Mining companies come in two sizes: junior and major. The majors are the large companies that develop mineral deposits and sell them on the open market. The majors do some exploration, but their primary business is bulk mining. Juniors, by contrast, are the small exploration firms that search for new deposits but usually do not fully develop them alone. When majors want to find more deposits, they can always buy up or partner with juniors that have proven reserves.
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ROI Issues with Majors and Minors
The return on investment (ROI) is one of the most important numbers for most investors. Unfortunately, ROI doesn't tell the whole story when comparing mining majors to junior mining stocks. The volatility in juniors is legendary, but the top five junior mining stocks in a given year will inevitably outperform the top five major mining stocks, simply because they are on different levels when it comes to risk and reward. Rather than looking at ROI, the divide between these two is more about appreciation and income.
Mining Stocks as Inflation Hedges
Major mining stocks offer very different advantages to investors compared to their smaller cousins. Mining majors, like the materials they mine, can act as an inflation hedge for investors. When the inflation rate starts to creep up, precious metals and minerals with industrial applications also start to rise in value. As metals and minerals see price spikes through futures and open market buying, the share prices of the majors also increase because the reserves they have in the ground are now appreciating assets. Although the value of a mining major's reserves increase, the costs of mining them often do not (or at least not as dramatically), so profit margins also grow during these economic cycles.
A similar effect takes place in mining juniors that have proven reserves, but unless minerals are being dug up and sold - thus realizing profits with the more generous margin - the effect only lasts as long as the inflationary cycle.
Appreciation: Advantage of Juniors
Many junior mining stocks never remove a significant amount of salable material from their finds. A lot of the movement in their stock prices is speculative and based as much on the company story as any of the assay results. Moreover, mining juniors can be serial diluters, issuing shares every time they run low on capital. When investors catch on and capital can no longer be raised, mining juniors are quick to fold up and disappear - sometimes reappearing later with the same management and a different name.
That said, it is these very risks that make junior mining stocks attractive to investors; the risks are so high that the rewards can be huge. While there are no doubt some mining investors with nothing but juniors in their portfolios, junior miners are best thought of as a place to park some speculative capital rather than your retirement nest egg. Juniors can offer off-the-charts appreciation, but they can also be a total write-off when things go wrong.
Income: Major Dividends
Whether a junior or a major, the boost from an inflationary cycle will eventually flatten out as inflation either decreases or a new normal is established. Having stocks that follow major economic trends isn't good or bad, but it can lead to uneven performance, depending on how and when you benchmark these stocks against those in other industries.
Mining majors often lag behind large stocks in other sectors when there is a bull market, unless inflation is the main driver of the upward trend. This can be frustrating for investors, but some mining majors compensate their investors with dividends. The size of dividends depends on the health of the company and the stage of the overall economic cycle, but investors looking for an inflation hedge, coupled with some income, can do much worse than mining majors.
The Bottom Line
As with every investing decision, choosing between majors and juniors comes down to what you need to reach your investing goals. Do you have designated speculative capital to put into stocks that can potentially yield huge returns? If so, then there are a lot of interesting junior stocks out there. This may involve a lot of research into the management, finances, deposits and so on, but the potential rewards are on par or better than investments with a similar risk profile.
Do you want some stable income stocks that can help to protect your portfolio against inflation? Then mining majors might be the better fit. If you have already been investing in income stocks, you have the key metrics to evaluate stocks of mining majors from the dividend perspective. The main difference is that these companies have mineral assets that go up and down in value, making book value fluctuate more than most dividend paying stocks.
If you are keen on the mining sector as a whole, then there is plenty of room for a sector-specific portfolio containing both.
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