The Most Important Thing Illuminated

What Type of Thinker are You?

The depth to which you research and think about an investment will most often dictate how successful you are. Howard Marks uses a great comparison of first versus second-level thinkers. He says,

“First-level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority).”
~Marks, The Most Important Thing Illuminated. pg.4

“Second-level thinking is deep, complex and convoluted. The second-level thinker takes a great many things into account…Second-level thinkers know that success in investing is the antithesis of simple.” ~ Marks, The Most Important Thing Illuminated, pg.4

Here is a real world investing situation with a first and second-level solution: A gold mining company publishes a news release about lower production numbers for the next quarter, unfortunately, matching the previous quarter’s low results.

• A first-level thinker reads the news release and says let’s dump the stock

• A second-level thinker reads the news release and asks, “can they fix this production issue? What is the value of the stock if they can only produce at this current rate of production?” Most people will sell the stock because of this news; I think you should buy if there’s value there!
It’s easy to see the difference between the two lines of thinking and why the second-level thinker will always beat the first-level thinker. BE A SECOND-LEVEL THINKER! In the end, the choice may be the same, the best choice may be to sell, but by getting more complex with the questions you ask, a more reliable conclusion can be made.

“Upshot is simple: to achieve superior investment results, you have to hold non-consensus views regarding value, and they have to be accurate. That’s not easy.”
~Marks, The Most Important Thing Illuminated, pg.7

A Lesson from One of the Best

On numerous occasions, Rick Rule of Sprott Global, has spoken about the concept of answering ‘unanswered’ questions when you’re evaluating a company’s upside potential. After researching the basics of the company and what their end goal is, you should be able to assemble a list of questions that must be answered to reach that goal. It’s a good idea to try to roughly estimate a company’s value if that goal is achieved, which will give you a sense of their upside potential.

Recently, I wrote an article about an investment idea that I’ve been contemplating, Sandspring Resources. For those of you who aren’t familiar with Sandspring, it’s a 4.1 Moz gold project in Guyana. The following is an example of a few questions the company must answer to reach their goal of constructing a producing gold mine:

• How high will the gold price go and for how long? Sandspring’s economics are highly leveraged to the gold price. A strong gold price above $1300 USD for a prolonged period of time makes it a very good value proposition. In my mind, this is the most important question of all, as I believe that, barring a major political shift in Guyana, even if management decides not to drag their feet while attempting to build the mine, tremendous share price appreciation is in the future if the gold price continues to rise.

• Will they finance the project and, if so, how? There are a few different ways that they can finance the project, each with positives and negatives for the shareholders. They will only try to finance this project with a strong gold price and, therefore, this shouldn’t be an issue.

• How large of an impact will the drill results at Sona Hill have on the company’s economics? They are drilling 8000 metres over the course of the next year, good results could mean that the gold price may not need to be above $1300 USD for it to be of good value.

• Will the mine be permitted for construction? This is always a huge question when it comes to mines. It is one thing to drill and find mineralization, it’s another thing all together to permit a mine. Fortunately for Sandspring, a neighbouring mine, Guyana Goldfield’s Aurora Project, has been permitted and is producing.

• Are the people involved able to take this project successfully to production? They have done it in the energy sector in North America, can they parlay that to Guyana?

By answering these questions, you create more questions. The process is never over, you need to determine where your exit is and follow through when you do or don’t reach that goal.

As Rick Rule puts it, “it is easy to confuse a bull market with brains.” I can totally attest to this, because coming out of the crash in 2008, everything I bought went up. As the bear market bore its ugly head in 2012, I wasn’t ready for it and neither was my portfolio.

I can’t stress how important it is to buy at the bottom of the market’s cycle. True value lays where the majority of the investing population believe it’s not. A great example is the first six months of this year, when the precious metals market came back with a boom. For the last four years, the junior miners have been beaten down, dropping over 90% in nominal terms, and yet, the talking heads of the mainstream media and a good portion of your average investors believed there was no return from this hole.

With the money flowing into the resource sector the last few months, you almost can’t make a mistake – all boats are rising. This is very characteristic of a bull market in the junior resource sector. However, the more confident the general population becomes, the less comfortable you should be.

Until next time,

Brian