Buying Juniors vs. Majors

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Leverage is what junior mining companies are all about. With a major mining company, investors must pay for the mine, the mills, and all the other capital costs in order to get exposure to a commodity. Thus, if the commodity goes up 20%, the company’s share price will go up, but the sheer size of the company limits the gain.

In a perfect world, junior companies deliver extreme leverage to commodity prices. Leverage is traditionally defined as a high rate of debt versus equity and enterprise value (EV) as equity plus debt minus cash. For juniors, EV is equity plus future capital minus cash. What is nice is the future capital will only be spent if the project’s commodity price is strong, which gives investors increased leverage to commodity price swings.

When the market is weak, the majors go down 20% and juniors go down 70%, but when the market is strong, the majors go up 20% and the juniors go up 70%. When the market is down, a junior is much cheaper to buy than a major.

Keep in mind that when we look at juniors, we’re assuming there is an economic resource in the ground. When you buy projects with exploration risk, you add additional risk that is not tied to commodity prices. If in the spring of 2009, you bought 12 quality juniors with real resources, you would have outperformed buying BHP or Vale.

When you have a stable growth market and junior premiums similar to major company premiums, like in pre-tsunami times earlier this year, then it makes sense to sell juniors and buy majors.

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