The U.S. Government has established a series of rules and regulations to "protect" average investors from "risky" investments. One of the ways they protect us is by limiting certain investment opportunities to accredited (rich) investors. On an individual level, accredited investors are individuals who have at least one million dollars in liquid assets or have earned an income over $200,000 for the past two years. (Apparently, if you only make $199k per year, you are a brain-dead cow and can't be trusted with your own investment decisions.)
One type of investment that is unavailable to the average investor is the private placement. Private placements are simply deals made between a company looking to raise capital and a financing company or broker which provides capital. Typically, the broker will establish terms for the financing and then raise money from its accredited clients to invest in the deal.
The natural resource sector is one area that is particularly conducive to private placements. The up-front capital requirements are high and the payout, while potentially lucrative, is uncertain.
Take for example, a small oil exploration company that owns the rights to oil production on a tract of land. It has done the legwork to verify the oil reserves, acquire permitting, set up purchase and sales agreements, etc. Now it needs to raise capital to actually drill the well and begin producing oil. It could ask the bank for a loan, but banks are careful with their capital these days, and prefer safe income producing assets to risky, oil speculation. It could sell stock to raise money, but that would dilute existing shares and the stock price it could get from those shares may be less than desirable. A third option is raising money through a private placement.
Private brokers are willing to take more risk and have the experience and know-how to properly analyze the companies they are investing in, or in some cases, partnering with. These brokers are able to provide viable companies with the capital they need to get over a hump or quickly ramp up production. In a good deal, the capital is employed effectively, the company grows its output, and the company and investors both enjoy healthy gains.
So how can the average investor who doesn't have a million dollars get a piece of the private placement pie? (Say that five times fast.)
Answer: Invest in a company who's business model is essentially making private placements. I'll mention the companies I'm referring to in a minute, but first, a few questions to ask yourself to see if these are the right stocks for you:
- Do you believe governments around the world will resort to printing more money to paper over their huge debts and avoid a deflationary collapse?
- Do you think natural resources like oil, gold, coal, etc. are becoming more energy intensive (and costly) to produce as the resource grades continue to drop?
- Do you have the patience to invest for the long term and the conviction to not be swayed by market sentiment?
If you answered yes to these questions, I'd recommend looking into Sandstorm Gold (SAND) and Sandstorm Metals and Energy (STTYF.PK). These companies are self-described "streaming companies," which provide up front capital to resource companies in return for the rights to buy a percentage of their production at a low fixed price to re-sell at the market price. In my view, these companies are basically in the business of making private placement deals with resource companies.
Perhaps the best known example of a commodity streaming company is Silver Wheaton (SLW). Silver Wheaton was listed in 2005 and its stock price has gone up nearly 900%. I think Silver Wheaton will continue to do well in the coming decade but it is a fairly established company with an excellent track record, which is reflected in its higher stock price. I believe the Sandstorm companies can replicate Silver Wheaton's success, yet they are still relative unknowns and their shares can be picked up for a much better valuation.
Investing in speculative resource companies can be very risky business. The Sandstorm approach mitigates many of the risks in the way it structures its contracts and the types of companies it does deals with. (Check out Sandstorm's investor resources for details.) Having a portfolio with multiple streams further spreads the risk if an individual deal goes bad.
But even with these mitigation precautions, deals can go bad. Sandstorm M & E found this out the hard way with a deal with Royal Coal, which burned through its cash and had to stop production. Whether anything can be salvaged from the Royal Coal deal is unclear, but as this article points out, the worst-case outcome from Royal Coal and other not-so-sweet deals may already be priced in to the shares, which have fallen from $6 to below $3.
On the flip side, Sandstorm captures the upside potential of commodity prices as well as expansion of production by its partners. In an environment of rising input costs, Sandstorm has an advantage over traditional mining companies because its cost of goods sold are fixed.
In my view, Sandstorm Gold and Sandstorm M&E are companies you buy for the long haul. Their stated strategy for investor return is music to my ears:
Step 1: Use their current capital (and ample credit line) to make strategic deals with producing or near production resource companies that provide future cash flows.
Step 2: As new cash flows come on line, use those flows to finance more strategic deals.
Step 3: When the cash flows exceed the capital requirements for deals they consider to be excellent investments, return the excess capital to investors in the form of a dividend.
Bottom line; if you believe in the commodities story, but don't have the government's approval to invest in private placements, perhaps Nolan Watson and Sandstorm can do it for you. Check them out and decide for yourself.