Junior Miners: Poised for Impressive Gains

Like all commentators, I am somewhat constrained in what I write about: it has to be a subject in which people have interest. Sure, I could write about Greek mythology or backpacking in Bolivia, but if no one reads it, it becomes a fruitless exercise – and raises that cliché question “if a tree falls in a forest...?”

Regular readers will have noticed that I have been writing about precious metals mining companies more often in the last few months – and this is no accident. In my interaction with readers/investors there has been a sharp rise in awareness of and interest in these companies.

In contrast, during the panic of last fall, miners in general – and junior miners in particular – had been devastated by the Wall Street-engineered sell-off, with many losing more than 90% of their value. With these companies sitting at once-in-a-lifetime valuations, no one (outside of the hardcore commodities investors) wanted to touch these companies.

In recent conversations with people, I have used an example of a brand-new, junior gold exploration company which I am holding – a spin-off of its parent company, which has already produced one major gold discovery. It was spun-out shortly before the worst of the panic at a price of 9 cents, and was pushed down to as low as 2 ½ cents. It closed Wednesday at 73 cents a share – an advance of nearly 3,000% from its 52-week low.

This is still an early-stage exploration company. If the property it is currently exploring lives up to its potential, this junior is still at no more than 1% of its long-term value. However, as I wrote in a recent commentary (“Investment Check-list for Precious Metals Miners: part I”), such companies are like “lottery tickets”. They are highly-speculative, and should never be considered “core holdings” in anyone's portfolio.

It is with the miners who have advanced into production where most of the truly exciting investment opportunities exist. These companies offer spectacular up-side growth potential, with limited down-side risks. Before I discuss their fundamentals in greater detail, let me review how this investment opportunity was created.

Precious metals miners (and commodities producers, in general) are expected to leverage the gains in the underlying commodities which they produce. I explain this concept in detail in a previous commentary. However, since 2007 (and for the juniors, back to 2006) these companies have grossly under-performed versus the price of bullion – irrespective of whether the price of gold (and/or silver) was rising or falling. Put another way, they have been getting steadily cheaper based on the underlying fundamentals.

This has naturally caused a great deal or consternation in this sector, even amongst the most committed “gold bugs”. There are several potential explanations for this phenomenon. Some have suggested there are simply too many of these companies. There are more than a thousand mining companies in the precious metals sector alone, although a number of these companies had all of the “life” crushed out of them last fall, and exist in much the same manner as U.S. zombie-banks (though without their own taxpayer-funded lifeline).

This argument loses most of its persuasiveness when the size of the sector is looked at collectively, however. A recent commentary (with accompanying graph) illustrates this vividly – unfortunately I forgot to bookmark it. It showed how the collective market-cap of the entire precious metals sector was much less than that of Exxon Mobil (XOM). Clearly there are enough investor-dollars floating around to support a sector of this size.

My preferred explanation for the sector-wide under-valuation of these companies is the creation and growth of the infamous, “bullion-ETFs”. As I have indicated in many previous commentaries, the legitimacy of the larger “bullion-ETFs” (which are supposedly backed by the same bullion banks which are the largest “shorts” of gold and silver in history) is seriously open to question – with the question being: do they really hold any bullion?

There are many bases for challenging these “fronts” for the bullion banks. I have previously raised the most important question to these bullion banks in a previous commentary (“Your ETF Silver is For Sale”): why do you have a “for sale” sticker on every bar of silver which you hold for SLV, and other (so-called) silver bullion-ETFs?

As that previous commentary points out, every ounce of silver contained in bullion-ETFs is listed as part of official “silver inventories” - meaning that anyone with enough money could buy every ounce of silver supposedly “held” by SLV. Of course, the other interpretation of that data is that the “bullion” of the silver bullion-ETFs is simply being added to inventory numbers to pad them – and hide the fact that silver inventories have plunged by 90% since 1990.

If the bullion-ETFs are indeed nothing more than the fraudulent shells which much of the data suggests, then these entities become the perfect weapons of the anti-gold cabal – which (of course) includes the same bullion banks which claim to back the bullion-ETFs.

Anyone suggesting that bullion-ETFs are completely legitimate faces the enormous hurdle of explaining how/why the largest “shorts” in the history of commodity markets would also be the sponsors/guarantors of what have become the largest investment vehicle (on the “long” side) for small investors in this sector.

Legitimate or not, bullion-ETFs have pulled tens of billions of investor dollars intended for precious metals into these paper-trading vehicles. Naturally a large chunk of that money would have gone into real bullion, if not for the creation of the ETFs. However, for whatever reason, many small investors are simply unwilling to hold “physical” gold and silver. Previously, all of these dollars would have gone into the shares of mining companies – as the next-best proxy for holding physical bullion.

Absent these billions, mining companies have not been able to leverage the gains in bullion over the last few years. This has also removed what is historically seen as one of the most important, bullish technical indicators from this sector: the out-performance of the miners – very convenient, indeed, for the bullion-bank “shorts”.

With this reference to bankers, I can't forget to include the rumor about last year's sell-off of Canadian mining juniors (which do the bulk of global exploration for minerals). After all of Canada's banks collectively cut-off 100% of all financing/credit from Canadian mining companies (despite being the strongest, best-capitalized banks in the world), it is rumored that these banks then also collectively shorted all these same companies.

In the case of exploration companies (which, by definition are not yet producing revenues), cutting them off of all capital and then ruthlessly shorting them has about as much “sport” in it as shooting fish in a barrel. I'll leave it up to readers, individually, to judge for themselves if this sounds like a strategy which a banker would be likely to pursue.

Irrespective of the cause, the fact is that by last fall, precious metals miners had fallen to their lowest valuations (versus the price of bullion) this decade – a decade in which the price of gold and silver has quadrupled. As my previous example illustrated, valuations have improved in the sector, although given the impressive moves higher for gold and silver, these companies are still cheap versus bullion itself.

Given the tendencies of bankers to back “winners”, suddenly the same mining companies which couldn't get a penny one year ago are now being welcomed with open arms by Canadian bankers. It is with this set of parameters that we can now look to the future for these companies.

With rising share prices (and equally impressive gains in trading volumes), many of these companies have very attractive charts – adding yet another source of demand: the speculative traders. While these are clearly the most fickle segment of the investment community; high trading-volumes, great volatility, and strong underlying fundamentals are a combination likely to maintain the interest of these buyers.

Just one year ago, these companies were totally starved for capital, ignored by analysts, shunned by investors, and at their worst valuations of this decade-long bull market. It is typical of market psychology that such scenarios often form the basis for the strongest, bull-market runs.

Now these same miners are all fattened with new capital, sought-after by investors, and fawned-over by analysts. However, unlike the fantasy-rally in U.S. markets, where valuations are grossly excessive by any rational metrics, precious metals miners are objectively inexpensive – still under-valued versus the commodity they produce.

Some of the gold perma-bears have cited the fact the miners have not outperformed bullion as a reason to believe to that this sector is poised for a crash. Some have even resorted to the hysterics of calling the precious metals sector a “bubble” (see “Beware Fortune's Gold Warning”). Ignore these fear-mongers.

The price of gold remains at less than half of its all-time high when adjusted for inflation, while silver is at only a tiny fraction of its inflation-adjusted high. Meanwhile, the miners are valued cheaply versus current bullion prices. No honest and informed commentator could describe such parameters as a “bubble”.

The fact is that if precious metals miners had been greatly outperforming bullion over the last two years, the same perma-bears would be “warning” investors that the sector was ready to crash because of the outperformance of the miners. The only difference between those two contradictory stances is that the second is actually rational. At some point (many years down the road), when the miners have fully-leveraged the price of bullion (plus an extra premium for “irrational exuberance”) then this sector will reach a long-term “top”.

However, with the same banksters who undermine precious metals at every opportunity serving the precious metals sector through refusing to curtail the excessive creation of new debt and the paper they call “money”, the end of the precious metals bull-market remains out of sight – on even the most distant horizon.

The time to buy into precious metals miners is not when everyone living on your street holds shares in at least a couple of these companies. The time to buy is now: when valuations are cheap, few yet understand these companies, and the bull-market remains “young”.

As more and more questions are asked about the legitimacy of bullion-ETFs, this is yet another new source of demand for precious metals miners. Should these funds become completely discredited, or should one or more funds formally default on their obligations to unit-holders (both being possible scenarios) the flow of dollars away from the ETFs and into the miners will go from a trickle to a flood.

Those who remained loyal to this sector have already regained their losses from last year and begun making real gains again. The good news is that our “party” has just begun.

Disclosure: I hold no position in Exxon-Mobil or SLV

Comments

[fireball]

hi jeff
banksters and politicians hate precious metals. it gives privacy to individuals and it makes stealing through inflation extremely difficult if not impossible. keeps them a little more honest.
i want to thank you for the hint on svm. do you like roy or atusf?

2009 Nov 20 09:43 AM

[Jeff Nielson]

Hi Fireball.

Sorry, but I'm not familiar with those last two references.


On Nov 20 09:43 AM fireball wrote:

> hi jeff
> banksters and politicians hate precious metals. it gives privacy
> to individuals and it makes stealing through inflation extremely
> difficult if not impossible. keeps them a little more honest.
> i want to thank you for the hint on svm. do you like roy or atusf?

2009 Nov 20 10:07 AM

[fireball]

roy is a royalty company around $4 p/s. atusf is altius. i'm also looking at exeter resources. looks like this dollar bounce may give opportunity on metals.

2009 Nov 20 11:00 AM

[The Recusant]

Great article once again, Jeff. It was one of the Dr. Doom authors, perhaps Panzner or Schiff, that stated in his book that the PM miners would not receive the investment attention that they deserve until later after the inflationary period started and the retail investors see the obvious benefit of investing in both gold and its producers. The potential of hitting one of those "grand slams" is a high probability by investing in the miners now while the prices are low. Of course one should spread their investment over a number of miners rather than just one. My miner investments have begun looking like a private miner mutual fund!

2009 Nov 20 11:40 AM

[Jeff Nielson]

Hi Recusant.

Yes, it SHOULDN'T have taken this long for the precious metals miners to appear on investors' "radar", but for a variety of reasons (many of which are listed above) it's not surprising.

For those who have been invested in these companies for a while, it has been frustrating, however for newcomers to the sector it spells "great values".

2009 Nov 20 12:41 PM

[frdm45]

Hi Jeff from a fellow Canuck,

Great article! I agree, it seems absurd to say these miners could crash when most of them are not far off their lows.

Do you think there may be some pick-up in demand for these shares in the new year when funds are reevaluating what they are holding and looking for the new "it" sector? What other major catalysts do you see spurring this sector, or do we just have to be patient for another two or three years and see gold hold above $1200, $1500?

thanks, keep up the good work!

2009 Nov 20 01:02 PM

[James75]

Silver will outperform gold as the gold/ silver ratio's come closer together. The historic ratio of 16:1 could possibly go even lower as there is much less available silver above ground than in history. I buy my silver bullion cheaper than anywhere I've found acting as an affiliate for silver snowball. Check it out here: silversnowball.com/1939

2009 Nov 20 01:03 PM

[Jake2]

A novel I do not want. Some concise and to the point analysis I do.

2009 Nov 20 01:05 PM

[Jeff Nielson]

Hi Frdm!

I expect demand to continue to strengthen for precious metals miners from several directions - so, yes, some fresh buying in the New Year sounds like a likely prediction.

While it's hardly scientific, I would encourage people to do some Google-searching (like I have done) using phrases like "junior miners", "precious metals miners", and "Van Eck junior miners fund" - to see the ENORMOUS amount of investor-interest in this one new offering.

Certainly OTHER fund-managers are going to notice this - meaning we could see a half-dozen imitators spring up, next year alone (increasing buying/demand for these companies much further).

I'll also go out on a limb and predict that major, "bullion-ETF's" will see their holdings flatten-out - despite continued strength in gold and silver. This will be due to ever-increasing DOUBTS about the legitimacy of these funds, diverting ANOTHER large chunk of investor-dollars into the shares of these miners.


On Nov 20 01:02 PM frdm45 wrote:

> Hi Jeff from a fellow Canuck,
>
> Great article! I agree, it seems absurd to say these miners could
> crash when most of them are not far off their lows.
>
> Do you think there may be some pick-up in demand for these shares
> in the new year when funds are reevaluating what they are holding
> and looking for the new "it" sector? What other major catalysts
> do you see spurring this sector, or do we just have to be patient
> for another two or three years and see gold hold above $1200, $1500?
>
>
> thanks, keep up the good work!

2009 Nov 20 02:17 PM

[Jeff Nielson]

Hi Jake.

You sound like an investor who gets really excited about seeing articles with lots of charts.

Instead, what you got from me was to point out that gold perma-bears (the greatest CRITICS of this sector) are telling investors that precious metals miners have NOT "leveraged the gains in bullion". This is EXACTLY the same thing as saying that these companies are UNDERVALUED versus the price of bullion.

While you may prefer to look at charts, I prefer to put my money on the fact that the biggest CRITICS of precious metals miners are telling investors that these companies are undervalued.


On Nov 20 01:05 PM Jake2 wrote:

> A novel I do not want. Some concise and to the point analysis I do.

2009 Nov 20 02:21 PM

[indianamark]

A great article. An answer to the current propaganda about a " bubble". I think a lot of people will agree with John Paulson: "why didn't I buy gold three or four years ago"

2009 Nov 20 03:27 PM

[bob adamson]

Jeff,

Wouldn't you agree that, should someone want to invest in a junior miner, they should consider waiting now for a pull back in the precious metals producers sector of the market? These juniors are quite volatile and this market may, arguably, be ready for a pause after finally having a few good weeks.

What do you think?

2009 Nov 20 11:41 PM

[Jeff Nielson]

Bob, if there is a rally which is looking "tired" at this point, it's the fantasy-rally in U.S. markets.

Precious metals miners are CHEAP versus the price of bullion. Period.


On Nov 20 11:41 PM bob adamson wrote:

> Jeff,
>
> Wouldn't you agree that, should someone want to invest in a junior
> miner, they should consider waiting now for a pull back in the precious
> metals producers sector of the market? These juniors are quite volatile
> and this market may, arguably, be ready for a pause after finally
> having a few good weeks.
>
> What do you think?

2009 Nov 21 11:05 AM

[jay brebner]

very good article (maybe a short story - definitely not a novel). Any opinion on PAL? I like their recent gold aquisitions.

2009 Nov 21 03:37 PM

[Luke Skywooker]

I like silver juniors and silver bullion. One difference I see. the ETF's have attracted lots of interest. If people had to buy actual silver bullion and hold it, there wouldn't be any where near as much interest in silver as there is with SLV - it's so easy to buy, hold, and sell. Bullion involves buying, weighing, authenticating, shipping, storing, etc etc etc. Hard to sell, repeat steps above. Carry silver around, who wants to go through all of this??? If you can make money by purchasing SLV at 14 and selling it at 18, it becomes a tempting alternative. Who knows? SLV may go to 25 in the next 6 months.

2009 Nov 21 07:46 PM

[Avenir]

Hi Jeff,
I really appreciate your article. It got me looking around for a few things. The iShares Silver Trust (SLV) prospectus is online. It gives a net asset value of $3.4 billion on what I estimate to be holdings of 8000 metric tons as of 2009-2-27.
The US Department of Interior in their Geological Survey report (minerals.usgs.gov/mine...) says that ETFs were holding 5290 metric tons.
Now, my estimate may be off for SLV's holdings, but my calculations were on the conservative side per what they reported in their prospectus. That would mean they got 2700 metric tons added in the first two months of 2009... that seems a little unrealistic. Definitely something off here...
thanks again,
Avenir

2009 Nov 21 10:56 PM

[goodasgold]

But what if SLV crashes because it has far less if any actual silver than it claims? And why doesnt it allow actual taking possession? Managing actual silver bullion is tedious but what you hold is real but I much prefer that to a high risk that SLV is smoke and mirrors considering the principals involved and inability to take delivery.


On Nov 21 07:46 PM Luke Skywooker wrote:

> I like silver juniors and silver bullion. One difference I see. the
> ETF's have attracted lots of interest. If people had to buy actual
> silver bullion and hold it, there wouldn't be any where near as much
> interest in silver as there is with SLV - it's so easy to buy, hold,
> and sell. Bullion involves buying, weighing, authenticating, shipping,
> storing, etc etc etc. Hard to sell, repeat steps above. Carry silver
> around, who wants to go through all of this??? If you can make money
> by purchasing SLV at 14 and selling it at 18, it becomes a tempting
> alternative. Who knows? SLV may go to 25 in the next 6 months.

2009 Nov 22 12:28 AM

[PYRAMIDHUNT]

More and more funds and investors will buy silver and gold miners because of the heavy 28% tax on GLD and SLV every year whether you personally sold your holdings or not since both are trusts. It was only recently that the media publicized this fact.

www.thestreet.com/_yah... or just search "Your Gold Could Bring Hefty Tax Bill"
l

2009 Nov 22 08:11 AM

[PYRAMIDHUNT]

Critics argue that pm miners are still stocks and may not mirror the gains of pm because of the risks of bad management, confiscation or war in the countries of pm miners, and most important...the pm miners since they are stocks then it will plunge if stock market crashes.

2009 Nov 22 08:19 AM

[Jeff Nielson]

Any future "crash" scenarios will result in gold and silver going UP - not down. The reason is that gold and silver are NOT simply responding to inflation fears - but rather in response to the imminent failure of the fiat currency system.

Those fears will RAPIDLY mount should there be ANOTHER crash - meaning gold and silver will DECOUPLE from the broader economy. Thus, with gold and silver miners making record PROFITS during any crash scenario, this will ensure that precious metals shares outperform all other sectors.

As for "bad management", no companies have worse management than the Wall Street fraud-factories - so precious metals miners have nothing to fear in THAT comparison.


On Nov 22 08:19 AM PYRAMIDHUNT wrote:

> Critics argue that pm miners are still stocks and may not mirror
> the gains of pm because of the risks of bad management, confiscation
> or war in the countries of pm miners, and most important...the pm
> miners since they are stocks then it will plunge if stock market
> crashes.

2009 Nov 22 11:26 AM