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Dudley Baker on Gold Stocks Warants Buying Opportunity

Commodities / Gold & Silver Stocks Nov 18, 2008 - 06:15 PM GMT

By: The_Gold_Report


Best Financial Markets Analysis Article“It's either the end of the world or a fabulous buying opportunity”

His pitch is irresistible: “Buy a basket of juniors with warrants and it could be the easiest 500% you'll ever make.” In this exclusive look at one of the most overlooked and misunderstood investment vehicles, Dudley Baker of explains to The Gold Report exactly what warrants are and how they increase the odds of winning vastly higher returns. With a little arm-twisting, Baker even reveals some of his most prized “unbelievable” opportunities.”

The Gold Report: Could you start by explaining what a warrant is and how it differs from a futures contract?

Dudley Baker: A warrant is basically a security. It gives the holder the right, but not the obligation, to purchase the underlying stock at a specific price within a specific period of time. It sounds very similar to a call option except that it really is a security and a warrant will trade in much the same way as common shares. A warrant is assigned a symbol and will trade on the exchange or, in the U.S., it will have U.S.-assigned symbol where it can be traded over-the-counter.

TGR: Are all the warrants traded in the over-the-counter market?

DB: No, no. Most will always be private. Many precious metals investors know ‘warrants' because they are frequently issued in a private placement. But most of those warrants never trade on any exchange and they're not transferable. On my website only cover those warrants that are trading, the ones you and I could go out and buy. For example, Warren Buffet conducted a private transaction with General Electric and Goldman Sachs. There will never be a market for those. That's the distinction, whether it's a warrant with a private placement or an initial public offering. In rare cases a company can get the warrants listed if they were issued in connection with a private placement.

TGR: So Buffet purchases the stock and then is awarded the warrants. Is it GE or Buffet who decides to make those warrants transferable?

DB: In this case it probably would be Buffet. Since he actually owns those warrants it's his decision.

TGR: Let's to back to the private placement example. Aren't warrants used as a sweetener for a private placement investment? In that case, who makes the decision as to whether those warrants are transferable?

DB: The company will make that decision. In Warren Buffet's case, let's say that he's the only holder of the Goldman Sachs and GE warrants. Even if the company said we want these to trade, there's nobody to trade them because there's only one guy, Buffet, who owns them and he's probably not going to trade them. The chances are that he would just convert the warrants or the company would buy them back at some point. But in the case of the private placement of a mining company, there may be hundreds or even a thousand participants. If the company decides to list those warrants, those 500 to 1,000 individuals could decide to trade them. So now we've got some liquidity. And we always need that liquidity. So there are a lot of opportunities even for the bigger companies that have warrants trading.

TGR: So when warrants are initially issued, they could be privately placed, or publicly traded.

DB: Right.

TGR: Are most of the warrants that are publicly traded related to financial transactions other than mergers?

DB: They could be issued in connection with the financing for an initial public offering. A lot of warrants start with the private placements, the initial public offerings, and mergers. So warrants that are trading come about through a number of different circumstances.

TGR: Given the current stock market and the merger and acquisition environment, would you expect increased interest in the purchase of warrants?

DB: You mean what is the future for warrants?

TGR: Yes.

DB: Let's put it this way. The most important thing is to have a solid understanding of the underlying fundamentals of the company. Do they have a good story? Is there potential for the stock to greatly increase in value? And then we have to ask, maybe before we buy the commons shares: will trading a warrant give us a lot more leverage? If so, what is the remaining life of that warrant? It is especially important in this environment to have as long a life on a warrant as possible. Many of the warrants in our database have three years or more of a remaining life, which is really great. Some of them have four or five years. One actually has an 8-1/2 years going out to 2017. I see great opportunities going forward.

Are we going to blast off in a rally this week, next week, next month? I don't know. But I'm very confident that in the coming months and years that gold and the junior mining shares are going much, much higher. So I'm very comfortable buying warrants in the juniors. It is critical to have as long a life as possible. I cannot stress enough how important it is to look at that underlying common stock. If the company's common stock does not go up, there's no way the warrants are going up. So we have to be confident that the company will be able to execute its business plan. Then we hope for a skyrocketing market here in the coming months and years.

TGR: So the real advantage of a warrant as opposed to the common shares is the leverage.

DB: Exactly and that's why we'd start looking at a warrant. It gives us a lot more bang for our buck, a lot more leverage. I'm always looking for a minimum of two times the leverage. So if we're looking for a common stock to go up 100%, I'm leveraged to make at least 200% by buying the warrant.

TGR: How would you compare a warrant to a call option?

DB: Good question. A call option is just going to trade on the Chicago Board Options Exchange, whereas a warrant is actually going to trade like a common stock on the TSX. The main difference we've got is time and we always want as much time as possible. There are so many call options out there on the mining shares, but maybe they've got 90 days or 180 days, one year at most. That's not enough time for me. In this treacherous market environment that we've had over the last two years, options are really just speculating. I like to think that if we can find a long-term warrant on a good company that has a two-year minimum life—if not three years or more— now we're investing. This way, time is on my side. On my website I've got some examples of my trades and the common denominator of those that generated roughly 1,000% or more return was the fact that all of those warrants had over a three year remaining life when I bought them. Time is the key to my success with warrants.

TGR: I would think time really plays very well right now with the market being at 52-week, if not 5-year, if not 30-year lows.

DB: Incredible, yes.

TGR: It probably can't go much lower in the next three years.

DB: That's exactly how I see it. You can make a blanket statement that nearly all of the juniors and warrants are off by at least 90% in value. Either you believe this is the end of the world and the game is over or this is just a fabulous buying opportunity. I was buying this morning. I've usually do several transactions each week, so I just continue to build inventory, accumulate mining shares and warrants, which I'll sell in the future at substantially higher prices. So, if we can find a warrant that, say, has a three-year or longer remaining life, it's going to be hard to imagine how high it might go in a few years. It used to be that if a stock were trading for less than 10 cents, you'd be crazy to consider it. In this environment, a lot of juniors are selling for less than 10 cents; good companies with cash in the bank. The opportunities out there today are truly incredible.

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