Are You A Contrarian? Test Yourself With This Stock
The biggest gains in the stock market go to those who have the discipline to invest when everyone else is in panic mode. In other words, be a contrarian. An old stock market adage states, “Real wealth is created by the steady accumulation of an asset when its outlook is the bleakest.” Right now the contrarians have plenty of bleakness in commodities, especially mining stocks, and more specifically gold mining stocks.
Since reaching a peak in 2011, the price of gold has wiggled around $1100 per ounce. Also, since 2011, most gold mining stocks are down 50-90% in price. Mining gold became increasingly unprofitable as the costs to develop and operate mines rose and the price of gold fell. Until recently, the price of oil was a drain on profitability – since it takes oil to power the trucks and other machinery to pull gold ore out of the ground and turn it into shiny coins. Many miners were struggling to break even or were just happy that they were only losing a few dollars per ounce. The cost of closing a mine is expensive too, so it made economic sense just to lose a little every day.
Currently, the environment for gold mining is different. Oil is much cheaper than it was a year ago so the daily costs of exploration, development, and production is much less. Labor is much cheaper too, since many mining companies have cut back on employees just to stay in business (which creates a surplus of miners looking for work at any wage). Interest rates are still low and investors are hungry for yield which means some of it will find its way into mining projects. Yet, the sentiment towards gold miners is rather bleak even though there are plenty of reasons why gold mining stocks should rise in price.
Prudent investors will look to gold mining companies that generate profits during this time and make sound investments in them. Contrarians, on the other hand, will seek out the companies that are losing money on every ounce and then wait for spectacular gains. These stocks will jump the most as they move from losing money every day to breaking even to profiting as the price of gold crosses above their cost of production. This will cause all kinds of investors to pile into these stocks for no other reason than the expected rise in earnings per share. Take a look at the chart of Harmony Gold Mining $HMY if you need proof. After missing expectations and reporting a loss for the quarter in November, the stock price has quadrupled since then.
A mining company does not even need an operating mine to benefit from this situation. An exploration company with a decent sized project awaiting development is just as good. Take for example Exeter Resources ($XRA, $0.43). It has a very large and very promising deposit in Chile called Caspiche. For all the reasons listed above, the pace of development seems rather slow. In fact, it makes the birth of a baby elephant look lightning fast. Until the last six months, all gold projects were not worth the time or expense regardless of drilling results. Today, a project like Caspiche looks very attractive to everyone whether they are financiers, big cap gold miners, and yes, contrarian investors. But still, its chart is not screaming, “Buy! Buy! Buy!”
The purchase of XRA stock would be an asymmetrical trade. It would have optionality. In simpler terms, the upside for the stock could be 10 to 15 times its current price and the downside would be the current price and no more. This is the holy grail for speculators. This optionality does not eliminate the risk of owning the stock but it does give some assurance that the worst is over. Going back to the quote in the first paragraph, the best way to play XRA is to buy shares every month, or every quarter, so that you will be steadily accumulating an asset when its outlook is the bleakest.
Note: Brad Hartung is writes the blog Small Cap Pirate. You can view his stories on biotech and junior mining stocks at: bit.ly/1Vlx0y3.
Category: Gold Stocks
