Learn why even the best mining penny stocks entail high risk for investors. But if you follow these rules, you’ll have a much better chance of success

Penny mining stocks are some of the riskiest stocks Successful Investors can buy. These companies aim to find mineral deposits with mine-making potential—but such finds are exceedingly rare. Because of this, it’s even more important to try to maximize investment quality and invest only in the best mining penny stocks.

For example, we automatically rule out investing in penny mines that promote themselves too aggressively or do so misleadingly. The mine-finding effort is more likely to succeed if the managers focus on finding a mine rather than hyping their stock.

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Realize that the best mining penny stocks are very hard to find

One rule of thumb for mining stocks is that you have to look at 1,000 “anomalies” to find one “prospect,” and that fewer than one “prospect” in a thousand turns into a mine. In other words, finding a mine is a million-to-one shot.

That’s one reason why penny mining stocks are typically highly speculative, and are apt to cost you money. Another reason why pennies are risky is that it’s relatively cheap and easy to launch a penny mine stock and sell shares to the public. So, the penny mines promotion business attracts more than its share of unscrupulous operators and stock promoters. That’s increasingly the case when unmined, easily reached deposit sites are harder to come by worldwide.

However, the best pennies can play a role in a small portion of your portfolio, specifically the part you devote to aggressive resource investments.

Watch for these 4 factors when looking for the best mining penny stocks

1. We want to see experienced management with a proven ability to develop and finance a mine.
2. We look at environmental constraints where the junior mines are looking for minerals. In Europe and certain parts of the U.S., pennies need a particularly rich find to justify the costs of overcoming environmentalists’ objections.
3. When we recommend penny stocks exploring for minerals, we prefer those that operate in an area with geology that is similar to that of nearby producing mines.
4. We think you should avoid stocks trading over the counter, where such things as regulatory reporting are lax.

Investing successfully in mining stocks means avoiding even the so-called “best” mining penny stocks

The best mining stocks are steady, profitable, and involve well-financed companies.

However, you should always resist the temptation to load up on mining stocks, no matter how attractive they appear. If the market goes into a downturn, these stocks could suffer more than average.

We recommend that investors diversify their portfolio across most if not all of the five major sectors, including Resources. However, note that some markets are inherently unpredictable, especially energy and mines.

Avoid flow-through funds when looking to invest in the best mining penny stocks

Flow-through limited partnerships are tax shelters that mainly invest in the flow-through shares issued by junior mining and oil companies. These companies spend the proceeds from the shares they sell on mineral exploration and development, an activity that qualifies for certain tax credits and tax deferrals. These tax benefits “flow through” to the partnerships and then to their investors. In general, to take advantage of these benefits, investors need to hold the partnerships for a fixed period, usually 18 months to two years.

Investors buying into flow-through limited partnerships are typically able to deduct 100% or more of their investment against income by the end of the second year. This leaves the investor with a cost base on the units of zero. When you subsequently redeem or sell the limited partnership units, you pay capital gains on the entire balance of the sale. That’s advantageous for investors, because capital gains are the lowest taxed of various income streams that investors can receive.

However, the problem with these tax shelters is that they may persuade you to make a risky investment you wouldn’t otherwise make. Moreover, a portion of the benefits are set aside for brokers and the partnership’s organizers. What’s left may not be enough to pay you for taking on the extra risk.

Keep in mind that most flow-through issuers are junior companies that are short on financing, or don’t have enough income to make full use of the tax benefits associated with their exploration. That’s why they sell these benefits to investors.

One big drawback in flow-through limited partnerships is that almost all of the flow-through mining and energy stocks they invest in are highly speculative. The partnerships are also usually in a hurry to invest their money to pass the tax deductions on to their investors as quickly as possible. That can lead to some hasty stock selections.

Rather than invest in flow-through entities, we think you are much better off keeping things simple and investing in strong, more-stable mining stocks.

Use our three-part Successful Investor approach for the bulk of your overall portfolio

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Do you keep any mining penny stocks in your portfolio? How are they performing for you?

This article was originally published in February 2020 and is regularly updated.