Legendary resource investor Rick Rule has long argued in favor of what he calls “optionality.” Equally legendary speculator Doug Casey calls this type of stock a “land bank” play. The idea is that we can make money betting on companies that have large deposits in the ground but are selling cheap because of low commodity prices, and then waiting for higher prices to make those projects economic.
I can think of companies that published detailed feasibility studies that proved conclusively that their projects didn’t work at current prices. International Tower Hill Mines (THM, ITH.TO) was a case in point years ago. Their bankable feasibility study showed that their massive Livengood gold project wouldn’t work until gold prices rose above $2,000 per ounce. That was a good reason to sell, back then, but today, $2,000 gold doesn’t seem that far off.
With the likes of Bank of America calling for $3,000 gold in the years ahead, it would seem like a good time to consider investing in gold optionality plays.
For those who’d like more background, Rick does an excellent job of explaining optionality in this video, starting about 4.5 minutes in. One of the key points is that for it to work, management needs to resist the temptation to spend money trying to improve their uneconomic deposits. Ideally, they just leave things be and spend as little as possible—including on their own pay—until higher prices increase the value of the gold (or whatever metal it is) they have in the ground.
That’s why Doug calls these land bank plays. The gold, silver, copper, uranium, etc. is safely vaulted in the ground. You don’t have to do anything but wait for higher prices to increase the (perceived) value of the asset in hand.
It may seem crazy to buy into assets that we know are not worth what it would cost to mine them, but the strategy has some strong plusses.
- There’s no exploration risk—the deposits are already discovered, and in many cases, well defined and understood.
- There’s also no permitting or technical risk.
- A mine that hasn’t been built yet can’t go bankrupt.
When the price of a given mental is making positive headlines, as gold is today, investors get excited when they discover companies with giant deposits selling at deep discounts to their peers. The pile-in can be incredible. I’ve seen land bank plays deliver 10x returns in previous cycles.
Optionality is the simplest “buy low, sell high” strategy in the resource sector.
That said, I don’t own any land bank plays at present, and I’m not planning to buy any.
Here’s why:
- Optionality plays usually require a great deal of patience. To get in really cheap, you have to buy in when the price of the metal or other mineral is so low, nobody even wants to hear about it. Then you have to wait for prices to go manic, which can take many years. That’s fine for patient speculators like Rick, but doesn’t work well for a newsletter writer like me, with many readers eager for the next quick win.
- It’s risky to buy into a land bank when prices are already on the move. If we miss the cyclical bottom for the commodity in question, or deliberately wait until prices start to rise to avoid owning a stock that goes nowhere for years, dirt-cheap prices are usually long gone. This leaves us vulnerable to reversals that few investors can stomach—especially when they know the deposit was uneconomic to begin with. Jumping on the train after it’s already in motion can get us hurt.
- Management often screws up. To get the most out of an optionality play, management has to resist the urge to start playing with big yellow trucks. By resisting, they keep the burn rate low. This keeps shareholder dilution low, which increases the value added per share when rising prices increase the (perceived) value of the assets in the ground. But in my experience, few management teams can resist. They get impatient and decide to make the deposit bigger, or try to improve its economics with more drilling and engineering. Odds are that such work won’t make the project much better, but it will dilute the potential upside per share for investors.
- Mr. Market doesn’t always cooperate. Remember that these are uneconomic projects to begin with. If companies that owned them in the past blew up spectacularly as a result of spending millions on projects that don’t work, it can leave a lingering stench over the project going forward. And rightly so. Sure, other things being equal, higher prices are great for projects that didn’t work at lower prices—but other things are never equal. Oil is under pressure at the moment, reducing fuel costs today, but in general, operating costs and regulatory burdens are always increasing. A project that might have worked at $2,000 gold a decade ago might need $2,500 or $3,000 gold today. If that’s obvious enough, share prices in a given optionality play may not rise as much as speculators in the stock hope.
- Due diligence is still required. Optionality plays may seem like the perfect investment for a lazy speculator. Just buy ‘em when nobody wants ‘em and forget about ‘em until prices rise and we can cash in. Right? Unfortunately, no. As above, picking the right land banks matters; ones that can present a more credible case for becoming mines in the future will do better. There’s also the risk of management screwing up while we’re not paying attention. Land banks do still have operating costs, and if payday takes too long the dilution along the way can be brutal. And then there’s always political risk. Even in the most pro-mining jurisdictions, a change in the political winds can be very bad news. I don’t believe there is such a thing as a lazy speculator strategy—not a good one.
Where does this leave us today?
The rising gold tide I do expect to continue will probably lift most gold-related ships. But given that gold is already so visibly on the move, I wouldn’t go for gold—or silver—optionality plays today. Late 2015 would have been the ideal time to buy… but, apart from the fizzled rally in early 2016, any time from 2014 to 2017 would have been okay.
What about industrial metal land banks?
I might look into those if I were a private investor with no one looking over my shoulder, but not yet. When the global recession of 2020 takes industrial mineral prices well below the average cost of production and people don’t even want to hear about copper, iron, nickel, and so forth, that would be the time for very patient contrarians to look into optionality in that space.
At the end of the day, optionality can deliver terrific gains when its day in the sun arrives. The good news is that it’s easy for savvy contrarians to pick up land bank plays dirt cheap when the commodities in question are near their cyclical lows. The bad news is that “the day in the sun” can take many years to arrive.
Optionality isn’t for lazy speculators, but for patient ones.
That’s my take,
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