labor costs, regulation, nationalization, natural disasters, etc. For some the risks are too much to justify the potential reward. Overall a company like Sandstorm (or Silver Wheaton, Franco-Nevada, etc.) reduces some of that risk, or more accurately maybe, spreads it out, while still giving the investor significant upside potential.
Have you assessed the counter-party risk with DGP, and if so, how did it impact your decision to invest? What about contango risk? Is DGP your only exposure to gold? That would be good information to share, as I’m sure a lot of others herein have ETF and/or ETN investments as well.
Thanks Mark!
Thanks for the timely feedback and for allowing the posting of contrary opinions… another attribute I like about your site. [can you add a spell check feature?]
Your points are well taken. Sandstorm can work if mgmt keeps striking good deals and gold rises but I felt compelled to point out the lack of a link between thier stock price and the price of gold. Figured new investors would be dissapointed if they learned that the hard way.
I feel Sandstorm is a deal making enterprise which, as a rule, I stay away from. That’s just me. I’m afraid of the deal makers accruing too much of the benefits when things go right or walking out the door for a number of reasons; usually personal.
I did not mention this in my first comment as it was lengthly enough but regarding deals, I see two challenges/limits: 1) as gold prices elevate more financing options become available to miners shifting the balance of power in negotiations plus as prices rise as we move through gold’s bull market years future deals offer more downside risks with less upside (deals struck as we approach the peak – whenever that is – will be big losers) and 2) if Sandstorm strikes deals that are too good their contract miners will not be left with enough profits to function properly leading to problems all around.
I probably should not have mentioned DGP because it is a leveraged product and not right for some investors. There are better ways to gain leverage such as using traditional long-term, low, fixed-rate, tax-deductable loans.
I’m comfortable with DGP so I use it. I bought it for two reasons. First, I’ve been VERY bullish on gold for a while and it has grown into an embarassingly large position for my clients and myself. Second, because there can be much slippage, tracking error, decay with ETFs and ETNs that use futures due to daily rebalancing and contango, I wanted a product that would overcompensate me, thereby more than offsetting the decay issues.
Everyday I note the % change in DGP vs. GLD and IAU and contrary to my original thinking, DGP is just about a perfect 2x product. For example, year to date, GLD and IAU are up 27.4% while DGP is up 56.2% (2x would be 54.8%). To me the tight tracking is a nice bonus but even if there was some decay I would own it.
IMO, nobody should own a 2x product unless they have an unshakable conviction about something and even then it needs to be sized correctly. Most should own 1x products because in a down market, the daily rebalancing of 2x futures based products will prevent you from gaining back the same amount of dollars for similar % gains. All the decay issues is why I don’t own a single agriculture ETF/ETN although I’m bullish on food prices.
At some point I will switch to GLD or an equivalent 1x ETF/ETN for gold. Then at some later date, I’ll be getting out completely. Knowing that shooting for perfect timing is risky I plan to make both switches in steps.
Based on the history of the U.S. dolalr and gold, this is going to be one hell of a ride for all of us… both ways!
It sucks that central bankers are making us play this game!
Mark,
Thank you for being so interested and engaged! I am always learning new things from others, and I’m glad to have intelligent debate. Contrary opinions are always welcome!
All your points make sense. I agree with you on the ETF/ETN stance. I did a little analysis of DGP as well, since your comments, and I may incorporate it into my portfolio, despite my usual reservations. It seems to be performing just as you say…
I wish there were a decent way to play the ag side, as I believe the ag complex in general is going much higher. I have been buying and rolling futures contracts to play it. DBA was suggested, as was RJA, but both are not ideal for reasons mentioned above and more. What’s your take?
Ag is the area I have found most frustrating. It seams like a no-brainer when you look at global trends but execution is difficult.
I dabbled in RJA, DBA and a couple others but eventually bailed out of all even though I think food prices are in a long-term bull market because they were underperforming. It was hard to release them as I’m a long-term investor. Sidways moves in food prices net out to a loss for these ETF/Ns. You really need to own them during a very strong move.
Two big issues I have with food investing are the shorter supply lead times vs. mining and easy product substitution. The price swings in food are usually short-lived due to both factors making it tough on an investor. Farmers quickly switch crops as prices change and consumers switch eats even quicker.
I’ve come to think that picking a couple of specific foods with depressed prices is better than buying a basket. This seams managable to me. In fact , just last week — inspired by rereading an old Jim Rogers book, Hot Commodities– I decided to try and learn about a product with one of the longest supply lead times… coffee. I figured if I cannot time this crop who’s price swings are more gentle and long lasting (relatively speaking), than I wont’ be able to manage other ag products. Coffee will be my “Intro to Ag” class.
My favorite way to invest in ag is Potash (POT). It’s a great company in a sector with outstanding fundamentals. It’s really a super ag play when the stock price is right.
I made some money on it but sold just before the hostle takeover attempt started so I missed the big move and 3:1 split. I follow it but doubt I’ll be getting back in anytime soon. The upside is not as interesting as I need it to be. It’s worthly of following.
I don’t like buying farm equipment makers as an ag play in general. Now you own stock in a manufacturing company with their unique set of costs and problems. Obviously, if a specific company’s fundamentals look appealing than I’ll go for it but I don’t classify it as an ag investment.
For what it’s worth, soy, corn and wheat are all staging breakouts here, will be interesting to see how DBA and RJA track.
Not to hog the comments space here but there is one more thing I would like to add regarding why I decided to own DGP over GLD. I am worried that some of the physical gold bars held by GLD may be subject to multiple ownership claims due to excessive, undisclosed leasing prior to GLD’s purchases. Should news along these lines break what would happend to the price of 1) physical gold, 2) GLD shares and 3) DGP shares? That’s worth thinking about.
My opinion is that the prcie of #2 would tank but the price of #1 and #3 would soar. So I feel safer in DGP than GLD.
Mark,
I agree with you on this. I think GLD and SLV are disasters waiting to happen. I play options on GLD and SLV, but that’s it. I think it’s a scam, frankly. There are just way too many questions about these ETF’s. Your DGP call might just be the ticket. Just to throw it out there, I also really like the GDX and GDXJ, and also the SIL for exposure to the miners, big and small…
Wow. What an interesting conversation. I’ve been riding the gold trend for the past 5 years and am fascinated at how little the interest is on gold as an investment. I was 19 years old when I made my first bullion purchase and ever since then I haven’t found any fundamental reason to not be exposed to this market. In fact, my portfolio is about 95% exposed to the precious metals. I’m more heavily weighted to the mining equities side because I am young and quite honestly, trying to hit a homerun when this is said and done. Although my bullion position has done much better then my equities position in the past 5 years, I haven’t realized any gains/losses so it doesn’t really matter until they are realized. I just don’t see an end in sight yet for how long this bull market can go on for so I will continue to add on corrections and sit tight. I’m an amateur investor but what I’ve learned is that you don’t have to be an expert to make good money in the markets. I studied finance in college but have learned much more from my self education. If you read alot and have a basic understanding of FIN,ECN, and ACC, identifying the trend and being patient will put you on track to making abnormal returns. I’m a young lad still so patience has been my hardest goal to accomplish.
Thank you guys for such an enlightening conversation. I gained alot of wisdom from reading your comments.
Thanks Jonathan! Good to see young people reading this blog (not that I’m an old man.. yet). I agree, I don’t see any reason to cash in anything gold-related at this point. Beware the volatility however, and don’t be panicked out of your positions. As long as one doesn’t utilize leverage you should be able to ride out the wild swings that are likely coming. I think we have a LONG way to go in this bull market.
I wholly agree with you on the buying of warrants. I’ve been buying warrants for a few years . I bought NGD.wt.A @ 2.77. I also own the B warrants. I’m going to sell some shares of XG Extorre Gold today and put the proceeds into SSS.wt. I missed out on the Silver Wheaton run but won’t make that mistake again. Thank you very much for the great info. on warrants you have been a great help to me. I’ve been watching FNV.wt since it was $3.54 but I didn’t pull the trigger, it’s now around $10.35, a big mistake. I own some Argonaut Gold stocks and the warrants but I think I will sell the Stock and purchase some more warrants. Thanks again for taking the time to help out an ordinary Investor like me, Cheers, Roy.
Roy,
I like NGD as well. I actually owned some of the warrants a couple years back but sold a bit too early! Enjoy the gold run, and thanks for reading!!
Hello,
I know that this is an older post… but I am also a new investor and like Jonathan have learned a lot by reading the discussion here. I was wondering what your thoughts were regarding Sandstorm Metals & Energy.
Jeff,
I still like SSL, it’s a long-term hold in my opinion. It pulled back a bit with the rest of the PM stocks, giving a nice re-entry, alas I didn’t add. The warrants could have been picked up cheap.. Bottom line, I like it. Management is stellar and I like betting on management.
Mark
Thanks Mark. Agreed re: betting on management – it is ultimately the people who make the difference. Right now I am having a hard time determining a good price for both SNDXF and STTYF. I have recently purchased shares at $1.47 and $0.37, respectively, but I am trying to do a little more research, and also practice some patience, before purchasing more. I am also new to warrants. They sound a lot like options, which I am also unfamiliar. In general I like to keep things simple… but Sandstorm has definitely motivated me to look into those a little more.
Mark,
Huge fan of the blog. Just read up on Sandstorm’s sister company – Sandstorm Metals & Energy. (detailed and thorough write up at Above Average Odds Investing) Given your familiarity with Sandstorm Gold and Nolan, I’d be curious to get your take on SM&E.
Cheers,
junto
Junto,
Thanks for that! I’m not as familiar with SM&E. I like SSL because it’s precious metals focused. Nolan is sharp though, so I would be comfortable almost just following him into whatever he does. That’s our bias towards buying management. That being said, again, I like the precious metals more than the base metals.
Cheers,
Mark
Thanks Mark. Appreciate the quick response. Certainly agree that management is key, especially with these types of companies.