Make the Miners Work for Your Capital
Between early 1848 and the end of 1855 more than 300,000 people from around the world poured into California to make their fortunes by seeking gold. That historic gold rush proved transformative for the state and fast-growing U.S.A., but relatively few gold seekers actually made a fortune. While the gold rush produced billions of dollars in gold, historians believe that merchants made far more money than miners. Overall, perhaps only half of all gold seekers managed to make a profit, which in most cases was modest. Those few with the capital, geologic expertise, and business acumen to establish effective gold mining companies tended to make the fortunes.
For the average investor lacking in geologic expertise and extensive mining knowledge, investing in microcap mining and exploration stocks can be likened to setting out for California in 1849 as a novice gold prospector. Such investors have perhaps a 50-50 chance that they’ll make money from their investment, with most gains being modest at best. Only a few of the 100s of microcap and small cap mining companies will emerge as fortune-making investments due to big strikes and/or being gobbled up by the bigger players. For every junior mining company that successfully digs and drills its way into becoming a big board company or gets bought out at a hefty premium for its claims, dozens muddle along year-after-year with the share price mainly floating in relation to the mining target market price, while dozens of others go bust each year.
This begs the question as to how an average investor should go about finding the small mining company gem that has what it takes to make the big strike and best capitalize on their claim(s). Or, at the least, bank some profit on a junior player that may not hit the motherlode, but is finding enough of its targeted commodity to move its share price higher.
First Off, Consider the Basics of Investing in Mining Companies
The risk to reward ratio of investing in microcap mining and exploration companies can be enhanced by understanding both the business and what drives mining share prices. As with any microcap, you can get burned by shady schemes, lack of results, bad management and/or business decisions, insufficient capitalization, and stock market downturns. Likewise, you can profit through good timing, business model success, and overall market gains, not to mention hitting the motherlode.
As with a publicly traded company in any sector, the more you know about the specific business and its industry in general, the better you can understand what influences a distinct company’s share price. With mining in general there are more than a 100 commodities targeted, from the aforementioned gold to numerous highly valuable rare earth metals, and every other metal and mineral in between. Each of these are valued by their specific commodities market price, which is primarily dictated on a daily basis by supply and demand. There are also numerous different extraction and processing methodologies, which play a role in the cost/profit ratios. A company that can extract gold at a cost of $250 per ounce is going to bank far more potential profit than one that needs to expend $800 for each ounce.
Of course, the company has to find the proverbial gold before it can mine it, which is where a fundamental knowledge of geology comes into an investor’s play. If nothing else, you should understand the geologic importance of where the exploration is taking place and learn how to read drill results. A particular area’s geology will largely dictate what metals and minerals might be found there, which is certainly helpful in determining its potential viability.
The key to understanding exploration results is to know that “grade” measures the amount of a metal or mineral present in the particular ore being mined. Base metals are reported according to percentage per ton, while precious metals are reported according to grams per ton. The type of metal or mineral will dictate amounts needed to score a high, medium or low grade. For example, high-grade molybdenum is anything over 0.5%, while high-grade iron ore requires more than 35%. Likewise, high-grade gold is anything over five grams per ton, but a silver high-grade requires more than 50 grams per ton.
This all represents the bare bones basics, but absent such knowledge an investor in microcap mining is no different than a 49er who started digging at the first patch of California soil they reached.
Weighing Mining Potential Versus Pitfalls
Once you’ve nailed down the bare bones knowledge of the mining sector, you should consider what pitfalls might trip you up, as well as what positive factors might help support your investment. Turning first to positive factors, a stake in mining company shares represents investment in a real asset with real-world application and value. That is, as long as the mining company successfully finds and can extract it. The target metal or mineral will typically always be under some sort of demand because there is a finite supply of it. Not only does this mean that a mining company’s claim asset(s) always hold some value, but also that the asset price typically recovers after declines because any declines cause mine shutdowns that then hinder supplies which forces renewed demand.
Additionally, metals and minerals have a spot market price, which underlies the value of the mining company. This can be tracked daily and serves as an overriding bellwether to support your investment thesis. Other positive factors include:
- Share prices of microcap mining stocks generally trade at a huge discount to potential cash flows—investing in the pre-production stage represents relative low risk when compared to potential gains.
- Catalysts, such as positive exploration reports, can cause rapid, big gains in the share price.
- A bull market in a specific metal or mineral tends to lift all companies in the specific mining sector.
- Larger companies are always seeking out smaller companies with promising claims and typically pay a premium to acquire them.
As for potential pitfalls, just assume that investing pitfalls in general cover the mining industry. But also know that:
- Shyster mining companies with no viable underlying metals or minerals in their claim(s) do go public and sucker people into investing in fool’s gold.
- Companies can make exploration results appear better than they truly are, which obscures the true value of the claim.
- Exploration and extraction are expensive, with necessary capital expenditures requiring new investor cash inflows—hello dilution!
- Mines take time to build and exploration is a slow process, which can cause positive investor sentiment to wane and put pressure on the share price.
- Delays in reporting exploration results are not uncommon, putting further pressure on the share price by disgruntled investors.
If You’re Not an Expert Focus on Finding Them
OK, so you’ve got the mining basics figured out, understand what influences the sector and individual company share price, and are willing to navigate through potential sector-specific investment pitfalls to find microcap companies with the greatest likelihood for success. What next?
We’d like to tell you that you can just take expert advice such as that offered by The Momentum Letter to find microcap mining company gems. But we’re not mining experts and only have a limited hobbyist level of understanding of geology. Had we been alive and heading to Northern California in the late 1840s, we’d likely have secured more success selling shovels and picks than we would have at digging or panning for gold. Alternatively, though, we probably would have sought out success by teaming up with geologic and/or mining experts with an already established record of hitting valuable gold strikes.
This is a core component of The Momentum Letter’s approach for targeting promising microcap mining and exploration companies. Sure, just about every nascent microcap mining company’s prospectus gushes poetic about the motherlode of gold, silver, platinum or whatever mining target it’s sitting on. However, our initial focus isn’t on the claim(s), but on the people who are involved with the claim(s), be they owners, management, assayers, geologists, drillers, and/or capital market investors. These people already have a stake in the company (and claim) and their respective histories in the mining business provide a big tell as to the company’s prospects for success. Not that past performance is automatically indicative of future positive results, but who would you rather follow into the vast recesses of an unexplored cavern: A noted spelunker with dozens of successful cave explorations or someone who’s dabbled in caves but never gone deep?
Along with Seeking Out Experts, Look for Mispriced Risk
Along with following the lead of mining industry experts, we seek out mispriced risk that is underpricing the assets and offering us bargain-basement share prices. This can often happen when a microcap mining company is starting to ramp up operations and releasing initial exploration results. In many cases, the share prices of such companies can be subdued during these times due to capital-raising induced dilution and investor hesitancy. Such hesitancy is typically fostered by investors thinking that it’s too early to jump in and that there will be plenty of time to get in once the company offers more definitive proof of their claim(s)’ value. Not that such thinking can result in a case of missing out in the blink of an eye, but an earlier entry can definitely prove far more profitable than jumping in when news drives the investing herd into play.
What is the Company’s Thesis on the Claim?
Once we’ve identified promising mining companies based on their talent pool and apparent mispriced risk, we turn our focus on other parameters. In particular, we like to know what exactly the company thinks it can pull out of the ground and what evidence management has that backs the estimates of what may be hiding in its claim(s). Because we’ve vetted the management team, we feel that we can take their thesis about “what lies below” at face value and trust any subsequent exploration reports and assays.
Once the reports start coming in, an investor can start playing around with the numbers relating to potential high- and medium-grade ore volumes, cost of production, and market price. At its simplest, a case of estimating an average amount of metal or mineral that can be extracted from each ton of ore, times the market price, minus the per-ton extraction cost. Most companies also do this, but you can play around with their estimates by factoring in any number of variables.
Timing of Investment Also Plays a Role
As with many investments, timing your investment in microcap mining companies is key for making big gains and mitigating risk. If you invest in a mining company after it has released exploration results indicative of the motherlode, you’re late to the party.
If you’re impressed by the management and are especially intrigued by their thesis, jump in strong pre- or mid-exploration while the price is low and the risk is mispriced. As other investors get wind of the claim’s potential, the price will likely rise with initial positive exploration results, which allows you to reduce your own risk by unloading some for a small profit to cover all or some of the costs of your remaining shares. Then you can sit back and patiently await the exploration results that you hope will proclaim the motherlode.
Examining Real World Examples
Our focus on “people,” “mispriced risk,” and other parameters can be seen with both of our current mining picks, Trillium Gold Mines Inc. (CVE: TGM) and Walker River Resources Corp. (CVE: WRR). Management team members of both of these gold mining and exploration companies have decades of impressive experience that includes participation in significant strikes. The pedigrees of initial team members helped draw additional experienced talent to the companies, as well as increased interest from mining-focused capital market investors. These are all people with intimate familiarity with gold mining success and ones who would not likely put their reputations on the line to chase fool’s gold.
Let’s break down all of the factors and examine how each applies to both companies:
- Focus on the Talent
Both companies have plenty of insider talent and have drawn the interest of mining investor experts, but our perceptions about how their respective talent pools will move each company to success differ. While TGM’s geologic and engineering talent are both impressive, we are more intrigued by management’s experience in packaging up a collection of mining assets to capture the attention of bigger operations. They’ve got the gold and now they’re going to prove to bigger players that extraction is economically viable and worth taking over. That is, taken over at a premium.
Our interest in WRR is spurred more by the possibility of an unignorable asset. WRR CEO Michel David has an extensive 35-year career as a gold-mining expert that includes a number of significant gold discoveries. His historic success and willingness to put his own cash on the line for this project suggests that Michel is onto something. In fact, he’s been passionately interested in the property for almost 30 years—a passion that culminated with his 2012 purchase of it followed by the recent onset of exploration.
- That Mispriced Risk
We got interested in both Trillium Gold and Walker River when investor interest was at a low point. Trillium caught our attention because it is sitting on claims that had been valued at up to $200 million during the previous bull market in gold. The subsequent bear market put the brakes on exploration and investor interest in the company evaporated along with the bull market share price. Significant grades of gold identified during previous explorations are still awaiting extraction and the rising price of gold has made such extraction financially feasible.
Meanwhile, re-examination of the geology of Trillium’s flagship property suggests that previous exploration efforts may have missed parallel veins of gold running along productive strikes. This spurred the excitement of Trillium’s new highly experienced management team and caught our attention, too. The high price of gold also has Trillium mounting new exploration efforts in some of its other claims. All of these claims are located in one of Canada’s most prolific gold producing regions and most can be easily geared up for operational extraction.
Investment remains subdued in TGM because investors want to see more proof of high-grade gold. What investors are missing, though, is that the grades already seem to be there in economically viable amounts and located near mines that are operational ready for extraction. This latter factor significantly boosts the claims’ value and makes the operations attractive to bigger players.
Walker River’s thesis is similarly intriguing. Company CEO Michel David has long been convinced that plenty of gold remains undiscovered in claims that haven’t been actively mined in almost 100 years. Michel’s thesis posits that previous miners did not have the equipment and technology to reach all of the gold deposits. Today’s equipment and technology can get to it, and Michel is convinced that there is plenty worth getting.
Initial drill results pulled out outstanding grades that topped ounces—rather than grams—per ton. Despite this, the share price remains subdued, though we believe this will quickly change with release of positive results from the latest ongoing exploration efforts. In short, despite investor interest from some big names, smaller-scale investors are not yet willing to take a bet on Michel’s thesis.
- Buy When Underpriced
Based on the previous points, we believe that both TGM and WRR remain seriously underpriced and are currently screaming buys. There’s not much room for the share price of either to go down, but plenty of space for upside momentum. By getting in now, investors position themselves for a number of catalysts that will propel the share prices higher. We expect to see more positive drilling results that will continue to show high-grade gold in economically recoverable amounts. WRR seems more likely to produce awe-inspiring grades, but TGM’s grades should continue to prove economically viable and attractive to bigger players in need of boosting reserves.
- Understand the Upside Potential
While impressive exploration results will undoubtedly spur share-boosting investor interest, the bigger gains with microcap mining companies tend to come when major and/or mid-tier mining companies start showing interest in the findings. The bigger players tend to make a move on smaller companies when their exploration consistently produces impressive grades that cannot be ignored. If Walker River’s exploration reports continue to show similar ounce-per-ton results as their last one, bigger companies will definitely start taking a closer look.
If Trillium Gold can continue to produce even moderately decent grades from their flagship property, as well as some positive results from other claims, bigger companies will likely also take notice. Most of Trillium’s claims are in prime locations that are extraction ready with plenty of room for expansion. With proven economically viable grades, a larger company might want to add Trillium’s claims to boost its own current dwindling reserves.
The last, and least likely, share price booster would arise if the companies themselves start making the switch from exploration to extraction. This would definitely serve as a buy signal to the mining investing community but share price gains would likely be a slow burn acceleration due to capital costs (hello more dilution!) and time needed to get up and running.
In the Proverbial Nutshell
The short form to our Quick Guide to Investing in Microcap Mining Companies is as follows:
- Avoid shyster companies and/or those being led by people with little or no name recognition in the industry.
- Follow companies being led by experts in the field and try to determine what they’re getting into in the early days.
- Know the company’s mining/claim thesis and develop your own thesis about how the company can achieve success.
- Invest in the early days when risk is mispriced, shares undervalued, and the news is only just starting to flow.
- Always be prepared to get out of your position if either management’s thesis or your own start to get invalidated.
- De-risk as risks get more appropriately priced.
- Hold on to remaining shares while you patiently await the theses to play out.
