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.
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.
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!
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.
Timing the market is the most ridiculous idea out there. (Well, maybe not the MOST ridiculous idea out there but it’s pretty out there and it’s pretty pervasive so maybe it’s high up on the list).
The thinking behind timing the stock market goes something like this: “Oooh! I want to buy that stock. But the price is too high right now. Maybe I’ll wait until the price goes down.”
And then when the price does go down, the thinking changes to: “Ouch! I want to buy that stock. But the price is low and what happens if I buy it and it goes lower?”
This is true for real estate, too. A potential homebuyer might say: “Whoa! Houses are too expensive right now. I’m going to wait until home prices come down a bit before I buy.”
But when the sellers market becomes a buyers market, the potential homebuyer now says: “Yikes! House prices seem to be declining. What if I buy and the house declines even further in value?”
I hear this line of thinking OVER AND OVER AND OVER AND OVER. I heard it when I was a stockbroker and I hear it today in my work with financial and real estate professionals. I’ve tried to talk people out of this thinking but it can’t be done. (And the truth is, sometimes I fall into the trap, too!)
Like some optical illusion, the price of a stock or a property is never perfect right now and investors believe that by waiting, they can buy it at a “better” time.
Unfortunately, there never is a better time. EVERY price point has its advantages and disadvantages. Unfortunately, investors only see the disadvantages to buying now (regardless of price point) and the advantages of buying later (regardless of price point)… and they don’t seem to remember what they said only a few months ago when the price was different.
And waiting for a market bottom or market top is impossible because it takes months of data from indicators (including lagging indicators which come after the event) to prove a market peak or valley.
Timing the market is a fools game because investors and homebuyers are always looking for the perfect price point (even though they often can’t identify what that price point is and, even when they do, they fail to act when the price reaches that point).
Timing the market is ridiculous idea and a fools game… but it’s not impossible. You just have to rethink what you mean when you want to time the market.
Joe Average and Jane Average (Mr. and Ms. Average to you) try to time the market but they fail. There are people who CAN effectively time the market. I’m talking about short term traders. Short term traders (day traders and swing traders in the stock market, and real estate investors such as flippers in the real estate market) can time the market and many of them do pretty well at it.
Here’s why some people can time the market but most people fail at it:
Information volume and prioritization: Successful market timers do it effectively because they receive a barrage of information and they filter out what they don’t need. Compare this to Mr. and Ms. Average who glean tidbits from headlines or from the half-wits around the watercooler at break time and act on each piece of limited info that they get, as if the latest piece of information is the most correct.
Entries AND exits: Successful market timers consider both entry and exit positions before they buy. To a successful market timer, an “expensive” stock is still cheap if the price goes up and a “cheap” stock is still expensive if the price ends up going down. The same goes for those in real estate. It doesn’t really matter what the entry point is… it’s how much you can sell it for afterward when you are ready to sell. Compare this to Mr. and Ms. Average who likely intend to hold their stocks for decades and who will have to live in their house. They are making entry-only decisions and forgetting that there are other (hard-to-measure) aspects to owning these assets.
Mindset: Successful market timers view the (financial or real estate) markets as their “business”. They make money from it. Therefore, they make decisions from a business perspective. The Average family, on the other hand, is looking at buying stocks for their retirement portfolio or their next home and they are trying to weigh their decisions on a much more personal level, which makes the stakes seem higher.
Buying a range instead of a single price point: Successful market timers don’t look to one specific price point as THE bottom or THE top. Rather, they expect to buy a range, buying through the bottom and selling through the top and fully realizing that they might miss a few points here or there but overall they are hitting it at the right time. Mr. and Ms. Average, though, see every single low price point as a question (“is this the bottom or will it get worse?”) and every single high price point as the top (“is this the top or will it continue to climb?”). In a way, they are making a technical trading decision without any technical information.
Don’t bother trying. You cannot time the market… at least, not in the way that you want to time the market.
Sure, the question is asked with the very best intentions. People want to find good stocks to invest in and they look to people who might know a bit more than they do to help guide them. Fair enough; I get that.
But best intentions aside, this is a scary question and I’m always alarmed when I’m asked for this advice. Here’s why:
A GOOD INVESTMENT FOR ONE PERSON IS NOT A GOOD INVESTMENT FOR ANOTHER
The people who ask me this question are not people I know really well. They are people who have connected with me online — usually via email, and usually because of my connection to the graphite e-course. How can I possibly know what is a good investment for them? I’m a very risk-tolerant investor so I don’t mind investing in stocks that are far more speculative than others. And our timelines might be different — on some stocks I’m willing to watch in the short-term while with other stocks I’m fully expecting to hold for months or even years.
To give you an example: I bought a speculative junior resource stock that I liked. The stock was cheap but I’m confident about the trajectory of the company and expect to hold the stock while they go through the complicated and time-consuming permitting process. But a friend asked me what I was investing in, I told him, and he bought this stock too. Unfortunately, it has dipped a bit in the recent resource market dip and he’s getting panicky. He complains about the investment and I expect he’ll be selling it shortly at a loss.
So if that’s the case for my friend, it is certainly going to be an even greater issue for people I don’t know!
THE MARKET CHANGES
The other reason that I’m scared by the question “what’s a good investment?” is that the market changes. Investments come and go. There was a time when Research In Motion seemed like a good investment. There was a time when Berkshire Hathaway didn’t seem like a good investment. Apple seems like a magical do-no-wrong investment right now but that won’t last forever (sorry to burst your bubble).
I remember working at an investment tele-center helping self-directed investors buy their stocks. One guy was stockpiling gold like crazy. I was fascinated because no one else was doing it. Everyone else at the tele-center laughed at the guy. This was in 2000, when gold was about $275/ounce. Today, it’s over $1600/ounce.
THE DEFINITION OF “GOOD” IS A FLEXIBLE DEFINITION
When someone is looking for a good investment, there is something very interesting going on. They are looking for a stock that is going to go up in price. And they don’t mind buying it if they are confident that the price is going to go up. However, most average investors look at past performance to determine whether or not a stock is going to go up in price. Therefore, if a stock has been going down in price and it’s super-cheap, they might be reluctant to buy it because “what if it keeps going down?”
However, as Warren Buffett explains over and over, a cheap stock is exactly the stock that you want to buy. You should buy stocks when they are beat up. But very few people do this. Most people aren’t really looking for a “good” investment. They’re looking for an investment that has recently risen.
So I’m scared when people ask me to recommend a “good” stock. I never recommend anything (not only because I’m prohibited by law but also because my definition of “good” and their definition of “good” are not going to be the same).
Stock prices go up and they go down. Since 2008, stock prices have fluctuated (sometimes wildly) and investors don’t always know what to do.
The expert advice out there is mixed: Some wisdom says “Cut your losers and let your winners soar”, meaning that you should only hold stocks that are generally going up. Other wisdom says that the best time to invest is when other people are running scared from a stock, meaning that you want stocks that other people see as losers (i.e. the stocks that are down).
So what should you do if the prices of the stocks in your portfolio drop? Cut them? Hold them? Buy more?
Here’s what I think…
Assuming that you did sufficient due diligence when you first bought the stock, then identifying the changes in the market’s valuation of the stock as well as the overall market sentiment can reveal what you should do.
Dig into the news about the stock. Ask yourself this question: “Why has the market changed its mind about the value of this stock?” Figure out what has changed: What news item or piece of information has altered the trajectory of the price?
Take a step back and look at the wider picture — the industry and the market as a whole. What’s happening at the bigger level that might have an influence on this stock?
Then use a chart like this as a guide to know what to do with the information you’ve discovered above…
If information about the company of the underlying stock has remained the same and if the market is unchanged (upper left quadrant), then this price drop could be something else, such a temporary sell-off (i.e. for tax loss purposes or institutional investor portfolio rebalancing). In those cases, I prefer to double-down and buy more.
If the information about the company of the underlying stock has changed but the market remains unchanged (upper right quadrant), then I need to take a closer look at the stock — to revisit whether I think the fundamentals are still true and to sell if they are no longer true.
If the company hasn’t changed but the market has (lower left quadrant), then I’ll revisit the stock but in general have tended to hold my stocks during this time. Market corrections are cyclical and I’m not going to worry about them too much.
If the company has changed and the market has changed (lower right quadrant), then it is very likely time to sell because my entire profit thesis when I first bought the stock is no longer relevant.
This chart isn’t ever going to be perfect for everyone — we each have different investing goals and time horizons — but when you open up your portfolio and see that one or more of your stocks have fallen, a tool like this is a useful way to take a step back and apply a layer of analysis to the situation so that you don’t simply sell in an uneducated knee-jerk reaction.
There are a lot of potential investments out there and it’s hard for investors to sort through stocks and evaluate each one effectively.
One of the ways investors get around this is by categorizing stocks in similar ways so they can do a better job of comparing apples to apples.
These categorizations come in many forms — Sometimes these categories are formal. Sometimes they are informal. Sometimes they are by industry (such as metals and mining stocks) or sometimes they cross industry boundaries (such as greentech, which covers a wide range of eco-friendly stocks); sometimes they are by market capitalization or sometimes they are by the price of the stock. Sometimes these classifications are very specific (such as graphite stocks).
One informal classification of stock is sin stocks.
Sin stocks is a term investors use to classify certain types of stocks that are associated with society’s “vices” — companies that sell alcohol, tobacco, gambling (and other vices). There are a lot of sin stocks out there!
Even if I’m not a smoker or a gambler (and only a moderate drink), sin stocks are fascinating to me: They thrive even in highly regulated (and sometimes litigious) environments. Some are taboo but some aren’t. Some are (arguably) addictive but some aren’t. There’s a huge barrier to entry around many of them, which helps to keep competition down. And some investors argue that sin stocks are “recession-proof” because people still smoke and drink and gamble in difficult economic times. Although I’ve seen this to be true anecdotally and I have seen some numbers to back this up, I’ve never seen undeniable financial proof that sin stocks are recession proof.
In researching sin stocks, I discovered that there were a lot of people writing about sin stocks but no site that curates information about them. And although I don’t necessarily endorse or use all of the products or services these companies sell, I felt like there was an opportunity to examine sin stock investments. That’s why I started the website Sin Stocks Report.
On this site, I write and curate information about sin stocks for investors who are interested in this group of investments.
I’ve been at it for a few months now and I’ve been surprised at the variety of sin stocks out there — not just in the traditional sin stock areas (like alcohol, tobacco, and gambling) but also in other areas like sex, conflict, and more.
So if you’re an investor who is interested in sin stocks, or you are looking for a new batch of investments to consider adding to your portfolio, head over to Sin Stocks Report and check it out! (Just don’t let your mother catch you!)
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.
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…
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 article from Gold-Eagle.com called Mining Company Fundamentals 101 provides excellent detail on share structure, ownership percentages, and value calculations. They do discuss other points in this article but the first half of the article is devoted to financials and is quite informative.
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.
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.