What are mining stocks and how can you successfully invest in them?

What are mining stocks? Great question. Mining stocks are investments in companies that produce or explore for minerals, such as uranium, coal, molybdenum (which is used in steelmaking), copper, silver and gold.

Mining stocks can generally be broken up into two categories, majors and juniors. Majors are mining companies that have been in the mining business for many years and more often than not they operate on a global scale. Majors have proven methods for exploration and mining, and have consistent output year over year.

Junior mining stocks are mining companies that are new or have been in business for a decade or less. They are usually smaller companies and take on risky mining projects. If a junior mining stock is successful at finding and mining, it can mean huge returns for investors.

What Are Mining Stocks: Lowering Your Risk on the Mining Investments You Make

We continue to recommend that you cut your risk in the volatile resource sector by investing mainly in stocks of profitable, well-established mining companies with high-quality reserves. For that matter, resource stocks (and this includes oil and gas, of course) should make up only a limited portion of your portfolio—say less than 20% for a conservative investor or as much as 30% for an aggressive investor.

While we think you should maintain some exposure in resource stocks, you should still aim for balance among all of our five main economic sectors: Resources & Commodities, Finance, Manufacturing & Industry, Utilities and the Consumer sector. You should always resist the temptation to load up on mining stocks, no matter how attractive they appear. If the market does go into a downturn, these stocks could suffer more than average.

Nine tips for picking a profitable mining stock

1. Location: We generally stay away from mining companies that operate in insecure and politically unstable regions like the Congo, Venezuela and Colombia. We also avoid those in countries with little respect for property rights and the rule of law, such as Russia or Mongolia. Mining is particularly vulnerable to political instability. You can’t move the mine to another country, and local citizens may sometimes get the impression that a foreign mining company is robbing them of their birthright, even though the foreign company’s capital and expertise would appear to be the best way to get any value out of the ground.
2. Environment: We look at environmental constraints where juniors are looking for minerals. In Europe and certain parts of the U.S, they need a particularly rich find to justify the costs of overcoming environmentalists’ objections.
3. Geology: When we recommend junior mining stocks that only explore for minerals, we prefer those that operate in an area with geology that is similar to that of nearby producing mines.
4. Financed: 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.
5. Low debt: We like mining stocks with strong balance sheets and low debt. Debt can be a problem for a junior minor.
6. Profitable: When we recommend mining stocks, we want to see positive cash flow, preferably even when commodity prices are low.
7. Really profitable: Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient for, or at least contributes to, the cost of developing a second mine.
8. Well-managed: We want to see mining firms with experienced management with a proven ability to develop and finance similar projects by working with other junior mining companies.
9. Expensive: We avoid mining stocks that trade at unsustainably high prices because of broker or media hype or investor excitement about the underlying commodity (such as gold). Instead, we focus on reasonably priced mining stocks with favourable geology.

Investing in mining stocks can lead to a big payday. But it is important to keep our nine points in mind in order to increase your chances of success.

We’ve covered the basics on what mining stocks are. Mining stocks are generally a riskier investment but can be highly profitable to the well-researched investor.

Are there other mining stock topics you’d like to see covered? Let us know in the comments.