Published: October 16, 2009

The Standard & Poor’s 500 Index has zoomed +61% from its March 9 lows, lifting investor spirits and fueling confidence in the U.S. economic rebound.

But there’s an even hotter index. This one is up +85% from its late-2008 nadir. And it’s tied heavily to companies that produce gold, silver and other commodities -- which themselves have been pretty hot of late.

I’m talking about Canada’s S&P/TSX Venture Index (CDNX), formerly known as the Canadian Venture Exchange. The “venture” portion of its title is appropriate -- more than 75% of the companies listed on the CDNX are so-called “junior miners.”

Since plunging some -80% from its ultimate highs in 2007, the TSX Venture eventually bottomed in late 2008. But as you can see in the accompanying chart, the index has already staged a remarkable recovery: From its low point reached late last year, the CDNX has already soared +85% to reach current levels -- a scorching rebound in only 10 months.

The Promise Posed by Commodities
This 10-month rebound is a pure testament to the value and future-gains-potential the so-called “smart money” sees in the junior mining sector. Investors clearly anticipate strong returns in the coming years and are prepared to commit their capital to the natural-resources sector. Some individual companies have already seen their share prices triple or even quadruple from their overall lows.

Keep in mind, too, that the small market caps of these juniors means the CDNX is a market that has traditionally been traded mostly by retail (individual) investors. I attribute the late-2008 sell-off some “weak-handed” investors who panicked and dumped their shares.

“Smart money” funds and institutional managers who recognized this inherent value have powered the rebound that started late last year. Many of these companies were selling, at one point or another, for less than the value of the cash they were holding. Buyers were getting the proven mineral reserves -- the minerals that we knew were in the ground -- for free.

Since then, the CDNX has been rising within a strong upward trend channel. But opportunities still abound.

Given the array of energy resources available on the CDNX -- not to mention the base metal and precious metal plays, too -- it’s easy to see how China must have viewed this index as a lineup of prizes that were ripe for the picking.

That’s why I expect quality Canadian mining concerns to benefit in a big way as China’s voracious appetite for resources continues to build. Beijing is known for its patience, and for a long-term view defined in years -- not just by the quarter to come.

With an economic growth rate in excess of 8%, foreign reserves of $2.273 trillion, and a population of 1.3 billion that saves 35% of its income, China is a growing global powerhouse. And its leaders understand better than anyone the true need for captive supplies of commodities in the years and decades to come.

That’s a lesson most investors would do well to learn.

China already is putting its cache of cash to work, buying commodity producers on the cheap, swapping treasuries for hard assets, and locking up that supply to meet its massive future needs.

For now, however, China’s newly acquired taste has the Asian giant scouring the global menu for a delicacy -- junior-resource companies.

Go for the Gold
Right now, the most compelling catalysts point to players in the precious-metals sector. These are the top four catalysts to watch for:

Peak gold: Global gold production is down 9.3% since its recent peak from 2003 (at nearly 2,600 metric tons) to 2008 (just over 2,300 metric tons), while gold’s price has tripled.

The China Factor: Beijing is actively encouraging China’s citizens to buy gold and silver as an investment.

The Crowded Room Effect: The entire gold industry sports a market cap of under $200 billion: When the crowd floods in spectacular returns will follow.

Marketing Magnetism: Market Vectors -- the player behind the successful Gold Miners Exchange-Traded Fund (NYSE: GDX) -- is launching a new Junior Gold Miners ETF to track its corresponding index. It will be composed chiefly of junior and mid-tier gold and silver miners, attracting more capital to the sector.

That still leaves us with a pretty big pool of players to choose from. Fortunately, I’ve found that there are two easy-to-use rules, or stock screens, that allow me to get to the best:

Do the Math: Use financial fundamentals to thin out your investment pool.

Buy the Best: When reviewing the candidates that remain, include as your final choices only the “best-of-breed” companies -- those with superior management, pristine balance sheets and quality assets.

The second rule dictates we buy only companies with financial stamina and a top-shelf management team. These attributes can help your portfolio ride out nearly any storm, as experienced managers have the ability to shoot the rapids when waters run as fast and rough as they did last fall.

If you buy a strong player, even on the basis of an expected takeover or merger that subsequently fails to materialize, you can continue to hold the stock because you are now the owner of a high-quality company. In other words, a strong company is still a good investment, even if you’re forced to hold it longer than originally planned. Now that you’re actually a long-term shareholder, you can expect to benefit from growth in the value of the company’s chief product as the escalating demand for that commodity drives the price higher over time.

Junior miners have a special place in secular commodity bull markets. The majority of larger mining companies simply can’t increase reserves enough on their own to replace depleted assets and meet anticipated growth in worldwide demand.

That’s why economic discoveries made by juniors, which often get sold to a major, create explosive returns for shareholders in the process.

It’s true that junior miners are a riskier asset class. But the potential of a return that’s 5, 10 and even 20 times your initial investment is too strong to ignore.

Canada: The One-Stop Shop for Mining Plays
There’s no doubt that Canada’s geopolitical stability and mature financial markets are alluring to investors. Factor in China’s ongoing global search for supplies of gold, silver, copper, coal, uranium and oil, and you can understand why you need to look “north of the border” for profits. Canada is becoming China’s personal shopping mall for natural resources.

As China puts more of its reserves to work, it’s going to have to work harder to find resource suppliers. That means it’s going to have to broaden its search parameters, going for increasingly smaller companies -- including those that aren’t even in production, yet.

Junior miners -- many of which trade on the CDNX -- have already benefited in a big way from these developments. And this trend will only continue.

Less than 12 months ago, this sector was one that investors actually despised.

Today, after a scorching rebound, it’s clear that investors are feeling much more upbeat.

Going forward, the profit potential is almost legendary in magnitude.

Canadian junior miners have already captivated China’s attention. Don’t they deserve yours, too?

-- Peter Krauth
Contributing Editor
Money Morning