A big stream in the torrent of questions I get from readers every day is for quantitative decision-making tools.
People want to know the “right” proportion of silver vs. gold stocks to own. Or the “correct” NAV multiplier for evaluating a royalty company. Or what the minimum acceptable percentage of insider ownership of a stock is. Or how high does grade have to be to make a mine profitable?
I could just answer that one size doesn’t fit all. That’s certainly true.
But these questions touch on something much more important that I think all investors should think through carefully and keep in mind.
If you remember anything from basic high-school science classes, you may remember the concept of significant digits.
The idea is that if you have a ruler that can only measure down to millimeters, it’s pointless to take your calculations to tenths, hundredths, thousandths, etc. of a millimeter. It’s just as much a waste of time to calculate milligrams if you have a scale that can only distinguish between weights of a gram or more. The same goes for any calculation done on anything we can measure.
This is why we round numbers up to units we can actually measure. Those digits are significant. The rest are not.
Why is this important to resource speculators?
Because it’s a common mistake to overthink many of the quantitative issues we face in making our investment decisions.
Craving certainty, we look for mathematical tools that give us impressive numbers that bolster our confidence. But the output of these tools depends on assumptions about things that are usually difficult, if not simply impossible to measure. They are often flat-out guesses.
Key Point: No matter how much math you pile on top of a guess, the result is no better than a guess.
In other words, none of the digits are significant. None.
I think that’s clear enough, but for an illustration of what I mean by this, please see my article on “The Adventures of Spreadsheet Guy”.
I bring this up because I still get requests, almost every day, for things that amount to methods for glorifying guesses so people can feel better about their speculations.
Let me be as blunt as I can…
Even the biggest and oldest mining companies in the world are speculative ventures that are ill-suited to conventional securities analysis.
Miners are not like, say, shoe manufacturers that can reasonably project supply, demand, and price trends for shoes. The root variables a miner faces and the prices of the minerals they mine are subject to such sudden and drastic changes, even the most conservative assumptions often fail to be conservative enough.
These companies spend billions of dollars building mines that they think will work. But they can never really know for sure until they build them, flip the switch, and see what happens. Spending hundreds of millions studying such a project greatly reduces the risk it won’t work, but never completely eliminates it.
And that’s just speaking of the biggest and most stable companies. These problems are magnified for smaller companies—and they’re basically off the charts for junior explorers with no revenue.
Don’t fall into Spreadsheet Guy’s trap of wasting time pursuing insignificant digits in order to produce an impressive result that can only give you false confidence.
This doesn’t mean we shouldn’t do what we can to evaluate speculations and rationalize our portfolios. We can, and should. But we should recognize the limitations of anything based on assumptions regarding things we can’t measure.
Details on this will have to wait until I can write a Due Diligence 101 book.
But there’s one main application of this idea I do want to convey to one and all. I’m not just bringing up Spreadsheet Guy to warn you about relying too heavily on guesses about future value companies may or may not deliver. It applies to the tools we use managing our own investments.
Key Point: Truly great speculations are so, so rare, I don’t ever want to turn one down because of some arbitrary rule, like a portfolio-balancing metric.
This is why my answer to many of the questions I get is so often that one size doesn’t fit all. Or that it depends on many variables. Or that I don’t want to glorify a guess by putting an impressive-looking number on it.
In short, apply all the metrics, math, and guidelines you want to your speculative investments, but don’t exceed your significant digits.
Or, more simply: don’t overthink things.
As a speculator, I’m quite happy if I just get the direction right on prices I’m betting on.
Sincerely,
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