Speculating and investing in
this sector is difficult. It is a far more difficult industry than others and
that is why companies continue to struggle and fail even with the luxury of
high metals prices. We've written extensively about the recent major bottom
in the precious metals sector and the very positive outlook for the equities
in 2012 and likely 2013. One can make money if they buy and hold a mutual fund
or ETF but they can generate far superior performance with a basket of the
right companies. The following explains what we look for in order to uncover
the juniors that will deliver outstanding returns.
Capital Structure
Capital structure refers to
share structure, market cap and the financial position of the company. First,
we want to see a share structure that is low in shares outstanding but also
low in its fully diluted count. This means there aren't tons of options and
warrants that can weigh down the stock after it begins a good run. The
overall share structure can also be used to grade management. Remember, most
of these companies do not make money and there way to raise money is to sell
more shares. Compare the achievements of the company with its current share
structure. Has the company been productive or has it been ineffective and
carries a bloated share structure?
Second and most important, the
more cash a company has the better. In looking at non-producers, it is
obvious that the companies with significant capital have an advantage over
those who have less than $2-3 Million in the bank and may have to finance
within the year. For producers, we want to see enough cash flow and capital
in the bank that the company can grow its production with minimal dilution.
Projects
In analyzing explorers and
developers, we want to find the companies with projects that are likely to
become a mine and are likely to be coveted by a large or major company.
Consider the location. Is it in a friendly mining jurisdiction like Mexico,
Nevada or Quebec? Is the location near an operation of a larger producer or
major company? If the answer to both is yes than it is far more likely to
become a mine. Also, we want to see projects that not only can be mined but
mined profitably. How did the market respond to a preliminary economic
assessment? Would the project payback cap-ex in a few years or five? A past
producing property is another good sign.
Let me provide an example. We
added Trade Winds Ventures to our model portfolio last summer. The stock
experienced a deep pullback but had stabilized for a few months. Trade Winds
had a deposit literally right next to Detour Gold's multi-million ounce
deposit at Detour Lake. It was a no brainer. This wasn't a grand slam but it
was a very nice return in about five months. The key, which is our next
point, is we bought it when it was cheap and not while it was zooming higher
in 2010.
Buy Takeover Candidates on the Cheap
This is especially true of the
explorers and developers. You are an investor and so are potential acquirers.
You both want something that has growth potential at a reasonable price. Like
a major company, you will not chase something that has already moved and has
little upside from its present market value. Thus, buy these targets cheap.
The market is coming out of a major bottom so there should be plenty of
candidates. On the first day of the year we added a US-listed development
company that we thought was cheap. Technically, it had very little downside.
It's up 25% since then. Had we bought it 12 months ago we'd be down 25%.
Favor Junior Producers with Development Projects
Juniors who make it to
production will do well but it it those juniors that can go from zero or one
mine to three or four that will be the biggest winners. We prefer producers
but we are looking for those that are likely to have multiple operations.
Producers that have strong development projects in the pipeline have
advantages over pure development companies and those producers lacking the
assets to grow production. For example, our favorite gold stock for the past
two years and largest position in the model portfolio is set to put its
second mine in production in the coming months and then its third mine into
production by the end of 2013.
Find Management Teams with a Track Record
This is especially important
if the company wants to be a producer. Mining is an extremely difficult
business and therefore your odds of success will be much higher with those
who have done it before. Two of our biggest winners, Gold Resource Corp and
First Majestic Silver, were led by people who had a great track record. At
the same time, the absolute biggest names will command a premium in the
market, so be judicious. Management is always important but in building and
operating a mine, it is paramount.
Technical Catalyst
Again, for the more
speculative non-producing juniors, one should always buy on the cheap or at
least buy something that hasn't made a new high in a year or two. When the
market turns favorable, juniors can rebound quickly as we've seen. For small
producers and development plays we look for a technical catalyst. If the
stock is near very strong support then we know the downside is limited and
the risk to reward is favorable. If the stock is close to breakout out of a
multi-year base then we know it has room to move significantly higher sooner
rather than later.
In recent commentaries we've
told you why you should be buying. This time we tell you what to buy, without
actually giving names. Hopefully you can extract a few nuggets from this
piece that will serve as a springboard for your research. We are excited
because this bull market is going to quietly ramp higher over the next
several years. The present is probably your last chance for at least a year
or so to buy many companies on the cheap. You can go at it alone or you can
consult a professional.
Good Luck!
If you'd like help in stock
selection and navigating this bull market then we invite you to learn more about our premium service.