Why Short-Term Risks in Junior Miners Could Lead to Long-Term Profits

The fall in the price of gold bullion has certainly hit investors, but there is even greater pain among junior mining stocks. 

Obviously, junior mining stocks depend on gold prices to generate revenues and earnings. However, unlike larger, more integrated companies, junior mining stocks might not have any cash flow, thus they depend on external financing for the development of mines and exploration work. 

Because gold prices have declined significantly, many junior mining stocks are suffering as the availability of financing is drying up. 

A stark example of what can happen to junior mining stocks in the gold bullion sector is the recent events regarding Colossus Minerals Inc.(OTC/COLUF). This company was trading at $10.00 a few years ago, and just closed a $28.75-million round of financing a month ago at a share price of $1.60. 

Just a few days ago, Colossus Minerals announced that production from its mine in Brazil will be delayed due to technical difficulties and the company might need to raise additional funds, with estimates ranging from $25.0 million to $50.0 million. In just one day, the stock was cut in half and is now trading at $0.80 per share. 

While many investors interested in gold bullion look to junior mining stocks as a way to get a higher return, there are significant risks associated with this sector—especially with gold prices so far below their peak, which will make financing difficult for many junior mining stocks. As costs remain elevated, this will ultimately result in firms working together to try and reduce production costs, at least in my opinion. 

There are two investment-minded ways to look at the current situation. One can look for junior mining stocks that are exploring for gold bullion but will need financing and so are trading at a very low price; these could be potential takeover targets. Conversely, the larger gold bullion producers that have excess cash on hand might be interesting over the long-term, since they could finance expansions and might look to buy assets at a discounted price. 

I would certainly look to gold bullion producers that have very low costs per ounce as well as suitable levels of cash to ride out the low price of gold bullion. With junior mining stocks unable to find financing, this ultimately means less supply of gold bullion on the market. At some point, the supply-and-demand dynamics do need to come into play. 

With larger gold producers such as Eldorado Gold Corporation (NYSE/EGO) announcing that they are reducing capital spending by 35% through pushing back the development of several gold bullion mines, this trend of slowing mine expansion will continue for some time, which should result in lower output levels of gold bullion. 

With lower levels of gold bullion produced and demand continuing to remain strong for physical gold bullion, over the long run, this should be bullish for the price. 

For the junior mining stocks that can withstand the current price of gold bullion, there could be long-term opportunities. However, I would certainly avoid any junior mining stocks that are desperately low on cash. There is the potential for significant share dilution as the company looks to raise capital at the expense of current shareholders.

~ by Sasha Cekerevac, BA 

This article was originally published at Investment Contrarians