Learn how to invest in junior mining stocks to make better investment decisions for the Resources component of your stock holdings

Despite the promising prospects of some top junior mining stocks, it’s important to remember that these stocks are among the riskiest you can buy. That’s why we think it’s a mistake to load your portfolio up with these potentially volatile companies.

Here’s a quiz to test your knowledge and learn more about how to invest in junior mining stocks:

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A.  True or false: Junior mining stocks come with greater risk than majors?

You are correct if you answered “True.”

Even though some junior mining stocks have strong profit potential, they entail higher risk than more established mining companies, for a number of reasons.

For one, the odds that the companies behind junior mining stocks will find an “anomaly,” or a geological formation that might attract a prospector’s interest, are slim. One rule of thumb is that you have to look at 1,000 anomalies to find one prospect. And fewer than one prospect in a thousand turns into a mine. In other words, finding a big enough deposit for a mine is a million-to-one shot.

Another reason is that it’s much easier to launch and promote one of these stocks than it is to build a profitable business. So junior mining stocks attract more than their share of unscrupulous operators and stock promoters.

B.  Learning how to invest in junior mining stocks for maximum gains involves…

1.  Looking for well-financed mines
2. Avoiding mining stocks that trade at unsustainably high prices
3. Look for mines with future demand
4. All of the above

You are correct if you answered 4.

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 the drilling or other exploration or development, in exchange for an interest in the property. As well, they have sound balance sheets with manageable debt.

We focus on reasonably priced mining stocks with favourable geology. We look at the market cap of mining stocks—including junior mining stocks—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 orebody.

C.  True or false: Flow-through funds are a good target while investing in junior mining stocks?

You are correct if you answered “False.”

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 investors in the fund.

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.

D. The following are key considerations in knowing how to invest in junior mining stocks with less risk… 

1. Look for environmental constraints
2. Select mines operating in an area with similar geology
3. Find junior mines with positive cash flow
4. All of the above

You are correct if you answered 4.

When investing in penny mining stocks, look at environmental constraints in places where junior mines are exploring for minerals. When we recommend juniors that are exploring for minerals, we prefer those that operate in an area whose geology is similar to that of nearby producing mines.

We also want to see positive cash flow, preferably even when commodity prices are low, in mining stocks we recommend. Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient to cover, or at least contribute to, the cost of developing a second mine.

E.  Resource stocks, including mining stocks, should make up…

1. The largest part of an investor’s portfolio
2. No part of a conservative portfolio
3. The dominant share of an aggressive investor’s portfolio
4. A limited portion of most investor portfolios

You are correct if you answered 4.

We recommend that you manage your risk in the volatile resource sector by investing mainly in stocks of profitable, well-established mining companies with high-quality reserves. For that matter, resource stocks (and this includes oil and gas, of course) as we said earlier should make up only a limited portion of your portfolio. 

Bonus tip: Use our three-part Successful Investor approach to make better overall investment decisions 

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

Over the last couple years, junior mines have had to share the interest of aggressive investors with cannabis stocks. How long do you think this trend will continue?

What is your opinion of junior mining stocks? Are there some that conservative investors should consider?