Small cap stocks can be risky but also have the potential to produce big rewards for patient, knowledgeable investors. In our latest edition of “Ask the Analyst,” Gravitas Financial analyst Stefan Muchal talks about how to invest successfully in mining stocks and points out possible warning signs every potential shareholder should be aware of before putting money into one of these names.
Tracy Lynn: In your opinion, what makes a mining company successful?
Stefan Muchal: There are a few fundamental factors that need to be there for any mining company to be successful. You need to have a deposit, that’s number one. If you don’t have a good deposit, you really don’t have anything. From there you can look at other factors like the management, are they capable and have the required skills to mine that deposit? From there, you can look at if it’s the right time to be in the market for that metal. There’s a lot of time when it’s not economical to mine a specific element or mineral and you need to move on to other companies. There are lots of bad times by good companies, after all.
Tracy Lynn: How do you know if a deposit is economic?
Stefan Muchal: There are a few factors that go into this and all of these are found in the feasibility study, which a bank uses to fund a project. But initially you want to look at the location. If it’s in the middle of a jungle as compared to being in a grassland somewhere, it’s a lot easier. I guess a good rule of thumb is if you don’t want to live there, you probably don’t want to build a mine. From there, you want to look at the geology. The main way we do this is through the drill results. Ideally you want a large, high-grade deposit. Most of these have already been mined so you’re going to get one or the other these days. Both can be economical, but it takes a lot more money, a lot more costs and a lot more time to mine a low-grade deposit.
Tracy Lynn: As an analyst, what specific metrics do you look for?
Stefan Muchal: There are a number of metrics that you can look at, but I guess the two I’ll highlight today are the strip ratio and the Net Present Value. The strip ratio is how much ore you need to move to get at the mineral that you’re after. The higher this ratio, the more rock you need to move and the lower the economics of this deposit. It’s actually what ultimately constraints the depth and the size of the mine. The other metric that is widely quoted and definitely an important one is the Net Asset Value. It’s the actual value of the deposit in monetary terms. You look at the deposit itself without taking into account the capital structure of the company. You first want to see the size of the resource, how long it would take to produce that and the cost of the production.
You then take this number and you discount it back to the present to figure out what the mine is actually worth today. You use a discount trade in this process, which is a way of determining the cost of money in the future compared to money today. This number can be a little bit manipulated by different people, so you want to look at what that discount rate is. If it’s high, it’s a more conservative number. You also can look at things like if it’s after tax or before tax, or the actual cost and assumptions that go into the inputs.
Tracy Lynn: What does it take for a junior mine to go from initial discovery to production?
Stefan Muchal: So the phases in any resource company are the same. You first need to explore for whatever you’re looking for. This will answer some basic questions like, what is it you’re looking for? Where is it? And how large it is? This is the most risky part of the process and where most companies don’t usually make it past. From there you want to go into a planning phase where you figure out how you’re going to develop this resource that you’ve found. From there, you go into construction where you actually build the mine. This is the most capital-intensive both in terms of money and labor and takes within usually two to three years.
From there you actually get into the production. Here is where you actually mine the resource that you found. It can take anywhere from 1 to 100 years depending on what the resource is and the size. And then after that, you need to close the mine, so you want to bring it back to its initial state before you started mining.
Tracy Lynn: How has mining changed over the years?
Stefan Muchal: You know, it hasn’t actually changed all that much in the last 100 years. The same steps that you go through to mine the resource have been basically the same in the last 100 years. What has changed is technology. It’s a lot easier to get different resources and lower-grade resources than you could in the past. You now can mine much larger resources at a lower grade than you could in the past. The average grade of most mines now on the gold side have dropped from maybe 2 grams per ton 15 years ago to about 1 gram. From there, also the other major change is in regulation. It now is a lot tougher to bring a mine into production due to regulatory and environmental issues.
Tracy Lynn: As an analyst, what are some warning signs that we should look for before we invest?
Stefan Muchal: So I’d recommend that anyone looking to invest in this sector start off on a company’s website. You want to look at a number of basic factors to see, firstly, is it a really promotional website? If it is, it probably is a promotional company and they’re not really focused on building value long term. From there you can look at different factors: If the management has moved from company to company, it has once been a gold company and now is a uranium company; they’re probably not good at either. Also, on the deposit side, if it’s a deposit that has been in a number of different hands over time, that’s probably not good now since it wasn’t good before. And another good factor to look at is if the management has their own skin in the game. If they’re invested in the company then they probably want to make this work.
Tracy Lynn: Great, well thank you very much for taking the time with us today!
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