Red Flags for Investors

Six months ago, something called VRify Technologies published a very funny spoof video of some of the nonsense employed by investor relations (IR) people in the junior resource space. They’ve just published an equally humorous sequel, with cameos by my friends Rick Rule and Brent Cook.

While I found the IR hack in the videos talking with his mouth full painful to watch, I can say that I’ve heard and seen almost everything in these videos in my years as a Due Diligence Guy. I should also say that I’ve encountered IR professionals who are quite the opposite of the hack in these videos, to the extent of refusing to even mention nonpublic information that could benefit them.

That said, a lot of IR people I’ve met will spin the facts as far as they can to sell their stories, up to and including flat-out lying to my face.

So I thought I’d share some of the red flags I’ve learned to watch out for.

• Visual assays. In the first video, the IR hack says, “I have two words for you: ‘visual assays.’” It’s true that if a sample contains a large amount of a visually distinct target mineral, one can visually estimate grade—if you limit your definition of grade to “traces,” “some,” and “a lot.” Certain copper, lead, and zinc sulfides, for example, are easy to see. But you never really know how much is there until you have real assays performed by a lab. For most gold deposits, you can’t see the gold at all—and specs of it can be highly misleading.
  
• Gross Metal Value. In the second video, the IR hack says, “I have three words for you: ‘gross metal value.’” It’s possible to calculate the theoretical value of metals contained in mineralized rock. If the current price of gold is $1,200, then rock with an ounce of gold per tonne would have a gross metal value of $1,200 per tonne. A 1-million-ounce deposit of such rock would have a gross metal value of $1.2 billion. But a high gross metal value doesn’t guarantee any real value at all. For starters, such figures exclude the costs of mining. But even if the grade were high enough to make the costs seem likely to be reasonable, such figures don’t even begin to address the political and technical feasibility of mining the rock at all. None of the serious players I know ever mention gross metal value.
  
• Closeology. One of the first things mining stock promoters will often say is that their company’s project is “near,” “adjacent to,” or even “on strike from” some famous mine. It’s true that, as they say, “the best place to find a mine is near a mine”—particularly for deposit types that tend to come in clusters, like porphyries or VMS lenses. But that doesn’t make it easy to find nor in any way guarantee that there will be another viable deposit close by, let alone on the particular company’s property. Being close to a mine is at most interesting. I give it zero value when appraising a share price.
  
• Famous investors. If a project is great, with a clear and easy to see value proposition, it doesn’t matter who else might own shares. Value is value. But if the most exciting thing a promoter can tell me about the company is that Eric Sprott, Rick Rule, or Doug Casey owns shares, that’s a red flag. It’s not that Eric, Rick, and Doug aren’t successful speculators—they are. But they operate on a completely different level from most retail investors. They usually buy in on highly leveraged private placements and can afford to cast a far wider net than most others. To be clear, I’m not saying that ownership by one of these gentlemen is a reason to avoid a stock—just that it alone presents no value to me as an investor.
  
• One-Hit Wonders. Experience has shown that the quality of the people in any given speculation is of the first order of importance. So it does matter when management of a company I’m researching has a track record of success. The more the better! But exploring for resources is an extremely difficult task, one that the best in the business fail at repeatedly. They aren’t the best because they can’t fail, but because they ever succeed at all. So, while I’m pleased to see past success in management’s careers, I don’t take it as a guarantee of future success. And if the past includes only one notable win, I keep in mind that this could have been a result of luck, not excellence. A company that relies more on touting on a single past success than the merits of its current project is waving a big red flag, in my view.
  
• Insider Information. One might think that getting useful information before the rest of the market does would make profitable trades a sure thing. And if the info was true, it might. But if some IR guy is telling me some confidential information (off the record, or just between us as friends, etc.), I’d be a fool to imagine I’m the only one he’s telling. That aside, it’s illegal and speaks poorly of his judgment—and the management that hired him. Quality players do not spill the beans before they’re supposed to.
  
• The T&A Ratio. Sorry if this is indelicate, but it’s true that there are companies that spend more money on promotion (which shows up as G&A on their P&L statements) than on exploration. In some cases, this literally takes the form of hiring attractive ladies who know nothing about the business to accompany analysts (who are mostly men) on site visits, or to attract visitors to company booths at trade shows. I’ve seen mature men responsible for millions of investment dollars so distracted by such “booth bait” and alcohol, they don’t even notice all the bright red flags waving crazily in plain sight. This is easy to see, but hard to measure. I find a company’s G&A ratio is a strong indicator.
  
• Geo-Jargon. Geology is a science. Geologists use a lot of big, scientific words. Same goes for other technical experts. Nothing wrong with that. But there’s no reason that whatever an expert is talking about can’t be boiled down to plain language for investors. If it isn’t, one has to wonder if they’re trying to hide something. For instance, when a press release starts with long technical description of rock types encountered rather than the bottom line of how much metal or oil or whatever was found, I’m not surprised to see that the company didn’t find much. If you feel that an IR person or any company communication is trying to snow you with jargon, they probably are.
  
• Twinning. This is when an explorer duplicates a past drill hole with a new, parallel one. There’s nothing wrong with this when it’s made clear from the get-go that the results confirm known mineralization. What legitimate reason would anyone have for doing this? A common reason is when there’s historical data that could be used in a modern resource estimate or economic study, if some of the old results are confirmed by new tests. But when a company duplicates past results just to get an exciting headline, or worse, obscures or neglects to mention the fact that a drill hole is a twin, it’s highly misleading. It’s hard to see such practices as anything but deliberate deception.
  
• Conceptual Resources. Countries have different rules for reporting, describing, and calculating the nature and value of mineral resources in the ground. In the US, you either have Proven and/or Probable mine reserves, or you have nothing. For a deposit to count as a mine reserve, it has to be more than drilled off with reasonable accuracy: it has to have demonstrable economic value. That means that until you’ve done some work studying the recovery of the resource from the ground and have fact-based cost projections at near-current prices, you have nothing. This strict approach places no value on resources that have been discovered but not yet advanced to the level of bankable mine reserves. In Canada, as per National Instrument 43-101, there are three officially recognized resource categories below mine reserves: Measured, Indicated, and Inferred. A Measured resource would be considered a Proven reserve if economic viability were added. An Indicated resource would be considered a Probable reserve if economic viability were added. Inferred resources show only the potential scope of a deposit. But some companies go further than this, touting “conceptual” resources. This is like saying, “If we find something, it could be thiiiiis ” I can’t think of a case where I heard of such resources in which the reality later met or exceeded the conceptual dream.
  
• Flavor of the Day. Resource markets are famous for their cyclicality. They are just as well known for their propensity for momentum to take stocks ridiculously high (or low). These traits make for fleeting trends in which any company with X commodity in its name can see huge increases in share price without any actual addition of value on the ground. Lithium, zinc, rare earths—lots of fashionable commodities have boosted share prices, just as adding the word “blockchain” boosted shares in many tech plays last year. Now, it is possible to make money by piling in to a flavor of the day early. I’ve done it myself. But it’s obviously very dangerous to buy in when a fad has had its run. And it’s hard to say when that will be. Because such trends create high valuations based on momentum and emotion rather than objective value, they tend to reverse sharply, like bubbles popping. What to do? Only buy in to a flavor of the day if the underlying fundamentals strongly support it going forward. Don’t chase stuff just because it’s rising. Speculate rationally if you can see that it truly is in a supply deficit or demand can realistically be seen to outstrip supply for years to come.

Someday I’ll write a book on decoding IR-Speak. It would make a nice set alongside a book on decoding Geo-Speak. Both projects are on my to-do list, but will be a while. The list above should be enough to get you started.

The main thing is to always, always, always be skeptical.

In fact, I thought of naming my newsletter The Skeptical Speculator. But as vital as skepticism is, I thought independence was even more important. Skepticism doesn’t help if one is biased—or bought. Hence The Independent Speculator.

Fortunately, both are virtues you can embrace as pillars of your own investing. I highly encourage you to do so, and salute those who already do.