I read some comments recently on how the prospect generation model is overhyped and a poor investment. I read something to the effect of them being a good business but a bad investment. For a start, most of them are not investments as they lose money. A good business may be a bad investment purely based its price. Mc Donalds is a great business but I wouldn’t invest as I believe the price is far higher than I believe the business warrants. However, what I define as good might not be the same as what you think is good. What I think that the person was saying, was that the stock price of the underlying business has not done as well as they had expected. But price and value are not the same thing. If I could buy a fantastic business with assets far exceeding its public price, run by exceptional people, I’d be first in line. Usually, this is not likely to happen all the time, but can happen in a brutal bear market for a short time.
Let’s have a look at this in more detail.
A good business makes for a good investment but the price has to be right to give yourself a margin of safety. A good business is one that firstly has good people directing it and have all the relevant skills and experience to run that business. Most importantly, these people should be ethical and moral. An investment is one that makes you money and generates value over long periods of time. It needs minimal capital to keep the business running and doesn’t pay its managers an arm and a leg. It also needs the least amount of government interference as possible. That is why it’s hard to invest in today’s climate. There are rules and regulations enforced by collectives backed up by a gun. How much red tape does a mining company have to cut through to make a profit? The profit gets swallowed up in bureaucracy. That is why I personally prefer investment companies to speculate on. These types of companies hold a residual interest in other businesses via investments, streams, royalties or direct stock holdings. Prospect generators fit that bill. There are investment companies available now that own stock in other companies that are trading below what that stock is worth at today's prices. As an investor and speculator, I like to buy companies that also invest and speculate.
So, what is a prospect generator or royalty generators or project generators as they are called?
Basically, what happens is the company buys up prospective land claims that they believe has whatever it is they are looking for. They do some exploration, maybe do some drilling and identify some targets. They then find joint partners that would like to progress the project forward and take a slice in the potential outcome. That outcome can be positive or negative. But more than likely negative.
You see not many people find what they are looking for. And when they find what they are looking for, it turns out to be the wrong thing. So, what these teams do is let their partners do all the heavy lifting and retain equity in the company, usually in the form of shares, or royalty payments on the project if it ever produces anything. Pretty risky if you ask me. But much less risky than an exploring company that does all the heavy work themselves and has to interact with all the blood-sucking politicians. Lots of money will be used to drill and explore. Investors will likely have their stake diluted in the need for the company to generate cash to proceed. And remember, most mines never make profits. They are like black holes. Your money will never see the light of day again. They sell what they produce, usually at low prices, while depleting the very thing they produce. It’s like eating your own tail!
I think sometimes that investors and speculators in the commodities space start thinking like miners and geologists. And that can be very different from thinking like a speculator. They both have very different tools in the tool box. It’s a different mindset. Speculators are looking for wild swings in price and value, usually caused by government distortions in the market. They are profit centered.
You will notice that Rick Rule is a big proponent of the project generation model, as is Brent Cook. Both very successful in their endeavors as speculators. Brent also has the expertise of being a geologist. But I’d make a guess and say he is a speculator first. Why do you think that is?
So, looking at well-run prospect generators is a good idea and can be a low-risk speculation while also achieving very high returns. It is important to limit your downside, even if that means limiting your upside. Remember, you can’t really be a capitalist if you have no capital. And mining exploration likes your capital!
I’m not against other ways of speculating. Each to their own. I just think using other people’s money to search your land in the hope of finding something while you get paid upfront and retain equity can be a smart move.
Just some thoughts and ideas and as always I welcome any feedback or points I may be incorrect on.