Category Archives: Risk Management

Arbitrage! Primero Mining and First Majestic

Mark Twain once said: “A gold mine is a hole in the ground with a liar standing on top of it.”  I think mining is more like a rusty, leaky bucket that you need to pour capital so as to keep the bucket filled.

A better description: mining is a capital intensive business that must be constantly replenishing its depleting reserves which are hard to find much less extract economically.

However, if you buy Primero Mining (PPPMF) say this morning 9:40 AM at 18 cents you will receive 0.03325 shares of First Majestic Silver (AG) that you short at $6.00, for example.   For each share of Primero bought at 18 cents allows you to own ($0.18/.03325) a proportional share of First Majestic at $5.41.  The difference between your short sale of First Majestic at $6 and 5.41 is ($6 – 5.41)/5.41 is about 10.9%.

Or the short sale of $6 of First Majestic converts at 0.0335 into a share price of Primero Mining of ($6 x 0.03325) or $0.1995.   The difference between the 18 cents that you paid for Primero and 19.95 cents received upon the closing of the transaction is (1.95 cents/ 18 cents) or 10.8%. The deal should close within the next twenty days.   The annual return if the deal closes in the next 10 to 20 days is over 100%.  March 13th is Primero’s shareholder meeting to approve the deal.

I believe there is a 98% chance of the deal going through thanks to all three parties benefiting. Wheaton precious metals’ (WPM) stream was restructured so there is now an economic mine and opportunity for WPM to receive cash flow. Primero shareholders are no longer faced with bankruptcy, and First Majestic has the money and the expertise to handle underground mining to expand their reserves and cash flows.,622803,622803,report=1

Also, the proxy advisor has given the go ahead for the MARCH 13th meeting.

If the deal would fall through, then let’s imagine your 18 cents is now worth $0 (PPPMF probably drops to 5 cents, but let’s be cruel) and AG spikes up 50 cents. On the deal announcement, AG fell 30 cents. Every dollar in PPPMF goes to $0 and every short dollar in AG loses about 10%.  A 2% chance of the deal not closing causes a loss of $1.10 for every dollar invested–which means an expected loss of 2.2 cents vs. making about 10 cents to 11 cents on each dollar invested in the arbitrage.  I have an expected value of about 8 to 9 cents on each dollar invested in this arbitrage within the next month.  Not bad considering my alternatives today.

See below 

Mexico-focused company First Majestic Silver has signed a definitive arrangement agreement to acquire all of the issued and outstanding common shares of Primero Mining for $320m.

Under the agreement, every Primero shareholder will receive 0.03325 First Majestic common shares in exchange for one Primero common unit.

Primero owns the San Dimas silver-gold mine in the Mexican state of Durango.
Primero has identified more than 120 epithermal veins with exploration potentiality throughout its production history.

In parallel with the deal, First Majestic has entered separate agreements with Wheaton Precious Metals International (WPM) to terminate the existing silver streaming interest at the San Dimas mine.

You can use Google Alerts to send to your email notices of buyouts, mergers, etc. Then do your homework.  These tiny, obscure deals are out there.

This is NOT a recommendation for you to do this arbitrage, but follow the logic or the lack thereof.   

Acq. Multiple, Yog Berra and Financial Satire, and Hedge Fund Quiz

While at all times Wall Street analysts try to justify the valuations, here is a fun quote (via Bloomberg) from 2002 looking back from Scott McNeely, the CEO of Sun Microsystems, one of the darlings of the 2000 tech bubble:

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes.

What were you thinking?”

An educational, savagely satirical view of our current market conditions and lessons on valuation.   I read about 40 investment letters a quarter and this is about the best I have read in five years. Hilarious! Mark McKinney – Its Like Deja Vu All Over Again – Final and his prior letter: I Dont Get It – Mark McKinney – Final 8292017 New

An excellent interview by Tobias Carlisle.   CHEAPNESS not quality wins!  Yes, I was somewhat shocked.   Why?


Ackman’s embattled Pershing Square hedge fund laid off 18 percent of its staff on Friday — a total of 10 pink slips that brought head count down to 46.

Investors have suffered in Pershing Square (PSHZF) vs. S&P 500:

He wants to hire an analyst who can THINK INDEPENDENTLY.  You walk into his office and he asks you, “Can you think independently as an analyst?”

How do you reply.   Be careful…………think for awhile before you reply.  What proof can you give?

If you are struggling to answer, then

will provide clues.

What determines the price of gold:

How the price of gold is determined Monetary Metals 2018

Bulls Rampage

Increasing debt for equity swap

Sentiment bullish and prices high relative to the past.

Charts: Every Picture Tells a Story Don’t It? –Rolling Stones

Above is a chart of the Barrons Gold Mining Index, the oldest mining index available.

Above are chart analogs of past bear markets in gold-mining stocks. Rather than using charts to PREDICT the next “Head and Shoulders Bottom” or the next ROUNDING BOTTOM (How about I show you MY bottom?) what can charts tell you about this PARTICULAR industry?   How is that information useful? Or is it?

Note the hedged comments of the publisher of the above charts.

Charts have never shown (based on my research) to have any statistical predictive value because of the subjective nature of interpretation–there are always two sides to a chart. Buffett stopped charting when he could flip the chart over and get the same answer.   Note this article

Now onto the bull market analogs.

Bull Market Analogs Article

Notice the difference with these charts of housing and banks.

What might account for the difference in the chart patterns?  What do the charts tell you about the mining industry?  IF–god forbid–you did wish to invest in precious metals miners, how might you adapt your strategy?  What explains (mostly) the shape of the above charts?  It is perfectly rational to avoid the industry but what do the charts tell you about the structure of the industry? Whip out your competitive analysis books or and post your thoughts.



Investing might be considered decision-making under uncertainty. Therefore the following exam.

You must answer BOTH questions correctly to be hired.  You are now in the final pool of candidates to work for a big hedgie fund. Now comes

Question 1:

Imagine playing the following game,  At a casino table is a brass urn containing 100 balls, 50 red and 50 black.  You’re asked to choose a color.  Your choice is recorded but not revealed to anyone, after which the casino attendant draws a ball randomly out of the urn. If the color you chose is the same as the color of the ball, you win $10,000.  If it isn’t, you win nothing-$0.00.

You are only allowed to play once–which color would you prefer, and what is the maximum bid you would pay to play? Why?

Question 2:

Now imagine playing the same game, but with a second urn containing 100 balls in UNKNOWN proportions.  There might be 100 black balls and no red balls, or 100 red balls and no black balls or ANY proportion in between those two extremes.  Suppose we play the exact same game as game 1, but using this urn containing balls of unknown colors.

What is your bid to play this game IF you decide to play?   How does the “risk” in this game (#2) compare to game (#1)?

Take no more than a minute.   So are you hired?!

Answer posted this weekend.

ANSWER (9/10/2017)

A Reader provides a clearer distinction in Question2:

Your second problem is ill-specified for your desired effect . You write that all combinations of red/black balls within the 100 ball population ARE possible; you don’t say they are equally probable. You need to assume them to be equally probable in order for the reader to infer that the expectations are identical between problem 1 and problem 2.

The reason being is that without defined probabilities on the possible ratios the long run frequency of draws from the second bag isn’t calculable. Hence the expected value cannot be computed and therefore cannot be used in comparison to the EV of problem 1 (you need probabilities in a probability weighted average after all).

You could suggest that the offeree has a 50/50 chance of choosing the correct colour (even if the long run frequencies are not known). But this not an argument born from expected value. This is an argument of chance and it assumes the offeree has no additional information from which to make their decision (which is hardly ever the case).

There are 100 possible choices for the proportion of red/black: 100 red balls/0 black balls, 99 red balls/1 black ball etc., 98/2, 97/3     with 100%, 99%, 98%, 97% probability of choosing a black ball all the way………… to 2 black balls/98 red balls, 1/99, 0/100. Put equal weight on them since random.  When computed, the average of the expected payoffs across all these alternative realities, one got an expected value of $5,000, the same as Game 1.

The two games describesthe Ellsberg Paradox, after the example in Ellsberg’s seminal paper.  Thinking isn’t the same as feeling.  You can think the two games have equal odds, but you just don’t feel the same about them.   When there is any uncertainty about those risks, they immediately become more cautious and conservative.  Fear of the unknown is one of the most potent kinds of fear there is, and the natural reaction is to get as far away from it as possible.

So, if you said the two games were exactly similar in probabilities, then A+.  The price you would bid depends upon your margin of safety/comfort.   You would be rational to bid $4,999.99 since that is less than the expected payoff of $5,000.  But the loss of $4,999.99 might not be worth it despite the positive pay-off.  A bid of $3,000 or $1,000 might be rational for you.   The main point is to understand that the two games were similar but didn’t appear to be on the surface.

The Ellsberg paradox is a paradox in decision theory in which people’s choices violate the postulates of subjective expected utility. It is generally taken to be evidence for ambiguity aversion. The paradox was popularized by Daniel Ellsberg, although a version of it was noted considerably earlier by John Maynard Keynes.  READ his paper: ellsberg

Who was fooled?

Anyone not answering correctly or NOT answering has to go on a date with my ex:

The Stock Market: Risk vs. Uncertainty

Life is risky. The future is uncertain. We’ve all heard these statements, but how well do we understand the concepts behind them? More specifically, what do risk and uncertainty imply for stock market investments? Is there any difference in these two terms?

Risk and uncertainty both relate to the same underlying concept—randomness. Risk is randomness in which events have measurable probabilities, wrote economist Frank Knight in 1921 in Meaning of Risk and Uncertainty.1 Probabilities may be attained either by deduction (using theoretical models) or induction (using the observed frequency of events). For example, we can easily deduce the probabilities of the possible outcomes of a game of dice. Similarly, economists can deduce probability distributions for stock market returns based on theoretical models of investor behavior.

On the other hand, induction allows us to calculate probabilities from past observations where theoretical models are unavailable, possibly because of a lack of knowledge about the underlying relation between cause and effect. For instance, we can induce the probability of suffering a head injury when riding a bicycle by observing how frequently it has happened in the past. In a like manner, economists estimate probability distributions for stock market returns from the history of past returns.

Whereas risk is quantifiable randomness, uncertainty isn’t. It applies to situations in which the world is not well-charted. First, our world view might be insufficient from the start. Second, the way the world operates might change so that past observations offer little guidance for the future. Once bicyclists were encouraged to wear helmets, the relation between riding the bicycle—the cause—and the probability of suffering a head injury—the effect—changed. You might simply think that the introduction of helmets would have reduced the number of head injuries. Rather, the opposite happened. The number of head injuries actually increased, possibly because helmet wearing bikers started riding in a more risky manner due to a false perception of safety.2

Typically, in situations of choice, risk and uncertainty both apply. Many situations of choice are unprecedented, and uncertainty about the underlying relation between cause and effect is often present. Given that risk is quantifiable, it is not surprising that academic literature on stock market randomness deals exclusively with stock market risk. On the other hand, ignorance of uncertainty may be hazardous to the investor’s financial health.

Stock market uncertainty relates to imperfect information about how the world behaves. First, how well do we understand the process that generated historical stock market returns? Second, even if we had perfect information about past processes, can we assume that the same relation between cause and effect will apply in the future?

The Highs and Lows of the Market

Warren Buffett, the world’s second-richest man, distinguishes between periods of comparatively high and low stock market valuation. In the early 1920s, stock market valuation was comparatively low, as measured by the inflation-adjusted present value of future dividends. The attractive valuation of stocks relative to bonds became a widely held belief after Edgar Lawrence Smith published a book in 1924 on stock market valuation, Common Stocks as Long Term Investments. Smith argued that stocks not only offer dividends, but also capital appreciation through retained earnings. The book, which was reviewed by John Maynard Keynes in 1925, gave cause to an unprecedented stock market appreciation. The inflation-adjusted annual average growth rate of a buy-and-hold investment in large-company stocks established at the end of 1925 amounted to a staggering 32.13 percent at the end of 1928.

On the other hand, over the next four years, this portfolio depreciated at an average annual rate of 17.28 percent, inflation-adjusted. Taken together, over the entire seven-year period, the inflation-adjusted average annual growth rate of this portfolio came to a meager 1.11 percent. Buy-and-hold portfolios in allegedly unattractive long-term corporate and government bonds, on the other hand, grew at inflation-adjusted average annual rates of 10.18 and 9.83 percent, respectively. This proves Buffett’s point: “What the few bought for the right reason in 1925, the many bought for the wrong reason in 1929.” One conclusion from this episode is that learning about the stock market may feed back into the market and, by changing the behavior of the market, render our “learning” useless or—if we don’t recognize the feedback effect—hazardous.
Is Tomorrow Another Day?

Risk and uncertainty are two concepts that stem from randomness. Neither is fully understood. Although risk is quantifiable, uncertainty is not. Rather, uncertainty arises from imperfect knowledge about the way the world behaves. Most importantly, uncertainty relates to the questions of how to deal with the unprecedented, and whether the world will behave tomorrow in the way as it behaved in the past.

This article was adapted from “The Stock Market: Beyond Risk Lies Uncertainty,” which was written by Frank A. Schmid and appeared in the July 2002 issue of The Regional Economist, a St. Louis Fed publication.

(Source: St Louis Federal Reserve)

A Review: The Bre-X Scandal

The Peak
It was touted by media and banks as the “richest gold deposit ever”
In December 1996, Lehman Brothers Inc. strongly recommended a buy on “the gold discovery of the century.”

Bre-X’s salted samples were never checked by a third party, people wanted to believe so they never questioned the rising price of the stock. Do not ignore the warning signs.

Patience is paying off in

When is a P/E not a PE: Case Study in Indexing

A tutorial on the dangers of Indexing investing. 

Know what you are doing IF you buy index funds!  You can learn a lot by studying Horizon Kinetics.  The video provides a valuation of the index and how to think about investing or not in indexes.

Also, more on indexing here:





Hedge Fund Analyst Quiz–NG $3 The New Normal

Your boss runs into your office and slaps this report onto your desk: Don‘t Bet Against Innovation_Sub-$3 Is the New Normal

After reading the report and using your knowledge of how capital cycles work, what would you say to your boss about using the information in that report for investing?  IF you wanted to make an outstanding investment, then how might the report help you?   The video below might give you a hint.  Remember that the JP Morgan report goes to thousands of portfolio managers and analysts, so how can YOU use the information to have an edge? Or can you? Comments needed in order to keep your hedge fnd job.

Good luck!


Indexing Madness or An Indexing Bubble

A must see discussion of today’s index investing distortions   What will turn the tide for active investors. Or read commentary : Q4-2016-Commentary_Final Grant’s Conference Presentation


Q2 2016 Commentary FINAL (See section on ETFs vs. Individual Stocks)

Articles of interest:

Risk Disclosure in Plain Language; Go LT Fundamental

Written in 1998 during the Internet Riot (from Cove Capital Blog)

Risks of Investing in IPS Millennium Fund
Plain Language Risk Disclosure (Funny)

First of all, stock prices are volatile. Well, duh. If you buy shares in a stock mutual fund, any stock mutual fund, your investment value will change every day. In a recession it will go down, day after day, week after week, month after month, until you are ready to tear your hair out, unless you’ve already gone bald from worry. It will insist on this even if Ghandi, Jefferson, John Lennon, Jesus and the Apostles, Einstein, Merlin and Golda Maier all manage the thing. Stock markets show remarkably little respect for people or their reputations. Furthermore, if the fund has really been successful, you might be buying someone else’s whopping gains when you invest, on which you may have to pay taxes for returns you didn’t earn. Just try and find somewhere you don’t, though. Dismal.

While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 – 4 years. It goes with the territory. Expect it. Live with it. If you can’t do that, go bury your money in a jar or put it in the bank and don’t bother us about why your investment goes south sometimes or why water runs downhill. It’s physics, man.

Aside from the mandatory boilerplate terrorizing above, there are risks that are specific to the IPS Millennium Fund you should understand better. Since most people don’t read the Prospectus (this isn’t aimed at you, of course, just all those other investors), we thought we’d try a more innovative way to scare you.

We buy scary stuff. You know, Internet stocks, small companies. These things go up and down like Pogo Sticks on steroids. We aren’t a sector tech fund, we are a growth & income fund, but right now the Internet is where we think most of the value is. While we try to moderate the consequent volatility by buying electric utility companies, Real Estate Investment Trusts, banks and other widows-and-orphans stuff with big dividend yields, it doesn’t always work. Even if we buy a lot of them. Sometimes we get killed anyway when Internet and other tech stocks take a particularly big hit. The “we” is actually a euphemism for you, got it?

We also get killed if interest rates go up, because that affects high dividend companies badly. Since rising interest rates affect everything badly, we could get killed even worse if the Fed raises rates, or the economy in general experiences higher interest rates beyond the control of those in control, or gets out of control. Whatever.

Many of the companies we buy are growing really fast. Like, 50% – 100% per year sales growth. Many of them also don’t make any money, although they may be relatively large companies. That means they have silly valuations by traditional valuation techniques. We don’t know what that means any more than you do, because we have never seen anything like the Internet before. So we might overpay for these companies, thinking we are really smart and can get away with it because they are growing so fast. It doesn’t take a whole lot for these companies to drop 50% or more, because nobody else knows what they are worth either. Received Wisdom can turn on a dime in this business, and when that happens prices fall off a cliff.

Even if we were really smart and stole these companies, if their prices run way up we are still as vulnerable as if we were really dumb and paid that high a price for them to start with. If we sell them, you will get pretty irritated with us come tax time, so we try not to do any more of that than we have to. The pole of that strategy, though, is that if we are really successful, you will have a lot of downside risk in a recession or a bear market. Bummer.

Finally, if you haven’t already grabbed the phone and started yelling at your broker to sell our fund as fast as possible, you should understand the shifting sands of technology. It doesn’t take billions of dollars to start a high tech company, like it did U.S. Steel or Ford Motor. Anybody can do it, and everybody does. Many of our companies are small, even though they dominate their market niche. It’s much easier for a new technology to blow one of our companies out of the water than it was in the old days of canal, mining, railroad and steel companies.

Just so you know. Don’t come crying to us if we lose all your money, and you wind up a Dumpster Dude or a Basket Lady rooting for aluminum cans in your old age.

Please e-mail us if we haven’t scared you enough, and we’ll try something else.
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