Why Gold Juniors Have Not Yet Popped

We have seen incredible rises in precious metals in the last few months - with gold having been over $1000 and silver above $20. Numerous senior mining producers have seen tremendous gains in stock prices in these market conditions. Junior companies, on the other hand have been quite lackluster in their performance. The Canadian Venture Stock Exchange ($CDNX) is a good benchmark of junior companies since it’s heavily weighted toward smaller mining companies. A look at the CDNX versus HUI ($HUI) shows that the performance of the venture exchange has been more than disappointing versus the index of unhedged gold producers. In fact, this comparison shows that the CDNX has depreciated by almost half of its value versus HUI in eight months.

Reasons Why Juniors Have Not Yet Popped

With gold reaching record levels, it only makes sense that junior companies ought to soar right? Wrong. As with most industries, things are not always what they seem; there are often numerous extraneous factors that affect the performance of companies, and it seems like junior gold companies have become a victim of these extraneous factors. The good news is that investors are beginning to understand what these factors are, what they mean and how they will likely affect the market in the future. Let us now explore some of the reasons why junior mining companies have not performed up to expectations:

1. Rising production costs – it is becoming increasingly more difficult to extract gold. This increasing difficulty coupled with the high energy intensive production has made it more expensive to mine this precious metal. For junior companies, this becomes even tougher due to the lack of scale economies. In addition, the weak dollar has eroded profits for many North American companies (the US is the world’s third largest producer, next to China and South Africa). For example, Gammon Resources (GRS) saw a net loss of $44MM in Q3 of 2007 despite skyrocketing prices.

2. Increasing popularity of ETFs – The first gold exchange-traded fund GLD was launched in 2004. ETFs make investing in gold easy and cheap; in addition, ETFs reduce mining risks, company risks and country risks. GLD has gained immense popularity with investors; it is now the eighth largest holder of gold in the world. This popularity will only increase as investors seek more diversified investment vehicles.
3. Growing fear of recession and the credit crisis – Junior mining companies tend to be more volatile and more speculative than established companies. The recession has changed many investors’ psychology, and the appetite for speculation has certainly seen a dramatic reduction. As a result, investors are staying away from the more speculative junior stocks.
4. Majority of juniors are speculative exploration companies and are not producers themselves – Exploration companies do not produce gold, and are unlikely to benefit from the surge in gold prices. It’s important to note that a majority of junior companies on the stock exchanges are classified as exploration – they do not have the capital or the skills to produce and process the gold themselves.

Time To Pick Up Some Junior Shares

The question on everyone’s mind is whether or not juniors will experience the same surge in stock prices as experienced by gold and many senior companies. I think the answer is likely to be yes. With the state of precious metals continuing to be wildly bullish, right now is the time to pick up shares of junior companies as they are tremendously undervalued. When the uptrend begins, it’s going to be over very quickly due to the low prices and relatively high volatility of these companies. The prudent investor will have a portion of their portfolio dedicated to junior companies to ensure that they’re ‘in the game’ when the time comes. Although this is a speculative play, the odds for these companies look good; and with sound analysis, you might just be able to pick the next ten-bagger.