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How to Own Precious Metals Warrants

Commodities / Gold and Silver 2011 Dec 01, 2011 - 03:53 AM GMT

By: Lorimer_Wilson

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 is no one writing about the merits of investing in the long-term warrants associated with a few of those companies?” Merits? Absolutely!

The proprietary Gold and Silver Warrants Index (GSWI) returned 92% and generated a 60% leverage of dollars deployed in 2010. Now that I have told you why you should consider investing in warrants and no doubt have your undivided attention read on as I outline:

• what warrants actually are,
• which companies have long-term tradable warrants,
• when the warrants should be exercised by,
• where these companies have their various mines and
• how to go about buying and selling them.

It is unfortunate that 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 but this article will change all that.

Why Invest in Warrants?

As I mentioned above warrants associated with gold and silver mining with a duration period of 24 or more months were up 92% in 2010 and 140% in 2009 in U.S. dollar terms (see a recent article here on the subject entitled Exposed! The Unknown World of Gold, Silver and Commodity-related Company Warrants). That compares very favorably 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%,
• that “laggard” gold which was up a “paltry” 30% and
• silver which was up a whopping 83%

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” or “silver spoon” 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 for Americans;
• they seem complicated because of their differing time durations;
• they require 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

1. Number of Warrants by Commodity

a) Only 135 companies have tradable warrants of which 67% are in the commodity/natural resource sector, i.e. mining or drilling, exploring and/or developing or purchasing via royalties.

b) Only 33 companies – yes, only 33 – have tradable warrants (37 in total) with an expiry date of at least 24 months duration which I consider to be the absolute minimum duration period and, as such, are included in my proprietary Commodity-related Companies Warrant Index (CCWI).

c) Of the 33 companies with long-term warrants:

• 19 companies are involved in some aspect of precious metals mining (as included in the GSWI);

• 8 are involved in base metal mining including zinc (1), 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.

2. 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 33 companies in question:

• 4 have market caps in excess of $2.5B;
• 1 has between $500M and $1B;
• 2 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
Warrants trade exactly like the underlying common stock and, as such, 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 which stands for the Committee on Uniform Security Information Procedures. The American Bankers Association established this 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.

c) Pink Sheet Symbols
Stocks and warrants that trade on the Pink Sheets fall into one of 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

and consist of a 5-alpha symbol ending in ‘F’ for Foreign for the 5 warrants that fall into this category.

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) Leverage
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 – is a doable calculation but is better left up to those in the business to provide. Precious Metal Warrants is one such provider calculating the leverage of each warrant at both random stock price levels and at fixed stock price percentage increases which is ideal for comparing the leverage advantage of one warrant versus another. To my knowledge of the 3 sites that provide warrant information they are the only one that provides this unique time/price increase calculation.

It should also be noted at this juncture that Precious Metals Warrants is the most comprehensive site on warrants providing:

• a complete list of ALL commodity related warrants both short- and long-term;
• the Canadian and/or U.S. stock exchange or Pink Sheet trading listing symbol of every warrant;
• the CUSIP number of every warrant;
• the exercise price of every warrant;
• the conversion terms of every warrant;
• the duration (i.e. expiry date) of every warrant;
• an evaluation (under-, over- or fair-value) of every warrant;
• the product involved with every company listed
• the location of operation of every company listed
• a subscription service (see details here) containing all of the information outlined above and much more
• advise related to buy-back offers and stock exchange arrangements that present themselves
• a free weekly newsletter (sign up here) related to warrants and much more

b) 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 6 to 12 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 terms of the warrant) once they are “in the money” or selling them outright at any time before they expire.

Dudley Baker of Precious Metals Warrants has this to say on the subject:

“Frequently I am asked whether warrants should be exercised if they are trading in the money…and my answer…is always the same – why bother!

For U.S. investors, to exercise or not to exercise is a non-issue because virtually all of the warrants trading on the resource shares are associated with Canadian companies and the warrants are not registered in the U.S. and, as such, while U.S. investors can buy and sell warrants, they are not allowed to exercise them.

Canadian investors could exercise the warrants, but again, why bother doing so? If you own warrants of a company you like, you will need to have your brokerage firm send the warrant certificate to the company's transfer agent along with the exercise price at which point they would send you the common shares of the company. As I see it why not just sell the warrants in the market and if you really like the company and want to continue with them, then just purchase the common shares. Simple, clean and saves a lot of time and paperwork and you are in the exact same position.”

c) 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.

d) 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.

4. Interacting 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 might wish to trade. As such, it will 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.

5. 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 your 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.

6. 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. As such, it is imperative that you 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 new bid or ask price because that price will just be the last trade in the U.S. and therefore may be days, weeks or even months old compared to the bid and ask prices on the more active Canadian exchanges. In such situations 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 of orders that can be placed when attempting to buy or sell a security:

1. 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.
2. 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.

a) 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:

• “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.
• Ask your broker to confirm the order by reading the order back to you and it’s done. It is as simple as that!

b) 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:

• “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 your ask price at the end of the day.
• 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

1. Last year a basket containing 1 each of the long-term commodity-related warrants went up 91% while their associated stocks “only” went up 57%.
2. 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.

Conclusion

It warrants (pun intended!) becoming more knowledgeable as to the which, when, where, why and how aspects of buying/selling warrants – and now you are!

Lorimer Wilson is editor of www.munKNEE.com (Your Key to Making Money!), publisher of a daily FREE Financial Intelligence Report which can be subscribed to here and a frequent guest contributor to www.PreciousMetalsWarrants.com which also offers a FREE newsletter (sign up here) and a subscription service (see details here).

Disclaimer: Please understand that the above is just the opinion of a small fish in a large sea.  None of the above is intended as investment advice, but merely an opinion of the potential of what might be.  Simply put:

The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions.

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