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The big gold and silver producers are preparing to unleash a round of bidding for junior exploration companies that will bid up the value of the whole sector, and stocks that are good, bad and indifferent will jump in value. You have been warned. Now is the time to buy. It is so obvious with gold and silver prices on the march…

Late 1974 saw the biggest run-up in gold and silver stocks in history, and in 1979 there was something of a repeat performance. Last week’s sudden jump in precious metal prices has gold investors thinking that another stellar increase in stock prices is in the offing, if only because alternative investment classes have such a dismal immediate outlook.

Gold and silver equities have been disappointing performers over the past couple of years. Cost inflation has dented profit margins for the big producers, and capacity expansion has been subject to delays. But these fears may have been overdone, and rising precious metal prices will now begin to feed straight through to the bottom line.

The smaller junior exploration stocks have been hit hardest, and languish at a record low in comparison to the gold price. Indeed, prices have been falling for two years. In terms of asset values the juniors are now outstandingly good value. In 1974 and the late 70s this stock category delivered the highest advances, soaring 20, 50 and even over 100 times in price.

Will history repeat itself? The general of the gold bugs, Jim Sinclair, the multi-millionaire trader whose website www.jsmineset.com is required reading for serious precious metal investors, certainly believes it will be. He recalls how even juniors with poor claims saw their shares rocket in the 70s.

Besides that he is currently leading a campaign against ‘illegal shorting’ of junior stocks, which he holds is the sole reason for their current low valuations. Hedge funds have been going long on major gold producers and shorting their smaller brethren. Yet the fundamentals suggest that time is running out for the shorts, and may be just about up.

How do you value a junior exploration company? If it is just about the hope that its claims will deliver a big strike then this is akin to gambling. Juniors issue shares to fund their exploration activities and the idea is that shareholders will participate in a discovery.

However, in a bull market for gold, especially one like we have at present which about to take off to much higher levels on the back of inflation, financial and banking crises and most likely a stock and bond crash, then the assets of the junior explorers are obviously going to rise in value. What are these assets?

The main asset of a junior explorer is not the money it collects from share sales. Its assets are the parcels of land, the claims which it has staked. These are the future sources of gold and silver. And in a bull market the value of claims rises much faster than the value of precious metals, and so will the value of the owners of these claims.

The analogy of the dot-com boom is a fallacy as the assets of a junior mining company are tangible in terms of contracts to claims which are readily saleable. Where the analogy is correct is that this will be the place to find the best buys and biggest performers of the coming precious metals boom.

Buying a basket of juniors is probably the best option as the risk is then spread among say ten stocks rather than concentrates in one company. These are small companies and things do go wrong with management and due diligence is not easy, so diversification is a proper strategy.

Fortunately there are many specialist website purporting to offer the best advice, often for a monthly fee. It is hard to choose between them but www.goldseek.com and www.golddrivers.com are consistently reliable, and one good cross-check on shares is to only buy those recommended by several different websites.

Buying smaller stocks in exploration companies is not a strategy I would normally advocate to the non-specialist. But the opportunity to gear up on a major increase in gold and silver metal prices is now just so good it is to be recommended to everybody, like the dot-com stocks in 1999.

Of course, you do have to remember to exit at the right time. The dot-com stocks needed to be sold by February 2000, although missing the top of the market did still leave good profits for early players who sold late. Doug Casey, a leading expert on this area of the stock market who writes some excellent newsletters compares the juniors to burning matches that burn bright and then fade to nothing.

And this is really the characteristic of any investment in an asset price bubble, and that is what is going to happen in the junior exploration company sector. That might sound incredible today as prices have been shorted to death and many investors are throwing in the towel.

But you only have to look at the price of gold and silver to know that this is illogical and unsustainable. How can the assets of the companies that search for gold and silver be falling in value when the value of those metals is surging forward? It just has to be a market anomaly.

Market anomalies are how investors make big profits. The price of silver is another example of a market anomaly, as this column argued last week. Silver has underperformed every other metal, except gold in this commodity price boom and yet its supply and demand situation is arguably the weakest of all.

So if you want to hedge your position in the junior explorers with a second opportunity to achieve leveraged performance to the rise in price of the underlying metals, then again silver stocks are to be recommended. The smaller companies might well deliver the best performance but unless you want to deeply diversify you could stick to the bigger names.