Investing in Junior Gold Mining Companies: Four How-to Essentials

By Walter A. Marting, Jr. Director, Cibolan Gold Corporation, Nevada

When surveying the universe of junior gold mining stocks – and some analysts estimate there are over 4,000 listed firms on the Canadian, USA, Australian, London and Johannesburg exchanges – investors should be mindful that extraordinary returns are typically found only in a very small subset of Junior Gold Mining Companies.

Approximately 5% of the junior gold mining firms deliver over 90% of the returns. The level of returns among that small subset can be spectacular but the risk is daunting. When investing in junior gold mining companies, (or any type of junior mining firm) they must be analyzed with rigor and discipline with the investor focusing on at least 4 essential factors. Filtering companies through these 4 criteria is no guarantee of success but it should enable the intelligent investor to avoid some major trapdoors.

1st Essential for Successful Investing in Junior Gold Mining Companies – Management

When Investing in Junior Gold Mining Companies, the serious investor needs first to look at the quality and experience of a mining firm’s management in deciding whether to make an investment. Without question this is the determinative factor of a junior gold mining company’s success.

The people running the company must be professionally competent and should have an established track record of past successes. They also must be committed in terms of having a significant stake in the firm’s equity. Above all else they must know what they are looking for – a simple concept to state but many junior gold mining company management teams lack a clear vision of what the type of deposit they are seeking looks like, and little idea of its true potential profitability. Management also must be ruthless when it comes to bailing out of a project that is not proving out. Most of the junior gold mining companies an investor will see are ones where the management team is simply holding on, hoping for a buyout offer or for a bonanza strike in the next drill hole.

There is a virtuous circle for the best junior gold mining companies. It begins with management teams that most frequently find the best prospective mining project. Experienced management teams typically take the project to the better promoters first then onto the pre-eminent financial houses who can raise capital faster and on better terms. This approach generates more cash flow for the management teams to find still better projects. When investing in junior gold mining companies, the investor needs to tap into this upward spiral of value.

It is a tired but true saw: an excellent management team can make a success of an average mining operation but an inept team will botch even the richest ore body.

2nd Essential for Successful Investing in Junior Gold Mining Companies – Location

The project’s location must be considered from several vantages when investing in junior gold mining companies:

  1. The mining district and the project’s proximity to other producing mines
  2. The availability of infrastructure (roads, electricity, water and labor force)
  3. The regional as well as the intra-claim geology and geochemistry

The geology of the junior mining project can be evaluated in several ways. One of the most helpful tools when investing in junior gold mining companies is the Canadian National Instrument (“CNI”) 43-101 Report. The 43-101 report is a mineral resource classification standard used for the public disclosure of information relating to mineral properties, and it is widely used throughout North America and in other regions. The report complies with strict guidelines on how mining companies can disclose scientific and technical information about mineral projects.

Another way to evaluate the geology of the mining project when investing in junior gold mining companies is by its proximity to other proven or operating mines. There are mining locales or geologic trends where multiple mines are located. Finding a junior mine operation in the middle of a prolific gold mining and silver mining area helps validate the possibility of a successful junior mine and large potential investor returns. Keep in mind: To find “elephants” you need to start in “elephant country”.

Established infrastructure is another key element when investing in junior gold mining companies. Access to roads, utilities, water, labor and equipment can make a significant difference in the cost of the ore mined and in the cash generated by the project. If a mining firm has to pioneer all or many of these infrastructural necessities then it will need a higher grade ore to be competitive with a mining project that has all of this in place.

3rd Essential for Successful Investing in Junior Gold Mining Companies – Predictability

In the context of mining company evaluation, predictability refers to the stability and regulatory consistency of the political jurisdiction in which the company operates. Junior mining firms are finding it increasingly to their advantage to operate in regions that have predictable regulatory frameworks around mining operations. When investing in junior gold mining companies, take a look at The Fraser Institute of Canada’s annual rankings of the top ten most mining-friendly jurisdictions in the world. In 2011 they were, in order:

  1. New Brunswick
  2. Finland
  3. Alberta
  4. Wyoming
  5. Quebec
  6. Saskatchewan
  7. Sweden
  8. Nevada
  9. Ireland
  10. The Yukon

The bane of mining firms worldwide has been incurring the substantial cost of finding, developing and initiating production on a rich ore zone in a less than stable political jurisdiction and then just when the project is generating significant cash flow having it either confiscated or made uneconomical because of arbitrary increases by the state in royalty or other mineral related payments.

One recent example of just this sort arbitrary state action occurred in August of 2011, when Hugo Chavez decided to recall the country’s gold reserves and nationalize the gold mining industry. Speaking on state television via telephone, the leftist leader said he would introduce a new decree in the coming days to put exploration and extraction of gold into the government’s hands.

The effect on the equity valuation of a firm that is operating in this kind of unpredictable environment can be enormous. John Doody, author of the Gold Stock Analyst compares two gold mines in different regions of Venezuela:

ONE: Agnico Eagle’s resource of 18.06 mil ounces of proven and probable is valued by the market at $461/oz.

TWO: Crystallex’s resource with almost the same number and type of ounces – 16.86 million – is valued at only $4/oz.

What’s the difference?

According to Doody, Crystallix’s ounces are at a site in Venezuela where Chavez is denying a construction permit and is probably considering confiscating the mining operation. With that level of political uncertainty, the difference in stock price seems justified. This is an extremely important consideration when investing in junior gold mining companies.

4th Essential for Successful Investing in Junior Gold Mining Companies: Capital

Last but not least, when investing in junior gold mining companies, the discerning investor needs to look at the how the firm has deployed its capital. Has most of the money gone into General and Administrative expense or into Investor Relations expense suggesting the management team is more interested in mining the firm’s stock certificates than the ore body? Or has most of the money gone into drilling, assaying and ore body evaluation and the preparation of corresponding reports? If the former, it must be a red flag to investors that management is more focused on promotion than production. If the firm has completed a CNI 43-101, or a Preliminary Economic Assessment or, even better, a Pre-Feasibility Study, that includes a definitive resource calculation and some estimates of a project’s economics, then that is an excellent sign that management has spent its capital wisely and is looking to build shareholder value through development and exploitation of the mineralized material.

The other thing an investor needs to consider when investing in junior gold mining companies is the level of the firm’s debt. Long term debt in the form of convertible debentures, can be a fast lane to bankruptcy court if the firm has no immediate cash flow. Frequently these debenture holders want to drive the share price down so they can convert into greater amounts of equity and this can send the company’s shares into what’s known as a “death spiral.” This set of circumstances is a common outcome among the juniors that are constantly strapped for cash.

Most juniors an investor will encounter are not in a strong cash position, which represents opportunity when investing in junior gold mining companies. Investors need to determine if the firm has enough cash on hand to sustain minimum levels of operation when investing in junior gold mining companies.  This leads us back to our first point – look first to the experience and track record of the management team when investing in junior gold mining companies. If they pass muster then additional work and time spent on other aspects of the firm’s business is probably justified.

Following these guidelines when investing in junior gold mining companies can indeed take some of the risk out of buying junior gold mining stocks. Generally, those interested in gold as an investment or as an inflation hedge are wise to consider blending the types of gold investments in their portfolio. Holding the hard asset in the form of coins or bullion is a solid strategy. So is adding in some junior gold mining stock as well if it matches your risk tolerance. The returns can be exceptional.


About Walter A. Marting, Jr.

Walter A. Marting, Jr. has spent a large part of his career both as a senior executive for a Fortune 500 mining company and starting and running his own junior gold mining company. After graduating from Harvard Business School in 1975 and following three years in the US Navy with SEAL Team Two, Mr. Marting joined Amax Inc. as an underground mine Production Supervisor at Amax’s Climax Molybdenum property in Leadville, Colorado.

Mr. Marting spent two years working underground and in Climax’s open pit operation before moving to the Company’s headquarters in Greenwich, CT. In 1982 Mr. Marting was named Vice President — Finance for Amax Europe in Paris, France. Mr. Marting helped build Amax’s global mining presence from its Paris headquarters and had financial oversight of the company’s European and African exploration and development and ore processing activities. He left Amax in 1984 to start his own mining company that undertook the re-opening and operation of the famed 16-1 Mine in Allegheny, CA.