I was thinking about investment frameworks today. I’ve never explicitly laid out my own process. If I had to I’d say the following points are the most important in my framework (mining related):
The project has to score well (decent grade, IRR, preferably in a good jurisdiction, tried and tested mining method, simple process). There can be complexity but the simpler the better.
Value has to be a concern. There’s so much uncertainty in junior investing. We need to get 3-10x payoffs on the winners to offset the inevitable losses.
Momentum. This one is tougher. I’m not sure where I stand on this. Revaluations happen fast.
Increasing base. This can mean production, resource, reserve. Not picky.
Preservation of ownership percentage. I get that dilution is going to occur. I’d just like to get under as many warrants and options as possible.
I was looking at some valuations today, single asset development projects.
One that jumped out at me was New Polaris. I’d not heard of Carnac resources until today. They released a technical report on New Polaris in March.
Valuation: They have an enterprise value of ~$9 million. The post-tax NPV5% is ~$210 million; works out to a EV/NPV value of less than 5%. Well this is interesting.
Now obviously production, if ever, is far out. Within the comparable peer group, however, these guys are cheap.
This is an example of the asymmetric returns that I like. What’s the worst that can happen? You lose 100%. What’s the upside here?
Now I’m not a chartist but there looks like there could be a tide change.
On the warrant and option from there’s not too much that is below the current stock price of $0.065/share.
So, this project is cheap. Has some momentum indicators and there’s not a lot of drag on the option/warrant front.
They have ~2M in cash and spent about the same last year. Not the worst cash balance out there but not the best.
Carnac has a mixed bag of miscellaneous projects. The only one that really stands out is New Polaris. ~10 g/t, historic mine, challenging infrastructure, challenging metallurgy (probably). Does not check the box as a simple project.
Overall, I think this is pretty interesting. Will watch.
I think it’s fair to say that we’ve all grown accustomed to
miners overpromising and underdelivering. Whenever a new project is coming
online there is a palpable uneasiness that is detectable in analysts,
management, and investors. Will the project hit the guidance throughput? Mining
I don’t want to group all projects into the underdeliver bucket but there is certainly a large percentage that not only fail to deliver on ramp-up projections but also in ultimate capacity. The chart below shows actual vs. projected mining rates for a large project that was recently constructed. Now I get that management can be overly optimistic and ramp-ups can be challenging. You’ll notice that the year 1 tonnage is way off of the projection but, by year 2 and 3, the company has closed much of the gap. What I’m more interested in is the levelling off of production and the inability to ever achieve expectations regarding ultimate mining rates.
Management will often highlight specific variables that are
performing worse than expected. Shovel downs are decreasing availability.
Pioneering is impacting productivity. A large weather storm reduced operating
time. These are all possibilities. What I’m
interested in, however, is why production falls short of budget when all variables are as expected.
But how can this be?
How can production be less than expected when all inputs are as expected? Well,
I think that the companies contracted out
to perform mining studies underestimate volatility’s role in determining production
Let’s look at a simple example:
The capacity table shows one shovel that is paired with three trucks. You’ll notice that truck and shovel capacity is
fairly balanced, both around 25K tons mined per shift. You could expand the time period
to encompass a year and this is how most
feasibility studies determine equipment requirements. Now they would use variable
parameters for each of these factors based on the specific conditions in the
mine during the period (haul distance) and planned maintenance.
Ok, nothing wrong here, right?
These assumptions grossly underestimate the influence
randomness within each variable. Fluctuations in, say, availability have asymmetric
impacts on the production of the mine. -10% one day and +10% the next does not
average out to zero impact on the mine. It averages something less.
This histogram of shift-by-shift availability reflects the average that is shown in the table (77%). This histogram reflects the outcome of 730 simulations (1 year’s worth of shifts) of another probability density function that is based on actual data.
These availability values were used to calculate shift production
for an entire year. The chart below shows the mine’s production as a function
of shovel availability. You’ll notice
that tons mined per shift increases linearly as shovel availability is increased -the mine is shovel limited-. Once
availability exceeds 70%, however, the mine
is limited by truck capacity.
This is the root of
the issue. Mine production falls short when shovel availability is lower than
average and cannot sufficiently increase production when availability is higher
than average. This asymmetry makes it
effectively impossible for feasibility parameters to be achieved.
Average simulated production is barely over 20K tons per shift. A far cry (-18.5%) from the 25K tons per shift that would be predicted by the study. Coincidentally, this is the same delta between actual and planned tonnage in Y5 of the earlier chart.
Mines are fragile. They are hurt by volatility and cannot
make up production on the positive side because rates
are capped by a new bottleneck. It’s
my opinion that this static mindset, when
it comes to production scheduling, is the root cause of lots of the industry’s
So what do we take away from this very simplified example?
Well, it pays to have buffer
(excess) capacity. Miners with small equipment fleets are the most susceptible to
volatile operating parameters as they don’t
have other units to average out the shift-by-shift outcomes. In general, a
static approach to forecasting will overestimate long term production.
So I woke up this morning thinking about gold producer price
to NAV5% discounts/premiums. I’ve struggled to understand the intuition behind
being priced at a premium to NAV5% as this implies that the appropriate
discount rate for the stream of cash flows is less than 5%. How can this be
given that gold mining is inherently risky. Arguably more so than the typical
business in the S&P 500.
Well there are a couple of explanations for this pricing
Analyst NAV assessments underestimate the future
stream of cash flows
This is possible but I doubt this is the answer
as any future resource conversion is going to occur so far in to the future
that it would be discounted to oblivion
Analysts use a flat price deck when creating the
You could make the case that a nominal price
deck should be used but this change would be offset by the use of a nominal
discount rate; probably not the answer.
NAV5% is not the correct discount rate to be
used for specific gold producers.
I think this is the underlying logic driving the
price to NAV logic.
In the gold space, small companies typically trade at a
discount to their NAV. Generally, discount to NAV is negatively correlated with
size; smaller company, larger discount. The intuition behind this equilibrium
makes sense as larger companies are more diversified (operationally and
jurisdictionally). Senior producers generally trade at a premium to NAV and
streaming companies trade at an even higher premium.
Being priced at a premium is a challenging concept to understand.
At the extreme, this can imply that the purchase of the security will provide
cash flows that are less than the purchase price. This is very similar to
negative interest rates. Unlike negative interest rates, however, the pricing
of these securities is not manipulated by quantitative easing and central
banks. The “rational” investor is doing the pricing.
So how can a discount rate of zero (or negative) be
justified. The capital asset pricing model states that the equity risk premium
is the risk free rate + beta * equity risk premium. The current T-bill rate is
around 1% so this implies that the beta of these investments must be zero or
slightly negative. This train of thought led me to start looking into beta and
the correlation of gold to the broader economy.
So what is beta? I like to think of it as a leverage factor
for stock returns. A beta of 1.25 means that the stock will move 125% of the
move of the general market. Beta can also be thought of as “risk” factor. A
high beta implies high risk -higher volatility- and investors will require a
higher rate of return for an investment in the security.
If we look at the beta of monthly returns from 1973 to the end of 2018 we see that gold has exhibited a negative beta with respect to the S&P500. Conversely, copper, oil, and silver have positive betas. These relationships make sense as these other commodities are more related to economic growth and, in turn, the S&P500.
The beta values are misleading as they understate gold’s performance relative the S&P500 during times of instability.
Because, as you’ll see in this chart, gold generally hovers around a beta of zero during periods of relative calm and spikes in other occasions (2008).
chart that gold acts as insurance during calamity, increasing in value by more
than the S&P falls.
This post is a continuation of yesterday’s dive into the
relationship between company-wide grade and cash flow from operations. Spoiler
alert, there was no relationship. This fact isn’t surprising given the
multitude of other factors that impact a company’s cash flow from operations.
I decided to get a little more granular and look at this
relationship on an asset basis.
The chart shows that increased production correlates with lower AISC, an expected result given economies of scale. Large scale project require large capex and, as such, require low operating costs to provide attractive rates of return. This makes sense.
If we compare AISC for open pit operations vs. processed grades we see the trend that we were looking for! Increased grades results in lower AISC. Finally.
Similarly with UG operations, higher grade and lower opex.
The purpose of this analysis is to answer the question: “Is
I’ve heard this line
often and am interested in correlating mined grade to cash flow from operations
to see if there is any relationship.
I’ll start with a
broad assessment, ignoring the obvious impact of mine type (UG/OP).
The chart shows a couple of
interesting points. Pretium and Kirkland Lake are really in a league of their
own in terms of reserve grade for producers with >200K oz per annum of
The chart isn’t that useful with these higher reserve grade operators. Let’s take them out.
The chart, with a 5 g/t cap looks as follows:
Moreover, unfortunately, there really isn’t any relationship between reserve grade and CFO/oz (darn). This isn’t that surprising as reserve grades aren’t mined grades and there are countless other factors that impact the profitability of an operation. I was hoping that grade would be king-enough to prove some relationship.
This investigation will require further analysis. While we’re at it. Let’s look at 2018 production.
The chart shows that, as expected, more gold production = more CFO. It’s interesting to note which operators fall above or below the trend line. Kirkland Lake, Newcrest, and Sibanye stand out as a strong performers while Anglo Gold Ashanti is a laggard.
The last chart we’ll
look at is a comparison between 2018 CFO per oz produced vs. current enterprise
value per ounce. Now we wouldn’t expect CFO
to directly translate to enterprise value
think that this chart is interesting because it provides commentary regarding
how much reserve value is going to be captured by the company (or at least the
market’s perception of it). The shading of the dots reflects the comparison
between these two metrics.
The variation in this metric is very impressive. Take New Gold for example, in 2018 the CFO per oz was close $550 while the company’s enterprise value per reserve ounce is only $100/oz. As mentioned, there are innumerable other items to consider (asset quality, assets not in production, CFI, capital structure).
Not really sure how to conclude this. Relating grade to cash flow is going to be tricky.
Mining is risky. With a commodity output, they operate in an environment of perfect competition. It’s capital intensive and they don’t need to contend with depreciation alone, there’s also depletion. Pit walls can fall, people can get injured, and governments can penalize mines at will (nationalization, permitting, fines).
In a previous post I looked at Franco Nevada’s negative retained earnings and meager returns on capital invested. Given historic performance I thought it would be interesting to look at implied returns from prospective investments and the sensitivity of project failure.
Let’s say that Franco invests $250M in eight projects and the expected post-tax return is 4%. Well, what needs to go wrong to obliterate the return of the portfolio.
Well, this would do it:
1 project fails immediately
1 project fails at year eight
1 project fails at year ten
1 project ends two years early
What are the odds that this could happen? That’s an interesting question. It’s certainly higher than 5%. I imagine 50% is closer to reality. There’s also the impacts with grade issues and ramp up.
What is the purpose of a corporation? Let’s not get into the
stakeholder vs. shareholder debate. At the core, a corporation’s goal is to
increase its shareholder’s wealth. Otherwise, why start the corporation? I’d only start a company if I believed this investment would yield more
value (return) than a risk free asset. I’d want to be compensated for this risk as
well, hopefully earning a materially higher return than a riskless asset.
A corporation’s purpose, while simple, is easily convoluted
by countless factors. The owners of the corporation may not understand it in themselves.
I’m not Stanley Druckenmiller but I’m
no finance/business slouch either. After a couple
thousand hours of studying/working in finance, I
can honestly say that I’m only starting
to build a picture of what I consider to
be a “good” business. Why is this the case?
There’s so much noise.
A company’s price and fundamentals are so
detached. Who am I to say that a
company with zero earnings is a bad company? The
FANGs, they don’t earn much and yet
they are the best performing stocks in
the past decade. The fact that growth stocks don’t
trade on fundamentals makes it easier for
non-growth stocks to trade on the same basis. The market doesn’t hold them to account, don’t they see
I think Warren Buffet
has it right. The Berkshire Hathaway owner’s manual states that their goal “is
to maximize Berkshire’s average annual rate of gain in intrinsic business value
on a per-share basis.” This makes sense. If
I’ve got a dollar, I want to invest it in the area that’s going to
give me the most dollars in return. Berkshire
defines intrinsic value as the present value of future cash flows. They trade money. Trade 1 dollar for 1.08 dollars. Makes sense.
A $100 million investment with a $100 million NPV is subjecting
earned dollars to zero return. Now that doesn’t
make sense. Who would do that?
Well, as far as I can tell
Franco Nevada does this, and a whole-heck
of the mining industry.
Why do I say this? Well let’s take a look at the financial statements
for FNV for year end 2017.
Ok, so I’m a shareholder. How much money have I pumped into this company?
Wow! 6.5 Billion in total, the value has steadily marched higher over the past decade. Must be some good returns to justify this. Well, FNV has generated $836M in net income of the past ten years. That’s a pretty measly 1.88% on the contributed capital. Hmmmm.
But, but, they pay a
Yeah, they do. But it’s more than their net income.
So what does this really mean. Well FNV is paying out more than their making. Is this good business? Let’s keep issuing capital, take on some debt, and pay some dividends. More people see the dividend track record and subscribe. That’s an interesting cycle… sounds familiar. What’s the name for that?
Well, if you were a
shareholder between 2007 and 2016 it hasn’t
been good business. Earnings haven’t increased and the return on your equity
has been pretty lousy.
But who cares! The stock price is going up.
And a big reason for
that is steeper valuations from a PE perspective (note the chart above takes
out PE ratios over 100). In an environment where your competition is miners with a destructive track record for
capital allocation, you’re the best looking
girl at the bar.
Now I’m not saying
that the people that run FNV are bad miners. They just aren’t deploying capital
in a fashion that produces high returns. But
this begs the question, why are new players (triple flag, orion, osisko,
sandstorm) entering the business? With competition, prospective returns surely
aren’t going to go higher. The narrow margin of error may get pushed lower.
There’s also the question about why people own these stocks. I mean, it’s precious metals exposure and it’s certainly outperforming Barrick but common. Return on equity less than a LT treasuries. These are not risk free assets.
Yesterday Newcrest announced that they were increasing their stake in Solgold (owner of Cascabel property in Ecuador (85%)). This will take Newcrest’s ownership of Solgold to 15.33%. Newcrest had previously purchaed shares of Solgold in 2016 and 2017. What makes this interesting is that BHP has also shown interest in the property, purchased 100,000 shares in October. Newcrest will not be the larget shareholder in the company, followed by DGR global (11.24%) and BHP (11.18%).
So what is going on here? Well SolGold has an enterprise value of US$810M so this company is not cheap. Cascabel must be one hot ticket. Yup sure is...
Resource update in November showed 10,900,000 tonnes of copper and 23.2M oz of gold. Wow. Amazing. The resource contains 2.95B tonnes at 0.52% Cu. Perhaps even more interesting, there’s a high-grade core of 420M tonnes at 1.47%Cu; almsot $100/tonne rock at $3/lb Cu.
The November 2018 investor presentation highlights the fact that modern exploration activities have allowed the for the discovery of the property. Drill results contain some of the best porphyry copper gold intervals ever recorded. For example. Hole 12, 1560m at .59% Cu and 0.54 g/t.
The image above (from November 2018 investor presentation) shows the gargantuan extent of the deposit. Based on the geochem data it looks like there are a bunch more targets as well.
Given Newcrest’s experience with block caving, it’s not surprising how interested they are with the property. Look at the benchmarking!
Solgold also owns multiple subsidiaries with a 3,200 km2 land package.
Well. Solgold is pretty amazing. That’s what’s going on with Solgold.