I have often wondered if any of the junior gold producers has ever tried to model itself after a gold Exchange Traded Fund (“ETF”). This hybrid-model may be a way for companies to provide shareholders a way to partly leverage themselves to physical gold rather than leveraging solely to the performance of a mine. Let me explain further.
Consider two identical junior mining companies starting up a new mine. Each of their two projects is identical; 2 million gold ounces in the reserves with annual production of 200,000 ounces resulting in a 10 year mine life. On an annual basis, let’s assume their annual operating costs and debt repayments can be paid for by the revenue from selling 180,000 ounces of production. This would leave 20,000 gold ounces as “profit”. The question is what to do with those 20,000 ounces?

Gold Dore

Company A sells their entire gold production each year. At $1200/oz, the 20,000 oz gold “profit” would yield $24 million. Income taxes would be paid on this and the remaining cash can be spent or saved. Companies may decide to spend more on head offices costs by adding more people, or they may spend some on exploration, or they could spend on an acquisition to grow the company. There are plenty of ways to use this extra money but returning it to shareholders as a dividend isn’t typically one of them. Now let’s jump forward several years; 8 years for example. Company A may have been successful on grassroots exploration and added to reserves but historically exploration odds are working against them. If they actually saved a portion of the annual profit in the bank, say $10M of the $24M, after 8 years they may have $80M in cash reserves.
Company B only sells 180,000 ounces of gold each year and puts the remaining 20,000 ounces into inventory in a vault. Their annual profit-loss statement shows breakeven status since their gold sales only cover their financial commitments and nothing more. In this scenario, after 8 years Company B would have 160,000 gold ounces in their vault, valued at $192 million at $1200 gold price.
If you’re an investor looking at both these companies in the latter stages of their mine life, which one would you rather invest in? Company A has 400,000 ounces remaining in mineral reserves and say $80M cash in the bank. Company B also has 400,000 ounces of mineral reserves and $192 million worth of gold in the vault. If I’m a gold bull investor and foresee a $1700/oz gold price, then to me Company B might theoretically have $272M in the vault. If I’m a super gold bug, then their inventory could be worth a lot more..theoretically.
I assume that the enterprise value of Company A would be based on its remaining reserves at some $/oz factor plus its cash in the bank. Company B could be valued the same way plus its gold inventory. So for me Company B may be a much better investment than Company A in the latter stages of its mine life. In fact Company B could still persist as an entity after the mine has shutdown simply as a “fund” that holds physical gold. If I am a gold investor, then Company B as an investment asset might be of more interest to me.
My bottom line is that it appears that most of the time companies sell their entire annual gold production to try to show profit on the annual income statement. Possibly this is to put some cash in the bank and to show “earning per share” to the analysts. My question is why not inventory the extra gold and wait for prices to rise if the company doesn’t really need the money or doesn’t want to gamble it on exploration or acquisitions? This concept wouldn’t be a model for all junior miners but might be suitable for a few companies to target certain gold investors.  They could provide an alternative junior mining investment especially interesting in the final years of a mine life. Who wants to buy shares in a company who’s mine is nearly depleted?  I might if they hold a lot of gold.
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4 thoughts on “45. Do Any Junior Producers Model a Gold ETF?

  1. hardrockminer

    First of all, company B has to pay taxes on their gold. At a 30% tax rate that would amount to roughly $58 million, which brings their poke down from $192 million to $134 million. That’s still more money than company A has saved at $80 million, so presumably A has spent $54 million on exploration or other investments that didn’t work out. Too bad…so sad…that’s the nature of the business.

    What your thesis really boils down to is whether a company that finds a mine should continue to explore after their first success or whether they should stop exploring and call it a day after the first mine expires. Presumably a good company with good people will use their income wisely and will find other deposits to sustain their cash flow. Since I only invest in good companies (hee hee!!) I’ll invest in company A rather than B.

    A word on share price…analysts recommend share price based on the discounted expected future earnings. People purchase shares on the same expectation. What is the value today of a share in a company with no earnings for 10 years, vs the value today of a company with steady earnings every year?

  2. Ken Kuchling Post author

    True, but what is the NPV of a company with 2 years left or 1 year left in its mine – maybe close to zero. But what if those guys had 200,000 oz sitting in the vault; it’s a different company. I think the point is if gold is $1100 now, should you sell 100% of your production at that “low’ price or only sell what you need to pay expenses and then gamble you can sell the rest at a higher price in the future. If gold drops, it was bad idea but if gold rises you can pat yourself on the back for not selling everything at $1100.

  3. hardrockminer

    I think the precursor to Goldcorp (Dickensen) did that back in the ’80’s or ’90’s. Rob McEwen was president at the time. I don’t know if it made money or not. Gold didn’t really take off until around 2007.

    Every company had to decide what to do with retained earnings, which is really what unspent earnings are. There are a multitude of options and simply holding them in a vault is one option I guess.

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