Picks and Shovels
When he was the Editor in Chief of Stansberry Research, Brian Hunt saw more investment ideas come across his desk in one week than most people do in five years.
As you'll see below, one of his top ways to make huge returns in booming sectors or commodities is "picks and shovels"... a "sleep at night" way to profit from a bull market.
Stansberry Research: For many investors, the safe, "sleep at night" way to make huge returns in booming sectors or commodities is to own the "picks and shovels" of the boom. Can you explain how this idea works?
Brian Hunt: Sure. The idea of owning "picks and shovels" in order to profit from a big sector or commodity boom simply means owning companies that supply the vital tools, products, or services many participants in the boom must use... rather than taking the riskier route and buying the individual players in the boom.
The classic success story here was back in the 1850s, when a German immigrant moved from New York to San Francisco to participate in the California Gold Rush.
Rather than taking the "all or nothing" route of looking for a big gold strike, the German immigrant sold basic goods to the miners. This was a much safer, surer way to acquire wealth than trying to find the one big strike.
The immigrant eventually started producing a new type of durable pants to sell to the miners. They became a huge hit... and the German immigrant got rich. His name was Levi Strauss. Levi didn't risk it all on trying to find the big strike, he just sold the stuff everyone else needed to try to find the next big strike themselves.
Stansberry Research: How about a few modern examples?
Hunt: Two great "picks and shovels" stories of modern times come from the recent Internet and energy booms: Cisco and Core Laboratories.
Cisco was one of the ultimate "picks and shovels" investment plays of the Internet revolution. Rather than try to pick which website companies were going to be successful, an investor could have just bought Cisco instead.
Cisco made the routers and switches – what some folks called the "plumbing" – required to build the Internet... and the stock climbed more than 9,500% from its IPO in 1992 to the 2000 bubble peak.
Remember... during this time, thousands of companies tried to become the Internet's "next big thing." A handful made it. Most did not. Cisco just sold the "picks and shovels" to build the Internet and soared. It was the surer bet. It was the "sleep at night" bet.
Now, let's take the story of Core Laboratories.
Back in 2003, if investors believed that crude oil was set for a big price rise, they had a handful of different vehicles to choose from. They could buy speculative futures contracts... they could buy a small oil company exploring for oil in some remote jungle... or they could have bought shares in Core Laboratories.
Core Laboratories used specialized technology to analyze oil and gas deposits. They helped oil companies decide where to drill in order to find big deposits and helped them manage those deposits once they were found. Core did no drilling or exploration of its own. It was paid by lots of different market participants who were doing lots of drilling and exploration.
As oil prices climbed from $30 per barrel in 2003 to $100 per barrel in 2008, Core's customers had more money to spend on exploration. Core's revenues surged... and the stock went from $5 per share to $60 per share... a gain of 1,100%.
It was a pure "picks and shovels" play on the oil boom. Rather than take on the risk of owning shares in a company looking for oil in just a handful of places, a Core Laboratories investor could sleep soundly. They knew the company was collecting a steady stream on money from a huge number of oil companies.
Stansberry Research: Most people don't realize there are "picks and shovels" investments in nearly every industry. Can you give us a few more examples most folks don't realize exist?
Hunt: Sure. I have two more. Let's talk farming, then biotechnology.
In 2006, corn and soybean prices entered a big bull move that took both crops more than 200% higher. Emerging markets like China started growing richer and consuming more livestock... which resulted in increased demand for grain to feed the livestock.
Rather than going out and buying a farm... or going into the futures market to buy corn and soybeans, an investor could have bought shares in fertilizer producers like Potash and Mosaic. These two companies produce and sell the vital fertilizers farmers slather on their fields to increase crop yields.
As crop prices climbed and farm incomes rose, demand for fertilizers increased. Potash shares gained 600% during the boom... Mosaic gained 900%.
Again, we see huge returns were made in companies that sold vital tools, products, and services used by an industry in a big upswing.
Now, developing drugs in the biotechnology field is a lot different from farming, but it has its "picks and shovels" plays as well. For example, there's a type of business called contract research organizations, or CROs.
These are companies that perform lab and testing work for big pharmaceutical and small drug development companies. They assist these companies with the huge undertaking of developing and testing new drugs they hope to one day sell for billions of dollars.
Many drug companies are risky bets on just one or two drugs making it to market. CROs aren't like that. They just do research and development. When the industry is in an upswing, CROs take in revenue from lots of different clients... who are all looking to develop new blockbuster drugs.
From 2003-2008, one of the big CROs, Covance, climbed from $20 per share to $90 per share. It was a way to play the rising tide of the risky biotech sector, with a much surer outcome than buying a company betting it all on one drug.
Stansberry Research: OK... we've covered the rewards of "picks and shovels" ideas. But every investment idea has risks. What are the risks for "picks and shovels"?
Hunt: There are two major risks.
One is company-specific risk. There is a risk the company's managers make bad decisions that reduce their competitive edge. This is where you have to do a great deal of research and know the playing field... or pay a knowledgeable industry expert to do it for you.
I think most folks should stick to the biggest and best players when looking to make "picks and shovels" investments. The larger, more stable companies depend less on debt to conduct business. They have higher profit margins and their cash flows are more stable. Stick with the biggest and best "picks and shovels" companies, and you add another layer of "sleep at night" safety.
The second risk is that when a sector or a commodity booms, it's eventually followed by a bust.
Most "picks and shovels" ideas should not be viewed as long-term investments. They should be viewed more as trades that can last for two, three, even five years.
For example, even the best "picks and shovels" plays in the oil industry will get hammered if oil declines by 50%. Even the best crop fertilizer producers will suffer badly if corn and soybeans enter a long-term bear market. You have to be ready to sell these investments when the market turns.
Stansberry Research: Any final words?
Hunt: One last thing... It's important to keep in mind your goals and risk tolerance as an investor.
I'm not attacking the strategy of buying riskier "one shot" exploration or production plays. You can make terrific returns by owning the "one shot" companies. But investing and trading in these types of companies requires more specialized knowledge. They carry more risk... more than most folks are comfortable taking on.
That's why "picks and shovels" can be so useful to the conservative investor.
Stansberry Research: Thanks for joining us today.
Hunt: My pleasure.
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