Junior Mining Companies Primed for Big Gains

By Russell McDougal

Nobody likes the junior mining companies these days. Gold, silver and commodity prices in general are all soaring. Yet the tiny explorers can hardly catch a bid. How long can this persist?

Truth be told, the juniors are set up to throw quite a party. Think back to your most memorable high school “extra curricular activity” and let’s get ready for a replay. Toss in financial rewards as a bonus.

Junior explorers are tiny, efficient and mobile. They do the heavy lifting in global resource discoveries. Especially the Canadian companies. If you’re Canadian and have a geological background you likely also have wanderlust. Have drill- will travel!

On the other hand, the larger “senior” gold mining companies have a long standing and clear cut problem. They produce gold each and every year and thereby chew through their quantified reserves.  These reserves must be replaced or the company’s reason for existence goes away.

The seniors are not the ones who find the largest percentage of gold deposits. They have been maintaining or growing reserves through mergers and acquisitions for several years now. When Newmont Mining (NEM) acquired Franco Nevada in 2002 there were zero new ounces of gold reserves created. One company simply went away and a larger company was created. The same thing happened when Barrick Gold (ABX) took out Placer Dome in 2006.

The larger gold companies do most everything through committee. They have a level of bureaucracy that isn’t present in the small companies. The juniors can act quicker in staking a property or deal making. Qualified geological personnel are in short supply due to the decades-long resource bear market of yesteryear. When a Barrick Gold geologist makes a discovery he gets a big thank you and maybe a pretty plaque. When a geologist with a tiny micro-cap explorer makes one he’s found the mother lode. He has tremendous financial incentive to succeed through company stock, options or warrants.

High quality geological talent has moved to the juniors.

I’ve been aware of this game of “reserve replacement” problems for over 10 years. The seniors need gold and they will inevitably have to come looking in the direction of smaller companies with proven goods.

The seniors don’t like to pay up, but they inevitably do. Goldcorp (GG) bought out junior Virginia Gold’s Eleonor gold discovery in a deal valued at $475 million. Those of us who bought shares early saw returns of $50 to $100 for every initial dollar invested. If you find it, they will pay. So, how are the companies doing that are designated the most significant gold finders?

You wouldn’t know it by looking at this chart that gold, silver, oil and most commodities are up significantly in the last year and a half. The shares usually show a high degree of correlation to gold prices but they are actually down at the present time. This CDNX index is the best overall representative of the Canadian junior explorers. There is a total disconnect between commodity prices and explorer prices.

Junior stocks have hit the skids over the last 12 months. When the relative strength index (RSI on the above chart) has gone near or below 50 this decade a rally has ensued. We’re there again. The juniors are oversold.

Stocks like the old Virginia Gold are best bought during such times of overall sector weakness. They are on sale.  If Buffet advocates buying “straw hats in winter” we can correspondingly buy Canadian parkas in summer.

Yes, the biggest mining companies must replace their reserves. They will be looking to quality junior projects with proven ounces in the ground. The juniors are set to throw a monster ball.

Disclosure: none

Comments

[GMiki]

It's certainly about time. :)

[GMiki]

It's certainly about time. :)

[GMiki]

It's certainly about time. :)

[MarcCourtenay]

Makes sense. Good article and very timely

[startouch]

Good point. I wish the author would share with us some specific company picks. A list of companies stating their reserves, stage of development, financial condition would be great. The problem I find with juniors is transperancy. The old saying 'A mine is a hole in the ground with a liar on top' still holds true, unfortunatly.

[jock]

40% of the companies in the CDNX are oil & gas, and therefore not relevant to the author's points on junior mining explorationcompanies. They have a different dynamic in the marketplace.

[Clavis]

I am afraid 'Startouch' you will have to do your own homework or contribute to the good doctor's subscription service.
BUT, we could ask him to disclose; once again; his ten rules which he evolved over many years investing in the junior miners.

[silveraxis]

I see no sign that majors are particularly desperate to replace reserves at this point. Before going on a buying spree, they would first start lining up to do JV deals on the best projects, resulting in terms that are very favorable to the junior partners. I'm not seeing that yet. Quite the opposite, the majors are acquiring 50% equity interest in world-class properties by merely providing a portion of the financing and development expertise (think Novagold, Northern Dynasty).

One of the problems is that there aren't that many great projects out there. Juniors put mines into production not by choice but because it is their only choice. Most majors think forward to the next cyclical downturn and wouldn't dare touch some of the "mines" being launched by the juniors these days. If you can tell the difference, you can probably do well buying specific juniors and then waiting for the big fish to bite but otherwise it might make more sense to buy just the majors or at least juniors that are partnered with majors.

If you are buying stocks that appear undervalued to you based solely on "proven ounces in the ground", good luck to you (it will be needed).

[iman]

Newmont's CEO recently said that they are not finding the reserves they need, I think that's a sign that buyouts will happen.

As far as Majors investing in Juniors there is a lot of that going on; Terrane got financing from Goldcorp and Goldcorp has an option to buy into the company, Agnico Eagle has a good sized stake in Golden Goliath, Riverside Resources is now partially owned by Kinross. Let the majors do the due dilligence on the juniors for you.