The promise of big gains and the leverage that the junior mining market offers can be a powerful lure. But many retail investors jump into the high-stakes junior mining game ill-prepared and often at the wrong times. A poker face and nerves of steel just aren't enough - retail investors have to do their homework, too.
"People that are in this market, they need to be equipped for it," says Mickey Fulp, writer of the newsletter MercenaryGeologist.com. "Most people don't belong in this market - it's gambling. It's just like going to the casino."
However, Fulp notes that, in junior mining, the house doesn't always have to win. With the right information, investors can up their odds, positioning themselves for the highest gains possible while avoiding losing everything.
For new investors itching to get in on the game, that includes basic knowledge of how the market works, and the factors that can make a junior mining stock fly - or weigh it down, even in the face of good news. With that in mind, we asked some experts from across the junior mining spectrum for some tips on understanding share price movements and distilled them into nine elements.
1 Commodity prices
Commodity prices exert a powerful influence on junior share prices and the good news is that, despite the deep recession in the West, we are still very much in a secular bull market for commodities driven by demand from China, India and other emerging economies -- from which all commodities are likely to benefit.
"I think the secular trend is still firmly in place, but I would remind (investors) - like I have to remind myself every once in a while - that within a secular trend, there's always cycles," says Malvin Spooner, the author of a book for lay investors, Resources Rock and a cofounder and former president and CEO of resource-focused Mavrix Fund Management.
Not only will there be bear phases of the secular bull market, but various commodities will come in and out of favour during that larger cycle. Of course, the trick is to pick the right ones - the commodities that are on the upswing rather than those that are already peaking.
Spooner says the first step to investing in junior mining stocks is to develop a basic understanding of the underlying commodity. "It doesn't have to be sophisticated," he says. Just researching the basic fundamental supply and demand for the commodity in question will yield insight into where the price might go in the future and help identify promising commodities before they take off.
"Usually it's the stuff nobody's talking about," Spooner says, pointing to diamond juniors as "underappreciated" and also to uranium, which enjoyed lots of pre-recession buzz and a huge price spike in 2007, but has since stagnated.
"Let's face it, demand for uranium will eventually start to pick up, and stocks are priced as if it will never pick up."
Brent Cook, a geologist and writer of the newsletter ExplorationInsights.com also sees promise in uranium. "Probably the most beat up sector right now is uranium - and that's probably where the best bargains are right now if you're willing to wait a year or two and see how it pans out."
Once investors identify a commodity that may have some upside, there are two ways to go. The less risky choice would be to invest in an established producer of the commodity in question when the price is in the dumps.
"The more daring (investors) and the ones that want to have more fun would say, ‘well, I'd like to move down the foodchain and try to get an exploration company because if this all unfolds as planned, these are the stocks that are going to go through the roof,'" Spooner says.
Regardless of the commodity you're looking at investing in, the gold price in particular is an important one to watch as it drives investor sentiment.
"Basically in our little market, when there's a robust gold price, we're going to have a robust junior resource stock market -- the whole thing is driven by gold," says fellow newsletter writer Fulp.
2 Investor appetite for risk
By the end of 2007, well before the major markets crashed in late 2008, the bear market for junior miners had already begun, Fulp says.
"When the crash started, the junior resource sector was kind of the canary in the coal mine." he says. "We (the sector) kind of foreshadowed what was going to happen and there's a reason for that, because when people get antsy in the big markets, the first thing they do is cut out their venture capital investments because those are the highest rewards but they're (also) the highest risk."
The junior mining market is remarkably sensitive to investor sentiment, a factor that could sent junior share prices tumbling if the world gets scary enough. The market is relatively healthy right now, with money available to juniors once again, but there's no doubt it's still a little skittish. It's not hard to imagine, for example, that the Greek debt crisis could spread, or that China's growth could stall, encouraging investors to park their money in less perilous places.
"The junior market is for gambling," Cook says. "People gamble when they're feeling wealthy or rich or successful. When the big markets take a serious hit and people's pension funds get hit, they're less likely to go out and buy some 20¢ company that thinks they're going to find the next big gold discovery."
3 ‘Typical' share price progression
It may be comforting to know that there actually is some predictability to the wild ups and downs of junior mining share prices.
During the lifespan of a successful junior -- from exploration and discovery to production -- its share price typically will rise at certain times, and decline or stay flat at others. After a discovery by a junior is confirmed with enough drilling, its share price soars. The chart shows that there is usually a speculative peak in share prices - somewhere between the release of the prefeasibility and feasibility studies. A decline then follows as a more realistic valuation takes place, then the stock starts to take off again as the company nears commercial production.
Michael Fowler, senior mining analyst at institutional equity firm Loewen Ondaatje McCutcheon, teaches a course at the Prospectors and Developers Association of Canada convention every year on share prices and their relationship to the mineral exploration cycle that attracts everyone from students to CEOs of juniors. He says that flat area in the chart is due to expectations being brought back down to earth, as the pragmatic, matter-of-fact details of building and financing a mine are worked out.
"In the middle of that area, it's very realistic - there's not a lot of speculation during that period so the stock is basically on a low," Fowler says. "But as they raise the money and then the company starts to build the mine and then moves toward production, then there's some speculation as to earnings coming in and you usually get a rise before the first day of commercial production." And after that, he says, it's an earnings story.
Unfortunately, while the chart is supposed to show the "typical" share price progression of a junior mining stock, given that only a tiny percentage of juniors succeed, the chart is atypical.
"That's the classic cycle but that's actually not usual because what happens is somewhere along that cycle, something goes wrong."
Fowler says the full cycle could take as little as five years and as long as 30 years - averaging about 10-12 years.
Osisko Mining (OSK-T), which is building a gold mine at its Canadian Malartic property in Quebec, is one real-life example of the pattern.
4 Share structure
Even in the best of times, 95% of all juniors will eventually fail, Fulp says, with most diluting themselves to the point of worthlessness within an average of five to seven years. But the market crash accelerated the demise of many companies that were forced to finance at ridiculously low prices to stay alive. Fulp, who notes that as of early May, the TSX Venture Exchange index had only recovered to about half the level it stood at in April 2007 (which was roughly 3,300 points), says many juniors now have so many shares outstanding that they will never have a strong share price.
"What's happened is the good companies have recovered and gone on perhaps even to have higher valuations, but there's very few good companies in the junior resource sector. And the majority of them have failed, or are failing basically because they dilute themselves out of practicality."
He suggests that investors look for companies with a low number of shares outstanding with respect to the stage of the flagship project. For a startup company, for example, he looks for 10-25 million shares outstanding, while a junior at a more advanced project stage should be in the range of 40-60 million shares out. For a company going into the development stage, Fulp likes to see no more than 100 million shares out.
Of course, these guidelines are a bit of a moving target, and depend on peer comparisons as well as the junior's market capitalization. Fulp says that his own guidelines have changed a lot since even 2003, when many juniors had less advanced properties - and even since the last boom in the ‘90s, when juniors had fewer shares out (but also weren't able to raise the kind of money they can now).
Lastly, watch out for cheap outstanding warrants that will be expiring soon, says Craig Stanley, vice-president, research at Pinetree Capital. Enough warrants in-the-money can limit the share price, regardless of how well the company is doing.
"If they're underwater, meaning the exercise price is lower than the share price...the people who have those warrants are going to exercise them and probably sell their stock and that will be a drag on the share price," Stanley says.
5 Liquidity
While the lower the shares out, the better, you don't want to give up liquidity.
"Liquidity can be a huge thing," Pinetree's Stanley says. "You can easily buy a stock but when it comes time to sell it, you can all of a sudden be looking around and there's nobody out there and you have to really drop the price to get a trade."
While particularly important for institutions, retail investors too should be aware of where liquidity is going to come from. Stanley suggests that if the company has drill results coming out, whether bad or good, at least the news will keep the stock moving.
You also want the public float to be substantial - 50% or more, says Fulp, because retail investors are the ones that provide trading volume.
He considers a junior to have low liquidity if it trades less than a quarter of its shares outstanding in a year; moderate if it trades around half its shares out, good if it trades 75-100%, and excellent if it trades over 100%.
"High and low volume are often correlated with high and low stock prices - when there's low volume there's no buyers so the stock price is going to be low at that point," says the newsletter writer. "The only people buying would be contrarians like me looking for undervalued stocks. When volumes are high is generally when the highest prices are."
Another helpful tip: Fulp says that you can expect nearly all active exploration juniors to double in any 52-week period (i.e., the stock's high will be at least double the low).
6 Promotion
"Promoter" doesn't have to be a bad word - even though it may bring to mind unsavoury characters driving pump-and-dump schemes. Promotion - reaching out to institutional and retail investors as well as the media -- is essential to providing liquidity and momentum in the stock.
"I think one of the biggest things that people should realize is that nothing will go up unless somebody tells the story," Fowler says. "If they're (the company) not well known and they're not well promoted, then it doesn't matter how good the results are - nobody cares."
Promotion isn't as important to long-term share price movements as they are in the short-term, but it is one of the top considerations when making junior mining stock picks (see "Follow the four Ps," December 2008 edition of Mining Markets).
7 Financings
One factor that can shed light on a company's share price and its prospects for gains is its financial situation. Juniors typically raise money via private placements, and participants in private placements are obligated to hold their shares for a four months, after which time they become free-trading. That can create an overhang when they do come on the market, which could result in a sudden price drop.
"Sometimes with these companies, especially if their share price has gone up a lot, when that four-month period comes off you'll see the share price fall because guys have sold to lock in their profit," Stanley says.
Conversely, if the company is getting low on cash, that can also be a drag on the share price. A quick look at its most recent financial statements can be telling, Stanley says.
"If they only have $100,000, they're going to have to raise money so that's probably why the share price is not moving a lot," Stanley says. "The market knows that they're going to have to come out and raise money and (investors) want to get in at the lowest price possible."
8 Insider trading
Although one of Fulp's investment criteria is significant insider, family and friends holdings (or "insiders with skin in the game"), insider trading can be problematic. It can provide signals to buy or sell, but it can also put a damper on gains, especially if the stock is illiquid. Insiders massively selling into good news, for instance, can kill what otherwise would have been a healthy bounce for the stock price.
And although most insider trading is benign, the newsletter writer says there are enough murky trades going on that he finds it well worth checking up on about once a week. Fulp warns that the regulators in Canada aren't as aggressive about pursuing illegal insider trading as they are in the States. "The shenanigans that go on in Canada is stuff like what landed Martha Stewart in prison in the U.S."
Insider trades are reported on the websites SEDI.ca (the System for Electronic Disclosure by Insiders), as well as CanadianInsider.com.
9 Seasonal trends
For the most part, seasonal trends that may have been more prominent in the past appear to be disappearing because of fewer seasonal barriers to exploration and greater information flow thanks to the Internet.
Pinetree Capital's Stanley, for one, is a skeptic: "I've looked at this stuff pretty intensely and I've never been able to find anything that's really statistically significant on a seasonal basis."
However, most experts agree that the summer doldrums phenomenon - when volumes and prices drop as a result of exploration work taking place in the field, and everyone else going on vacation -- still affords a buying opportunity. Tax-loss selling season in December can also offer entry points.
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