The best mining company stocks will have a record of success and a strong management team

Mining company stocks involve the exploration for, and the development and production of minerals. While sometimes risky, mining stocks can also be strong performers when commodity prices move up.

We think most investors should consider holding some mining stocks as part of a well-diversified portfolio.

How to pick good mining company stocks

Look for steady production: Some of the most highly promoted mining company stocks, including gold mining stocks, are penny stocks that have yet to produce an ounce of gold or other minerals. Many must still add to their reserves, invest in mine-feasibility studies, and raise a lot of money before they go into production. The prospects for most of these penny-mine properties, even though they may be in areas with production from existing mines nearby, are far from certain.

Seek strong reserves, low production costs and mines that are already producing: Good mining company stocks have a range of development projects, but their strong base of production cuts the risk of relying on new developments alone.

Look for longevity in reserves: When you invest in any resource stock, gold included, you need to look at how long the company’s reserves are likely to last. Those with low reserves need to have consistent success in their exploration programs to maximize the production of the mine and the surrounding area. That success is far from guaranteed.

Invest in stocks with a broad base of operations: Even if the company has strong reserves, the best mining company stocks with the least risk also have a diversified reserve base. That way they are not dependent on a single mine’s production or political stability in any one country. Mining companies can also increase their reserves by making acquisitions—with mineral prices down from their record highs, you may see an increase in mining company acquisitions at distressed prices.

Invest in well-financed mines: We look for well-financed mining stocks with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best junior miners have a major partner who has agreed to pay for drilling or other exploration or development, in exchange for an interest in the property.

Focus on stable political regions: We generally stay away from mining companies operating in insecure and politically unstable regions like the Congo and Venezuela, or in countries with little respect for property rights and the rule of law, like Russia or Mongolia. Mining is inherently a politically vulnerable business; you can’t move the mine to another country, and local citizens sometimes believe that a foreign mining company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.

Should you invest in mining stocks?

We recommend that investors diversify their portfolio across most if not all of the five major sectors, including Resources.

However, some markets are inherently unpredictable, especially energy and mines. The markets for fungible goods like oil, interest rates and gold are especially unpredictable.

Markets like these are so enormous that there is no practical limit to how much you can trade in them. It follows that if you could predict them, you could wind up acquiring a measurable proportion of all the money in the world, and nobody ever does that. That’s why it’s a mistake to build your portfolio in such a way that you have to accurately predict the future direction of fungible goods like oil, interest rates or gold.

Instead, invest in sound Resource companies that will gain from rising production and cash flow, rather than commodity-price predictions.

Bonus Tip: Build a sound portfolio

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

For example, manufacturing stocks may suffer if raw material prices (including energy) rise, but in that case your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

If borrowers can’t pay back their loans, your Finance stocks will suffer. But high default rates usually lead to lower interest rates, which push up the value of your Utilities stocks.

As part of their portfolio diversification strategy, most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

Do you own mining company stocks? How have they performed for you? Share your story with us in the comments.