The best Canadian mining companies are well-financed with low debt and good management

The best way to invest in Canadian mining companies is through high-quality mining stocks as part of the Resource sector of your portfolio.

Mining stocks are affected by fluctuating commodity prices in addition to their own business and operating risks. Still, while sometimes risky, mining stocks can also be strong performers when commodity prices move up. However, due to the volatility of these stocks, TSI Network recommends that they only form a modest part of a well-balanced portfolio.

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The benefit of investing in Canadian mining companies in the Resource sector

Resource companies produce and sell commodities. So it’s hard for them to bring a distinct product to market. But they can distinguish themselves by how well they find and produce their products.

The top resource companies acquire a lasting competitive advantage by developing their engineering, financial and political expertise.

Resource companies do sometimes turn out to have hidden environmental liabilities, as do companies in other sectors. But the top resource stocks also create their own hidden assets. They accumulate rights to promising acreage long before the land rush starts. They have the technical and political skills they need to foresee and deal with environmental and political obstacles.

Inflation and volatility of resource stocks

The resource sector is subject to wide and unpredictable swings in the prices it gets for its products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.

In addition to rising and falling with the business cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they provide a hedge against inflation.

You may feel resource stocks could languish for years. You may think it’s best to stay out of them until inflation moves up. But these stocks could give us an early warning of coming inflation. They may shoot up long before inflation revives.

Finding the best Canadian mining companies

When we’re looking at investing in Canadian mining companies, we look for well-financed companies with no immediate need to sell shares at low prices. They typically have strong balance sheets with low debt. If they’re junior explorers, we’ll consider them if they have a major partner who can finance the mine to production.

However, we avoid any Canadian mining companies that trade “over the counter,” where such things as regulatory reporting are lax. And we don’t invest if the stock is trading at an unsustainably high price, because it’s likely the result of broker hype or investor mania.

Instead, we seek an experienced management team with a proven ability to develop and finance a mine. We make sure they’re not in any insecure or politically unstable regions, or in countries with little respect for property rights and the rule of law.

Finally, we look at the market cap versus the estimated value of the mineral resource they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of its ore body. We like a stock’s market cap to be no more than half the value of the mine. We assume that the company will be able to expand its reserves after the mine opens, but if the reserves are double the stock’s market cap, it provides a margin of safety.

Are junior mines of Canadian mining companies worth it?

Mining companies can generally be broken down into two categories, majors and juniors. Junior mining companies typically have negative cash flow since they’re spending money in hopes of finding a mineable deposit.

Many investors have asked me whether they should invest in juniors.

My answer is that you should always first ensure that your portfolio is spread out across most if not all of the five main economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance, and Utilities). However, junior mines can play a role in the smaller part of your portfolio that you devote to more aggressive investments.

Even though juniors can have strong profit potential, they entail higher risk than more established mining companies.

How do you feel about Canadian mining companies that work in suspect locations or with questionable extraction processes? Share your thoughts with us in the comments.