How to Find the Best Resource Stocks During The Brexit Volatility

Democracy prevails!

Last week, the United Kingdom voted to leave the European Union (EU), an unelected and undemocratic bureaucracy.

UKIP leader Nigel Farage told supporters that ‘dawn is breaking on an independent United Kingdom’.

The country has snatched back its sovereignty. It can make its own rules and laws, without interference from Brussels. The European Commission (EC) destroyed the UK fishing industry. To make matters worse, it passed laws to ban short selling in London during the next financial crisis. In this case, when the sovereign debt crisis hits, without this draconian law, London should survive as the financial capital of Europe.

While this is great news, more volatility is likely in the short term. Punters are trying to figure out what it all means.

On Friday, the British Pound hit levels not seen since 1985. The Dow Jones crashed 600 points. And gold skyrocketed, hitting a high of US$1,360 per ounce. It closed slightly lower at US$1,315 per ounce.

With plenty to discuss, let’s talk about investing in resource stocks during this volatility.

Why the big picture matters for resource stocks

A number of Resource Speculator readers have asked that I explain the process I go through to identify and evaluate stocks before I recommend them. Today, I’ll share that answer with you as well.

To begin with, I implement a ‘top-down’ investment approach. This means stock fundamentals, while important, come last.

I spend most of my time analysing the ‘macro playbook’, which I showcase frequently in Money Morning. Without a worldview, how can you possibly know where to invest? My first goal is to avoid sectors that are destined to collapse. This should help protect your capital, allowing you to play the game for another day.

At the moment, I’m probably the most bearish resources analyst in the world. But this doesn’t mean we can’t make money buying resource stocks — far from it.

It just means, unlike the majority of analysts, I have nothing to gain from selling a bullish tale. I’m here to give you straightforward, honest advice. And when the commodities outlook looks grim, I’m not going to sugarcoat it.

Investment banks and brokers use the ‘bottom up’ approach. This mainly focuses on fundamentals and valuations, often neglecting the bigger picture. These analysts nearly always show you ‘rosy’ stock valuations. If they aren’t bullish, their clients — ASX-listed companies — will shop somewhere else. They mostly make money by raising capital and assisting with mergers and acquisitions. There can be a strong self-interest tainting their analysis.

Investment bank forecasts are notoriously horrible — they were bullish heading into the Global Financial Crisis of 2008/09, losing their clients more than just their shirts. In my view, their horrible track record is why they don’t track their performance.

While my track record isn’t perfect, I’ve worked hard to strengthen my top-down approach over the past year. The majority of stocks on the Resource Speculator buy list are now in the black. The best stock is up more than 190% today. And, we’ve bagged multiple gains this year, from 70% to more than 100%. I talk about a few of these gains in a free special report released over the weekend, looking at my methods and my predictions for the next round of resources winners. You can read that report here.

Digging deeper

I attribute a lot of my success to correctly forecasting the big picture.

All of last year, I argued that the resources bull market would return in the second quarter of 2016. I revised this argument in late February/early March to Resource Speculator readers. The updates explain my broader term outlook for commodities heading into next year.

Based on my analysis, instead of launching into another bull market today, I forecast a second quarter bounce for resource stocks. As you can see, this forecast is on target. As you probably know, I do not expect this bounce to last, which should see plenty of delicious buying opportunities in the months ahead.

Only after I have the big picture sorted — which involves technical analysis — do I turn to fundamental analysis.

I use an extremely rigorous process when analysing and selecting stocks. I hunt for stocks which are trading under the radar. I like companies with plenty of near term activity, quality geology (i.e. high-grades, lots of nearby discoveries, attractive rock characteristics), good cash flow potential, strong balance sheets…the list goes on.

Once I’ve found a good company, I examine its enterprise value (market cap, plus debt less cash). I don’t care for valuation techniques such as discounted cash flow (DCF), net present value (NPV) or asset risk weightings. These techniques — and many more — are subjective and use far too many assumptions, most of them linear. The world isn’t linear — it changes. This is why having a macro view is important.

Referring to enterprise value, I like buying speculative stocks worth less than $15 million. This minimises the risk and maximises the potential reward of the trade. Of course, there are some situations when I don’t mind paying a bit more. But there’s definitely a limit, which is why I stress the importance of buy-up-to prices to my readers. Don’t pay too much. If you miss out, there’s always another day and another stock to buy for the right price.

Importantly, risk management is crucial for your resources portfolio during the good and bad times.

Resource Speculator risk management guidelines

While traders often set a 5–15% stop loss strategy, I’ve implemented a 40% stop-loss policy for quality stocks. Quality stocks are developers and producers. The wider stop loss is based on a longer term investment horizon. It’s also based on the Resource Speculator buy-in prices.

My stop-losses don’t apply to speculative stocks — companies without proven assets. In most cases, they’re looking for the motherlode. If they find it, regardless of market conditions, you could make huge profits.

As you will read in my free report, one of our past big winners was 88 Energy [ASX:88E]. I recommended that readers buy it up to 1.2 cents per share last year. At one stage, the share price collapsed 50% below the buy-in price. Yet, once it hit the crude oil motherlode, 88 Energy skyrocketed 550% in five days at the 13-year low in crude oil. We sold, and my readers walked away with a handsome profit — and far in excess of the current share price.

Of course, many speculative stocks don’t work out. This is why I always say punt no more than you can afford to lose on any speculative stock.

Speculative stocks offer a big reward when they pay off, as 88 Energy did, but they are extremely risky. So don’t get emotionally attached! Unlike investment banks and stock brokers, if I recommend a speculative stock and it doesn’t work out, I’ll cut it immediately. In my view, capital preservation is key.

Some readers have said they’re not interested in speculative stocks. I understand this. But based on my top down approach, it’s not time to buy the best resource stocks. The best resource stocks could crash significantly during the months ahead. While some punters may be scared to buy when this happens, I see it as a once in a lifetime buying opportunity.

When resource stocks start to crash harder, I’ll strategically recommend the best of the lot. Being a contrarian resources investment newsletter, with a strong top-down approach, Resource Speculator readers should make massive profits in the years ahead.

While we wait to pick up the best resource stocks for scraps in the dollar, your best bet is sticking to speculative stocks. Remember, speculative stocks can make you huge gains despite the market conditions.

In my view, there’s no better place to make big gains than in resource stocks this year. Both in quick speculations, and after the crash with longer term investments. That’s why I wrote the free report, ‘Three ‘Bounce-Back Mining Belters’ to Buy NOW’, which was published Saturday.

Implementing my top-down approach, I’ve found three resource stocks that could make you massive profits in the months ahead. This is despite the market conditions.

To get your FREE report today, click here.


Jason Stevenson,
Resources Analyst, Money Morning

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