Few stocks can post quick, massive gains quite like junior miners.
For instance, GoldQuest Mining‘s (TSXV:GQC) share price jumped 313.3 percent on May 24, from $0.075 a share to $0.31, after the company announced that it had tapped into a rich gold deposit at its Las Tres Palmas property in the Dominican Republic.
The stock’s run didn’t stop there. GoldQuest has since more than doubled to its current level of $0.66 a share. In all, that’s a gain of 780 percent in just over three weeks.
Junior mining stocks: not for the faint of heart
The challenge for investors is that for every junior like GoldQuest there are dozens that flame out. That’s because the odds of finding a mineable resource are shockingly low. And when juniors report disappointing drill results they tend to drop just as quickly as they rise.
For example, shares of oil and gas explorer CGX Energy (TSXV:OYL) fell 70 percent, from $1.05 to $0.315, in two days in May after the company failed to find oil at its Eagle-1 well off the coast of South America.
That’s a typical story among junior miners. In an article about junior gold stocks, mining industry consultant M. Stephen Enders sums up the long odds these companies face, commenting, “[t]he probabilities of success in exploration for a >4 million ounce valuable gold deposit are on the order of 1 in 10,000. Even allowing for large differences of opinion on the efficiency of a junior explorer or the probability of discovery, the probability of success ranges from 1:500 to 1:20,000.”
Enders attributes these low probabilities to a number of factors, including ineffective management and inadequate financing. In terms of the exploration properties themselves, he stated that “area selection is not as rigorous as it is in the major companies and is not always in the most prospective areas.”
How junior miners operate
Junior miners have one of the toughest jobs in the mining industry: finding a mineral deposit. The kicker is that these companies don’t actually make money. Instead, they raise funds from investors to explore for minerals.
If a junior makes a big discovery, it rarely develops and mines it on its own. That’s because very few junior companies have the resources necessary to develop a property; for many, the goal is to hit upon a deposit that’s attractive enough to catch the attention of a major producer that will buy it from them at a profit.
Another path a junior may take is to try to partner up with a larger firm that can give it access to the financing it needs to build a mine. Partnerships are also important as they can give juniors access to mining expertise that would be unavailable to them otherwise.
Right now, most of the world’s junior miners are listed in Canada, with roughly 2,000 on the Toronto Stock Exchange and TSX Venture Exchange. Another 1,000 juniors are listed elsewhere around the world, including on the London Stock Exchange and the Australian Stock Exchange.
Tips for investing in junior mining stocks
Even though the odds against success are great, many investors are attracted to junior mining stocks because, as resources specialist Peter Krauth writes, “all it takes is just one 10-bagger to make up for all the dogs in the pound.”
Here are a few tips on how to spot those winners:
- Be aware of political risk: Krauth said that it’s worth taking the time to familiarize yourself with the countries in which junior miners operate, particularly in the nature of the local governments. “It’s simple,” he writes. “The last thing you want is for some kleptocrat to wait until tens of millions have been spent to discover a massive gold deposit, only to turn around and revoke a key permit or expropriate the land.”
- Experienced management is crucial: Because there is little room for error, investors should look to juniors whose management has a solid track record, including significant exploration experience. Strong management topped the list of Brent Cook, editor of the Exploration Insights, a mining-investment newsletter. “Of the roughly 3,000 junior exploration companies combing Earth chasing down anomalies,” he writes, “maybe half can be thrown out because of incompetent or unfocused management: management is key in the junior sector – get to know them.
- Stay alert for signs of trouble: Because these companies plunge quickly on bad news, Cook also recommends keeping a close watch on their actions so you can spot trouble before other investors rush out the door. “Junior companies thrive on news releases,” he writes, “so an investor’s job is to interpret the drilling, metallurgical and sample results in the context of the target being explored. When things start going wrong, get out and get out fast.”
Timing looks good to hold carefully selected junior miners
Finally, most advisors agree that you should only invest in junior miners with money you can afford to lose, and should limit your exposure to a reasonable portion of your overall portfolio.
“It’s certainly not anything that you should rely on for your RRSP, for your retirement,” said Michael Fowler, a mining analyst at Loewen Ondaatje McCutcheon, a brokerage that focuses on junior miners.
Still, all signs point to a continued high level of merger and acquisition activity in the mining sector for the rest of the year, so if you do your homework and select the right junior miners, you could position yourself for strong gains as they get snapped up by majors.
Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article.