Sunk costs are going up in value and down in price… 

1. With rates going up the cost of capital is going up.
2. With inflation going up the value of sunk costs is going up.
3. Since this sector is sentiment driven everything goes up and down (Down like right now).

The “easy” money trade

The “easy” money comes when sentiment pendulum has swung to extremely low levels. This is when anyone who is able and willing can buy banked success for less than what it probably is worth and oftentimes for less than what it cost to produce the success in the first place. Right now there is no shortage of advanced explorers, developers and/or producers that are selling for less than sunk costs.

The opportunity cost of Alpha goes up as Beta gets cheaper

In a declining market the only real shot of getting a paper or “permanent” profit is to take Alpha risk. What I mean by this is that only companies which materially shock the market, with an unexpected value increase, have a shot at bucking the trend. When sentiment is high and ounces in the ground are overvalued it makes perfect sense to primarily be in Alpha plays. Why? Because even if ounces in the ground will fall significantly with the next downturn in sentiment there is a shot that this is offset by a large increase in ounces in the ground. The other option would be to be in Beta plays that might be trading for up to $100/oz and inevitably suffer a big paper loss as the sentiment crashes and ounces in the ground trade for as little as $20/oz for a while.

The problem with Alpha plays in bear markets

You have probably seen a bunch of junior explorers put out good drill results etc that resulted in a neutral or even negative price action. You have certainly seen bad results get punished hard. As a matter of fact the only exploration stories that have done well are the truly exceptional ones. In other words it has been kind of a rigged game for Holders at face value (While you as a Buyer can often buy success after the fact while taking no risk or pay a higher price!). In short we as Holders take on Risk, often exploration Risk, without really getting anything on the Reward side even if we are lucky enough to see a successful drill campaign.

The benefit of Alpha plays in bear markets

Typically the only people in the gold space who have been able to celebrate these last couple of years, to varying degrees and sometimes only for a limited period of time, are people who have been lucky/smart enough to have been on board of a significant discovery story…

The pitfall of Recency Bias

So for about three years we have seen Beta go down >70% on average and at the same time many of us have dabbled in Alpha plays where the game has been increasingly “rigged” against us. Yet the only wins, if any, have been in the rare occasion that a junior has potentially made a very significant discovery. Thus we have kind of been taught to only focus on Alpha plays despite the unfavorable odds on average. And I would say we have been increasingly taught this as the bear market is now over 3 years old.

The thing is that the longer we only see Alpha “work” (the longer and deeper the bear goes), the more we will be convinced that “Alpha” is the only place to be, while the merit of Beta relative to Alpha is actually going up.

Remember, the “easy” money is to ride this sector from a bear low, to a bull high, when the ounces in the ground get revalued by perhaps as much as 5X from bottom to top. A true nightmare scenario would be to only be in the highest risk, early stage exploration juniors and see them all fail (odds are always against a significant discovery) just in time for the bull to start. In this scenario one might be unlucky and end up with pretty much zero ounces and not only paper losses, but perhaps permanent losses, just in time for when ounces in the ground are about to pay off bigly.

Sure one might actually have lets say a few real discoveries, starting from a cheap price, and have a couple of future 10-20 baggers in store. The problem with this is that it is unrealistic to believe that one can withstand the pressure of holding all shares of lets say only two success stories until they make up >90% of the portfolio. With that said there sure are a lot of explorers that have already made discoveries (post discovery cases) and are still cheap.

Conclusions

The point of this article is to suggest that even though Alpha plays by definition can work in any market conditions the opportunity cost or relative Risk/Reward versus Beta is getting more unfavorable as sector prices/sentiment declines. If one were to pick 20 juniors with decent projects, ounces in the ground and that had the staying power to stick around for the bull, then I would expect the majority of those picks to be multi baggers at the next sentiment high. On the flip side one would need to take exploration risk for Alpha plays to multi bag and the earlier the story the higher the risks. It is unlikely that even a junior that has a drilled a few good holes will do very well during a bull if the story turns south (Lets say stops growing before having reached the critical threshold for success).

With that said I think there are some post discovery alpha plays which look cheap and where I think they have good odds of being able to grow for years to come and eventually produce significant resource estimates etc. One example would be Goliath which technically does not have a resource, and therefore no banked ounces in the ground at face value, but which looks likely to have a multimillion ounce system with potentially some obscene bonanza mineralization to boot.

Best regards,

THH