Commodity-Related Warrants Warrant Your Attention
With all the interest in physical gold, silver and other commodities these days, and the large/mid-cap companies who mine the metals and the juniors who are exploring for them, it begs the question: “Why has no one written about the 91% returns and the 60% leverage generated by the long-term warrants offered by a select few miners and royalty companies in 2010?” The information in this article and the links to a variety of resources will change all that and make you ready and able to reap the benefits from investing in this much misunderstood asset class. Words: 2585
So says Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!). Please note that this paragraph must be included in any article reposting with a link* to the article source to avoid copyright infringement. If this article does not contain the 9 hyperlinks provided which are crucial to the full picture intended please go to the original source for access to those links.
The answer to the question “Why has no one written about the 91% returns and the 60% leverage generated by the long-term warrants offered by a select few miners and royalty companies in 2010?” is simple : Almost all Americans and most Canadians (investors, brokers, financial advisors/planners and financial writers alike) are either unaware of, or not very familiar with, warrants. Those few who think they are in the know unfortunately have very limited knowledgeable as to the which, when, why and how aspects of buying and selling warrants.
It is little known fact that those commodity-related warrants with a duration of 24+ months were up 91% in U.S. dollar terms in 2010. That compares very favourably with:
- the GDXJ (a basket of mid- and small-cap miners) which was up ”only” 55%,
- the GDX and HUI index (baskets of mid- and large-cap miners) which were each up 33% and
- that “laggard” gold which was up a “paltry” 30%!
With returns like that isn’t it about time you became aware of this asset class and how to go about claiming “the pot of gold” for yourself or your clients?
Investors’ ignorance (that is such a harsh word but you know what I mean) about warrants is probably due to the fact that:
- they are listed almost exclusively on the Canadian stock exchanges;
- the SEC has put some limitations on trading in them;
- they seem complicated because of their differing time durations;
- investing in them requires some specific knowledge as to how to go about buying and selling them and
- they are limited in number.
That being said, it is “oh so easy” if you know what you are doing and, again, this article will explain everything in detail.
What are Warrants?
A warrant is a security giving the holder the right, but not the obligation to acquire the underlying security at a predetermined (i.e. exercise) price and for a specified period of time (i.e. term or duration).
A Breakdown of the Warrant Asset Class
a) Number of Warrants by Commodity
– As of October 15th, 2011, only 135 companies have tradable warrants of which approx. 90 (67%) are in the commodity/natural resource sector, i.e. mining or drilling, exploring and/or developing or purchasing via royalties. (See here for a complete list.)
– Only 34 companies – yes, only 34 – have tradable warrants (38 in total) with an expiry date of at least 24 months duration which I consider to be the absolute minimum duration period (See here for details.)
– Of the 34 companies:
- 19 companies are involved in some aspect of precious metals mining of which 2 are royalty payment companies;
- 9 are involved in base metal mining including zinc (2), uranium (1), nickel (1), coal (2), cobalt (1) and iron ore (2);
- 5 are involved in oil and gas operations and
- 1 is agricultural-related.
b) Number of Warrants by Company Market Capitalization
Everyone seems to think that warrants are only associated with penny stocks but that is simply not the case. Of the 34 companies in question:
- 4 have market caps in excess of $2.5B;
- 1 has between $500M and $1B;
- 3 are between $250M and $500M;
- 10 are between $100M and $250M while
- 16 are less than $100M.
How to Trade Warrants
Buying and selling warrants can be very confusing if you are not aware of the unique information required to do so and understand just how to go about it. Below you will find all the information you need to know on the subject:
1. Buying Warrants
a) TSX/TSXV Symbols
Because warrants trade exactly like the underlying common stock they are assigned a symbol. Since most warrants are associated with Canadian companies it is easy for Canadian investors to execute orders using their Canadian symbol but less so for Americans.
b) CUSIP Numbers
For American investors the best and most accurate way to trade in warrants is to use the security’s CUSIP number. CUSIP stands for the Committee on Uniform Security Information Procedures of the American Bankers Association which established a format of unique codes for all North American stocks, bonds, puts, calls, warrants, etc. as assigned by Standard and Poor’s. The CUSIP number consists of a combination of 9 characters, both letters and numbers, which act as a sort of DNA for the security uniquely identifying the company or issuer and the type of security. The first 6 characters identify the issuer and are assigned in alphabetical order; the 7th and 8th characters, which can be alphabetical or numerical, identify the type of issue; the last digit is used as a check digit. (For a complete list of stock and warrant CUSIP numbers and their related stock CUSIP numbers trading on the TSX/TSXV exchanges go here.)
c) Pink Sheet Symbols
Many U.S. brokerage firms are not willing to open a ‘foreign account’ (i.e. an account that allows a U.S. based investor to purchase Canadian securities using Canadian symbols). Using Pink Sheet symbols (a 5-alpha symbol ending in ‘F’ for Foreign) are an alternative way to go for the 5 long-term warrants that have such designations. (For a complete list of commodity-related stock and warrant Pink Sheet symbols go here.)
For the record, stocks and warrants that trade on the Pink Sheets fall into one of these two categories:
- companies that don’t meet the listing requirements of the New York, American or Nasdaq stock exchanges or
- companies — usually foreign — that are unwilling to jump through the regulatory, legal, and accounting filings that accompany listing on the major exchanges. That is the case with most of the commodity-related companies with warrants. They are Canadian based and see no reason to create a duplicitous legal and accounting department just to be traded on the NYSE. They have already met all those legal, regulatory, and accounting requirements in their own country and feel that the burden is on YOU to read their home country filings.
You can calculate the leverage of a warrant – the extent of the advantage or disadvantage of buying the warrant at its current price relative to the current price of the associated stock given the exercise price of the warrant – yourself, or you can get it free here.
2. Selling Warrants
Some investors erroneously believe that you have to hold warrants until the expiration date but that is the worst thing you can do because when warrants expire they will do so without any monetary value i.e. they are worthless. Instead, investors must treat warrants as they would stocks and either sell then when the warrants have met their price objective or well before they expire.
3. Exercising Warrants
a) When the Exercise Price is Achieved
It is important to note that if your warrants are “in the money”, i.e. the common stock is trading above the exercise price of the warrants, and the warrants are approaching the expiration date, you must take some action because, unlike call options where the value of the expired option is placed automatically into your brokerage account, that is not the case with warrants. When warrants expire they expire worth absolutely nothing!
From an American perspective you have only one viable option and that is to sell your position before the expiration date (and to do so at least 6 months before the expiry date is highly recommended because the value of a warrant often drops drastically during its final months of life) because, according to U.S. law, Americans cannot exercise a Canadian warrant unless its associated shares have been registered with the SEC because, should they exercise a warrant, they would be receiving a newly issued share which would be illegal.
From a Canadian perspective you have the option of either exercising the warrants (i.e. converting them into actual stock in the associated company according to the term of the warrant) once they are “in the money” or selling them outright at any time before they expire.
b) When an Early Buy-Back Offer is Made
Should a company make an offer for your warrants via an early buy back offer you have the choice of either accepting the offer or selling your warrants outright unless the company had a specific early call feature (which you should have been aware of at the time of purchase) in which case you would be legally obliged to sell.
c) When There Is a Stock Exchange Arrangement
In a stock exchange arrangement, the warrants will continue on as warrants of the acquiring company with the same expiration date and with the exercise terms adjusted to reflect the terms of the stock exchange in the merger. The owner of said warrants will want to assess the prospects of the new owner to assess the upside potential of their ‘new’ warrants and if the assessment is not positive to sell out before others come to the same conclusion. (For guidance in regards to buy-back and stock exchange situations you might want to subscribe to this fee-for-service site where the well-informed editor provides advice to subscribers.)
4. Dealing With Brokerage Firms
a) Canadian brokers: As there are symbols for all Canadian warrants Canadians will find the placing of orders very easy to execute and, as such, convenient to use online brokerage firms if so inclined. Be that as it may, please make note in the last paragraph in this section how ‘exactly’ to go about placing your order with a broker.
b) Non-Canadian brokers: The situation is not as straight forward for those individuals using non-Canadian brokerage houses because many online brokers are not set up with the symbols for the warrants you wish to trade. As such, it may be necessary to deal with a broker directly and have him/her enter the order for you. Because a broker needs the correct symbol for placing the order the most important thing you can do is give the broker the actual CUSIP number for the warrant you wish to purchase and, where possible its Pink Sheet symbol, to avoid any confusion on the part of your broker.
c) Communicating with non-Canadian brokers: Your broker may need to be educated on how to exercise an order. As such, never ‘ask’ your broker if they will execute your order for warrants but, instead, ‘tell’ them exactly what you want them to do. If you just ‘ask’ many brokers will say they don’t trade in Canadian warrants so they can’t execute the order. However, if you ‘tell’ them exactly what you want them to do on your behalf most will be more than happy to comply – and below are exactly what instructions you should give them.
5. Placing an Order to Buy or Sell
Warrants, like many small cap stocks, often have very thin markets (i.e. demand) and, as such, usually have a big spread between the bid (the price at which you are willing to make a purchase) and ask (the price at which you are willing to sell) price. That being the case, it is imperative to place only “limit orders” when buying or selling warrants associated with Canadian commodity-related stocks.
When American investors go online and see that a warrant of interest is trading with a U.S. symbol placing an order should be problem free. However, if it has a Pink Sheet symbol the price for the most recent bid or ask price should not be used as a basis for establishing a bid or ask price because that price will just be the last trade in the U.S. and therefore may be days, weeks or months old compared to the bid and ask prices on the more active Canadian exchange. In such a situation you should visit here for the up-to-the-minute bid and ask prices, as quoted in Canadian dollars. You can also go here where you can access comparative charting capabilities for both the warrant and the associated stock, recent news on the company, its latest financials, 30 day price history and access to the most recent research on the company. You will also need to go to a currency conversion site to get the current U.S. dollar to Canadian dollar exchange rate because you will be buying the warrants priced in Canadian dollars.
There are two kinds orders that can be placed when attempting to buy or sell a security:
- Market Orders: A market order does not have a set price and is therefore executed immediately at the current ‘market’ price. Markets, especially OTC markets, can be highly volatile, and the price of execution may differ dramatically from the price at time of order entry. Those who use market orders are more concerned about the speed of the execution as opposed to the price.
- Limit Orders: A limit order has a set price and may only be executed at the set price; however, a limit order may never get executed because the market may move away from the set price. Those who use limit orders risk not having an order executed.
If you want to place an order to buy, for example, 5,000 warrants of ABC Mining Company with a CUSIP number of 123456789 and you want to limit the price you pay to $1.43 Canadian then give your broker these specific instructions:
1. “I want to buy 5,000 ABC Mining Company warrants, CUSIP number – 123456789 – at a ‘limit price’ of $1.43 in Canadian dollars”. Add the words “which will be good until cancelled” if you are entering a stink bid or if you are trying to buy a very thinly traded warrant.
2. Ask your broker to confirm the order by reading the order back to you and it’s done. It is as simple as that!
If you want to place an order to sell 3,500 warrants of ABC Mining Company with a CUSIP number of 123456789, for example, and you don’t want to part with your warrants for less than, say, $1.69 Canadian then instruct your broker as follows:
1. “I want to sell 3,500 ABC Mining Company warrants, CUSIP number – 123456789 – at an ‘ask price’ of ‘no less than’ $1.69 in Canadian dollars” and again add the words “which will be good until cancelled” or “until the close of business today” if you want the opportunity to reassess you ask price at the end of the day.
2. Ask your broker to confirm the order by reading back your instructions to you and it is done. Again, it is as simple as that!
Why Bother Investing in Warrants
- Last year a basket of 1 each of the long-term commodity-related warrants went up 91% while their associated stocks “only” went up 57%.
- Warrants are priced about 60% less on average than their associated stocks and, therefore, you are in an ideal position to leverage your dollars very effectively.
There’s your answer as why you should consider investing in warrants as opposed to their associated stock. Investing in warrants gives you the opportunity to earn more dollars (in percentage terms) with considerably fewer dollars at risk.
It warrants (pun intended!) becoming more knowledgeable as to the which, when, why and how aspects of buying/selling warrants – and now you are!