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Three
months ago (April) we covered the reasons we primarily invest in
junior exploration companies. We promised to follow up with some criteria we
follow in attempting to pick winners. Here are five things we look for when
evaluating and selecting junior exploration companies.
Management
has a track record and experience.
There
is a decent number of executives in the junior industry that were part of or
led a company to an acquisition. If they have done it before then they know
what needs to be done in order to do it again. If management has not been
involved in a transaction, check to see if they have discovered a deposit or
expanded a resource through drilling. Also, seek out the executives that had
ample experience at a major company.
Do
not stop with the CEO. Also consider the track record and experience of the
chief geologist. They are just as important.
Strong
capital structure and a small retail float
The
capital structure refers to the cash, shares outstanding and warrants and
options. We are looking for companies with cash, tight share structures and
tight floats. That means enough cash to move forward (without needing to
raise multiple times) a low number of warrants and options and a small retail
float.
The
float is the number of shares available for trading after subtracting closely
held shares. The smaller the retail float, the more amount of stock is
tightly held (by insiders, institutions and large investors). Stocks with
tighter retail floats can rise more quickly than stocks with larger retail
floats. It’s basic supply and demand and the size of the retail float
is just as important as the overall structure itself.
Industry
sponsorship
Juniors
can have industry sponsorship through joint ventures or investment. Has a
major gold mining company invested in the junior or partnered with the junior
on its project? That would certainly lend quite a bit of credibility to the
junior and its project.
Note
that this is only one criteria and not a declaration to follow every major
company into every investment they make. They can get better terms than you
and I and they make mistakes too.
The
company has a deposit or could find a deposit a major would want
To
be specific that means a project with multi million ounce potential and
grade. We are looking for 2M-3M oz Au potential with 100K oz Au/yr production
potential at a minimum. To be more specific, we want high margin potential
projects. Something with marginal grade could be high margin and something
with very good grade could only be marginal. Size and grade are a good
starting point for high margin potential but one size does not fit all.
Speaking of size, look for projects that have district-scale potential. In
other words, look for very large land packages that could host more than one
deposit.
Exploration
companies are obviously further down on the food chain and not concerned with
economic studies. However, in general we want projects that could have an
internal rate of return of 15%-20% per year at $1100 to $1200 Gold.
Look
for value and growth potential
Price
is what you pay and value is what you get. You are either a contrarian or a
victim. These are obviously quotes from investors much smarter than me.
Buying high and selling higher can work in the conventional markets but it
rarely works with respect to exploration companies. That could be because of
the cyclicality of the industry as well as the much publicized “life
cycle” that junior companies go through.
Valuing
exploration companies is subjective and can be quite difficult. In short, we
want to buy value but also growth potential. In other words, look for
projects or deposits that have exploration upside. Companies can add value
this way even if metals prices do not rise. The ideal situation is a junior
that is undervalued but could grow its deposit materially.
Even
though metals prices are down over the past 12 months, they are not
preventing companies from being rewarded by adding value to their deposits or
discovering new deposits. This reflects the turn in the industry cycle in
late 2015 and that will not change even if metals prices retest their lows.
We have a bearish outlook for the next six to nine months and if Gold breaks
below $1200 it could create some very compelling values in the junior
exploration sector. To
learn about which juniors we own, are following and hope to buy in the
future, consider learning more about our premium service.
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