Junior Gold Stocks

By: Scott Wright | Fri, Dec 29, 2006
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There is no arguing that the gold-stock sector has been one of the hottest in the financial markets since the turn of the century. The venerable HUI gold-stock index has seen a nearly 1,000% rise from trough to peak in the last six years and the stocks that comprise it have won investors and speculators legendary gains.

Within the gold-stock world though lies a sub-sector that is not represented by an index and really has no boundary on its potential. Like an underground blood-sport event or a big-city basement casino, junior gold stocks fly under the radar and only those investors who actively seek this realm may successfully enter it.

And drawing another analogy to the aforementioned locales, gambling in the junior gold-stock world can either leave you bloody and bruised with empty pockets or reward you with spectacular gains that even Las Vegas odds-makers could not fathom.

Little known to the average investor, this gold-stock sub-sector supports capital markets that don't show up on most radars. These stocks are so petite that you'll never see mainstream media coverage on them nor will you likely get recommendations from your broker.

But even with a limited pool of investors going after the junior gold stocks, their popularity has risen considerably in recent years. In and even out of the typical gold circles there has been significant chatter surrounding the up and coming junior gold stocks that are expected to shoot to the moon.

For investors seeking junior gold stocks in which to speculate, the primary challenge lies in not only identifying these stocks but in discerning which ones are the good ones. With hundreds of junior gold stocks to choose from, I decided to hunker down and seek out some of the quality junior gold companies that are positioning themselves to greatly capitalize on this gold bull going forward.

I knew this task would be arduous, but I expected that the reward potential not only for my own trading capital but that of our loyal newsletter subscribers would be well worth it. So I spent the last few months threshing through hundreds of junior gold stocks in search of some high-probability-for-success winners.

Sometimes this adventure seemed mind-numbing as it is often difficult to dissect these companies and peel away their layers in order to get a glimpse of their cores. But for the most part it was downright exciting. What an exhilarating experience it was to learn about the GenXers of the gold-mining industry!

Collectively these junior golds hold the key to the future balance of the economics of gold. Whether directly or indirectly, junior golds will greatly contribute to the supply side of the gold trade. I can probably write a novel on my findings, but in addition to a recently published research report identifying our favorite junior gold stocks, my intent for this first of a two-part commentary on this topic is to reveal some areas of research that I found most useful in analyzing junior gold stocks.

History/Management: When researching a junior gold stock, taking a close look at company history and its existing management team can be quite revealing. Those companies that are strong-suited in this area will advertise their prowess. But often you have to dig deep in such obscure resources as old prospectuses, regulatory filings, MDA reports, old press releases and perhaps even a refined online search. God bless the internet!

You will find that some juniors have rich histories than span through the flows and ebbs of a full commodities-market cycle. Yet others are fresh new start-ups that have emerged since today's secular gold bull took shape. And there are even a handful of others that may have gone through name and/or management changes to either mask the past or shift their strategic direction.

If there is a history, learn what you can from it and view it objectively. What accomplishments, if any, does a junior have on its resume? Has the company exhibited asset growth and valuation growth? What changes has it gone through and how has it weathered adverse market conditions? These are just a few of the questions that should be addressed in this line of research.

Answers you may find when researching this thread will range considerably. Some juniors only ever want to explore for gold, and are good at it. It is not always a bad sign if a junior with a lengthy history has not yet graduated to become a gold producer. I found that some companies have outlined business plans that mandate a divestiture at the end of a gold project.

Some juniors are great at discovery but outright avoid development and hefty project-funding risks. They believe in increasing shareholder value by either keeping their gold in the ground or selling it to the bigger fish in order to obtain the capital to start the cycle all over again.

For every encouraging story though there are those that are a bit shady. Some companies have been sitting on a project for decades without making significant progress. When the markets are tight they hibernate, and when the markets are good they turn on the spotlight steering unsuspecting investors to their stagnant stories.

As for management, experience is pivotal in the success of a junior. Junior gold companies have little room for error in their operations and an experienced management team with a successful background is of utmost importance. You will find that successful management teams are headed by highly-trained geologists, experienced and respected industry tradesmen or a combination of the two.

And as goes with company history, management history can be very telling when researching the junior golds. Have members of management had past successes or failures while in decision-making positions? Has the team or individual led successful voyages or captained sinking ships? Are the executives industry veterans or serial promoters?

Asking these questions and more will help lead to prudent decision making. And the answers you find may astonish you. To give you an example, after a little digging, I discovered that some companies that looked good on the outside were actually founded or run by someone that drove previous resource expeditions into bankruptcy. Others were run by someone with a background in the tech industry with little knowledge of resource development. Probabilities for long-term success don't bode well for these types of companies.

Good management and a productive history radically increase the odds that a junior can blossom in a gold bull market. Diligent research on this front can pay great dividends.

Exploration: The title "junior gold" is synonymous with "junior explorer". This is because the essence of junior gold stocks is exploration. For the most part juniors do not produce gold. Their function in the lifecycle of bringing gold to market rests in discovery, advancement and development of promising gold deposits.

The juniors that we marvel at with hopes of massive gains usually possess a project or portfolio of gold projects that are in the exploration stage. And depending on the market capitalization of a junior, you can usually deduce in which phase it resides.

An early phase of exploration in which many juniors reside is called greenfields. Greenfields exploration is the poke-and-find method of exploring a broad target area that has initially favorable geology with little or no evidence of mineralization. This is probably the most important phase of exploration in the gold industry as it is ultimately responsible for its longevity.

Without greenfields exploration, global mined gold supply would dwindle in a matter of decades. And unfortunately greenfields exploration is one of the riskier phases of exploration. The probability that an identified gold target turns out to be a mineable deposit is very low. And when various studies finally reveal a target to be a dud, then all the invested capital put into exploration ends up good-for-naught. Exploration is not cheap!

Greenfields exploration is not only a vital stage for the juniors, but also the major producers. A lot of sunk capital goes into this phase. A sizable producer can absorb a greenfields failure, and actually plans for it since discovering gold is not the easiest thing in the world. But a junior that has very limited capital takes on far more leveraged risk in the greenfields phase. Many juniors become insolvent upon greenfields failure. This is a good reason why it is so vital that experienced geologists are on the payroll of the juniors.

Positive results from mapping, surface sampling and drilling in greenfields exploration could push a project to the next phase of exploration. This phase involves more detailed technical studies that include extensive drilling and core sampling. Many times an independent consultancy that qualifies under various mining codes performs these studies that are formally called scoping studies. A scoping study is usually the first step in examining the economic viability of a mineral deposit.

If a scoping study returns positive results, then a project usually gets advanced to the feasibility phase. Feasibility studies many times begin with a less time- and capital-intensive pre-feasibility study. This study may provide reasonably accurate yet rough project cost and operating schedule projections. Mature miners with deeper pockets will sometimes use pre-feasibility studies to make a construction decision.

Juniors don't usually have this luxury though because the bankers that finance the bulk of a junior gold project require what are called either full, bankable or definitive feasibility studies to be performed before they risk their capital on a gold mine that is slave to the volatility of the commodities markets.

These full feasibility studies are comprehensive technical reports compiled through extensive drilling programs that reveal the true depth and breadth of a gold deposit. This study typically provides detailed project capital costs, economic reserves, operating cost projections, mine life projections, IRR scenarios, recurring expenses, timelines and much more.

Ultimately these phases don't have defined parameters and depending on the size of the deposit can have vastly different lead times. Some of the more extensive studies may take several years to complete especially for some of the thin-pocketed juniors that can't employ a dozen drills at a time.

Now theoretically the more advanced an exploration project is, the higher the probability that deposit may come to life. This same logic can be used to scale market capitalization as hinted at above. But this line isn't always followed precisely which is why each project needs to be examined independently.

After finding out where a junior gold stock falls in the exploration cycle, then you can start asking these questions. How long has it been in its given phase? Is it making progress in its efforts? Is it reporting its results and are they positive? Has it projected when the next phase will likely begin?

In researching this thread you may come across some juniors that don't have as good a project as they claim. But you may also find some undiscovered and less-marketed juniors that have an undervalued project when scrubbed against their peers. Exploration activity should absolutely be considered when researching a junior gold stock.

Resources: Resources are ultimately the bread and butter of a junior gold. In a nutshell, resources are the estimated gold ounces within a specific location that a junior claims to possess. This gold is identified through geologic evidence obtained via various methods and depending on the strength of the resource has an attached level of certainty relating to its economical extraction.

All the wiggle words in this loose definition are important to note for resources. Whereas gold producers are extracting their gold from gold reserves that are proven to be economically feasible, resources are not yet so. Resources do not have enough evidence to presume economic viability. More testing and drilling needs to be performed in such feasibility tests as mentioned above in order for resources to get the upgrade to reserves.

Though resources are the first step to defining a possible gold deposit, even the regulatory agencies that preside over the gold stocks require disclosures so as not to sway investors to believe that estimated resources will ever prove to be economical. Like when lifting a footprint at a crime scene, you can only estimate the size of the perpetrator. Until you have further evidence, nothing can be proved. This is the same reasoning for resources.

Though resources are not yet proven to be economical, simply attaining resources through technical studies allows juniors to gain a foothold on their projects so that they may continue to advance exploration. And similar to the different phases of exploration, there are different levels of resources.

Resources scale up in viability with some of the standard phrases you will see being inferred, indicated, measured, probable and proven. Without getting too technical, the ore grade and sample size weigh heavily on which level a resource will fall in. Once enough evidence is obtained on the depth and breadth of a deposit, resources can scale up the resource curve either until the evidence supports shelving the project or taking it all the way to production.

And economics play a huge role in how these resources may be presented and viewed by the markets. It may be discovered that there are indeed resources within a deposit. But the geological intricacies of the deposit only allow these resources to be economically recoverable at $700 per ounce. Today these resources are not feasible reserves, but if gold is over say $1,000 per ounce a couple years from now, these resources will then become economically viable reserves. Again, resources need to be viewed objectively on a project-by-project basis.

Some juniors have very strong resources and even reserves, and some have claim to really weak resources or none at all. Once you find out what type of a resource a junior has, then it is important to determine how its exploration will support and grow them. In examining junior golds, a red flag can be hoisted if no activity or operating plan is discernable for identified resources. A company that sits on its laurels and just hopes its resources alone will carry its stock through this gold bull will sorely disappoint investors.

The general rule of thumb for resources is the higher up the classification scale the better, the more the better and the more focused the activity the better. Juniors that have a knack for discovery that results in identifying new resources as well as those juniors that grow and upgrade their existing resources should always be viewed with favor.

In addition to the three research points I highlight above, there are two other major areas of focus I will discuss soon in part two of this junior gold stock commentary. First, funding and financing for the junior golds are often overlooked by many investors, but for a variety of reasons it is vital to pay careful attention to this area.

And now more than ever geopolitics are playing an increasingly important role in the gold-mining industry. Juniors are certainly not immune to geopolitical travails. Stay tuned for part two of this series where I will dissect funding, financing and geopolitics pertaining to junior gold stocks.

Ultimately there are dozens of facets that need to be addressed in order to effectively research a junior gold stock before surrendering capital to this exciting sector. Before you entrust your hard-earned capital to a basket of junior gold stocks, useful research and analysis are crucial in order to uncover the true nature of a company.

Junior gold stocks are fun and speculating in this realm can yield vast riches if played right. But it is important to look past the smoke and mirrors that many juniors exhibit. Though a company may look good from the outside and have good initial momentum, if it actually has poor assets without a legitimate business plan it will swallow investor capital so fast it would be difficult to recover.

Quantifiable research really helped refine my search for the quality junior gold stocks and a little due diligence in these areas could avert potential disasters. Risk is acceptable in the junior gold stock world, it comes with the territory, but it is prudent to mitigate this risk through greater understanding.

In our just-released research report that covers Zeal's 20 favorite junior gold stocks, we profile each stock guided by the fundamental research methodology highlighted above. In identifying what we believe are the best-of-the-best junior gold stocks, we are rewarded with utility on multiple levels.

This report not only provides us with deeply researched junior gold-stock profiles to choose from, but when the technicals warrant we have the arsenal to make fresh recommendations to our newsletter subscribers. If you are interested in cutting-edge commodities-market analysis and stock picks, please subscribe to our monthly Zeal Intelligence newsletter today. And if you would like our latest stock report at your fingertips that covers the exciting junior gold-stock world, it is available now.

The bottom line is junior gold stocks have the potential to reward speculators with legendary gains in this gold bull market. This risky class of gold-mining stocks is utilitarian in its existence as the juniors provide investors with vast speculative opportunities in addition to serving an important role in the gold-mining cycle. And among the countless juniors to choose from there is a wide spectrum of quality that includes both the studs and the duds.

But through diligent research it is possible to thresh out the good from the bad. With the three fundamental areas of focus I highlighted today along with two more that I will touch on in the next part of this series, we can possess the tools to help guide us to the winners.

 


 

Scott Wright

Author: Scott Wright

Scott Wright
Zeal LLC.com

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Thoughts, comments, or flames? Fire away at scottq@zealllc.com. Depending on the volume of feedback I may not have time to respond personally, but I will read all messages. Thanks!

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