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When I was interviewed by KPHN live radio about penny stocks, the host of the Total Business Show, Scott Simon, asked me to share some of my favorite penny stock success stories. I gladly brought up Bre-X.
While the majority of people have a negative connotation about the stock (the reasons for which are detailed below), I explained that it was actually an excellent investment from the perspective of penny stock investors.
You see, it was the penny stock traders that made excessive profits (and I do mean excessive - hundreds of dollars turned into millions) from the stock, while the more conservative and 'safe' investors were the ones who got so badly burned by getting involved late at high prices.
Bre-X Minerals falsified their core samples from their gold-mining claim in Busang, Indonesia. Simply, they incorporated a process known as "salting" the samples. When a core sample is prepared for examination, it is generally rinsed off. The Bre-X jokers were bold enough to put flecks of alluvial gold (which is harvested from river beds instead of from the ground) into the water they rinsed the samples with. On first glance, an untrained examiner would think that the ground where the sample came from was loaded with gold.
Bre-X once traded as low as $0.04 (in 1991), and on a split-adjusted basis eventually hit levels of $286.50! (Figures are in Canadian dollars, as Bre-X was a Canadian company and traded in Canada before also being interlisted in the U.S.)
While some quick math reveals that $1,000 could have become $7,162,500, it is mainly the dishonest insiders that would have seen these kinds of gains. For the most part, the majority of investors (individuals, institutions, mutual funds...) bought in at prices closer to the top end of the penny stock's ascent.
While no one has yet been found responsible for the scam, many fingers pointed at Michael de Guzman, the chief geologist who had access to the core samples. de Guzman "committed suicide" shortly after the hoax was revealed, by "jumping" out of a helicopter over the Indonesian jungle. This sentence should probably read, "de Guzman was pushed..." but we'll leave it at that.
The point is that most people who hear about Bre-X instantly react by bad-mouthing penny stocks. However, they got burned by buying it when it was a large-cap, for hundreds of dollars per share. Meanwhile, the penny stock traders who got in at levels below $2.00 made a fortune.
I think that the whole Bre-X fiasco should be a shining reminder of the power of penny stocks. The profit potential is unlimited.
Remember, you and I are not in the business of verifying the accuracy of core samples. We are in the business of making money from our penny stock trades. The truth of the details are far less important than the perception of the details, especially since penny stocks are driven by speculation.
The comments above are not to say that I knew it was all a scam. None of us did. That is the whole point. Getting in early with a penny stock, based upon any reason or rumor, regardless of accuracy, can be a profitable experience.
Lehman Brothers: Described the Busang claim as the ''gold discovery of the century'' and recommended Bre-X as a strong buy.
Fidelity Investments: The world's biggest mutual-fund company held 7.3% of Bre-X just before the collapse.
J. P. Morgan: The key investment banker to Bre-X, it was shopping Busang to world mining giants.
Kilborn Engineering Pacific: The respected Canadian mining engineering firm reported that Bre-X's Busang deposit contained 71 million ounces of gold.
Gold Mining Giants: Eager to get in on the Busang claim, gold companies tried to woo Bre-X. Placer Dome offered $4.7 billion in a takeover bid; Barrick made its own undisclosed offer. Indonesia rejected both bids in favor of Freeport-McMoRan, which offered to pay $400 million to help mine Busang.
Indonesian Governement: The Suharto regime grabbed 40% of the Busang deposit for the Suharto family and other Indonesian interests. It did not pay Bre-X compensation.
Another Bre-X style scam is much less likely now, especially because of the lessons learned. However, I do not doubt that there will be other scams that are just as brazen, only the theater or delivery method will be something new.
A good penny stock investor knows that it is not important if Bre-X really has any gold in the ground or not. Instead, the majority of investors need to think that Bre-X has real minable reserves, so that the good penny stock investor can exit his/her position while everyone else gets on board. Profits are made by the reaction of investors to company news, and by the implications of the news.