'Why I speculate in exploration juniors …' – Steve Todoruk

Key points:  Steve Todoruk talks when to get in and what happens along the way for speculators in these stocks.

Steve Todoruk joined Sprott Global Resource Investments Ltd. as a Senior Investment Executive in 2006. He is probably one of the best people to talk to about the life-cycle of junior mining stocks.

He recently explained the speculation process in these stocks. Here’s a short-hand version (to view the full version, click here):

I believe that one of the most exciting — and potentially rewarding — ways to invest in the mining sector is through shares of small companies that have just announced a new, potentially large, mineral discovery.

The following chart, originally published by Brent Cook, nicely depicts how these stories often play out.

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Fig. 1:  “The Most Important Graph In Mining”

Most of the more than 1000 Canadian exploration companies in existence are out exploring their properties and performing various tests (soil sampling, prospecting, geological mapping, and geophysical analysis).

They are trying to delineate worthy or attractive targets/anomalies. If they come across an anomaly of interest, they will drill-test the area in the hope of being the next company to announce a significant mineral discovery.

The far-left side of the chart depicts this early exploration stage where they are toiling away on the property, having made no significant discoveries.

Most never succeed; nothing exciting tends to happen to their share price.

So we wait for that occasional junior to defy the odds, and announce the intersection of good-grade mineralization. This signals a potential new discovery.

I look at the grade, thickness, and location of the intersection, along with a few other variables. If I like what I see, I will start advising my clients to acquire shares.

We hope that the company needs to raise more money soon, which may allow Accredited Investors to enter at preferential terms (such as with warrants) through private placements.

For speculators willing to take on high risk for the opportunity to participate in extraordinary gains, I believe this stage is one of the best times to open a position in a junior exploration stock.

The junior’s share price may move upward quickly afterwards, signaling that something really exciting or material may have been discovered.

From the time a junior drills its first good drill hole, the game is on. The company may spend another 2 or 3 years drilling the deposit.

Over these next 2 or 3 years, if the junior can keep growing the value of its deposit, the share price is likely to climb as well.

Some of the more recent but historical examples of juniors (and their investors) that have enjoyed this ride are the two below:

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Fig. 2: Virginia Gold Mines Ltd. stock chart. July ’04 – April ‘06
Share price rose with ongoing drilling. As the deposit grew, the share price increased to reflect the higher asset value attributed to that discovery.

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Fig. 3: Aurelian Resources Inc. stock chart. September ’05 – March ‘08
Investor perception of the new discovery’s size pushed the share price higher as Aurelian drilled its Fruta Del Norte discovery. The stock eventually settled out and trended sideways when it began to appear that drilling had delineated the full deposit size.

Eventually, the company announces that it has fully delineated the size of the deposit. At this point, the share price typically takes a breather from what may have been a long upward climb.

In many instances, a major mining company will take over the junior, in order to complete the project and build a mine. For example, Goldcorp took over Virginia at $10 per share in 2005; Kinross Gold Corp. bought out Aurelian at $34 in 2008; in 2011, Rio Tinto took over Hathor Exploration Ltd. at $4.70.

In other cases, majors wait for the junior to “de-risk” the project by doing less exciting work like engineering, metallurgy and environmental studies.

The market does not typically see this process as adding value (though it does) and so the stock tends to plateau or go down.

Some current examples of juniors in this stage are Mag Silver Corp. and Rubicon Minerals Inc.

The market usually starts to wake up as the junior nears completion of the de-risking studies.  If the story culminates with a takeover, shareholder can often receive a takeover premium above the highest price where the shares have ever traded.

In this scenario, everyone walks away happy. Shareholders in the junior made money (sometimes a lot of it). The big mining company has a new mine, growing its assets for its shareholders.

Sometimes, even though a new discovery looked good, majors don’t see the deposit as worthwhile to mine. This means a takeover will probably never come. When the market realizes this, many investors will likely head for the exit, and the junior will be stuck with the deposit.

The junior may try to build the mine on its own. Like many investors, I believe small exploration companies should not build mines, and would want no part of this kind of a story.

Two new discoveries that may be economic are the high-grade uranium discovery announced by Alpha Minerals Corp./Fission Uranium Corp. in central Canada late last year, and Reservoir Minerals/Freeport McMoran’s new high grade copper-gold discovery in eastern Europe.

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Fig. 4: Alpha Minerals Inc. stock chart. September ’12 –September ‘13
Stock trade sideways pre-discovery, until a new discovery was made. Investors bought the stock betting the new discovery would become economically viable. More drilling seemed to confirm the hypothesis and share price grew.

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Fig. 5: Fission Uranium  Corp. stock chart. May ’13 – September ‘13
As Fission Uranium and Alpha Mineral drilled their property, the apparent size of the uranium deposit continued to increase, pushing share prices higher.

Junior exploration companies offer attractive potential returns immediately following a new discovery, according to Steve. If everything comes together, investors who remain with the stock may eventually be able to cash out in a takeover by a bigger mining company at or near the shares’ all-time high.

Along the way, however, if their drilling results disappoint, you may need to head for the exits.

To view Steve’s full talk, please click on the image below.

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Questions? Contact Steve Todoruk.

Steve Todoruk worked as a field geologist for major and junior mining exploration companies after he graduated with a B. Sc. in Geology from the University of British Columbia, in 1985.

Steve joined Sprott Global Resource Investments Ltd. in 2003 as a Senior Investment Executive. To contact Steve, e-mail him at stodoruk@sprottglobal.com or call him at 1.800.477.7853.

P.S.: Interested in natural resource investing? Click here for Rick Rule’s Guide to Natural Resource Investing.