Junior Gold Producers

Not only do the small gold miners level the balance of the economic scale, they offer investors incredible opportunities to leverage the fortunes of their underlying metal.  This oft-unheralded group operates hundreds of mines that span the globe, many of which have excellent fundamentals.  And based purely on their small size, any positive news can send their stocks flying.

For this reason and more, at Zeal we decided to dedicate our latest research project to the contingent of smaller gold miners, or as we call them, junior gold producers.  And what we found was an exciting group of stocks poised to take advantage of this secular gold bull.

So what qualifies a gold stock for this junior-producer category?  First and foremost, these miners must be producing gold at a commercial scale.  After that, it simply comes down to a production-volume threshold.  And if you have been at all attuned to the gold-mining arena, you’re likely familiar with the three major categories that all gold miners fall into.

The largest miners are known as the senior, or major, producers.  The next group is commonly referred to as the mid-tier, or intermediate, producers.  And lastly are the junior producers.  Analysts, investors, and executives alike have long categorized gold miners into these three groups.

Now while most can agree on the nomenclature of this three-category breakdown, that’s about it.  Depending on who you ask, the thresholds of these categories can vary across a wide spectrum.  And since there is no true standard, I’ve fashioned my own guidelines for how to parse out these gold miners.

In order to qualify as a senior producer, a miner must produce at least 1% of the global mined supply of gold.  This translates to production volume of at least 750k ozs per year.  Since these larger miners are so rare, I’ve seen folks lower the seniordom bar to 500k ozs.  I’ve also seen higher thresholds of 1000k or even 2000k ozs.  But I believe the latter is unreasonable since there are only a handful at this level, and the former is also unreasonable as it diminishes exclusivity.

Next is the mid-tier producer, and my general rule of thumb (outside of volume) is that this miner is operating multiple gold mines.  Usually this criterion translates to production of at least 200k ozs per year, which naturally leaves junior gold producers as those with annual volumes less than 200k ozs.

Now there are obviously exceptions to this rule.  There may be a producer with multiple mines producing less than 200k ozs.  And there are those producers with a single larger-scale mine producing over 200k ozs.  When this is the case I default to raw volume, regardless of the number of operational units.  But in general, these rules are very well-encompassing of this industry.

With this 200k-oz threshold, those mining companies falling into the junior-producer category number nearly 100 (trading in the US and Canada).  And this group sure is a diverse bunch.  On the low end we have tiny miners with market caps around $10m, some producing at rates of less than 10k ozs of gold per year.  And on the high side there are those pushing 200k ozs in annual volume, some with market caps in excess of $1000m.

Each of these miners has a unique profile.  And though the undertaking of getting to know them was quite cumbersome, it was also quite rewarding.  After navigating operations, financials, geopolitics, and management among the many fundamental characteristics I consider when analyzing these stocks, some exciting junior gold producers emerged at the top.

In this process of uncovering the best of the best, one of the first things that stuck out was this group’s geographical diversity.  And this was no surprise considering the nature of these junior producers.  These smaller miners typically have an appetite for risk, and are not afraid to take on logistical challenges.  Interestingly, this mannerism is the antithesis of their more risk-averse counterparts.

When it comes to where the mid-tier and senior producers explore and develop mining operations, they tend to gravitate towards regions with low geopolitical risk and fairly-easy-to-manage geology.  And the simple reason for this is their heightened sense of fiduciary duty.  These larger miners are much more cognizant of how “the Street” and institutional investors view things, so they naturally suppress their appetite for risk.

While junior producers also seek to be responsible with the capital shareholders have entrusted them with, there isn’t as much pressure on where they apportion their capex.  Therefore these smaller miners are more willing to explore for gold and develop mines in regions that pose higher risks.  But with these risks comes the potential for greater rewards.

Some of the world’s finest gold deposits are being mined by these juniors within the remote deserts of west Africa, the rugged terrain of South America’s Andes mountains, the thick rainforests of remote equatorial islands, Eastern Europe’s war-torn Balkans, and the borders of countries notorious for government meddling.  Risks don’t always pay off, but by taking risks juniors have been able to successfully tap gold deposits that many of the larger producers wouldn’t have ventured to develop.

While junior producers indeed profitably produce gold all across the globe, within this spread is one particular gold-rich jurisdiction that has seen a bevy of junior-level mines sprout up over the course of gold’s bull.  And this heavy geographical concentration is located in one of the world’s most historic precious-metals havens, Mexico.

Mexico’s combination of reasonable mining laws, favorable geology, and rich mining history has made it prime breeding ground for the next generation of quality gold mines.  And Zeal’s latest research report embodies this concentration, with half of our dozen favorite stocks operating their flagship mines within this country’s rich PM belts.

Another interesting tidbit I noticed on the location of the mines operated by junior gold producers has to do with selection criteria.  Provocatively it is no secret that many of those in search of this yellow metal adhere to the mantra “the best place to find gold is in a gold mine”.  And this makes sense.  Rather than the tedious, time-consuming, expensive, and low-probability-for-success undertaking of greenfields discovery, why not start looking where gold is already known to exist?

Consequentially the juniors have had smashing success either making discoveries and developing adjacent to historic gold zones, or actually resurrecting operations at past-producing mines.  Interestingly over half of the elite junior gold producers that made the cut for our new report are operating gold mines that had once seen past production, with most of the rest mining in areas that had seen historic regional operations.

Domicile and logistics aside, this research also reiterates the importance of quality management, a major ingredient for success for these junior gold producers.  By now many of the management teams of today’s premier juniors have already proven their worth as bona-fide mine builders, simply by the fact that they manage producing mines.  And if a junior ever hopes to graduate into the mid-tier category, management must maintain that knack for development while also demonstrating the ability to execute savvy acquisitions.

And you’ll find that many of the best junior gold producers are run by executives with very successful track records.  In our report, several of the profiled companies are run by folks that had previously grown junior explorers into large mid-tier miners that were acquired for hefty premiums.  You’ll also find some of these small miners run by senior-level talent, former executives of some of the world’s largest gold producers.  These guys know how to groom and grow gold-mining companies!

One final high-level observation from researching this junior-producer realm that was of particular interest to me, and should be of interest to any investor, has to do with mine maturity.  Of the twelve miners profiled in this report, the average age of their flagship mines (from commencement of commercial production or tenure post-acquisition if the mine was already producing) is only three years.  And of the six miners on this report that just rolled out new mines in the last two years, the average age is only about ten months.

Why do most of the best junior gold producers happen to be so young in their mining lives?  The simple answer has to do with churn, as this junior category usually only serves as a springboard to bigger and better things.  The quality companies just don’t seem to last long in this category.  They are eventually either acquired by the larger miners, or quickly graduate to the mid-tier category as a result of M&A and/or organic growth.

These two major reasons for lack of category longevity make junior-gold-producer stocks thrilling investments and speculations.  Especially since the reasons for leaving this category typically translate to big gains for shareholders.  In my years personally trading and analyzing this sector, I’ve found this to be standard protocol for this category of stock.

If I was to update this thread of research two years from now, there is a very high probability that many of today’s quality juniors would not reside in this category for reasons mentioned above.  And I’d be willing to bet they’d be replaced by a new generation of juniors molded by some of the same entrepreneurial managers.

On the acquisition front, it is actually quite common for the larger miners to replace reserves and grow operations via M&A rather than organic development.  As these larger companies expand their operational portfolios, they naturally focus more on mining and less on exploration.  And in order to stay ahead of the curve and manage risk, they’d rather acquire those juniors that have already conquered risk and successfully developed gold deposits.  A lot of M&A happens within this junior category.

On the growth front, investors can find a lot of excitement in these junior producers.  With most of them operating a single mine, the prospect of expansion or the addition of a second operation can really get a stock moving.  Any positive news on discovery and development is a huge boon for juniors, whereas the same news for their mid-tier and senior counterparts is not likely to be as moving.

Simply put, it is a lot harder for positive news to move a $3000m, $10,000m, or $20,000m stock than a $350m (average market cap of all junior producers in our pool) or $770m (average of the twelve stocks profiled in the new report) stock.  Just for illustration purposes, say a miner either decides to develop a new mine, approves the expansion of an existing mine, or makes a significant discovery.  Which category of stock do you think would be most affected by such news?

News like this for a senior or even mid-tier producer operating multiple mines would be positive, but it wouldn’t translate into huge upside movement for the stock.  Going from 7 to 8 mines, or even 3 to 4 mines, would not have as much of a strategic impact as going from 1 to 2 mines.  Pushing through a mine expansion, while good, is also not a strategic game-changer for the larger miners.  And while making a significant discovery is always a bonus for any miner, all it would do for the larger miners is add to an already-sizeable portfolio of exploration and development projects.

In contrast is your junior producer, operating only one mine while holding a small pipeline of generative projects.  Going from 1 to 2 mines, expanding operations at its flagship mine, or making a huge discovery is a lot-bigger of a deal.  This type of news typically sends junior-level stocks flying.

Such positive newsflow would indeed create differential buying pressure for the larger miner, but based on its larger market cap its stock would only move marginally higher.  As for the junior producer, with its much smaller size even just a little differential buying pressure can shoot its stock higher at a much faster clip.

But I’d be remiss not to mention that this scenario works just as well in the other direction.  The diversification present in a larger miner’s portfolio allows it to better absorb negative news on one of its mining operations, whereas negative news on a junior’s single operation would have much more impact on its structural integrity.  Junior gold producers indeed hold more risk, which can obviously leverage to the downside.

This is why investors must be prudent on which junior gold producers they choose.  Like all sectors there are the good, the bad, and the ugly.  And if you choose the good, there is the potential for legendary gains.  In our hot-off-the-presses research report we profile our dozen favorite junior-gold-producer stocks, which we believe to be among the best of the best.  Buy your report today in order to have each fascinating in-depth fundamental profile at your fingertips!

At Zeal we’ve been layering into precious-metals stocks in our acclaimed newsletters, and so far our subscribers have seen excellent unrealized gains.  And it’s not too late to continue deploying into these stocks with technicals still bullish and seasonality favorable.  We expect to pull from the stocks in this latest report, and those in our two previous reports focused on junior explorers, to continue to build our book of higher-risk speculations that ought to greatly outpace the gains in the metals and their larger producers.  Subscribe today to see how we are trading and also to gain unparalleled commodities-market analysis.

The bottom line is even though junior gold producers reside on a small segment of the global gold supply chain, those elite well-managed companies hold incredible potential for investors willing to take on the extra risk.  These small companies mine gold all over the world, and those producers with low-cost, long-life, and unhedged operations will greatly leverage gold’s gains.

Another major feature of these small miners is they tend to be movers and shakers.  Often those with quality assets tend to move in the direction of the M&A path, with the larger miners desperate for resource growth.  There are also those juniors poised to grow on their own, and only remain juniors for a short while as their growth path matures.  Catching these producers in the sweet spot of this junior category can greatly reward the diligent investor.

Scott Wright

October 1, 2010

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