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Basics Of Penny Mining Stock Speculation - Part One

Thankfully, however, there are a handful of valuable books available to those who want to learn the basics of junior stock investing. One such resource is the somewhat dated -- but still extremely useful -- book by Robert Bishop entitled "The Investor's Guide to Penny Mining Stocks." Published in 1987, this volume contains a wealth of information on the basics of the junior mining sector in general including an overview of the exploration and mining process. It also contains numerous valuable tips for picking the right low-priced mining shares for maximum profit, both for growth-oriented and conservative-minded investors.

At the time the book was written, the price of gold was near the $450 level, not far from where it currently stands. Bishop begins his explanation of penny stock speculation principles in the junior mining sector by noting, "...it remains essential to understand that all mining stocks are at the mercy of price of the commodity being sought, developed or mined...As a group, precious metals stocks are almost wholly at the mercy of future rice trends." This is an important starting consideration for any investor in the junior mining stock sector to consider up front.

If you as a prospective investor believe that the gold price is headed higher, then the junior mining stocks would be an excellent leverage tool for profiting from this expected rise in gold's price. Bishop adds to this basic observation by noting, "Aside from an appreciation that gold stocks are at the mercy of the gold price, having a well-defined point of view on the price trends of precious metals will help dictate both the degree of commitment and the timing of purchases and sales of penny mining shares. Having a philosophy on gold also makes it easier to take action at the appropriate time -- or to weather the periodic price adversity that is common to all markets, sometimes especially so in the case of gold."

Bishop further adds that having an opinion on gold will also help determine whether mining stocks are held for the duration of a long bull market in precious metals, whether a trading strategy is adopted, or whether these markets are avoided altogether.

The next most common question asked by the prospective junior mining stock investor is, "How much or what percentage of my capital should I allocate to a mining stock portfolio?" My own answer to that question is that it depends on the individual investor, namely, what is emotional make-up when it comes to the financial markets (e.g., aggressive and risk-averse, or conservative and subject to being frightened by temporary pullbacks in share price). I also advise to my subscribers that only that portion of their available discretionary capital should be allocated to their portfolio that they feel they can afford to lose if worse absolutely comes to worse. In other words, never commit needed funds in the junior mining stock sector -- only commit those funds that are purely discretionary and not immediately needed for day-to-day business and personal survival.

In a similar vein, Bishop writes, "It depends almost entirely on the person asking the question, his overall investment philosophy and its relation to current economic conditions and the investor's level of experience with the investment -- whether it be gold, common stocks, junk bonds or rare coins." He adds, "I believe people should seek a comfort level and gain experience in the market. Based on that experience, the investor should work to develop a strategy that suits his financial and temperamental willingness to assume financial risk and, perhaps more importantly, squares with his own track record in the market."

Bishop advises that just as precious metals mining stocks represent a segment of a larger portfolio, penny mining shares should occupy only a portion of a broadly diversified precious metals portfolio. At its core, that portfolio should consist of gold and silver bullion and blue-chip producers, says Bishop. "Like a pyramid rising from a base of security, more speculative issues should be added to a portfolio only after a conservative safety net is in place. At least some portion of the bullion is an insurance policy that should be held through thick and thin; beyond that 'insurance' position, the metals should be bought and sold based on changing economic conditions." He opines that the blue-chip gold stock are best suited to profiting from cyclical advances in the price of gold.

With respect to diversification Bishop adds, "Within the context of a precious metals portfolio, penny mining shares should represent a diversified group of companies. Mining is a game of bad odds, and owning shares in numerous companies reduces some of the inherent risks of mining stocks while at the same time increases the probability of rewards."

Penny mining shares are naturally much more speculative and volatile than blue-chip stocks of senior and mid-tier producers. They also tend to be highly seasonal from year-to-year. As such, they should normally represent a much smaller portion of the well-rounded precious metals portfolio. Nevertheless, there are times when it pays handsomely to be heavily long the low-priced junior golds. The big advantage to owning junior mining shares is that in times of a rising gold market they can out-perform the blue-chips by hefty percentages. Knowing when such times are likely to begin is a subject addressed by Bishop in his book.

"When everyone thinks alike, everyone is likely to be wrong" is the essence of the contrary opinion investment strategy advocated by Bishop. Humphrey B. Neill, who authored the preceding quotation, is generally regarded as the "father" of contrary opinion investing. The necessity of going against the crowd illustrates human nature at work, observes Bishop. It is also an example of crowd psychology that drives home that is easily the most important tenet of investing: Go against the crowd and you will be right more often than you will be wrong, he says.

For example, it was a timely move in 1980 to be a seller of silver when the infamous Hunt Brothers silver market corner debacle was at a peak and the wily brothers made the front pages of Time and Newsweek, as Bishop observed. It was also timely from a contrarian standpoint to later buy silver once again when the brothers were forced into filing bankruptcy years later. "The advantages of buying at market extremes is even more important in penny markets," says Bishop, "because these stocks are so much more volatile than bullion itself."

As an example, Bishop noted that in the year his book was written the price of gold ranged from $378 to $482, a range of 27 percent. In contrast, the average stock of the junior mining shares at that time had a range of approximately 320 percent. "A contrary strategy rewards investors in any market but, because of the greater volatility of the penny shares, the rewards of true contrary investing are significantly more pronounced," writes Bishop.

Just as important as knowing when to buy is knowing when to sell. A strategy that Bishop strongly advocates is the sale of stocks that haven't performed to expectations. "The inability of many investors to bite the bullet, whether it be with stocks that aren't working out or merely aren't ripe with the same expectations they were at the time of purchase, is the reason many investors end up owning 25, 30, 50 or more companies," he writes. "These people buy companies and, rather than sell when things don't work out, relegate them to a kind of 'nonperforming' corner of a portfolio. Like old clothes in a closet that they hope to wear again, some investors file these stocks away in hopes that they'll come back to life."

Bishop goes on to address what is perhaps the most widely recognized strategy to take profits, viz., selling half of a stock position if it doubles in price. He dismisses this strategy as being "a sure way to instill mediocrity in a portfolio." Instead of this he advises isolating the best stock in a portfolio, rather than arbitrarily selling half of what may turn out to be a stock that should have been held for much larger gains. He cites a study by the New York Stock Exchange that showed that a stock that went up by 1,000 percent had 27 changes of ownership on the way up. Conversely, stocks that declined by the same percentage changed hands only twice on the way down. "The people in this example, at least, were cutting short their profits and letting their losses run -- exactly the opposite of the way it's supposed to be done," observed Bishop.

Bishop urges taking partial profits at various times in a soaring stocks, a sentiment that even the most aggressive traders should concur with. He advises selling on a double "only if it squares with a short-term trading philosophy or your own ultraconservative investment viewpoint."

January 30, 2005

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