Should Investors Use Warrants for Leverage in 2008?
Are you still a non believer in this bull market in gold and silver? What an awesome beginning to 2008 with a gain of over $25 in the price of gold on the first day of trading for 2008 and as we write this piece, spot gold is at $859.00. Probably even the talking heads at the popular TV channels are getting excited and soon we will have all investors joining 'our' party, and what a party it will be.
We will leave all the reasons and logic for this bull market and the height to be reached to our peers in the business. However, we do agree, that in time, gold will easily exceed $1,500 per oz. and much sooner than most of our friends and analysts are forecasting.
We realize that the average investor is not yet aware of the concept of investing in the mining sector. Also many readers are disappointed in the performance of their junior mining shares to-date which have lagged both the price of gold and the popular gold indices and we expect this to change very soon with the junior gaining ground.
So will this backdrop, we ask, have you positioned yourself wisely to maximize your gains as this bull rolls on? Probably Not.
Believing in the long-term bull market in the precious metals sector, investors are encouraged to seek out those investments which will achieve the maximum return on their investment dollars. So, let's discuss briefly some of your choices for deploying your capital:
Gold coins, bullion or a goldmoney acount
Exchange Traded Funds - ETF's
Mutual Funds - those specializing in the precious metals
Shares of large capitalization mining companies
Shares of junior mining companies
Options or Leaps which trade on the Chicago Board of Option Exchange (www.cboe.com)
on your favorite mining shares
Warrants - specifically long-term warrants trading on some of your favorite mining shares
Most of the above investment alternatives are familiar to those of you visiting this website. The last alternative, warrants, however, is frequently overlooked by 90% of investors. We ask why this is and find it is only due to a lack of knowledge and understanding. So allow us to explain some of the characteristics of warrants.
Realizing that many readers are familiar with options and perhaps leaps we start by distinguishing the differences in these investment vehicles.
Options and leaps give the investor the right but not the obligation to acquire the underlying security at a specific price and expiring on a specific date in the future. While options usually have a short-term life of 30 days to 180 days, leaps may have a life of up to 2 years. Options and leaps are created/written by other investors and no benefit accrues to the underlying company.
Warrants on the other hand are offer by a company, usually in connection with a financial arrangement or new issue of shares. Historically, warrants are very common in the mining sector and the warrants are viewed as a means of an additional incentive or an 'equity kicker' to get the deal done. The holder of warrants, very similar to options and leaps, has the right, but not the obligation to acquire the underlying shares at a specific price and expiring on a specific date in the future.
When on occasion an investor or even an analyst in our business will say, "warrants are just not for me", it drives me crazy. When I inquire, what do you mean warrants are not for you, they say they are too risky, or that they are not a speculator, yada, yada, yada. (I personally consider myself an investor not a speculator and normally hold my positions for well over a year.)
What if the warrants are long-term having a remaining life of over 2 years? (Many of the warrants now are being issued with a 5 year life.) And what if long-term warrants are trading on one or more of your favorite mining companies? If you believe in this long term bull market and you are purchasing shares in a mining company, due diligence, suggests that you inquire or know if that specific mining company or energy company has long-term warrants trading.
Frankly, we believe that long-term warrants should be included in all investors portfolio and one way to manage the risk is to invest only 10% to 20% maximum of your investment dollars to warrants. Another means of managing your risk is to reduce your investment dollars in warrants of the underlying company. For example, if a mining company is selling at $10 and the warrant is trading at $2, and if you want to own or control 1,000 shares, purchasing 1,000 shares would cost you $10,000, so instead you purchase 1,000 warrants for $2,000 and you will have basically the same position (controlling 1,000 shares) with fewer dollars at risk while still having the great potential gains as the share price rises in the bull market. Bottom line is that you can control your level of risk by increasing or decreasing your dollar exposure to specific warrants.
What is leverage? The essence of the answer is that the anticipated gain on the warrant must be greater than the anticipated gain on the common stock. This more rapid growth in the value of the warrant relative to the common stock is called leverage. We encourage investors to seek out those warrants, first, that are trading on their favorite companies and second, those that have the longest remaining life until expiration and which have great upside leverage of 2 to 1 or better. This means that investors will potentially make twice as much, 2 to 1, from the increase in the value of the warrants as opposed to the common shares of the company.
To summarize, investors today have many choices and methods for participating in this bull market. Warrants are but one of those many choices, albeit, my personal favorite, because of the leverage opportunities.
We would encourage those of you who are long-term investors to carefully select the shares or long-term warrants of your favorite companies and accumulate them at these bargain prices, now.
For those readers desiring more information on warrants you may wish to visit www.PreciousMetalsWarrants.com where you will find much more information and education on warrants in our new Learning Center and you can signup for our Free weekly email, The Warrant Report.