With gold recently trading at its nominal high it is only natural that investor curiosity about precious metals mining companies should start to grow and the fact that relatively few investors know much about the various types of companies in this market sector is an indication that this market is many years away from peaking. [This article will change all that.] Words: 1912

So says Jeff Nielson (www.bullionbullscanada.com)  in an article* which Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has further edited ([  ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. 

Below Nielson lays out a basic check-list of what to look for in these companies.

Large Caps

The biggest choice for investors is deciding what size of mining company they want to invest in. There are clear trade-offs here. For simplicity, I will focus my discussion on the gold miners because in the case of silver miners, the sector is so small relative to gold mining that there aren’t the same, sharp divisions between different classes of miners.

The “pluses” and “minuses” in buying shares of a large gold miner (generally companies which are already producing at least half a million ounces of gold per year) are very similar to buying large-cap companies in other sectors. [On one hand,] the companies are more liquid, have less volatility, and are “covered” by a lot more analysts [while on the other hand, these companies typically have much more modest growth profiles than smaller producers because the size and quality of new gold discoveries are generally vastly inferior to new deposits discovered in previous generations. Indeed, with gold production only rising by about 2% per year throughout this bull market, despite a...[major increase] in price, many (including myself) are now talking about the concept of “peak gold”. This means that investors buying into these companies will generally have to rely upon a rising price of gold to earn a return on their investments as “organic growth” for most of these companies will not be a major component of their value.

Before going further in this discussion, let me take a minute to talk about analyst “coverage” of gold miners. Specifically, the coverage of precious metals miners by mainstream analysts is superficial and mediocre, at best. About all you get from such ‘analysts’ are simple, bottom-line financial summaries, with (in most cases) virtually no insights at all into the operational performance of these companies. Thus, any “guidance” they provide as to “price targets” are virtually meaningless.

Typically, the “price targets” of these “analysts” are simply 5% to 10% above whatever the current price is because they have little to no understanding of the gold market. In short, any investor who devotes a weekend of serious study to precious metals miners would likely have a superior understanding of these companies compared to most mainstream analysts.

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The Juniors

The alternative to investing in large gold-producers is to buy the “junior” miners. Since this is where both the greatest selection and the greatest profit-potential exists, I will focus the remainder of this discussion on the “juniors” – with the understanding that some of this analysis will also be applicable to larger miners (but naturally on a larger scale).

The “junior miners” are not separated by market-cap, but rather by category. I place them into three groups with similar valuations and similar levels of risk:

1. producers
2. a) near-term producers, b) advanced-stage exploration companies
3. early-stage explorers

Before discussing these companies in detail, let me provide investors with an important warning. There are significant risks associated with investing in these companies – even those that have producing mines. While these are certainly not the sort of “fly-by-night” entities investors were pumping their money into during the tech-bubble, such investing must be done carefully. There are two approaches which I would recommend:

1. for conservative who see such investments as representing the “speculative” component of your portfolio that they find one or two companies that they like, and invest perhaps 5% of their portfolio accordingly
2. for investors who have more enthusiasm for this sector, and who want to make precious metals miners a significant component of their portfolios, that they divide their investment dollars into a “basket” of preferred companies. Most experts in this sector follow this approach – based on the following reasoning:

It is an established fact that the junior miners (as a whole) will always outperform the large-cap producers but the risk for individual juniors is much greater than for the larger companies. By buying a “basket” of these companies one can capitalize on this superior performance and accept the fact that some of these companies will end up as losers.

1. Producers
As the name implies, these are mining companies which have officially commenced commercial production. Once a junior miner begins production it typically represents a beginning of the returns these companies will generate for investors as few, if any, are able to commence commercial production at their maximum potential output. Getting a mine into a smooth chain of production, from extracting the ore to producing the “concentrate” which is shipped to refiners/smelters is a process at least as challenging as other “manufacturing” processes – and generally more so. Most new mines will at least double their initial production over time. In the cases of mines which have large reserves/resources, it is not uncommon for production to even triple or quadruple – as production hurdles are overcome, and cash-flow allows production to be expanded.

Investors buying into junior miners will have three ways to capitalize on their investments in these companies:

1. hey can profit on the rising price of the commodity, with the natural leverage inherent in the business model of all commodity-producers.
2. they can realize gains from the increasing production of these mines, and
3. they can benefit from improving valuations on these companies as the combination of rising production and a track-record of consistent production reduces the risk-profile of these miners.

2. a) Near-term Producers
As the name implies, these are mining companies which are past the highly-speculative stage of merely finding an ore-body. They have already established that they have a mineral resource capable of supporting a commercial mining operation. Through a “feasibility study” they have identified and selected a specific process for mineral extraction which is also commercially viable. They have obtained all the necessary permitting and royalty agreements with the local government. Most importantly, they have all the financing necessary to take them into production.

Again, just because most of the speculative issues have been resolved with these companies does not mean they are free of risk. There are nearly as many things which can go wrong in building a mine as in operating one. However, because these miners are in an earlier stage of development than the producers, there is more up-side potential in these companies – and commensurate with that, there is also more risk.

2. b) Advanced-stage Exploration
I have chosen to lump these companies with the “near-term producers” (as opposed to the “early-stage explorers”) for two very important reasons:

1. Unlike the “pure” explorers, these companies have already done extensive drilling on their property, and have established commercially significant grades of ore in those drilling-results. Depending on exactly how far they have progressed in their chain of development, these companies generally already have “resource estimates”. A resource estimate is a scientific evaluation of the quantity of ore in a given area, extrapolated based upon the quantity of drilling data. Where such data is at a minimal level, the analysis produces an estimated “resource” where there is still a fairly considerable margin of error. When drilling is done more extensively (thus producing much more data), the analysis produces an estimate of “reserves” – a quantity/concentration of mineralization with a high degree of reliability.
2. Once this resource estimate is completed (which hopefully demonstrates a potentially viable mineral resource) the next stage is to undertake feasibility studies – to demonstrate that it is also possible to mine that ore at a profit, and thus obtain financing to build a mine.

All feasibility studies must make assumptions about commodity prices in order to ascertain whether production is commercially viable and, as such, a company could conduct such a study and be told that their resource is not “commercially viable”. However, should the price of the commodity rise significantly (or if a second study was done which simply assumed a higher price) that same body of ore could suddenly become economical. The reverse is also true in that, should the price of a commodity fall, or should input costs dramatically rise, an ore-body previously judged to be commercially viable could suddenly be considered uneconomical.

With significant volatility in both commodity prices and input costs, in theory the analysis of any particular ore-body could flip-flop several times. Indeed, when commodity prices plummet or input costs skyrocket, even mines in operation for decades are sometimes forced to close (at least temporarily). Despite all these variables, these companies are still much less speculative than the early-stage explorers, and thus their valuations will tend to be more closely aligned with near-term producers than with the pure exploration companies.

3. Early-stage Explorers
At worst, buying into these companies is like buying a lottery ticket [and,] at best, buying a winning lottery ticket. Putting aside that flippant remark, these companies are generally all highly-speculative in that they are “mining” companies which are just beginning to explore their property. They range from companies which have done little-to-no drilling on their properties, to companies which have done preliminary drilling and established some level of mineralization but are still a long way from establishing that they have discovered a commercially viable body of ore.

The important point here is that there are factors which dramatically affect the chances of these “lottery tickets” becoming “winning lottery tickets”:

1. Location. Obviously a company drilling in an area with a history of profitable commercial mining has a better chance of discovering a future mine than a company drilling in some “virgin” wilderland. Conversely, a company which is exploring “in the middle of nowhere” which does discover a significant body of ore will generally provide more profit to investors – much like successfully betting on a horse with high odds.
2. Management. A company run by people with a previous track record of discovering significant deposits is more likely to succeed again than explorers which lack that experience. Sadly, it is very difficult for novices to know/identify such expertise making these mining companies generally more suitable investments for those with experience investing in this sector, or (perhaps) through paying a subscription for the advice of an experienced analyst.

The stocks of junior mining companies are not the place for investors with a “get rich quick” attitude. Investors need to “do their homework” and remain disciplined. There is an enormous amount of volatility in this sector which requires people to buy and sell rationally rather than emotionally. Those who tend to “chase” these companies on the way up and dump them on the way down will have a hard time making consistent profits. Instead, investors must be patient and buy on “weakness”, and along with that regularly take profits when significant gains materialize. Those who do not feel comfortable with such trading are probably better off sticking with the larger, more-established miners.

* Original Source

Related Articles:

1. Jeff Nielson: What to Look for When Considering Which Gold Mining Companies to Buy

While investing in gold mining companies is not quite as simple as novices to this sector might at first conclude, neither is it so overwhelmingly complicated as to make these companies inaccessible to individual, retail investors. Below are a number of things to look for when considering an investment in such companies. Words: 2745

2.  Goldrunner: a Gold & Silver Tsunami is Approaching – Fast!

A tsunami doesn’t start with a bang, but with a whimper. The first sign is a little hump in the water way out in the distance that is barely notable. Anyone who catches a glimpse of it simply continues to expect the day to be the same as the last many days – calm and beautiful waters along the shore. This is the point where we are, today in the Precious Metals sector. Many have seen the little roll of water out in the distance as Gold edged up in the first move of a more parabolic slope, yet most investors are mired in the same expectations of yesterday – a return for Gold to correct down into a lower base. Our analysis based on the fractal relationship to 1979 shows, however, that the mid 900s are a realistic target for the HUI by the end of the year or early in 2012; that $52 to $56 should be achievable for silver, with $58 to $62 as real possibilities; and that Gold should go the $2250 level followed by $2500 with the potential for $3,000, or a bit higher, now on the radar screen. Let me explain why that is the case. Words: 2130

 3. Gold Stocks: Get Ready, Get Set, GO!

Both gold and silver continue to trade well below their inflation-adjusted highs in nominal terms, and the market is now beginning to acknowledge the profit potential that precious metals equities offer at today’s bullion prices. We believe the equities will offer more upside than the bullion over time. Many of the smaller names are well priced and have momentum behind them. The prospects for gold stocks look extremely bright [for very good reasons. Let us explain.] Words: 2250

 10. 9 Things to Look for When Choosing a Junior Mining Company to Invest In

In mining exploration, an “anomaly” is a geological formation that might attract a prospector’s interest. However, one rule of thumb is that you have to look at 1,000 anomalies to find one prospect and fewer than one prospect in a thousand turns into a mine. In other words, finding a mine is a million-to-one shot and that is one reason why junior mining stocks are highly speculative. Another reason is that it’s much easier to launch and promote one of these stocks than it is to build a profitable business. So junior mines attract more than their share of unscrupulous operators and stock promoters. Words: 504

11.  Best Hedge Against Inflation Is Owning Gold and Silver Mining Stocks

We are about to encounter major inflation and the absolute best hedge against such inflation is by investing in the companies that mine gold and silver. You often get leverage of 2 to 4 times the price appreciation of gold or silver. If gold goes up by 50%, your miners may very well double or triple in value. Words: 1426

12.  Why Invest in Junior Miners?

Leverage is the simple answer. It is not uncommon for junior mining companies to experience huge gains (10x or more) very quickly as news of a discovery is made known to the public. Words: 893

13.  Gold & Silver Company Warrants Warrant Your Attention

Talk about a small world we live and invest in! The galaxy of warrants trading on the TSX/TSXV consists of only 167 planets (i.e. constituents) in total of which only 40 are stars associated with 34 commodity-related stocks that have sufficient brightness (i.e. 24+ months duration) to warrant (the pun is intended!) the attention of earthly investors. My telescope has identified each of them and below I provide you with the particulars of each so you will be in a position to do your due diligence and begin to prosper above and beyond what you could achieve investing in the commodities and/or stocks themselves. Words: 1674

HUI: YOU AIN’T SEEN NOTHIN’ – YET!

We appear to be at the 3rd wave juncture where the large cap producer gold and silver stocks and intermediate precious metals producer/developer stocks tend to start to move much better - and where the smaller explorer class starts to kick up its heels. Let me show you what I mean with a few charts that will give you a clear visual of why you ain’t seen nothin’ yet when it come to the future performance of the stocks (and warrants) of gold and silver mining and royalty companies. Words: 1036

So says The Goldrunner (www.Goldrunner.com) in an article* which Lorimer Wilson, editor of www.munKNEE.com, has reformatted and edited [...] below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.) The Goldrunner goes on to say:

The AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index HUI- 3 OF III MOMENTUM RUN

In the chart below we can see that the HUI (AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index) of 16 large/mid-cap stocks (see here) is continuing to exhibit its fractal relationship compared to late 2005 and compared to the primary fractal in early 2002. The HUI has now broken out and appears to be completing a re-test of the top. It looks like the time for the mark-up phase in the larger cap PM stocks which make up the HUI is upon us. I have marked similar points in the HUI chart to show the similar characteristics to the 2005 period.

HUI target of 940-970 into May/ June 2011

The next chart of the HUI shows the similar price movements and indicators in the primary fractal of wave 3 of I (2002) versus the current 3 of Wave III movements. We can see that at this juncture in the Wave 1 fractal, price rose up to the angled line that extended off of the top of wave 1 of I. Thus, we expect the price rise into May/ June of 2011 to rise up to the angled line off of the top of Wave I. The similar rises in 2002 and 2005 were about 1.18 times (1.16 to 1.18) the height of the cup, added to the top of the cup. Thus, our potential target into May/ June of 2011 for the HUI lies up around 940 to 970. We’ll use the chart as a potential target zone and see how it plays out. Above the HUI chart I have plotted 3 large cap PM stocks, Gold Fields (GFI), Yamana Gold (AUY) and Kinross Gold (TSE:K, NYSE: KGC) that have underperformed as of late. I’d expect these stocks to perform much better into May/ June of 2011.

Expect An Explosive Rise in HUI Constituent Gold Fields Ltd

Because few investors actually invest in a PM Stock Index it is necessary to track the progress of the individual stocks that we do invest in while tracking the charts of the HUI helps to give us a better feel of what the sector is doing as a whole. Below is a chart of Gold Fields Ltd (GFI) [a constituent of the HUI] showing the very large cup formation that has developed. We have shown how GFI acted in the 2002 period in a similar cup environment that matches up at one degree lower of Elliott Wave Fractal Degree. We can see in the chart plotted above the GFI chart that Gold in Rand is mired in a triangular correction. If we see a break-out of that triangle in Gold in Rand to the upside- we’d expect a rather explosive rise in the chart of GFI. We have circled on the chart a very similar triangle break higher in Gold in Rand back in late 2001 that powered GFI into the huge 3rd wave rise in Wave I. Historically, South African Gold Stocks have had huge 3rd wave moves relative to the other waves.

Non-HUI Stocks NGD and NSU At Their Sweet Spots

While it looks like the juncture for the large cap stocks (of which the HUI is a proxy) run is close at hand the intermediate producers and soon to be producers are still the sweet spot of investing at this time. As such, we tend to favor stocks like Nevsun Resources (NSU) that should be producing soon and whose chart suggest a potential target of $16 to $18 on this run (from the current $6.50 or so) up to as high as $22. New Gold Inc. (NGD) whose chart suggests a potential target of $22 (from the current $10 or so) up to a possible $28. If the HUI busts out as the charts suggest, we’d expect a higher sloped rise in the intermediate producers along with that HUI rise which in “GR terms” means that I expect NSU and NGD to bust vertically out of the tend channel they are currently rising through.

Explorers Stocks Starting to Run

The explorer stocks are starting to run, and we’d expect them to perform much better into mid 2011. Many of these charts have exhibited a “low chop” rise that is breaking out. The next target for many of these charts will be the “old highs.”

Per the LT fractal back to the 70′s, the PM stocks still might have 90% of their gains ahead of them before this PM Stock Bull is over. We have only reached the top of a mole hill on our trip up the mountain, it seems.

Gold Bullion Has Potential to Rise to $2,250 by mid-2011

A few months, ago, we had outlined a potential range for $Gold to rise into mid- 2011. We placed that range at $1,800 to $2,100 with a mean of around $1,950. There is angled line resistance around $1,875 in that time-frame that might serve as stiff resistance [however] the potential is still there  for…

Conclusion

Gold to rise up to around $2,250 into mid- 2011 along with the HUI reaching 940-970.  

 Editor’s Note:

There has been a lot of investor interest in Van Eck Global’s Market Vectors Junior Gold Miners ETF (GDXJ) but the question is: will it live up to those lofty expectations? Words: 868

In further edited excerpts from the original article* Jeff Nielson (www.bullionbullscanada.com) goes on to say:

The GDXJ consists of 37 gold miners and prospectors with a weighted average market capitalization of only $850 million and a minimum cap of $150 million. The top 10 holdings, representing 46% in total, at its launch are:

Coeur d’Alene Mines (CDE), 6.6%
New Gold (NGD), 5.6%
Silver Standard Resources (SSRI), 5.4%
Hecla Mining (HL), 5.2%
Gammon Gold (GRS), 4.7%
Alamos Gold (AGI), 4.3%
Semafo (SMF.CN), 3.8%
Silvercorp Metals (SVM), 3.7%
European Goldfields (EGU), 3.4%
Golden Star Resources (GSS), 3.34%

Geographically, the portfolio is heavily tilted towarded Canadian-based companies at 62.6% with the U.S. and Australia far behind.

Here are some short-comings of the ETF:

1. Many Top-quality Gold Juniors do NOT Qualify for this Fund
The fund is not allowed to invest in any “junior” with a market cap of less than $150 million, with $200 million being the normal threshold. As such, thanks to the slaughter which these companies were subjected to in 2008/2009, dozens of top-quality gold juniors do not qualify for this fund – and this limits the selection available to the fund, although there are still many companies to choose from.

2. The Fund Invests in Mid-cap, NOT Small-cap Gold Miners
Also, contrary to the name of the fund, the fund will invest in mid-cap gold miners – with market caps in excess of $500 million. While there are some quality companies in this group, as well (with strong growth profiles), the inclusion of these larger companies will tend to reduce the up-side for this fund below what it would have been had the fund focused only on the small-caps.

3. Losses Can Exceed 100% of the Amount Invested
The “small print” in the prospectus also gives potential investors in this fund a good reason for worry: the intention of the fund to invest in “derivative” investments. This category of investments is described as “swaps, options, warrants, futures contracts, and currency forwards”. The prospectus warns that investments in these instruments could result in losses exceeding 100% of the amount invested!

4. Fund Overly Exposed to Derivatives
It gets worse. The fund intends to have at least 80% of its capital invested in the core assets around which the fund is based. However, this does not mean it will have at least 80% of those dollars invested in the shares of these companies. The company stated that these “derivatives” would be considered part of the core assets of this fund (meaning part of that 80% core). This means that theoretically the fund could hold 0% mining shares, and all derivative instruments. Obviously that is an extremely unlikely scenario. The point, however is that there is no possible excuse for deviating into these especially risky assets.

In Conclusion:
Apparently the people managing this fund don’t think that they can achieve a high enough return through investing in mining equities alone. This certainly suggests that this fund lacks the expertise to identify the best growth “stories” – and so wants to be able to attempt to “juice” returns through the same, Wall Street, Ponzi-like investments which have caused most of the problems in financial markets.

I had previously expressed personal interest in buying into this fund – as a relatively “safe” and diversified investment (within this sector). However, should the fund managers choose to invest heavily into derivative investments, the actual holdings of mining equities could be limited, and thus not offer an amount of diversification to justify experienced investors into putting money in this fund – and certainly the “safety” I had hoped for is also not present.

I would rather pick my own stocks one at a time, since I have no intention/desire to invest in the types of risky instruments in which this fund intends to dabble. I wish that I could be more enthusiastic in recommending this fund to investors.

“The devil is in the details,” goes the cliché – and certainly the managers of this fund have chosen to “make a deal with the devil.” People investing in precious metals are generally doing so to escape from the dubious (and often fraudulent) “exotic” financial products invented by the devious minds of Wall Street.

It would appear that this point is simply not understood by Van Eck. While the fund managers could choose to risk few of their investor dollars in derivative instruments, the fact that they will not commit themselves to more specific (and more responsible) guidelines for how and where they invest those dollars means that I have to reluctantly “pass” on investing in this fund.

For those investors who do buy in, I certainly wish you luck. However, I also advise you to keep a close watch on exactly what assets are held in this fund. Should the actual holdings in mining company shares not come very close to the 80% “core” in this fund, I would urge investors to seek other options for their precious metals investments.

*http://seekingalpha.com/article/172870-van-eck-s-new-junior-gold-miner-etf-a-preliminary-analysis

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- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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