10 Rules for Successful Speculation in Junior Resource Stocks
“Deliberate, planned speculation is, in my opinion, the best and safest method to improve one’s chances of preserving the purchasing power of capital or maintaining its constant convertibility into cash without loss.” ~ The Battle for Investment Survival – G.M. Loeb – pg.69
Speculating in the junior resource sector is fraught with risk. Consequently, this is also the reason it’s possible to earn such big rewards.
‘Risk’ is a complicated concept because it means something different to each person. In some cases, those who put their capital into the junior sector have a very high tolerance for risk, while others are blind to or naive about the amount of risk they’re taking on. Naivety or ignorance is usually the product of speculating during a bull market rally, which can mislead anyone in to thinking they’re a genius.
For me, success in the junior market has evolved from discipline. Over the years, I’ve developed a series of criteria or rules that I use to dictate how I buy and sell in the junior resource market. To get you started, I’ve put together a list of criteria for your reference. In reality, there isn’t just one list of rules that will work for all of us; each person will have their own set of criteria to guide their speculating.
These aren’t listed in any specific order – let’s take a look!
Rule #1 – Sell Half on a Double
The junior resource sector is fraught with risk, bad things can happen to good companies. For this reason, I think it’s prudent to sell half of your position on a double. This allows you to take back your principal and ride the speculative wave of a new discovery, the release of a resource estimate or a mine’s first gold pour with the risk of losing capital.
Rule #2 – Don’t CHASE a Stock
Have you ever found a company and, while performing your due diligence, the share price rose above the price at which you first saw it or were willing to pay for it? I have. Early on in my speculative career, I chased and paid a higher price than I wanted for a stock, only to have the price come back a couple months later. My point is, the junior market is highly volatile, most of these stocks will come back to you if you’re patient. Some won’t, but that’s okay, too.
Rule #3 – Don’t Over Pay for a Company
As part of your due diligence process, a comparison to a similar company is advantageous because you should be able to gauge if your company’s price is cheap, expensive or even with its peers. Company comparisons are great, but they can also be a hindrance if done improperly. Here are a few tips to guide your comparison:
- Companies exploring for or mining the same metal
- Companies preferably in the same jurisdiction or in jurisdictions that are similar. This is complicated, so be as specific as you can. For example, Canada is a large place with 10 provinces, each of which is very different from a political standpoint.
- Companies at similar points in development. An example is both companies have a resource of similar size in the measured and indicated resource category. From here, you can have a number of different ratios, most importantly, the number of ounces to enterprise value (#/EV). More simply, but not as effective, number of ounces to MCAP (#/MCAP).
NOTE: Explorers can be hard companies to compare; typically, most of the speculation is based around the people managing the company, and past success typically translates into higher premiums.
Rule #4 – If You Don’t Measure It, You Can’t Manage It
Measuring your performance is key to evaluating how you’re doing, and for many, this may be the biggest eye-opener.
Measuring your performance isn’t difficult because most brokerages provide some form of portfolio tracking for you. Not only do you need to ensure you’re making money, but you want to make sure that you’re beating inflation; this silent killer will erode your purchasing power.
Continuing with the making money theme, if you’re going to speculate in junior stocks and take on an enormous amount of risk, you better be getting a good return. To be in single digits in return percentages isn’t good enough for speculations. If this is all you can achieve, you’re better off buying an index or fund where the management is done for you. This can be a harsh reality for some, but not acknowledging this fact can lead to major losses in a bear market.
Rule #5 – Buy Value
This may seem like a simple statement, but it will be the hardest of the rules to follow, depending on how stringent you want to be. In my experience, this has been the most important rule guiding my speculations. As Rick Rule says, “Money is made on the delta between price and value,” and what better value can you receive than buying something that’s detested by the majority? Be a contrarian or you will eventually be a victim!
Rule #6 – Don’t Speculate with the Mortgage Payment
“There are not nearly enough good investments or speculations to go around. Hence on an actuarial basis, when one ventures into any kind of investment or speculation, the odds are against one.” ~ The Battle for Investment Survival – G.M. Loeb – pg.86
Most speculations aren’t going to work out, therefore, don’t speculate with money that you don’t have or that you should be using to pay your mortgage or your bills. In a bull market, it can be very easy to let emotion take over your logical mind and tempt you to risk it all. Speculate within the confines of a set of rules and there’s less chance this will happen.
Rule #7 – Don’t be Afraid to Sell
Without a doubt, you will have positions that are negative in their return. First and foremost, you must understand why the share price is falling and, secondly, after understanding why, buy more or sell your position. Every day you don’t sell a stock, you buy it.
The tendency can be to hold on to positions in the HOPE that they come back to at least even. In most cases, this is going to be a fool’s errand, because when the story changes, very few companies can put the pieces back together successfully.
Secondly, make it your goal to find the fatal flaw in a company and get out as soon as you identify it. Brent Cook and Joe Mazumdar of Exploration Insights refer to this all the time – it’s sage advice!
Rule #8 – Be Skeptical
Challenge and make sure you understand what you’re reading and hearing about the market and companies. A great quote from T.H. Mitchell, author of Canadian Mining Speculation, on being skeptical about your speculations,
“The speculator must take the attitude that all price movements are manipulations by the professional operators. This is not true, but to be on the safe side the speculator must operate as if it were…All news releases are promotion, all price changes are manipulations and all important discoveries are basically unimportant…pessimistic thinking…opposite of the optimistic public – can they expect to be a successful speculator over the long pull” ~Canadian Mining Speculation – T.H. Mitchell – pg.87
I highly suggest reading this book, or at the very least, check out my review here.
Rule #9 – Read or Listen to Both the Positive and Negative
Confirmation bias is a very real part of human nature. For those who haven’t heard of this, it’s the act of seeking out information that confirms our assumptions or theories. In the junior resource sector, this can be a HUGE mistake because none of us have all the answers.
Actively pursue non confirming information. Be critical of yourself. Determine how you could be wrong and the opposite opinion could be right. It can be a very humbling and important process.
Rule #10A – The Smaller the Better – # of Companies
You don’t hear the smaller the better very often. My point is keep your speculative portfolio to a manageable size, so that you can understand the companies to the best of your ability and follow news flow as it happens. Each person is different in how much information they can handle given everything else going on in their life. In general for those with full time jobs, but still want to speculate having a portfolio under ten makes a lot of sense to me, you can’t kiss all the girls or boys!
Rule #10B – The Smaller the Better – Restrict Your Speculations to Only a Few Jurisdictions
Jurisdictional risk is a complicated subject because it goes much deeper than a country-by-country basis; provinces or states within those countries can be very different from one another. Because of this, I highly suggest limiting your speculations to a couple of jurisdictions, where you can really understand the risks of that specific region and monitor news flow as it happens.
There are many ways to make money in the junior resource sector, and I’m well aware that there are ways that contradict the rules I’ve listed here. My point is that no matter how you plan to make your money, having a set of rules to lean on during the process will make you a more successful speculator.
Create a set of rules for yourself, speculate according to them, and I know you will be more successful in your pursuit of alpha.
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Until next time,
Brian Leni P.Eng
Founder – Junior Stock Review
Disclaimer: This is not investment advice or a recommendation. I’m not an investment professional, nor do I know you and your specific investment criteria. Please do your own due diligence.
