Investing Near The Bottom Of A Commodity Cycle: Junior Mining

A Conversation With Brent Cook

By Aditya Pattanaik

In 1975, Charles Ellis published his seminal article on investing, “The Loser’s Game.” He likened investing to a game of tennis between two amateur tennis enthusiasts, in which winning was more about keeping the ball in play and less about hitting winners. In trying to beat the market, he argued, a focus on minimizing investment errors was more important than picking the winning horses. More than four decades later, as I write this article near the bottom of a protracted bear market in the metals and mining sector, Ellis’ lesson of playing-not-to-lose seems paramount.

As a long-term investor in the junior mining sector, I have sought two outcomes for my own portfolio while waiting for a commodity cycle to turn: preserving capital and minimizing the amount of dilution of the equities I own. In doing so, I have accrued specific lessons on due diligence, discipline and patience — from my own experiences and those of other successful investors.

I recently picked up some useful insights from a conversation with Brent Cook, a veteran geologist-investor in the junior mining sector. What does he do differently today as an investor, after having been through a comparable bear market 20 years ago, when he first started as an investment analyst with Rick Rule? The déjà vu feeling was hard to ignore as the conversation progressed; history doesn’t always repeat itself, but it does seem to rhyme.

To retail investors, Cook offered up particularly noteworthy lessons on winning the loser’s game. Cook began by describing market conditions in the late 1990s, which sounded a lot like today’s junior mining sector:

“I joined Rick Rule in 1997, just as things were collapsing in the metals and mining market. Initially, I would really just focus on the geology. If the project seemed like it had a good shot, if it was a good exploration play, I would consider the stock. But I lost a lot of money doing that. By 2000, I was $90,000 in the hole. This was on a $250,000 loan from Rick. A lot of stocks just kept going down. You’d think it can’t go any lower, and then it did. And it kept going lower and lower. It was bad. Nobody cared about this sector. It was all about the internet boom.”

In a bear market, good projects run by competent individuals are often on sale. But watching an investment drop 30%, 40% or even 50% below a sale price that one picks can test a person’s conviction in an investment. The bottom is almost always impossible to pick. I wanted to know whether Cook’s entry and exit strategies into and out of a stock had changed over the years, especially in an indifferent market.

FOCUS ON THE FUNDAMENTALS

Cook maintains his belief that if you position yourself in companies with good projects and people you trust — and if you know their business plan — then when things turn, you’ll perform really well. He recalled one of his earliest investments, made in 1998, in Virginia Gold Mines, which would end up discovering the 5-million-ounce Eleonore Gold deposit in Quebec seven years later. Cook detailed his initial investment:

“Virginia Mines was one of the first companies I bought after I joined Rick in 1998. It went from being a $3 stock to a 75-cent stock with 50 cents in cash. I bought some at 75 cents thinking it was a good deal. And then it went lower — first to 50 cents and then to 35 cents. It was trading for less than cash, with a real solid guy at the helm. There was no single project that was a winner, but they kept churning out a bunch of good ideas. The market just wasn’t interested. I finally sold the stock at $1.20 three years later, after sitting there with not a lot happening. I sold it all. It was my one of my first wins in three years.”

The narrative for Virginia Gold Mines changed dramatically two years after Cook’s sale when the company came up with the Eleonore Project. Cook flew out and looked at some of the early results in the field. The geology looked promising, so he bought back into the stock at $1.50. Eleonore turned out to be a 5-million-ounce gold deposit. The market sentiment was also changing. The story ended well, with over 1000% gains on the stock — and seven years in the making.

Cook’s message then is to focus on the fundamentals and pick good companies. And then be patient. Today, many good junior mining companies and long-term retail investors are again in this position of patient waiting. Still, seven years is a long time to wait.

Virginia Gold Mines Stock Chart

KNOW THE REASONS FOR OWNING A COMPANY

Cook’s Virginia Gold example led to a discussion about exit strategies in a bear market — specifically, when not to be patient. Greed or fear, or both, is usually at play at this point. A disciplined approach becomes particularly important. Rule has often made this point — that he always buys a stock for a specific reason, and if the reason for owning a stock goes away, he sells his position ruthlessly. Cook emphatically agrees on this point:

“One of the things I’ve learned the hard way is that if your thesis for owning a stock fails, … sell it. In the long run I think it works out better that way than hoping that maybe something else will work. If I’m buying a company for a specific project and the project fails, I’m out. Likewise, if the management changes its business plan to one I don’t like, I’m out. … Take the losses and run.”

What were his thoughts on looking beyond people, projects and price in making an investment, especially in pre-revenue companies? Cook noted that he ended up losing a lot of money initially by just focusing on the geology, in a generally downward trending market.

“The first thing I still look at is the project. If I don’t like the project, there is not a lot of reason to invest in the people. The project could also include the business plan. The due diligence checklist is a big part of it. But I also look more closely at share structures, working capital, JV agreements and business plans. Is what they are spending the dollars on really going to advance the project forward? … If it doesn’t, it just gets worse and worse.”

To illustrate his point, Cook highlighted his investment in Glass Earth Gold, an exploration company that locked up the ground next to the Waihi deposit in New Zealand, an 11-million-ounce gold deposit. The geology and geophysics showed that the mineralization continued on to Glass Earth’s ground. The company had joint ventured the project with Newmont and the first few drill holes confirmed the geological thesis. The problem was that Newmont’s drilling program was not very aggressive, so it was only drilling a few holes every year.

To generate revenue, Glass Earth shifted its focus to alluvial mining on the South Island. But this wasn’t the company’s primary skillset. As a result, it lost money and withdrew from the alluvial mining gig. The property ultimately ended up in the hands of OceanaGold, which drilled it recently and found a large deposit. A bad contract with the JV partner and Glass Earth’s business-plan change to something it was inadequately equipped to handle ended up badly for Glass Earth investors.

PLAYING-NOT-TO-LOSE

Investors differ in their circles of competence, risk-taking abilities and incentives. Over the course of my investment journey, I’ve collected my own set of checks and balances to stack the odds of success in my favor. Knowing what I know and knowing what I don’t know — and then finding trustworthy advisors to fill these knowledge gaps — were an important part of this journey.

The lessons of sound investing are simple in theory. Controlling the urges to react to falling or rising stock charts in volatile and cyclical markets is the difficult part. Successful investing takes time, discipline, patience and a temperament that derives neither great pleasure in being with the crowd nor against the crowd. Investors that focus on the longer term, that understand the fundamentals of an investment in great detail and that play-not-to-lose seem, on average, to win the most.

In explaining what makes him a better capital allocator than most of the competition, Charlie Munger has said, “A lot of other people are trying to be brilliant. We’re just trying to be rational.”1 Perhaps Munger’s words are a fitting summary of my conversation with Cook.

1 2017 Berkshire Hathaway Annual Shareholder meeting

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