In April 2006, Aurelian Resources (CA:ARU) made the gold discovery of the century. It was a once-in-a-lifetime find, the kind most miners can only dream of.

The stock went from about 12c to $10 in under a year. It was called the Fruta Del Norte deposit and geologists will still be talking about it going to their graves.

The latest drilling shows there are almost 14 million ounces of gold in the ground. Given that an ounce of gold costs some $900, you get an idea of the fortunes that were to be made when that mine came into production: not just for everyone involved in the company, but also for the locals and indeed for the country. Unfortunately, that country was Ecuador.

The Ecuadorian authorities, in their infinite wisdom, passed a new mining mandate in April 2006, invoking an immediate 180-day suspension of all activities on virtually every mining concession in the country. What’s more, they abolished some 88% of existing concessions. In a single stroke those fortunes were all but wiped away.

Aurelian wasn’t alone: IMC, Iamgold, Dynasty, All Metals, Corriente, Lowell’s and Ascendant Copper were all hit.

The moral of the story is one I have banged on about many times: the risks in mining are enormous, whether it’s geo-political risk, currency risk or stockmarket risk, i.e. mining shares don’t always track metal prices. So to be sure, you must own the physical metal itself. And if you are going to speculate in junior mining stocks, it’s much better to do so in safe countries.

Where’s safe?

Once such place is Mexico. Her rock is famously rich in gold and silver and her people, who have been mining for centuries, are expert. Mining is deeply set in their culture. With an emerging middle-class and a stable government, respectful of property rights, it’s a reasonable place to do business. The peso is pegged to the US dollar, so thanks to the latter’s weakness, operating costs have been kept low.

It’s possible that, as output from the famous Cantarell oilfield declines, the Mexican government will turn to mining to replace lost revenue – particularly if the silver price ever does what we all hope it will – but for now it is comparatively safe.

The problem is there are more junior mining companies in Mexico than there are Dalmatians in a Disney film. So how do you find the right one?

Well, there are lots. One in particular that I like and recommended back in March as a buy below $4 is Gold Resource Corporation (US:GORO), run by the Reid family. Bill Reid used to run US Gold. He sold out to Rob McEwan, but kept a couple of assets back for himself, which he then rolled into GORO, a new company he set up with his son Jason and his brother David. He then raised some money and set to work developing those assets.

Typically, if you participate in a fundraising for a mining company, you will be given a share at a discount and a warrant. Many investors sell the share as quickly as they can and keep the warrant, thus getting their equity out while still getting the benefit from any serious upside. This process puts unnecessary selling pressure on the stock and, later on, should warrants get exercised, creates undesirable dilution for shareholders.

But Reid never issued a single warrant. What’s more he raised money from sources he believed would remain long-term investors, rather than short-term speculators. So GORO, despite the bear market elsewhere in junior mining stocks, has been tightly held, short of selling pressure and has maintained a nice steady uptrend since its listing at $1 back in 2006. It’s now trading at $6.

Reid’s family own a huge share position in the company, which means that when they act they do so in the best interests of shareholders. When the stock came under selling pressure earlier this year, Reid quickly found out who the seller was – a fund who had to get out to meet margin calls elsewhere – and set to work looking for a buyer, which he duly found. The selling pressure was relieved and the stock resumed its uptrend. The right guy to have on your side.

But that selling pressure meant that you had a chance to buy the stock as recommended below $4. If you did, congratulations. Last week the board announced the appointment of a top operations manager and followed next day with the best drill results to date. The stock cruised on up and you are now up 50% in just a couple of months. GORO remains on course to start production later this year or early next. Needless to say, I own stock.

Buy gold or buy oil?

Finally, a quick alert on the gold-oil ratio. It’s a very useful tool that a lot of traders use: how many barrels of oil will an ounce of gold buy? At the moment the ratio is about 6.85 barrels of crude per ounce of gold. Even with the gold price up so much since last summer, that’s an extreme. We’ve only been at these levels five times in history: during the oil crisis of 1920; in 1976, 1982, 2001, and 2005.

During the post 1929 fall-out, the ratio got to 70 barrels per ounce of gold. But the mean is about 15 barrels, and a reversion to the mean would entail the gold price, measured in oil, doubling from here. I wouldn’t dare to ‘short sell’ oil, it’s too risky a trade. Nevertheless history is telling us to take some of your profits on your oil trades and move them into gold.

Turning to the wider markets:

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After their recent bull run, London shares cracked by 2.9% on Tuesday. A wave of selling lowered the FTSE 100 index by 185 points to 6192, with high-flying mining stocks being hit particularly hard. Banks, in contrast, fared less badly while drug companies were supported by investors looking for safe havens. Yell, publisher of Yellow Pages, dived 26% after halving its final dividend.In Europe, similar declines to London were seen, with the German Xetra Dax declining 1.5% and the French CAC index shedding 1.7%.

Weakness in Wall Street was the catalyst for Europe’s late afternoon fall, with the Dow Jones Industrial Average losing some 200 points from its four-month high to close 1.5% down 12829. Figures showing ‘core’ producer prices rising at their fastest pace since 1990 helped to spook traders, while oil prices continued to soar. But the broader S&P 500 and the tech-heavy Nasdaq both ended the day down just 1%.

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