This Is What To Watch For When Thinking About Investing In Junior Gold Miners

August 3, 2017

This Is What To Watch For When Thinking About Investing In Junior Gold Miners

  • There are many risks—ranging from political risks to meteorological—to keep in mind with junior gold miners. I’ll describe some of them to give you a better picture of what can happen.
  • However, the negative attitude towards junior miners also provides excellent investing opportunities.
  • We’ll look at what makes the stock price of a gold miner move and how to recognize the pattern.

Introduction

The VanEck Vectors Junior Gold Miners UCITS ETF (NYSEARCA: GDXJ) has gone through some significant restructuring in the last few months because it was getting too big. The ETF simply had too much in the way of funds to continue buying stocks of junior gold miners (market capitalization below $2 billion), and had to increase the threshold by including gold miners that have a higher market cap.


Figure 1: VanEck Vectors Junior Gold Miners UCITS ETF top holdings in March 2017 and July 2017. Source: VanEck.

As you can see, the ETF is completely different than it was 4 months ago. For that reason, I’ll go through the junior gold miners left in the ETF, thus from the 10th holding onward, in order to provide you with an overview of the miners, their potential risks and rewards, so that you can create your own junior gold miner portfolio exposure by selecting a few that fit your risk reward profile.

Additionally, we’ll also look at what makes their stock prices move in order to learn and recognize similar patterns. It’s important to note that all miners are different as there is no equal mine in the world.

Kirkland Lake Gold Ltd (OTCPK: KLGDF, TSE: KL.CA)

The first thing to note about KL is that it has significantly outperformed the GDXJ in the last 6 months. What’s always good to do is to look at what happened and search for similar patterns in other miners.


Figure 2: Kirkland Lake Gold vs. GDXJ in the last 6 months. Source: Yahoo Finance.

What made the stock price move so significantly was that the company delivered on its potential.


Figure 3: Kirkland’s flagship Fosterville mine increased production and lowered costs. Source: Kirkland.

It was a known fact that the company would mine higher grades, but the investment community opinion was that a miner is a person standing next to a hole in the ground and lying, to quote Mark Twain. Therefore, significant stock price improvements are really only seen after a miner really delivers on what management has promised. So the first thing to look at when analyzing junior gold miners is to find investments that have a high probably of delivering on their plans and increasing cash flows.

Alamos Gold (NYSE: AGI)

AGI is a producer that isn’t profitable, but is cash flow positive with a price to cash flow ratio of 14.6. It currently has all-in sustaining costs of above $1,000 per ounce which is what makes it unprofitable. Nevertheless, if gold prices increase significantly, AGI’s margins would explode as its costs would remain fixed.

The second thing going on with AGI are its 6 projects that have the potential to double AGI’s gold production. However, there is still a long way to go before AGI delivers on those projects and as seen above, the market rewards delivering, not promising.


Figure 4: AGI’s Turkish development projects. Source: AGI.

What’s good about AGI is that is has no long term debt at the moment and thus will be able to finance the projects, but some analysts are questioning AGI’s data because they increased the net present values from the 2012 prefeasibility study by 185% in the new 2017 study thanks to expected improvements in project economics for their Agi Dagi project in Turkey. The point is that a lot of things can go wrong with such projects and they could soon turn from a positive net present value into a negative one which leads to shareholder value destruction. That is way the markets reward actual numbers and cash flow rather than potential.

The second thing to watch when investing in miners is their mineral reserve life, i.e. how long it will take to deplete their current reserves. If the mine life is short, the company might incur significant cash outflows to replace reserves and shareholders could be left empty handed.


Figure 5: Gold miners life of mine comparisons. Source: AGI.

In the above case, AGI is among the best but is not the best. However, you can see how many gold miners don’t have a very long mining life.

B2Gold Corp (NYSE: BTG)

BTG is a growth miner and has guidance for 2018 production of more than 900,000 ounces of gold, thus 70% higher than 2017 guidance.


Figure 6: BTG’s estimated production. Source: BTG.

The third thing to watch for when analyzing gold miners is political risk. BTG’s Fekola mine is in Mali where the Northern Mali Conflict is ongoing. So political risk must be closely watched and understood when analyzing miners.

The fourth thing to watch for is what the profits per share will actually be after all the projects become developed. The above potential growth is impressive for BTG, but we mustn’t forget that BTG has 965 million shares outstanding, so even with revenues around $1.1 billion and delivering on the expected $800 all in sustaining mining costs in 2018, the total net profit, after calculating taxes and interest costs, comes out around $250 million from a quick back of the napkin calculation which results in earnings per share of $0.25 and gives a forward 2018 price to earnings ratio of 10 which isn’t that low for the development and African political risks. On top of it, the Fekola mine life is just 7 years, so there won’t be eternal production.

Hecla Mining (NYSE: HL)

HL mining is a low cost gold and silver producer. Its net profit margin on revenue is almost 15% and operating cash flow margins are 37%. Both metrics are extremely high and are a result of the low cost mines Hecla operates.


Figure 7: Hecla’s revenue distribution. Source: HL.

Such good fundamentals lead to higher valuations. Hecla’s price to earnings ratio is 21.64 while its price to cash flow ratio is 8.7.

The fifth thing to watch for when analyzing junior gold miners is potential union strikes. Hecla’s Lucky Friday mine is currently shut down due to a unionized strike. Such issues can severely impact a miner, especially in the short term.


Figure 8: Hecla’s Lucky Friday mine. Source: HL.

However, such issues usually are resolved, especially in jurisdictions where the rule of law is good. Therefore, such opportunities can also create interesting investment opportunities.

Oceanagold (OTCPK: OCANF)

Oceanagold is another low cost miner currently trading close to 52-week lows, and the company has severely underperformed the Junior Miners ETF.


Figure 9: Oceanagold’s stock performance in the last 3 months. Source: Yahoo Finance.

The reason for the underperformance is the suspension of its Didipio mine in the Philippines for environmental reasons.


Figure 10: Oceanagold’s mining assets. Source: Oceanagold.

Such suspensions are a bigger risk than unionized strikes and have to be calculated into the risk reward puzzle when approaching a miner as an investment opportunity. So another thing to watch for are the risks coming from environmental actions. This can be done by reading local newspapers and assessing the sentiment surrounding the mining operations. It might sound silly to read local newspapers, but it can lower risk significantly.

First Majestic Silver Corp (NYSE: AG)

AG is a predominantly silver miner with all of its operations in Mexico.


Figure 11: AG’s mining operations. Source: AG.

The problem with AG is that many of its mines have trouble with unionized workers and the level of worker satisfaction at its mines is the lowest it has been in the company’s 15 year history according to the CEO. This certainly doesn’t bode well for AG, and points out the risks of investing in miners.

Regis Resources Ltd (OTCPK: RGRNF)

What’s special about Regis is that it pays a dividend that currently yields 3.2%. This isn’t the case with many of the above mentioned miners and demonstrates that the company is able to produce what is most important when analyzing a miner, cash.

The stock price is close to its 52-week high despite the decline in gold prices and the GDXJ. As was the case with Kirkland Lake Gold, Regis has really delivered in the last few years as all of its financial metrics improved.


Figure 12: Performance measures for Regis. Source: Regis.

The price to earnings ratio is 15.3, and the price to cash flow is 9.9. Thus, if you want quality and dividends from miners, it certainly comes fairly priced.

Nevertheless, Regis isn’t without risks. In 2014, severe rainfall flooded two of its mining pits and negatively impacted production. This is just another example how trouble for miners can even simply fall from the sky.


Figure 13: Flooding at a Regis mine. Source: Ferret.

Conclusion

After going through all of the interesting individual mining stories described above, it’s clear that investing in junior gold miners stocks requires a lot of knowledge. The good thing is that if you liked some of the above mentioned companies, you can start following them and invest after you’ve learned enough about the company and the management.

I personally follow the two miners I have been invested in for more than 3 years now, and know enough about the risks, rewards, management, and fundamentals to sleep well at night. But my knowledge comes from spending hours doing research, reading through technical reports about future projects, and analyzing the commodity environment. I understand not everybody can do that. Therefore be sure to keep reading Investiv Daily to be notified when we share interesting, in depth research on specific miners that present low risk high reward potential investments.

By Sven Carlin Commodities Gold Gold Miners Investiv Daily Share: