How to spot a great gold miner

This is a great time to be buying gold mining shares, says Tom Bulford. Here, he explains how to spot a potential winner, and picks four stocks to watch.

"Initially, the miners worked in hazardous and humid conditions underground often risking their lives. They went underground in a bucket let down by a rope, practically crawling down the shafts with only candles to illuminate their way. The temperatures were very high underground and often touched 67C. It was literally like working in hell and their bodies were often burnt black with the heat."

This is the account of mining gold in the early part of the 20th century. I discovered it while researching a gold mining company for the latest issue of Red Hot Penny Shares.

Things are a little better these days. What I particularly like about this gold mining company, in comparison with the many other young hopefuls of the penny share market, is that it has a realistic chance of developing a very substantial gold mine. What's more, this mine is in a country with a trustworthy political and legal system.

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This is a great time to be buying gold mining shares. Gold is climbing. And when I look at this sector, I see a clutch of deeply undervalued stocks that could really soar in the months ahead.

I think there is also a real appetite for these stocks right now. I know one of my colleagues, Simon Popple, is launching a new letter this week. If you read Simon's MoneyWeek cover story recently you'll know the scale of the opportunity here.

Today I'd like to show you how you can find the very best opportunities in the gold mining sector right now.

The gold and US economy correlation

After hovering in a trading range for a few months, the gold price broke decisively above $1,700/oz last week. As a recent paper by RBC Ambrian points out, movements in gold are fairly well correlated to levels of concern about the global economy in general, and the US economy in particular.

Last week's US employment numbers furthered concerns about the economic health of the USA, and with the euro area stumbling towards the next chapter of its crisis it is hard to see confidence being restored in a hurry.

While prices of industrial metals are under pressure, gold bulls are smiling. RBC Ambrian reckons that the best way to play its rising price is through shares in gold mining companies.

Four mining stocks to watch out for

You need to be selective though. I won't be recommending you buy a gold miner today I need to save my tips for my Red Hot Penny Shares readers. But I can tell you what you need to consider before you buy a gold miner.

Criteria to consider include the likely size of the resource; time to first production; financing requirements; the availability of essential power lines, road and rail links and water supply; and the hardest call of all, the local political climate.

When miners are gunned down in South Africa, which until not so long ago was considered a relatively safe and peaceful mining location, you know just how incendiary mining projects owned by foreign interests can become.

Taking all of these and other relevant factors into consideration, RBC Ambrian likes the following:

Avocet Mining (AIM: AVM): This West African gold miner "has strong exploration upside, achievable expansion targets, and we believe it is well positioned to turn around production problems."

Mandalay Resources (TSX: MND): "Mandalay has successfully ramped up production at Cerro Bayo, in Chile, and is producing at cash costs of less than $300/oz."

Aureus Mining (AIM: AUE): Another West African play, "Aureus is the owner of the New Liberty Project in Liberia. Despite a very high strip ratio, the project has strong economics and we believe that it represents a take-over target."

Papillon Resources (ASX: PIR): "It is the owner of the Fekola Project in Mali. Papillon recently announced a maiden resource of 3 million oz of gold and early metallurgical test results have been positive. Exploration upside is impressive."

There are huge quantities of untapped gold

For Red Hot Penny Shares though, it is that ancient mine that intrigues me. Let me tell you a little more about the early days.

"The early miners had to handle explosives with their bare hands at high risk to themselves. Several of them met grisly ends when the explosives went off accidentally and many fell to their deaths in the deep tunnels. The underground tunnels were damp, dark and unhygienic, so epidemics like plague and cholera were rampant."

Not surprisingly, labourers were in short supply. So the company that ran the mine insisted that they wore tight metal bracelets on their left wrist "to ensure that they would not run away or, if they did, would be easily found".

Hygiene was not great either. "The workers lived in tin shacks with little or no ventilation. They had no access to clean potable drinking water, toilet facilities etc. They just used the open fields to do their business." Malaria was rampant and to drown their sorrows the miners drank a 'country brew' made by "fermenting lots of stuff including old batteries, dirty and polluted water, spoilt fruit and vegetables, molasses, malt, and methylated spirit... Many men succumbed to the reactions brought on by consuming it."

I don't wonder! But here is the point. This old mine could still contain millions of ounces of gold. And my Red Hot miner wants to get its hands on it.

To find out about how you can put your name onto the Red Hot Penny Shares list and receive all my weekly updates click here.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

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