How The Pros Analyze Gold Stocks: Part I

I spend a huge amount of time trying to value gold and silver stocks for the simple reason that they have the ability – unlike many other asset classes – to generate massive returns in a very short time frame. But in order to see those gains materialize you have to understand a little about the intricate processes of mining and the regulatory framework that miners must follow when reporting their gold and silver reserves.

Now that I understand the process I can say that it is interesting work, but the first few times I was completely lost in a sea of technical reports and mining lingo that might as well have been written in Mandarin.

So I'm extremely sympathetic to those of you who aren't versed in this foreign language of mining economics, but want to invest in the space. When Kevin forwarded me an email from a reader that asked all the right questions I decided to tackle the subject in as close to plain English as I'm capable of.

Here's my best effort to translate…

Subscriber comment: I have some questions regarding mining companies as I am a little bit lost and confused when it comes to the technical reports and the resource reserves. Hopefully you can provide answers and explain to me these issues in more detail.

Tyler Response: First off, this reader is not alone. He's lost because mining is complicated business, and honestly the technical reports don't really simplify it. But if you focus on the big picture, and understand the analysis framework you'll be able to dissect and interpret the reports pretty quickly. There really is a pretty sharp learning curve – if you can focus.

As an aside, the regulatory body responsible for the framework and definitions is the Canadian Institute of Mining, Metallurgy & Petroleum (CIM). Its regulatory standards are outlined in its National Instrument 43-101 – Standards of Disclosure for Mineral Projects (or NI 43-101 for short), which is why you'll see companies list their gold and silver ounces as 'NI 43-101 compliant'.

The trick to understanding this whole mess is to remember that we need the regulations to govern how companies report their 'in ground' gold and silver ounces because, well, they are underground and we can't see them.

The regulations also create a framework that helps companies access the capital markets and raise funds to build mines. Since investors like to know they'll get their money's worth (and there is ample room for fudging numbers) mining companies are required to complete very detailed economic studies which show how many ounces they have in the ground, how much a mine will cost to build, how long the mine will be in operation for, and all the associated costs, cash flows, and so on.

These studies can take three forms: a Scoping Study (very early stage), a Prefeasibility Study or a Feasibility Study, depending on how advanced the project is.

Since the basis for these studies (and the company's future for that matter) depend on how many ounces are on the property and how many makes sense to mine, the regulations state that ounces must be classified into different categories depending on how much confidence a 'qualified person' has that they actually exist. The qualified person functions a bit like an auditor, and needs to be a licensed engineer or geoscientist who demonstrates that he knows what he is talking about.

So that's the big picture. In my next issue I'll explain what the different classifications of ounces are, what they are each worth, and how you can tell if a mining stock is a good buy based on how the market is valuing its ounces in the ground.  


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