How to Value a Gold Mining Company.

(Originally published on November 18, 2016 at goldtradingmastery.wordpress.com)

If you’re trying to accumulate gold, it can be unclear whether gold mining companies are a good investment. In which cases does it make sense to buy physical gold and in which cases does it make sense to buy mining companies instead? Looking back at history, there have been some times when physical gold outperformed mining companies and sometimes when the opposite has happened. So how do you know which one to invest in at which time?

One way of solving this problem is to just look at a chart of mining companies priced in gold and use technical analysis to determine whether the gold-price of these companies is likely to go up or down. However, this just begs the question of why the price is moving on the chart the way that it is in the first place. And…if you’re an inquisitive person, you may want to know why fundamentally the price of mining companies sometimes outperforms the metal itself.

Understanding the fundamentals can also help you to predict movements in the price ahead of time, before technical analysts have a chance to figure out what is going on. And this can benefit you as a trader.

So here is how to value a gold mining company.

Step 1 – Determine the Enterprise Value of the Company.

The first thing you need to do when valuing a gold mining company is to determine its “enterprise value” or the value of all of its physical assets.

To begin with, search for the market cap of the company. In this case, I’ll use Newmont Mining as an example. A quick search in Bing or Google reveals this page that shows NEM’s market cap to be $17.34 billion (as of Nov. 17, 2016).

Once you’ve got that information, you need to find the balance sheet of the company. Here’s a good source today for that info.

Look at the balance sheet and find anything that looks like it’s money the company owes. In most cases, this includes the entire “liabilities” section. The only case in which you would not want to include a liability as “money owed” would be if somehow the company owed gold, equipment, land, or some other unit that is not denominated in a fiat currency. But this is rare.

Take this list of “money owed” and add it together. Then add it to the market cap.

For example, Newmont Mining has total liabilities of  $10.89 billion.

liabilities

Adding this to the market cap of $17.34 billion gives a total of $28.23 billion.

After determining this number, add up all of the cash held by the company and all money owed to it by others. This is sometimes not easy because balance sheets tend to be written in a language that only accounting geeks understand. But after doing lots of searches for the definitions of accounting terms, it eventually gets easier.

In the case of Newmont Mining, we can look at their balance sheet and find the following entries that look like cash held and/or money owed to the company.

  • Cash: $3.08 billion
  • Long term note receivable: $222 million
  • Intangible assets: $152 million
  • Accounts receivable: $445 million

newmont-cash-1

newmont-cash-2

Now take this list of cash and/or money owed to the company and add it up together, then subtract it from the previous total. In this case, we get $3.08 billion + $222 million + $152 million + $445 million = $3.899 billion of cash on hand and/or money owed to the company. When we subtract this from the previous total of $28.23 billion, we get $24.331 billion.

So the enterprise value of Newmont Mining in dollar terms is $24.331 billion.

However, what we really want to know is the gold enterprise value of the company. So the last step we have to accomplish to determine the enterprise value is to divide this number by the USD price of gold. In this case, the USD gold price is $1215.79. So the final EV is $24.331 billion/$1215.79 = approx. $20.013 million oz.

This means that it would currently cost 20.013 million oz. gold to buy the entire company.

Step 2 – Determine the Enterprise Value Per Ounce.

Now you have to find out how many ounces of gold the company actually owns, both above-ground and in-ground.

The easiest way to do this is to go to the company’s website and look for a document called “reserves and resources” or “reserves and mineralization” or something like that. Newmont Mining’s latest resources report can be found here.

In this case, Newmont Mining has 73.72 million ounces of gold remaining in all of its mines combined.

newmont-reserves

Once you find out this number, divide the Enterprise Value by it. In this case, it’s 20.013 million oz./73.72 million oz. = approx. 0.271 oz. This is how much gold it is costing you to own each ounce of gold that Newmont Mining has title to. This number should always be much less than 1. Otherwise, you are better off buying physical gold instead of this company’s shares.

Fun side-note: You can take the resource number and divide it by the number of shares outstanding to determine how many ounces of gold each share represents, then take this number and multiply it by the number of shares you own to determine how many ounces of the company’s gold you own. This isn’t necessary to determine the company’s value, but it’s still fun ;).

Step 3 – Determine the Total Cost Per Ounce.

Obviously, owning a bunch of gold that’s underneath the ground or even in reserve is not as valuable as owning gold bullion that’s already been processed. After all, it costs money to dig gold out of the ground and refine it.

So the next step is to determine how much gold it will cost you, the owner of the mining company, to dig this gold out of the ground. You can do this by finding the company’s All-In Sustaining Costs or AISC. Most mining companies provide this information in their annual reports and quarterly earnings reports.

In this case, Newmont Mining’s latest earnings report states that their AISC is $910/oz.

Take this dollar figure and divide it by the USD price of gold to determine the gold cost per ounce to produce each ounce of gold. In this case, $970 per ounce/$1215.79 per ounce = approx. 0.7978 oz. cost per ounce of gold produced.

Now add the enterprise value per ounce plus the cost per ounce to get the total cost per ounce. In this case, it’s approx. 0.271 + 0.7978 = 1.0688 oz.

The lesson learned here is that, at least for the moment, it costs more than 1 oz. gold for you to buy enough shares of Newmont Mining to produce 1 oz. gold. So, at least from a fundamental perspective, Newmont Mining is currently overvalued.

What Happens if The Gold Price Changes?

Once you know how to value a gold mining company, you can use this information to determine what value the company would have in hypothetical situations where the gold price is increasing.

For example, let’s say that the gold price increases by an average of 18% over the next seven years while the inflation rate increases by only 2.5% on average (like they both did in 2001-2007). Assuming that Newmont Mining’s costs were to rise at no greater than the rate of inflation, this would give us a dollar AISC of $1,153 and a dollar gold price of $3,873 at the end of the seven years (using the compound interest calculator found here).

As a result, the AISC denominated in gold would be approx. 0.2977 oz. When added to the current enterprise value per ounce, this would result in a total cost of approx. 0.5687. This means that you would be paying a little over 1/2 an ounce in order to get 1 oz. gold.

Of course, gold mining investors aren’t stupid. If the scenario I have just described were to happen, the market cap of NEM would rise continuously over the next seven years, making the enterprise value rise as well. But now that you know how to value a gold mining company, at least you can catch those chances where a company is temporarily undervalued.

Update 6/26/2017.

When I first wrote this article, I had the nagging feeling that I was getting something wrong. I felt that It just couldn’t be possible Newmont Mining’s stock was valued higher than its gold reserves minus its costs. That didn’t make any sense.

Well, I now realize my mistake. When I did “step 2”, I used Newmont Mining’s proven and probable reserves but not resources. There is a very important distinction between the two. There is a higher level of evidence required for a company’s gold deposits to be included under “reserves” than under “resources”.

But most mining stock investors rely upon the latter instead of the former. Specifically, they rely upon the “measured plus indicated” resource.

In addition, reserves are usually included in the “resources” report. So resources are a broader measure of gold deposits than reserves.

However, to complicate things further, Newmont Mining does not follow the usual convention of including reserves in resources. So in order to compare Newmont to other miners, you have to add the proven and probable reserves to the measured and indicated resources to get an accurate indication of the company’s gold deposits.

The bottom line is that I had been unfair to Newmont Mining by underestimating how much gold it had under the ground.

After having made this correction, here is the data that could have been used to evaluate Newmont’s stock price at the time this blog post was first published.

 

  • Proven and probable reserves: 73.72 million ounces
  • Measured and indicated resources: 33.62 million ounces
  • (Measured + indicated resources) + (proven + probable reserves): 107.34 million ounces
  • Enterprise value (at time of blog post): 20.013 million ounces
  • Enterprise value per ounce: 0.186 ounces
  • AISC (in gold): 0.7978 ounces
  • Total cost per ounce: 0.9838 ounces
  • Profit per ounce invested if gold price stays the same: 0.0162

As you can see, the stock was a good buy at the time of writing.