Investing in junior mining shares... What risk? What reward?

Most people are risk averse because it's been bred in them from early childhood. Protective parents caution their children "Don't climb that tree, you might fall." "Be careful of that dog, it might bite you." That caution carries over into early adulthood and then into the workplace, where "don't rock the boat" makes the most sense. Is it any wonder that when it comes to investing people are subjected to two conflicting ideals? One is to make as much money as possible, and the other is to take as little risk as possible to achieve this. How can this be done? Well, it can't. Many people resort to professional money management in their desire to achieve these diverse aims.

Even the best money manager will fail if the investment cycle is not with him or her. A major benefit of understanding the Kondratieff cycle is that it allows us to make lower risk investments in each of the four Kondratieff seasons. In each of the seasons there are appropriate and inappropriate investment mediums. For example, in the Kondratieff autumn, stocks, bonds and real estate make the best investments, whereas investing in gold and gold stocks are high risk. The opposite is true for the Kondratieff winter. The trick is recognizing where we are in the cycle. Fortunately there are events that provide us with that information. For example, we know when the great bull markets in stocks, bonds and real estate are about to commence in sync with the onset of the Kondratieff autumn. Four events precede this: the peak in interest rates, the peak in prices, a bear market in stocks, and a recession. These events occurred between 1980 and 1982 and similarly between 1920 and 1921. Following those events one could have invested in real estate, bonds and, in particular, stocks, with the confidence that these three investments were about to begin the biggest bull market of a lifetime.

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Spring

• Gradual increase in business activity and employment.
• Consumer confidence increases in line with growing economy.
• Consumer prices start a gradual increase from very low levels.
• Stock prices begin a steady rise and reach a peak at the end of Spring.
• Interest rises slowly from historic low levels in line with gradual credit expansion.

Summer
Summer War

• 1st Cycle: War of 1812
• 2nd Cycle: US Civil War
• 3rd Cycle: World War I 1914-1918
• 4th Cycle: Vietnam War


• Financed by massive increase in money supply leads to large inflation which peaks at the end of Summer.
• Gold prices reach significant peak at end of Summer.
• Interest rates rise rapidly and peak at end of Summer.
• Stock market under pressure and ends Summer with a bear market low.

Autumn

• Massive stock bull market financed by fiscal and monetary largesse.
• Stock prices reach euphonic peak to signal start of winter.
• Inflation and commodity prices fall.
• Real Estate prices rise and reach peak at beginning of winter.
• Gold and Gold equities in bear market, reach bear market low at Autumn's end.
• Debt reaches astronomical levels by end of Autumn.
• Massive consumer confidence due to stock prices, real estate prices and plentiful jobs .

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Winter

• Stocks start major bear market, the bear market is in proportion to the preceding bull market.
• Debt repudiation significant.
• Bankruptcies.
• Banks and quasi banks in crisis.
• Credit crunch - interest rates rise.
• International currency crises - a la 1931-34.
• Gold and gold equity prices rise as deflation takes hold.

The onset of the Kondratieff Winter is signaled by a peak in stock prices at the end of the great autumn bull market. So it was in 1929 and 2000. This means that we are now in the deflationary/depression stage of the cycle.

'Winter is the worst of times, and the best of times'. It is the worst of times for stocks, real estate and bonds, just as autumn was the best of times for these investments. But it is the best of times for gold and cash. Thus, investment risk has increased dramatically for stocks, bonds and real estate; whereas investment risk in gold and cash is at the lowest point of the entire cycle.

At the height of this autumn bull market an investment manager deemed cash 'trash'? It isn't any more. Cash is king now. Why? Because it's liquid and because its purchasing power rises during the deflationary winter.

If cash is king, what is gold? Well, according to John Exter, a New York Federal Reserve banker in the 1970s, it's a more powerful king than cash. Indeed, during the deflationary winter depression, gold is the most liquid of all assets. In the 1970s John Exter produced an inverse pyramid in which he showed assets in descending order of liquidity. At the top of the pyramid, he deemed small business the most illiquid asset. At the very bottom of the pyramid is gold, considered the most liquid of all assets; more important than cash, which Exter pronounced 'IOU Nothings'. Gold has no IOU attached to it. It is easily transportable and is accepted as money in any country.



There are several reasons why gold performs so well during the Kondratieff Winter and why investment risk in gold is at its lowest during this time.

1. During winter there is a high probability of severe financial and economic dislocation. The massive debt bubble disintegrates, causing bankruptcies and banking problems. The largest debtors and the largest creditors are always vulnerable during the winter debt cleansing process.

Other likely occurrences include the following:

• Derivatives debacle.
• Real estate bust.
• Private Pension plan failures.

2. The world monetary system is collapsing just as it did in the previous Kondratieff Winter. At that time, after Britain abandoned the gold standard in 1931, all other countries followed suit and the world monetary system disintegrated. This Winter, the world is abandoning the US dollar. This portends monetary chaos.

Reserve monetary leadership always goes to the world's largest creditor nation. The US is the world's largest debtor nation.

3. American leadership in the financial, economic and political arenas is waning. This leadership too, passes to the leading creditor nation.

4. Under British stewardship throughout the 19th Century, gold was money. For the first time in more than 5000 years, following US refusal to back the dollar with gold in 1971, the entire world has been subjected to a fiat money system based on the dollar. Governments, particularly the US government, want to convince you that their paper (debt) is as good as gold. You be the judge.

Fiat /Paper money systems have never survived. History is filled with examples like the Assignant and the Confederate dollar.

5. Gold and gold equities are scarce. Annual gold production amounts to a measly 2500 tonnes, which is approximately 75,000,000 ounces. The total market capitalization of all the publicly traded gold stocks is only $200,000 billion versus $17 trillion US equity market cap. Imagine what happens to the price when real demand comes into both the physical metal and gold equities!

Producers vs. Explorers

If gold is a low risk investment during the Kondratieff winter, should we buy the gold producers or the exploration companies? Let's examine the 'pros' and 'cons' of each of them.

Gold Producing Companies:

Pros:

• Investment grade. Large Market Caps-appropriate for investment funds.
• Cash flow via production.
• Excellent liquidity.
• Share prices generally rise faster than the price of gold itself.

Cons:

• Depleting their resources through production. Difficulty finding sufficient reserves to maintain production at current levels;
  e.g. Newmont produces 7.2 million ounces each year. Approximately 9 million ounces is required to replace this production.
• Hierarchal management-slow to make decisions.
• Exploration subject to committee review and budgetary constraints.
• Limited exploration since 1998.
• Only a small number of companies to choose from.

Junior Exploration Companies:

Pros:

• Responsible for 70% of discoveries.
• Growing their gold.
• Quick response management.
• Innovative geologists; prepared to see the unconventional.
• The onset of the Kondratieff winter suggests the largest bull market in gold in the entire cycle. In that environment share prices rise faster than those of their production counterparts.
• A major discovery positively impacts the share prices of most exploration companies.
• An ability to release regular news in progress.
• Management usually owns a large stake in the company and has a vested interest in achieving positive results on the behalf of all shareholders.

Cons:

• Management not trusted - think Bre-X
• Viewed as very high risk investments.
• Investors don't understand news releases, because they are usually not geologists-and are unable to evaluate a discovery in progress.
• Poor liquidity; small market caps-not suitable for most investment funds.
• Difficulty in raising money; major dilution at low share prices.

Evaluating Juniors:

The key is Management. The Long Wave approach, developed by my team at Bolder Investment Partners is subjective but still useful.

A Simple Evaluation System:

Management: 30 Points

• History
• Integrity
• Technical skills
• Management skills
• Relationships
• Ownership in the company

Properties: 20 Points

• Grass roots/discovery/gold in the ground
• Access/Power/Water

Blue Sky: 15 Points

• How big could this be?

Political Risk: 15 Points - A, B, C, or F

• A = Quebec
• F = Venezuela, Ecuador

Market Capitalization: 15 Points

• Comparative values
• Value of gold in the ground

Promotion: 5 Points

• How well does the company get the word out?
• Conservative versus flashy

I much prefer investing in juniors versus seniors in a gold bull market, because:

• There is significantly more upside price potential, because of the leverage.
• Easy to be selective. There are plenty to choose from. Follow the management.
• Exciting to follow progress; discovery-resources-reserves.
• Management is usually dedicated to enhancing shareholder value. It wins, too.

So there you have it, I believe that gold at this point in the Kondratieff cycle is a low risk investment and good junior gold mining shares are arguably an even lower risk than their senior producing counterparts.

Disclaimer : The opinions and conclusions contained in this report are solely those of the author. The information contained in this report is drawn from sources believed to be reliable, but its accuracy and completeness is not guaranteed. It does not provide investment advice, because the author has no knowledge of the specific investment objectives, or the financial circumstances and specific needs of any individual reading this report. The author accepts no responsibility or liability incurred by the reader as a result of any loss incurred in any investment decision by the reader, whether direct or indirect, insofar as the purpose of the article is stimulate thought and enquiry and is opinion and not investment recommendation. All readers must obtain expert investment advice before committing funds. Readers of this report must understand that statements regarding future prospects may not be achieved. Investment values are subject to gains and losses. The information and recommendations contained in this report is not a solicitation to buy or sell securities that may be mentioned in this report. The information contained in this report as of the date shown, and the author assumes no obligation to update the information or advise on further developments.