AuEx Ventures, a Reno, Nev.-based enterprise with fewer than 10 employees, went public in mid-2005 at $0.50 a share. The company’s mission? To find new precious metals deposits in Nevada.

Thanks to the use of high technology, combined with detailed knowledge of the local geology, AuEx was able to locate not only a major new gold deposit, but also a completely new mining district in Nevada. Management used sophisticated processing of satellite imagery to look for traces of gold — helping to quickly survey thousands of square miles of barren desert and identify high-potential zones.

For AuEx, the result was the discovery of the Long Canyon gold deposit, in a place where large deposits of this kind had never before been found.#-ad_banner-#

For AuEx’s early investors, the result was a 12-fold increase in the share price in a little over five years. After identifying more than a million ounces of gold at Long Canyon, Fronteer Gold bought AuEx in late 2010 for close to $6.50 per share. (And not long after that, top-tier producer Newmont Mining (NYSE: NEM) bought Fronteer for $14 a share, a 37% premium.)

What investor hasn’t dreamed about catching a wave like this one?

Before you fall prey to the next tempting penny-stock pitch that hits your inbox, however, consider this:

There are about 3,000 publicly listed junior companies in the world (about two-thirds of which are listed in Canada). Only a tiny fraction of these are likely to ever make it big, or even make it at all.

Ironically, as you’ll read below, it’s those very odds of failure among the explorers that can help increase your chances of success as an investor in the potentially lucrative exploration sector.

	Dave Forest

That is, if you know what to look for.

Dave Forest is a trained geologist who’s worked in the mining and oil and gas sectors for more than a decade. He’s been involved in a number of oil company ventures and consultancies, including a position as chief operating officer for Condoto Platinum (CPD.AX), an Australian company with operations in Columbia. Dave, who previously managed the energy research division at Casey Research, is also director of Notela Resource Advisors, an advisory firm.

Dave knows what to look for.

And he’s the newest member of the StreetAuthority team. Last month, Dave took the reins of Scarcity & Real Wealth and Junior Resource Advisor, the source of this week’s pick.

Bob: With those kinds of odds going against the junior explorers, how can individual investors make any money in this space?And he’s the newest member of the StreetAuthority team. Last month, Dave took the reins of Scarcity & Real Wealth and Junior Resource Advisor, the source of this week’s pick.

Dave: It’s true that most mineral exploration companies will not succeed. But that lack of success actually works in favor of investors who know what to look for in this business. Because so few companies come up with good ideas, the few management teams that do are in great demand, and the projects they identify are extremely valuable. This is why a good exploration prospect can sell for millions — and a mineral discovery can go for billions.

We can tell quantitatively that there’s a market for good exploration projects. That’s because mining companies — majors, mid-tiers and juniors — are constantly buying and selling exploration properties. In this year‘s second quarter, a total of 66 deals were struck, more than double the number of deals from the first quarter. That alone shows demand for exploration projects is strong.

But the really interesting metric is the purchase price that acquiring companies paid to gain control of these projects. The average deal valued a good exploration property at nearly $5 million. That’s fascinating to me, given that a competent management team can generate such a property for only hundreds of thousands of dollars. The implied return on investment for this activity is higher than nearly any other industry I’m familiar with.

The really interesting thing is that this market is fairly evergreen in the face of changing economic conditions. Mining is a cyclical business. The fates of companies that dig up and sell metal trend up and down with changes in commodities prices. But exploration — the business of making and selling ideas about where significant ore deposits can be found — has little to do with metals prices. These companies do not produce gold or copper. They produce concepts for discoveries. And if you can discover a deposit that is in the upper tier globally in size, grade and amenability to mining, someone will want to buy it. There’s always a demand for world-class finds.

Bob: How does analyzing junior companies differ from other types of companies?

Dave: These companies defy traditional financial analysis. Instead, investors in this sector have to analyze the technical abilities of individual management teams. Do these professionals have expertise that gives them insight on where major deposits might be found? Are they spending money effectively to achieve measurable results? Are they capable of making the right decisions about how and whether a project should be advanced? 

Answering these questions is not straightforward. Management staffs don’t come with an annual report that lays out their attributes in an easy-to-read chart. You have to assess their capabilities by asking them questions and looking at their past work. 

This is not something most business schools teach. There are millions of MBAs who can analyze financial statements as well as — and likely better than — I can. But when I analyze the mind of an exploration professional, I’m competing against only a few others who can do the same. That greatly increases the odds I’m going to detect value that’s been overlooked.

Bob: What do you look for in a promising junior resource company?

Dave: I’ve found that it’s important to “look for the genius”: identify the one thing (and it’s usually just one thing) that management does exceptionally well. In the case of a company like AuEx Ventures, the genius was groundbreaking use of a new technology in a proven mineral district. Sometimes the genius simply comes down to the fact that a geologist has focused his entire career on one area and knows the rocks there better than almost anyone else. Whatever it is, that one thing is critical — all the value springs from it.

Another critical point is that most geologists fall into two groups. One consists of eager and generally younger professionals who get sent into the field but usually lack the experience to home in on the often cryptic signals of mineralization. The other is veteran geologists who have amassed a great body of useful knowledge and wisdom. Professionals in this group have usually been rewarded with a promotion to management, where they seldom get the opportunity to use their knowledge in a practical setting to find mineral deposits. This is a pervasive structural problem in the industry: The people who know what to look for aren’t the ones looking, and the ones looking don’t know what to look for. 

I thus look for teams that can show competence in both designing and executing an exploration program. A good management team will know what a significant ore deposit — the kind that another company would want to purchase — looks like. The team will then be able to identify areas that are fertile for deposits that fit these criteria. They will be looking for the right thing in the right place.

Bob: You had an interesting recommendation in your most recent issue of Junior Resource Advisor. Can you tell us about it?

Dave: I’ve recommended that my subscribers buy Ivanplats (OTC: IVPAF). The company holds one of the world’s largest and richest copper development projects, in the Democratic Republic of the Congo. This is a grass-roots discovery masterminded by Ivanplats’ adept technical team. They found a copper deposit with truly remarkable richness of grade and a lateral extent of tens of miles. Recent studies have assessed the value of this deposit at over $1 billion net to Ivanplats. And yet today the company trades at an enterprise value of $600 million. The company also holds a promising project in South Africa for platinum, a metal I think is going to perform very well over the next few years. 

The company is run by one of the most successful management teams in the business — people who’ve made major discoveries that went on to become mines in different parts of the world. Examples include the Voisey’s Bay nickel mine in Labrador, Canada, and the Oyu Tolgoi copper-gold project in Mongolia, which is just now starting up production under the supervision of mining major Rio Tinto (NYSE: RIO). The Voisey’s Bay project was sold for $4.3 billion, and Oyu Tolgoi at one point commanded a valuation of $15 billion. This is a team creating value.

Today you can buy Ivanplats stock for 65% below what key industry players paid when the company went public less than a year ago.

P.S. — Ivanplats is one of Dave’s top three junior resource picks right now. To learn how to get the names of Dave’s other two favorites, click here.