Will Junior Mining Stocks Be the Investment of 2011?

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J.S. Kim submits:

If you think gold and silver as an asset class are severely misunderstood, and they are, then multiply that misunderstanding 10 times, and you will realize the level of misconceptions that exist around junior mining stocks.

You may feel that this is an odd time to write a piece about one of the riskiest sectors in the precious metal investment class, especially as gold and silver prices continue to plummet in the futures markets, but the proper time to buy-- of course-- is when fear is high and prices are low. However, once this correction ends, and I believe that it will end somewhere around the $1,300 an ounce mark and within a week, and not with a further $250 an ounce correction and the $1,090 an ounce mark called for by Seabreeze Partners Management's GP Doug Kass, I expect junior miners to have a banner year.

Even with my expectation of increased volatility in precious metal stocks throughout 2011, I believe that 2011 will be another strong up year for junior mining stocks after a very solid year last year. For now, I'm not going to worry about Mr. Kass's recent call for gold to shed another $250 an ounce unless gold breaks below $1,300. Though none of us have a crystal ball that allows us to predict the future with certainty, I will only readjust my stance that this correction is days away from ending if gold breaks below $1,300. Furthermore, as you can see from the chart below, the declaration of select financial analysts in the mainstream media that the current state of this gold bull resembles the parabolic blow-off tops of the 2000 dot com bubble and the 2008 oil price spike is patently false.

Though I haven't reproduced the 10-year silver chart here, if one were to draw a long-term trend line through the last ten years of silver prices, one would see that despite the short-term spike in oil prices to close 2010, there is no parabolic spike above the long-term trend line for silver either. For now, I'm going to directly contradict Kass and predict a pop higher of at least $40-$50 an ounce in gold sometime during the 10 trading days between January 28 and February 11th.

So now that we've established that there has been no blow-off top for gold or silver yet, let's turn our attention to the even more misunderstood topic of junior gold and silver mining companies.
To begin, let's squash the notion that you can invest in junior mining stocks by investing in the Junior Gold Miners Market Vectors ETF [[GDXJ]]. Let's take a look at the top eight holdings of this ETF that comprise more than 27% of the ETF's net assets: Hecla Mining ( HL ), European Goldfields (EGFDF.PK), Coeur d'Alene Mines ( CDE ), Allied Nevada Gold ( ANV ), Gabriel Resources (GBRRF.PK), Alamos Gold ( AGIGF.PK) and Silver Standard Resources ( SSRI ). Hecla Mining has a market cap of 2.20 billion, European Goldfields, 2.74 billion, Couer d'Alene, 1.99 billion, Allied Nevada, 2.21 billion, Gabriel Resources, 2.48 billion, Alamos Gold, 1.87 billion and Silver Standard 1.79 billion. Nearly all of the top 8 holdings in this "junior miner" ETF have market caps of near 2 billion dollars and fit the definition of mid-cap stocks rather than the tiny, small cap stocks that are representative of junior mining stocks.

For example, more typical junior mining stocks like Greystar Resources (GYSLF.PK) currently has a market cap of approximately $276.24 million and Great Panther Silver (GPRLF.PK), $224.27 million. On the other side of this spectrum, a large blue chip company like Apple ( AAPL ) currently has a market cap of about $308.10 billion. With respect to market cap, it would take 1,115 to 1,373 companies the size of Greystar Resources or Great Panther to equal the size of Apple. In other words, junior mining stocks are so small that a small amount of interest in a fundamentally sound junior mining stock with a great story can move the stock price higher by 30% in a matter of days. Of course, a hedge fund or one very wealthy investor that decides to divest a substantial percent of shares in a junior mining company can also move the price down 30% in a matter of days as well. Thus the combination of great risk and great reward that exists in the junior mining sector.

So what are some of the biggest misconceptions that exist with junior mining stocks? The nonsense surrounding the junior mining sector is nonsense of a different nature than the nonsense that surrounds the major mining stocks and the gold / silver futures market. Bankers manipulate everything that has to do with gold and silver, including major and intermediate mining stocks, gold and silver futures contracts, gold / silver ETFs, and even junior mining stocks. In past years, it has been widely speculated that US hedge funds have unfairly manipulated junior mining stocks downward by taking large short positions against them to hedge their long positions in the major gold / silver miners and / or long positions in the gold / silver futures markets. When many of the junior mining stocks sold off by 75% during the latter half of 2008 after the US Federal Reserve enlisted the help of their puppet bullion banks to orchestrate a sell off of gold and silver in the futures markets, many investors were permanently scared off from ever investing in junior miners again. In fact, the share price of many junior miners have still not come back to par since that time.

So why would I be advocating paying attention to junior miners now? Besides the fact that many of the best junior miners are on sale now, as gold and silver prices complete their current correction / consolidation phase and turn higher, I expect junior mining stocks to start attracting much more attention along with higher gold and silver prices.

Many junior miners are among the lowest cost producers of gold and silver in the world or are prime acquisition targets from larger gold and silver companies that are suffering from depleting gold / silver reserves today. As interest in junior miners increase, if the rumors about hedge funds maintaining large short interests against junior mining stocks are true, then maintaining these short positions will become a very risky proposition in 2011. Furthermore, if these rumors are true, then as the majority of shorts held against junior mining stocks run for the exits, a lot of pent up energy in junior mining stocks will be released. I believe this was largely why 2010 was a banner year for many of the best junior mining stocks, as more than a handful rose by 200%, 300%, and 400%.

Finally, interest in any one junior mining stock by a billionaire or multi-millionaire can be enough to blow the short interest of any hedge fund manager in a junior mining stock out of the water. In other words, when dealing with stocks with such small market caps, it only takes a small interest in them to cause their share price to double or triple. So if you believe gold and silver prices will continue to rise in 2011, you should most definitely consider learning more about junior mining stocks.

That said, there are many pitfalls that you must avoid. Junior mining stocks are notoriously volatile and they will remain volatile to the downside at times even if hedge fund managers unwind all the supposed shorts they hold on this class of stocks. The vast majority of drill assays reported by junior mining companies will yield zero results and not significant discoveries of gold and silver. Out of the hundreds of junior mining stocks that exist, probably no more than few dozen merit serious consideration for investment. Exploration companies that actually discover an economically mineable monster deposit will be few and far between and the exception to the rule, not the norm. As the global monetary crisis intensifies, politics and government regulations / taxation may move solid junior mining companies into a riskier investment class depending on the jurisdictions in which they operate.

In addition, junior mining stocks can also experience large unexpected drops in share price for no fundamental reason, but merely because one large investor decided to cash out, even if just to take profits. Furthermore, financial representatives, including the PR teams of junior mining companies themselves, are prone to misrepresent their potential at times. When a junior mining company is reported to have "discovered" a million ounces of gold, you should not take this report at face value. Often further digging will reveal that said company has no financing to bring the discovery to production, and that the million ounce "discovery" is a wishful extrapolation of resource estimates based upon only the best drill results and ignorance of all the bad drill results.

So yes, the risks can be significant for an investor that dives headfirst into junior mining stocks without any experience, so much so that even gold mining executives that invest in junior mining companies have relayed expectations of only a 20% success rate among their junior mining investments. In conclusion, I believe that success rates with junior miners can be upwards of 30%, 40% or even 50% or more with a little bit of due diligence and under the right circumstances, such as those that will exist in 2011. Just don't be suckered into purchasing junior mining investments sold to you by analysts that don't understand this sector and that you yourself do not understand. With junior mining stocks you must always perform some research yourself to ensure that you understand each junior mining company you own at all times. Never violate this rule and you should be able to use junior mining company investments to considerably boost your profits in 2011.

Disclosure : As of the writing of this article, the author is not invested in the GDXJ, Greystar Resources or Great Panther Silver, but does hold other undisclosed junior mining stocks.

See also China North East Petroleum's Shengyuan Acquisition: Significant Upside Potential on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Commodities

Referenced Stocks: AAPL , ANV , CDE , HL , SSRI

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