Junior mining stocks have been beaten up over the last three years. Investor sentiment toward exploration companies has not been this bad in near 40 years. Financings for new drill programs are few and far between. It takes one hell of a track record from management, and a damn compelling property, to even raise enough money to do a 5,000 metre drill program in 2015. You’ll recall in 2010 and 2011 when 5,000 metre drill programs were considered meek.
From Howe Street to Bay Street, financiers and promoters have all but abandoned mining plays for tech stocks. What is considered the pinnacle of mining conferences, the PDAC in Toronto, wasn’t even on the calendar for many mining executives this year. Plain and simple, deals in the junior mining sector aren’t getting done at even a quarter of the pace they were just three years ago.
Furthermore, in the precious metals sector, there hasn’t been a world-class discovery made in years. This has a lot to do with the fact that there is limited money available to explore with, making it very difficult to find a great deposit that can stir up the market.
This is great news for investors because it will lead to supply shortfalls in the coming years. In light of that, now wouldn’t be a bad time to start looking for opportunity. No reason to rush in, but from my vantage point, it certainly looks like a great time to start doing some homework on junior mining stocks.
12 Things to Consider When Doing Your Homework on Junior Mining Stocks
1. Are you buying junior mining stocks in a seasonally bullish or bearish time of year?
For the Venture exchange, which is heavily resource-based, late June and late December have historically been strong periods to buy.
2. Volatility is inherent in junior mining stocks.
However, their cyclical and seasonal habits can help with timing entries and exits. Embracing volatility and using it to your advantage is critical.
A typical bear market for the TSX Venture only lasts around 7 months. A typical bull market lasts for slightly less than a year.
3. Junior mining companies have less than a 5% chance of going into production or being bought out.
Very few junior mining companies achieve the main goal of the industry (buyout or production); however, the majority of them, at some point, see their share price make a run. These runs are often temporary and are based on positive drill results, seasonally bullish times of year, increased speculation, a nearby discovery, or a bullish period in a particular commodity cycle.
4. Junior mining companies are nimble and can cut costs very quickly in bear markets.
This is important to remember. Unlike most businesses, exploration companies have relatively few fixed costs. Drilling is seasonal and can be delayed depending on whether or not the exploration company has work commitments on its property.
Exploration companies do not have hundreds of employees on the payroll. Drillers are typically on contract work and many of these junior explorers have half a dozen full-time workers or less. A junior with a burn rate of half a million dollars a month can easily cut that down to $50k by stopping drilling during a down market.
5. Buying a junior mining stock before it has made a discovery provides the biggest upside potential.
(just make sure you understand the risk)
Owning a junior miner’s stock before it has made a discovery comes with tremendous risk. However, prior to a discovery, the company typically has a tiny market cap, allowing for the potential of massive price appreciation if a major discovery is made.
Look to sell a junior mining stock on the back of a discovery. It’s always nice to take profits off the table; and, given their volatile nature, within 60 days of a discovery the junior mining stock will start to retreat. Junior miners typically lose about 60% of their peak gain after a discovery sends the stock ripping higher.
Rob McEwen (founder and former Chairman of Goldcorp) created a great example of the life cycle of a successful junior mining stock:
Stage 1: The discovery phase (nothing pays like discovery)
Stage 2: Building the mine (capital intensive and usually results in substantial dilution, lost interest from the market, and a declining share price)
Stage 3: Production (profits are reaped by the mining company and value of shares increase again)
6. The most important asset a junior mining company has is not its property.
Management is, by far, the most important and valuable asset a junior mining company has. Invest in management teams that have proven track records.
7. Judge the fiscal responsibility of management teams before purchase. Review the financials.
As a broad guideline, use my 25/75 rule…
Briefly, this means that no more than 25% of a company’s total capital should go to administration fees (including management salaries, corporate communications, office space, and so on). The remaining 75% of capital should be spent advancing projects or building value through acquisitions. Below is a quick example:
If a junior mining company has six full-time employees, including its CEO and President, the total monthly administrative costs may be $50,000 (including office lease, marketing, and so on). That equates to $600,000 per year in administrative costs (excluding audit fees). In a typical market environment, with that monthly administrative expense, the company should be spending roughly $1,800,000 annually to advance its projects or make strategic acquisitions. You can look at previous financial statements of junior mining companies to see if they have followed this criterion.
In a bear market, such as the one we find ourselves in, our criterion may not be feasible for cash-tight companies. So, to see if they have practiced this criterion during a relatively strong market environment, view previous financial statements from 2012, 2011 and even 2010. This is a test of management’s motivations. Are they looking for a paycheck and fancy office space? Or, are they looking at a big score by advancing their project(s) to a buyout or production stage?
8. Do insiders and management own at least 10% of the company?
The more they own, the better.
9. Have management or insiders recently sold shares in the company?
Of course, management and insiders may sell shares in their company from time to time. Everyone needs a liquidity event at some point or another. In fact, management selling some stock in their company after making a major discovery, or before mine construction, isn’t necessarily negative at all. If management is rewarded, and sells part of their stock position in the company they have been working on for years in order to benefit from the gain, that’s okay with me. If they are personally cashed up to a degree, they won’t be enticed by a low-ball offer for the company’s asset.
So, if management sells some stock after achieving positive development, that’s understandable, provided there isn’t a consistent selling habit.
10. Are there any comparables valued higher than your prospective investment?
You may think you have found the most undervalued junior miner to ever list on the stock market, but if you cannot find nearly identical comps trading at higher valuations, there is almost always a reason for its discounted share price.
If you think you have found an inexpensive junior miner the first thing you should do, after finding all possible information you can about its management and assets, is search for as close to an identical company as you can find – then see what the market values it to be worth.
Uncomplicated stuff indeed, but rarely executed on.
Just to be clear on what a comparable is, I have made a list to help in your hunt:
– Must operate in the same country (preferably same state or province as mining laws change throughout).
– Must have the same ownership (percentage) in project and similar carrying costs.
– Must have similar strengths in its management (track records).
– Must be exploring for the same commodity.
– Must have similar grade drill results (includes depth) and / or resource calculations
(remember, a deposit with mineralization starting at surface is different than a deposit with mineralization starting 200 meters below surface).
– Must have close to the same amount of cash in the bank (a 20% or less difference in capital is acceptable).
– Must have similar capital structures (does not have to be exact but should be within 25% of the outstanding shares).
– Must have similar insider trading records (simply, is management buying, selling or not
doing either).
11. Is the junior mining company operating in a historically corrupt country or region?
If so, be prepared to deal with the unexpected… junior mining companies carry a tremendous amount of risk as is. Operating in a country with a track record of nationalization increases the risk.
12. If you are risk averse, don’t buy junior mining stocks.
These investments aren’t for everyone. No investment is worth losing sleep over.
If you’re like me, a contrarian and somewhat of an eternal optimist, you’re probably starting to look at this beaten down sector for some trading opportunities. Soon enough, I believe a major discovery will be made in the precious metals sector that gives junior miners a healthy bid once again. I hope these 12 tips help in your due diligence process of junior mining stocks.
All the best,
Aaron
* If you’re not already a member of PinnacleDigest.com and would like to receive reports like this one, once per week via email, please click here to join for free.
This article represents solely the opinions of Aaron Hoddinott. Aaron Hoddinott is not an investment advisor and any reference to specific securities in the list referred to in the article does not constitute a recommendation thereof. Readers are encouraged to consult their investment advisors prior to making any investment decisions. The information in this article is of an impersonal nature and should not be construed as individualized advice or investment recommendations.
PinnacleDigest.com and its employees are not a registered broker-dealer or financial advisors. Before investing in any securities, you should consult with your financial advisor and a registered broker-dealer.Nothing in this article should be construed as a solicitation to buy or sell any securities mentioned anywhere in this newsletter. This article is intended for informational and entertainment purposes only. The author of this article bears no liability for losses and/or damages arising from the use of this article.
