International Man: What is so attractive about making investments through private placements versus buying in the open market?
Doug Casey: There are a lot of advantages. To start with, you don’t pay a commission to a broker. If a broker is involved, the company pays the commission.
Second, private placements are almost always done at a discount to the current market price. Depending on the price of the stock and how badly a company needs money, it can be 5%, 10%, even 15% or 20% below the current market.
Third and by far most important is that you almost always get a warrant attached. A warrant gives you the right, but not the obligation, to buy another share at a fixed price. Warrants are critically important, and they come in many flavors.
It might be half of a warrant, good for only six months at a significant premium to the market price of the stock, but a typical warrant is for two years, with a strike price only slightly above current market. You can determine its value using the Black-Scholes formula, but let’s not get into the math here. The point is that a warrant is always very valuable.
The best situation is a five-year detachable warrant, with a strike price close to the market price. Most warrants are not detachable. In other words, they’re part of your portfolio, and if the stock goes above a price, you can exercise it—but you can’t detach it from the original private placement and sell it separately.
The detachable warrant, however, trades separately and has its own market value. These are unusual and highly desirable.
But regardless of their particular characteristics, warrants are a significant reason to do private placements.
I try not to buy a resource stock unless it’s in the form of a private placement—a PP. Resource companies are risky for a lot of reasons. PPs allow you to de-risk them to some degree and greatly increase your upside.
There’s only one real disadvantage to PPs. Namely, there’s typically a holding period of about four months before you can sell your stock. Depending on the market, that can be an advantage or a disadvantage. The disadvantage is that you’re “locked up” and illiquid for a while. But if you’ve chosen a PP wisely, that fact may keep you from shooting yourself in the foot by selling too soon.
If you like a company, you should always check to see if it’s possible to buy a private placement. If it is, you should almost always do that as opposed to buying in the open market.
Most of the private placements I get into are resource-related stocks, mostly precious metals. Most of the stocks traded in Vancouver are resource-related, but there are a good number of technology deals too.
When I first got into the resource market, I didn’t know enough to look for private placements. After I gained some experience, private placements were basically the only type of buying that I would do. Unless I really like a company and a private placement isn’t available. Then, of course, I’ll buy on the open market.
International Man: What do you look for in an ideal deal, and why?
Doug Casey: The critical thing with buying any stock is the fundamentals of the company. If a company is in trouble, it doesn’t matter how good the terms of the financing are—you don’t want to own its stock.
I try to be disciplined using my “Nine Ps” method for resource stock evaluation to determine if I want to buy into a financing. I won’t go into explaining the details here; that’s a whole different subject. But I suggest everyone become familiar with them.
Finding good PPs used to be hard. Historically, there was no easy way to know which companies needed financing. There was a loose network of investors and speculators who would call each other. That required knowing the managements of companies and whether they needed to finance and being in the room in order to be in on the deal.
This has always been a problem and a reason the public in general hasn’t been involved in financings. There was no way for them to find out about it, except by happenstance.
International Man: When is the best time to participate in a private placement? How does the overall stock market and where a particular industry is in its market cycle affect a deal?
Doug Casey: The last eight or so years have generally been a bad time to be doing private placements in resource stocks, because the trend of all commodities has been down.
Most companies raising money in private placements have been rather desperate, just trying to keep the doors open, and there hasn’t been a lot of interest in putting money into the space. The market’s been bad, but the deals have been pretty good from a buyer’s point of view. You should be looking for a buyer’s market like this.
Right now, it’s still a buyer’s market, because perceptions lag. But as we speak, the market has turned, and the bear market has ended. The bull market has begun. Gold has gotten back to $1,800, and I think it’s going much higher. It’s an excellent time to position yourself for the next couple of years, which I think are going to be very good.
If this bull market is anything like the last one, the average junior mining stock could go up 1,000%, and if you have warrants, you could double your profits. I kid you not. These are the most volatile stocks on earth. I personally owned one stock in a previous bull market that didn’t go up 1,000%, but 1,000 times. That said, most mining stocks are burning matches.
What people often do with PPs after the four-month hold period has expired is sell the stock, take their capital of the table, and de-risk their position. Then hold on to the warrant in case the company gets lucky or the market keeps moving.
The ideal portfolio in junior resources is nothing but cash and warrants—not actually owning the stock itself. Again, that’s the advantage of PPs. They let you do that.
International Man: How come more people don’t know about investing through private placements?
Doug Casey: Most people don’t know about investing in the resource markets at all—period.
And they don’t know anything about gold stocks or anything about the mining business.
On top of that, in the past, private placements have been just for professionals. Now that seems to be changing, but I certainly don’t recommend buying them willy-nilly. You must understand the fundamentals of the business.
Most PPs are in the resource business. Much more than any other area of the stock market.
Because junior exploration and development companies have no cash flow. They’re constantly spending money and have no income. They’re necessarily and constantly raising money. They’re always doing private placements.
In the past, it was just professionals who knew about them. The public can now get involved in them—but that doesn’t excuse them from doing research.
These things are lottery tickets, it’s true, but you shouldn’t treat them as lottery tickets.
Editor’s Note: In this rare message, legendary gold investor Doug Casey shows you the secret to how he invests and the most lucrative “insider” way of multiplying your gold mining stock returns.