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Why Won't Conventional Value Investors Touch Resource Stocks?

|Includes: ConocoPhillips (COP), GDX, GDXJ, SIL, SILJ, SOIL

As I started my journey learning about investing, building my investor education business, building my extensive contacts list starting in 2007, I tend to favor the value investing and contrarian investing methodology. I also like finding small and medium cap growth companies that are hated. Often, this happens to be in the commodities sector as nearly every value investor hedge fund manager or supposed value investing expert will not touch any resource stocks with a 10 foot pole or will only do so for a very short term trade.

Because of this negative and in my opinion uninformed bias, I've managed to find extremely hated and undervalued growth stocks with improving balance sheets for way below book value and often a huge discount on proven and probable reserves making the small company attractive as a takeover candidate.

I am routinely lectured by many conventional value investors about how they do not understand gold or resource stocks or how these companies always have increasing capex and can never generate free cash flow. Many cite Warren Buffett's Conoco Phillips (NYSE:COP) disaster, which is Buffett's largest ever loss.

However, if Buffett would have bought Conoco when it was hated at $13/share years ago or bought the company about 2 years ago again after it dropped a lot as the company restructured its balance sheet, sold off unprofitable natural gas assets and focused on oil he would have done well.

I am writing this blog article to hopefully wake up at least one conventional value investor to investing in resource stocks. It is not rocket science to invest in these companies.

The easiest way to be successful and to find a margin of safety is to buy a company with a good or improving balance sheet when the spot price of the commodity is selling for below the average all in production cost of the industry. This bottom up approach should be done after a top- down research is done on supply/demand fundamentals for the commodity.

For example, gold and silver were selling for below their all in production cost and if someone had researched supply/demand for physical metal properly instead of believing the mainstream media or the poor research of many Wall St analysts they would have realized that demand for physical metal was rapidly rising in Asia, while there was huge supply problems. It should not have required a genius IQ to figure this out that many miners were going to go bust if the metal price did not go higher to respond to rising demand.

There are a number of other commodities where demand is about to rise or already rising and the spot price of the commodity is below the mining industry average all in production cost. Trying to pick the exact bottom of a resource or commodity cycle is a fool's errand and it is better to average down and accumulate around where one thinks is the bottom.

I think gold and silver miners have fully bottomed and over the next 3-5 years many will easily go up well over 100%. I have achieved the same types of gains in other resource stocks in copper, oil, etc in the past and I have no doubt that this will happen in the future as well. It just requires a 2-4 year time period I would say to maximize returns on a resource stock position (if you can commit for 5 years with the right companies you have a shot at 600% or larger gains) as long as you buy and accumulate positions during the cyclical bear part of the cycle at the lowest valuations and then hang on for the change in perception/revaluation. Unfortunately, most humans including value investors who are supposed to be more disciplined, more long term focused, etc lack that kind of patience for huge returns. As long as this is still the case, there will always continue to be enormous bargains in the resource sector because not even professional fund managers are willing to consistently buy what could be market bottoms.