Do’s and Don’ts of Investing in Mining
Fireweed Zinc (FWZ)
In the last ten years, gold has gone up 41%. In the same time, GDX (ETF of gold mining companies) has fallen 55%, and GDXJ (ETF of junior gold mining companies) has fallen 68%. What was expected to be a leveraged response from mining companies has actually been an inverse-leverage response. Why? I discuss this and many other issues in a recent talk I gave at Mining Investment London:
In the linked booklet, which I wrote several years back, I also mention the sources of information I research when analyzing mining companies.
Fireweed Zinc (FWZ; C$1.50) has gone up 80% since I last wrote about it. I will be acquiring more if FWZ weakens.
As I mention in my above speech in London, those who “value” companies merely based on their “resources” (or some other rule of thumb) position themselves for a loss in their portfolio. What you have to include in your valuation are the grades of the metals in the rock, capital expenditure required, cost of processing the rock, cost of transportation of the concentrates, cost of smelting the concentrates, royalties to be paid, corporate expenses, etc. To provide proper weighting to all these charges and expenses, one must start building a discounted cash flow (DCF) statement.
On 10th January 2018, FWZ released its resource estimate. It helps me put together some numbers. To be on the safe side, I would use their C$105 NSR cut-off resources. This would give me a 2 MTPY mill-feed for a fifteen year mine life. I would use C$105 per tonne as the cost of mining and processing the rock. Recovery of zinc is 79%, of lead is 82%, and of silver is 85%. You have to do some backward calculations, but based on what I did, NSR (after deduction of transportation costs) on zinc is 61%, on lead is 69% and on silver is 76%. There is a 3% NSR royalty to be paid on a part of the project representing 40% of the resources–this royalty can be bought for C$5.25 million. I looked up for a similar 2 MTPY project for capital required to put it into production, and then an approximate cost of constructing the road.
What metal prices should I use? I am happy to use the future prices from LME’s website and deflate those a bit for expected inflation. These would be very similar to the current metal prices.
I never build-in any fancy expectations of metal prices in my valuation.
My DCF statement based on the above shows a robust IRR, and an upside even if I use a 20% discount rate. There are always a lot of technical, permitting, and political risks associated with any project. So, I prefer not to fall in love with any stock, but try to objectively change my valuation as I get any new information. I will keep my DCF statement handy to tweak it for any future news that comes out.
In the linked interview with Cory Fleck of the Korelin Economics Report I give my views on FWZ.
Later next month, I will be speaking at Mining Investment Asia (Singapore). I will also be on a site visit with Novo Resources in Australia.
Associate: Rajni Bala
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