Investing Profitably in Gold and Silver Stocks

  Mar 23, 2010

Many successful investors adopt the theory:

 

“You make your money largely on the purchase price you pay for an investment.”

 

That is you take advantage of market inefficiencies to purchase undervalued assets which over time realize their true value. To be able to do this you must have a sense of value.

 

 1. With property you might use sales data and rental yields.

 

 2. With typical stocks you might refer to sector PE ratios for relativity.

 

How do you value Gold and Silver Mining Companies?

 

Metals companies, unlike more traditional business types, can not be accurately assessed using common valuation methods such as PE ratios. These companies are typically called Asset Plays. All mining companies have different quantities of metal in the ground. You are not just paying for profit making ability but also this untapped inventory of mineral wealth.

When valuing gold and silver stocks it helps to think in terms of what you are paying per ounce of metal in the ground. Some important factors to consider which often influence what you pay include:

 

1. Track record.

The more profitable and successful the company has been, the more you pay for a share of its metal inventory.

 

2. Project(s) Development Stage.

The more ounces of gold and silver associated with advanced projects (producing, feasibility study), the more you the investor pay for a share in the metal.

 

3. Growth Profile.

This is largely determined by how many advanced stage projects the company has in its portfolio. The strength of the growth profile can largely influence what price you pay per unit of metal.

 

4. Financial strength.

If a company is cash poor with large quantities of crippling debt, this will often adversely affect the price. The company in a sense gets discounted for balance sheet risk. 

 

5. Analyst Coverage.

The more popular an individual company is, for whatever reason, the more per oz you pay. This is very often the risk you take when blindly investing based on recommendations from popular financial newsletters. First in best dressed as they say! 

 

Total Cost per oz (TCO)

 

GoldNerds has developed a unique indicator called Total Cost per oz (TCO). TCO is designed to help everyday investors easily assess and compare the respective valuations of advanced stage gold and silver stocks.

Quite simply, TCO works out how much the investor is paying per oz of mineable metal in the ground. It then adds what the production costs for this metal are likely to be. This is achieved by taking the following factors into consideration:

 

1. The Share Price you pay.

This importantly determines the Enterprise value (EV) per mineable oz you pay for the metal in the ground. Enterprise Value importantly isolates what you pay for a company’s physical assets. Every company has different financial circumstances which need to be considered. When comparing valuations for different companies, you want to be comparing apples with apples. To put it simply liquid assets such as cash reduce a company's Enterprise value and liabilities such as debt increase it. As an investor you want to be paying a lower Enterprise Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2. How much is it realistically going to cost the company to mine the gold (cash cost per oz).

We factor in present day production costs as well as feasibility study information for undeveloped projects (future cash cost).

 

3. Ongoing capital expenditure for existing producing assets and development stage projects.

This is an important consideration very often overlooked by investors. It can very often be the difference between a mining company generating positive cash flow and not.

 

4. Development capital expenditure for undeveloped projects.

This is the cost to build a new mine. This is based on feasibility studies and technical reports released by the company.

 

From a combination of all this information we generate an indicative Total cost per oz (TCO). All else being equal, the lower the TCO, the better the potential opportunity for investors. The TCO concept prompts investors to start thinking about the relationship between all these individual factors which help determine value.

 

GoldNerds Data (Extract from North American Pro Version)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The 9 columns above in my opinion represent the most important segment out of the 30+ columns of information available in the GoldNerds Professional product. Company names would ordinarily appear down the left hand side. All the preceding share capital, financial and reserve/resource information combine into this important section.

 

 

1. EV per Mineable oz

The EV per mineable oz represents how much you pay for each oz of mineable gold in the company’s inventory. Mineable gold is a customized number allowing the investor to be as conservative or aggressive as they like. Conservative for instance could mean using just reserve category ounces in your analysis (proven economic viability). Aggressive might mean including a portion of the resource category (over and above the reserves). EV per mineable oz needs to be considered in the context of many of the factors we have previously highlighted. Its usefulness comes from being combined with some of the segments below to form the Total Cost per oz number.

 

2. Current Production versus Future Production

As the name implies, Current Production gives you a rolling 4 quarter summary of the company’s current production. Future Production includes the current numbers and adds any production from undeveloped projects. These two numbers are worth comparing.

When you study the best performing gold producers from around the world, you very quickly pick up on the fact that most have a solid portfolio of advanced development stage projects. At the very least, this ensures they can maintain existing production levels well into the future. More often than not, however, these companies are able to grow production. When looking for new companies to invest in or studying existing positions, it pays to assess this data. You want to primarily invest in companies with sustainable production and the ability to grow.

 

3. Development Costs

This simply gives you the remaining development costs associated with any undeveloped projects. If you run your cursor over the cell you get a breakdown of the projects and how much if anything has been spent already. As I mentioned earlier, the more undeveloped projects a company has, the cheaper their ounces of metal are going to be on a TCO basis (all else being equal). It can very often be a lucrative strategy to invest in these companies and benefit from the development premium the company will enjoy once the projects are completed. Provided management have a successful track record in developing projects, this will minimize the execution risk.

 

4. Current and Future Capital Costs

Ongoing capital expenditure is one crucial area often overlooked when analysing gold and silver producers. Investors very often look at the cash cost, compare it to the spot price and if one is less than the other assume the company is making money. If only it was that easy! For the 60 producers we track (North American version), the average cost per oz spent on ongoing capital expenditure is US$160/oz. This is a very tricky piece of information to track and in my opinion justifies the GoldNerds subscription fee all on its own!

 

5. Current and Future Cash Costs

The current cash cost is what it is presently costing the company operationally to produce an ounce of gold based on a rolling 4 quarters of information. Future cash costs takes into consideration undeveloped projects and works out a cash cost on the assumption these projects are up and running. It gives investors some insight as to what the future potentially holds for the company. It must be said that feasibility study information needs to be taken with a grain of salt. Actual results can often differ markedly from reality!

 

6. Total Cost per oz (TCO)

This last piece of information brings everything together. It is an estimation of what you are paying in total for each mineable ounce of gold the company could produce. The average for the 60 producing companies we presently track is US$860/oz. Like with any indicator, it’s the companies that trade significantly above or below this average which should draw your attention. The next step is to consider many of the factors we have discussed in ascertaining a reason for the discount or premium you are observing. If you can’t find any logical explanation for a significant discount, you may just have stumbled across a wonderful opportunity! Alternatively, if the TCO is well above the average, the stock is probably fully priced and you would be well advised to wait for a more appropriate entry level.

 

Why Buy a GoldNerds Subscription?

The information in this service is comprehensive and thorough. Everything you need to help make appropriate investment decisions is included. At GoldNerds we don’t tell investors what to buy and sell. We provide investors with the tools and information necessary so that they can make their own informed investment decisions. From experience, we know that the most successful investors are the ones who have the ability to make investment decisions independently. We accept that for this reason our product will always appeal to a smaller universe of investors. Most cannot be bothered developing the appropriate skills necessary to be successful. The important question you need to be asking yourself is:

 

 

For further insight into how the GoldNerds service can and has been used to excellent effect we encourage you to click here. Alternatively click here to see an extract from our brand new Australian Gold Stock Summary report where the TCO indicator has been put to work. The full version of this report has been made exclusively available to GoldNerds Professional subscribers.  

 

If you have already decided this information could be invaluable in helping you make investment decisions we encourage you to subscribe.  

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