Mining is a Terrible Business

A gold mining company is perhaps the single best example of the average investor's worst instincts. I know that's not what you want to hear, but my job as the editor of this publication isn't to tell you what you want to hear – it's to bring excellent investment opportunities to your attention.

I'll do that in today's letter – but if I'm being completely honest with you, I have to tell you exactly what kind of uphill climb you're facing in the junior resource sector. I simply wouldn't be doing my job if I didn't underscore and highlight the downsides of this sector.  

There's the risk factor – which I characterized earlier this week as a 1 in 100 chance of success – at best.

There's the emotion involved – thanks to the high risk-reward profile, as well as the charged nature of gold. Gold investors tend to invest with their hearts – they're rightfully angry that the government is devaluing the currency – but then they run pell-mell into the arms of gold mining companies – which is like curing your alcoholism by starting a meth addiction.

That's why every jr. resource CEO tells a story. I recently visited Toronto to attend the largest mining conference in the world – and I attended dozens of presentations during my short international trip. The common denominator is a heart-rending tale of massive wealth just sitting up in them thar hills – and very little in the way of concrete evidence supporting the story.

And there's the plain and simple bad business model that a gold mine entails. Until they find a resource, the average gold mine company has nothing but a remote and inhospitable piece of property. Everyone around the world hates gold mines, so they all are located miles from anything approaching civilization.

When and if the company's team of geologists and engineers discover a resource, they spend millions of dollars developing it, only to sell it all off. As soon as they go into production, their resource begins to dwindle with little hope of being replenished.

It would be like spending millions of dollars to open a store with a set amount of inventory – and then selling off all of that inventory until it's gone.

There simply isn't a venture more badly designed to return capital to you outside of a casino than a gold mine.

And like a casino, it's not about you at all – it's about the people who get your money.

Don't play the game unless you know who you're dealing with.

You can research a company's insiders by checking their SEC filings at SEC.gov – or alternately, (and more likely if they're a junior resource company) go to the Canadian government website Sedar.com to check filings for Canadian companies.

Also, another way to see exactly how honest a company's board of directors may be operating the business is to look at a ratio of their Selling, General and Administrative Expense (SG&A) – which is generally a line item on a company's official filings – vs. their total expenses.

A company's SG&A covers a variety of miscellaneous costs – so it should not encompass a huge chunk of a junior resource company's total expenses.

Since SG&A is so loosely defined, its easy for a less than reputable company to let some capital flow through that "expense" instead of putting it to good work for the company's shareholders.

That's just one example.

If you actually read through a full annual filing of a junior resource company, you'll probably find other examples of potential graft, or at least questionable business practices.

Before you buy a single share of a company, it's a good idea to try to spot something that doesn't add up. I use SG&A as an example because it typically shows up on a filing, and it is pretty easy to see if it outweighs other expenses.

The point is: you need to be aware of what's going on at these companies before you buy them – not after.

Invest carefully,

Kevin McElroy
Editor
Resource Prospector Pro