A few of the best ways to invest in the precious metals market using leverage is to buy silver and gold mining stocks, futures and options. These investments provide leverage to a rising gold and silver price. Investors with higher risk tolerance would look to take more risk for higher rewards in the future, so they are likely to lean toward using futures and options for the most bang for their buck. However, there is another vehicle that provides leverage that most investors know little about, warrants.
What is a warrant?
If you know options, then the concept behind a warrant is not hard to understand. A warrant gives the buyer a right, but not an obligation, to purchase the securities at a specific price from the issuer (such as a mining company) during a certain duration of time. It sounds exactly like options except you buy the warrants directly from the company. Also, the time frame to expiration on a warrant is longer than options. Most warrants are 2 to 4 years from expiration when the mining company issues them.
Why should precious metals investors consider investing in warrants?
One of the main advantages with investing in warrants over options is the longer time frame. You can purchase LEAP options, which expire 6 months or longer, but most only stretch out from 12 to 18 months. On the other hand, investors can find warrants than expire 2 to 4 years from now.
The longer the duration, the more likely the investment will be in the money and make a profit. If you invest in options, the window of opportunity to make a profit is smaller since the duration is shorter.
Another reason to invest in warrants is the cheaper price compared to owning the stock. Some precious metals stocks that carry a hefty price-tag can be found selling warrants at half the price in some cases. If investors have a strong conviction over a particular company, then why not take more risk and buy the warrants for a higher return? The worse that could happen is that investors lose the money they put into the warrants.
Finally, by doing some research, an arbitrage could present itself since warrants are one of the most underappreciated and unknown investment vehicles in the market. This is because U.S. investors don’t pay much attention to warrants like Canadian investors. Consequently, there are a few warrants right now that are mispriced because of this lack of awareness.
Recommendation
For beginners that have never invested in warrants, I would recommend focusing on risk management. One can increase their chance for profit by focusing on warrants with expiration that are 4 years out. Remember, the longer the time frame, the better the odds for making a profit.
I would also focus on precious metals stocks with strong fundamentals and a good growth profile in reserves (which are mostly junior mining and royalty stocks). These type of stocks usually have an increase in cash, revenue and profit margin. This translates into a higher stock price and a rise in the value of the warrant.
Conclusion
Investing in warrants should not be a major component in a portfolio unless willing to accept a high degree of risk proportional to the reward. However, they can be utilized for higher leverage as a minor component in a portfolio for some. Most importantly, due to their general lack of awareness by the wider investment community, the chances for gross mispricing in warrants' value could be likely, especially for some key companies.
