I started following Gold and precious metals in 2002 and first invested in small cap and junior resource companies in 2005. Until recently I always focused on junior producers rather than junior explorers. Production stories were easier for me to understand. Towards the end of the 2008-2011 bull cycle I began covering more exploration companies and by late 2016 my focus had almost shifted entirely to exploration companies. In this piece I discuss the reasons why I currently favor junior exploration companies.
Exploration Companies From This Point Offer Greater Upside Potential
From the very bottom or from around the start of bull markets producers are the best buy for two reasons. First, producers make huge moves off the bottom. In studying bull and bear markets in gold stocks I’ve noticed that producers not only make huge moves off the bottom but a good deal of their upside during a bull market is captured during that initial move.
From late 2000 through 2003 the HUI gained 640% but from the 2005 low to the 2008 peak it only gained 213%.
I looked at eight producers in the GDXJ (with a median market capitalization of roughly $1 Billion) and measured their performance from their 2015-2016 low to 2016 peak. The average gain was 314%. For this group to rise another 314% we would probably need to see Gold retest its all time high. That would require much more time than the roughly nine months to one year required for the initial rebound.
Secondly, exploration companies as a group tend to lag the sector until a turn has been confirmed. Individual explorers can certainly make huge percentage moves off the bottom but as a group more value is found in explorers after the initial surge.
Exploration Companies Can Be Less Dependent On Rising Metals Prices
Once metals prices have bottomed and the cycle has turned, exploration companies don’t necessarily require rising metals prices to be successful. If a junior explorer has made a discovery that could be economic at $1100-$1150 Gold, then it doesn’t require Gold to consistently rise in order to create value. That junior can add value by growing its discovery through more drilling or it can add value by de-risking the project and moving it closer to production. If metals prices are not rising then a producer needs to grow its production or grow its resources and reserves to add more value. It’s very difficult for a producer to do that considering most of its capital would go into the mine.
We should note a new bull cycle is important for exploration companies. During a bear market, only the absolute highest margin deposits are sought after. Exploration is cut back and capital for the junior sector is scarce. Junior explorers are extremely reliant on a bull cycle. They need it to be in place but from there don’t necessarily need metals prices to shoot to the moon.
The Big Money is Made in Exploration
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Source:: The Daily Gold