In grading a junior miner I have five main concepts, they include:

Management assessment: Track record, interview, insider buying/selling records, and word of mouth — I try to determine whether management is an asset or liability (only assets pass).

Share structure: A good share structure is one that hasn’t seen any chance for distribution yet, and where insiders and key people still have a meaningful enough stake in the company.

Capital structure: Does the company meet my solvency tests (past and future)?

Scope: Risk versus reward: Is there enough upside relative to the risk category of the deal — for risky juniors I like a 10:1 ratio…for blue chips a 3:1 ratio…etc.?

Valuation: Absolute and relative. This is not really objective. Typically I will want to understand the reason for the market’s current valuation — relative and absolute — and if the reason for an expected favorable change in valuation is plausible. I’ll be looking for areas that the junior is undervalued — where you can pick up shares for a hefty discount.

After I’ve taken into account all of these concepts and if the junior company passes all of my filters, I may make a trip to the mine site if practical, and “kick the tires.” This is also a very important step in ensuring the quality of a junior miner — and more importantly, this step helps avoid small fly-by-night operations and shell companies.

Along with my basic concepts for grading juniors I’ve developed five additional criteria to identify which companies are most vulnerable to buyouts. In my search for takeover candidates I’ve focused on the following themes I call them my takeover checklist:

1. How big is the company’s deposit? The majors are thinking big here. Companies like Newmont threw every possible resource it had at growing its reserves in 2005 — and at the end of the process, had fewer reserves than it started with? A deposit of at least 5–10 million ounces will add a lot of gold to the books in very short order. So the juniors with large deposits are always favorable.

2. How far along is the deposit’s development? The majors don’t want a company that’s just begun drilling and doesn’t have a clue how much gold it’s actually sitting on. They want a sure thing — something that’s just been discovered, or something that’s just about to go into production.

3. Is the mine located in a mining-friendly country? The third thing the majors don’t want is what happened recently in Ecuador. After a huge gold discovery Ecuador’s government suspended mining for six months so it could rewrite the country’s mining law — and undoubtedly seize more or the profits for itself.

The lead developer of that site, Aurelian, got whacked 31% the day of the announcement. So it’s essential the government in the country where the mine is located is mining-friendly.

4. Is the mine economic at current prices? If there is not enough information on the resource or if the grades aren’t high enough — some mines may never pass a feasibility test.

In these cases the mine may not end up proving to be economic — this is a clear barrier to any major buyouts.

5. Does the company have the ability to put the mine into production? Some companies are looking to “flip” a mine. Essentially I don’t want to look at companies that are just looking to be bought out. I want to make sure a junior has the capability and assets to develop a mine. Major gold producing companies will avoid buyouts if the junior looks to be flipping a mine without any intention to mine it themselves.

All of the information that I gather about a junior comes from various places. I’ve been watching the mining industry for the past 18 years so many of my junior picks will come from my contacts as an insider in Vancouver’s mining and investment industry.

But along with that “insider” information I will always perform my due diligence which includes: tracking research, analyzing annual reports, searching through other filings, scanning industry news, attending company board meetings, and scanning charts for unusual bullish or bearish activity.

But finding the right junior miners takes all of this and more. It really is a full-time job. So when you’re looking for the right junior miner to invest in this gold bull market, remember to do your due diligence.

Good trading,

Ed Bugos
July 18, 2008

The Junior Miner Checklist was originally featured in the Penny Sleuth.