Gold minig valuation

Gold minig valuation

Gold is the most popular precious metal for investors. Everything around us comes from mining, but the possibility of striking gold with penny stocks that have the potential to turn into a multi-million dollar mine-producing company. The risk is around every bend even after the mining company has started production, which is why it is crucial to know how to value a mine.

Every mining company starts out as a cookie cutter of another.

Technical Report

Mine Status
Every mine that goes into production has a technical report written by geologists and engineers. This report is called "NI 43-101". The first page of the technical report will tell you the type of report, which basically means the stage of the mine. These stages are:

  1. PEA (Preliminary Economic Assessment): is a very early stage report takes many months that defines the resources but that is pretty much it. The probability of a mine with a PEA eventually going into production is very low.
  2. Pre-Feasibility Study: has a 10%-30% chance of the mine going into production down the road. It defines the resources with more confidence and discusses the possible economics of the mine. And this stage takes from 2 to 3 years to complete.
  3. Feasibility Study: the most advanced stage of the mine before construction and development begins. Aside from the majority of the report being a technical assessment, it is essentially a detailed business plan, and this stage takes from one year to two years to accomplished.

A technical report can be hundreds of pages long. But we just need to extract the necessary info to value a mine:

  1. Mine Start Year:
    If the company has already made significant plans to develop the mine after the feasibility study has been issued. This phase is pre-production and the very first gold produced is called a "gold pour". We are looking for the year in which "commercial production" starts, and before full capacity production, the company tests the processing and optimizes the plant.
  2. Reserves & Resources:
    By the time a feasibility study is written on a mine, the resources are reported with a high degree of certainty. These are called Proven & Probable Reserves. Each category of reserves or resources tells you the degree of certainty that the stated minerals are indeed there and mineable. If you’re trying to value a mine that only has a PEA, you may only see Inferred Resources.
  3. Annual Production Run Rate:
    The plant production is how much are the raw rock is mined and processed to extract the gold. Gold is expressed in troy ounces.
  4. Gold Recovery:And once gold is extracted through the plant at the gold grade, the gold gets further processed to become refined. To get the refined simply multiply the recovery rate to the gold produced.
  5. Operating Costs:
    It’s divided to Three categories:
    (A) Mining cost consists of all costs associated with excavating the ore (e.g. mine equipment operator cost, fuel cost, maintenance cost, explosives cost, etc.). Expressed as US$ per ounce of gold produced.

    (B) Processing cost includes costs associated with the plant, where the ore is processed into gold (e.g. equipment maintenance, plant labour including plant engineers, water treatment, lease, power and utilities, etc.). Expressed as US$ per tonne processed.

    (C) G&A cost is comprised of salaries in corporate office, HR, security, environmental costs, land patent tax, etc. Expressed as US$ per ounce of gold produced.

    In Mining, we have to note that operating costs are stated as cost per ounce of gold produced. And that’s because to be able to compare among other gold companies in the industry, and since the gold price is an important economic indicator for the economy in general and for mining specifically.

  6. Capital Costs:
    Capital costs are categorized into:
    (A) Initial Capex consists of construction and development of the mine. All the costs before the plant is producing gold.
    (B) Sustaining Capex is cost associated with maintaining or upgrading all the equipment and assets throughout the life of the mine.

Also provided in the feasibility is a schedule of how the costs are allocated throughout the mine period. However, many companies spread out the initial capex for the sake of the economic valuation.

Valuation Model

Because a mine’s economics is a set of cash flows in and out during a defined period of time, the best valuation approach to use is the Discounted Cash Flow "DCF", which the valuation model in this example uses. Adding up all of the discounted cash flows, we will derive the Net Present Value "NPV".

If you have access to professional databases like Capital IQ or Bloomberg, then you can look up analyst consensus of gold price forecast, but if you don’t, there are free sites that blog about gold price forecasts. The best place to pull analyst consensus is I approach valuations on the conservative side, so I’ve assumed a gold price of $1,300 in the mine start year of 2020 then decreasing to $1,100 until the end of the mine life.

Revenue is simply the recovered gold multiplied by the gold price.
The higher the risk the mine has in meeting the forecasts, the higher the discount rate.
The valuation of the mine.

Finally, look at the company’s latest balance sheet and add cash and subtract debt to arrive at what the intrinsic value of the market cap is and compare it to the current stock price.

Due Diligence

  • Threat of New Entrants.
    Financing is a principal barrier to entry in the precious-metals industry, which is heavily capital intensive. Constructing mines, production facilities, exploration and development and mining equipment all require large sums of capital. This capital is required before the mine is in production. Therefore, favourable financing terms are extremely important. In short, long-term survival in the precious-metal market requires significant capital.

  • Power of Suppliers.
    The only supply-side issues that miners face deal with government regulations and rules. The supply of land is plentiful, but gaining approval and permits to mine the land can be difficult, especially if environmental risks are high.

  • Power of Buyers.
    Gold is a commodity-based business, so the gold from one company is not that much different from another's. This translates into buyers seeking lower prices and better contract terms.

  • Availability of Substitutes.
    Substitutes for the precious metals industry include other precious metals such as diamonds, silver, platinum, etc. These are worthy substitutes for gold, but they are not as widely accepted as gold. Gold has the advantage of being standard for a world currency, so a gold bar in the U.S. is worth the same as it is in Ecuador.

  • Competitive Rivalry.
    Gold companies don't compete on price, mainly because the prices are determined by market forces. But gold companies do compete for land. The backbone of a precious metals company is its reserves, and the only way to beef up reserves is to explore for good mining areas. Companies go to great lengths to discover gold deposits, and the discovery is on a first-come-first-serve basis.

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