Tuesday, 27 March 2012

Selecting explorers and junior miners

Searching for excellence

Precious metal explorers as investment vehicles have a long standing track record of extreme volatility. As Rick Rule of Sprot Asset Mgt. USA uses to formulate it: “We have known both the thrill of victory and the agony of defeat”.
It is obvious that the success of precious metal explorers goes together with both the exploration talent of a small team of geologists and with their broader management skills. Add just a grain of luck in picking among the promising geological anonalies the successful drilling locations. To end this introduction with another quote of Rick Rule: “Profitable miners ultimately will see their share price reflect increased cash flows from mining operations, but you can’t count on a gold bull market to bail you out of a dumb decision on an explorer investment.”

Why mining majors don’t send their own explorer teams into the hills

Most major gold mining companies have a team of geologists on their payroll. So why don’t they devote their efforts to finding the next generation of promising locations for their companies to proceed in building new mines? In an interview with Jim Puplava on Financial Sense, Brent Cook of Exploration Insights gives most of the answers: Successful explorers are inclined to work independently. They often quit working for a major mining corporation and start up their own company. Moreover, while working for a mining major, they came across projects that have been put on hold in spite of decent explorations results. (Just think of Pretivm Resources, started by exploration veteran Bob Quartermain.)
Geologists continuing their work for major mining corporations often specialize in extending existing reserves. Especially with underground operations with known reserves for only few years of exploitation, they are most successful in finding the continuation of veins at geologic faults.

Some of the hurdles

Gold wouldn’t be quoting near $1700/Oz if it were easy to find. If a gold resource is identified, numerous drillings will be needed to quantify the resource (and getting a NI-43-101 compliant resource description). Resources will be upgraded from the inferred to the measured and indicated categories. Simultaneously, different aspects of potential mine construction will need to be studied. Those may lead to a preliminary economic assessment, proving the economic viability of the project. I’m just enumerating some essential phases of exploration and mine development, at each of which major problems may show up, putting the project at risk. Probably only one exploration team out of ten is successful at identifying a sizeable resource that looks promising enough to continue with development. Among those successful projects, only a small fraction will eventually make it into an operating mine.
Generally the gold explorer having identified such a resource will be bought out by a major mining corporation. Size of the deposit and proximity to existing mining infrastructure are real triumph cards triggering the interest of mining majors.

Explorer-developers rarely turn to mining

Only on rare occasions, explorers proceed with a project throughout permitting and mine construction until operating the mine. Excellent geologists rarely are competent mining engineers: the expertise needed in mining being completely different from that in exploration, it is clear that the transition to a miner will demand sourcing in competent engineering and management staff. The financing necessary for mine construction will inevitable be a major challenge for an explorer developer considering to try it on their own.
Brent Cook formulates it like this. “When selecting explorers with viable projects in the stage of being permitted, I prefer a project which a mining major is likely to bid for, not the project an explorer is doomed to build into a mine.”

Stock picking dilemma

Writing something sensible on picking explorers doesn’t make me a stock-picking expert. Though I may find a good reason not to consider over half the stocks I come across, there will be enough failures among those I consider suitable picks… and the one real gem in there, I might take a profit on after it doubled…
Many of us junior mining investors have their list of stocks they follow and/or are invested in. Our aim is "keeping track of market tendencies and trying to figure out which juniors do better and why". This drove me to implement a new contributor driven explorer & junior mining spreadsheet.

The contributor driven explorer and junior mining spreadsheet

Pooling efforts with any cooperative peers out there, I started the “contributor driven explorer and junior mining spreadsheet”. The idea is to get a selection of explorers or junior producers of silver and/or gold. The first focus is on Canadian listed juniors, but I may take on board an explorer with main listing on the AMEX, ASX or the LSE as well.
The selection should then be the basis of a discussion forum open for comments on and links to drilling results for the explorers, operational results for junior producers and investment plans with their financing conditions for both.
Included as a benchmark are some of ‘the classics’: PM Mining leveraged plays NUGT and DUST, PM mining ETF’s: Market Vectors GDX and GDXJ, the Global X Gold explorer ETF GLDX and silver mining ETF SIL, the HUI and XAU mining index. Though I don't particularly like the leveraged plays NUGT and DUST, keeping them in the benchmark will show the viewer by how much these products underperform the market over any rally / swoon cycle. The flaw is not in a lack of compliance with their benchmark, but rather by design. The HUI and XAU both are focusing on large-cap miners, with Van Eck's GDX being the ETF mirroring the performance of precious metal mining majors. Van Eck's GDXJ and escpecially the Global X Gold Explorer ETF GLDX are somewhat better benchmarks for what we have in focus here.
There is one important difference: Unlike the explorer and junior mining ETF's mainly slanted towards mid-cap stocks, we mainly target micro-caps with a total market capitalisation smaller than $200 M, but small caps below $1 Billion are also eligible for inclusion. Share price is not considered an inclusion criterion. Successful juniors will remain on the list unless they grow into the mid-cap range (over $2 Billion).
The contributor driven explorer spreadsheet was started late October 2011. After five months, we are 0.8% above break-even (closing prices of March 26). Yet including the stocks deleted (‘exile’-sheet) we would be posting a 2% loss. This disappointing result however compares favourably to the 24.7% loss on the GLDX Etf (which comes closest to our focus) or the 20.6% loss on GDXJ.

Additional lists

The spreadsheet has a few additional lists:
  1. The successful exits (any explorers taken over or divested taking profit) and
  2. the ‘exile’, where I keep the explorers taken off the list. Weeding out laggards and taking a loss  though painful, is essential in portfolio maintenance. Cutting losses is as much about swallowing your pride as about saving whatever is left.

Further discussion

Going forward, I intend to post about list updates on the TF-metals forum on the thread: Selecting explorers and junior miners. After that website has been thoroughly reorganized, with all 'old topics' archived, a new thread was started in the 'Traders' section. Because of the continuing miner bear market late 2014, it has been called: Precious Metal Miners: Fathoming the Abyss

Further reading:

More similar papers are linked to in the top section of the list of blog articles.

No comments:

Post a Comment