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We are not miners ourselves, but we have long experience as traders and investors in the sector. We will explore a few areas for traders and investors to keep in mind.

A critical point is that there are stages in the life of a company.  These stages are exploration, development, and production.  A company can be in any one of these stages or all three.  The major companies continue exploring for new ground and developing new mines while they operate existing mines.

The exploration stage comes first. In this stage a company is an entity that may or may not have rights to a piece of property. It may or may not have made any significant discoveries. So exploration stage companies present levels of risk that need to be recognized. Their stock prices can swing very wildly due to actual developments such as discovery of a deposit, or by rumors or runs started by stock speculators. These are usually “penny stocks” traded by speculators, mostly on the Vancouver Stock Exchange and on the over the counter markets in the United States.

After a company has proven reserves which have been reported to the authorities, they gain more gravitas and are considered to be actual assets by investors. These companies then formulate development plans on starting mining operations. Investors and speculators have opportunities here to get in on the ground floor of something big, or to lose it all if the projects fail. These companies are traded on the Toronto Stock Exchange, and can get off of the penny stock pink sheets (OTC, or Over the Counter) in the U. S and get listed on the NASDAQ or NYSE.

The safest space for trading and investing are companies with working mines in production. This can be a single mine, or a global empire of numerous mines. Generally, miners are divided by investors into Junior Minors, and Majors depending on the size of the company and their proven reserves in the ground. The majors generally have a bit less leverage to metal prices, but are regarded as safer investments due to diversification of income sources.

Check out the current trend strength of gold miners here.

In addition to companies focused on exploration and production, we must also mention royalty companies.  These companies operate as a source of funds for developing miners.  Developing a mine is a very expensive undertaking. Money can be sourced from:

A) Selling shares of stock, thus diluting current shareholders.

B) Borrowing from banks or other lenders, which risks not being able to service the debt.

C) Selling a portion of the future mine output as a royalty, reducing future earnings.

Royalty companies buy a percentage of future production (a royalty) in exchange for capital funds to develop the mine. Royalty companies aren’t miners, but they get their income from mines.

The safety of investing in royalty companies depends on financial factors. Where did they get the money to buy the royalty? Did they borrow it? Did they sell shares in their own company to acquire it?

So it is important to look at the balance sheet of the royalty company in order to see if they are financially sound when investing in them. The value of their royalties depends on metal prices and the dependability of their partners to deliver. Examples of large diversified royalty companies are Royal Gold and Franco Nevada.

The mining sector investor must be aware of the leverage potential both up and down caused by changing metal prices. Take a simplified example of a fictional silver miner. If their all in sustaining costs are $15/oz, then they make $1 per ounce at a sliver price of $16. Profits double at $17, pushing the share price up, possibly double or more. However, if silver goes to $14 they go out of business if it stays there too long, while the share price plummets. So if you have a miner which has a cost of production that is very close to the price of silver, you can expect extreme price volatility, and even risk losing it all as the price of silver rises and falls.

As a cautionary note, it is crucial to look at the debt level of a company. It is easy to check the quarterly balance sheet item for Cash and Long Term Debt. Famous stock analyst Peter Lynch sardonically noted that a company can only go bankrupt if they have debt. He advises checking to see if they have more cash than long term debt.