The smallest gold mining stocks in their capital and production are called the "juniors." Sometimes that is contrasted with "seniors" or "majors." Today, it is useful as we will discuss a middle category—the "mid-tiers." A simple way of defining these categories is by size; specifically, the ounces of gold they produce each year. More complex but necessary is to talk about their stage of development.
Exploring, developing a mine, getting it permitted, producing up to 300,000 ounces a year.
Established and producing up to 1,000,000 ounces a year.
Many mining properties, significant capital investment, and more than 1,000,000 million ounces a year.
Each of those levels is associated with a different degree and type of risk. But the most risks to consider by far attach to the juniors. Companies of all sizes need to keep replenishing their estimated and proven gold ounces in the ground; the life of many mines, before they are no longer worth operating, is only 10 years.
That means a constant search for new gold strikes, and the juniors are at the forefront. The mid-tiers and majors also explore, but more and more they rely on the juniors for the exploration and the drilling to establish the amount and richness of the ore and acquire them at a big premium to their stock price. Sometimes, instead, a mid-tier will merge with a promising junior, giving its stockholders shares in a much larger company.
Recent blogs published by Crux Investor have reported the progress and prospects of junior mining projects from TriStar Gold (TSX) in Brazil to GoGold (TSX) in Mexico and Maritime Resources (TSX) in Newfoundland and Labrador. Amanda van Dyke of South River Asset Management offered four "pillars" to look for in a junior—beginning with the quality of the "asset" itself—and then considerations such as management.
In an interview with Crux Investor, John Lewins, CEO of K92 Mining Inc. (TSX-V: KNT), explained how the recent meteoric rise in the stock's price had to do not with the gold price but the asset itself—the Papua New Guinea mine's organic growth through discovery of new in-ground assets that made the company a low-cost producer.
Companies are springing up constantly so it is difficult to know how many there are worldwide. Toronto Stock Exchange Venture (TSX-V) is probably the largest single home to "micro-cap" start-up mines in the world.
Because a major new way to invest in junior mining stocks has been buying shares in GDXJ, an exchange-traded fund (now the largest such fund in the world), we will return here to the question of "mid-tiers." GDXJ is the not-so-little brother of GDX, the giant ETF that invests in the "majors."
It is the largest of its kind in the world. GDXJ declared its goal as making it possible to invest in a large selection of diversified junior mining companies. But as the gold price rose and the gold mining stocks became red-hot—especially the juniors, which tend to have the best leverage to the gold price—billions in investment capital poured into GDXJ.
The world centers of trade in the juniors are the Toronto and Vancouver stock exchanges and many of the companies are in Canada. You have to buy Canadian stocks to get a high-quality, diversified portfolio of juniors. The problem was that securities law in Canada defines any more than a 20% investment in a company as a "takeover" and the investor must offer to buy the shares of all stockholders in the company.
How can you invest new billions of dollars in the small junior mining sector, with small-cap stocks at low prices, and not easily shoot up to 20% ownership? You can't. Therefore, with no announcement of a change in strategy, GDXJ began to acquire companies much larger than 300,000 ounces a year.
Today, there are relatively few true juniors in the portfolio. There are mostly mid-tiers and some majors. There is now a big overlap between the holdings of GDX and GDXJ. This means GDXJ is no longer a true play on the junior gold miners—although it is the world's largest ETF advertised as doing so. One additional problem is that capital urgently needed by the junior gold miners—and, in a sense, intended for them—is going via GDXJ to the mid-tiers and majors.
For investors, there are two conclusions:
One challenge in the junior gold mining company arena is the number of new gold strikes reported. A new junior gold miner is born. But it can require five or more years before the first ounce of gold is produced. The company must do extensive drilling to define the size of the strike and the richness of the ore. Before it does much else, it must get permits from the government (usually the local government)—and that, even in the most favorable localities, is an obstacle course.
The company must scope out the project to carefully estimate the costs of developing and operating the new mine as well as the projected gold price in five years or more to see if it will cover the costs and yield a profit that justifies the risks. It then must construct the mine, the access roads, the power lines, possible employee housing, and often community projects used to bribe the locals into accepting the mine.
Then, by the time the first ounce is "poured," the company probably has considerable debt and may have committed some percentage of its early years of production as a pledge against a loan.
Pinnacle Digest offers the estimate: "In the mineral exploration business, one out of every 1,000 prospective mines eventually reaches production." Of course, that has little to do with the risks of buying the juniors in general, since most of the publicly-owned juniors already have reached the production stage.
Let's look at these and other factors one by one. The investor in junior mining stocks must try to obtain information on all this, verify it, evaluate it, and then compare it to the same categories of information on other juniors. Of course, few individual investors do this research on their own. They certainly do not go to the mine sites to "kick the rocks." Fortunately, the gold stock field is amply provided with seasoned professionals who do kick the rocks, crunch the numbers, cross-examine company executives, and search out overall market intelligence that puts stocks in the context of trends that support the gold price.
The first thing we can know about a new mining company is "who it is." Who launched this venture, who runs it, who funds it? Since the venture will not be a public company at the earliest stage, the amount and quality of information are not regulated.
That is why investors look for known names. Many brand-new ventures are launched by seasoned executives from the majors who want their own company, or geologists who have worked for the majors for years.
The money could also be coming from a known investor in the gold sector who is taking a chance on the management. Whatever the case, competent, experienced, reputable management of a company, however "junior" it is, can reduce the risks of a host of obstacles. There are impressive checklists of red flags by those who know the field. Here is a story of one such "trophy" acquisition of seasoned leadership.
Every new enterprise requires capital and, at each successive stage, the new gold miner needs more. Sometimes, if an investor—say an executive from the majors—is behind the new venture, the capital already is there. Many companies will try to "go public" very, very early to get capital. Some will pledge a percentage of their production to obtain working capital. As long as capital lasts, a company, good or bad, keeps going. When capital runs out, a company, however good, can't keep going. The issue is crucial.
There is a Biblical Job somewhere in every prospective mining company, a long-suffering spirit ready to go through the process of performing an environmental assessment, the permitting process, the community meetings to convince locals the company will boost the economy and not pollute. As each step in permitting is taken or fails, the stock's price reacts.
Indeed, the final permitting, the clean bill of health, can be the single best rocket fuel for the stock. But realize that this process in the United States, Canada, and Australia, for example, can be arduous… but it can at least count on a fairly transparent regulatory process, impartial justice from most courts, and a bureaucracy that is not on the take. As exploration for new deposits has moved into many African nations, Latin America, South America, and China, the "country risk" must be evaluated in each case.
The juniors are "hungry" players willing to take the risks of exploration, early development, and permitting. At some stage, these companies may look extremely attractive to the mid-tier and major firms, which are under constant pressure to maintain a crucial statistic: "proven or probable ounces" still in the ground.
If the capital is available, it is much easier to purchase a proven, permitted mine with a big strike of proven ore. At that point, if the developers are willing to sell, the majors will pay a big premium on the stock price to acquire the company. A smaller company, say a mid-tier, might be willing to merge.
That still is a big success for the junior. But...many shareholders in a junior that has huge potential and has taken step after step toward production will oppose selling the company simply because the profit potential, after all the years of risk, is huge.
Most silver is not dug out of the ground by silver miners (primary producers of silver) but by gold miners. That’s because the gold ore may come with many other minerals, especially silver and copper. And these actually may be far more abundant than the gold. The new company sells these byproducts and, often, the profits are viewed as reducing the cash costs of producing an ounce of gold.
In discussing factors in evaluating a junior as an investment, a question to ask is who else is acquiring the stock? If the company is still private, no uniform, regulated information will be available. If it is public, you have information on major stakeholders, including mutual funds, ETFs, and others. This is a significant indication that the company passes the "smell test" with individuals deeply involved in the field.
Every mine, as it assesses the prospects for successful development, must plug in a forecast of the price of gold when the mine begins to produce. No one knows what the price will be one year in the future. Certainly not five years in the future, when the mine may come online.
Your estimate of the expected gold price may not square with that in the company's financial projections. But with the rising gold price, mines in the western states of the U.S. abandoned as "depleted" a century ago, when a gold price of $32 an ounce had to cover costs and produce a profit, are being opened and operated profitably with gold at $2,000 an ounce. The expected gold price is pivotal to estimates of the new mine's viability.
In a recent interview by Crux Investor, Rick Rule, president of Sprott Resource Holding and prominent commentator on gold, has said that he would not be surprised at short term corrections in the gold price after recent marked gains—but in the next two to three years he is "wildly bullish." And Frank Holmes, also interviewed recently on Crux Investor, has said that in the next three years, gold could go to $4,000 an ounce."
Predictions today of the long-term gold price are uniformly positive among seasoned analysts.
Balance these two facts:
First, the junior gold mining companies present the highest potential for profits of almost any sector of the market. Out of the ashes of the 2008 financial panic and stock market crash, the world's two largest gold miners over the next four years rose more than 200%.
But solid junior mining stocks, beaten down briefly in the crash, rocketed. New Gold ran from 0.75 USD to highs of 14.15 USD and Novagold, another well-known junior play, ran from 0.37 USD to highs of 16.90 USD. We are looking at 1,800% and about 4,500% gains, respectively.
Second, each junior mining stock is a high-risk investment with the potential for a 100% loss of your capital. The answer is to invest in the sector, not in just one or two individual stocks. Another term for this is "diversify"—a golden rule for any investment, but especially for the juniors.
Crux Investor exists to provide market intelligence, coverage of market sectors, and insight into the best companies to give you the confidence to invest in an area like junior mining stocks. The smaller public companies in areas like this are our specialty. And our mission is to provide the excellent coverage needed to manage the risks of investing in these companies for their huge profit potential.
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