In Search of Speculative Perfection

August 2, 2002

During my nine years dealing with speculative stocks and cycles, I have noticed that during such times you develop somewhat of a procedure that separates the "wheat from the chaff". The initial stages of your investment career are spent following others and this could well relate to reading newspapers and magazines and once the Internet exploded every forum available to you was the source of a wealth of information. Have you ever stopped and wondered why a hot stock tipped in the newspaper opened up with a flurry then decayed like a junk food addicts teeth? With another example you have picked off a hot tip of a major announcement and you sit their with your jaw dropping in amazement at how the market could be so unforgiving to the hottest story since "Yahoo". It all boils down to how a stock moves from being totally neglected and unloved into a market darling. At times the majority of companies will be savagely beaten with the ugly stick, however it is how they handle the lean times that can determine their ultimate success or failure.

In one of my favourite financial books, "One Up On Wall St" by Peter Lynch there is a chapter that relates to the search for the elusive ten-bagger, which in my opinion is what stock market speculation is all about. Whilst the 5c short-term trades provide an adequate adrenalin rush, it is the satisfaction of watching a junior explorer evolve into a profitable producer that makes the whole experience worthwhile.

TWENTY QUESTIONS AND A BASIC ASSESSMENT

Normally the stock market for many is the second biggest investment they will make throughout their lives. When we embark on buying a new car we often will look for the features, value for money, and most importantly the rate at which the asset will depreciate once you drive it out of the caryard. I would much prefer a decent gold producer than a car with the "new" smell, however in striking a balance we cannot discount our partners who derive more pleasure out of chocolate and shopping than a considerable winner on the market. It could well be said that paper gains on the market are not really "tangible" until they are realised. I remember only a couple of weeks ago sitting at a blackjack table, playing to the rules with only the occasional "suicide split" and dropping around $100 that really hurt despite the fact I carried the thought of a $7 per ounce rise in the gold price to the bar with me.

Have you ever noticed the difference in attitudes and skill of the players at a casino during the week, or a few hours prior to the drunken players in nasty Hawaiian shirts arriving in droves? The same could well be said for the markets opening rotation as you tend to get a bout of either panic buying or selling, before normality is usually restored an hour to two later.

Twenty Questions….

  1. Is the company well managed?
  2. What category does the company fit into? I.e. producer, explorer or both.
  3. Does management have a track record of bringing new projects on stream?
  4. Do management own a considerable amount of the total issued capital?
  5. Have those behind the company experienced both boom and bust times?
  6. Is the company issuing cheap stock and options to themselves and friends on a regular basis?
  7. Does the company regularly update their website?
  8. Is the commodity the company is producing/exploring for out of favour, or showing some signs of improvement?
  9. Does the commodity offer potential based on a medium-term return to economic growth despite the potential for a double-dip recession?
  10. Is there an investor information kit available and is it current?
  11. Does the company secretary or director return your phone calls?
  12. Are directors constantly in meetings when you ask to speak to someone?
  13. Does the company have a tight structure, where the top 20 own in excess of 50% of the issued capital?
  14. Would the company seek near-term cash flow to fund a larger scale project down the track, rather than dilute their shareholders?
  15. Does the projects location suffer from political risk, and if so has the market over-discounted the risk profile?
  16. Are the quarterly and annual reports well presented, and include potential threats as opposed to continually being upbeat?
  17. Is the company heavily promoted in the papers and on the Internet yet the share price hardly moves?
  18. Has the company ever been suspended for failure to pay ASX listing fees or failure to lodge a report prior to the cut-off date?
  19. How did the company's share price hold up in the wake of the significant near-term sell off in gold and commodities?
  20. Would you increase your holding if the share price halved on low volume with no negative news?

If the majority of your answers to the questions are yes (75%), the odds of finding a medium-longer term growth situation have been greatly enhanced. In order to assist the process I have provided a brief case study of Aquarius Platinum (AQP), which I covered in 1998, and again in my book in 2001. Unfortunately my buy and sell notes match perfectly (after hoping there was some loose stock floating around), and whilst the 45% profit was handy, it was certainly a lesson in developing patience towards the more solid speculative situations.

AQUARIUS PLATINUM (AQP)

In June 1998 Aquarius Platinum was trading at 45.5c. The company underwent a code change from AQS and AQP, in late 1999 (hence the chart does not show the move from the sub 50c level.

  • AQP maintained a tight structure, throughout its early stages and had supportive major shareholders.
  • During the initial periods of weakness there were concerns based on Russian supplies of PGM's. The perceived near-term price pressure resulted in little interest directed towards PGM stocks.
  • In 1998 the company indicated the potential to producer 100,000oz of platinum per annum, with palladium and rhodium production.
  • The collapse of the Rand in 1998 delayed the company's listing in 1998 and also resulted in the share price falling to a low of 38c.
  • The price of PGE's soared in 1999/2000 and AQP benefited from the commodity upside, and also being one of only a handful of platinum producers/explorers listed on the ASX. (Attracted the bulk of the money flow). Towards the end of the PGE run, there were a number of new entrants into the sector, along with companies electing to refocus their attention on previously neglected tenements.
  • AQP achieved growth through project acquisition and increasing their production profile.

The significant increase in AQP (the stock was in fact a 20-bagger) was not simply based on the strong performance of PGM's from late 1999. It was a combination of having a strong management team, tight capital structure and being a standout in their sector.

HINDSIGHT IS A WONDERFUL THING

We all like to look back through charts and dream of holding a significant stake in a company like AQP from a low level and selling out just before that imaginary bell rings to signal the top. The fact remains that many like myself at the time would settle for a modest profit and move on. I had a small number of clients that held on through the majority of the rise, and it was more of a case of not needing the money than sound financial management. The temptation to sell your winners and hold onto the kennel of dogs in the hope of miracle tends to dictate during your financial career and as a result many fail to progress over a number of years.

NARROWING DOWN THE FIELD

In racing terms you would want a field similar to that of the Cox Plate as opposed to the Melbourne Cup. Trifecta punters would be all too aware of the potential of a long shot to fill the minor places, and as a result they tend to box the field for the third selection, which blows the cost out of the ticket significantly. Once you have negotiated the culling process, portfolio allocation comes to the fore, and as with most long-term situations you should allow for a 50% correction in the share price at some stage. (Post S11 a number of the longer-term situations fell on low volume, however they were able to recover fairly quickly).

PLACE YOUR BETS

The rationale behind the potential ten-bagger could range from a company moving into production 2-3 years down the track, or looking towards a tightly held explorer with encouraging initial results, that would be well received during a precious metals/commodity boom. Investors have a tendency to disregard production scenarios that are in excess of six months out, and this is a key advantage for a patient investor that would rather gradually accumulate than exhaust their capital in one purchase. For those that are looking towards the exploration scenario, some avenues of research should include, the proximity to major geological hot spots, a review of the Gawler Craton boom in 1996, Bre-X in 1997, and the price activity of Poseidon in 1969/1970. I have researched and come up with four candidates (lowest price 7c, highest low 50's) that could well develop into mid-cap diversified resource companies over the next five years. With the precarious state of the US market, and doubts over a sustainable economic recovery in the short-medium term, the challenges are certainly immense but with weakness there always lies opportunity.

Due primarily to the California Gold Rush, San Francisco’s population exploded from 1,000 to 100,000 in only two years.