Valuing a junior miner's gold in the ground

At any given time, there's a single international spot price for an ounce of refined gold. Gold is priced in U.S. dollars: $1,076.50 per ounce as we go to press. But what about the gold an exploration or mining company has in the ground – how do we value that?

Given sufficient data, you can estimate a reasonable net present value (NPV) for a project and deduce what each of the company's ounces should be worth. To do this, you need to know annual output of the proposed mine, proposed capital expenditures, energy and other costs, and many more things. For most deposits held by the junior companies we tend to follow, there's just not enough data available.

Another approach is to compare the value the market is giving a company per ounce of gold in hand against the average value the market gives companies with similar ounces.

The most obvious way to define “similar” ounces in the ground is to use the three resource and two mining reserve categories defined by Canada's National Instrument NI43-101 regulations – the industry standard. We combine these into three broad groups, as we believe the market tends to do as well:

• Inferred: the lowest-confidence category, based on just enough drilling to outline the mineralization.
• Measured & Indicated (M&I): these higher-confidence categories have been drilled enough to establish their geometry and continuity reasonably well.
• Proven & Probable (P&P): These are bankable mining reserves – basically Measure and Indicated resources with established value.

So, what does the market give a company, on average, for an Inferred ounce of gold? M&I? P&P?

To answer this, we combed through every company listed on the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSX-V) and pulled out the ones with 43-101-compliant gold resource estimates (or mostly gold) – no silver, copper, etc. Of these, we kept only those with resources that fall almost entirely into only one of our three broad groups: Inferred, M&I, and P&P. In other words, we did not include companies with half Inferred and half M&I resources (though we did include companies with mostly P&P reserves, because most are producers – or soon will be – and are regarded that way). That left us with about 90 companies to calculate some averages on.

That's not a large sampling universe, and we had to make some judgment calls when it came to defining what companies should fall in each category, but it's what we have. So take these averages with a large grain of rock salt, but here they are:

• US$20 per ounce Inferred
• US$30 per ounce for M&I
• US$160 per ounce for P&P

Armed with this information, if you didn't know anything else about an M&I resource (political risk, type of ore, etc.), but you saw that the company that owned it was trading at $10 per ounce, whereas its peers are valued at around $30 an ounce, you can conclude that there must either be something very wrong with the project or the stock is a great speculation. If there's nothing wrong with the project, there's an implied growth potential in the stock price, based on the difference between what the company is getting per ounce and the market average for similar ounces. In this case, it would be:

$20 x # Ounces ÷ # shares.

As a matter of perspective, a few years ago the market was giving a company about $25 per ounce Inferred, $50 for M&I, and about $100 for P&P. Then, when gold ran up over $1,000 before the crash of 2008, these valuations went out the window, and some companies were getting over $100 for merely Inferred ounces – do we have your attention now?

Conversely, just after the crash, there were companies having a hard time getting $10 for M&I. That was clearly a sign that it was time to buy, and we did, with gusto.

It's also why, when the Mania phase gets underway, we'll be selling into it as gold approaches the top; we will not be attempting to time the top. It's far better in this business to be a day early than a day late.

Today, the market is willing to pay more for advanced and producing stories ($160 P&P) but is discounting earlier-stage stories, hence the lower M&I valuation than in previous years ($30). These figures will change again as the market's appetite for risk changes.

Now let's compare these numbers to those of a few sample gold companies. This table includes the market capitalizations (share price x # shares) of our sample gold companies expressed in USD (because that's what gold is priced in), not the usual CAD. The second column has the value of each company's resources, as per the average numbers given above (i.e., [# Inf. ounces x $20] + [# M&I ounces x $30] +[# P&P ounces x $160]). The implied growth is a simple ratio of these two numbers, expressed as a percentage.

Gabriel and Coral Gold look pretty cheap, Luiri slightly expensive, but in most cases there are good reasons for this. For example, these averages by confidence category ignore the typically greater cost of extracting gold from low-grade sulfide ore, as compared to high-grade oxide ore.

We don’t follow the companies in the table above -- they are just examples -- but here's our take on their implied growth ratios:

• LGL: Luiri's flagship Luiri Hill project, located in Zambia’s Central Province, has only 800,000 ounces in total resource, 82% of which fall within the least reliable Inferred category.

Although the current resource estimate is based on lower-grade material, the company’s gold looks fairly valued. However, LGL is working to define more high-grade areas of mineralization both within and outside the resource boundaries, and not without success. For example, drilling from the Matala deposit, lying in the heart of Luiri Hill, has delivered high-grade intercepts from the central shallow zones, like the recently published 21.1 g/t Au over 5.6 m (starting from 56 m), including 41.1 g/t Au over 2.8 m (starting from 56 m of the same hole #114).

Conclusion: The company looks a bit expensive at the moment, probably because the market sees Luiri’s upside potential coming from the new high-grade ounces being added in forthcoming resource estimates. If the marker were underestimating how much gold Luiri might be adding, it could still be a good speculation, but you’d have to be pretty sure of your calculations projecting that greater value to be added soon.

• GBU: Gabriel Resources appears undervalued when using average ounce prices, plus there is a lot of upside outlined in the economic study on the company’s Rosia Montana project in Romania, released last March. The study suggests excellent project economics, including low cash cost (US$335/oz), after-tax NPV of almost US$1 billion at 5% discount, and after-tax IRR of 20.4%, all at an uber-conservative US$750/oz base case gold price.

However, the company was sued by environmentalists in September 2007, and suffered regulatory setbacks. GBU shares tanked, and this is why the company’s gold is still selling at a discount; there is high political risk. Gabriel’s share price has soared recently on words of support from the government officials, but it’s still perceived – rightly – as high-risk. If Rosia Montana gets permitted to go into production, GBU shares should make very rapid gains.

Conclusion: The government of Romania has made supportive noises about Rosia Montana before, to no avail, and the company doesn't appear screamingly cheap right now, so the risk-to-reward ratio looks too high to us.

• CLH: The company is focused on the Robertson project located on the Cortez Trend in Nevada. Coral Gold has recently revised the project’s resource estimate at $850/oz gold (which looks fairly conservative, given the recent price action) to 3.4 million ounces, all Inferred. Our guidelines suggest that these ounces should be worth about US$68 million. Mind you, this gold is contained within what CLH believes to be well-known Carlin-type mineralization in a mining-friendly jurisdiction. Why does the market value these ounces way cheaper then?

We think it’s a metallurgy issue. Lacking sufficient metallurgical data from all Robertson targets, CLH used numbers from a deposit called 39A to stand in for the whole project. The problem is that 39A is one of the deeper Robertson deposits, and large-scale heap leach operation, the preferred scenario for Robertson, showed high strip ratio, which would probably result in high capital expenditures and operating costs.

Conclusion: Robertson ounces are cheap due to valid concerns over the project’s economics. If the company can fix these problems, its resources could be revalued upward dramatically.

Bottom line

We often get asked what an Inferred, or M&I, or P&P ounce is worth in the ground. The $20, $30, and $160 figures are only rough guides, and you must consider the reasons why some ounces are given more or less by the market, but they're a good starting point.

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