Why most penny mining shares are just a hole in the ground that swallow your cash

Reader SP has asked me why I haven't recommended more exploration stocks in the hot mining sector. This is a very good question - so here's my answer.

• They don't usually make good investments. This is, of course, a sweeping generalisation and I dare say you can come up with many examples of small mining stocks that have rocketed. But this is an area of the market which, more than most, is fuelled by hope only to be dashed upon the rocks of harsh commercial reality. The first rule for successful investment is to avoid big losses, and it's very easy to run them up in this area of the market.

• Exploration stocks are high risk. For all their prospective licences and promising geologists' reports, exploration companies are basically worthless until they actually hit whatever it is they're looking for. And that frankly makes me uncomfortable.

• Some of them operate in countries that have me reaching for my atlas. So it's impossible to verify the corporate spin by visiting them on site. And even then, one can hardly be skewered onto the end of a drill and plunged underground to nose around a bit.

• This lack of proximity also means the news of any lucky strike or drilling failure will doubtless have reached many other ears long before it gets to you and me. When there's news, I want to have a chance of being somewhere near the front of the queue.

• Finance. Most new exploration companies start with a licence to drill or mine and some cash to do it. But in the event they do strike lucky, they generally don't have the funds to actually bring it into production. At that point, they have to bring in a bigger partner and they're not necessarily negotiating from a position of strength. They also find that the country's government quite naturally wants a slice of the action, and won't be rushed.

• This all takes a long time. Programmes rarely run on schedule. These companies are operating in a hostile environment, both from a geographic and meteorological perspective. Recently, I met with a company that had experienced a long delay because its license area was being used for secret experiments by the Russian army.

• One of our share tips was for Simmers and Jack Mines. This is a mining company, which has cleverly tapped in to the global hunger for uranium. This is a much needed requirement for nuclear energy plants. The future looks good for the company, and the risks here are far outweighed by the huge market for the resource.

• Finally, enthusiasm for exploration stocks always comes when commodity prices are near their cyclical high. This is self-fulfilling, as all those new exploration dollars bring forth the extra supply that depresses the price. And as prices fall, all those new projects lose their financial viability and are quietly mothballed.

So I am wary. But I'm also open-minded, and if I see a company where the rewards genuinely outweigh the risks I'll tell you.Best of all, you can TRY Red Hot Penny Shares free for 1 whole month before you commit a cent on our service. Start your 1 month risk free trial now!

The past is not a guide to future performance. Trades in stocks recommended by Red Hot Penny Shares are small company shares. By their nature, such investments can be relatively illiquid and, as a result, hard to trade. This makes such shares more risky than other investments. Please seek independent financial advice if necessary. Profits from share dealing are a form of income and subject to taxation. Levels and bases of, and reliefs from, taxation are subject to change, and depend on individual circumstances.