How to Invest in Small-cap ASX Gold Stocks

What is a gold stock?

Like all listed stocks, public gold companies issue shares that are available for investors to trade. When you purchase shares of a gold company, you are essentially purchasing a stake in the business.

There are two main types of gold companies in which market participants can invest: major gold-mining companies and junior gold stocks. Although no gold stock investing method is 100 percent foolproof, backing a gold company that is producing metal can alleviate some stress as miners are relatively stable compared to juniors. Gold juniors face many more potential headwinds as they are still exploring for metal and may or may not be successful.

Development-stage companies are a third type of gold stock to consider. These firms have made a discovery, but still have plenty of work to do before they begin mining — they are often engaged in activities like mine planning and construction, as well as permitting and community consultations. On the risk spectrum they fall between majors and juniors.

Why consider small-cap gold stocks?

Small-cap stocks are companies with small market capitalizations — in the gold space, juniors fall into this category.

Junior gold stocks can be an enticing prospect for investors. That's because a big discovery can propel the company's share price higher. For those who time their entry well, the returns can be staggering.

However, investing in small-cap gold stocks is also very risky. Discovering viable gold deposits is difficult, rare and capital-intensive, and many companies fail at the tasks involved in exploration and development. Just as a major find can be positive, stock values can shift drastically when juniors report disappointing drill results or poor returns.

Aside from that, gold juniors rely on investors for cash, and must remain disciplined when it comes to capital allocation. And although gold is known for its stability, they also have to contend with potential price volatility.

Despite those potential problems, many investors still like to play in the junior gold stock arena. We’ll explain how to raise your odds of finding a successful company in the next section.

How to choose a small-cap gold stock on the ASX?

Investors should amass as much information as possible before investing in a small-cap gold stock on the ASX. Here are a few tips on how to get started on due diligence and spot potential winners:

• Be aware of political risk — When investing in a junior, it's worth familiarising yourself with where the company is operating. You don’t want to wait until tens of millions of dollars have been spent on discovering a massive deposit only for a key permit to be revoked. Metrics like the Fraser Institute's investment attractiveness index can provide an overview of which countries are more receptive to mining projects, but timely information is key, too. Wars, strikes and election cycles are particularly noteworthy and should always be looked at.

• Experienced management is crucial — Because there is little room for error in mining, investors should look to juniors whose management has a solid track record, including significant exploration experience. News about staff changes like resignations, new hires and company restructurings may seem small at first, but team updates are a crucial point to be aware of when choosing juniors.

• Keep up with company news — Junior mining company valuations are heavily affected by business activities like the development of new partnerships or acquisitions by mining majors. Keeping up to date is important here; juniors are often high-risk investments that rely on strong partners to provide extra resources and expertise. Pay special attention to news about partnerships, management changes, licence acquisitions and disputes.

• Read studies and reports — Understanding technical reports and studies is crucial to understanding the progress of junior mining companies, many of which rely on successful exploration to turn a profit or bring in major partners. Many of these reports are technical, so it’s important to appreciate the details and understand topics like mineral grading, licencing, reserve estimates and test types.

• Use purchasing criteria — Speculating on junior mining stocks is common, but can be heavily influenced by personal biases and impulse choices. It helps to bring a more rigid, objective approach to picking junior mining stocks. Rick Rule of Rule Investment Media suggests buying a stock for a specific reason and selling that stock if the reason disappears. Thinking like this allows decisions to be made more quickly and with more clarity.