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BAY STREET-Junior miners present big risk in bear market
August 14, 2011 / 2:35 PM / 6 years ago

BAY STREET-Junior miners present big risk in bear market

* Analysts recommend established miners in current climate

* Recession fears may make financing of projects difficult

* Senior miners may present good buying opportunities

By Julie Gordon

TORONTO, Aug 14 (Reuters) - With recession fears weighing on equity markets, resource investors would do well to steer clear of speculative Canadian mining plays and put their cash into producing miners with strong balance sheets.

Leading market indicators are pointing to slowing global growth, which will likely lead to lower demand for resources as the construction and manufacturing sectors pull back.

Add to this, the cost of building and operating a mine is spiraling upward, while recession worries could lead banks and the equity markets to shy away from funding new projects.

This puts junior miners, especially those without any production yet, at a serious disadvantage as they don’t have the cash flows to build a mine, not to mention sustain their business.

It’s enough to make even the most seasoned investors swoon.

“I always stay away from the juniors,” said investment manager Barry Schwartz of Baskin Financial. “In good times they obviously can be home runs for you, but in bad times it’s a triple play and something you don’t want to be in.”

Exploration and development-stage mining companies are speculative, meaning investments are based on theoretical production and current metal prices.

Schwartz argues that investors could instead find some good buying opportunities among larger players, given the pullback in equities over the past few months.

It’s a tactic that mining analysts echo.

Stifel Nicolaus analyst George Topping said he is bullish on the world’s top two gold producers, Barrick Gold (ABX.TO) and Newmont Mining (NEM.N). Both are trading below year highs even as the spot price for bullion climbed to a record high of $1,813.79 an ounce this past week.

“If you’re a retail investor, you’re looking for yields,” he said. “You can get the yield and have an investment in gold at the same time.”

While Topping prefers precious metals such as gold, platinum and silver during a downturn, he is also bullish on copper, an industrial metal used in wiring and electronics.

“When you look at the developing countries, part of their overall development is the delivery of power to the population,” Topping said. “That’s something that during a downturn you actually speed up, you don’t cut back.”

Topping favors mid-tier producers like Quadra FNX QUX.TO and Lundin Mining (LUN.TO) over the majors, and is especially bullish on HudBay Minerals (HBM.TO).

“It’s a well run company with a pristine balance sheet,” he said. “It’s the best defense in a difficult market, at some point the market’s going to realize that.”

“GOLD” HARD CASH

For Morningstar analyst Min Tang-Varner the magic word is “gold” and investors looking for big returns on bullion should focus on producing miners with low cash costs.

She notes that during the downturn of 2008, many gold miners were heavily hedged, meaning they did not gain as much benefit from the high gold price. This time around, none of the major producers have gold hedges.

“The more leveraged to gold prices they are, the better they will perform when gold prices go up,” Tang-Varner said.

Add to that, if oil and consumables fall as they did in 2008, the gold miners could see their costs come down and margins go even higher.

While that is great news for producers with strong project pipelines, including Goldcorp (G.TO) and Kinross Gold (K.TO), it won’t help the juniors who don’t yet have output, and as such, have no cash flows.

Their best bet is a takeout, Tang-Varner said.

“Normally, these exploration-stage kind of companies, they tend to have quite a bit of upside when their projects do actually get bought,” she said.

But for some investors, the wounds of the 2008 financial crisis are still too fresh and the best bet is to just walk away from mining stocks completely.

With a bearish outlook on the equity market, independent investor Dennis Gartman, author of the influential Gartman Letter, has a firm view on what people should do with their money.

“Stuff it in the mattress or put it in the bank,” he told Reuters. “Earn what little return you’re going to get, because it will look wonderful compared with how much you could lose.” (Additional reporting by Euan Rocha; editing by Rob Wilson)

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