How to Get Struck by Lightning

How to Get Struck by Lightning

By Louis James, Chief Metals & Mining Investment Strategist

Two M&A deals have already delivered paydays for investors in junior mining stocks this year: Goldcorp’s half-billion-dollar purchase of Probe Mines in Canada, and Tahoe Resources’ billion-dollar acquisition of Rio Alto Mining, a Peruvian gold producer.

Now the arrival of a new, well-capitalized bidder for mining properties—X2 Resources—has raised prospects for more blockbuster deals like last year’s $3-billion takeover of Osisko Mining by Agnico Eagle and Yamana Gold. X2—a still-private UK company headed by Mick Davis, former CEO of mining giant Xstrata—has raised $5.6 billion to buy up “blue chip” assets in the mining sector.

Given Xstrata’s pedigree as a base metals company, I don’t expect X2 to go stalking any of our favorite gold exploration juniors—or even base metals juniors, for that matter. The company is more likely to buy deposits and operations from major mining companies that are looking to simplify and focus their businesses.

I have some guesses as to which properties will appeal the most to X2, but even if I’m right, those guesses wouldn’t be easy for investors to profit from. Suppose X2 lands a great deal for itself, taking a prize asset off the hands of a big mining company fighting reduced margins. That might be good news for X2, but it’s not a public company you can invest in, so you’re not invited to the party. For the seller, it’s an unhappy fire sale, nothing for shareholders to celebrate.

Knock-On Effects

To find M&A opportunity in junior mining stocks, look a little further down the road.

There are only so many prime assets out there. Every time X2 takes one off the market, other buyers get pushed to shop further down the food chain. Some are going to reach down to the junior level—especially to the handful of juniors that have in fact discovered world-class deposits.

And then there’s market psychology… Mr. Market sometimes acts a bit loopy, but he does show some recurring patterns.

Last year’s Osisko deal wasn’t good news just for the company’s shareholders, it put a strong gust of wind in the sails of junior and even mid-tier mineral exploration, development, and production companies. The thrill only lasted a few months, but it was real. With its $5.6 billion budget, X2 is promising a series of such gusts, one after another… enough to make 2015 much better sailing for the better junior mining stocks. And they’re still so cheap, it won’t take much to move them, even if gold spends the year bouncing along the bottom.

Position to Catch the Bolt

When a larger company buys a smaller one, it usually pays a premium over the recent stock price, in an instant delivering shareholders a bonus of 30-50%, sometimes as much as 100% or more. The sector average over the last five years is 49.5%.

So even if the mining sector goes nowhere all year, positions in the right companies could go vertical in a day, the moment a takeover bid is announced. But to get struck by lightning, you need to be standing in the right place at the right time.

(Watch our upcoming online event, GOING VERTICAL, to find out how to best position yourself for big gains and which deep-value stocks to buy.)

I track a set of companies with high takeover potential. You can build your own list by focusing on the same basics.

• Only a company with a big deposit is a serious target. A gold miner needs a multimillion-ounce deposit.

• It has to be politically safe. With everything in the sector on sale everywhere in the world, why bid for anything in a country that expropriates foreign mining companies?

• The company’s deposit needs advanced feasibility work by reputable engineering firms, or drill results that are so extraordinarily consistent, there’s almost no question of economic value. Big mining companies seldom bid for maybes.

• The deposit has to be feasible at lower metals prices. Yes, we think metals prices are headed higher over the next few years, but the majors think in terms of decades. For them, a mine is no good unless it can make money even when it’s selling into a weak market.

There will be M&A activity in the mining sector this year. Mines are, by their very nature, depleting assets. Mining companies must discover more ore on their own or buy other companies’ discoveries. It’s either that or they literally mine themselves out of business.

With the severe downturn in metal prices putting the squeeze on margins, the majors have all cut way back on exploration budgets—on the order of 75% in some cases. So you can be sure they will be bidding for smaller companies.

If you’ve ever thought you’d like to be the one ahead of the crowd, here’s your chance: just focus on the very best takeover targets in the currently very cheap junior resource sector.

Today, March 10, at 2:00 p.m. EST, eight industry experts and investment pros discuss how investors can find these stocks with “vertical potential” and which companies they like most for their own portfolios right now. Register here to watch GOING VERTICAL—it’s free.