TWELVE GUIDELINES FOR BUYING GOLD MINING STOCKS
The twelve guidelines should help you to better understand
some investment basics regarding the mining industry, especially
if you do not have a background in geology or mining engineering.
I have kept this as non-technical as possible so no one falls asleep.
Keep in mind, these are basic guidelines and far from complete.
·• If the company does not have an independent
professional resource calculation for gold or silver or other minerals,
know that someone is either speculating or guessing at the most
critical data point regarding mining industry valuations. Be careful
not to confuse “resources” with “reserves”.
Measured and Indicated resources are reliable as a resource. “Inferred
resources” are very speculative mineral inventories, so be
careful when “inferred” is used. A resource still has
a long way to go to become an economic deposit, as opposed to “reserves”
which are deemed to be proven economic and mineable ounces calculated
by very strict engineering and government rules. Canada’s
National Instrument 43-101 is one such guideline regarding resources
·• I would suggest your portfolio be 60% invested
in companies already producing gold or silver profitably. The other
40% divide into companies close to production with impressive projects
or very far along in defining large and significant mineral resources.
Producers should include majors and mid-tiers (your monetary insurance,
since they undoubtedly have the goods in the ground). Look for mid-tiers
with good growth profiles. Junior producers with new projects are
Companies with lots of money in the bank or access
to sponsorship from top investment banks in Toronto, London and
Vancouver is vital in this capital intensive business and always
a good thing to look for. Diversify: have at least 15 good companies.
Depending on your risk tolerance you could allocate a small portion
to grass roots exploration stocks but know this is the very high-risk
end of the business.
The industry has changed in the last five years.
Exploration and development budgets from 1998 to 2002 declined dramatically.
Therefore going forward, in my opinion, any substantial project
that is near feasibility (an extensive outside engineering report
based usually on tens of millions of dollars of geological, metallurgical,
and engineering work) could be a buy-out candidate for major and
mid-tier companies that need to catch up on reserve replacement
·• “Good management” is an overused
word. My definition of good management is 20 year mining professionals
who have had successful executive positions with large or successful
mining companies or projects in the past. If you see names like
Barrick, Newmont, Placer, Anglo, Goldfields, etc. on the resume
you are most likely dealing with some quality professionals. People
who ran mid-tier companies or successfully helped bring medium to
large projects to production also qualify. There are always exceptions,
but you better know who you are dealing with. Direct mail pieces
touting some gold stock and claiming top management should be carefully
·• Size is very important. The larger the deposit
or potential resource the better. Small mines are not worth your
trouble as there are few institutions that will finance them and
fewer companies that will ever acquire them. With gold mines try
and look for 2-3 million ounce and above possibilities. Mining giant
Goldfields, only targets projects with 2 million reserve ounces.
With silver, 100 million ounces should be your minimum. But the
above still has to be qualified. If the resource is too deep under
the surface, of very low grade (richness), or has one of many other
negative reasons it may not ever be economic to mine.
Tonnage is important. Big tonnage operations create
economies of scale that can make some low metal values economic
to mine. Three hundred million tonnes (a tonne is 2204.62 pounds,
not to be confused with a ton which is 2000 pounds) for an open
pit gold mine is big. Ten million tonnes open pit is small. For
an underground operation, tonnage can vary dramatically and grade
and mining widths become more important (we will discuss this below),
but one million tonnes would be small. For a base metal open pit
deposit, one billion tonnes would be huge, while 20 million tonnes
would be small. So remember in this business – Big is Beautiful.
·• Grade (richness) is crucial. How much bang
for the buck are you getting per tonne of rock. If the grades are
high enough the above tonnage discussion becomes less relevant.
With a near surface potential open pit gold deposit, 2 grams per
tonne (a gram is .03215 of an ounce) would be excellent. 1 gram
would be fair as long as you don’t have to remove too much
waste rock to get at the ore.
With underground mines, everything changes: depth,
the continuity and mining widths of the ore and the vertical or
horizontal plane of the ore all comes into play as well as many
other factors. Generally, to be on the safe side, if you can find
gold grades of 10 grams (about a third of an oz.) or more per tonne
across mineralized sections averaging 3-4 meters or more in width,
then you are looking at good potential. Lower grades across wider
widths also work (i.e. 6-7 grams across 10 meters) Keep in mind
these are rough guidelines and subject to many other factors, like
depth, vein continuity, overall tonnage and much more. But the sweet
spot in this industry is high grades across wide zones of mineralization.
·• Expansion possibilities for a company’s
production and resources/reserves are important. For non-producers,
resource expansion is crucial, because as these companies drill
and confirm more resources they will increase their intrinsic value.
This helps them handle the big hurdles of either financing the mine
or mines, selling-out, or bringing in a joint venture partner at
reasonable terms. Mining companies with plenty of production and
new mines coming on stream in the years ahead are usually a good
group to own. Growth is Good.
·• Cost per ounce of production is very important.
Companies with high costs are more risky since a low metal price
market will make them unprofitable, but they will have considerable
positive leverage if metal prices go up. A gold mine with $325 costs
per ounce, doesn’t make much at $375 gold, but if gold goes
to $425, the mining profit doubles. High cost producers are a double
I like low cost producers. They are safer, have lots
of cash flow to buy new properties and mines, will have more funds
for exploration and development and could eventually pay strong
dividends if gold stays in a new high price range over the years
(i.e. $450-500). Also large mining companies are not going to buy-out
high cost producers. They are risky and migraine headaches for management.
Mining costs are mostly a function of grades, mining
widths and tonnage. If you can talk to a mining engineer and get
a handle on the cost per oz. or tonne of the operation, you are
acquiring crucial data for your analysis. Companies operating at
high costs (within $100 of the gold price) or that have projects
that look like they will be high cost producers should be avoided.
High costs equal high anxiety.
·• Value per ounce: How much you are paying
for the gold in the ground is an important stat. The lower the better.
The following guidelines relate to a $350-400 gold price. If gold
were to go higher these numbers would increase. For advanced exploration
companies, try and stay in a valuation range around $15 per ounce
of resource in the ground. As an example, a company with 15 million
shares outstanding selling for $5 per share has a $75 million market
cap. With a 5 million ounce resource, the market cap. per ounce
is $15. As companies move up the food chain and expand and define
the resource and test metallurgy and do engineering studies, the
market cap. per ounce should go up to $30-50 per ounce. Depending
on the quality of the deposit these valuations can change.
Producing companies if bought out, can go for $100
to $150 per ounce of “reserves” in the ground. That
is an important guideline. You do not want to buy a stock where
you are already paying $100 per ounce for just a “resource”
(which means the “reserve” will actually be lower).
With the company just in the advanced exploration stage, there won’t
be enough upside unless the deposit gets a lot larger. Advanced
developmental (meaning feasibility to actual construction) companies
can be bought out for $40-75 per ounce of resource or much more
depending on many factors that are beyond the scope of this writing.
Usually the value of the ounces and the stock price
go up as more and more confidence is gained in the project. Initial
resource definition usually allows for a value of $5-10 per ounce.
At the bankable feasibility stage those same ounces could be valued
at $40-75 per ounce.
If you see a mining company with a well defined resource
and the gold ounces are valued at only $5 per ounce or so, just
know there is probably a reason and it is probably bad. Most likely
those ounces will never see daylight due to any number of reasons:
environmental, logistics and infrastructure problems, political
risk, low grades, high capital costs, narrow mining widths, high
strip ratios (how much waste rock has to be removed to get to the
ore in an open pit operation) and a host of other reasons. There
is a right price for the ounces, don’t overpay.
·• In a favorable gold mining environment, which
I believe we will have for the next 10 years, it doesn’t pay
to take undue risks. Try and find good merchandise and be careful
of the small grass roots exploration companies. Surface sampling
is the key to the difficult exploration business. Positive soil
and loose rock samples on a prospective property may have come from
many miles away twenty million years ago. This means an ore body
that is hopefully under the ground is not there. Only one inch of
geological movement in a subsurface rock structure every 100 years
equals in 20 million years, 3.2 miles. In geology you are dealing
with billions of years. Mountains you see were once ocean floors,
etc. Large and extensive outcrops (surface rock formations) that
have mineral showings can be a good indicator as well as widespread
crude and small local native mining activity. But it is no easy
task finding these minerals in large enough deposits to be economic
to mine. Surface showings are actually very important indicators
for economic mineral discoveries but unfortunately they are still
·• A key stat is cash flow per share if the
company is already a producer. Large gold mining companies can sell
for 15-20 times cash flow in a good gold market. Mid-tier and smaller
producers can sell for 25-35 times current cash flow because of
expected cash flow increases, from new mines coming on stream. In
this case the market is anticipating the future. Beware high cost
producers selling at high multiples of cash flow, as they will get
hit very hard if gold has a set back.
Companies expecting cash flow from future projects
are usually valued using a net present value criteria. In this method
the entire future cash flow of a mine is laid out and a value is
placed on this cash stream, taking into consideration the time value
of money. How much is the $500 million dollars that the mine will
make in the years 2008 thru 2018 worth today in the present. The
future cash flows have to be discounted in order to arrive at some
sort of present value for the projects. Many times a 5-10% discount
rate is used. I believe a lower discount rate is also ok, since
gold is an anti-discounting currency (i.e. gold’s price should
go up with inflation and interest rates therefore negating the discount
rate - because it will keep it’s future purchasing value).
Earnings per share is a tricky stat for the miners because of so
many non-cash charges and accounting complexities. In the long run
it all comes out in the wash, but during the years of the life of
a producing mine, cash flow is the king. Look hard at cash flow
per share or expected cash flow from projects.
·• Comparables are very important. Why would
you buy a stock where for every $1 you invest you get $5 of gold
in the ground when another company with very similar fundamentals
and resources gives you $40 of gold in the ground for every $1 you
invest. There actually may be a good reason, but the point is you
should know what that reason is. Comparisons are an important ingredient
to avoid overpriced companies and missing some real bargains. We
constantly do comparables at Kenneth J. Gerbino & Co. and I
suggest you do also. One should compare the basics: grades, tonnage,
costs per ounce, costs per tonne, smelter charges (for base metal
deposits), reserve or resource value per dollar invested, market
cap per reserve/resource ounce, discounted cash flows and the net
present values of the mining assets. Comparables allow you to better
shop the market.
·• Be careful of the term Gross Metal Value.
This is all the precious metal ounces or base metal pounds in the
ground multiplied by the current price of the metals. It is misleading
unless you have a lot more information and knowledge. Just know
that with any mineral deposit a company will never recoup anything
near the gross metal value of what is in the ground. The ore will
have a mine waste factor (5-15%), recovery losses in the mill or
from the leach pads (5-20%), and smelter, refinery, transportation
and penalty costs for base metals (20-35%). Throw in royalties,
state and local taxes and other expenses and you will see that gross
metal value is less important to your analysis than all the other
ingredients that would determine a quality mining investment. It
doesn’t mean the term is useless but it can be dangerous to
use on it’s own.
Well, there you have some basic guidelines that I
hope will help you through all the press releases and some of the
direct mail hoopla about all the billion dollar mountains out there.
Remember the more homework you do the better off you will be. For
other articles on gold and the economy please visit our website
Good luck in what looks like a long-term, mostly bullish
precious and base metal market.
Kenneth J. Gerbino
Kenneth J. Gerbino & Company
9595 Wilshire Boulevard, Suite 303
Beverly Hills, California 90212
Telephone (310) 550-6304
Fax (310) 550-0814