Part 1 and Part 2 covered what’s in the ground and how a junior rounds up the currency to spend on finding it, delineating it, proving it and planning to extract it. This final letter in this three-part series covers what a mine might be worth, what the market thinks it’s worth, and the method we use to judge. It’s the dialect spoken in Vancouver, where more juniors are run and promoted than anywhere else, and in Toronto, the center of Canada’s larger financial markets.
The Economics
A mining study—a preliminary economic assessment (PEA), a pre-feasibility, or a feasibility study—is a spreadsheet with a qualified person’s signature on it. Behind that spreadsheet are years of geology, engineering, metallurgy, and economic assumptions. These studies are essential to determining whether the rock becomes a mine. The market (or a partner) gets to see the company’s figures and decide whether to fund it.
NPV and IRR. Net Present Value and Internal Rate of Return—the study’s estimate of what a mine project is worth today and the annual return its cash flows imply. Both hinge on the assumed metal price. These are mine-specific measures, not valuations for a company with more than one project.
A dollar received later is worth less than a dollar in hand. To calculate NPV, each year’s cash flow is divided by (1 + r) raised to the number of years out, where r is the discount rate, usually (but not always) 5% for gold projects. So $100 million arriving in year five is worth $100 million ÷ 1.05⁵, or $78 million, today.
Example: a mine costs $300 million to build and throws off $100 million of cash per year for five years. Discounted at 5%, those five payments are worth $433 million today. Subtract the $300 million build cost and NPV is $133 million.
Studies report NPV both before and after tax. Some companies headline the pre-tax one because it’s bigger. Timing of the spending matters too.
IRR answers a different question that is akin to an interest rate (or rate of return) on the money invested. What annual return will the mine earn on the money spent to build it?
It is the discount rate (r) implied if the five annual payments, when discounted by r, are worth exactly the $300 million build cost. We already saw that with r = 5%, those $500 million of payments are worth $433 million today. But at r = 20%, they are worth about $300 million, which is the mine build cost. So the IRR is about 20%.
You can think about it like this: building this mine is rather like lending $300 million at 20% interest and being repaid in five equal installments. That is, if the mine works, if the assumptions remain, if a rebel force doesn’t blow it up, if a government doesn’t seize it.
IRR ignores size, though. A small mine with a 40% IRR can be worth less than a big one at 20%. NPV measures how much; IRR measures how efficiently.
Nudge the assumed gold price up and both NPV and IRR numbers jump. That’s the leverage of miners.
Always look up the assumed price deck the company used for its NPV/IRR calculation.
Payback period. How many years of cash flow it takes to recover the build cost. In the example above, three years. Shorter is safer.
Capex and opex. Capital expenditure (capex) is the one-time cost of building the mine. Operating expenditure (opex) is the cost of running it, per tonne or per ounce. Capex estimates have a habit of growing between the study and the groundbreaking. Partly this is early optimism. Partly it is cost increases from currency inflation.
A brief aside: when gold is pulled from the ground and put on the market, the gold supply is inflated. Gold miners’ job is to inflate. The critical difference between gold miners inflating the gold supply and central banks inflating the currency supply is that it takes work and risk to increase the gold supply. It takes nothing to create additional fiat currency. That is the profound moral failing that makes fiat currency so destructive.
Sustaining capex. The ongoing capital needed to keep a mine producing: replacement equipment, ongoing underground development, and tailings or infrastructure work needed to maintain existing production. It is the “sustaining” in AISC.
AISC. All-in sustaining cost per ounce: an industry measure of what it costs to keep an existing mine producing, including mining, processing, royalties, corporate overhead, and the capital needed to sustain output. Subtract AISC from the realized selling price per ounce and you have the producer’s AISC margin. But that is not net profit. Taxes, interest, non-sustaining capital expenditures, acquisitions, and the cost of building the next mine still have to be paid. The mine doesn’t necessarily send you the profit.
A producer whose AISC sits close to the gold price isn’t making a profit. It’s moving rock around.
Sensitivity table. The grid in the study showing how NPV and IRR move with metal price, grade, capex, and operating costs. If NPV turns negative on a small drop in the metal price, beware. If that drop arrives while the mine is repaying its construction debt, the lenders still get paid first. But equity holders take it on the chin, despite all the risk they took.
The Market
NAV. Net asset value: an estimate of what the whole company is worth on paper. Start with the net present values (NPVs) of its projects, add cash and investments, and subtract debt, the present value of corporate overhead, and any liabilities not already included in the project valuations. Divide by fully diluted shares and you have NAV per share. The company publishes its projects’ NPVs in its studies but NAV usually comes from analysts, who use their own assumed metal prices and costs, then discount the projects for the odds they won’t be built. Thus the same company can carry different NAVs.
P/NAV. Share price divided by net asset value per share. Explorers and developers trade at a fraction of NAV because most never become mines. Below 0.5 can be a bargain, but it may also be a reflection of lots of problems that others have noticed. Above 1.0, the market has already paid for success and is dreaming of more success.
Ounces in the ground. Tonnes of mineralized rock multiplied by grade, reported as contained ounces in a resource estimate. These are not necessarily recoverable ounces. They are the junior’s inventory, and the denominator in EV/oz. Beware: an inferred resource ounce a kilometer deep, in refractory ore, in a jurisdiction that hates miners, is worth a fraction of a proven reserve ounce in an open-pit oxide deposit in Nevada.
EV/oz. Enterprise value (market cap plus debt minus cash) divided by ounces in the ground. The quick way to compare explorers and developers. It’s what the market thinks the rock is worth. If peers trade at $50 an ounce and yours trades at $15, either the market missed some upside or you missed some downside. However, it is a crude comparison, because ounces in the ground come in various flavors: different resource categories, grades, metallurgical hassles, deposit types, and jurisdictions.
Lassonde Curve. A conceptual chart of a deposit’s perceived value over its life: a spike on discovery, a long slump through studies and permitting (the “orphan period” and “valley of despair”), then a second rise into production. Speculators make their money buying before the discovery, selling during the excitement of the discovery, and then again buying toward the end of the valley of despair just as the build decision is about to happen. For details, we have a full letter on the topic.
Liquidity. How easily you can turn shares into cash. First, whether you can sell at all: shares in a private company, shares still under a hold period, or a halted stock may have no sale available at any price. Second, how easily you can buy or sell without moving the price, measured by average daily volume and the bid-ask spread. Getting out of a large position in a thinly traded stock can take days or weeks, and the price sags while you do it.
Takeover premium. What an acquirer pays above the market price to buy a company, often 20% to 50%. Few juniors build their own mine. For most explorers and developers, a buyout is the happy ending.
Tax-loss selling. Year-end dumping of losers to harvest capital losses. Illiquid juniors fall for reasons unrelated to the rock. If you have capital to invest, November and December are often times to buy lowish when other people are selling lowish to take their losses. This is standard stuff for stocks of companies in the valley of despair, which have lots of potential future value, sure, but have immediate value now as tax losses.
Punt. A speculative bet made without your own due diligence, on the strength of a hunch, a hot tip, a promoter’s tout, or someone else’s homework. Size it like one: small enough that losing all of it hurts your pride more than your portfolio. Hopefully, the winners will pay for the losers. Best to punt only when the tip comes from someone you know well, who cares about you and has a record of tips that paid out. But it’s better to not punt, and instead do the 9Ps analysis.
The Analysis
Due diligence. The homework: reading the technical report, the financial statements, the share structure, the deal terms, and management’s track record, then checking the company’s claims against sources other than the company.
9Ps and 10Ps. Doug Casey’s method for analyzing junior resource stocks, a checklist of pillars that each start with P (or something that sounds like it could be a P): People, Property, Phinancing, Paper, Politics, Promotion, Push, Pitfalls, and Price. A tenth, Phat Lady, considers the exit: how liquid the stock is, who might buy it, and how an eventual exit might happen. That’s diligence.
If you become a paid subscriber, you will see these terms put to work in our 9Ps scorecards, where we run the numbers a news release doesn’t highlight.
Doug Casey is fond of the old line, usually credited to Mark Twain, that a mine is a hole in the ground with a liar at the entrance. Knowing the vocabulary won’t silence the liar, but it might help you recognize which number he failed to mention.
Sincerely,
John Hunt, MD
Editor, Doug Casey’s Crisis Investing
Thanks, Professor Doctor. Right on.