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Market Clue: Obscure Stocks Lead Mining Rally

Some of the most-impressive gains in the mining sector recently have come from some of its least-known stocks.

Endeavor Silver, an obscure Canadian company is up 95 percent in the last three months. Hecla Mining has climbed 85 percent and NovaGold Resources has more than doubled.

In contrast over the same period, large gold miners as measured by the Market Vectors Gold Miners exchange-traded fund (ETF) have climbed just 26 percent.

This marks the development of a new trend where investors hunt for bargains amid little-known gold and silver companies, many of which simply own properties but don't operate mines.

Those kind of companies are tracked by the Market Vectors Junior Gold Miners ETF.

That fund trailed the GDX for most of 2010 but has returned almost twice as much as the larger companies since the late summer.

Two key factors are driving the gains and giving the obscure names their leverage. One is that many small companies have much larger deposits than is currently known because reserves often grow once they are more fully explored. An entirely new set of analysts and investors are now poking around these companies and studying the geology of their deposits. As a result, some of these stocks will move without easily identifiable causes.

It also means that their financial statements will be largely irrelevant because they're based on old valuations of properties, which will complicate valuations.

Another factor is consolidation. Large miners such as Barrick Gold will look to grow via acquisition, and hope to use their expertise to identify companies whose deposits may be undervalued.

The good news is that trends like this happen long before a bull market ends, so there is still probably a lot of plenty of upside in the broader mining space. The bad news is that some of the best companies will have poor options liquidity and be hard to understand without an expertise in geology or mining technology.

Either way, with instruments like the GDXJ, many ordinary investors can ride this trend.

Disclosures:

David Russell does not hold significant shares of any of the above-mentioned companies.

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David Russell is a reporter and writer for OptionMonster.

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