Mining Companies Leverage

By: David_Morgan

This week I decided to look over some of our earlier reports and provide some information that can help to clarify some common misperceptions in valuing mining companies. The following is edited down considerably from a November 2007 Morgan Report. 

One of the best ways to gain leverage to the precious metals is still in the mining sector and specifically through both junior and senior mining stocks. One analytical method is to take the total resource (indicated and inferred) and determine how many ounces you as an investor are receiving per share or per dollar invested.

This methodology is one that is used by other analysts and before beginning our discussion I must state that as a young investor in the mining industry the first time I discovered such an analysis it seemed to be just what I was looking for because it seemed that buying the most silver or gold per dollar was certainly value investing and this gave me a sense of expectations that the market ignored.

Long term readers may recall that ***(named left out intentionally) uses this type of approach among others and quite frankly it is a tool and a useful one at that but please do not get carried away that this is the best way to examine any given mining prospect. For an example a consistent top pick by us would come out very poorly in this model yet this pick of ours is and has been one of the leading stocks in the sector and in our view will continue to be a leader all the way up. The main point is that all projects should be examined on an individual basis and comparisons must be made carefully.

Note: We had provided a matrix of companies mostly in the silver sector for our readers. 

First our work contains both silver explorers and silver producers and thus they cannot really be compared exactly. Notice that the producers sell at a much higher market capitalization per ounce than the explorers. There are several reasons for this, first a mine has great capital expenditure involved in the roads, buildings, machinery, housing, power and water systems. Additionally, in most cases the exploration costs were higher because the project had to be taken to feasibility and the mine put into production. 

This brings us to another important factor, are we looking at an open pit situation or are we looking at an underground mine? An open pit mine can be easier to put into production and far less capital intensive than an underground mine. That is why a company like Western Silver can show rather “skinny” average grades and still be economic. For an underground mine to be economic it must have much higher grades for the project to be worthwhile. So one question an investor should always ask is what type of deposit are we looking at in any given situation.

Another factor that I have seldom seen discussed is rate of production. Specifically, in an underground mine how many ounces are pulled up out of the shaft in a 24 hour period? This is important because some companies like to brag about huge resources and yet the mineshaft only allows a certain quantity of ore to come to surface. Now having a large resource is important but if you have a tremendous quantity of silver underground but can only bring an extremely small amount of it to surface your income statement will reflect that fact and your stock price may stall out leaving investors that do not understand the dynamics of mining confused. 

Obviously such a miner could sink another shaft or find other means of mining greater quantities of ore, but this is a large capital cost and in some cases may require that the original operation be put on hold. This could really upset the market and the stock price could suffer although those savvy investors would recognize the opportunity. But this would only be after carefully examining the numbers to see that the additional expense was going to produce a significant internal rate of return. In other words, would the owners of the company (shareholders) benefit?

We have just scratched the surface of some preliminary thinking that goes into a mining company analysis. I will be speaking at the Money Show in Las Vegas this week and am completing this missive on Mother's Day. With that in mind, I wish all Mom's everywhere a fantastic week, and the best to our readers always.

By David Morgan,
Silver-Investor.com

Mr. Morgan has been published in The Herald Tribune , Futures magazine, The Gold Newsletter , Resource Consultants , Resource World , Investment Rarities , The Idaho Observer , Barron's , and The Wall Street Journal . Mr. Morgan does weekly Money, Metals and Mining Review for Kitco. He is hosted monthly on Financial Sense with Jim Puplava. Mr. Morgan was published in the Global Investor regarding Ten Rules of Silver Investing , which you can receive for free. His book Get the Skinny on Silver Investing is available on Amazon or the link provided. His private Internet-only newsletter, The Morgan Report , is $129.99 annually.

Contact information: silverguru22@hotmail.com , http://silver-investor.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and I encourage you to complete your own due diligence when making an investment decision.

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