For well over a century, gold stocks have been one of the most popular investment assets among investors. While few quit their jobs to go mining for gold, anyone can easily invest in gold stocks through their online brokerage account. However, investing in gold stocks, particularly junior gold stocks, is not for the faint of heart. Extreme volatility is the norm, particularly among junior or small and micro-cap gold companies. An essential fact sometimes ignored is that: gold equities often drastically underperform the metal during bear markets or downturns for gold.
So, why do investors even bother with gold stocks?
Junior gold stocks offer incredible upside potential during gold bull markets.
During a bull market for gold, senior gold miners typically outperform the metal by a multiple of 2 to 3 times. If that wasn’t enough, junior gold stocks – while riskier by order of magnitude – can outperform the metal upwards of 10 times. With this in mind, it’s little wonder why speculators with a higher risk tolerance often opt for junior gold stocks.
In our Ultimate Guide to Investing in Junior Gold Stocks, we look at everything from how to invest in a junior gold company, the typical lifecycle of these equities, the different types of gold deposits, and even how to interpret drill results. So, buckle up – with gold back in its secular bull market after five years of consolidation between 2013 and 2018, the time to learn about investing in junior gold stocks is right now.
Why invest in junior gold stocks?
The simple answer is gold stocks outperform gold bullion during bull markets. Of course, as with most things in life, there is a caveat – while gold equities provide investors with more upside during bull markets, they also present more downside when gold declines.
Ed Coyne of Sprott Insights explains this principle in detail,
“Historically, rising (and falling) gold prices have a two- to three-times multiplier effect on gold stocks: If the value of gold bullion increases by 10%, mining stocks tend to increase by 20-30%, and vice versa. The reason: Miners have significant fixed operating costs and high operating leverage, meaning big swings in physical gold prices have a larger impact on miners’ profitability.”
Another reason to invest in gold stocks is the limited number of new gold discoveries. Check out the below chart from May of 2020:
It’s a well-documented fact that economically minable gold reserves have been in decline over the past decade. This makes gold companies that manage to make an economic discovery all the more valuable.
How do you invest in junior gold stocks?
Investing is easy once you have an online brokerage (e.g., Robinhood, Questrade, TD, RBC Direct Investing) account set up. The real challenge is finding a junior gold stock with a high-quality project, exploration upside potential, and, of course, a strong management team. After all, the road to production is a long one, and as we wrote previously about Mining Stocks,
“In the mineral exploration business, 1 out of every 1,000 prospective mines eventually reaches production. What happens to individual stocks along the way, through cycles of boom and bust, is dominated by speculators, drill programs, commodity prices, and management’s decision making – complete variables.”
Start with a Strong Management Team
There are stars in finance, just like in sports. Many of the top-performing CEOs continually find success throughout their careers. While never a guarantee, we like to start with management teams and leaders who’ve been acquired or even taken projects through to production. Right from the start, this gives us a level of confidence that an unproven management team simply cannot provide. We’ve written multiple ebooks on this exact topic – the most recent being “Leading Juniors to Multimillion-Dollar Buyouts (2019-2020 Edition)”.
Now that you’ve found a gold company with an accomplished management team, it’s time to drill!
Drill Baby, Drill
A CEO once told us that drills could be a terrible truth machine. It all depends on the grade found in the core. When evaluating junior gold explorers, nothing outside of management is more important than the quality of the project(s). Frequently, juniors are exploring an old mine or a prospective claim block that has returned high grab samples or has had some positive drill results in the past. Said junior would need to raise money (typically through a private placement) to expand its exploration program through various site survey methods, mapping, grab samples, trenching, and drilling. Keep in mind that most financings come with share issuance or dilution. Dilution is a silent killer that prevents many stocks from rising even after making a discovery. If a company issues too many shares in a bid to finance never-ending exploration programs, its odds of being a profitable investment decline markedly. Now, back to drilling…
How do you interpret gold drill results?
Junior gold stocks can go up multiple times in value based on exceptional drill results alone. So, what do great drill results look like?
UndervaluedEquity.com defines low, medium, and high-grade drill results for gold below:
|Low Grade||less than 1.5 g/t|
|Medium Grade||1.5 g/t – 5 g/t|
|High Grade||over 5 g/t|
But the grade of the drill results isn’t the only thing that matters – the length of the intercepts is essential as well. For example, 5 grams per tonne gold over 2 metres won’t get too many people excited. However, if said miner returns 5 grams per tonne gold over 20 metres, the market will likely react strongly. Deep intercepts combined with higher grades typically result in a flurry of speculation.
Once a mining company has created what we call ‘smoke’ (in other words, delivered promising drill results), the next exploration phase can begin. While drilling is a critical part of the exploration process, it does not prove how much mineral or metal is actually in the ground. For that, junior gold miners need to produce a National Instrument 43-101 or NI 43-101.
What is a National Instrument 43-101 (NI 43-101)?
According to Wikipedia,
“National Instrument 43-101 (the “NI 43-101” or the “NI”) is a national instrument for the Standards of Disclosure for Mineral Projects within Canada. The [NI 43-101] is a codified set of rules and guidelines for reporting and displaying information related to mineral properties owned by, or explored by, companies which report these results on stock exchanges within Canada.”
Created after the Bre-X scandal (which the 2016 movie Gold starring Matthew McConaughey was based on), the NI 43-101 is designed to ensure no fraudulent information relating to mineral properties is ever published and promoted to investors.
Now, included in the NI 43-101 are mineral exploration reports detailing the resources and reserves. However, even with a NI 43-101 report, a project still has a long way to go (keep in mind that junior gold companies typically burn a ton of capital reaching this point, anywhere between $5 and as much as $50 million or more depending on how much exploration, environment studies and drilling the said company does). Following an NI 43-101 report, the mining company will need to produce a preliminary economic assessment (PEA) to move the project another step forward. Remember, all exploration work is intended to prove whether or not a project is economic.
What is a preliminary economic assessment (PEA)?
According to Crux Investor,
“PEAs include estimates of the capital costs required to bring a project into production, operating cost, and cash flow. They also include mine plans and processing and production plans. PEAs are preliminary studies and often based on inferred resource estimates made with limited data. They are not suitable for economic decision making or reserve reporting.”
What is perhaps most important when it comes to the PEA revelations are the NPV (net present value) of the gold in the ground and the IRR (internal rate of return). The IRR is where the rubber hits the road, as this metric provides an estimate of an investment’s payback period. If a company puts forward a low IRR of 10%, big money knows it should not expect to see a total return of its money for at least 10 years. The PEA will also outline AISC or all-in sustaining costs to produce an ounce of gold. These numbers give larger investors an idea of the project’s potential profitability and can re-value a company’s stock if the results are positive.
Following an NI 43-101 and PEA, the next major milestones are more detailed feasibility studies.
What are feasibility studies?
There are three kinds of feasibility studies: a preliminary feasibility study (PFS), a definitive feasibility study (DFS), and a bankable feasibility study (BFS).
Let’s begin with the PFS, a much more detailed and accurate version of the PEA. Again, according to Crux Investor,
“They [preliminary feasibility studies] also include plans to mitigate potential impacts to the project, such as geographic or community obstacles, permitting issues or logistical challenges. After completing a PFS, a company will know if they should move forward with permitting or re-evaluate the project.”
After preliminary feasibility studies, definitive feasibility studies ultimately are designed to determine if the project can be an economic success. It is highly comprehensive and is conducted to be as accurate as possible, always challenging for mining. Finally, we have the bankable feasibility study, which the banks need to see before making an investment decision. If the goal is production, financiers often need to see this before any debt-financing or credit facility is established.
All of these reports and studies take time and money. The access and terms associated with capital often depend on what stage of the bull market the metal finds itself in; and, of course, the strength of the project or asset in development.
What is the difference between Mineral Resources and Mineral Reserves?
Mineral Resources and Mineral Reserves are vital concepts for investors to understand as they form the basis for a mine’s future viability. In simplest terms, the difference between Mineral Resources and Mineral Reserves is their level of geological confidence; for example, an Inferred Mineral Resource is the lowest level of confidence while a Proven Mineral Reserve is the highest level of confidence. Mineral Resources go from Inferred to Indicated to Measured in order of ascending geological confidence, while Mineral Reserves go from Probable to Proven.
With all of this in mind, there are some critical factors investors should be aware of when it comes to Mineral Resources…
First, although terms like “Inferred”, “Indicated”, and “Measured” Resources are recognized and required by Canadian regulations, the United States Securities and Exchange Commission does not recognize them. “Inferred Mineral Resources” have a significant amount of uncertainty as to their existence and as to their economic and legal feasibility. It cannot be assumed that all or any part of an Inferred Mineral Resource will ever be upgraded to Measured and Indicated categories through further drilling or into Mineral Reserves once economic considerations are applied.
Moreover, under Canadian rules, estimates of Inferred Mineral Resources may not form the basis of feasibility or other economic studies. Investors should not assume that all or any part of Measured or Indicated Mineral Resources will ever be converted into Mineral Reserves. Mineral Resources that are not Mineral Reserves do not have demonstrated economic viability. Mineral Resource Estimates do not account for mineability, selectivity, mining loss, and dilution. A mineral resources estimate may be materially affected by environmental, permitting, legal, title, taxation, socio-political, marketing, or other relevant issues.
Below is a helpful chart that investors can reference to understand the relationship between Mineral Resource and Mineral Reserve categories:
For further research, check out CIM (Canadian Institute of Mining, Metallurgy and Petroleum’s) Estimation of Mineral Resources and Mineral Reserves Best Practice Guidelines found here.
How do you assess the value of a junior gold stock?
When evaluating companies – especially mining companies – it’s essential to keep in mind the comparables concept (commonly referred to as “comps”). Back in 2015, we wrote,
“You may think you have found one of the most undervalued junior miners to ever list on the stock market, but if you can’t find nearly identical comps, trading at higher valuations, there’s always a reason for its cheap share price.”
We wrote an article about the comparables concept and how you can use it to assess the fair value of a junior gold stock.
Where do Canadian junior gold companies operate?
Canadians are known as the world’s miners. From Namibia and Argentina to Indonesia and projects as far north as the Arctic circle, Canadians search for gold on every continent (excluding Antarctica) and almost every country on earth. The vast majority of publicly traded junior gold companies can be found on the TSX Venture, Canada’s leading junior exchange for small and micro-cap companies.
Understanding jurisdiction as it relates to risk is a fundamental concept to grasp. A 5 million-ounce high-grade deposit in rural Indonesia with limited infrastructure or access and a history of political instability will not be as valuable as a project in Ontario near major roads and power. Environmental concerns can also bury a deal instantly. It is never wise to bet the farm on a deposit or emerging asset near any protected species or rivers or anything that could upset the local community. Environmental stewardship is of paramount importance in the 2020s. Furthermore, it is always risky to invest in any one company, as your control is minimal or non-existent, and there are dozens of factors that can influence the outcome.
If you’ve read this far, you realize investing in junior mining stocks can be a little bit like navigating a minefield. Although it can seem exciting and risk-free during a gold bull market, it’s important to remember that risk is always all around you.
At the end of the day, every junior gold company’s goal is to be bought out by a major. While there have been many successful junior gold stock buyouts over the decades, one stands out for its persistence in recent memory.
In an article titled, “The making of a Junior Gold Buyout: the Kaminak Story,” we wrote,
“For Canadian speculators in the junior gold sector, there is no higher honor than a major saying – “enough, we must acquire you and either move this asset into production or lock up the project before one of our competitors does”. Canada has no shortage of junior gold buyout examples. The latest involves a little company working off the grid, 130 kilometres south of Dawson City…”
Learn more about the inspiring story of Kaminak Gold
Yes, production is often the goal, but special assets tend to get bought long before a production decision, or at least on the way. When it comes to investing and speculating in junior gold stocks, timing the market and staying ahead of major macro trends is just as important as everything else. The all-important price of gold, which gold companies have zero control over, is a crucial factor that often holds the key to success and the ability to raise capital. With the threat of inflation rising in the wake of unprecedented stimulus, gold is back in vogue along with countless junior gold stocks.
So, from the very basics of how to invest to how to read and interpret drill results and essential metrics in various economic assessments and studies, the ins and outs and risks and rewards of investing in junior gold stocks are all right here—happy investing.
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