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