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PREVIOUS ARTICLE Stock of the Week NEXT ARTICLE 18 Share Tips - 22 March 2010

The Reserve Bank of Australia (RBA) is seldom lauded as a prophet of good tidings. But recent predictions by deputy governor Ric Battellino that the surge in mining activity – courtesy of commodities demand from China and India – could last another 15 years has potentially massive upside for savvy investors.

Most of the 600-plus miners listed on the ASX are small-cap explorers that are highly speculative in nature. Some of these resource plays will undoubtedly crash and burn. But investors who get the stock selection right could end up owning the next WorleyParsons (WOR) and make gains of a thousand percent-plus in years to come.

But with so many ‘penny-hopefuls’ to choose from, how should investors go about buying stocks with greater likelihood of delivering a nice kicker to their long-term share portfolio? The share price fortunes of miners already in production will rise and fall with both volume, and the outlook for commodity prices.

Yet when it comes to explorers, the biggest uplift in share price is on first discovery, followed by incremental share price increases as the project continues to de-risk. According to Chris Brown senior analyst with RBS Morgans, the key to unearthing the next junior explorer capable of becoming a ‘major’ is to buy into the stock when no one else is looking.

Where possible, that invariably means taking a position before exploration success. “There’s less compulsion to enter these stocks once much of the upside is already factored in the price. And once a discovery has been made – it’s then a question of backing the management,” says Brown.

Recent ‘rags-to-riches’ stories include market darling, Sandfire Resources (SFR) which experienced 4,205 percent share price growth in 2009 following the “greenfield” discoveries of high-grade copper-gold mineralisation at its Doolgunna project 150km north of Meekatharra in WA. Other stellar performers in 2009 included Rex Minerals (RXM) with a 1,397 percent share price rise and Ivanhoe Australia (IVA) with a 1,281 percent lift.

Brown says investors looking for these sorts of gains over a two-plus year horizon should start by building a mixed portfolio of mining juniors comprising around a dozen stocks. Realistically, he says they should assume that on a law of averages, only one or two of these stocks will find the proven ore bodies necessary to warrant a major share price kicker.

So what methods can investors use to go about buying speculative miners for long-term returns, especially prior to exploration success? Dumb luck aside, Brown says the single most important determinant of future exploration success is the quality and track-record of management and board in having done this before.

Equally critical, adds Brown is having a sizable enough parcel of ‘good prospective ground’,  a strong technical team with proven commercial ability and sufficient net cash – typically $10 million-plus – needed for extensive drilling or a joint-venture partner prepared to pick up the exploration tab. “If an exploration isn’t successful at first blush, investors also have to decide whether there’s sufficient upside in the drilling pipeline and the necessary cash to continue looking for quality minerals in the ground at in the right quantities,” says Brown.

While discounts to valuation often suggest substantial sizable returns of 200 percent-plus, Brown says investors should never under-estimate the myriad risks confronting any junior explorer. Firstly, there are numerous macro-economic risks like exchange rate movement, commodity price fluctuation, and heightened sovereign risk when operating within some offshore markets.

Then there are myriad stgelopment, production, and operational risks all of which can contribute to deteriorating margins that may threaten a project’s commercial viability. “Access to a skill-base is an ongoing problem, and while it may not impact existing operations, it may be an issue for explorers that enter production three or four years from now,” says Brown.

Based on the degree of blue sky the market is still yet to factor-in – which Brown says could potentially make it the next Olympic Dam – his most favoured junior miner is Rex Minerals (RXM). Shares in the large-scale copper miner initially surged close to threefold after it reported high-grade copper and gold drill results from its Hillside project in South Australia.

Other early-stage juniors that Brown also favours over a two year-plus horizon are:

Bassari Resources (BSR): An Australian-based exploration and stgelopment company primarily focused on mineral discoveries, predominantly gold, in the West African country of Senegal.

Emmerson Resources (ERM): A Tenant Creek gold explorer which listed at 20c back in December 2007, partially owned by Ivanhoe.

Sabre Resources (SBR): An Australian-based exploration and stgelopment company primarily focused on the exploration and stgelopment of the Ongava Multi-Element Project in Namibia.

Regis Resources (RRL): A mineral exploration company with significant gold and nickel exploration properties in the Eastern Goldfields of WA. On any metric, there’s still plenty of upside and the company’s strong track-record of operational success is impressive.

Even if a junior explorer isn’t going to be around in two years time – let alone ten – doesn’t necessarily mean it’s not worth investing in, reminds Andrew Muir analyst with Hartleys. He says investors shouldn’t overlook the attractive share price premiums to be gained when a mining junior decides to hand-ball a successful exploration onto a larger producer through any number of M&A or JV arrangements.

He says the rocky fortunes of some miners, notably Fortescue Metal Group (FMG) should also remind investors that there’s a lot more to overall success than finding economic ore bodies in the ground. “That’s particularly relevant for iron ore stocks often fraught with infrastructure issues, especially compared with something that can be mined much more economically,” says Muir.

There is no shortage of junior miners with compelling stories to tell, but Muir’s favourite is dual-listed South African gold producer, Gold One International (GDO). Trading at the biggest discount to his valuations, he says Gold One has an eight year mine life and numerous large projects within its pipeline.

Other junior miners favoured by Muir include:

Atlas Iron Ltd (AGO): A dynamic iron ore producer, with numerous key projects strategically located within150km of the port of Port Hedland in WA with a highly regarded management and good quality mid-term pipeline.

Jabiru Metals (JML): Floated in 2000 as a low-cost LME metals producer to stgelop the remnant resources of the old Teutonic Bore mine located in the Goldfields region of WA.

Riversdale Mining (RIV): Coal producer in Mozambique with a long-life mine, and successfully overcoming lingering infrastructure issues.

Avoca Resources (AVO): A gold producer/stgelopment company that recently acquired Dioro Exploration (DIO).

Silver Lake (SLR): A gold producer/explorer out of Kalgoorlie with significant potential for another mine.

Shaw River Resources (SRR): A Pilbara-based manganese-focussed explorer with good technical people and the backing of its largest shareholder Atlas Iron – it recently pick up a project in Ghana.

Impact Minerals (IPT): A uranium explorer in Botswana with a quality technical team with the potential for a very large find.

Sandfire Resources (SFR): Following on from its discoveries at the Doolgunna project in May 2009, Sandfire is continuing its aggressive drilling program and also has a deep pipeline of commodity projects.

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