As the world seeks to meet climate change objectives while supply chains adjust to geopolitical risks, we expect basic materials to be in high demand. That should benefit mining stocks and, ultimately, junior mining stocks, depending on the risk appetites of investors at any given time.
Like any speculative market, risks are high in junior mining. In my August 25th interview with Jim Goddard on Howestreet.com, I made the case for battery metals miners. However, I started the discussion by suggesting that investors may want to watch out for three warning signs that a junior mining stock may have above-average risk. I described these as the 2FC warning signs for a risky mining stock. Below, I summarize the risks associated with 2FC and provide some counter-examples of when companies are approaching these risks in a positive manner.
Before getting into 2FC, it is important to note that these are not the only risks facing a stock. Every quarter, an issuer should be filing their management discussion and analysis (MD&A) report on SEDAR that includes a discussion about key risks. Moreover, just because a stock may not have any of the 2FC warning signs, it does not mean the stock will go up. 2FC says nothing about the fundamentals of the underlying mining assets.
The three areas where we look for warning signs are:
When it comes to filings, we are watching for stocks where there have been a significant number of late public market filings. Earlier this year, we saw an example at International Lithium (ILC) where an insider made a number of filings in May that corresponded to transaction dates over several years. Generally, we would expect the insider or issuer to at least explain the reason for late filings. If no explanation is provided, that leaves us wondering.
On the positive side, and this is not something I discussed in the interview, I take note when an insider includes family members in their filings as it reduces uncertainty about potential buying and selling activity of family members.
An ACME Lithium (ACME) director includes the holdings of a family member in his filings.
If a junior mining stock has a relatively low amount of reported insider holdings and there are no family holdings reported, that could be a warning sign. At the very least, I would be curious as to why insiders hold so little of the stock if the project is a potential barn burner.
As we head into the home stretch of 2022, investors are beginning to adapt to the new investing environment of constrained commodities supplies over the medium term which is helping to support mining stocks. As of September 9th, the SPDR S&P Metals & Mining ETF (XME) is up 16.7% over the past two months versus 4.5% for the S&P 500 ETF. Improved sentiment should help to boost the market conditions for financings, particularly in the battery metals space. Over the next few months, as companies come to market to raise capital, we will see which managements cut good financing deals versus bad ones.
Every situation is different, but I believe a company is waving a bright yellow warning flag if its board approves a flow-through share deal with warrants. In an up market, for any project of quality, there should be little need for warrant sweeteners in deals that are already being sweetened with tax incentives. For non-flow-through deals, the fewer the warrants or the shorter their lifespan the better. We saw an example of a no-warrant deal on September 6th when August 29th morning report stock Torq Resources (TORQ) announced a $15 million investment by Gold Fields (GFI) at $1 per share which was above market and had no warrants attached. The deal is subject to customary approvals and conditions.
Finally, consulting contracts are another area to monitor, including related-party transactions which are disclosed quarterly in a company's MD&A. Consulting expenses are a fact of life in junior mining, particularly when it comes to exploration activities. At end of the day, it comes down to whether or not the expenses are reasonable for what is being provided. That has to be judged on a situation-by-situation basis. That is particularly the case when it comes to promotional contracts. Simply saying a PR firm or consultant has been engaged to raise awareness or provide introductions to investors without specifying how those introductions will be made always leaves me wondering just exactly what is going on. Look for specifics in a contract such as those spelled out in Torq Resources' August 2nd press release.
Torq Resources spells out what it expects its arrangement with Native Ads Inc. to deliver.
The 2FC risk review for a stock can serve as a handy checklist list as part of an overall framework to assess a junior stock's prospects. It can also be used along with our INK Edge Outlook process, assuming the stock is big enough to be ranked. Ultimately, the success of a junior mining stock will depend on a variety of factors, including the quality of the deposit, the abilities of management, and underlying commodity prices. As always, consult your financial advisor before making any investment decision.
Disclosure: I or members of my family hold Torq Resources and ACME Lithium as of the date of publication.