How to Select The Best Asset Type

There are many ways to make money in resource investing, extremes in cycles and employing leverage are paramount, however your ability to take full advantage of the asymmetric strategy (small risk versus huge reward) is predicated on using the right type of asset. Several members have asked me about ETFs, or a specific sector index, and all I can say is, that might get you a good return, but it won’t let you maximize the opportunity. Let’s review the types of assets and their characteristics, so that you can select the right one for the job.

Physical Assets

If you are focused on the precious metals sector this is a no brainer, right? You know the saying, you don’t own it if you can’t hold it, and ownership of Gold is important in our strategy. In fact from the Dragon Portfolio point of view, it’s one of our five key holding. Also, holding Gold is easy in terms of value density. At current prices a roll of 20 Gold Eagles is worth about $35K. Even silver is relatively value dense, you could stash a substantial amount in your safe. However if you wanted to own physical Wheat, Corn or Cattle? You would need a silo and a farm, and have to worry about its longevity, or what about crude oil, unless you had a tanker or one of those massive land tanks, it would simply be impractical. The cost of storage is a big problem with most physical resources, even when you have so much Gold or Silver that it makes more sense from a space and security perspective to keep it at a safe place like a storage facility.

Exchange Traded Funds (ETFs)

These are just indistinguishable from stocks, at least in the way you trade them. They are super liquid, at least most of them, and available from most brokers. ETFs come in two basic flavors; there are those that are a basket of stocks, individual companies, that are grouped to represent a sector or strategy, and provide a level of diversification, which translates to relative safety, lowered volatility which translates to less risk, and therefore a diminished ability to make money. The other problem is an ETF might have some really good companies in them, it may also have some dogs too. I would rather invest in only the top prospects, wouldn’t you? One advantage is if there are dividends from the individual companies, you get those dividends as well.

The other type of ETF is that which attempts to track the physical, like SLV for Silver and GLD for Gold. In this category there are ETFs for just about every resource type; Gold and Silver as previously mentioned, but also natural gas, crude oil, coffee, platinum, grains, lumber, and even uranium They generally invest in futures, and so they incur an underlying cost from managing the underlying assets. This is particularly true with leveraged ETFs, which are like having a faucet attached to it that is always on and money flowing out. Read the prospectus of a leveraged ETF in the risk section, virtually all of the leveraged ETFs will tell you if you hold them for a period of time you can expect to lose money. All of these leveraged ETFs eventually drop to very low prices and the managers are forced to do a reverse split so it doesn’t become a penny stock. Given that, they might be useful in very short term trades, but not investing.

Producers

This is one of my favorite asset types. Stocks of companies that actually produce the raw resource, they grow it, drill it, or dig it. There are generally three categories of producers, there are the Majors, the Mid-Tier producers, and the Minors. The Minors can be split into two more categories, those that have actual projects under way where they are pulling stuff out of the ground, and then there are the exploration firms that are out there hunting for treasure. The exploration firms are constantly trying to raise money for their hair-brained ideas. This is not to imply that they are crazy, because when they strike a valid resource their value can go up by 10X, 100X or even 1000X!

There are only a few Major producers in each resource category, and they are behemoths. They have the most money, the most people, the most access to capital. In the gold sector this would include companies like Goldcorp, Barrick Gold and Newmont Goldcorp.In the oil sector the majors would be household names like ExxonMobil and British Petroleum, or lesser known, but certainly bigger ones like Saudi Aramco and the Russian Rosneft. Majors are generally massive with assets all over the world with market caps from $5B to $400B. Most pay dividends.

The Mid-Tier producers range from $1B to $20B depending on the industry, and are simply much smaller versions of the Majors, with lesser diversified holdings and room for growth. The are often acquisition targets of the Majors, and therefore on our radar. Holding a company that is being acquired is often very profitable as the buyer usually pays a premium for the stock. A Mid-Tier company’s stock is usually less liquid and thus more volatile, which means in the course of boom and bust cycles, their price will swing wildly too, making then great potential investments, but you need to research and understand their particular assets to be successful.

Juniors are my favorite category of producers because this is where all the mergers and acquisitions happen. Juniors are typically valued based on the management team first and then the project. This is where the managers often have a huge or majority share holder stake in the company, they have “skin in the game.” Juniors are much more likely to be acquired by the Mid-Tier or Majors, and so if you can identify them based on certain criteria, you stand a very good chance of holding onto a likely take-over candidate. Juniors don’t have a lot of coverage by analysts covering them, in fact some may have no analysts looking at them, other than us of course. The way we find out about them is through knowledge of the industry, trade shows and conferences, watching the news, developing relationships. This is some of the inside stuff that makes this service so valuable.

Royalty and Streamers

In the world of precious metals and uranium, these are by far my favorite investable companies. They don’t mine the metals, they are the financiers of the exploratory companies and own a piece of many of the Mid-Tier producers as well, probably because they were their original investors. They make their money by financing operations and take a percentage of the take right off the top at an agreed upon price, always much lower than spot. Royals are great because they can have bast holdings with hardly any overhead, because they are really nothing more than a lending institution with huge interest in the things they invest in. Check out the holding in the U.S. Global Go Gold and Precious Metals Miners ETF (GOAU), the top ten holdings are mostly royals like Franco Nevada Corp (FNV), Royal Gold (RGLD) or Wheaton Precious Metals (WPM). All of these are great long term holds and I would recommend them for any portfolio.

Suppliers

In a resource sector boom or bust, all ships rise and fall with the tide. And because the companies involved literally get their hands dirty, they rely very heavily on major equipment manufacturers. The companies that supply mining equipment for example can be great long term, profitable yet conservative holds that produce great dividends. Companies like John Deer for farm equipment, or Schlumberger for Oil, or Bristow Group which sells helicopters used in offshore drilling, or Kennametal, which sells the teeth in those huge moles that dig tunnels. Not only are these great companies, and tend to move with the tide, it’s also a great way to get involved as a real player in the industry, you’ll gain tremendous insights by following the tentacles  as well as the head and shoulders.

Commodity Futures and Options

While these two asset classes are both leveraged derivatives, they are very different. We like the leverage in certain cases, plus the incredible flexibility of options under certain circumstances. But they both require extended knowledge to use them, so it will be rare that I will recommend an opportunity using futures or options. But a severe downturn, or directly after a price shock might be one of those times. Commodities are generally used by people in the cash market of various commodities to hedge their positions, they are also used by speculators, and unless you really know what you are doing, you can either make boatloads or lose boatloads. Options are great for insurance and for conservative plays like selling calls against your slow moving stock to collect income.

Conclusion

So, that just about covers it. There are many classes of investable assets in the resource sector. They can be summed up as conservative or risky, physical or leveraged. Each is suitable for different strategies, like speculative or long term investment. There’s a time and place for each.