By Andrey Dashkov, analyst, Casey Research
Gold is proving to be a smart investment this year.
Year-to-date, gold is up 13%… while the S&P 500 is down 6%. In other words, gold outperformed the market by almost 20% so far this year.
And while it’s hit some bumps in the road recently, it’s important to remember that gold doesn’t always go up in a straight line. But in a crisis like the coronavirus pandemic we’re living through now, it’s always good to hold some in your portfolio.
But even better than gold are gold stocks.
Take a look at the chart below, which shows one gold stock, Orezone Gold (ORE.TO), a development-stage gold company. Keep in mind, this is not a recommendation of Orezone. We’re just using it as an example.
Since January 31, the gold price has increased by 9%… and Orezone Gold’s shares have jumped by 37%.
That’s because gold stocks like Orezone have leverage to gold’s price… so when gold moves an inch, they can move a mile. In this case, Orezone’s stock provided more than a 4x leverage to the price of gold. Imagine how much higher it could run when gold really takes off.
But there’s a method to get even more “hidden” leverage to gold… without buying stocks.
Let me explain…
The Hidden Leverage of Warrants
You can get more leverage on gold with something called a warrant, which is a derivative of a stock.
I won’t get too deep into the details here. But if you own a warrant, you have the right, but not the obligation, to buy the underlying stock at a certain price before a certain date.
For example, Company X may have a warrant that gives you the right to buy Company X at $1 per share on or before December 31, 2020.
Warrants also have their own prices, like stocks. And some of them trade on public exchanges, so you can buy and sell them just as easily as common shares.
What you really need to know is that just as gold stocks give leverage to gold, gold warrants can give you extra leverage on the gold stock itself.
So let’s go back to the example of Orezone Gold from before.
You could have bought warrants from Orezone Gold starting on January 31. And if you had, you’d be pretty happy right about now…
Remember, the Orezone stock provided more than 4x leverage to the price of gold…
…but its warrants outperformed gold by 15x.
And also note that at their lows this year, the warrants were down 47% compared to January 31. The stock was down 48%.
In other words, the company’s warrants delivered more than three times the gain of the stock with no extra downside.
That’s what I am talking about when I say that warrants can be safe and deliver stellar returns.
Manage Your Risk
But here’s another thing you need to know. The market for warrants is tiny. It’s very small and very illiquid. That means you should limit the amount of money you put into warrants.
How much should you put in, then?
Here’s a rule of thumb for you from our experts on warrants, E.B. Tucker and John Pangere. They run our Strategic Trader letter, which focuses on warrants.
John and E.B. are the best at what they do. Earlier this year, their readers locked in a 1,000%-plus gain on one of the warrants in their portfolio. So they have a knack for picking winners that deliver returns you’ll rarely find in stocks. (You can find out more here.)
But even they know that you need to manage your risk no matter what you invest in. They recommend that warrants shouldn’t make up more than 10% of your total portfolio.
So if you have $100,000 invested in total, don’t put more than $10,000 into warrants.
And aim to keep each warrant position under $1,000. $200–$700 would be the ideal case. With these limits, you can build a portfolio of about 20 warrants.
These position limits will keep your risk in check. So even if one position goes to zero, your total portfolio of $100,000 will only lose about 0.5% of its value.
If all of them go to zero (which isn’t likely), your total impact will be just 10% of your portfolio. But again, we don’t think that that’s going to be the case.
In other words, if things go completely south, you will lose just one-third of what the stock market lost when it dropped by 30% in March.
And that’s the worst-case scenario. It’s more likely you’ll be able to reap outsized gains with warrants.
If you’re looking to get started, John and E.B. have built a strong portfolio of warrants in Strategic Trader… including some that have already netted triple-digit returns. Just go here to find out more about how you can get in on these gains today.
Analyst, Casey Research