When choosing the right location for doing business, mining is fundamentally different from other industries. Miners have to go to where the commodity is found. This often means building a mine in countries or areas that are politically unstable, have poor infrastructure, and often are plagued by a good degree of corruption. Once construction begins or when a mine is finally built, a miner becomes "extortionable" due to the very nature of the asset: immobility. Investors have to choose carefully where to put their money.
Location is probably the biggest business risk for mining companies. However, the risk of doing business in under-developed countries should be balanced against potential rewards. With a high probability of adequate returns, venturing into the riskier parts of the world may very well be worth the risk.
There is one group of mining companies that can substantially reduce the location risk so that investors would mainly have to assess only geological and company specific risk factors. This group of companies is the highly speculative junior explorers. The reason is simple: they have no assets they could lose. And in the rare case of a major discovery the rewards can be tremendous.
Typically, troubles for mining companies start during the development or early production stage. Problems mostly arise when a company is at a critical time or when there are assets in place that are being mined. Once a certain amount of money is sunken into the ground, miners, out of necessity, mostly will arrange themselves with changing conditions rather than risk losing their upfront investments and giving up future profits.
Junior explorers avoid this kind of risk almost completely. As long as they don't have any assets they can mostly go about their business undisturbed and unmolested, often being helped by local authorities and specialists. Once they find a mineral deposit is when they usually appear on the radar as a target. The dot on the screen becomes bigger and bigger the more reserves are being proved. Meanwhile, profits for shareholders begin to materialize by way of an appreciating stock price. From an investment perspective it can be a difficult decision to stick with the company through the development stage, to wait (or hope) for a buyout, or to (partially) get out in order to protect the investment.
Now, does this mean that as a speculation the junior explorers are less risky than established producers? Of course not. However, a quick look at the potential pitfalls that can lock up the money invested in a producer may possibly make you reconsider the perceived safety of going with the producers:
1. changes in the tax code
2. challenges to the land ownership status
3. delaying or denying permits
4. strikes by the workforce
5. assault and robbery (yes it happens!)
6. lawsuits, renegotiations, legal action
7. NGO activities
8. environmental issues (perceived or real)
9. accidents and safety issues
10. government exclusions of prospective terrains (happened in Mexico in 2008)
11. expropriation and confiscation
I don't know about you but for me this is more risk than I am willing to take. Furthermore, all of these factors are completely out of your control. There is not much you can do other than to sell your shares or sit tight and hope for the best. The whole situation leaves you feeling rather helpless all the while you have money tied up that could be deployed better elsewhere.
These are all reasons that make the junior explorers interesting because almost none of these risks applies to them. But don't let me be mistaken here. An exploration company is among the ultimate speculations because there is exactly one way for your investment to pay off: the discovery of an economically feasible deposit. This is, in one word, the geologic risk. And for most market participants this one risk factor is more than they are willing or allowed to take.
As a geologist the geologic risk of course does not prevent me from taking a look at this asset class. To the contrary, this is exactly what I take up as a challenge when I go over a new company. I am much more concerned about the quality and honesty of management and the credits and capabilities of the exploration team. However, evaluating the geological risk factor inevitably digs down to the roots of a company and often allows conclusions about the people running the company. Being able to evaluate the geological risk is what makes you see through all the fog and hype built around most companies. It puts you, the investor, in control.
So which specific stocks or investment vehicles look promising and which are to be avoided, and why? The first things that come to mind for US investors are ETFs that offer exposure to the gold miners. Let's take a brief look at three of them, GDX, GDXJ, and GLDX.
GDX, the Market Vectors Gold Miners ETF, includes all the Big Gold household names. These are globally diversified large cap miners like Barrick Gold Corporation (NYSE:ABX), Goldcorp (NYSE:GG), Anglo Gold Ashanti (NYSE:AU), Yamana Gold Inc. (NYSE:AUY), and Newmont Mining (NYSE:NEM). Silver Wheaton (NYSE:SLW) is also included in this index, although it is not a miner. This group of companies is generally perceived as the least risky of the gold miners since they all have a steady income stream derived from their producing mines. GDX is often recommended for gold stock investors that are the most risk averse, while in reality these companies could be affected at any time by one or more of the aforementioned risk factors, most likely changes in the tax code, strikes by their workforce, NGO and environmentalist activities, accidents and safety issues, and even expropriation. GDX presently is down 44% from its last peak around $66 in the summer of 2011.
GDXJ, the Market Vectors Junior Gold Miners ETF, adds some riskier companies to its portfolio, not all of them producers yet, as the fund's name implies. Examples of companies included are Torex Gold Res. (OTCPK:TORXF), Argonaut Gold (OTCPK:ARNGF), and Sandstorm Gold (NYSEMKT:SAND). Many of the companies in the fund are in the early development stage and do not yet have income producing assets. Their specific risk factors are typically challenges to their land ownership status, the delaying or even denying of permits and associated renegotiations and legal actions, and environmental concerns and local activists. Many of the stocks are available to US investors through the pink sheet market only, if they don't have an account that give them access to the Canadian or other international exchanges. GDXJ is currently down 59% from its last peak around $38 in April 2011.
GLDX, the Global Gold Explorers ETF, is perceived to be the most speculative of the gold miners ETFs. Typically, the companies composing the fund have no income source whatsoever and rely on frequent financing to survive, hopefully as long as their exploration activities define an economically viable ore deposit, in which case they make out like bandits. The fund includes pure exploration plays and explorers expanding an initial discovery or existing prospect, acquired from others or found by themselves. Some of the companies included in the fund are Torex Gold Res., Continental Gold Ltd (OTCQX:CGOOF), Seabridge Gold (NYSE:SA), and NovaGold Res. (NYSEMKT:NG). Many of the stocks are trading currently at three year lows. GLDX is down 73% from its last peak of around $19 in April 2011.
All three ETFs have been an excellent short sale for the last two years, not exactly what one has in mind when looking for an investment opportunity in the gold mining sector. In fact, they are not really investment vehicles but speculative plays. I like to think of the funds as sentiment indicators for the mining stocks. They move almost in lockstep with the Gold Miners Bullish Percent Index ($BPGDM), with GLDX being the fund that amplifies its movements the most. And gold stock sentiment is definitely rotten today. The index hit a low of 3.33 last Friday, coming down from a high close to 75 as early as last October, an astonishing 95% decline. This quite possibly sets the gold miners ETFs up as a speculative contrarian long play. The important thing to remember is to keep a watchful eye on sector sentiment. When you put money into the gold miners' ETFs you are basically long gold stock sentiment which is technically due to a rebound from today's levels.
Contrary to ETF speculation the concept of evaluating a miner's geological risk focuses on individual companies. The idea is twofold. First of all, it is about trying to avoid being held captive by sentiment and pick the stocks that promise the most potential return in relation to their risk profile. The discovery of a mineral deposit as defined in "if it is not economical it's not a deposit" most likely moves a stock even in the most pessimistic environment. The other aspect focuses on finding grossly undervalued stocks in a beaten down market. While this second approach is nothing new, when applying it to exploration companies the ability to assess the geological viability of a company's properties comes in handy.
That in mind I'll now take a brief look a junior explorer so tiny that its stock could rise tenfold and it would still be only a $ 60 million microcap. Yet, this company recently managed to sign an agreement with the Mexican subsidiary of Brasilian mining giant Vale (NYSE:VALE), giving them the option to earn up to a 65% interest in one of their properties by making work expenditures of $16 million within a six year time frame. Astoundingly, this is more than twice the company's present market capitalization. Vale will earn a right to 51% of the property by spending $8 million on exploration within the first three years.
The company is Canadian junior Corex Gold Corp. [CGEKF.PK]. which focuses on two projects in Mexico. I became aware of Corex a month ago when it was mentioned briefly in Mexican regional newspaper El Norte which announced the finalization of the agreement between Corex Gold and Vale.
Vale's interest is in Corex' Santana property, which is situated 10 miles west of Yecora in Sonora State. The Santana property targets an epithermal low grade bulk tonnage gold mineralization. A quick check of the Sonora Mining Panorama, published by the Mexican Geological Survey in 2011, confirms Corex Gold Corp. as the owner of the Santana concession, located in the Santa Ana municipality. It is listed as a gold-silver-copper target.
The Santana property lies within the geological map H12D76 Santa Rosa. The exact location can be identified by the coordinates of the drill holes provided on Corex Gold's website. Santana is surrounded by several mineralized areas and producing mines and prospects, most of them gold and silver. Corex identified eight mineralized target zones on Santana.
So what do they have to show so far? Gold grades, as provided on the drill hole data on their website, are not spectacular. The best intercepts grade between 1 and 2 g/t (ppm) with a few meters exceeding 3 g/t with a lot of lower mineralized intercepts below 1 g/t between the higher mineralized core. They do however indicate a potential that merits further exploration. The most interesting intercept to me is bore hole SR-08-05 in the Nicho Norte target which lists 1.03 g/t composite gold over 93 meters, beginning at the surface. Corex may indeed have an open-pit mineable heap leaching project at its hand.
A quick cross check of the bore hole data and the maps and cross sections Corex constructed from them reveals that known data about the property are accurately represented in their conceptual geological model. However, it is important to notice that all this is very early stage exploration. There are no technical reports provided by Corex on their website yet. I also did not find a resource estimation. A 43-101 report made in 2007 exists on SEDAR for the Caliche property, also in Sonora. Caliche, however, is not listed as a project on Corex Gold's website anymore.
Provided that Vale will soon begin to sink $8 million into the ground at Santana, a stream of probably good news can be expected out of Corex in 2013 to 2015. Drill costs in Mexico are around $100 - 120 per meter these days. A sample can be analyzed for gold for 230 Mexican Pesos ($17) at the lab of the Mexican Geological Survey in Chihuahua, within driving distance from Santana. The exploration budget is sufficient to drill and analyze several miles of core in the property.
As a speculative play the bet is that Corex Gold Corp. will over time come up with enough data to prove that they can convert enough of their resources into reserves to show that they really have an economically feasible deposit.
The stock is at its low of $ 0.07 with a diluted total of 84.4 million shares. Technical analysis is quite useless since the stock is very thinly traded. However, its chart is similar to that of the GLDX ETF and shows that the stock was hammered by the same miserable gold stock sentiment environment that beat the ETFs to a pulp recently. Corex Gold's stock is down 92% from its high around $ 095 near year end 2010.
The Santana property is not the only ace up in Corex' sleeve. Corex has an earn-in agreement with Glamis Exploration S.A. de C.V. for their concessions close to the prolific Concepción del Oro mining district. Glamis is the Mexican subsidiary of Goldcorp, which operates the elephant Peñasquito mine close to Corex Gold's Zuloaga and Santa Rita concessions. Goldcorp can earn-in to a 70 % interest of Zuloaga by spending $4 million over 5 years.
Corex Gold's stock may turn out to have a double upside. The expected positive news stream due to Vale's exploration on the Santana property may combine with a gold stock sentiment change to the upside soon. The market capitalization of the company is ridiculous considering that they already showed to have ounces in the ground that are probably mineable at a profit. The stock is flying way below the radar. I'm not aware of it being hyped anywhere.
Anyway, be extra careful with this one. Corex Gold Corp. is a very early stage exploration company even if they have two of the majors doing their exploration for them.
Additional disclosure: I have a long position in CGEKF (Corex Gold Corp.).