World Of Wallstreet

The Silver Wheaton Valuation Method (SWVM), Part 3: Valuing Silverstone Resources (SST.V)

In a recent article (click here), I introduced the Silver Wheaton Valuation Method (SWVM) which provides a convenient way of valuing producing and near producing Jr silver mining companies. The method takes the data point of Silver Wheaton's recent purchase of the silver stream from Aurcana's La Negra mine to produce a valuation of roughly $30.5 / annual produced oz of silver. This the valuation Silver Wheaton, a quite successful company in the silver miner space, thought was a good deal for its purchase of annual silver production. This valuation method provides a quick and dirty and conservative way of valuing Jr producing and near producing silver miners while the price of silver remains near its current level and especially when the cash cost of the silver is around the deal's $3.90/oz. A follow up article (click here) applied SWVM to Aurcana Corporation.

This article applies SWVM to Silverstone Resources (SST.V) a direct competitor (although much smaller) than Silver Wheaton. SST.V, like Silver Wheaton, is not an actual silver miner, but instead "produces" silver by purchasing the silver production, referred to as silver streams, from other mines. SST.V currently has three such mines under contract and a rather flexible deal for a preproduction property (click here for Silverstone's corporate presentation).

The presentation indicates that by 2011, Silverstone can expect a production of 4.5 million oz / year from its three silver streams. Silverstone will have to ramp up if it is to achieve this production as, annualizing its Q1 2008 production, it is currently producing 1.6 million oz / year. The preproduction property is expected to produce at least 1 million oz per year, although when this occurs is still TBD.

The presentation indicates that Silverstone has 141 million shares, fully diluted yielding a market cap (at June 16th's closing price of $C2.40) of 339 million $. So, giving Silverstone the benefit of the doubt and an annual production of 5.5 million oz yields a SWVM of 168 million $. So, SWVM says Silverstone is overvalued by 50%, that is, its stock price would have to fall by 50% to have its market cap match its SWVM valuation.

In contrast, Silver Wheaton is even more overvalued by SWVM. Silver Wheaton's stock price would have to fall by 79% to have its market cap match its SWVM valuation.

The conclusions from this series (Parts 1, 2 and 3) are:

• Silverstone is undervalued relative to Silver Wheaton, but is overvalued using SWVM. The market gives silver stream producers, with their multi-mine production and fixed cost per oz a good premium.
• Silverstone, according to SWVM, is overvalued relative Impact Silver which is overvalued relative to Aurcana corporation.
• Silver Wheaton got a very nice deal in the Aurcana corporation silver stream purchase. How good a deal Aurcana got depends on what the alternatives were. The deal did, if Aurcana executes its plans, increase Aurcana share holder value.

This table summarizes the findings so far:

The backlog of Jr near producers to look at next are First Majestic (FR.TO), Great Panther (GPR.TO), Endeavor Silver (EKT,END.TO) and USA Silver (USA.V). Let me know if there are some others worth looking at.

Leave me some comments. How do you like to value this kind of stock?

MontyHigh

The Silver Wheaton Valuation Method (SWVM), Part 2: Valuing Aurcana Corporation (AUN.V)

In a recent article (click here), I introduced the Silver Wheaton Valuation Method (SWVM) which provides a convenient way of valuing producing and near producing Jr silver mining companies. The method takes the data point of Silver Wheaton's recent purchase of the silver stream from Aurcana's La Negra mine to produce a valuation of roughly $30.5 / annual produced oz of silver. This the valuation Silver Wheaton, a quite successful company in the silver miner space, thought was a good deal for its purchase of annual silver production. This valuation method provides a quick and dirty way of valuing Jr producing and near producing silver miners while the price of silver remains near its current level and especially when the cash cost of the silver is around the deal's $3.90/oz.

The article went on to show that Silver Wheaton itself was significantly overvalued using this valuation method. This makes sense. Otherwise why would Silver Wheaton consider the deal attractive? The method finds Impact Silver (IPT.V) fairly valued. The response to this valuation on the stockhouse.com Impact Silver message board was that this valuation does not adequately value Impact Silver's exploration upside. I agree it does not put any value on that upside.

This article goes on to value Aurcana corporation itself. In fact, it values Aurcana before the Silver Wheaton deal and after the Silver Wheaton deal to determine both whether Aurcana is undervalued and whether the deal increased Aurcana's valuation.

As was profiled in a much earlier article (click here), Aurcana, prior to the Shafter project acquisition and Silver Wheaton deal, was a silver mine reopener with 80% of the La Negra Silver/Copper/Zinc mine and with a second Silver/Lead mine, Rosario, set to open towards the end of 2008. Without the Shafter acquisition, Aurcana expected to increase La Negra's production to 2000 tonnes / day and Rosario to 1200 tonnes /day for an annual silver production of approximately 2.9 million oz / year. This yields a SWVM valuation of 88 million $. Given the current stock price of $C.56 and the reasonably diluted number of shares (prior to the Shafter acquisition and Silver Wheaton deal) of 95.7 million shares yields a reasonably diluted market cap of 54 million dollars. The reasonably diluted number of shares does not include warrants and options with a strike price of $1.50 or higher. 

So, without the Shafter acquisition and Silver Wheaton deal, the SWVM method indicates that AUN is undervalued by 65% (that is, AUN's stock price would have to rise 65% to have a market cap that matches the SWVM valuation).

Aurcana expects to finance bringing Shafter to production by selling another silver stream to Silver Wheaton. The amount to be financed and the terms of that financing have not be announced. I estimate this as another 25M$ deal for 500,000 annual oz / year. I assume that La Negra's production is left at 1000 tonnes / day (and, of course, 50% of its silver production is delivered to Silver Wheaton). The result is that I estimate Aurcana's annual production to be roughly 4 million oz / year (after giving Silver Wheaton its due). Aurcana project this rate being achieved Q3 2009. I expect it will occur about 6 months after that.

With these assumptions, the SWVM valuation of Aurcana is $124 million. This indicates that the Shafter acquisition (if execution proceeds as plan) increases Aurcana's valuation by 40% (at the cost of 15 million additional reasonably diluted shares).

As a result, after the Shafter acquisition (if execution proceeds as expected) leaves Aurcana with a reasonably diluted share count of 111 million shares and a market cap of $62 million. Aurcana is undervalued by 100% (that is, AUN's stock price would have to rise 100% to have a market cap that matches the SWVM valuation).

I believe Aurcana can do a reasonable job of executing and so I am comfortable having a large Aurcana position in my portfolio. It is actually my second largest holding (after Gold Resource Corp, GORO.OB). I would consider the current price to be a good entry price if I did not already have a full position.

Next, I expect I will turn the Silver Wheaton Valuation Method on two other silver Jrs I admire: First Majestic Silver (FR.TO) and Silverstone Resources (SST.V). Like Impact Silver and Aurcana, I admire the management and prospects of these companies. I'm hoping that SWVM will provide some objectivity to compare these admirable company's stock price prospects.

Are there any other Jrs that you recommend I analyze? Leave me some comments. How do you like to value this kind of stock?

MontyHigh

The Meteoric Kodiak Exploration (KXL.V) Compared To Douglas Lake Minerals

This article is the third and last in a series about Douglas Lake Minerals and its Mbwemkuru property in Tanzania. The first article (click here), by Toby Hansen, introduced the company and the property and concluded that Mbwemkuru may be the largest alluvial gold project in the world with a wild guesstimate of perhaps 5 million oz of very-low operating cost, very-low capital gold. The valuation estimate based on 1 million oz of gold indicates an easy ten-bagger. The second article (click here) points out that all of the world's historic gold rushes (including the California, Klondike and South Africa gold rushes) began with alluvial deposits with very fast production of low cost gold followed by larger, even more prolific hard-rock mining of the source of the alluvial gold. So it seems that Douglas Lake Minerals may have something pretty exciting on its hands.

This third article compares Douglas to the most recent "to the moon" gold exploration company, Kodiak Exploration (KXL.V), which had a major find in Canada that was announced last fall.

The graph that follows compares the rises of each of the two exploration companies from their stock price low immediately preceeding the excitement. The X-Axis gives the number of trading days relative to that stock price low. The Y-Axis gives the relative stock price to that stock price low. For example, a four on the Y axis indicates that you would have a "four-bagger" (or the price would have quadrupled) on that date if you had been fortunate enough to buy on the low.

The first observation to make is that the trajectories of Kodiak Exploration and Douglas seem to be similar. We'll see in a few moments that Douglas is skyrocketing even faster than Kodiak given where it is in terms of news announcements and actual exploration results.

The second observation is obvious: unless you are already in, you did not get in at the bottom. Douglas Lake is almost an eight-bagger in less than two months. So, one needs to be careful with this one. Is there good reason to think it can continue to rise? The comparison to Kodiak may shed light on this question.

A brief history of the news announcements surrounding Kodiak's launch is as follows:

(1)  9/17/2007 - Kodiak announces expanded drilling and a purchase of more land at its Hercules project. You could say this is a hint that something good was found on the property, but the stock price does not noticeably react.

(2) 9/27/2007 - Kodiak purchases more property (after management awards itself stock options a few days earlier). In retrospect, something is happening, but the stock price does not react.

(3) 10/1/2007 - Stock price hops as Kodiak announces outstanding drill results of over one oz gold / tonne at the surface with 11 meters thickness. The grade is very good, but the combination of the high-grade and 11 meter thickness is truly outstanding.

(4) 10/22/2007 - Stock price jumps as Kodiak announces yet more outstanding drill results.

(5) 10/30/2007 - Stock price hits all time high shortly after Kodiak announces the finding of more ore-bearing veins.

(6) 11/6/2007 - The party is over as Kodiak announces a private placement. It seems that when the insiders sell part of the company that means the top is in.

Now let's look at the Douglas Lake timeline and see how it compares:

(1) May 8, 2008, A conference call with gold expert Bob Moriarty is announced (but does not take place) to discuss Douglas Lake's new alluvial property (even before a press release about the property is made). The stock price jumps.

(2) May 9, 2008, A press release announcing Douglas Lake has gotten the mineral rights for a large  alluvial property is published. The stock price has already jumped. The very compelling Bob Moriarty conference call (including a back of the envelope estimate of 5 million oz) takes place this day.

(3) June 2, 2008, The Chinese invest in Douglas Lake and get 20% for 6 million dollars (valuing the company at 30 million dollars). The stock price jumps as this is seen as an indication that the alluvial deposit is for real.

(4) June 11, 2008, Douglas Lake announces first quantitative exploration results for the alluvial project. Out of six "random" samples an average of 95 grams gold / tonne are announced. These are stunningly good results.

So, Douglas Lake, right now (at step (4)) has made its first quantitative exploration results. That puts it at the same point in exploration development as Kodiak was with its first quantitative results (at step 3).  Its hard to know where Douglas Lake will go from here, but Kodiak had more than a triple to go from when its first quantitative results were announced.

One big difference between Douglas Lake and Kodiak is the level of press coverage. I don't ordinarily pay attention to explorers but I couldn't miss hearing about Kodiak on the various mining web sites and message boards. I haven't seen anything like this for Douglas Lake. This lack of press coverage is one of the reasons I think Douglas Lake may still have a ways to run.

Learning from the Kodiak experience, I'm currently planning on holding onto my position until either a private placement with someone other than the Chinese (or the Tanzanian government or Tanzanian influential individuals) takes place or until disappointing exploration results are announced. The Kodiak experience indicates that there is plenty of upside that an explorer like Douglas Lake can experience if it continues to produce good exploration results. The fact that Douglas Lake's alluvial deposit can be brought into production without further financing leaves it in a position where it could go much, much farther without any dilution.

This will be my last post on Douglas Lake for a while, I think. The stock is so illiquid that, as with other juniors, you cannot expect me to preannounce my exit. For me this kind of exploration stock is something I intend to trade and hope to exit around the time of maximum excitement. We all have to take responsibility for our own trading.

Leave a comment and let me know what you think.

Monty High

DISCLOSURE: The author owns Douglas Lake stock and stands to benefit from a stock price advance. Douglas Lake is obviously a quite risky Jr exploration mining company and everyone must do their own due diligence and bear the responsibility of their investing decisions.

Weekly Inventory Update, 6/13/2008

Copper inventories fell again last week and I've turned from bearish to neutral on copper. Zinc inventories rose again last week (while the zinc price fell). I remain bearish on zinc.

Leave me a comment with your thoughts on the outlook for copper and zinc prices at this point.

MontyHigh

Douglas Lake Minerals Mbwemkuru: An Historic Deposit?

Yesterday, Toby Hansen authored an overview of Douglas Lake Mineral's Mbwemkuru (pronounced Bwam-koo-roo) property (click here).

Here's a brief recap: "Mbwemkuru has the potential of being the largest alluvial gold deposit in the world.  An alluvial deposit is one in which the gold is located in loose sand and gravel.  Essentially gold is deposited over time as sediment in a lake or river bed.  Douglas has identified an area of high grade gold measuring 22 km by 2 km described as beach sand.  Local artisans are producing up to 200 ounces of gold per month using burlap sacks, picks, shovels and pans.  Douglas says that the area has gold grades near the surface of 1 – 5 grams per ton.  Going deeper, the grades go up to as high as 50 grams per ton.  One huge plus of alluvial deposits is the gold is loose so grinding, milling and heach leap pads typical of hard rock operations are not required.  You can be in production with a front end loader and a sluice box virtually over night."

I was unacquainted with alluvial deposits when I first heard about Douglas Lake Minerals. Doing a little research (on Wikipedia) I found that every historic Gold Rush started with an alluvial deposit! This article summarizes my findings. 

As far as this article is concerned, placer mining and the mining of alluvial deposits are identical: "Placer mining (pronounced "plass-er") refers to the mining of alluvial deposits for minerals." [http://en.wikipedia.org/wiki/Placer_gold]

Wikipedia lists the following as History's major gold rushes:

• Roman (Spain) Gold Rush - "They used hydraulic mining methods on a very large scale to extract gold from extensive alluvial deposits".
  
• Georgia Gold Rush - "...the placer deposits found in Georgia almost literally meant that gold was just lying on the ground, waiting to be collected."
  
• California Gold Rush - "The first people to rush to the gold fields, beginning in the spring of 1848, were the residents of California themselves—primarily agriculturally oriented Americans and Europeans living in Northern California, along with Native Americans and some Californios (Spanish-speaking Californians). These first miners tended to be families in which everyone helped in the effort. Women and children of all races were often found panning next to the men". The use of panning indicates alluvial deposits.
  
• Victorian (Australia) Gold Rush - "On 20 July 1851 Thomas Peters, a hut-keeper on William Barker’s Mount Alexander station, found specks of gold at what is now known as Specimen Gully... leading to a rush to the Mount Alexander or Forest Creek diggings, centred on present-day Castlemaine, claimed as the richest shallow alluvial goldfield in the world."
  
• Transvaal (South African) Gold Rush - "...gold miners that had come from all over the world to seek out their fortunes on the alluvial mines of Barberton and Pilgrim's Rest... Scientific studies have pointed to the fact that the 'Golden Arc' which stretches from Johannesburg to Welkom was once a massive inland lake, and that silt and gold deposits from alluvial gold settled in the area to form the gold-rich deposits that South Africa is famous for."
  
• Klondike (Yukon) Gold Rush - "On August 21, 1896, the Skookum party discovered rich placer gold deposits in Bonanza (Rabbit) Creek which is located in the Yukon, northwest Canada."

As you can see, each of these major gold rushes began with an alluvial deposit like that of Douglas Lake Mineral's Mbwemkuru. Alluvial deposits are quickly mined at minimal cost and minimal capital expense. This means that Douglas Lake may be able to get into production very quickly and produce very low cost, very profitable gold. The exciting thing about each of these gold rushes is that eventually much more gold was mined from the nearby, hard rock source of the alluvial deposit's gold. This means that there is upside for Douglas Lake Minerals beyond what's in the alluvial deposit. The alluvial deposit was back-of-the-envelope guesstimated by Toby Hansen at 5 million oz of gold.

I'm pretty jazzed about Douglas Lake and think that it may very well be the most spectacular exploration play since Kodiak Exploration (KXL.V). KXL.V was more than a 10 bagger from its low to its high. I expect I'll follow up on this story with a look at the history of KXL's dramatic move and look at where Douglas Lake is in comparison to Kodiak Exploration metoric rise.

DISCLOSURE: I increased the size of my position yesterday. Although I'm optimistic about the upside for Douglas Lake, it is definitely risky. In my estimation its the riskiest postion in my portfolio. 

NOTE: The photos are from the Wikipedia articles illustrating alluvial gold deposit mining (aka placer gold mining).

Scoop: Douglas Lake Minerals – A Rare Opportunity?

[Editor MontyHigh's Note: Here's an exclusive early post of an article that will be on several gold mining web sites today. This Douglas Lake stock is one of those exploration plays that had been launching like a rocket without any significant news. This morning some significant news came out that is summarized near the end of this article. Please note that the author is Toby Hansen, click here for his most recent World Of Wallstreet contributions. The editor also has a position in Douglas Lake Minerals and will benefit from a stock price rise.]

Introduction

Douglas Lake Minerals (DLKM.OB) has been in operation for about three years.  Their primary focus is obtaining and exploring mineral rich properties in Tanzania. They have been very successful at obtaining licenses for over 50 properties.  A few years ago they partnered up with Canaco (CAN.v) to explore some properties.  Canaco began drilling on one property and didn’t find economical gold.  At the end of February of this year, Douglas Lake was on their last sandwich having very little cash and income.

Management made a potentially company saving deal recently.  Douglas negotiated and secured the rights to a property (Mbwemkuru) from a former intelligence director of the Tanzanian government.  The director worked 30 years for Tanzania and was given a choice for a retirement gift choosing Mbwemkuru.  As part of the new deal, the intelligence director gets an undisclosed sum of money and 3% royalty.  Tanzania gets a royalty of 5%.

Opportunity?

Mbwemkuru has the potential of being the largest alluvial gold deposit in the world.  An alluvial deposit is one in which the gold is located in loose sand and gravel.  Essentially gold is deposited over time as sediment in a lake or river bed.  Douglas has identified an area of high grade gold measuring 22 km by 2 km described as beach sand.  Local artisans are producing up to 200 ounces of gold per month using burlap sacks, picks, shovels and pans.  Douglas says that the area has gold grades near the surface of 1 – 5 grams per ton.  Going deeper, the grades go up to as high as 50 grams per ton.  One huge plus of alluvial deposits is the gold is loose so grinding, milling and heach leap pads typical of hard rock operations are not required.  You can be in production with a front end loader and a sluice box virtually over night.

Here’s their press release on the property:

http://www.douglaslakeminerals.com/news/2008-may20.html

Bob Moriarty, Douglas share holder and 321gold.com founder, spent three days at Mbwemkuru.  He was able to easily pan gold himself from the sand.  Bob travels all over the world visiting different types of mines and mineral properties.  He said in a conference call (see below) that he believes that being extremely conservative there’s 5 million ounces of gold at Mbwemkuru.  I highly encourage anyone interested in Douglas to listen to Bob’s conference call lasting a little over 10 minutes. 

Bob Moriarty conference call about the Mbwemkuru property: 

Dial toll free 1-877-289-8525, Code 21271884#

Having a property with huge potential is one thing but having the money is another.  Douglas Lake executed a memorandum of understanding with a prestigious Chinese Mining Institute (TIGMR) last fall and invited them to Mbwemkuru.  They stayed longer than planned coming away very impressed.  In less than two months TIGMR is taking a $6 million equity position in Douglas Lake, sending two core drills and the man power to explore the property.  The Chinese money is going to be used to quickly get Mbwemkuru producing gold by the end of this year.  

Douglas technical consultants say achieving 100,000 ounces production per year would be fairly easy to do.  I am not holding my breath for that level but if they simply achieved 25,000 ounces early on, it would bring in over $20 million revenue and enough cash flow to support active drilling of the property.  It should be noted that the sand/gravel gold rich zone is likely 10-20 meters deep as no one has hit bedrock yet.  The Chinese drills likely don’t have to go to the depths of traditional exploration plays such as several hundred meters through very hard rock.  This means Douglas could prove up reserves and resources much more quickly than is industry standard.

Valuation

Douglas Lake Minerals trades on the OTCBB under the symbol of DLKM.  The stock surged after Bob Moriarty’s conference call May 9th.  Presently it has found new multi-month highs trading and breaking side ways trading ranges.  There are 40.4 million shares outstanding, which should increase to approximately 47 million after the Chinese TIGMR equity position is completed.  Douglas Lake offers huge blue sky potential.  Gold exploration companies in general fetch a market valuation of $50 - $100 per ounce gold resources in the ground.  Producers get a much higher premium of $150-$250 per ounce.  Although it is very difficult to calculate a value on a company just entering formal exploration activities; we can try for an educated guess.

Assume mineralization is 1 gram/ton over the area of 22 km x 2 km and 2 meters deep.  The volume is 88 million cubic meters.  Sand has an approximate density of 1.8 tons/cubic meter.  The mineralization zone is 158 million tons.  Multiply this by 1 gram/ton results in 158 million grams.  A troy ounce is 31.1 grams so Mbwemkuru can have roughly 5.1 million ounces of gold.  The gold grades used are much more conservative than those reported thus far but it yields a quasi-conservative estimate on how much potential gold is there.  As a pure exploration play applying $50-$100/ounce market cap, Douglas could have a market cap of of $255 to $510 million.  Assume 50 million shares outstanding gives an upside potential of $5 to $10/share, which is quite impressive considering the stock trades under $0.75.

Sample Results

Just prior to going to press with this article, Douglas released the following news:

http://biz.yahoo.com/prnews/080611/to466.html?.v=36

“SAMPLE GRADE RESULTS

These samples were prepared and reported by Echo Tec Laboratories Limited - ICP certificate of analysis AK 2008-0657.

               -   MAH 1:             79.60 g/t (grams per tonne)

               -   MAH 2:            408.30 g/t

               -   MAH 3:             32.65 g/t

               -   MAH 4:              3.90 g/t

               -   MAH 5:              0.70 g/t

               -   MAH 6:             43.50 g/t

               -   Overall Average:   94.77 g/t”

Some grades of the samples reported are enormous as the vast majority of exploration projects rarely exceed 50 grams/ton.  Exploration is in the very early stages on the property but it would appear from their press release Douglas may have landed a world class deposit.

Near Term Stock Price Drivers

The huge potential in exploration stocks are the uncertainties surrounding them and the potential short, medium and long term completion of exploration goals.  On the horizon for Douglas are the following events that can cause the stock to move:

1)     Receiving the first payment by the Chinese TIGMR of $1.5 million.  This should give investors more confidence as to their commitment to the project/company.

2)     Bob Moriarty publishing his report about Mbwemkuru and the company on his often visited website 321gold.com.  His unique position of holding an equity position in the company, being on the property and extensive knowledge of the Douglas history and management team, should stimulate a great many investors interest in the stock. 

3)     Closing the $6 million equity investment by the Chinese.  This is expected to close on or before June 30^th.

4)     Intermittent drill result reports through the year at Mbwemkuru.

5)     Beginning limited gold production from the property by year’s end.

 Disclosure:  

The author has not been paid to write this article, nor received any other incentive to do so. The author holds a position in Douglas Lake and  will benefit from its increase in stock price.

Disclaimer:

The author's objective in writing this article is to promote potential investor interest in this stock to the point where they are encouraged to conduct their own research and verify facts. Neither the information, nor the opinions expressed should be construed as a solicitation to buy or sell stocks. Investors are recommended to obtain the advice of a qualified investment advisor before entering into a position.

 

The Silver Wheaton Valuation Method (SWVM), Part 1: Valuing Impact Silver

Silver Wheaton(SLW)'s recent silver stream deal with Aurcana Corporation (AUN.V) provides a significant data point for valuing Jr silver producers or near producers. This article describes how to apply this data point in evaluating these Jrs. Its written at a level understandable even by "newbie" investors.

The "Value Investing" method of investing in stocks is to invest in companies that are "really" worth significantly more than the value assigned by the stock market. The idea is that eventually (hopefully soon) the market will come to its senses and raise its valuation to something closer to the company's real worth via a stock price rise. My favorite introduction to this style of investing is Pabrai's "The Dhando Investor". The value assigned by the stock market is the company's market capitalization. Market capitalization (market cap) is easily calculated by multiplying the company's current stock price times the fully diluted number of shares. The fully diluted number of shares can usually be found in the Investor's section of the company's web site.

While it is easy to calculate the market cap, it is not so straight-forward to calculate what the company is "really" worth. The parlance for this is, "valuing the company". There are many ways of valuing companies and these ways vary significantly in their complexity and ease of calculation. When a company is dramatically undervalued, the method of valuing the company need not be extremely accurate. It need only be accurate enough that its error is significantly less than the amount it indicates that the company is undervalued.

This article provides a quick and dirty way of valuing Jr silver mining companies. This valuation can be used to identify companies that are dramatically undervalued. It can also be used as an initial filter to determine which companies are worth the effort of a full, detailed examination.

Silver Wheaton is one of the most successful companies in the silver mining industry (see chart below). It doesn't actually mine silver. Instead it buys the silver byproduct from base metal (or sometimes gold) mines. It can do this with win-win deals because the market values silver mine production more highly than base metal mine production. Typically the deal is structured as an up-front payment for the right to buy a fraction of the silver output of a mine at a low cost, for example, $3.90 /oz. Silver Wheaton wins when it sells the silver at market price (currently around 17$/oz giving resulting roughly 13$/oz profit for Silver Wheaton). The actual mining company wins by getting an up front payment plus the $3.90 / oz when the silver byproduct is actually mined. The $3.90 / oz helps lower the cash cost for the mine's primary metal.

The market likes what Silver Wheaton has done and is doing (see chart).

Silver Wheaton's recent deal with Aurcana Corporation provides a way for valuing producing or near producing silver mining Jrs. The deal, in simple terms, is: Silver Wheaton gets 50% of the silver production from Aurcana's La Negra Silver-Copper-Zinc mine. Silver Wheaton pays 25 million$ up front and $3.90 for each such oz delivered. From Aurcana's web site we see that La Negra is expected to produce 820,000 oz/year with a nice long mine life.

So, here's the key data point: Silver Wheaton, who is about the best in the industry, thinks it is quite profitable over the long term to buy a silver mine's production at $61 / annual oz produced. We can use this data point to value Jr silver miners and it is very relevant as long as the Jr has a cash cost near $3.90 / oz.

Let's use this valuation method to value Silver Wheaton itself. Since Silver Wheaton thought it was a good deal, one would expect that Silver Wheaton is valued more highly than this.

From Silver Wheaton's June 2008 presentation we see:

• Silver Wheaton expect to receive (produce) via its silver stream deals 27 million oz.
• Silver Wheaton has fully diluted 266 million shares for a market cap of 3.862 billion $.

Thus Silver Wheaton is valued at 143$ / annual oz produced. Silver Wheaton (as a major with diversified risk and a low cash cost of $3.90 / oz) is valued quite highly compared to what it just paid for its recent incremental increase in production from the Aurcana deal.

Impact Silver is an nice little silver mining company with four little producing mines near a company owned mill on a large property in a historic silver mining district in Mexico. The company management seems to have the desirable properties of looking out for the stockholder's interest by avoiding dilution and meeting its commitment (although it doesn't give a lot of future guidance). Having management that looks out for the stock holder is what I find really attractive at first glance.

Impact Silver has 49.8 million fully diluted shares for a market cap of roughly 51 million $. It produced roughly 350 thousand oz of silver in 2007 and seems to have a good plan for doubling that. So, applying the Silver Wheaton Valuation Method, what Impact Silver is "really worth" is 700,000 oz * 61 $/oz or roughly 43 million dollars. CONCLUSION: The Silver Wheaton Valuation Method indicates that Impact Silver is fairly valued. This means its valued for about what Silver Wheaton has shown it would be willing to pay for its expected silver production. As such, it appears to not be a good value investing target.

Please check back into www.worldofwallstreet.us for more silver Jr evaluations using the Silver Wheaton Valuation Method. I can tell you in advance that Aurcana Corporation is significantly undervalued using this metric.

MontyHigh

Off-Topic: Fear's Antidote

Its pretty easy for an investor to be fearful having studied the big picture and determined what they think is coming. And why really, in the long run, why shouldn't we be fearful? As the late Maynard Keynes said, "In the long run, we're all dead."

Here's what the man who knew Jesus best had to say: "Perfect love casts out fear." This begs the question: who has perfect love?

God has perfect love. When we know that the all-powerful God loves us and will take care of us and that "We will always be with the Lord" we are released from fear. We can spend our lives not fearfully "looking out for number 1", but genuinely caring for others. This is your life. Who do you want to be? Genuinely caring for others or looking out for number big number one?

"Perfect love casts out fear".

MontyHigh

MontyHigh: Noteworthy Charts 6/7/2008

From of my top 50 charts, here's what I think is noteworthy:

Here's my Jr top pick for the next two or three weeks. Technically it looks like something big is about to happen. Fundamentally, a bullish NI43-101 resource report is due by "mid june".

DJIA broke down badly on Friday. Many bearish items, but on Friday we have the breaking of the third fibonacci number targeting the March lows.

The monthly US dollar chart gives you some perspective. I don't know of anything fundamental or technical to change this trend.

Silver looks like its getting set to make a big move (with plenty of support below). Might be a good entry point.

I'll just take a moment to give you my own personal sentiment indicator: Things are the scariest they've been since the Bear Sterns weekend. In this case its not a specific event occurring, but rather an accumulation of fundamental bad news (peak oil, credit mess, inflation, foreclosures, etc.). I don't see this as a peak in scariness (like the Bear Sterns weekend) but more like something big settling in.

Monty

Best Of The Web: The Second Great Depression

Quite an admirable interview this week. Jim Puplava (click here). What makes this interview a cut above the usual Doom and Gloom investing dreck is:

• The author: Warren Brussee, is not the usual self-seeking, newsletter writing BSer. He's a good engineer (retired) who looked at the economy using the same kind of quantitative methods that were the basis for General Electric's Six Sigma quality improvement program.

• The method: Brussee used a quantitative way of looking at the economy (as part of creating an algorithm-based stock market investment program) and determined the data said the outlook was bad. The book is a result of that investigation. NOTE: I identify with the author quite a bit being a software engineer who has developed and traded (unsuccessfully) automated trading systems.

• Specificity: Most of these "doom and gloom" investing books is based on bad things eventually coming home to roost. Brussee's data indicated relatively precise dates (2007 thru 2008) for it all beginning and he put it in writing.

• Track Record: Most of the specific items in the book (foreclosures, bank failures, falling dollar...) have already started. Brussee has demonstrated credibility.

The main weakness I saw was in the specifics on what to do, as an investor, given the conclusions. One interesting thing I heard is that he fully expects the general US stock market to go down. Only inflation could prevent this. So, you could hedge and go short both the stock market and the dollar. I'm not doing this now, I'm long Jr precious metal mining stocks.

By the way, I'm part way thru a book on a similar topic: Addison Wiggin's Demise Of The Dollar. I find it less valuable as there is:

• A lack of graphs, charts and tables.
• Selective use of data to back the author's conclusions.

I caught Puplava in today's first hour using selective evidence by only mentioning the commodities that are rising rather than at least mentioning that some (zinc, lead, nickel) have done pretty darn poorly over the last 12 months.

Weekly Inventory Update, 6/5/2008

Copper inventories fell a little last week, but not enough to say the mildly rising inventory trend has ended. Zinc inventory increased a little last week. Apparently the falling zinc price has not cut into production yet. I'm neutral to bearish on both at this point.

Leave me a comment with your thoughts on the outlook for copper and zinc prices at this point.

MontyHigh

Not Scared Enough? What Happens To Oil Exports After The Peak?

Here's (click here) the scariest peak oil story I've seen lately. Its conclusion seems like a no brainer showing: As oil production declines after the peak, exports will decline much faster. Bad news for places like the USA, Japan, UK, EU... which import most or all their oil.

MontyHigh

P.S. If you've never heard of the Olduvai Theory Of Industrialization and you like far out ideas click here. Pretty wild and definitely a possibility (although I think a remote one because the world can do a lot with nuclear energy if it has to).

Best Of The Web: Story From The Great Depression

Click here for a sobering, recommended piece by William (Bill) Buckler on the US economy available on the excellent 321gold.com web site. What I especially liked was the following story, excerpted here (according to the copyright doctrine of "fair use"):

"...It happened during the 1930s when agents of bankers showed up to sell a farm they had repossessed. On the day of the auction, other farmers walked and rode up. They all had guns in their hands. The auction began and there were no bids. Finally, a younger man stood forward and offered one Dollar for the property. Silence. The agents for the bank tried to leave, only to find that they could not. The other farmers were still there and some raised their guns. Another long silence. Then the top man from the bank accepted the one Dollar bid and that one Dollar was handed over to be followed by a bill of sale. The younger man then handed another Dollar to the first farmer and all he said was that the other farmer could pay it back when he was able. The farm changed hands again and, entirely legally, the farm was back in the legal ownership of the original owner with no debts owing. The agents of the bank left in their cars in a cloud of dust. For a long way, they could see men and boys with guns along the roads. At the farm, the other farmers left one by one and went home. There had been no violence, nobody had died..."

MontyHigh

Best Of The Boards: Thoughts On The Aurcana Financing

Back in March I gave a "Fat Pitch" profile of Aurcana (AUN.V) (click here). Aurcana is a mine reopener which, at the time, had successfully reopened one mine (La Negra) with a second one (Rosario) due around the end of this year.

Since then, the price has fallen (with the price of silver), the company has acquired a third silver mine (bigger than the previous two put together, the Shafter mine) and just this week has announced non-dilutive financing for this acquisition. Aurcana has agreed to sell 1/2 of its current producing mine's silver output to Silver Wheaton for 25 MM$ up front (to pay for the Shafter acquisition) and 3.90$/oz of silver produced. They also agreed in principle to negotiate a forward sale of part of the third silver mine's production.

This kind of deal is pretty hard to understand at first, so I offer the best of the message boards to help understand it. At first I didn't like it, but now I think its an excellent deal. In a couple of years, Aurcana should (with no dilution) in around 18 months be a mid-tier silver producer (producing over 3 MM oz/year) with three operating mines. It looks like a five-bagger to me.

So, here's the best of the boards on the deal (from stockhouse.com):

(1) Coswil provides a summary evaluation:
"someone just paid us half our market cap today for half the silver from ONE mine

KA-BOOM   Just exactly the news we needed . ...coswil" Editor's note: That one mine is a primary copper/zinc mine with a big silver byproduct. The next two mines are primary silver mines.

"They didn't sell half of Shafter , they sold half of La Negra's silver only. That was sold for 25 million in order to pay for the shafter acquisition. They also get 3.90US per oz of silver.   As far as I can see we just got an up front payment of 25 million dollars + 3.90 per oz for the silver only from La Negra, and that's only for FIFTY percent of the silver from LaNegra. It's mainly a copper/zinc mine. Think about that. That payment along with the 3.90 per oz will end up being worth more than half of AUN's market cap (as of today) just for FIFTY percent of LaNegra silver.

(2) NoSleep provides a detailed evaluation:
"Aurcana has signed an agreement with Silver Wheaton Corp. that will result in Aurcana receiving a $25-million (U.S.) upfront cash payment from a silver-stream financing agreement on life-of-mine silver production from the La Negra mine. In addition to the $25-million (U.S.) cash payment, upon delivery of the silver, Silver Wheaton will also pay Aurcana a fixed-price payment per ounce of silver produced equal to the lesser of $3.90 and the spot price at the time of sale (subject to a 1-per-cent annual adjustment starting in the fourth year of silver production. As a result of the silver offtake agreement on La Negra, Silver Wheaton will be entitled to 50 per cent of the life-of-mine silver production generated from the mine. Reyna Mining and Engineering SA de CV, Aurcana's 20-per-cent partner at La Negra is fully supportive of the transaction with Silver Wheaton"

As for the amount of silver sold forward to Silver Wheaton from Shafter,  we won't know until negotiations are done. I suspect it will be close to 30%. I can't see it being much more than that. Shafter production is projected to be 3.2 million oz per year. If we sell close to a million a year, that'll be worth loads.

'Silver Wheaton and Aurcana have also agreed to enter into negotiations on a silver offtake agreement on Shafter in return for Silver Wheaton providing the capital required to reopen the mine.'

So unless I'm reading that wrong, there has been NO determination in regards to the amount of silver forward sold to SLW from Shafter. That is in negotiations only. Figure out what's needed to re-open the mine and we can probably determine how much will be sold to SLW.

I can't believe this stock didn't go ballistic. Management deserves serious cudos on this one.

In a period where juniors have a brutal time getting anything at all done right, AUN continues to progress towards their goals very quickly and efficiently. I'll have a cigar for management at the conference in Vancouver, that's for sure. How this all pans out in the long run, who the heck knows, but avoiding mass dilution along the road to becoming a mid tier silver producer is the single most important factor. It shows management cares about the shareholders.

If my assumptions are wrong here, or i've misread something, please feel free to correct me. But the way I see this is someone just paid us half our market cap today for half the silver from ONE mine.

Nosleep"

(3) A little more from Nosleep from a different board:
"I'm not sure I understand your take on the AUN deal. Using La Negra to bring a 3.2 million oz per year silver mine online is a spectacular plan in comparison to using what could have been a 50 million share equity financing which likely would have had warrants attached.

Even if they sell 30% of the Shafter silver forward that still leaves them with another 2.25 million oz of silver production from shafter per year and it will have a VERY long mine life. 42 million oz there now, that's 14 years. Likely more exploration will find more silver.

So now, they need no money, they have Rosario coming online, and have all the financing ready to go for Shafter. I just can't see anything bad with that, sorry.

Nosleep"

I like the outlook for Aurcana a lot and hold a bunch of its stock.

I think that in today's Jr environment, you might not see much upward price movement until Aurcana executes. The market today seems to want a Jr to actually generate significant oz or cash flow before rewarding it. One of the things I like about Aurcana is that it is on a trajectory to grow up and no longer be treated like a Jr. Minefinders (MFN, MFL.TO) and First Majestic (FR.TO) are similar, although further along. Metanor (MTO.V) and New Guinea Gold also have a plan for this kind of growth, but depend on exploration success to get them their. Aurcana need only re-open previously producing mines.

I'm hoping to publish an updated, detailed fundamental profile of Aurcana once I get a few more facts straight.

MontyHigh

Best Of The Web: More Jim Dines, The Address w/Transcript

I don't know if you found time to listen to the Jim Dines interview I linked to a couple of weeks ago (click here to see the review and link to interview). If you liked it you can get more of the same. This time its the address he gave the day before the interview. Not as scary and with more tradeable details. Click here.

I would say the main take-away from both is that it should be worth our time to keep an eye on the uranium stocks and look for the price rising through the downtrend.

Here's a link to the chart I'm following. Its of the Uranium Participation Corp (U.TO) which is pretty close to a Uranium ETF.

MontyHigh

MontyHigh: Why This Summer May Be Different

Major hat tip to this exceptional information source: Big Picture

Any thoughts on what this means going forward? Every seen any other graphs like this?

Monty

AceOfKY: More On Valuing Mining Stocks

We've been having a nice dialog about valuing Jr mining stocks with one of our favorite web sites, Gold Stock Strategist.

Here's the link to AceOfKY's original article.

Here's the link to gold stock strategist's reply.

And here's AceOfKY's response to the strategist (click here for an updated bio of AceOfKY):

Hi Scott,
My friend Doug (aka "MontyHigh") sent me to your website. Thank you for your intelligent response to my defense of the NAV valuation method. From your website I see that we share some equities in common, including Gold Resource Corporation (a favorite of mine) and Jaguar (although I sold my JAG position a while back because I thought the share price was getting ahead of itself.)

You are certainly correct that the valuation of an asset becomes more and more uncertain the further you project your assumptions into the future. I certainly didn't intend to suggest that the NAV method yields any level of absolute precision regarding asset value (is there such a thing?); all I'm saying is that it is vastly superior to the in situ and cash flow methods because it takes into account everything that the in situ and cash flow methods do, and more! If one believes that fundamental analysis/valuation is useful at all (many don't, of course) then you have to pick a method, or at least you have to apply some type of a weighting to the method that you feel is most valuable even though you may utilize several methods. There is no question that there is much subjectivity in a NAV valuation. In fact, analysts can butcher a NAV to the point it is virtually worthless. If you want an example, see my recent analysis of Blackmont's NAV valuation of First Majestic: http://www.investorvillage.com/smbd.asp?mb=144&mn=360&pt=msg&mid=4768040
This was a horrible valuation; any amateur could prepare something better than this professional did. The problem was not with his method, however, it was with the assumptions and data used.

I'm going to look at a couple of your assumptions in your example with Metanor Resources to try to illustrate my point. The article I wrote was really a messageboard/blog post; it was not originally intended to get picked up on Stockhouse, etc., So I didn't do a very good job of providing examples. Let's take a look at Metanor and see if this can shed some light on my argument. All I ask is that you subject your own valuations to the criticism that you leveled at mine. I will work here with the $280/reserve ounce and 10x cash flow assumptions that you used to value Metanor on your website.

    1. False Precision - the idea that an analysis provides a level of accuracy or certainty with regard to the present value of an asset that is dependent on future events. I agree, this can definitely be a problem with the NAV method. It is no less a problem with the in situ and cash flow valuations, too. By your in situ method, Moto Goldmines would have a valuation of over $1.1 billion since they have 3.939MM ounces of reserves. Current market cap is $357MM, giving you an upside of over 300%. Of course, you and all other investors would not consider giving Moto a valuation of $280/oz, specifically because of uncertainty of future events. You, in fact, have an excellent article on your website about quantifying political risk. And yet, you are not factoring risk into your valuations. You are doing this "in your head" so to speak. The NAV method gives you a tool to do this quantitatively. Is it subjective? Of course. Is it precise? Of course not. You are already applying the discount in the back of your mind and it has the same subjectivity, so I ask that you don't criticize the NAV method for this. The same thing applies for all assumptions (not just political risk) including future gold price. Do you really think, if gold goes back to $300/oz, that one should still be using a $280/oz valuation? False precision and uncertainty of the future affects all three valuation methods and any other conceivable method. You say that the NAV method suffers "more" from uncertainty over future events than the other methods, but I don't see any argument to this effect. The NAV method specifically discounts future earnings potential because of this uncertainty (along with some other reasons.) The in situ method does not do this at all, and the cash flow method doesn't either. Sure you will say, "I use different in situ valuation scales for different political risk profiles and different cash flow multipliers for higher versus lower cost gold miners." But aren't you just compensating for the deficiencies of the methods? By the time you compensate for all the deficiencies of these two methods, you will end up with something very close to the NAV method.


    2. NAV method yields a wide range of Valuations depending on assumptions used. Of course! But this also applies to in situ and cash flow valuations! In fact, when I see these valuations I like to say "Pick a number; Any Number!" Why use $280 per reserve ounce? This would give, for example, Gold Resource Corporation a value of $0 since they don't have any reserves. Using operating companies with reserves, Golden Star trades for $141/reserve ounce. Agnico Eagle trades for $608/reserve ounce. Let's see, this gives us x4 multiplier share price range for Metanor (I don't see that Metanor has any reserves anyway, looking at its website.) Now you will say, $141 and $608 are not the industry averages! That's correct, they are not. The 20% discount rate you used to criticize the NAV method is hardly the industry average either. I've never seen anyone use a 20% discount rate for a gold miner unless you're dealing with a Congo or Venezuela-type situation. The x4 share price range is a larger range than what you found when calculating the NAV for Metanor. Thus, using your own criticism, the in situ method is shown to be a less useful method.
How about cash flow method? Pick a multiplier! Any multiplier! AEM is trading at 44X 2007 operating cash flow. Northgate is trading at about 6.1x 2007 operating cash flow. That's a much worse range. There are very good reasons that AEM trades at a high multiple and Northgate trades at a low multiple. The NAV method gives one the capability to account for those reasons. The cash flow method does not. What does a 10x cash flow multiplier assume? At the bare minimum, it assumes a 10 year operating life (at the same cash flow) unless a company just happens to have a lot of cash on hand. Actually, much more than 10 years is assumed when you figure in the time value of money and capital structures. On a resource company with discrete resource holdings, you can't just assert that it should trade at 10x cash flow without having some type of reasonable substantiation.

    3. The cash flow and in situ methods yield valuations roughly in line with NAV as long as capital structures aren't too complicated. You don't give any justification of this, so I don't feel obligated to rebut it. I will only say that my own experience has been quite different; I have found large differences between the NAV and in situ methods when comparing high and low cost miners. And there are large differences between the NAV and cash flow methods when comparing a miner with a large resource base to one with a small resource base.

    4. In situ values the resource based on current market prices. I'm not sure why you're presenting this as a strength of the in situ method. If one could assume that commodity prices will remain constant in the future, this would have some value. There is no reason, however, to suspect that this will happen. The NAV method gives us the flexibility of using whatever prices we feel appropriate (i.e. - conservative when finding a buy point; more aggressive when trying to find a sell point.)

    5. The cash flow method is more dynamic and gives near term value. My own argument is that this is in fact a weakness of the cash flow method. It puts way too much emphasis on the next year or two and neglects the long-term potential (or lack thereof) of the company.

    6. The NAV method is very time consuming. I agree. I don't see this so much as a weakness as just a fact. It takes a lot of work to produce a legitimate NAV estimate. As with most things in life, the value in something is somewhat proportional to the amount of time you put into it. That being said, I do think it is better to keep NAV estimates simple and generate them on many different companies rather than spending days drilling down to the minute details of a company's operations. As I have already stipulated, the NAV method is not a precise valuation methodology (I don't think there is one), but it is superior to the other two proposed. I still usually require about a 40% discount to my NAV estimate before I will purchase a stock because I realize that errors, uncertainty, management incompetence, and subjectivity play a huge role.

In summary, I will just repeat what I have already said. Whatever the strengths are of the in situ and cash flow methods, the NAV method takes them into account. But it also takes into account much more than either of these methods. It is not precise by any standard, and it can certainly be manipulated into something completely unuseful. The value of this method, however, should be apparent to investors. I challenge you to send me a valuation of an asset sealed by a professional engineer or geologist that DOESN'T include a discounted cash flows valuation. I've never seen one. I would never prepare one in my own practise (which is industrial/institutional engineering rather than mining.) The in situ and cash flow methods as such (i.e. - without all of the discount factors and different scales that you keep in the back of your mind) simply neglect too much data to be useful for anything beyond quick back-of-the-envelope calculations.

Thank you for this exchange. I like your website and I think we can share some useful ideas in the future.
Ben Murphy, P.E.
(aka "AceofKY")

Weekly Inventory Numbers, 5/30/2008

Zinc inventory levels jumped up hard this week and copper inventories also jumped. I think the jig is up for inventory declines for the next few months and I'm bearish on both metals. I dumped my Tamerlane (TAM.V) for quite a loss yesterday. I bought in April during the "Permits Due Any Day" enthusiasm. The standard wisdom should have applied: Don't let a bad trade turn into an investment. The price of zinc and lead have fallen to the point where TAM.V's mine may not get financed.

Leave me a comment with your thoughts on the outlook for copper and zinc prices at this point.

MontyHigh

Weekly Inventory Update 5/23/2008

Zinc inventory levels popped back up this week. Since last week I got into a zinc miner (SRZ.TO) made a little and got out. Copper looks hard to read at this point. Both look a little scary to me and I'd rather be elsewhere. Still hold some Tamerlane that I bought in April during the "Permits Due Any Day" enthusiasm.

Leave me a comment with your thoughts on the outlook for copper and zinc prices at this point.

MontyHigh

Best Of The Boards: Bretton_Woods on Gold To Oil Price Ratio

Click here for a posting on my favorite precious metal mining board, Investor Village's Precious Metals.

Bretton_Woods describes (with amply annotated charts) his gold to oil ratio-based timing system.

Quite impressive.

MontyHigh

AceOfKY: Valuing Mining Stocks - In Defense Of Net Asset Value

While browsing the various fundamental evaluations of mining companies made by investors on internet message boards, I have consistently seen two valuation methodologies - the in situ method and the cash flow method - used frequently, while the traditional net asset value (NAV) method used by professionals is neglected or not used at all. The NAV method, I believe, is superior to the other two, and the following is a defense of this valuation technique.

The in situ valuation is the easiest valuation methodology to use for a mining company. It consists of merely adding up a company's resources and dividing this into the market cap of the company. If this quantity is less than the industry average, the company is said to be "undervalued." This method is easy, and it allows quick comparisons of dozens of mining companies. Unfortunately, however, it has a vast multitude of weaknesses:
1. It does not take into account a company's other assets and liabilities, such as cash on hand or long term debt.
2. It does not take into account the capital cost (either initial or sustaining capital) necessary to extract the ounces from the ground.
3. It does not take into account the operational cost necessary to extract the ounces from the ground.
4. It does not take into account future rises or falls in the commodity price.
5. It does not take into account the mineability (or lack thereof) of the resource. A proven/probable ounce is valued no higher than an inferred ounce (unless, of course, one uses different $/oz figures for the different resource classifications.)
6. It does not take into account the time necessary to extract the resource, or the time value of money.
7. It does not take into account the capital structure of a company.
8. It does not take into account the recovery rate of the resource, which can vary widely.
9. It is a relative valuation; it relies on the whole sector being valued accurately.
10. Using "equivalent" in situ resources does not take into account differences in the underlying resource fundamentals. The silver in a silver-lead polymetallic deposit, for example, may be in contango, but the lead may be in backwardation.
11. It does not take risk into account.
12. Industry "average" $/oz figures are statistically suspect; the deviation from the average is very large for many companies.

The in situ valuation, therefore, is a very weak method to use when valuing a mining company. It is most useful when many of the above items aren't known or can't be estimated accurately (such as in the case of an exploration company that has established a resource but has not yet performed a feasibility study.)

The second popular valuation method is the cash flow per share method. This method takes a little more work than the in situ method. First, one must determine the number of shares outstanding and then divide this into the cash flow of the company. Cash flow, in this case, is usually taken in the simple manner (Revenue minus non-GAAP cash costs) rather than using GAAP operating cash flow. The resulting cash flow ratio is then compared to the industry average for the sector to determine whether the company is undervalued or overvalued. This method also has significant weaknesses, however:
1. It does not take into account the size of the company's resource. Mining companies have discrete resources; they can only produce cash flow until the deposit is mined out.
2. It does not take into account a company's other assets and liabilities.
3. It does not take into account the capital cost necessary to extract the resource.
4. It does not take into account the time necessary to extract the resource, or the time value of money.
5. It only partially takes into account the capital structure of a company.
6. It is still a relative valuation; i.e. it relies on multipliers derived from the valuations of its peers.
7. Definitions of cash costs (non-GAAP) vary notoriously amongst the different mining companies.
8. It does not take into account future expectations for the underlying commodity (i.e. - the futures curve.)
9. It does not take risk into account.

Thus the cash flow method of valuation, while somewhat more useful than the in situ method, still does not take into account many of the factors that need to be accounted for in a valuation.

The most accurate way to value a mining company, I believe, is to determine its net asset value (NAV) based on discounted cash flows. All of the above weaknesses in the in situ and cash flow methods are addressed in the NAV method:
1. A company's other assets and liabilities can be figured into the calculation of NAV.
2. Resource size, capital and operational costs, recoveries, taxes, etc. are all accounted for in the cash flow schedule.
3. Expectations for future commodity price increases/decreases can be accounted for in the cash flow schedule.
4. One is free to add some (or even all) of the M&I resource into a mine life schedule as one feels appropriate based upon other research. Even if this is done, however, it is still discounted by the method since it adds cash flow at the end of the mine life. In other words, proven resources still receive the highest value.
5. The capital structure of the company is fully taken into account, including cash flows from option and warrant expiry.
6. It is an absolute valuation; it does not rely upon empirical averages established by peer groups.
7. Time value of money and risk can be taken into account quantitatively via the discount rate.

 
The NAV method does have some disadvantages, of course. Many precious metals miners seem to continuously trade at a premium to NAV. This is certainly true if one uses constant metal price assumptions in the valuations (this is most simple and most common.) The reason that precious metals miners trade at a premium to NAV is that the underlying commodity is in contango (i.e. speculators expect the commodity price to rise in the future.) The solution, however, is pretty simple. Depending on the intention of the valuation (e.g. are we finding a buy point or a sell point?) one can use whatever commodity price schedule they like and calculate future revenues based upon this schedule. Some professional analysts use a version of the Black-Scholes equation to calculate the "optionality" of each of the company’s assets with respect to the variability of commodity prices. Either way, it is not difficult to modify a NAV valuation to account for future commodity price increases (or decreases), or to just accept that a producing gold/silver miner will trade at a premium to NAV when using constant current metals prices.

Another deficiency of the NAV method is that it does not account for reinvestment of future cash flows. This is certainly true, but it is also true of the other valuation methods. There are simply too many unknowns in the mining industry to be able to quantitatively account for future reinvestment with any degree of accuracy. The NAV method is most useful in finding a minimum value (i.e. - a buy point) of a company. When one is trying to determine a sell point, peer comparisons and technical analysis should be used to supplement the NAV method. None should be allowed to replace the NAV method, however, as it is the most comprehensive method for taking into account all of the factors that influence the value of a mining company. We are in the midst of a bull market in commodities, and the rising commodity prices have masked what I believe to be fundamentally flawed valuation methodologies. Investors would do well to recognize that there is much more to mining than just a resource in the ground, and that one year’s cash flow isn’t sufficient to value a company with