Gold bullion bars are pictured after being inspected and polished at the ABC Refinery in Sydney on ... [+]
Investors have gone bonkers for gold lately, and some see the bull run continuing.
Those who invested in bullion, such as the metal held by the SPDR Gold Shares exchange-traded fund, have done well. But those who picked mining companies, especially the smaller ones, did even better.
If you have an appetite for risk and don’t mind a bumpy ride along the way, these junior, or smaller, gold miners are worth a look.
Smaller Is Beautiful In a Gold Bull Market
Junior gold miners tend to be more volatile than larger gold miners, which in turn are more volatile than the metal itself. In a bull market, volatility should be your friend if you can stomach a bit of whipsawing.
For instance, the VanEck Vectors Junior Gold Miners ETF , which tracks a basket of smaller miners, gained 20% over the past three months, according to data from Yahoo. That was way better than the performance of the VanEck Vectors Gold Miners ETF, which tracks a basket of larger miners, rallied approximately 11%. The SPDR Gold Shares fund was up 10% over the same period. None of the figures include dividends.
This shouldn’t be too surprising for seasoned investors. Smaller stocks get jostled around a lot like fishing boats in the ocean: They get tossed around a lot. Whereas, larger stocks are often more stable like aircraft carriers listing from side to side more moderately.
Larger Miners Need to Buy Smaller Miners
One way of looking at the value of a gold mining company is that it is worth the value of the gold reserves it has in the ground. The larger companies tend to mine a lot of gold, which means they are effectively depleting their resource base every year. One way or another the reserves need to get replenished or the company will go out of business.
The two ways to replenish the gold ore are to explore the wilderness and find a new deposit, or buy another company with an existing stock of gold ore underground. The latter is less risky for mining companies.
That all means that junior miners are much more likely to get taken over by larger ones while the price of the metal is rallying. When companies get taken over their stock prices tend to rally, and that benefits investors.
Exploration Makes More Sense for Junior Miners Than the Majors
If a junior miner finds a new gold deposit, it could make a large difference to its value. However, the same deposit might not even move the financial needle for a larger company. If you doubt that, keep in mind that discovering a massive gold deposit is a rare thing. Smaller discoveries are much more likely to benefit junior mining stocks.
One reason to be careful
Smaller companies tend to be more sensitive to credit crunches like we saw in the subprime meltdown of 2007-2009. If there is a crisis in the financial system these smaller firms will likely suffer far more than the large cap gold miners.
That means that as long as credit keeps flowing through the economy and the gold price remains robust then the junior miners are better bets.
The problems will start when either one of those factors (robust gold price, functional credit markets) breaks down.
At that point, watch out.
