4 qualities that a junior resource stock speculator needs

I think there’s a rule in the stock market that says: “If you buy a junior resource stock today, it will immediately decline and then falter for quite some time.

I’m joking, of course, but I think most junior resource investors will tell you that this has happened to them at least once (more likely: a dozen times).

I love junior resource stocks but they are not easy stocks to own! If you own junior resource stocks, or think you might like to own them, here are 4 qualities you’ll want to have. Trust me when I tell you: If you don’t have these qualities, don’t invest in junior resource stocks!!!

A PASSION FOR DUE DILIGENCE

It sounds like an oxymoron to put “passion” and “due diligence” in the same sentence. However, junior resource stocks are speculative and there are a lot of unknowns when investing in them. You’ll reduce the risks and increase the potential of gains by doing your due diligence first. Don’t make the mistake of just investing because someone you know has also bought that stock and is doing well with it.

Also: Due diligence is not a one-time even that you do once just prior to buying a stock. I believe due diligence is something you need to do over and over and over again — before you buy, before you sell, and regularly in between. Due diligence activities should be “triggered” by your own decisions and by external market forces. You should always be asking yourself: “Does this event change the reason that I bought the stock in the first place?”. Click here to learn how to do due diligence on a junior resource stock.

A B.S.-O-METER

There are many many many good people in the junior resource industry. They mean well, they’re hardworking, they’ve made some exciting discoveries, and they have some good insight to say. But there are the losers, too; the ones who see a junior resource stock as a great way to make some fast cash from an IPO before letting the company fall in value, or those who pump and dump stocks, making money on the gullibility of investors rather than the stock’s fundamentals. You need a very sensitive BS-O-Meter that can detect the slightest whiff of something being off.

EXTRA MONEY THAT YOU CAN AFFORD TO LOSE

I almost didn’t include this one because it is the most depressing of them all. But junior resource stock speculators should really be investing money that they can afford to lose. I’ve seen too many people who dump their life savings into stocks, only to watch those stocks decline. Don’t do it! The entry point to buying juniors is pretty low. So buy only with money you can afford to lose. This isn’t an alternative to buying a lottery ticket.

COURAGE

This is probably the biggest one. It was originally inspired by Rick Rule of Sprott Resources, an articulate thinker in an industry where those qualities are far to rare. He referenced courage in a talk he gave at an industry conference a couple of years ago and although he didn’t go into great detail about it, I think he was referring to these two types of courage.

Investors need courage to look past the unknowns: There are many unknowns in the industry and anything from politics to natural disasters to public sentiment can suddenly shift the stock price. So you need to do as much due diligence as you can to eliminate as many of the unknowns as possible, and then you need courage to live with the rest of the unknowns.

Investors need courage to act when their emotions are advising something different: All too often (and even in stocks that aren’t junior resource stocks), investors will buy when the price is high because everyone is excited about the stock, and then they’ll sell when the price is is low because they’re afraid of losing even more money. This all-too-common practice (ironically, even among conservative investors) is the exact opposite of what should happen. Investors should buy when prices are low and sell when prices are high. Of course, that sounds good in theory but it’s much harder to do in practice. Write down the reasons you bought a stock and then remind yourself of those reasons when you’re wondering “should I sell this stock?

 

Investing in junior resource stocks is not for the feint of heart. It’s not for the weak-willed or people who love to jump on bandwagons. Only invest if you have these 4 qualities! I think it’s fun. But it’s also worrisome and time-consuming and mind-boggling at times! Invest at your own risk!

11 reasons why I love junior resource stocks

Junior resource stocks are companies that explore and develop mineral/metal resources. Junior resource companies do one or more of the following activities: They get a property, explore for a particular metal, and then (if they find something worthwhile) they develop the mineral resource into a mine that generates cash flow.

Here are 11 reasons why I love junior resource stocks.

1. IT’S HIGHLY ENTREPRENEURIAL

The junior resource industry is highly entrepreneurial with a lot of businesses starting all the time. All that is required is a promising property and you can pretty much set up a junior resource company. That doesn’t mean people are going to invest in it, of course, but it does create some really exciting buzz that I absolutely love about the industry.

(Naysayers will point out that the highly entrepreneurial nature of the industry increases the risk of scammy companies that are bad investments. This is true. But it is also usually resolved when investors do their due diligence. In my opinion, the advantages outweigh the disadvantages.)

2. IT’S EASY FOR INVESTORS TO GET INVOLVED

While there are resource stocks that have very high stock prices, many — perhaps most — resource companies are “juniors”. That is, they are small companies with penny stock prices. This allows investors to get in at a low price, spending just a few hundred dollars to get a few thousand shares.

(Yeah, there’s a downside here, too: Penny stocks don’t have far to go to fall to zero. So if you’re going to invest, make sure you can afford to lose your money. In my opinion, a few hundred bucks isn’t a big deal to lose. I’m not putting my life savings in one penny stock!)

3. THERE ARE RISKS

There are risks to any junior resource stock: The underlying commodity might suddenly bottom out. Investor sentiment might turn away from the commodity or the company or the region they are operating in. Political risk is always present — in third world countries, you might end up with a crackpot dictator who takes over the mine; in first world countries, you often end up with excessive regulatory obstacles. I like all of these risks! They pose a challenge for the junior resource company and for investors. Smart companies need to figure out how to overcome those risks as much as possible; smart investors need to figure out ways to mitigate against those risks through their investing.

4. THE POTENTIAL IS THERE FOR BIG WINS

If you buy a blue chip stock, the possibility exists that the stock might go up. But the moves aren’t huge. It might climb slowly, advancing a small percentage each day when it does go up. These stocks are famously stable. But in a junior resource stock, stocks worth pennies can increase at a greater rate — going up by a significant percentage when they do rise.

5. YOU CAN LIMIT YOUR LOSSES

Stocks fall, too. And people who want safety and security in their stock investments will choose blue chip stocks because they aren’t likely to fall as much. But just as junior resource stocks can climb dramatically, they can also fall dramatically, too. However, since they have a low buy-in, you are only going to lose as much as you invest. So if you invest only as much as you can afford to lose then your losses are limited.

6. THE LAW OF SUPPLY AND DEMAND ALWAYS WINS

The market is the jungle and the strong survive while the weak perish. What influences strength and weakness is the fundamental rule of the markets: Supply and demand. The more you understand supply and demand, the better you’ll do in junior resource stocks. Supply relates to how much of the commodity is being readily mined and stockpiled; demand relates to how the commodity is being used. Increases in supply feed demand and drive the commodity prices down, which makes it less viable for a junior resource stock to operate; Increases in demand eat supply and drive the commodity prices up, which makes it more viable for a junior resource stock to operate.

7. EVERYONE NEEDS MINERALS

In general, the demand for minerals is there so a well-chosen junior resource company that is focusing on a specific in-demand mineral has the potential to do well. Minerals aren’t going out of style. Yes, specific minerals might rise or fall in price because of supply and demand but minerals as a whole will always be needed. It is the responsibility of the investor to figure out what minerals will be in demand and to invest accordingly.

8. I UNDERSTAND IT

There are many penny stocks out there, not just junior resource stocks. There are tech and biotech and greentech, for example. The problem is, I don’t understand them. I’ve spent some time studying the resource industry and junior resource stocks in general so I’m comfortable working in this industry.

9. SUCCESS COMES FROM DUE DILIGENCE

I love due diligence. I love to roll up my sleeves and research companies to find out what makes them tick. It’s not easy and other people don’t like doing it, which is probably why I like doing it all the more. Here’s a blog post I wrote about how to do due diligence on a junior resource company. While you can’t eliminate all risks with due diligence, you can identify many of them and that allows you to deal with them as much as possible. The other risks (the ones you can’t mitigate) are just part of the fun.

10. THERE IS AN OPPORTUNITY TO SPECIALIZE

Junior resource stocks are basically their own category but within that category are sub-categories: You might specialize by mineral type (gold, silver, graphite, etc.), geographic location of mines (South America, Africa, etc.), where in the mine lifecycle a company operates (explorer, developer, etc.). By identifying a few specializations, investors will feel far more comfortable navigating the complex supply/demand equation because they are more familiar with a specific mineral.

Of course that doesn’t mean you don’t invest in other sub-categories, but a specialization helps you to focus bit.

11. THERE ARE MANY PATHS TO SUCCESS

I also love junior resource stocks because they have many opportunities for success, which (in turn) impacts the stock price. The most basic path to success for a junior resource stock is to find a resource and mine it, eventually earning cash flow from the production of the mineral. But that’s not the only way they can succeed. They can be a prospect generator, finding resource deposits and partnering with others who will bring those deposits to production; they can do a joint venture with a company to bring the deposit into production (which is similar to the prospect generator method but maybe with a bit more control over the process and skin in the game); they can sell the project to another company (we’re seeing a lot of this in the industry right now); they can be acquired by a major producer; they can split the company into multiple companies (which happened recently to one of my holdings — I know own three very good companies instead of one). There are even other creative ways to succeed as well — I just heard of one company that not only mines its own products but it also owns a mill that mills ore for nearby mines as well.

 
There are risks to junior resource companies and you should never trade these stocks if you aren’t comfortable with the risks. It’s not for everyone but I love the challenge, the opportunity, and the edge-of-the-seat excitement that comes with this kind of trading.

How to do due diligence on a junior resource company

How can investors value a junior resource company so that they know whether or not they should invest in it?

While mowing the lawn, you see your neighbor so you walk over to him, lean on the fence, and chat for a while. He asks you, “So have you heard about ABC Gold Exploration Inc? They trade on the TSX and I hear they have just discovered the world’s greatest deposit of gold… EVER.

What do you do?

Some investors (too many, in fact) will run to their online self-directed brokerage account, check the symbol, and then stick some money into the stock. After all, their neighbor seemed pretty sure of himself.

Sure, we might SAY that we never do this… but it happens. MANY investors do exactly this.

In my experience, people love the idea of risky stocks but they hate risk, and they want to be cautious investors but rarely examine stocks closely before buying them (and instead are guided by emotion and the momentum of a stock’s popularity or unpopularity). Yes, that last sentence seems full of contradiction but it seems to be how people tend to trade.

So let’s say you hear about a junior resource stock. What should you do?

Regardless of the source (whether it’s an completely uninformed source, like your neighbor, or the most trusted source like an industry expert), you need to do the following 3 types of due diligence investigation BEFORE you a penny into that stock.

STEP 1: AM I READY TO INVEST?

Before you ever invest in anything, you need to do some due diligence and the first part of your due diligence is to take a close look at yourself. What kind of investor are you? How much risk can you handle? How much volatility can you handle? Will you lose sleep if your stock goes up by 25% one day but drops by 50% the next day? What happens if your stock drops by 75% and then stays that way for a long time? How much do you want to gain and how much are you willing to lose? What is the timeline that you want to make your money back?

So, before you jump into a stock just because your neighbor’s friend’s cousin knows a guy who heard something good about the stock, here’s what you need to do:

  • General due diligence action: Start by performing a personal assessment about your financial portfolio. The first 28 questions on my How to do your own due diligence blog post will help you with this.

It’s a good idea to revisit these questions periodically (schedule time to think about them once a month or once a quarter. It will go quickly because most of the answers will stay the same but it’s worth figuring out if anything has changed and how that impacts your investing).

If your due diligence reveals that you are okay with the risks and rewards that junior mining companies present, then you can move on to the next step…

STEP 2: WHAT IS THE MARKET LIKE?

Next, you look at the two elements that drive the stock market in general (and the prices of the specific commodity you’re looking at). Those two factors are: The supply/demand ratio and emotion. Examining the supply/demand ratio helps you understand the underlying fundamentals of the company while examining the emotion in the market helps you understand how excitement or fear can impact the price of a company.

You will gain a large advantage over other traders when you examine these two factors at the stock market level and at the more specific resource market level (because they are not always the same but they can influence each other).

The supply and demand ratio: Current metal prices (“commodity prices”) have an impact on the progress of a junior resource company, and metal prices are determined by supply and demand. If a company is operating in a market that has no demand or too much supply, commodity prices are low and it doesn’t make sense to explore, build, and operate a mine. However, if demand is high or supply is low, commodity prices might make it worthwhile to explore, build, and operate a mine. So it’s critical to understand supply and demand, and commodity prices.

Commodity prices are easy to identify – there are many sites and resources that provide that information, and this commodity returns table is a really good at-a-glance way to view commodity returns for the past decade. But for a great site that lists plenty of historical commodity prices and other information, IndexMundi is a good source to bookmark.

Slightly more difficult to identify are the underlying factors that drive supply and demand. Understanding what those factors are doing, and will do in the future, can help you know what the supply and demand is going to be like. For example, copper and molybdenum are driven by industrial growth and infrastructure growth. Graphite is driven by growth in the automotive industry, tech industry, and in the growth of Lithium-ion batteries. (Learn more about the underlying factors driving graphite’s supply and demand at GraphiteInvesting.com). Gold is driven by a sense of unease in the market (so people buy gold as a hedge). And so on.

  • Junior resource due diligence question: What are the underlying factors that drive the commodity price?
  • Junior resource due diligence questions: What has the commodity price done in the past? (See IndexMundi for the answer) And, does it confirm what I’ve just discovered about the underlying factors that drive the commodity price?
  • Junior resource due diligence question: What are those underlying factors doing right now? (Further research might be necessary to determine the answer to this question).
  • Junior resource due diligence question: What do I think those underlying factors will do in the future? (Further research might be necessary to determine the answer to this question).

Emotion: Although individual stock prices might reflect a lot of the information available to investors, the stock market is largely driven by sentiment. Happy investors who feel like there is plenty of money to be made will invest. Scared investors who are afraid of losing their shirt will keep their money out of the stock market. This supply of money in the market (high during good times and low during bad times) drives prices up and down. And contrarian investors who understand the concept of buying when prices are low and selling when prices are high can benefit. This excellent article explains the cycle of market emotions.

  • Junior resource due diligence question: Using the cycle of market emotions, where is the overall stock market currently?
  • Junior resource due diligence question: Using the cycle of market emotions, where is the underlying metal of the junior resource you are examining?
  • Junior resource due diligence question: Using the cycle of market emotions, where is the junior resource company you are examining?

So, we’ve looked at supply/demand and emotion in the market. Here’s how I like to use the information when I invest: In general, I like it when there is a lot of ongoing demand but little supply, and I like it when there is a lot of fear in the market. The reason is: The fear drives the price of the stocks down, which makes it perfect to buy low, but then the ongoing demand brings prices up. Then, as the emotion in the markets becomes less fearful, the prices go even higher.

Just because I invest like that doesn’t mean you have to invest like that. There are other equations of supply/demand and emotion that might influence your trading. But it’s what I like to do (and it’s why I’m investing in specific parts of the junior resource industry right now when I can find good demand, low supply, and a lot of fear.

This step gives you the “context” or the “climate” in which you are investing, and it helps you understand some of the factors that will affect your price that are larger than the company you are investing in. Now it’s time for the last step…

STEP 3: WHAT IS THIS JUNIOR RESOURCE COMPANY LIKE?

Now that you’ve spent time figuring out how comfortable you are with risk, and what the larger investing context is like, now you are finally ready to take a closer look at the junior resource company itself.

Some investors want one single number to determine the value of the company but there are many factors that will influence that number and that might work for Warren Buffett but he doesn’t deal in junior resource stocks. It is possible to find undervalued stocks but you can’t always easily compare one company to the next because there are political and commodity considerations to take into account.

For us junior resource investors, it’s not easy to compare one company with another. A gold company in Bolivia needs to be valued very differently than uranium company in Saskatchewan Canada. Instead, investors need to examine the following factors to determine whether they feel those factors are acceptable to them.

Business model of a junior resource company: A business model is the way a business is structured to use its competitive advantages to operate and make money. Different companies will bring different strengths (and weaknesses) to a business model. You can start answering these questions now but you might refine them as you continue through this part of the junior resource due diligence.

Junior resource companies have business models like “Prospector” (where a company searches for resources), “Explorer” (where a company acquires a claim from a prospector and explorers it further, perhaps bringing the mine through the feasibility stage), “Developer” (where a company takes an explored resource and builds a mine), and “Producer” (where a company mines the resource and brings the product to market). Many junior resource companies do more than one of these roles (some are prospectors and explorers, some will prospect, explore, and develop, others will take a mine from discovery all the way to production). There are also hybrids of this model. A “Project Generator” business model is a good example – where a company will explore a resource and then partner with a senior company to develop the mine and extract the resource. And some mines don’t just take stuff out of the ground, they have a “mine-to-market” business model where they hope to extra minerals and then mill them into sellable metal.

I haven’t found a lot of information written on junior resource business models (and different companies might use different language to describe what they do) but each model has its own opportunities and challenges. For example, an explorer might not have a lot of cash flow so it might have to go back to the market frequently for money (until it sells its deposit or partners with a larger company). And a developer/producer might make some good cash flow but it is expensive to build a mine, so they need a lot of money up-front. Knowing what the model is gives you a point to start thinking about the opportunities and challenges that the company faces.

  • Junior resource due diligence question: What is the business model of that junior resource company?
  • Junior resource due diligence question: what strengths and weaknesses does this business model represent (and how will these strengths and weaknesses impact the company and the price of its stock)?

Life cycle of a mine: All mines go through a pre-defined lifecycle – from the point where a prospector takes a closer look at a big piece of empty ground, all the way through to the point where a giant mine is in operation. (This is related to the business model, above – often, companies derive their business model by specializing at a point in the life cycle of a mine).

There are several stages in between the prospecting and the finishing mine, and each stage has its own risks and rewards and opportunities and challenges. (Note: Some companies have several mines in one stage of the life cycle while other companies might have several mines that are each in different stages.) To familiarize yourself with these risks and rewards, a good place to start by taking a look this video below…

And be sure to check out this simple interactive mining lifecycle page from The Global Speculator.

Then, for more detail, check out what Brent Cook wrote: Life Cycle of a Junior Explorer and then to go read the five-part series about mine life cycle at GoldInvestingNews.com: 1. Staking a Claim; 2. Regional Exploration; 3. Resource Definition and Feasibility Study; 4. Assessment and Approval; 5. Mine construction; 6. Operating the mine.

  • Junior resource due diligence actions: Using the above information, figure out what the company is doing now and will need to do in the future to move forward in the process. Then determine the impact on the company and the impact on the stock price. You’ll also need to think about the level of risk at each stage – what the risks are and how the company is handling those risks.

Resource: Now it’s time to do some due diligence around the actual resource of the mine. You’ll want to pay attention to the following three factors (assuming that you have already done the other due diligence listed above):

  • The amount of the resource (how much is there?)
  • The extraction plan (how easy or hard it is to get the resource out of the ground?)
  • The purity of the resource (how much work is required to make the resource ready to turn it into a product?)

Each type of metal measures the resource differently – some by tons, some by ounces; some use open pit mining; some have very pure minerals that require little separation from the impurities while others need to be separated out of the ore. So don’t be dazzled by the individual numbers without getting some comparisons.

A really helpful resource that is written about gold (but is useful even if you invest in more than gold explorers) is this PDF entitled Models and Exploration Methods for Major Gold Deposit Types. It gets pretty detailed and scholarly (you WILL scan some of it instead of reading it because it’s not very exciting) but it’s about as close as you’re going to get to digging in dirt without getting dirty.

  • Junior resource due diligence question: What is the geology of the area of the world where the junior company is working?
  • Junior resource due diligence question: How much resource is claimed to be there?
  • Junior resource due diligence questions: How does this amount of resource compare to other companies in the same area? (How much resource do those other companies have? Are they finding more? What is the purity? How hard is it to get out of the ground?)
  • Junior resource due diligence questions: What is the company’s plan for making money from that deposit? How far away are they from achieving their goal?

Politics and Location: Junior companies operate in different jurisdictions – both politically and geographically. Each one will have an impact on how successfully a mine operates.

Political jurisdictions might be mining friendly, mining unfriendly, or unstable (politically unstable examples include: A country might unexpectedly nationalize a mine that has just been discovered, or a government might collapse during a coup). So investors need to determine what the political landscape is of the area that the junior resource company is operating in.

  • Junior resource due diligence question: Is the political landscape stable or unstable?
  • Junior resource due diligence question: Is the political landscape pro-mining or anti-mining? (Along with political leaders, consider different interest groups that might have a strong say in whether or not mining work is completed in a particular area).

Part of the location question is the question of infrastructure. If there is water, power, roads, and a potential workforce nearby then it is much easier and cheaper to set up a mine, compared to those situations where a mineral deposit is discovered far from civilization and diesel generators have to be barged in only when the water isn’t frozen.

  • Junior resource due diligence question: What is the infrastructure like? (No infrastructure can mean higher costs to develop a mine).

Management: Next, investors need to look at management. Since just about anyone can start a junior resource company (no experience necessary!), it’s important to know what the background of the management is and whether they are experienced and skilled at operating the company with the business model, life cycle, and location that they are working in.

Look at the website to get a list of management and the directors. Then look at the following:

  • Junior resource due diligence questions: What is the experience that each person had? Although longevity in the industry is one helpful indicator, it’s certainly not the only one. Also ask: How much experience has this person had with this particular type of business model?
  • Junior resource due diligence question: What connections do management and the board of directors have with larger companies? Is there a potential joint venture relationship possible?

Financials: The financials of a company will also help you to value the company and they are essential for you to review. I’ll go into detail in a moment, but here is a bird’s-eye-view of the numbers you want to pay attention to:

  • Are there ways that the company is making money right now? Do these support exploration?
  • How much cash does the company have right now?
  • How much is the company spending right now?
  • If the company doesn’t get any more money, how long will it last until it needs to find more?
  • How will the company get more money if it needs the money?

Below, I’ve provided a number of really helpful resources. Each one gives you a slightly different perspective or way to value a company. I don’t think there is any one single right way. I prefer to do several of these methods and decide how I feel about the company based on a collection of numbers.

So, to get started, go to the company’s website or to a site like Yahoo Finance to get their latest financials. Then go through the list of videos, websites, and PDFs I’ve provided below to piece together a picture of the financial health of the company.

InformedTrades.com provides the following 3 excellent videos about how to understand financial statements of mining companies. Watch these! They are very good.

Roger Montgomery shows us how long the mine will survive at the current amount of money it spends:


The really good stuff is between 1:20 and 1:45

His advice is to look at a company’s expenses over the year, divide the number by 12 to determine the cash burn rate. Then look at the how much money the company has in the bank.

This PDF from Mining.com helps investors use financials to find the real value of junior mining companies.

Although the content of this site has nothing to do with mining, they have devoted a page to this really helpful mining calculation: Enterprise Value Per Ounce and Cost Per Ounce.

Check out Paul van Eeden’s articles How to value a mining stock and How to value an exploration company.

If you want to get really advanced, this 81-page PDF from basinvest.com gives a lot of detail about using financials to value a mining company.

Each company will need to be weighed on its own financial strengths and weaknesses. You are looking for the answer to this question:

  • Junior resource due diligence question: When will this company become profitable and will it need to dilute its share price or borrow more money to get to that point?

Answer that question and you will have a fairly good idea of what to expect. Ideally, you want a company that has cash flow coming in from operations (perhaps selling or JVing properties or selling ore). If you don’t have that, then you want a company that has money in the bank that can afford to explore or extract the deposit for a while before it needs more money.

ADDITIONAL MUST-USE RESOURCES

8 Page Guide: Resource World Magazine put out a great 8-page guide to valuing a mining stock. This guide gives a good introduction to various aspects of a junior company – including geology, mine life, and financial calculations.
Excellent video from BuchanBullBullion: This guy does an amazing job of outlining great tips, ideas, and websites that investors should look at when they are doing junior resource due diligence:

Some highlights from the above video:
1:35 – 2:03: How to research management
3:10 – 3:54: How a little knowledge can help you profit from volatility
3:57 – 7:05: Fundamentals to look for in a junior company
7:05 – 14:00: Understanding the lifecycle of a mine

ResourceInvestor.com: This article from ResourceInvestor.com called How to value a mining share goes into greater detail and lists 8 factors that investors need to be aware of when they are valuing a mining company.

WHAT YOU END UP WITH

After doing all of this research, what do you end up with? Unlike some stock research, you don’t end up with a single, simple number that indicates whether or not you should buy the stock. Instead, you end up with a sense of the company’s short-term and long-term health, and short-term and long-term opportunities. You end up with enough information to either feel comfortable about owning the stock because you reasonably expect the price to go up, or uncomfortable about owning the stock because you reasonably expect the price to go down.

Of course there will always be things you didn’t consider — a CEO who goes rogue, a crazy investor who gets the jitters and sells their holdings and drives the price down, etc. But in general, you gather enough information to feel overall bullish or overall bearish… for good reason.

If and when you decide to invest, the next step is to “screw your courage to the sticking place”, as they say in Shakespeare, and be confident in your purchase. If a stock price falls but nothing has changed in the information you gathered then there is no need to sell. To help with this, I suggest you develop an exit strategy for each stock.

An exit strategy consists of the following elements:

  • A profit thesis (the reason why you own the stock and expect it to go higher
  • A best-case-scenario exit strategy (the point at which you will exit the stock or at least re-evaluate whether you should continue to hold the stock). I like to include a share price and a date.
  • A worst-case-scenario exit strategy (the point at which you want to jump off of the sinking ship).

Here are a couple of examples of my profit thesis: I hold one company because it has an amazing gold resource that is increasing in size, is run by management with plenty of experience, and is in a politically stable area. My profit thesis is that as long as gold is in demand, and as long as this company can find more and then extract it, they are going to do okay. But I’ve also set a price and a date in the future. If either of those become true (the price rises to the price I’ve identified, or the date arrives that I’ve identified) then I will re-evaluate.

Another example: I hold a company that owns a past-producing mine and on-site mill. They have all of the infrastructure and they have a new deposit. My profit thesis is that I believe the stock price is going up as soon as they can get their new deposit out of the ground and into their on-site mill. Again, I have a price and a date and I’m just waiting for either of those to be true before I do anything. The stock has gone down — (it dropped by 30% this spring!) — and there were many days when I had to go back to my profit thesis to remind myself why I bought the stock. Nothing had changed except for market emotion so I stayed the course.

CLOSING THOUGHTS

As you can see, there are many things to consider when doing your due diligence in in a junior resource company. Look at as many facts as you can and decide whether you believe the stock’s potential risks and potential rewards are right for you. If they are, buy with confidence and courageously hold your stock until the facts change.

Improve your junior resource investing with this tool

Junior resource companies are like the many-headed Hydra: One dies and two more will take its place. Every time I turn around, another junior resource company is proclaiming that it has struck a bonanza-grade deposit of whatever resource it’s exploring for, the deposit goes ALLLL the way down, and they’re neighboring the greatest producing mine of all time.

As an investor, it’s easy to get caught up in the hype and to spread yourself too thin as you look for compelling investments – in one day you might look at a gold explorer in the Abitibi belt and then a silver explorer in Peru and then a graphite company in Mozambique and then a rare earths company in China and then a uranium company in Saskatchewan.

I realize that I was almost overwhelmed by choice and it was actually making my investing less successful and less enjoyable.

What I wanted was a way to focus my research, tune out the noise, and figure out how to become a better investor.

So I put together this simple chart as a starting point. I created 2 columns, “Preferred” and “Not paying attention”, and in these two columns I sorted jurisdictions and resources that I was interested in paying attention to and jurisdictions and resources that I’m not paying attention to right now.

Here’s the chart:

Preferred Not paying attention
Jursdiction Canada

  • Alberta
  • Saskatchewan
  • Manitoba
  • Ontario
  • Quebec

US

  • Alaska
  • Nevada
  • California
  • New Mexico
  • Arizona

Mexico

South America

  • Peru
  • Argentina
Africa

Asia

Australia

Europe

Resources
  • Aluminum
  • Coal
  • Lead
  • Nickel
  • Rare earths
  • Molybdenum
  • Oil/Natural Gas

HOW A SIMILAR CHART COULD BE USEFUL FOR YOU

  • By identifying which jurisdictions and commodities you’re interested in, you’re helping to focus your attention on some of the things that best capture your attention, which is a great place to start when looking at different investing opportunities. When I hear about a new gold mining opportunity in Ontario, I’m giving myself permission to take a closer look because it’s the jurisdiction and resource that interests me, so I’m presumably more familiar with the details. (Even if I’m not an expert, I am at least starting from a base of familiarity). If you’re familiar in just a few areas, you can make better apples-to-apples comparisons of mines that explore near each other… compared to learning what makes a good uranium mine in Saskatchewan and then having to relearn what makes a good molybdenum mine in Australia.
  • By adding something to the “Not paying attention” column, I’m not sweeping an entire continent or commodity into the trash can, never to look at them again. In fact, I do own companies that mine in these jurisdictions or work in the resources listed in the “Not paying attention” column. However, this chart serves to keep my euphoria in check when I hear about an AMAZING new exploration story. If it’s an aluminum mine in Asia, the chart is a reminder to me that these aren’t in my “Preferred” category so I need to do an extra check during my due diligence because I might not be as familiar with the jurisdiction or the resource. In the case of Flinders Resources (TSX: FDR) it was in a jurisdiction I was not as familiar with but I invested in anyway… I just needed to do some extra legwork ahead of time.
  • This chart also becomes a curriculum to help me learn to be a better investor. I can identify some of the jurisdictions and resources in my “Preferred” category and learn more about them. For example, I can see by looking at this chart that I’m woefully uneducated in the states/provinces of Mexico, Peru, and Argentina so that might be a good place to start. Or perhaps I can build on my interest in gold and dial in more information about gold-copper-zinc plays. And, I can do the same in my “Not paying attention” category. If I feel that I want to range out into a new jurisdiction or commodity, I can be more strategic in deciding what to look at next. For example, perhaps I’m willing to take on a little more political risk in my portfolio so I could look at some explorers in Africa or Asia.

I should also note that just because something is ON the chart doesn’t mean I’m invested in it. Copper is a good example right now. But it does mean that I’m familiar with the resource and that familiarity helps me trade more effectively. And I’ll keep an eye on copper for when I might find another opportunity that interests me.

A chart like this helps you to sort through the barrage of exploration companies, tune out the noise, and find exactly the kind of companies you are most likely going to get excited about.

You don’t have to just use the two categories – jurisdiction and commodity – that I’ve done here. There might be other elements you can also include to help you focus even further: Some others I might consider would be: Type of company (explorer, developer, producer, etc.), business model (prospect generator, mine-to-mill, etc.), market cap, stage in the mine lifecycle,

My latest project: Graphite Investing

I’ve been writing for the metals and mining industry for several years now. It started with some work I did for an oil and gas magazine back in 2002 or 2003. That morphed into an interest in the mining industry (especially junior resource companies) and I’ve done a ton of writing for the industry.

I have watched different resources rise and fall. Rare earths, for example, was one of those bubbles where I got access to early research and wrote about companies through their meteoric rise. The rare earths bubble burst but not before I watched a lot of people make a lot of money and I thought: “Damn. I knew it was happening but didn’t get my own portfolio in gear to do something about it.”

Although I am no expert in the resource industry, I do enjoy access to a lot of experts that most investors don’t have the time or connections to hear. This gives me an advantage and I promised myself that I would watch for the next resource opportunity and jump in when it arrives.

That opportunity (in my opinion) is here and it’s…

GRAPHITE MINERALS

When most people hear about graphite they think of the stuff in their pencil. But graphite is a resource that nearly EVERYONE relies on nearly every single day. And without getting into too many details, the supply/demand imbalance is acute. There is a HUGE and growing demand for graphite but the supply is not nearly sufficient to keep up with today’s demand (let alone the massive growth that is expected).

For this reason, I’m doing 2 things.

First, I’m investing in graphite. Yeah, the market is down and every publicly traded company’s stock price is seriously depressed but I think there is value and room for growth in some well-chosen graphite companies.

Second, I’ve started a website (GraphiteInvesting.com) to share with others the exciting story about graphite. It’s one of those minerals that few people realize just how essential it is. The website offers a free graphite investing e-course that describes the supply/demand imbalance and shows investors exactly why they should be paying attention to graphite.

If you have an interest in resources or in supply/demand imbalance opportunities, take the free course to learn more about graphite minerals.

(Note: I am not a licensed financial advisor and my bullishness on graphite is not a recommendation to buy. Everyone should always do their own due diligence first before making any portfolio decisions. See my disclaimer for more information).