The gold mining industry is one of the most risky, volatile and cyclical markets in the world. These factors provide opportunity to make or lose a fortune in a short period of time. By focusing on risk mitigation, an investor can position themselves for significant upside while limiting their risk of loss. Many investors choose to participate in these markets by using options, futures and stop loss orders. I highly recommend against this approach. The gold markets are as ancient as time, and using a cautious and careful approach will reap far greater rewards than using leverage and trying to predict short-term future events.
The toxic instruments that provide leverage to gold related investments are heavily promoted by the financial industry. They profit from your loss. Futures, Options, Leveraged ETFs, Stop-Losses are all financial instruments invented to take your money. The money never ends up in the hands of a mining company, it goes strait to the banks and their trading desks. These instruments are your enemy.
One time-tested method of investing in the gold mining industry is participating in the TSX-V. Toronto has a history of leading the world in mining, and it is on the venture exchange that the up-coming mining companies of the world are incubated. These junior companies provide similar risk/reward profiles to the venture capital tech and bio-tech companies in the U.S., however, the companies on the TSX-V are open for retail investors to participate! There are tons of problems with investing in these tiny companies, but by sifting through the companies utilizing our austere screening methodology, we can find some jewels in the rough.
For those not familiar with junior mining stocks on the TSX-V, let me shed some light on their appeal. These companies generally do not have cash-flow or producing assets. They have land with a concept. By testing their land, they can see if it is endowed with an economic mineral deposit. The tests cost money, and the likelihood of an economic deposit is increased or decreased depending on the amount of testing. It is very similar to bio-tech companies creating a new drug, as the certainty of viability increases, the value increases. Eventually a large mining company buys the project and complete the final stages to production.
What are the factors I use to screen out bad companies?
-Liquidation Value of the Company, cash and other assets.
-Management, ownership and experience.
-Partnership Agreements, partner spending obligations.
-Financing, how much did other investors pay for their ownership?
My approach is strait-forward and very simple. It works when the markets are cheap. A different approach is necessary when they are expensive. They are cheap now, so I'll focus on that methodology. I'm going to use real companies in my examples, please don't take this as a buy or sell recommendation.
First: Assume that all of the assets of the company other than cash and liquid assets available for sale are worth nothing. That way I don't get tricked into over paying by some scientist or geologist or promoter. Many companies will tell you the land they are testing is valuable, but in fact, that land is a liability that needs to have money spent on it! Do not let a management team convince you that their land is better than their competitors and worth paying extra, -there is a lot of land and the important part is the testing of the land! This first step gives me a down-side target for my investment if things do not work out on the project being tested.
Second: I look at how much of the company the managers and directors own, if they don't own at least 10% that is very troubling. If the insiders of the company do not own a significant portion, they will not have their incentives aligned with investors. Incentives are the most important thing! By aligning incentives, numerous virtuous cycles are created, and if this is not the case, you will almost guaranteed lose money. Insider ownership is critical.
Third: Look at partnership agreements. If your company has a partner who is willing to spend money on their property to earn an ownership, that is a good sign. The geologists from the earning-in partner have reviewed the project and their willingness to spend money on the project validates the investment/exploration concept in ways that I (as a non-geologist) cannot. Bringing in a partner is a critical sign of health in a junior exploration company. It conserves their capital, reducing the need for future financing and dilution of your ownership, it provides an extra set of geological and financial eyes to review the property, and it provides a deep-pockets partner to eventually buyout the smaller company and build the mine in the case an economic discovery is made.
Fourth: Financing. If the company financed at a significantly lower price just recently, you should ask if you're paying too much for the shares. If the management just told the world we think the price is worth X and you're paying more than what they just sold shares to other investors, you should question if you really need to buy now.
I company that I currently own and fits into the above mentioned criteria is Radius Gold:
Radius Gold (RDU) (RDUFF) has roughly $9-10m in assets, and $100K in liabilities with a market capitalization around $9-10m. In my understanding this means if you buy shares at current prices they are backed dollar for dollar with real assets (mostly shares in other companies in the case here). You're paying no premium for the business or it's history, projects, structure, contacts and management team. Insiders own roughly 10% fully diluted. The most recent financing was in 2011 for $3.6m at $.60. They've been able to grow the assets of the company (during a bear market) without dilution. They do not have any significant partnerships that I would value currently. The managers and directors have been responsible for multiple successful large silver mining companies including Endeavour Silver and Fortuna Silver. The management has a track record of success.
Investing in a company like Radius allows me to sleep well at night knowing that managements interests are in alignment with shareholders, they know how to successfully deploy resources into the gold and silver markets, and the price is as good as you can hope to find.
Disclaimer:
I am not a professional financial adviser and cannot legally give investment advice. The purpose of this article is not to get people to invest but simply to share my opinion. The markets are highly volatile and can cause investors to lose money. Do not invest anything in the market that you cannot afford to lose and please do your own research before investing into anything.
I primarily invest in IRA accounts that are not subject to taxes. I would not buy and sell to balance my portfolio as frequently as I do if the transactions were taxable.