Tuesday, November 12th, 2013 @ 10:06PM

By Dennis Miller

The airline tried to zap us with an overweight luggage fee on our flight home from the Casey Summit in Tucson. I was toting piles of notes and ideas to share with our readers, and I had to open two suitcases for the whole world to see. Your 73-year-old scribe was on his hands and knees moving clothes and folders between suitcases, but I managed to sneak in under the weight limit.

A few notes on the junior mining sector were among the stacks of paper I had to shuffle around. Lately the price of gold is seemingly going nowhere, and junior mining stocks are in the tank. Nevertheless, people had a tremendous level of interest in these companies, as evidenced by the crowds around their tables in the Map Room.

What was going on? My colleague Louis James and I sat down after the conference to discuss some possible explanations. To bring everyone up to speed, here are a few highlights from my interview with Louis in the March issue of Money Forever.

• Junior mining companies look for precious metals in quantities large enough to be mined profitably.

• Juniors are like the research and development arm of the mining industry. When larger companies buy them out, junior mining shareholders often see spectacular results.

• Most junior mining companies either hit it big or go bust. There are substantial risks, but also the possibility of phenomenal rewards.

• Research is the key to finding the right ones. ETFs and mutual funds that invest in junior mining companies use the basket approach, which dilutes the potential for fantastic gains. A qualified, experienced research team, however, can pick the winners out of the field of losers.

Now, back to my more recent chat with Louis:

Dennis Miller: Louis, for a sector that is really beaten down, there seems to be an awful lot of interest. What is going on?

Louis James: The interest you saw at our Summit was not representative of most investors, few of whom have the courage to be true contrarians, like Doug Casey.

The mining sector as a whole is being taken out behind the woodshed and thoroughly thrashed. This is understandable; metals prices across the board are lower than they were a year ago. Worse, while metals prices were rising, shareholders rewarded management for growth above all else, even profitability. Now that prices are not as high as in recent years, shareholders are screaming for healthier balance sheets and bottom lines.

Shareholders are fleeing these “ships” in droves, whether they are actually sinking or not, and they’re taking their money with them. This reduced liquidity is making it difficult to finance projects, even for large companies, and many of the smaller ones that don’t have much money are facing extinction.

It’s quite grim.

However, people like Rick Rule and Doug Casey are almost salivating at the opportunities shaping up. Most of our readers understand why: we want to “buy low and sell high”—and some terrific bargains along these lines are coming into focus.

Of course, you have to believe that metals prices will rebound, and that as a consequence share prices in companies that explore for and mine them will soar. Otherwise, this “opportunity” will look like a chance to jump on a sinking ship. Emotionally, that’s hard for many people to grasp.

Logically, however, it’s a no-brainer; global population continues to grow, as does the affluence of the now two-billion-strong worldwide middle class. The demand for metals may fluctuate in the short term, but it can only go up over time. That is true even as increasing environmental regulations, taxes, nationalization, and “not in my back yard” thinking drastically constrain supply around the world.

I dislike using abused expressions, but there really is a “perfect storm” brewing, and that’s exciting for the speculators who recognize the opportunity.

Dennis: Are larger mining companies in a position to start buying out juniors with proven reserves?

Louis: Many are financially able to do so, but they are unwilling to take chances on anything less than obviously stellar acquisitions at present. Shareholders are correctly taking management teams to task for making questionable acquisitions just to show more gold or copper or other metals on their books. It’s perverse: when prices were higher, the majors were buying, but now that great companies are on sale, they have pulled in their horns.

That can’t last long, however, because mines are, by their nature, depleting assets; the more you mine, the less there is left in the ground. And one of the first things big companies do when they need to cut spending is to slow or even stop exploration. That means the bigger fish have to buy up the little ones with the goods, or they cease to be the bigger fish.

Dennis: The stories of junior mining companies in the International Speculator are quite intriguing. What should new subscribers expect from these write-ups?

Louis: Writing the newsletter each month is an enormous winnowing process for me. I’ll come back from a field trip, or my team and I will conclude a lengthy period of due diligence with reams of data. We have to boil it all down to the essentials investors need to know to make their decisions.

The market is down right now, so it’s neither surprising nor alarming that some of our picks are as well; it happens. This is why we buy stocks in tranches: never the whole position at once, but in pieces, putting market fluctuations to work on our behalf, lowering our average costs.

But you have to keep your eye on the bigger picture. With the market prices down, we’ve started to build positions in several great, high-grade stories that were previously too expensive to qualify for “buying low.”

Dennis: I get the impression that there is real cause for optimism in the junior mining sector. Am I reading you correctly?

Louis: Absolutely, and in more ways than one. It’s a good thing, not a bad thing, when a product you like goes on sale. It gives you a chance to buy more at better prices. It’s an even better thing when something previously too expensive for your budget goes on sale and becomes affordable.

Also, the best of these companies have cash in the bank and continue advancing their projects, adding value as they go, regardless of the market’s fluctuations.

There are companies on the verge of substantially adding to their resources in the ground. I can think of one or two that are close to doubling their deposits, if not more. There are companies that have assets their larger neighbors need. I can think of one offhand that will almost certainly be taken over at a premium for current shareholders before the end of this year.

In fact, many junior resource stocks doubled their share prices between mid-June and the end of August this year. They were so beaten up, it was easy for a rebound in metals prices to lift the whole lot. Share prices have fluctuated down again, setting up investors who get in now for the same kind of near-term potential. That’s not without near-term risk, of course, but in the long term, the best of the best should deliver spectacular gains.

Dennis: I wanted to talk to you sooner rather than later because you’ve identified some prime takeover candidates in the International Speculator. After reading one of your write-ups, I personally doubled my position in the company.

It looks like the majors have gone from buying everything in sight, to reluctance, to buying only “no-brainers”—meaning those juniors with proven and probable reserves and demonstrated economic value.

Based on your experience, when the tide shifts again, will the higher-quality juniors be snapped up quickly?

Louis: Absolutely. When the tide shifts, I expect a flood of M&A deals. That’s almost guaranteed, because no larger company wants to become a smaller one, and the only way to avoid that is to buy the successful explorers.

However, the success of the particular no-brainer you are referring to does not depend on the majors getting off the fence. Its key property is completely surrounded by that of another company that was just bought out, and our little guy has drilled into high-grade gold on both ends of its ground. It is virtually certain that the larger producer that bought the company with the surrounding property will buy our junior explorer; not doing so would defy both common sense and hard-boiled business logic.

Dennis: Louis, I know you’re heading back on the road again, and I really appreciate your time.

Louis: My pleasure, Dennis.

While the volatile junior mining sector may test your patience, it can also be hugely rewarding; gains of 200-400% are not a rarity. But to get to those gains takes nerves of steel, especially in the inevitable downturns of the market. As Benjamin Franklin said, “He that can have patience can have what he will,” but that patience is sometimes hard to come by.

 

Posted by AIA Research & Editorial Staff
Categories: AIA Newsletter