Posted on Dec 3, 2010

Junior mining stocks can be exceptionally profitable investments.  They can be much more profitable for investors than stocks of large & mid-cap mining companies, or ETFs & index funds that track metals (gold, silver, or other metals).  However, they are not necessarily more risky than any other investment.  But you do need to know how to pick and evaluate them.  Below, I answer several questions related to this that Ive been asked.

Why invest in junior mining stocks?

As mentioned in an older article [How To Invest In Gold Related Investments ], historically the largest returns have come from small-cap junior miners.  There are more opportunities available for investors in this area. Junior miners are usually involved in early exploration and drilling programs, while some have small production operations as well.  One reason is due to many new entrants into the industry who are small and relatively unknown.  They are not familiar names and are not mentioned in the news to the same extent that household large-cap names are, like Goldcorp [GG /tse:G ], Barrick [ABX /tse:ABX ], or even IAMGOLD Corp [IAG /tse:IMG ].

They also have fewer proven drilling results or little to no production to look at.   They therefore have lower visibility which causes investors to over analyze, hesitate in making an investment, make larger mistakes in valuation, wrongly assess the risks, or simply miss them all together.  This creates opportunities for investors who are able to sort through all the companies and see good value.

Another reason why I like investing in junior mining stocks is because I am familiar with the mining industry and have more in-depth knowledge in this area. My father used to work for a very large mining company, and many times he would talk in general about his work.  He was often part of small pilot projects, that required setup of the processes required to recover the metal from the ore.  In high school  also used to double check the grammar of some of his reports, and would be interested in what some of the tables were describing.  Many were tables of metal grades as well as recovery results.  I certainly would have never guessed how useful understanding the details of mining reports and operational processes would be!

There are so many junior mining companies, where do you begin to look?

First, I would narrow down by the particular metal or group of metals. There are many including precious metals such as gold, silver, palladium, platinum, etc.  There are also industrial metals such as  nickel, copper, iron, aluminum, zinc, etc.  There are also special purpose metals, examples would be lithium and uranium.  Both these metals will be highly sought after in the coming decades, especially with the automotive industry rushing headstrong towards the electric powered car.  Uranium will definitely be needed even more, as nuclear power will be one of the only ways to generate massive quantities of electricity that would satisfy the upcoming surge in electricity demand.

Personally, I like the precious metals such as gold and silver, and copper in the industrial group.  Gold and silver are usually seen as safe havens to inflation and currency devaluation (as irrational as it is), and so investor demand will continue to increase.  Its due to the massive US debt from printing money, and the global currency battle [see Why Investing In Gold Can Be Profitable, and When The Bubble Will Burst ].  With copper, it is one of the most highly used metals, with a wide range of industrial and consumer applications.  Industrializing nations such as Brazil, Russia, India, China, and Mexico should see increased consumption in the coming decade.

After selecting metals, search industry forums for names of companies presenting material.  Many junior miners participate in industry conferences in order to gain investor exposure and to tell their story.  They often give presentations about their projects.

Other good resources for looking up names of junior mining companies are:

• the Canadian Venture Exchange (many are listed here first before being listed on the TSX)

• the Toronto Stock Exchange (many are listed here after they grow large enough)

• the holdings of junior gold mining ETFs such as

• Van Eck Global Market Vectors Junior Gold Miners ETF [GDXJ ]

• Market Vectors Gold Miners ETF [GDX ]

• Use a stock screener and filter by industry for companies that have a market capitalization between $250 million to $1 billion.

Unfortunately there isn’t a junior silver or a general junior miners index.

What characteristics should be considered when evaluating junior mining stocks?

The characteristics to look for when evaluating junior mining stocks are relatively the same whether they are in the gold, silver, iron, or other metals:

• Location — Location matters in this industry.  Look at prospective areas, that have high potential for good results.  Look at the properties and land packages in their portfolio.  Prospective locations in North America that are well known include Ontario, Alaska, Nevada, Quebec, and parts of Mexico.  In South America, Argentina and Brazil, Chile, etc.

• Politically Stable Areas (low political risk) This is related to location.  Look for mining friendly countries and locations such as North America & South America, as examples.  Other countries may have high potential and multi-million ounce deposits, but it might not be feasible if the local government (or even at the federal level )imposes severe taxes, or other impeding restrictions and constraints.  A very good example of this is First Quantum Minerals Limited [tse:FM ] and their terrible Kolwezi Project ordeal. and the subsequent Frontier Mine suspension, in the Democratic Republic of Congo (DRC).  Some places have high potential rewards, but also with very high risks.  An example of a huge success story (so far) is Nevsun Resources Ltd’s [NSU /tse:NSU ] Bisha project in Eritrea, Africa, where they have begun plant commissioning in October 2010.

• Well Funded, Good Balance Sheet — Look for companies that have a large treasury with little to no debt.  Because most junior miners are not in active production, they have no earnings.  However, they are actively involved in drilling programs and exploration activities, which require money.

• Exploration Results / Grades — Look for junior miners who are doing good progressive work, and getting meaningful exploration results.  Good exploration results illustrate the potential of the mineral deposits in the property.  Concentrate on the grades.  Better metal grades mean the company has good potential to recover a significant amount of the metal, that would make the project economical and profitable. In the long run profitability will affect the stock price.  Compare the grades against other similar companies.  Also look for good surface assays and geophysical indicators.  If a significant portion of the higher grades are closer to the surface, it may be possible to mine open pit, which will end up being both an easier and cheaper operation to run.

• Management For any young company, management is key.  They need to have vision and a plan for the company. Look at their past experience, knowledge, and see what kind of track record they might have.  I like to see senior management owning a significant portion of the company, which shows they are committed, and more likely to be shareholder and investor friendly.

• Little Investor Attention — Investors can also look for the companies that despite performing good work and achieving solid results, are simply not getting good following or investor attention.  These are the “sleeper” type opportunities that I’ve mentioned before.  These companies also usually available at lower prices and bigger discounts to their intrinsic value.  A good example was Rubicon Minerals.  They had exceptional bonanza grades a few years back, but attracted little investor interest.

• Low Operational Costs — If the company has some production in operation, look to at the costs. This is indicative of how they may operate when in full production. Different companies have slightly different techniques, processes, property locations, etc so it can vary between the miners.  The lower the cost, the higher the profits.  One example is Minera Andes who has one of the lowest costs of production.

• Infrastructure — Do they need to build up infrastructure or are there existing roads and power.  If the company does need to build infrastructure look at what kind and the cost.  Remote locations and inhospitable environments will end up costing more.

Isn’t investing in junior miners risky?

Not necessarily.  They do experience more price volatility, but that should not be confused with investment risk (see article ).  Risk usually comes from the investor, misjudging the actual risks to the business. As Warren Buffett & Benjamin Graham said, risk comes from not knowing what you are doing. The majority of the time, investors invest into businesses they do not understand or know little about.  Often, not enough research & analysis is done prior to making an investment decision.  In the age of the Internet, information is available almost instantaneously.  But investors need to read it (awareness) and be able to understand the information presented (knowledgeable), in order to be able to determine the impact of the information.  Only then can proper decisions and assessments be made.

For example, for mining in particular, it is being knowledgeable on things such as:

• the difference between the mining industry in Ontario (Canada) versus Africa.

• gold grades of 200g/t over 15m.

• silver grades of 200g/t over 15m.

• copper grades of 0.55%

• open pit.

• infrastructure needs.

Look at the risk versus the reward.  A good investment should be low risk and have high reward.  The odds should be heavily slanted in your favor. If an investor only makes investments under such conditions and passes on ones that do not have low risk, their portfolio returns would look very different.  High returns would then come from each holding, rather than just one or two (while the others are negative returns).  Stay clear of things you do not understand, or learn them and advance. It is passing on the high risk investments and learning in new areas that make investors like Buffett successful, and not just lucky.  One can be lucky with one or two investments, but not with the majority of them (in various industries & sectors), over a span of many years under different economic conditions (good & bad).

To learn more about the mining industry, the processes, grading, etc. read information on company websites and investor presentations for starters.  Look up technical terms and words that you come across on a site like Wikipedia to get a general understanding.  Books and industry papers, are another resource for further in-depth knowledge.

What kind of returns do you see for junior mining stocks?

There is never any guarantee with stocks or even ETFs and index funds for that matter. It can also go both ways as we’ve seen with First Quantum (although they are not a junior mining company) and Nevsun.  That is why investors really need to do their home work when it comes to evaluating investments.  But in general, no other investments related to metals and mining can come close to the type of return that junior mining stocks can and have provided over the long term.

Looking at some examples, we see that over 1 year the returns are higher for juniors, but over 3 years the results are quite different. In general, over even more years, the difference is quite staggering:

Mid-Cap & Large-Cap Mining Companies:

• Goldcorp [GG /tse:G ] = 17% year to date, 23% over the last three years (2008 now).

• Barrick [ABX /tse:ABX ] = 32% year to date, 22% over the last three years (2008 now) .

• IIAMGOLD Corp [IAG /tse:IMG ] = 4.2% year to date,100% over the last three years (2008 now) .

• Yamana [AUY /tse:YRI ] = 4.8% year to date, -8% over the last thee years (2008 now) .

Gold Index:

• Shares Gold Trust (ETF) [IAU /tse:IGT ] = 23% year to date, 69% over the last three years (2008 now) .

Small-Cap Junior Mining Companies:

• Rubicon Minerals [RBY /tse:RMX ] = 18% year to date, 304% over the last three years (2008 now) .

• US Gold Corp [UXG /tse:UXG ] = 161% year to date, 113% over the last three years (2008 now) .

• VG Gold Corp [tse:VG ] = 132% year to date, 157% over the last three years (2008 now) .

• Minera Andes Inc [tse:MAI ] 261% year to date, 91% over the last three years (2008 now) .

• Nevsun Resources Ltd [NSU /tse:NSU ] 167% year to date, 173% over the last three years (2008 now) .

For this example I’m just picking arbitrary calendar years here, but an investor would never arbitrarily pick their price points, let alone based on the calendar or timing.  Investors should always invest based on the current price and its valuation.  I use a margin of safety of 50%.  That means the stock must be trading at least at a 50% discount to its intrinsic value.  Investors should buy shares when the price experiences pull backs and fall out of favor.  The objective is the same as shopping, to buy at the best possible prices to lower your average cost base.  Because junior mining stocks experience more price volatility in the short term than their larger counterparts or even the metal indices, the opportunity to acquire shares (every once in a while) at relatively lower prices is quite high.  In this way, returns can become on the order of 500-600% rather than 200% over the long term, and that is a significant difference.  However, I’d really be happy with anything in the double digits (10%+).

Investing in junior miners also mean that you are investing into a company that is in the exploration phase, while mid and large-cap miners are in full production. They are really two different businesses that are operating in two totally different modes. Its like buying seeds of a fruit compared to the fruit itself.

How long do you usually hold junior miners for?

I’m a long term value investor, so I tend to hold for 5 years or more after purchasing. It also gives the people at the company a chance to perform meaningful work and produce results.  I encourage investors to take the attitude that they are investing in a real business that is doing real work. When you invest in a business, its always a committed and long term venture.  Jumping in and out over the course of the year is not being very committed or having the ownership attitude.  I usually dispose of stocks once they’ve reached their intrinsic value, see little to no growth (business-wise), if they are unable to fix detrimental problems (that will kill the business), take a direction in which I do not agree with, or if I find significantly better opportunities elsewhere that serves the same purpose in my investment plan.  In general, investors should think of investing in stocks, like investing in a private company. Thinking this way gives investors a better perspective when valuating companies.

The information provided is not in anyway a complete or exhaustive.  There are other areas that can be discussed in further detail, as well as questions related to general stock investing.  However, I hope this article answers some important questions that will help investors get started and begin to pick and evaluate junior mining stocks.

Please note that the stocks mentioned in this post are for example purposes only, and are not meant as individual investment recommendations!

DISCLOSURE: I hold shares in Rubicon Minerals, US Gold Corp, VG Gold Corp, and Minera Andes Inc.

Update: In the junior mining returns example, I originally had written last two years when I meant from 2008 now which is pretty much three years.  Time sure passes by fast!  Thanks for the comment, which pointed me to my typo.