Editor's note: This weekend, we're taking a break from our usual fare to talk about defensive investing. In this excerpt – adapted from the September 2022 issue of Gold Stock Analyst – Garrett Goggin explains how to find high-quality defensive assets in the mining and precious metals industry... and shares why it's critical to protecting your wealth through a downturn.
I can still see the lick he put on Joe Ferguson out in Detroit... I thought he'd killed him.
That's former football coach Mike Ditka talking about the team that put him in the Hall of Fame... and recalling an especially memorable play...
When the Chicago Bears arrived in Detroit for the last game of the 1985 season, the team was 14-1. Their spot in the playoffs was assured. No one would have blamed Ditka if they rested their key players. Most teams would have, especially against a forgettable opponent like the 7-8 Detroit Lions.
But not the Bears.
When Lions quarterback Joe Ferguson lined up to start the game, he stared out at a Bears defense loaded with future Hall of Fame players like Mike Singletary, Richard Dent, and Wilber Marshall – all ready to chase him down.
On the third play, linebacker Marshall laid a thunderous hit on Ferguson's chin. The quarterback went sprawling and lay limp on the ground for several minutes as trainers huddled over him. Ferguson eventually walked off the field, but his afternoon was done.
In an NFL Films documentary, linebacker Singletary recalled being on the field after the hit, listening to his teammates "barking" about who was going to be the next guy to hit Ferguson. "And I'm looking at these guys and I'm saying, 'Wait, wait, wait. The guy is bleeding at the mouth, the guy is bleeding at the nose. You don't have to kill the guy,'" Singletary said. "We don't care. He's the quarterback. We're going to get him. That's what we do."
That was exactly what the '85 Bears did all season.
They were a legendary team, built on the best defense in NFL history. Nicknamed the "Monsters of the Midway," they led the league in fewest points allowed and fewest yards allowed.
They collected 34 interceptions and recovered 20 fumbles. And Joe Ferguson was just one of the 64 quarterback sacks they tallied. In one three-game stretch in November, the Bears defense scored more points than it gave up. Including the playoff games, 14 out of 19 teams they played scored 10 points or less against the Bears.
We're sharing this story because it reminds us of the basic fact that defense wins championships, not offense.
Glamorous quarterbacks and explosive offenses are fun to watch. However, the record books are full of teams that lit up the scoreboard and then fizzled in the playoffs.
Very few Super Bowl trophies were won by teams with shaky defenses. Good defenses hold down the damage an opponent can do... and also set teams up for success when they get the ball back.
You should think about your mining portfolio the same way...
Sure, everybody gets excited by the huge gains possible from small leveraged mining stocks. That's the fun stuff – the offense. But few people win by emphasizing those kinds of stocks.
Instead, you want to build your mining portfolio with stocks that will minimize the damage when gold and silver prices are struggling. And those same high-quality miners are the ones that will be best positioned when the bull returns.
So today, I will describe how we do this with silver stocks in our Gold Stock Analyst (GSA) newsletter...
We'll cover how playing defense first helps protect us when silver's price is falling... and explain why our strategy has positioned us for big profits when silver stocks rebound.
Most newbies to the sector want exposure to the most highly leveraged silver play available – because that should give them the biggest pop when silver rises to the moon. They fill their portfolios with lower-grade and higher-cost silver explorers, developers, and producers.
Since these risky bets are barely profitable (if at all), their profits and total asset value can double, triple, or soar even more from their low initial levels when silver rises. The stocks quickly follow, often rising multiples.
But most of these investors never consider the other side of the equation: what happens when silver drops or even treads water.
In those cases, reckless investors are stuck with a portfolio of money losers. Liabilities grow with no profits to pay them down. Equity value quickly falls to zero.
Without the ability to turn a profit, many mining projects are liabilities, not assets. Think of these companies as leaky buckets... With more expenses than income, the bucket quickly drains and needs to be replenished over and over. Shares outstanding rise exponentially, and share prices fall toward zero.
This is why GSA doesn't base its investment strategy on predictions about where gold and silver are heading.
Yes, we believe prices will rise. But if you base your investment decisions on the belief that silver is going to double to $50 tomorrow... you are setting your portfolio up for destruction.
You would hold the most highly leveraged companies in the sector. These companies are the least profitable, carry the most debt, and are closest to bankruptcy. If your timing is right, your once-in-a-lifetime bet stands to do well. But if your timing is off and silver does nothing or falls, you will get decimated.
It is critical to avoid these miners. GSA does the research to separate the good ones from the leaky buckets.
These leveraged miners can't grow profitability in new ways. They're not like Apple, which can spend money up front to invent the iPhone or the iPad... and then release a new version with different colors every year. That's not how mining works.
The greatest value is created in the exploration stage. Finding a rich deposit is extremely rare, however. Sure, if an explorer succeeds, its value can rise from near zero to hundreds of millions of dollars overnight. But you are betting on a lightning strike.
A portfolio of small bets on 100 leveraged mining plays could see 99% of them fall to zero over time. That single outlier could make a discovery and see its share price soar 10X higher. But that one 10X winner is unlikely to make up for all the other losses.
That's why building a great defense is so important...
As an investor, you need to seek out the companies that have assembled a collection of the highest-quality assets possible – just like how great football teams pull together a roster of talented players.
Grade is one of the most important variables in our research. Lesser silver companies operate lower-grade mines that suffer from higher costs and are run basically at breakeven. Management gets paid, but shareholders suffer. Over time, cash runs low, shares are sold, dilution occurs, and the share price declines.
On the other hand, high grades lead to low costs... which lead to strong margins. These higher-grade producers generate significant free cash flow ("FCF"), which they then use to build shareholder value through share buybacks, smart capital allocation, and dividends. Profits continue whether the price of silver is high or low. And shareholders don't suffer losses and dilution.
In GSA, our Fave 5 portfolio of silver stocks enjoys off-the-charts grades. So these companies have wide margins compared with the average miner. When silver prices rise, Fave 5 margins will expand further, leading to more profits to drive shareholder value.
The last trait we look for in mining stocks is speed. We want projects that offer a quick payback on their capital investments. The faster you can get your original investment back, the better. Everything beyond the original capital expenditures spend is profit used to boost shareholder value... the more, the better.
This is the key to investing defensively... The Fave 5 quality miners should remain profitable throughout a downturn, and the share counts should remain stable. Lesser miners with average projects lose money and sell shares, so when profits resume, their earnings per share are lower. The inferior miners can never catch back up.
Downturns are inevitable and unfortunate. However, when silver resumes its climb, Fave 5 profits will explode... and stock prices will leap higher, supported by booming FCF, share buybacks, dividends, and smart capital allocation.
These stocks have a big, strong, and quick defense managed by great leaders – measured by grade, margins, and payback. That means shares outstanding have remained constant. Profits per share will rise higher than ever... And the stock prices will follow.
Editor's note: Gold's recent breakout made headlines. Now, with the economy still on the verge of recession – and the Federal Reserve signaling that its hawkish moves might be over – the gains ahead could be even bigger. Last week, Garrett sat down with Gold Stock Analyst editor John Doody to explain why they believe a historic gold boom is coming. Plus, they revealed the inner workings of the gold system John spent his career building... Click here to learn more.