Sprott Inc (SII)

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Glum Resource Market Creates Value Plays: Adam Footer

http://sprottgroup.com/thoughts/articles/glum-resource-market-creates-value-plays-adam-footer/

Having lived through the pain, you might as well stick around for the gain.
-- Rick Rule

The last two years have been tough for the natural resource sector – though as of November 5, gold was up nearly $100 from its late June low of around $1,220 per ounce1. Today (Friday, November 8) gold saw a steep fall back down to around $1,285, which has been tied to a report of stronger job growth in the U.S.2.

Adam Footer, an Investment Executive at Sprott Global Resource Investments Ltd., says the two-year fall has left the junior market under-followed, and describes two types of companies that could make good investments now.

“Most people are either depressed about the sector or have stopped watching out of lack of interest,” he explained. “If you want to invest in the sector, you have to act within the context of the current market. You cannot ‘throw darts’ and you cannot buy low-quality companies, because in a disinterested market, these boats will not float.

“A common mistake that I see is focusing too much on tomorrow’s metals prices – which we do not know. Predictions are often wrong and will only bias your analysis when it comes to stock selection. Instead, adapt to today’s market and plan to invest without immediately higher precious metals prices.

“An area to look at could be potential takeover targets that control high quality assets. You may be early, but you can be fairly confident that you will get in cheaply relative to a few years ago.

“For people invested in the sector, continue to know what you own; some companies can ‘control their own destiny’ because they have cash on hand and are performing work that will generate news. Positive drill results or a new discovery can still make a stock stand out regardless of the trend in commodity prices.

“In this type of environment, we look for stocks that the market has to care about – i.e. companies that can put out positive news, giving the stock near-term upside potential. No matter how bad the market becomes, there will be serious money in the sector. Because of this, there are still companies that the market has to care about, even when it does not pay attention to most of the companies out there.

So what can you do today?

“Ask yourself if the companies that you own can go higher if the market stays still, or gets worse in the next year. In a lot of cases the answer will be no.

“Then you have some decisions to make – selling positions to raise cash, reallocating within the sector, scaling out of some positions, or even reallocating your portfolio to increase your yield or income allocation. Hoping for your stocks to go back up costs you money and kills your morale -- ask anyone who sat through the NASDAQ decline in the early 2000’s. Set yourself up for success in this market, not the market of three years ago.

“If you have cash to invest, there are some nice opportunities out there. But don’t rush, and don’t commit everything at one time.

“You can start by looking at what stocks bucked the trend this year. Remember that we are in a bear market: any junior that performed well this year is an outlier and may be doing something exceptionally well. Is there potential for this to continue for the next year?

“In most cases these outperforming stocks were driven higher by exceptional exploration results that discovered or grew an asset. When an asset grows it usually increases in value, regardless of the market conditions, and share prices can increase accordingly.

“Another opportunity lies in companies that are trading sideways at a depressed price, but own an asset that is known to be of high quality. These stocks often fall to the wayside because they are no longer publishing attention-grabbing news releases. Their high-quality asset, however, is the same regardless of whether we are in a bear market or a bull market.

“Remember that grade is king. If you can buy high-quality, high-grade assets at bear-market prices, then you will feel good about it when the market eventually turns bullish.

“So there are two strategies that can help you narrow your focus. You can buy the high quality that the market has forgotten, or you can buy the small segment of companies that are putting out news that the market still cares about. These are two ways to try to reduce risk in an otherwise very risky sector.

“Finally, remember to temper your expectations, because if you expect prices to rally immediately after making a stock purchase you stand to be disappointed. Buy because you believe you will be rewarded when this market turns around regardless of how long it takes.

“Using this approach, you own the best-in-class assets, which stand to lead the way when the market shifts to early-stage bullishness. You can then consider re-allocating to more risky or speculative positions. But now is not a time to take on a lot of risk through blind speculation.

“Bear markets are hard to sit through, but we believe we can make it work for us in the long run. It is a matter of finding the right course of action and sticking to it.”

P.S.: For 10 questions Rick Rule asks before investing in any natural resource play, click here.