Making Money in Canadian Oil and Gold Mining Stocks

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 |  Includes: BWLRF, COLUF, LSTMF, QADMF, STO
by: The Patient Investor

There are many junior oil and gold mining stocks that trade between 25 cents to 10 dollars that can double within six months to three years, but they can also lose value very rapidly. So how do you invest in these stocks and make money?

I first started investing in Canada in the mid 1980's when some clients started companies and did Initial Public Offerings (IPOs) on the Vancouver Stock Exchange (VSE). The VSE was a very wild and wooly market - it was Caveat Emptor - buyer beware. Most of the companies were mining the investors instead of mining for minerals. I would estimate that maybe 2 to 5 companies in a hundred new companies actually went on to become viable businesses, and there were a substantial number of frauds - management would fake drilling results, disappear with the money raised, or run pump and dump stock schemes.

For additional information, see a brief history of the VSE which then morphed into the TSX Venture Exchange. During the late 1990's and early 2000's the regulators and the new exchange cleaned up their act. Now almost all mining companies must prepare a 43 - 101 report on a mine and file it on Sedar.com, similar to the SEC's EDGAR site. There are still scams, pump and dump stock schemes, and many companies go bankrupt; however, now many of these small companies become successful businesses listed on the Toronto and New York stock exchanges.

Now that you have some background information, we need to learn how to find good companies to invest in and how you invest in these companies. The first thing is understanding that you can buy most of these small Canadian companies through the US pink sheets. When I have a Canadian company such as Novus Energy, the first thing I do is go to the TSX website to look up the symbol and get the quote. You will notice they have quite a lot of information on their website, including the company's website under the company heading. When you decide to purchase, then you go to a US quotation site and do a symbol look up for Novus Energy. You will come up with the symbol NOVUF, or at some you will see NOVUF.PK. This quote will be in US dollars, so you do not need to adjust for currency differences between the US and Canadian dollar. Then you enter your order and it will be executed; here is a good website that explains everything in more detail.

What I normally do is just put in a market order if the bid and asked are about a penny or two difference. Otherwise, I put in a limit order. Most of the time the quote is usually fairly current in more active stocks, but bid and ask quotes can be very old at times. I do most of my trading at Schwab, and some of the newer and smaller Canadian companies do not have a US pink sheet quote. In that case, I call Schwab international trading section and request a pink sheet symbol; they then have to get approval from a manager to trade the stock and request a symbol for the stock. When I get the symbol, I then use my internet account to trade the stock. This process usually takes about a day or two.

Now the most important thing: how do I find good companies to invest in and make money? I have some websites that provide information on mining stocks: Infostock, Resource Clips, mining company website, Kitco, and Kitco live. These are the best sites I have found regarding oil information, new oil plays, research information, CAPP, and a list of Canadian oil companies. Some other good oil information websites in the US and Canada are Shale Oil Plays, oil industry primer, and Oil Magazine. I also do Google searches periodically to find new information on the internet.

Another good place to look for companies are industry conferences put on by brokerage companies and industry groups; most of these conferences are available to listen to on line with company presentations in either power point or adobe reader format. What I do is get the company's name and then go to their website to find out information about the company before listening to the presentation. This way I can eliminate many of the companies and just listen to the ones I am interested in. When looking at the companies for the first time I pay particular attention to the number of shares, options and warrants, background of the management, number and size of projects, the amount of the resource, location of the project and the amount of money they have and the price of their common shares.

At the present time, I am more interested in oil companies than gold mining companies for the following reasons. Horizontal drilling and new fracing techniques have increased oil production tremendously, which has dramatically increased oil company profits. The new shale deposits and other oil areas are very large areas that contain the oil in the rock, not like the older oil plays in oil pools that have accumulated in much smaller areas. Once you have delineated the oil play areas, there are very few, if any, dry holes. At the present time I would avoid companies that are primarily natural gas producers. In my opinion, natural gas prices will not begin to improve until July to November of 2012 and into 2013.

The second reason for picking oil is generally the ramp up time for new oil plays is 1 to 3 years, while bringing mines on line is generally 5 to 15 years for greenfield projects. So your money works faster in oil.

The third reason that I like oil companies is the ability to produce more oil from manipulating and extending the new horizontal drilling and fracing technology. This is best exemplified by two companies: Brigham Exploration Company (BEXP) - see their latest presentation (.pdf), pages 33 through 51 and Petrobakken Energy Ltd (PBKEF.PK) - see their latest presentation (.pdf), pages 10 through 14. When both of these companies use the technology that the other company is using, they will drive down costs of production even more and produce substantially more oil at the same time. Right now, both companies can frac two wells with one fracing crew and speed up this process but in a little different method.

The final reason I like oil is that most junior, intermediate and large gold mining companies are overvalued or risky in my opinion, and if gold doesn't increase in value, these companies' common share prices will decrease.

What do I look for in companies? I want multiple projects with large land areas, a high amount of resource, experienced management, low number of shares, and in a good location.

For gold mining companies with open pit heap leaching projects, I want at least a million ounces of gold reserves and production of 75,000 ounces of gold a year. In third world countries I want at least 50 million tons of ore at .8 grams of gold a ton. In the US or Canada, I want 50 million tons of ore at 1.2 grams of gold a ton. For underground mines with a milling operation, I want at least 1.5 million ounces of gold reserves and production of 100,000 ounces of gold a year. I want at least 20 million tons of ore at 6 grams per ton in third world countries. In the US or Canada, I want 20 million tons of ore at 8 grams a ton. If a US or Canadian company produces much more gold a year and has much larger reserves, I will look at a little lower grams per ton.

The reason for wanting higher grade ore in the US and Canada is higher labor and operating costs. Also, if the company is producing other metals as part of its operations, then a lower grade of gold ore can still be very profitable. The reason I want more production in an underground mine and milling operation is it usually costs much more to produce an once of gold than in an open pit heap leach mine. I usually try to invest in these companies once they have raised money to bring a mine into production or after the scoping/feasibility report is finished.

Presently, I have three mining companies that could be good investments. All of these companies fit my parameters more or less.

Quadra FNX Mining LTD. (OTC:QADMF) This company has a large precious metal production and it should increase in the future, but the major driver is copper and will remain so in the future. However, the Sudbury operations have the ability to maximize the production in three different metals: copper, precious metals and nickel. They also have ore that is valued at over $1,000 a ton at the current metal pricing. This allows the company to generate profits from the most profitable metals and ore at anyone time. They are just beginning to get into this higher valued ore and will not reach the highest grades until 2012 to 2013. The downside is they sold a royalty interest to Gold Wheaton (OTC:GLWGF) covering part of their precious metal production.

Colossus Minerals, Inc. (OTC:COLUF) This is a precious metals company with a project in Brazil. This company has some of the highest precious metal assays that I have seen in the mining industry in the last 45 years. However, the amount of ore is impossible to determine at the present time. If there is a substantial amount of ore, as it appears there is, this company will make a lot of money.

Breakwater Resources, Ltd. (OTC:BWLRF) This company is primarily a zinc company although they do have some gold, lead, copper and silver. If the price of zinc stays at the current level or increases, this company will make a lot of money, and they have a mine to bring back into production in 2012.

In an oil company operation I want at least 50,000 acres in a horizontal drilling play and at least 20,000 acres for a vertical drilling play with multiple oil pay zones. Preferably, there should be at least 2 or more different area oil plays. The oil plays should have production of at least 200 barrels of BOE (barrel of oil equivalent) a day initial production for horizontal wells and 50 barrels BOE a day for vertical wells. The production should be higher for both types of wells if it is an over pressurized reservoir.

Assuming the wells are going to a depth of three thousand to six thousand feet and four thousand to five thousand feet laterals, the cost for a horizontal well should be 1.8 to 2.8 million dollars and a vertical well 400 thousand to 800 thousand dollars. The reason for the large difference in cost is the type of fracing used, type of pad developments, type of rock, drilling water disposal wells, and number of laterals off of one bore hole. All of these variables can change costs dramatically.

Almost all oil wells also produce some natural gas, so generally I want at least 80% oil and some natural gas liquids (NGL). I would like to see at least 300,000 EOR (equivalent oil reserves) of reserves per horizontal well and 70,000 EOR of reserves per vertical well. The BOE and EOR above includes all of the production oil, NGL, and natural gas converted to equivalent barrels of oil. Each barrel of oil is equivalent to 6000 cubic feet (or 6 mfc) of natural gas. The energy equivalent is 6 to 1, but the current price ratio has recently varied from about 17 to 25 to 1 versus a more normal 10 to 12 to 1 price ratio. If the natural gas production is higher than 20%, then I want a corresponding increase in reserves and production to off set the lower price for natural gas.

For good Canadian oil companies, I would look at this research report prepared by a major Canadian brokerage company new oil plays; it rates the plays and the companies. Prior to my finding the report, I had researched Canadian oil companies using the parameters above and came up with most of the same companies they had in the report. Some of the small Canadian oil companies I found are: NOVUF.PF, PETEF.PF, ROAOF.PF, OTCPK:CLLZF and OTC:SCSZF. If oil stays above 90 dollars a barrel for the next three years, these companies should all at least double in price during this period of time. Like all of these smaller oil companies, they are more risky than the larger companies, although one, CLLZF.PK, is verging on an intermediate sized company now.

Disclosure: I am long BEXP, OTC:NOVUF, PETEF.PK, OTC:SCSZF, OTCPK:CLLZF, OTC:ROAOF, OTC:QADMF, OTC:BWLRF.

Additional disclosure: I may buy or sell any of the stocks mentioned in this article at any time based on world events and specific company information. I am also long COLUF.PK