Investing in junior miners: Assessing the risks
Juniors miners/explorers are primarily the owners of the world's future mines, but investing in them is fraught with risk.
Posted: Friday , 23 Dec 2011
COQUITLAM, BC (Ahead of the Herd) -
It's a fact in the mining world that most discoveries are made by a) junior mining companies and b) old time individual prospectors.
It's hard to invest in a prospector, fortunately if you want to invest in a potential discovery or the building of something of value - be in on the discovery of a mineral deposit and be there as the company moves it down the development path towards a mine - there are quality junior companies to choose from, there are opportunities to back excellent management teams with your investment money.
Juniors, not majors, own the world's future mines and juniors are the ones most adept at finding these future mines. They already own, and find more of, what the world's larger mining companies need to replace reserves and grow their asset base.
But what do you need to know, and do, before investing in the junior resource sector? How do you pick a junior that you are happy to own for the long term while management builds value?
The first thing you need to know is juniors are risky, and that managing that risk is your number one job. Your priorities are:
· Know yourself
· Identify a dominant global long-term theme
· Know the different development stages of a junior
· Know who you are invested with and the story
· Have a sound money and risk management plan in place
Your Risk Profile - know thyself
Some people invest in early startups solely because of the management team in place, others invest for the potential of what a property might host, some will wait until after a discovery is made and invest as drilling progresses and resources are built thus reducing their risk. Yet others will wait till money is raised, permits in place, the mine is being built and cash flow is just over the horizon.
You pay less per share because there is more risk, or you pay more because there is less risk - more risk should mean a bigger payday, less risk less of a pay day. Only you can decide the level of risk you can tolerate versus anticipated profit you expect to make and only you know how much patience you have to sit while developments, the story, plays out.
Discipline is necessary to stick to the investment plan you have formulated - are you going to let volatility shake you out of your position? Run to the hot tips, chase after momentum and churn your portfolio?
Determining your investment risk profile is the first step an investor should take. Only you can determine how much risk, how much volatility you can stomach - you need to know the level of risk you are comfortable with and if you can exercise the necessary patience and discipline it takes to be a successful investor in this sector.
Risk profiles run the gauntlet from ultra conservative to speculative and everything in between.
Conservative: A low tolerance for volatility, no risk, most want their portfolio to provide them with an inflation adjusted income stream to pay living expenses.
Moderate: A majority of investors would fit into this middle of the road category. Many are seeking good returns for retirement and or college funding. Willing to take on some risk.
*Aggressive/Speculative: High tolerance for volatility, risk. Can handle significant fluctuations in the value of their investment. Usually have income from other sources or are young enough to continue working and recoup losses. These types of portfolios have little or no annual income yields but have the potential for very high capital gains.
*This author invests almost entirely in speculative investments - get in early behind great management teams with outstanding projects, step back and let them go to work building, creating something of value. My timeline for a pay off can be out two to three years from the initial investment date. To earn the truly great rewards, one must be invested early behind experienced competent management teams - you need to be ahead of the herd.
A Thematic Approach - Following the trend is often the best path to profits
When looking for an investment the approach taken should involve studying global long term dominant trends - reading, watching and listening (the internet is a do it yourself investors greatest tool) will give you all the facts as to what's going on in the world. Then study the different sectors in order to select the one that is going to match up well with what you think is the soon to be overriding theme. This is top down investing.
The second part of your search for the dominant investment is a bottom up approach. This is where you find individual companies in the specific sector you have chosen to invest in. Pick the company you want to invest in based on the quality of its management team and your risk profile - what stage is the company in?
If you've done your homework all the necessary ingredients for a potentially successful investment - one that's tailored specifically to your risk, patience and discipline levels - should be in place.
Stage and risk
Greenfield (GF) - early stage exploration - the most upside (and by far the greatest risk) comes from buying a junior when they are exploring and make an initial discovery. Great drill assay results can send a juniors share price skyrocketing. The reverse can also be true. Junior explorers, the greenfield plays, are the riskiest plays by far. Strike out on assay results and it could be goodbye to a share price rise for a very long time - till the company finds another project they can work on. If you're buying into this kind of play make sure the company has another fallback project in its portfolio.
Post Discovery Resource Definition (PDRD) - these companies have already found something, the share price has settled back after the initial discovery (never chase a company whose share price has already exploded, the share price has had its run, for now the moneys been made. I try and enter after the excitement has died down and the share price has settled back) and the company is going in to see what they have and hopefully produce a 43-101 compliant resource estimate and build upon it. The risk has been greatly reduced, the waiting time for a discovery non-existent and the reward very nice considering the much lower amount of risk.
Nearer term producers (NTP) - those further down the development path towards a mine. Because these companies are well advanced along the development path a lot of the guesswork about grade, size, costs and metallurgy have been taken out of the equation for us. They have done sufficient work to give investors a certain level of confidence that their project will successfully move towards being a mine.
The later stage companies (those doing feasibility studies, permitting and money raising) can have an excellent entry point for investors - they often enter a quiet period when they are doing the advanced studies and raising money to go into production. They often base (a flat share price) for quite a while through this period - possibly a good time for accumulation of their shares if you believe in the story. After the money is raised for production investors can see they are going mining - cash flow is just over the horizon - and the share price will often break out of its trading range.
Everything about a company flows from management - the ability to find a project or have projects or joint ventures (JV) offered to the company, development of the project in a timely efficient manner, financings done at a higher and higher share price, control over the share structure along with management interests aligned with shareholder interest.
The most successful management teams have three complementary but very different sides. The first side of the team is the people who can find the quality projects and who have the technical expertise to explore, develop and advance them. But a good all round junior isn't comprised of only these people - there has to be more.
The second side of a successful team are the members who have the ability to make deals for projects, go into the board room and sell the story to the institutional investor and raise the money needed for acquisitions, exploration and development.
The third side of the team are the people with the ability to tell the story to retail investors.
Officers of the company make up side one and side two, they should be experienced business persons, geologists, mining engineers, lawyers and accountants. The president and or the chief executive officer should be the public face and voice of the company. They do not have to be geologists or engineers, they do have to be smart businessmen and strong salesmen or women who can make the best deal possible on acquisitions and go out and sell their company to the different brokerage houses who can than raise the needed money from their own clients to acquire, explore and hopefully advance the company's projects.
Do not make the mistake of thinking side one and side two management can do side three. Giving dog & pony shows to a group of brokers and mining analysts, an institution or group of high net worth individuals, being on TV and doing interviews is a much different skill set than running a promo campaign to retail investors and actually picking up a phone and talking to them all day.
Make sure the company you are interested in has all three skill sets.
Money and Risk Management
All successful speculations start with extensive due diligence - identifying the overriding dominant global theme, picking the company's that match your particular risk/timeline profile and then weeding out the weak based on the quality of management. Once your investigation is done you need an investment plan.
A systematic approach to risk management must be used to protect your investment capital. You have to be sure you're clear on your objectives and set guidelines for yourself - you need to follow the plan you've laid out.
The plan could be:
- How much to invest
- Buying your shares, usually in three tranches
- Map out a rough timeline for the company to reach important milestones
- Plan your exit strategy - which milestone, and subsequent market strength do you exit on
To follow a plan you need to develop and master two traits:
The best returns come to those who:
- Learn their investment profile - know yourself
- Ride long term dominant global trends
- Pick their own investments - knowledge is power
- Put together a sound plan knowing themselves and their chosen investment
- Have discipline
- Show patience
- Learn from their mistakes
The bottom line is to be patient with your chosen management teams. If a company's goals for its projects are being met and management is increasing shareholder value while successfully telling their story then your patience will be rewarded.
You need the confidence that stems from having a thorough understanding of the reasoning behind your investment and the story management is painting. Have the patience and discipline to watch and monitor and not jump ship to play the latest flavor of the month or hot tip - it's best to ignore the cheerleaders.
Discipline yourself to ride out the minor ‘ups and downs', they are part of the game - the true reward is to recognize potential, buy a stock for pennies and sell it for dollars, never being shaken out of your position because of short term volatility and noise.
Richard (Rick) Mills is host of www.aheadoftheherd.com