Education: Mining Stocks
The TSX Venture, headquartered in Toronto, Canada is the junior Exchange to the TSX and a natural resource centric exchange. More specifically, the index is heavily weighted to the mining sector; in fact, more than 60% of the issuers (despite a commodity bear market which lasted from April of 2011 to January of 2016) classify as mining-related stocks. The resurgence of this sector, led by lithium and gold stocks in 2016 is proof of its resilience and typical of its boom-bust nature. When commodities are surging and in a bull market, the vast majority of capital raised in Canada flows into the mining sector. For that reason, mining is a major focus of ours at Pinnacle Digest.
History and access to world-class resources have created this environment and many of the largest, most prolific buyouts in Canadian history have involved mining stocks. Canadian speculators have returned to this sector, time and again, despite its recent and sometimes brutal downturns, because of these headline-grabbing buyouts. If ever there was an industry which the term ‘buyer beware’ was applicable – it’s this one. In the exploration business, 1 out of every 1,000 prospective mines eventually reaches production. What happens along the way, through cycles of boom and bust, can only be defined as speculation, plain and simple.
In the small-cap sector, management remains the most valuable asset and important commodity a publicly traded junior mining company can have. Remember that always, because, when you invest in mining small-caps, first, you are investing in the company’s human capital.
Top 3 Factors that Influence Mining Stocks:
- Sentiment towards the overall sector and the specific Commodity
- Quality of project (high-grade drill results, proven or probable reserves, location, no political issues, positive feasibility study, etc.)
All three of these factors must be in play to realize a truly winning investment when it comes to mining stocks. Notice the order of the above factors. If the sector is not in your favor, the best management team in the world will not be able to achieve the highest or true value. If management is not exceptional, mistakes will lead to missed opportunities. Again, without top shelf management, true value will not be reached. Lastly, the quality of the project could go completely forgotten or undervalued during a bear market; however, with the top two factors (strong management, positive sentiment) working in its favor, a mining stock has the potential to receive huge valuations.
It may seem easy to make money when a bull market is raging and sentiment is positive; however, the real money or buyout potential exists when all three components listed above are present.
Getting positioned in a down mining sector?
Finally, the chances of surviving or thriving in a market downturn are much greater when management is proven and the project speaks for itself. These factors allow companies to raise capital even in the worst of times. We chronicled this feat in ‘The making of a Junior Gold Buyout: the Kaminak Story’. Timing when sentiment or the general markets will turn and begin to favor mining stocks is no small endeavor. Let’s start with a few basic metrics you can use to gauge sentiment towards the broader commodity market and to determine whether or not it is a favorable environment for senior and junior mining stocks.
Baltic Dry Index | Mining Stocks
The Baltic Dry Index has proven to be a bellwether for the mining sector and the stock market as a whole; but first, let's determine what it is. The BDI is a barometer of real demand for commodities around the globe because it tracks the price of shipping raw materials, including metals, grains, and fossil fuels across various trade routes on three different-sized merchant ships - Capesize, Supramax and Panamax.
In respect to the BDI’s impact on mining stocks and the TSX Venture, in a March 20, 2016 Weekly Volume, titled What's Behind this TSX Venture Bull? We wrote in respect to the BDI, that:
"It accurately forecast the past three major market crashes, including 1987, 2000 and 2008. In 1986, the index hit its first all-time low; in 1999 it hit a 12-year low, and then in 2008 it fell from above 11,000 to roughly 780. After rebounding to nearly 2,500 at the beginning of 2014, the BDI hit a new all-time low of just 290 this February."
Click here to read the entire report.
In predictable form, when the BDI is touching new all-time lows, major commodity indices have also been sold off to historic lows. Therefore, by monitoring the Baltic Dry Index, a quick, surface-level shot at the present global demand (or whether we are in a bull or bear market) for commodities can be obtained. Take the current bull market on the TSX Venture for example. The Baltic Dry Index was hitting all-time lows in late-January and February of 2016; and, at the same time, pessimism was peaking on the Venture. On February 8th, 2016 the BDI crashed down to a low of 290.00. By December 7th, 2016, just ten months later the index had rebounded to 1,186.
BDI – 1 Year Chart
chart source: http://data.cnbc.com/quotes/.BADI/tab/1
The BDI’s run in 2016, makes the Venture look tame. The Venture hit a low of 466 on January 20th and by August 11th had rebounded to about 848.
TSX Venture – 1 Year Chart
The price of key commodities should be followed closely as a bull market in precious and base metals will also drive valuations of mining stocks higher.
Finding Comparables: key to mining stock research
As a ‘proactive’ and ‘independent’ investor in mining stocks you have to do some of the little things well. Don’t quit your day job, but if you’re not willing to put in a good handful of hours to compare a specific project or junior mining stock to some of its peers, don’t risk your capital in this space.
Way back in 2011, Managing Director of Pinnacle, Aaron Hoddinott whipped up a piece on comparables titled The Importance of Finding Comparables for Junior Mining Stocks. This advice is timeless and rings true today. Below are a handful of metrics to consider when comparing two projects in the search for undervalued assets:
- Must operate in the same country (preferably same state or province as mining laws change throughout).
- Must have similar (doesn’t have to be exact) strengths in its management.
- Must be exploring for the same commodity (I know, it’s obvious).
- Must have similar grade drill results (includes depth) and resource calculations.
- Must have close to the same amount of cash in the bank.
- Must have similar capital structures (doesn’t have to be exact). Very important. You need to know who owns the stock in the company and at what prices.
- Must have similar insider trading records (great resource for Canadian stocks is Canadianinsider.com).
Just by comparing a company’s drill results or resource estimates to another company operating in a similar or even different region, can give you an idea of whether or not the said company may be over or under valued. Remember, it is all about market cap, the share price can be very misleading. We travel to mines and exploration projects all over the world to enhance our research. Check our trip to Antofagasta, Chile, in November of 2016:
Production type: Heap leach vs. hard rock?
While there are different ways to process ore, the two most popular, especially when it comes to gold, are heap leach and hard-rock mining. While one could write a novel on each method and the differences between the two, hard rock mining normally entails moving a lot more dirt. Heap leaching utilizes cyanide or acids to dissolve and separate the metals from the ore, whereas hard rock or underground mining involves more machines, usually more electricity and more time and energy to run the same amount of material through a series of crushers, washers, etc. to separate the metal from ore.
If two companies have about the same grade, say 1 gram per ton of gold, but one is running 50,000 tons per day through its mill, while the other is moving only 10,000 tons per day, most often the costs will be lower for the latter. Where it becomes more complicated is when one company has lower grade, but is running more material, compared to a higher-grade deposit that is running a bit less material. These are all questions company executives should be able to answer.
Don’t get fooled by the hype.
A promotion or series of marketing campaigns can easily inflate the price of a junior mining stock. Run comparables to be sure the company and its key asset is not overvalued. Remember the ‘buyer beware’ mantra we outlined on the first page.
Insider buying | a must in Junior Mining Stocks
Insider buying and insider ownership is one of the, if not, the most important factors to understand and be privy to. When we meet with management of a new company or prospective client, one of the first things, we ask is: how much does management own? Would you buy a Corvette from a guy who only drives Jaguars? If you are going to put your hard-earned money into a company, management better have some incentive. You can check out CEO salaries on Sedar.com or in the company's annual financial statement. The goal is to find CEOs who are trying to create wealth through an increasing market cap valuation, not through their monthly salary. We look for significant insider ownership when it comes to junior miners, taking a shine to those with some serious skin in the game.
Know the Price Per Ounce
If you are looking at gold mining stocks, and the company has a proven resource, it is easy to calculate what the ounces in the ground may be worth in a potential acquisition. Before even getting started, you need to know the value the market puts on those ounces.
Kaminak Gold's Coffee Deposit, the most prolific buyout of 2016, had probable gold mineral reserves of 2.2 million ounces (46.4Mt at 1.45g/t), and total inferred gold mineral resources of 2.2 million ounces (52.4Mt at 1.31g/t).
The buyout, proposed by Goldcorp, was for $520 million, which divided by 4.2 million equals 123.809. So, Goldcorp valued Kaminak's high-grade gold deposit at $123 per ounce in the ground. Many junior gold stocks saw their gold trading for between $5 and $10 an ounce in the ground during the bear market of 2011 to 2016. The quality gold deals have since rebounded to $50-$100 per ounce in the ground - some even higher.
Junior Gold Stocks | A Volatile Game
Canadian gold stocks are among the most volatile of any equities in the world. Junior gold stocks are even more volatile. This constant volatility and changing sentiment can create massive moves and great opportunity for the risk-hungry investor. Understanding what moves this market is not something that can be learned in a weekend or even over a few years… it takes patience, experience and ample research to have a shot at making huge gains in this sector. If one thing is certain, it’s that the odds are stacked against the majority of junior mining companies; but, just as real are the fortunes made in every mining stocks bull market.