Twelve Guidelines for Buying
Gold Mining Stocks
Kenneth J. Gerbino
J. Gerbino & Company
June 8, 2004
The twelve guidelines should
help you to better understand some investment basics regarding
the mining industry, especially if you do not have a background
in geology or mining engineering. I have kept this as non-technical
as possible so no one falls asleep. Keep in mind, these are basic
guidelines and far from complete.
- If the company does not have
an independent professional resource calculation for gold or
silver or other minerals, know that someone is either speculating
or guessing at the most critical data point regarding
mining industry valuations. Be careful not to confuse "resources"
with "reserves." Measured and Indicated resources are
reliable as a resource. "Inferred resources" are very
speculative mineral inventories, so be careful when "inferred"
is used. A resource still has a long way to go to become an economic
deposit, as opposed to "reserves" which are deemed
to be proven economic and mineable ounces calculated by
very strict engineering and government rules. Canada's National
Instrument 43-101 is one such guideline regarding resources and
- I would suggest your portfolio
be 60% invested in companies already producing gold or silver
profitably. The other 40% divide into companies close to production
with impressive projects or very far along in defining
large and significant mineral resources. Producers should
include majors and mid-tiers (your monetary insurance, since
they undoubtedly have the goods in the ground). Look for mid-tiers
with good growth profiles. Junior producers with new projects
are also ok.
Companies with lots of money in the bank or access to sponsorship
from top investment banks in Toronto, London and Vancouver is
vital in this capital intensive business and always a good thing
to look for. Diversify: have at least 15 good companies. Depending
on your risk tolerance you could allocate a small portion to
grass roots exploration stocks but know this is the very high-risk
end of the business.
The industry has changed in the last five years. Exploration
and development budgets from 1998 to 2002 declined dramatically.
Therefore going forward, in my opinion, any substantial project
that is near feasibility (an extensive outside engineering report
based usually on tens of millions of dollars of geological, metallurgical,
and engineering work) could be a buy-out candidate for major
and mid-tier companies that need to catch up on reserve replacement
- "Good management"
is an overused word. My definition of good management is 20 year
mining professionals who have had successful executive positions
with large or successful mining companies or projects in the
past. If you see names like Barrick, Newmont, Placer, Anglo,
Goldfields, etc. on the resume you are most likely dealing with
some quality professionals. People who ran mid-tier companies
or successfully helped bring medium to large projects to production
also qualify. There are always exceptions, but you better know
who you are dealing with. Direct mail pieces touting some gold
stock and claiming top management should be carefully checked
- Size is very important. The
larger the deposit or potential resource the better. Small mines
are not worth your trouble as there are few institutions that
will finance them and fewer companies that will ever acquire
them. With gold mines try and look for 2-3 million ounce and
above possibilities. Mining giant Goldfields, only targets projects
with 2 million reserve ounces. With silver, 100 million ounces
should be your minimum. But the above still has to be qualified.
If the resource is too deep under the surface, of very low grade
(richness), or has one of many other negative reasons it may
not ever be economic to mine.
Tonnage is important. Big tonnage operations create economies
of scale that can make some low metal values economic to mine.
Three hundred million tonnes (a tonne is 2204.62 pounds, not
to be confused with a ton which is 2000 pounds) for an open pit
gold mine is big. Ten million tonnes open pit is small. For an
underground operation, tonnage can vary dramatically and grade
and mining widths become more important (we will discuss this
below), but one million tonnes would be small. For a base metal
open pit deposit, one billion tonnes would be huge, while 20
million tonnes would be small. So remember in this business -
Big is Beautiful..
- Grade (richness) is crucial.
How much bang for the buck are you getting per tonne of rock.
If the grades are high enough the above tonnage discussion becomes
less relevant. With a near surface potential open pit gold deposit,
2 grams per tonne (a gram is .03215 of an ounce) would be excellent.
1 gram would be fair as long as you don't have to remove too
much waste rock to get at the ore.
With underground mines, everything changes: depth, the continuity
and mining widths of the ore and the vertical or horizontal plane
of the ore all comes into play as well as many other factors.
Generally, to be on the safe side, if you can find gold grades
of 10 grams (about a third of an oz.) or more per tonne across
mineralized sections averaging 3-4 meters or more in width, then
you are looking at good potential. Lower grades across wider
widths also work (i.e. 6-7 grams across 10 meters) Keep in mind
these are rough guidelines and subject to many other factors,
like depth, vein continuity, overall tonnage and much more. But
the sweet spot in this industry is high grades across wide zones
- Expansion possibilities for
a company's production and resources/reserves are important.
For non-producers, resource expansion is crucial, because as
these companies drill and confirm more resources they will increase
their intrinsic value. This helps them handle the big hurdles
of either financing the mine or mines, selling-out, or bringing
in a joint venture partner at reasonable terms. Mining companies
with plenty of production and new mines coming on stream in the
years ahead are usually a good group to own. Growth is Good..
- Cost per ounce of production
is very important. Companies with high costs are more risky since
a low metal price market will make them unprofitable, but they
will have considerable positive leverage if metal prices go up.
A gold mine with $325 costs per ounce, doesn't make much at $375
gold, but if gold goes to $425, the mining profit doubles. High
cost producers are a double edge sword.
I like low cost producers. They are safer, have lots of cash
flow to buy new properties and mines, will have more funds for
exploration and development and could eventually pay strong dividends
if gold stays in a new high price range over the years (i.e.
$450-500). Also large mining companies are not going to buy-out
high cost producers. They are risky and migraine headaches for
Mining costs are mostly a function of grades, mining widths and
tonnage. If you can talk to a mining engineer and get a handle
on the cost per oz. or tonne of the operation, you are acquiring
crucial data for your analysis. Companies operating at high costs
(within $100 of the gold price) or that have projects that look
like they will be high cost producers should be avoided. High
costs equal high anxiety..
- Value per ounce: How much
you are paying for the gold in the ground is an important stat.
The lower the better. The following guidelines relate to a $350-400
gold price. If gold were to go higher these numbers would increase.
For advanced exploration companies, try and stay in a valuation
range around $15 per ounce of resource in the ground. As an example,
a company with 15 million shares outstanding selling for $5 per
share has a $75 million market cap. With a 5 million ounce resource,
the market cap. per ounce is $15. As companies move up the food
chain and expand and define the resource and test metallurgy
and do engineering studies, the market cap. per ounce should
go up to $30-50 per ounce. Depending on the quality of the deposit
these valuations can change.
Producing companies if bought out, can go for $100 to $150 per
ounce of "reserves" in the ground. That is an important
guideline. You do not want to buy a stock where you are already
paying $100 per ounce for just a "resource" (which
means the "reserve" will actually be lower). With the
company just in the advanced exploration stage, there won't be
enough upside unless the deposit gets a lot larger. Advanced
developmental (meaning feasibility to actual construction) companies
can be bought out for $40-75 per ounce of resource or much more
depending on many factors that are beyond the scope of this writing.
Usually the value of the ounces and the stock price go up as
more and more confidence is gained in the project. Initial resource
definition usually allows for a value of $5-10 per ounce. At
the bankable feasibility stage those same ounces could be valued
at $40-75 per ounce.
If you see a mining company with a well defined resource and
the gold ounces are valued at only $5 per ounce or so, just know
there is probably a reason and it is probably bad. Most likely
those ounces will never see daylight due to any number of reasons:
environmental, logistics and infrastructure problems, political
risk, low grades, high capital costs, narrow mining widths, high
strip ratios (how much waste rock has to be removed to get to
the ore in an open pit operation) and a host of other reasons.
There is a right price for the ounces, don't overpay..
- In a favorable gold mining
environment, which I believe we will have for the next 10 years,
it doesn't pay to take undue risks. Try and find good merchandise
and be careful of the small grass roots exploration companies.
Surface sampling is the key to the difficult exploration business.
Positive soil and loose rock samples on a prospective property
may have come from many miles away twenty million years ago.
This means an ore body that is hopefully under the ground is
not there. Only one inch of geological movement in a subsurface
rock structure every 100 years equals in 20 million years, 3.2
miles. In geology you are dealing with billions of years. Mountains
you see were once ocean floors, etc. Large and extensive outcrops
(surface rock formations) that have mineral showings can be a
good indicator as well as widespread crude and small local native
mining activity. But it is no easy task finding these minerals
in large enough deposits to be economic to mine. Surface
showings are actually very important indicators for economic
mineral discoveries but unfortunately they are still high-risk
- A key stat is cash flow per
share if the company is already a producer. Large gold mining
companies can sell for 15-20 times cash flow in a good gold market.
Mid-tier and smaller producers can sell for 25-35 times current
cash flow because of expected cash flow increases, from
new mines coming on stream. In this case the market is anticipating
the future. Beware high cost producers selling at high multiples
of cash flow, as they will get hit very hard if gold has a set
Companies expecting cash flow from future projects are usually
valued using a net present value criteria. In this method the
entire future cash flow of a mine is laid out and a value is
placed on this cash stream, taking into consideration the time
value of money. How much is the $500 million dollars that the
mine will make in the years 2008 thru 2018 worth today in the
present. The future cash flows have to be discounted in order
to arrive at some sort of present value for the projects. Many
times a 5-10% discount rate is used. I believe a lower discount
rate is also ok, since gold is an anti-discounting currency (i.e.
gold's price should go up with inflation and interest rates therefore
negating the discount rate - because it will keep its future
Earnings per share is a tricky stat for the miners because of
so many non-cash charges and accounting complexities. In the
long run it all comes out in the wash, but during the years of
the life of a producing mine, cash flow is the king. Look hard
at cash flow per share or expected cash flow from projects..
- Comparables are very important.
Why would you buy a stock where for every $1 you invest you get
$5 of gold in the ground when another company with very similar
fundamentals and resources gives you $40 of gold in the ground
for every $1 you invest. There actually may be a good reason,
but the point is you should know what that reason is.
Comparisons are an important ingredient to avoid overpriced companies
and missing some real bargains. We constantly do comparables
at Kenneth J. Gerbino & Co. and I suggest you do also. One
should compare the basics: grades, tonnage, costs per ounce,
costs per tonne, smelter charges (for base metal deposits), reserve
or resource value per dollar invested, market cap per reserve/resource
ounce, discounted cash flows and the net present values of the
mining assets. Comparables allow you to better shop the market..
- Be careful of the term Gross
Metal Value. This is all the precious metal ounces or base metal
pounds in the ground multiplied by the current price of the metals.
It is misleading unless you have a lot more information and knowledge.
Just know that with any mineral deposit a company will never
recoup anything near the gross metal value of what is in the
ground. The ore will have a mine waste factor (5-15%), recovery
losses in the mill or from the leach pads (5-20%), and smelter,
refinery, transportation and penalty costs for base metals (20-35%).
Throw in royalties, state and local taxes and other expenses
and you will see that gross metal value is less important to
your analysis than all the other ingredients
that would determine a quality mining investment. It doesn't
mean the term is useless but it can be dangerous to use on its
Well, there you have some basic
guidelines that I hope will help you through all the press releases
and some of the direct mail hoopla about all the billion dollar
mountains out there. Remember the more homework you do the better
off you will be.
For other articles on gold and the economy please visit our website.
Kenneth J. Gerbino
Kenneth J. Gerbino & Company
9595 Wilshire Boulevard, Suite 303
Beverly Hills, California 90212
Telephone (310) 550-6304
Fax (310) 550-0814