From 2005 – 2009, I was 75% invested in emerging precious metal producers and did fairly well. As a whole the junior exploration-emerging producer space is as unscrupulous and ripe with idiots as any other industry. Most junior exploration-mining companies are run by geologists that have as much business sense as my cat. You combine the lack of managerial talent with the need to constantly raise money, and it’s of no surprise why many of these companies are a nightmare. Needless to say the biggest risk to investors is dilution. You would not think the risks would be that great given the fact that we in the midst of relatively bullish commodity market. Even with a tailwind, for a junior mining company to take a project from moose pasture to mine takes a perfect blend of the right management + marketing + project fundamentals + luck.
Here is a list of guidelines I used to use when I was actively investing in junior mining, and I believe these still hold true today. I think it is also applicable to any resource company, not just precious metals:
Bet on the Jockey not the Resource: Invest in production-focused management teams that have successfully put mines into production in the past. Also, make sure they are owner management (own a significant interest in the company). Management needs to be financially aligned with shareholders.
Be Careful with Geologists as CEO: Just because a geologist was credited with finding a 5 million ounce gold deposit in the past doesn’t mean he has the wherewithal to push a project into production. In most cases a Geo CEO is like having a mad scientist run a board room meeting. I’m not saying that all Geos are bad CEO’s, they just need to have business sense.
Share Structure is very Important: Does the company’s share structure allow for stock appreciation? Too many juniors are set up to fail from the very beginning by having too many shares outstanding. You want a stock with a tight share structure so that when milestones are met every incremental buyer results in stock price appreciation so money can be raised at higher prices.
Invest in High Grade, Low CapEx, and Low OpEx Projects: Hope for the best but plan for the worst when it comes to expected prices of the underlying commodity. Almost any gold project makes money at $1500 ounce gold. I want to invest in a project that can make money at $500 gold. In Q1 2011, the average gold mine cash cost per ounce increased to $620 oz up from $470 oz two year ago. In most cases, high grade equals low cost. Invest in companies that still make money at much lower commodity prices.
Invest in Junior Mining Companies with a Dividend Strategy: This sort of relates back to everything above. If management owns enough of the company, and the project is low cost, management should have the proper incentive to pay a meaningful dividend. A company that outlays a fixed percentage of cash flow for dividend distribution along side an increasing production profile creates an ascending floor on the stock. Decades ago many smaller mining operations were traded on the regional stock exchanges like the Spokane Stock Exchange or the Denver penny stock market. Historically, the only reason shareholders bought these securities was because of the dividend. Over the course of time it seems dividends have become less and less important to mining management teams. As an investor that has followed the industry for several years it is ridiculous that very few producers or emerging producers don’t have a dividend strategy. Gold Resource Corp (GORO) has executed its dividend strategy brilliantly as they now have the highest or one of the highest dividend yields of any miner.
Invest in “Pound the Pavement” Management Teams: I always felt that if you are public company, it is management’s fiduciary duty to let the world know the company exists. In my view management should be telling the story somewhere (either conferences, investor roadshows, etc) at least once every couple of months. Nothing is more annoying then hearing shareholders or management complain that the stock is “depressed” when management does nothing to get the word out. Management should always take the blame for where the stock trades, period.
As I’ve outlined in the first paragraph, the biggest risk to investors in junior mining is dilution. Even though I’m mostly out of the junior mining space, I still follow quite a few micro cap (sub $500m market cap) emerging producers. A company I’ve followed for years is Arabian American Development (ARSD), which is a profitable petrochemical company that also owns a 37% interest in a Saudi Arabian Copper, Zinc, Gold, Silver mine that is set for production in the first half of 2012. Another company is Timberline Resources (TLR) that has a 50/50 carried interest in the Butte Highlands Gold Project which is expected to produce 60,000 oz gold annually starting first half 2012 at a $500 cash cost. Another interesting one is Comstock Mining (LODE), which consolidated a majority of the historic Comstock Lode district. If you don’t know what the Comstock Lode district is, it is basically the place where the Gold Rush of the 1860’s began. Ten years ago, a non-mining entrepreneur (now LODE Chairman) slowly began acquiring properties in this historic district, self financed development, and today the Comstock is expected to be in production in early 2012. None of these companies have a dividend strategy, but at least they don’t have the financing risk of most juniors.
Junior mining stocks are very difficult to successfully invest in even in a bull market. The key is creating some guidelines based on past successes, which is what I’ve tried to outline in this article.
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