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New questions raised on mineral rights valuations
GOLD MINING
THE massive downward rerating of gold shares around the world has prompted the revisiting of how mineral rights should be valued when transactions take place between owners. "During the 1980s, several exploration companies listed on the JSE. They had paid perhaps R60 a hectare for options over ground exercisable at R10 000/ha. Their quoted companies were valued at this R10 000/ha even though the money had never been paid and seldom was paid," recalls Andy Clay, executive director of independent mining consultants Venmyn Rand. So if rands a hectare is a somewhat arbitrary figure, what about using the value of gold actually contained in the mineral rights? "We need to be able to value the mineral rights on a formula using the number of kilograms multiplied by the value of the option per kilogram. "In 1996 we were asked to look at the mineral rights valuation method at JCI, which incorporated option pricing. To arrive at an option price, we need to make some assumptions. A company with gold-bearing mineral rights is long of gold in the ground which cannot be exploited immediately. "But estimates of the appropriate type of mine needed to recover the gold can be made by estimating capital expenditure, recovery, working costs and so on, to give a cash-flow projection and arrive at a net present value for the project. In this way, we can replicate an option," he explains. In theory, the orebody can be mined when the net present value moves out of the negative to zero and above. "In essence, it is a perfect option. The slope of the graph once this hurdle has been breached will determine the number of ounces in the resource that you would be prepared to write call options on." Nearly lost? This indicates an intention to mine and produce gold which will be delivered in terms of the call options. The intention to mine gold is prevalent only among those who are bullish about the gold price. The green light comes on when the gold price reaches the level at which a mine could be developed. The cash flow model takes into account the depth of the resource and other mining considerations. The grade will depend on the pay limit: as the gold price climbs, a lower grade of ore can, and indeed legally has to be, mined. The gold price might take forever to reach the hurdle, and Clay notes that it is not really feasible to go longer than 10 years. "The whole idea is that you calculate a value based on intrinsic assumptions and factor it into the current gold market as you would any other options." Clay notes that the risk-free rate of return such as earned on government stock is about 15%, so the yield curve on the mineral-rights project needs to exceed this handsomely because of the comparatively large risk. Using the option-pricing method, gold in various mineral rights has been valued at between $1 and $7 an in situ ounce. "It's not just a thumbsuck. It goes back to first principles." Valuing gold in the ground in terms of market capitalisation an ounce or working costs an ounce is coming under scrutiny. "We are sceptical when companies claiming to mine at a cost of $220/oz never pay a dividend because they don't make any money. Accounting differences as to what constitutes working costs are highly variable: the amounts spent on capital expenditure to maintain the ore reserve, off-mine refining, mine rehabilitation and so on have to be taken into account."
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