Stem cells which have the capacity to self-renew and generate differentiated progeny are thought to be maintained in a specific environment known as a niche. The localization of the niche, however, remains largely obscure for most stem-cell systems. Melanocytes (pigment cells) in hair follicles proliferate and differentiate closely coupled to the hair regeneration cycle. Here we report that stem cells of the melanocyte lineage can be identified, using Dct-lacZ transgenic mice, in the lower permanent portion of mouse hair follicles throughout the hair cycle. It is only the population in this region that fulfils the criteria for stem cells, being immature, slow cycling, self-maintaining and fully competent in regenerating progeny on activation at early anagen (the growing phase of hair follicles). Induction of the re-pigmentation process in K14-steel factor transgenic mice demonstrates that a portion of amplifying stem-cell progeny can migrate out from the niche and retain sufficient self-renewing capability to function as stem cells after repopulation into vacant niches. Our data indicate that the niche has a dominant role in the fate determination of melanocyte stem-cell progeny.