|
|
|
|
By Dennis Boyko
January 12, 2010
Version 0.17 updated January 28, added a disputes point to the Valuation Factors section.
Version 0.16 updated January 19, added a share holdings bullet point to the Valuation Factors section.
Version 0.15 updated January 18, added land holdings bullet point to the Valuation Factors section.
Junior Gold Explorer Valuation Observations outlines a data driven arguement
for using a Gold Explorer-Producer Valuation chart (Market Capitalization per ounce of Gold Equivalent
versus Average Ore Value per tonne) for valuing gold explorers and gold producers.
Looking at the current Gold Producer Valuation Line (a full size chart with data from the close of trading on 2010-Mar-09 is included at the end of this blog and a small scale chart with December 24, 2009 data is presented here), an investor immediately has a basis for assessing whether or not a junior gold stock's valuation is as expected. That is, all things being equal, gold producers are expected to appear on the Gold Producer Valuation Line and gold explorers are expected to appear on the left hand side of the Explorer-Producer Gap. The Explorer-Producer Gap is the gap indicated by the heavy green arrows (i.e. the area between the two dashed lines) in the Gold Explorer-Producer Valuation charts.
Unexpected placements on the Gold Explorer-Producer Valuation chart are of interest when one considers individual gold stocks:
If there isn't an explanation based from the facts related to the company's gold deposit(s) and current financial situation then there is reasonable probability that the gold stock in question is mispriced.
Any mispriced stock in the market can be reasonably expected to correct as the mispricing is discovered. Over time, mispricing on a given stock should disappear.
The size of the Explorer-Producer Gap gives a general indication as to whether explorers are being valued at a premium or a discount relative to producers. As discussed in Junior Gold Explorer Valuation Observations, at the end of 2009, gold explorers appeared to be overly discounted relative to gold producers. The size of the Explorer-Producer Gap did however shrink over the course of Q4 2009.
Gold Explorer-Producer Gap exists because of the $$, time and risk deltas between the two groups Junior gold explorers may be thinly trades, followed by few (if any) analysts, and as a result may be occasionally be mispriced in the market. Gold producers such as Kinross Gold and Agnico-Eagle are on the other hand widely traded and extensively followed thereby reducing the chances of a market pricing error. Therefore, the Gold Producer Valuation Line provides a solid valuation basis. The Explorer-Producer Gap is the natural consequence of the following differing factors between gold producers and gold explorers:
Capital Expenditures requirements to move an ore deposit from a simple exploration project to fully developed operating mine,
Discounts as a result of the multi-year time lines required to turn a promising deposit into an operating mine, and
Risks inherent in mine development projects.
The suggested valuation process using the Gold Explorer-Producer Valuation chart consists of:
Determining the current Average Ore Value per Tonne and Market Capitalization per ounce of Gold Equivalent for the gold stock of interest using recent spot market metal prices, stock prices, and NI 43-101 compliant (or equivalent) disclosures. The GoldMinerPulse Metal Valuation Reports and charts provide this data for listed companies after the close of each trading day. Market Capitalizatin per Ounce Computations details the algorithms GoldMinerPulse follows to compute these metrics.
Checking the relative position on the latest chart and then judging if the placement is as expected:
Established gold producers are expected to fall close to the Gold Producer Valuation Line. If not then your gold producer is potentially an exception.
Gold explorers are expected to fall to the left hand edge of the Explorer-Producer Gap. If not, then your junior gold explorer is potentially an exception.
Assessing unexpected valuations to determine if there is a valid reason for the unexpected placement on the chart. Unexepcted placements occur when:
fundamental issues exist and these issues are causing investors to discount the stock (e.g. the host country is starting to talk about outright bans on mine construction),
markets anticipate good news causing investors to discount the stock (e.g. outstanding drill results may cause investors to anticipate future NI 43-101 resource expansion),
market hasn't interpretted the stock's fundamental data correctly (e.g. a long term strike has ended allowing a company to resume production but the changed situation hasn't impacted the company's valuation),
GoldMinerPulse (or your metric source) have not interpretted the stocks fundamental data correctly (e.g. missed counting reserves/resources, double counting reserves/resources, fully diluted share counts are wrong, etc.).
Focusing on valuation exceptions, since the valuation exceptions are the best candidates for generating exceptional returns.
This blog is intended to enumerate the generic issues that would cause a gold stock's valuation to deviate from expected valuations. However, before looking at the types of issues that would explain valuation exceptions, I take a brief look at the common alternate choices for gold mining company valuations.
Some people in the mining industry say that no two mining properties are the same making valuation on the basis of comparables very difficult if not impossible. Many in the investment community use Cash Flow, or Net Asset Value as the basis for valuing gold stocks.
I do enjoy reviewing Net Asset Value (NAV) and Discounted Cash Flow (DCF) calcuations. A NAV and/or DCF at some level is essential to fully understand a company's current situation. However, I also believe that NAV and DCF have fundamental limitations and in the end, for individual investors looking at junior gold explorers, are not as useful as a Gold Explorer-Producer Valuation chart. Specifically, NAV and DCF are critically dependent on the expected future gold, silver and base metal prices over the coming years, and in many company scenarios, possibly out as far as 20 years. But estimating the future gold, silver and base metal prices or even a price ranges is itself a hugely difficult challenge when you look at the range of price movements for gold and silver over the last 50 years. Secondly NAV and DCF need much of the cost data that would be provided by a Feasibility Study. However most junior explorers have not reached a development stage where a Feasibility Study would be available. Furthermore, NAV and DCF calcuations are also indirectly dependent on energy pricing and macro issues such as regional politics and environmental concerns which are again difficult to model.
Gold Explorer-Producer Valuation charts leverage the market to compute the future expected price of gold. The financial community has models for estimating future prices but models do fail, occasionally in a spectacularily fashion, as we've seen in the 2008 financial melt down. Various security exchange control bodies impose rules on commodity valuation assumptions. The US securities and Exchange Commission staff currently require a 3 year trailing average for gold and silver prices in economic studies (for exapmle, see the MAG Silver Scoping Study Conference Call Transcript for discussion of regulatory controlled metal price assumptions). Again, given the current economic environment, do you believe the 3 year trailing average is a reasonable forecastor for future metal prices?
Even with the Wall Street disclaimer above, I believe that the markets as a composite whole are the best (only?) mechanisms for estimating the future prices of gold, silver, copper, lead, zinc, etc. and that, the Market Capitalization per ounce of Gold Equivalent the market assigns to each gold stock is in general an accurate expression of the best available future metal price expectation. Unfortunately, the gold, silver and base metal prices, which directly contribute to a company's Average Ore Value per tonne are just one input the markets use to compute a Market Capitalization per ounce of Gold Equivalent for a gold stock. However, a host of generic factors may be issues for a specific gold stock and these issues can cause the expected Market Capitalization per ounce of Gold Equivalent to significantly deviate from would be normally expected for a given Average Ore Value per tonne. These generic factors are discussed in the next section.
Many factors can cause a given gold stock's position on the current Gold Explorer-Producer Valuation chart to deviate from its expected placement. These factors include:
Ability to mine -- are permits available, is there local support or opposition, is the government mining friendly or is mining banned. Is the mine site near a world heritage site? Are there land use conflicts? For example, consider El Salvedor and Mining Location Risks.
Mining feasibility -- does the company have Proven + Probable reserves and a matching Feasibility Study? Is the necessary funding to implement the mine development plan detailed in the feasiblility study available or accounted for in the current stock price? As an example, Osisko, is being valued by the market on the Gold Producer Valuation Line since Osisko has demonstrated mining feasibility and raised capital. Canplats Resources is not valued in the same way since mining feasibility has not been demonstrated and mine development capital expenditures have not been funded.
Management team -- what is the experience of the management team to plan and execute based on the type of mine, partnerships involved and the host country regulatory environment? What are the track records of management and, if applicable, the joint venture partners?
Land holdings -- what operating mines are near company land holdings? Is there drilling activity nearby? Have airborne surveys identified future drill targets? Are the holdings in an area with abandoned mines, either historical workings or mines abandoned due to low metal prices in the early 1990s? Some silver companies, Alexco Resources (AXR) and Impact Silver (IPT), and gold companies, San Gold Corporation (SGR) for example, appear to trade a premium to their peers. However, each of these companies holds land holdings with old mines (or old mine sites) and have idenfitied immediate high grade ore targets for near term production (or are already in production) and offer significant upside potential for future resource and reserve discoveries in terms of multiple future drill targets.
Share holdings -- what shares of other companies are being held? Many times, junior gold and silver explorers/producer settle sales with shares. For example, Garibaldi Resources (GGI) sold its Temoris project (54,810 hectares adjcent to Coeur's Palmarejo project) to Paramount Gold & Silver (PZG) for 6M shares of PZG. Although Garibaldi Resources has a very significant land position in Mexico's Serria Madre, Garibaldi has until recently traded at a valuation roughly equal to the value of its PZG shares holdings.
Geopolitical risks -- what is the risk of being nationalized, having your project cancelled or being subject to a future mining banor?
These risks are insignificant in some mining regions (e.g. Canada) but
could be significant in Venezula and other countries. For example, consider a January 2010 news story,
Pakistan province aims to end Barrick mine venture.
If Barrick's Reko Diq project had a positive Feasibility Study, that Feasibilty Study is potentially at risk of becoming irrelevant. Therefore, the geopolitical risk factor
is beyond what is typically estabilished in a Feasibility Study.
Another example of Geopolitical risk
would be Venezuela's move to nationalalize Crystallex's Las Cristinas gold mine. If Crystallex were plotted on a Gold Explorer-Valuation chart,
it would appear in the extreme upper left hand corner
since few if any investors expect Crystallex to be able to produce gold from Las Cristinas. Also see Geopolitical risks below.
Precious metal premium -- gold and silver companies command a premium while base metal producers may trade at a discount. For example, consider Yamana Gold (YRI) which recently had an average ore value per tonne of US$47.01 and Market Capitalization per ounce of Gold Equivalent of US$60.82 placing Yamana Gold well to the left of the Gold Producer Valuatioin Line. However, Yamana Gold only gets 32.9% of its market capitalization from gold and is being valued more as base metal / copper producer than a gold producer.
Hedging -- if a company is using various hedging strategies then its placement on a Gold Explorer-Producer Valuation chart is expected to be distorted since the potential for future gains (or future losses) have been reduced by the hedge.
Companies with multiple deposits -- a given mining company may own multiple ore deposits of which only a small number have been advanced into or prepared for production. As a result, the individual deposits need to be considered and the overall company evaluated as a combination producer and explorer.
Cash flow failures -- Producers, especially small producers, may have trouble achieve the necessary economy of scales forecast in their Feasibility Studies and as a result may not be able to realize their full valuation potential due to cash flow problems. Alternatively, future cash flow potential may be diminished as a mine approaches its end of life phase. In such cases, a company is expected to move towards the left hand side of the Gold Explorer-Producer Valuation chart.
Anticipated financing -- the need to raise capital for general operations or infrastructure likely means stock dilution or hedging of future production. When the market anticipates pending financing then a company's placement on a Gold Explorer-Producer Valuation chart is expected to drift to the left in anticipation of future dilution. Small producers may have trouble achieve the necessary economy of scales and as a result my not be able to realize their full valuation potential due to cash flow problems.
NSR Royalties -- what percentage of net smelter return is subject to royalty obligations? Are there buy-out options / caps? Are the royalities industry typical or extraordinary?
Market conditions -- speculative manias, or gold fever, strikes with regularity and prices of explorers with great drill results, in the right region of the world, get irrational price run-ups. Companies with bonanza grade drill results that are not part of any NI 43-101 report should be watched with caution -- betting on drill results is much more of a casino style gamble than an investment. Now, I do love gambling but I prefer to do my gambling on green felt as opposed to drill results released in advance of NI 43-101 disclosures. BreX and the Busang project are perhaps the best example of speculative feaver.
Excessive promotion -- promotion does happen on junior explorers (and major as well no doubt). It is always a good idea to check where the out of the money warrants and options are relative to the stock price. Are there slightly out of the money options and warrants due to expire in the near term?
Option and Warrant expiration approach -- since GoldMinerPulse uses a fully diluted share count, which includes out of the money options and warrants, expirations can cause minor shifts in a given company's placement on the Gold Explorer-Producer Valuation chart.
Interpretation errors -- an apparent exception may simply be the result of miscalcuations by GoldMinerPulse or your own source of the company's reserves and resources. This is particularily a problem when relying on multiple NI 43-101 complaint disclosures in cases where the company has NOT provided consolidated figures.
Disputes -- pending lawsuites may account for a pricing exception since the market may be anticipating an outcome from and its resulting implications on a company.
By definition almost, junior explorers have not reached a development stage where they would have been able to prepare a Feasibility Study or even a scoping study -- for more discussion of scoping studies and how a Scoping Study differs from a Feasibility Study please see What is a Scoping Study?. Therefore, for most junior gold explorers the following additional factors need to be considered as part of the Mining feasibility exception assessment.
Quantity of ore -- demonstrating feasibility of small deposits is hampered by lack of opportunity to achieve economy of scale in future operations. High grade ore with an accompanying high Average Ore Value per tonne is not going to be of interest to established gold mining companies and therefore limits interest in the deposit.
NI 43-101 classification -- Proven + Probable reserves are more valuable (certain) than Measured + Indicated resources and Measured + Indicated resources are more valuable than Inferred resources.
Recovery and metallurgy factors -- what percentage of in situ metals will be lost in mining and processing stages? The recovery and metallurgy factors would be fully accounted for in the Proven + Probable reserve estiamtes but are unlikely to be fully understood when a resource is in the Inferred category. Therefore this factor is directly related to NI 43-101 classification factor.
Infrastructure factors -- what are the estimated mine development costs? are there good road to ths site?, what are the available power sources?, is water available for mining usage?, is a workforce availability and is there housing for the workforce?, are exisiting mills/smelters available?, etc. I.e. what needs to be built, when and what cost?
Operating costs -- what are the expected operating costs over time to process a tonne of ore and extract the metals? How sensitive are these costs to the price of oil or the price of the main source of power (i.e. the national power grid) for the mining/processing operation?
Expected extraction methods -- underground extraction can be 10 times more costly than surface extraction. For example, look at Fresnillo slide 6 of 26 where the Herradura open pit had an operating cost of roughly $5/t while Fresnillo underground and Cienega underground ran at $35 to $60 per tonne.
Quality of the independent NI 43-101 reports -- what is the track record of the groups doing the estimate and what have were the changes to the estimate as the deposit progresses from an inferred classification to a proven classification.
Non NI 43-101 reports -- gold mining companies that do not trade on Canadian markets do not produce NI 43-101 reports. In such cases, the mapping of reserve and resource disclosure standards need to be understood.
The Gold Explorer-Producer Valuation chart, based on stock prices and metal prices at the market close on 2010-Mar-09, is presented below (this chart is updated after the close of trading in North American markets). All companies in the chart are represented by their TSX or TSXV trading symbol. The lower left hand corner of each box on the chart marks the company's Average Ore Value per tonne versus Market Capitalization per ounce of Gold Equivalent. Gold producers are typically denoted by a * following their trading symbol.
 |
 |
 |
 |
|
| PartyCasino is the online casino operated by PartyGaming Plc. PartyGaming Plc is listed on the London Stock Exchange and is part of the FTSE 250 in the Travel & Leisure sector. | ||||