Make a wrong move, and investing in penny mines can cost you your investment.

In the 18th century, pioneer economist Adam Smith (author of The Wealth of Nations) wrote that the public tends to overvalue what he called “speculative ventures.” The world has changed a lot since then, but his warning still applies—and especially when it comes to penny mining stocks. These are low-priced stocks (often traded in pennies, but perhaps as high as $5 a share) that often have a mineral deposit and hope to transform it into a profit-making mine.

As mentioned, the investing public as a rule tends to overvalue penny mines. Investors pay too much attention to the vast profits that can come with success, and too little to the obstacles that stand in its way. Most penny mines fail to achieve their goal.

Penny mines: the background information you need to make a smart investment

The deposit may be less rich or less suitable for mining than it appears on the surface. Before the company can start mine construction, it has to determine that the project is technically feasible. It has to get government authorization for the mine, mill and related activities. All these approvals have to overcome environmental objections. In addition, the company has to carry out a series of financings to raise money for all this activity.

Financing always depends on the current market price and price outlook for the mineral that the promoters hope to produce. If the outlook weakens, financing can fall through at the last minute.

The majority of penny mines wind up being stalled indefinitely due to one or more of these hurdles. The penny mine may then go into financial hibernation for months, years or decades. A future promoter may take a second kick at the can, of course. If so, new financing almost always dilutes previous investment, sometimes down to nothing, or close to it.

Penny mines share prices can be very volatile—and unpredictable

The share price of a penny mine can go through a series of wide fluctuations while the company pushes on with its quest. It may look like it’s possible to make money by buying low and selling high while this is going on. Many investors try to do so. But most investors wind up losing money in penny mines. There are simply too many ways for a venture like this to go wrong.

Success is even more elusive for ventures aiming to produce minerals that are currently in great demand (for example lithium for electric car batteries), but that may be replaced in years to come by new technology. That could happen just as a new mine comes into production. Success can also be elusive for mineral deposits in volatile countries like the Congo.

Penny mines: what we look for in an investment opportunity

• We look for well-financed junior mines with no immediate need to sell shares at low prices. That’s because doing so would dilute existing investors’ interests. The best junior mining firms have a major partner who has agreed to pay for drilling, or other exploration or development, in exchange for an interest in the property.
• We avoid penny mining stocks that trade at unsustainably high prices because of broker hype or investor mania about the underlying commodity (such as gold). Instead, we focus on reasonably priced penny mining stocks with favourable geology.
• We want to see penny mining stocks with experienced management that has a proven ability to develop and finance similar projects by working with other junior-mining companies.
• We look at environmental constraints where the junior mines are looking for minerals. In Europe and certain parts of the U.S., junior mines need a particularly rich find to justify the costs of overcoming environmentalists’ objections.

Look at the market cap of all penny mining stocks

We also look at the market cap of 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 ore body. We like a mining 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 mining stock’s market cap, it provides a margin of safety.

In today’s stock market, how do you feel about investing in junior penny mines as opposed to established mines?

Penny mines can seem appealing when they’re successful, but the chances of success are slim. What would convince you to invest in a penny mine?