Mining Stocks – The Importance of Diversification

by FI Fighter on February 6, 2017

in Cobalt, Graphite, Lithium, Precious Metals

When it comes to the concept of diversification, I have mixed feelings about it… Yes, I do believe in “diversification”, but not in the typical sense that many investors (particularly financial planners, mainstream media, your friends/family/co-workers, etc.) all preach…

No, I don’t believe that I should ALWAYS own:

  • X% in bonds
  • Y% in cash
  • Z% in stocks
  • Etc.
  • Etc.
  • Etc.

 

In fact, in the summer of 2015 (around the time I first turned bearish on general equities and real estate), I started listening to various sources, trying to find some kind of philosophy (viewpoint) that resonated with me.

I stumbled upon this Stanley Druckenmiller video…

“If you look at a normal portfolio, most people will make 70% to 80% money that year on 2-3 ideas… even though they’ll have 30-40 things in their portfolio. My concept was to put into those 2-3 ideas that I had the most conviction in. I was also lucky to travel across asset classes, so I traded: commodities, currencies, bonds, and equities. And it gave me the discipline, if I didn’t have a good idea in equities, I was happy to have no equities. Or the same thing with bonds. So when you have a quiver with a bunch of arrows in it, you can usually find something to put a lot of money into.

The only other thing I’d say is too many investors look at the present. The present is already in the price. You have to think out of the box and sort of visualize 18-24 months from now and what the world is going to be and what securities might trade at.”

The obvious is obviously wrong.

 

Yup, you could say I definitely took those words to heart when I started buying up mining shares hand over fist later that year

Fast forward to the here and now, and I can tell you that my thoughts on diversification haven’t changed at all… Right now, I still see absolutely ZERO appeal in: general equities, dividend growth stocks, bonds, real estate (particularly Class A rentals in prime locations), etc…

Really, the only things that I still continue to like at this time are cash, physical bullion (gold and silver), and mining stocks (gold, silver, cobalt, lithium, copper, nickel, zinc)…

That’s it…

SCREW DIVERSIFICATION! 😉

Having said that, I should make the important distinction here — Although I don’t feel the strong need to diversify my portfolio in the general sense, within whatever sector I’m targeting (e.g. mining stocks), I think it’s extremely important to hedge our bets, in case things go wrong…

I believe that BIG MONEY is ultimately made in the macro, not the micro… But over the years, I have grown to realize that how we pick and choose our individual investments within the micro can also make a profound impact on our investment returns.

Case in point, let’s analyze two gold stocks, B2Gold (BTG) and New Gold (NGD). One year ago, had you surveyed a typical gold mining stocks investor and asked someone, “Which company represents a better buy, BTG or NGD to play the impending bull run in precious metals?

I’m pretty certain that the response you would have gotten would have been very mixed… Some investors might have leaned towards B2Gold, since they are a lower cost producer and have a very economical and robust new project in Fekola (located in Mali) that is due to come online soon (late 2017) to really hep the company ramp up its annual gold production…

On the other hand, I’m sure many investors would have preferred New Gold… Similar to B2Gold, New Gold also has a massive new flagship development coming down the pipeline in 2017 that is expected to really help turbocharge the company’s growth profile… Despite the fact that New Gold’s Rainy River project (located in Ontario) carries with it a much steeper CAPEX bill (thus substantially lowering the IRR, increasing the payback period, etc., compared to many other similarly sized gold deposits out there), the prevailing argument made at the time to support the investment thesis in NGD was that since the company’s entire portfolio of assets are all located in safe, first-world jurisdictions (e.g. USA, Canada, Australia, etc.), it deserves to trade at a market premium to other gold producers, such as B2Gold (who have a strong focus in Africa).

Even with the benefit of hindsight, I can still see the case for both sides, and really, it’s oftentimes very difficult (if not next to impossible for the average retail investor, like myself) to try and forecast and foresee future problems that may occur with these mining companies…

The mining industry as a whole is probably best summed up as a “crapshoot”…

Anyway, without further ado, let’s look at the performance of BTG and NGD over the span of 1 full year.

BTG is up 301% while NGD is down -0.69%!

Wow, what a HUGE delta!!!

For BTG shareholders, we are talking about some potentially life-altering gains that were made here (depending on the size of your initial investment)… As for NGD, the shares are actually in the RED after 1 full year

Damn…

“Aren’t both these companies the FREEKIN’ EXACT SAME thing? We’re talking about identical mid-tier gold producers, right!?!”

WTF…

Seriously!?!

Unfortunately, that’s just the way the game goes sometimes… And anyone who has played mining stocks for any duration of time is probably not too surprised with the outcome…

 

When it comes to the micro picture, quite honestly, I feel like there’s a shit ton of luck that goes into these speculations…

 

Certainly, we all try and do the best that we possibly can, but for realz, this stuff ain’t easy to pick out! Even when you think you’re buying into a “sure thing”, you just never, ever, ever know for certain…

Gotta eat some serious humble pie in the mining game… Actually, I think the same should apply for all asset classes, not just mining stocks!

 

But in case it wasn’t CLEAR enough already, here are my thoughts summarized — Mining is an inherently risky, unstable, and unpredictable business (if you don’t have extremely high risk tolerance and an iron stomach to deal with the volatility, don’t bother even attempting to play!)… So, ALWAYS hedge your bets and make sure you’ve got a portfolio comprised of many prospective companies (I personally like to target around ~20 stocks or so, but YMMV)!

 

That’s MY approach to “diversification”…

Mining stocks possess a ton of inherent, built-in leverage, which can really help an investor make MASSIVE gains and reach early FI sooner than they ever dreamt possible… The BIG MONEY is made in the macro, but the importance of pinpointing the right micro investments shouldn’t go understated…

 

You need BOTH the macro AND the micro to succeed!

 

So, please don’t “put all your eggs into one basket“…

 

Go BIG, or go home!

 

Just make sure you “diversify” a little! 😉

 

Fight On!

{ 2 comments… read them below or add one }

1 SFtraderNo Gravatar February 14, 2017 at 2:11 pm

Great point and summation of what it means to have a diversified mining portfolio. Being newer to the mining space (and a Rainy River victim) I’d have to agree that its totally unpredictable how some stocks in the same sector move substantially while others don’t. Take the recent move in GoviEx for example, quadrupling off the bottom in the uranium space, as opposed to Energy Fuels which had a nice run, but not nearly with the same type of gains. On one hand you have a company with high quality assets ready to turn production on at the drop of a hat (UUUU), and on the other you have a company with no production capability but massive resources that are out of the money by at least $30 spot of the underlying commodity (GXU). Without hindsight, which one moves 4x as the commodity price increases? I’m quickly learning that the only solution is to have a little bit of both…

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2 ChillywitNo Gravatar February 17, 2017 at 7:32 am

I love this post in which you compare diversification within versus between asset classes. I’m a beta investor as opposed to an alpha investor. Meaning, I invest in a particular market through ETFs rather than pick individual stocks. I like to be concentrated within one particular class too, and right now that’s precious metals and mining. I avoid stock picking because I find it too frustrating and volatile. I maintain a core position in GDXJ that I’m not selling until this precious metals bull market matures. In the meantime, I juice my returns by buying a fund like JNUG during corrections, and hedge my paper gains with JDST after bull runs. Doing this also gives me the sense, real or imagined, that I’m doing something actively with my investment rather than sitting passively on the sidelines. We’ve had a good run so far this quarter, so next week I’m going to employ my JDST hedge. It’s interesting that I find myself employing my hedge around the time you stir up the mix of your stock portfolio. You might be my new “contrarian” indicator even though we have the same investment outlook. I enjoy reading your insightful blog and about your travels. Keep posting!

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