Why the boom in speculative mining shares is a sign for caution

The number of investors chasing big winners in shares like Argosy Minerals Limited (ASX:AGY), Castillo Copper Ltd (ASX:CCZ), and Tawana Resources N.L. (ASX:TAW) says something about the state of the market right now, in my opinion.

More than half of the stocks on yesterday’s 52 week highs list (from the Sydney Morning Herald) were speculative resource and energy stocks. Copper, lithium, graphene, diamond, pot stocks, and so on:

source: Fairfax media

Many of these companies will fail to deliver market-beating returns to shareholders over the next 3-5 years.

If anything, many of them will probably bounce along in mediocrity, raising capital every so often to pay management salaries and exploration expenses. Then whenever the next boom comes around, they’ll seek the opportunity to cash out by seizing the new opportunity – just as Queensland Bauxite Ltd (ASX: QBL) has suddenly decided to change its business model to focus on marijuana.

While these types of stocks can be popular among traders because of their very occasional meteoric rises, the economics of running a resources exploration business are extremely poor.

First, exploration and staff are expensive, especially when the company has no income. Second, exploration companies are usually quite small, around $20 million to $40 million or so, and if they find a viable resource, they need to raise multiples of their capital to actually build a mine.

It depends on the resource, but a mine could cost $100 million or so – the company would need to issue 5 new shares for every 1 that you already hold in order to raise the money.

Third, even if you stick around through all that, small miners usually have high costs of production relative to larger players in the sector, which is a concern especially if resource prices crash. That’s not to say that the odd small miner here and there won’t be a success, but the odds are thoroughly against you.

By all means, own speculative stocks if you like, but be highly sensitive to the risks and limit your purchases to a very small part of your portfolio.

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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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