The insightful Nassim Taleb’s book on investing, Skin in the Game, advocates what he calls a “barbell strategy.” He shows how splitting one’s investments between low-risk and high-risk opportunities can outperform a more cautious, middle-of-the-road strategy.
I’ve written before that disciplined resource speculation can add a lot of upside to the high-risk end of an investor’s barbell.
Today’s market volatility and some of the responses to it that I’m seeing make me think that many investors take the analogy too far… or they seek to apply it incorrectly.
If you think about it, the old “60/40 rule” for splitting one’s capital between stocks and bonds is a type of pre-Taleb barbell strategy. Bonds may not be as low risk as they once were in the modern financial world, but that’s another matter. For a general investment strategy, splitting allocating some funds to high-risk, high-reward speculation and some to safer, more solid bets makes sense to me.
The problem I see is that some investors are applying this macro-level strategy on a micro-level.
Specifically, I see some resource speculators “balancing” high-risk, early-stage exploration plays with major—presumably much more solid—producers.
What’s wrong with that?
Nothing in the resource sector is solid. It’s all highly speculative, even the majors. I remember when major copper producer Teck fell off a cliff in 2008. The stock dropped from $49.55 to $3.23—a 95.3% haircut in just a few short months. It did almost the same thing from 2011 to 2015, without a market crash (just a prolonged bear mauling).
It’s a mistake to think that buying senior gold, copper, or other commodity producers makes investors safe from potential major capital losses.
It’s not all bad, since high volatility among the majors can deliver extraordinary capital gains as well. Several have doubled since their March 2020 lows. This is really something when you consider that despite reaching record highs, the S&P 500 is only up 16% over the last year, while the VanEck major gold miners ETF (GDX) is up 29.3%.
The point is that, as my friend Doug Casey likes to say, mining stocks are the most volatile stocks on earth.
And that means that if we can’t handle the heat, we should not enter the kitchen.
Specifically, it means that owning shares in some major producers does not justify throwing caution to the wind on a bunch of super-high-risk junior exploration plays.
I say this because I get fairly frequent requests for potential 10-bagger picks (stocks that might go up 10x). Occasionally, people ask how to identify potential 100-baggers.
Such stocks do exist. I’ve never nailed a 100-bagger myself, but I saw it happen to Paladin Energy 15 years ago. I have, however, bagged a few 10x winners in the past. (First Majestic, Fronteer Gold, Osisko, and Northern Peru Copper come to mind, but the data on these trades belong to my former employers, so I can’t document any claims I might make about them.) I expect to have even more in the future.
But here’s the thing: I hoped for a double or better in any stock I wrote up, but I never knew in advance which ones would be 10-baggers.
Neither did my bosses, by the way. That’s why we used a large basket approach.
What this tells me is that if I load up my portfolio with the kind of super-high-risk penny stocks, hoping for a 100-bagger to make all the pain worthwhile, I’m likely to go broke before such a rare, happy lightning bolt strikes.
If I do the same with very-high-risk potential 10-baggers, the odds are good that I’ll take so many brutal losses, I’ll give up before payday.
This is all the more so if I have a bunch of supposedly safe majors to “balance” my high-risk gambles—and the whole sector goes into reverse, taking all the stocks in the space much lower.
So what then—just give up?
Not at all.
I’ve found that a form of cautious speculation works for me.
By this, I do not mean that I focus on mid-tier producers, as a cautious middle ground between junior explorers and major producers.
I do avoid the extremes of the biggest mining companies and the earliest-stage (pre-discovery) explorers. I focus on the types of companies I’ve seen deliver the most value for the least amount of risk:
- Success In Progress. These are post-discovery stories that keep delivering value-adding drill results time after time.
- Pre-Production Sweet Spot. These are first-time mine builders that make the transition from pouring money into holes in the ground to getting money out of much larger holes in the ground.
- Exploration with Cash Flow. I don’t have a clever name for this, but it’s exactly what it sounds like. I can be very patient with good explorers if the company isn’t burning cash.
- Small producers with huge growth on tap. I don’t have a clever name for this either, but the idea is to look for profitable companies that may double production, or better.
- Great royalty plays. What makes one of these great is a complicated question, but it includes good cash flow and growth.
There’s a lot more I can say about each of these types of speculations than I can include in this essay. I’ve written full—and free—reports on the first two. In time, I’ll get to the rest.
To see how I analyze such opportunities, you can sign up for My Take, which now has a database of 370 recently updated resource stock evaluations. Whether you want to invest in any of the ones I like, my analysis can teach anyone a lot more about what to look for in these types of speculations. (And I take requests for coverage as well.)
But the basic ideas I’m trying to get across today are yours free of charge:
- Don’t kid yourself about being protected from downside by employing a barbell strategy within the resource sector.
- Do pursue the best resource speculations with discipline and due diligence.
That’s what I do with my own hard-earned money.
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