Sunday, July 29, 2007

Copper $1.50 Next Year?

Some things you read stop you mid-step and send you re-evaluating what makes sense to you. Early I posted that I believe the average price on commodities would be higher than they have been.

The evidence shows that companies were cannibalizing their assets to reduce costs when commodities reached their all time low in 2002 and set up a squeeze on supply that has caused on average about a 6-fold increase from the 2002 lows, which if the lows were reasonable, would be utterly unsustainable pricing, but the lows were as insane as some of the highs have been, like $50k/ton nickel.

Frank Veneroso has been promoting that investors are at enormous risk due to the excessively high price of commodities and he uses that benchmark low in 2002 to say copper increased to peak of 570% of its low, which is true and by using these numbers he calculates numbers and projects scenarios that would wipe out commodity investors. His report can be found on his web site,

Sprott Asset Management has been promoting that because of China and emerging markets commodities are in a super cycle like one that has never been seen before, and their material is worth reviewing,

Investors that listened to Mr Veneroso over the past couple years have missed tremendous gains in the commodity market, and certainly from my analysis I believe some of those gains are unsustainable, but an all out implosion of the sector as a whole?

Independent information, for example, DryShips, a shipping company shows historical graphs of what has been shipped to China.

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This graph is for ore, but this kind of data is abundant on the Internet for shipping of commodities if you look at shipping companies. Indeed, shipping companies have done very well because of this utterly enormous increase in imports from China. By all accounts, China has been a sinkhole for commodities.

If I hand pick the low, as Mr Veneroso has, and contrast it to the high in terms of shipping, 7.4 m tons from December 02 to 29.5 m tons in Feb 06 is a 4-fold increase in ore imports, but that is over stating the growth of imports as is Mr Veneroso’s claim of 570% for copper. Overall, China’s demand for commodities has grown and the growth or ore is about 2.5 times what it was about 5 years ago.

Steven Saville maintains that the global boom in commodity prices is driven by inflation, not real growth, and his post,, is worth reading. What particularly got my attention was the graph of SS CPI Adjusted Copper Price.

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A strong criticism of the Veneroso report is that he uses government inflation data, data that if anyone compares to their true costs knows is a blatant lie. I have calculated that the inflation that I have experienced in my non-discretionary costs is more like 5-6% over my adult life, and something I recently read pointed out that US government data specifically excludes housing, food and energy. Veneroso’s report would be more useful in assessing where commodities actually stand if it took into consideration realistic inflation rates because there are some truths to some of the things he says.

If anything, Saville’s graph shows a downward price trend with high levels of volatility and possibly the beginning of an upward trend.

So, what is the “truth”?

Investors need to come with their own "truth" that makes sense to them based on the evidence presented to them. What seems plausible to me may not seem plausible to others. Only time will tell which “truth” was correct.

For me to come up with what seems plausible I look at a bigger picture, and I go back a hundred years and try to relate what I am seeing to what I believe to be true.

So, a hundred years ago the concept of open pit mines was utterly new and a grade of 2% copper, stellar by today’s standards, was considered low grade. Mining was predominately underground and equipment obviously antiquated. Adjusting for inflation the price of copper was actually around today’s price, and if you further adjusted it for the manipulation to understate inflation, the price of copper was actually grossly higher than today. The graph above does show that copper had been declining in price and I would suggest that to go back further you would find a much longer term decline in the price of copper.

So, technology improved and the leverage of work output improvements to each worker declined as machines continued to get bigger and better. It is analogous to computer technology. In the 90s each computer upgrade was 100s and perhaps 1000s of times better, but lately upgrades are well under 100% better.

For mining, it would not surprise me if the efficiency of workers has improved because of these bigger machines so that one person in the actual mine does in the range of 100 times the productivity of 100 years ago. A lesson from my schooling is that real wealth is created by this kind of efficiency of leveraging worker output and it enabled wages to increase, prices to decline and I suspect, at least for copper, that it hid an overall declining grade of copper being mined over the last 100 years.

The Bingham Canyon mine started mining a 2% grade and the grade they now mine is less than 1/3rd of that. Some minerals are far more abundant, like aluminium, so over all grade declines would not be as significant, and for me, that is the most plausible reason aluminium has not seen the same degree of ramp up on price. It is my guess based on what I know about the world.

Today’s machines have reached limits of technology. You can’t build a 30-story wood frame building because the tensile strength of the wood will not allow it, as are the limits of today’s machines. There may yet be technological improvements, but they will be much slower coming and they will never give the kind of leveraged improvements of the past.

Living in BC, my truth points to a very strong other source of leverage of earnings for mining companies as the gains in technology declined – the export of jobs to countries employing slave labour wages. In BC in the 80s mines closed and were no longer economically sustainable. The move of the mining industry to countries with lower wages allowed the continued overall decline in commodity prices. Mines with good grades in North America were sustainable, but this trend wiped out lower grade mines.

The move of highly leverage productivity jobs to other countries empowered workers and workers have demanded and gone on strike for better wages and working conditions in these other countries, so the wage gap has declined and the options to export jobs to lower paying countries has dried up.

So, basically not a single economy of scale to reduce prices exists anymore, not increased leverage of output due to technology, not export of jobs to cheaper countries and to top it off, declining grade of mined ores can not longer hide behind these effects. I believe many analysts are missing the decline of grade in their analysis when they come up with something like $1- to $1.50 copper as a long-term price.

And then there is yet another point to take note of, the over burdening level of US debt and spending that is killing the US currency. Commodity prices are quoted in US dollars and there has been an enormous decline in the US dollar with respect to other countries, for example, Canada, Australia, Russia, Chile, and China.

Canada vs US
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Australia vs US
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Russia vs US
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Chili vs US
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China vs US (2 yr)
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The US dollar has not declined with respect to all countries, but in terms of the world market, the US commodity price quote has not increased to the same degree if the prices were quoted in other currencies.

So as I see it, there are four driving forces for increased commodity prices:

  • Inflation

  • Wage demands in excess of inflation

  • Declining grade which leads to increased costs

  • A declining US currency

Considering these factors, I simply cannot see a long-term copper price being less than about $2, and costs for producing commodities will exceed the rate of inflation overall. Indeed, a real risk to investors is declining margins due to increasing costs.

However, an estimate of a long-term price isn’t a statement of belief that prices will never go below the price. Clearly, in 2002 prices were below a long-term sustainable price, as they are currently most likely above a long-term sustainable price.

Read More......

Thursday, July 26, 2007

Exploring Declining Grade

In 1905 the Bingham Canyon mine opened mining a copper grade of 2%. Last year the grade they mined was 0.63% and the reserves they have left to mine have a grade of 0.54%. In 2003 Goldcorp’s Red Lake mine mined a gold grade of 77.5 g/ton, and 28 g/ton in 2006. These are a couple examples of a trend of declining grade in individual mines and within the industry as a whole as the best deposits tend to be mined first. This post looks at declining grade in a single mine. I suspect that declining grade affects costs exponentially rather than linearly, and I will examine that next post.

There is no question that grade is related to profitability. Looking back to Goldcorp’s 2003 financial reports, when it was much simpler company with just two gold mines, Wharf and Red Lake, it is absurdly easy to see the contrast in the two mines. For 2003 the Wharf mine had an operating profit of $100,000 and on the $24,900,000 in revenue, it left an operating margin of 0% reported on the financial reports. The average grade mined for the year was 0.9 g/ton. Red Lake had an operating profit of $153,000,000 on $224,000,000 in sales, or a monstrous 68%!

Indeed, in 2003 Goldcorp reports that from the 602,845 ounces it produced, 532,028 from Red Lake and 70,817 from Wharf, earnings were $85.7 million with an average gold price of $364. At a price of $600/oz, assuming 40% of the increase goes to taxes, at this rate you’d expect 600,000 oz of gold to earn about $170 million, or each 100,000 oz of gold produced to earn just over $28 million. If you correct for the fact that the Wharf ounces contributed nothing to earnings -- all $85.7 million in earnings came from Red Lake’s 532,028 ounces – Red Lake would have earned about $30 million per 100,000 oz had gold been $600/oz. Goldcorp actually earned more that year by selling off stockpiled gold, but that is an independent action in terms of individual mine’s profitability.

In 2006 Goldcorp’s Red Lake produced 665,600 oz, had an average price of $609 and contributed $177.1 million to the earnings. That is below the $203 million one would expect if Goldcorp had remained as profitable assuming 40% going to taxes. In fact, only 32% went to taxes and controlling interests, so with 32% used instead, one would expect $216 million towards earnings. The calculation I did here was:

($30 million +(($609-364)/oz)*(1-0.32)*100,000oz/$1,000,000)*(665,600oz/100,000oz))

where the $30 million per 100,000 oz was calculated above, the $609-364 is the increase in gold price realized, the 1-0.32 gives the 68% that should go to earnings, the 100,000oz/$1,000,000 converts the number to millions of dollars per 100,000 oz and the 665,600oz/100,000oz corrects the number of ounces to what Red Lake actually produced.

To put this change of how much more Red Deer ought to have earned based on how well it did in 2003, use the calculation $216/$177 -1 = 22%. There would be 2-3% inflation per year, but overall, profitability per ounce at Red Lake declined at a rate of 6.8% per year.

But even that does not include Goldcorp’s vision for 2006. They write in their summer 2004 Outlook:

It is December 2006, and the winter freeze has already engulfed Ontario’s northwest, but operations at Goldcorp’s Red Lake Mine are running at a feverish pace with the completion of a new 7,150-foot shaft that now gives greater access to the world’s richest gold deposit.

The $100 million project, which was completed on schedule and within budget, has increased production from 510,000 to 700,000 ounces per year and lowered costs from $80 per ounce to $70 per ounce. What’s more, the shaft has been constructed with excess capacity so that when ongoing exploration uncovers additional reserves, production will be able to increase accordingly. This will help achieve Goldcorp’s ultimate goal of increasing the company’s annual production to 1 million ounces.

Their vision was to reduce cash costs by $10/oz, which at that 32% tax rate should add even another $6.80*665,600/1,000,000 = $4.5 million, or, ignoring that they missed their production target by 5%, earnings ought to have been $220 million, or 24% more than they achieved.

Missing their production goal by about 5% is a relatively minor problem. But their cash costs of $195/oz are 179% above there vision!

How can a vision go so wrong?

In 2003 they mined 242 thousand tonnes of ore and in 2006 they mined 769 thousand tonnes of ore, a 218% increase, but because of the decline in ore grade they only mined an extra 25% more gold.

The costs are given per ounce of gold produced, but the numbers may make more sense trying to look at them as cost per ton.

So, in 2003 the grade was 77.5 grams per ton, or 77.5/31.1 = 2.49 oz per ton. With costs of $80/oz, $80*2.49= $199/ton. So the cost per ton of ore processed was $199.

In 2006 the grade was 28grams per ton, or 28/31.1 = 0.90 oz per ton. With costs of $195/oz, $195*0.90= $175/ton, or a decline of almost 14%, almost identical to the 14% decline in costs outlined in Goldcorp’s vision.

In this example, the rising price of gold has completely hidden perilously increasing costs due to declining grade and enabled a healthy profit margin to be maintained, but it is a rapidly declining margin relative to production, cost per oz of gold increased 179%!

Goldcorp’s remaining proven and probable reserves average 22.24 g/ton. They have 1.55 million ounces at a grade of 41.48 g/ton, and then the probable grade declines to 18.57 g/ton for 3.64 million ounces. If we use the $175/ton of ore processed, the cost per ounces for mining a 41.48 g/ton gold ore grade would be (31.1/41.48)*175 = $131 per ounce of gold. The 18.57 g/ton would have a cost (31.1/18.57)*175 = $293 per ounce of gold, and considering the average of the grade, 22.24 g/ton you get cost per ounce of gold of $245.

What this means to investors is that failing to pay attention and assess the quality of the reserve grade and whether it is maintaining, improving or declining could cost you dearly in your investments. It means that you absolutely cannot look at a gold stock, or any other metal for that matter, and mentally calculate that if they are doubling their production profits should double. It also means that the values of assets in the ground are highly dependent on grade. This simple look suggests that Goldcorp’s 1.55 million ounces of proven reserves in Red Lake are worth about $160/oz more than the probable reserves of 3.64 million ounces, and by the time Goldcorp starts mining the reduced grade, gold will need to be about $830/oz to maintain profits at Red Lake, not improve profits.

It is utter nonsense to add up the reserves and resources of grossly different metal grades and come up with some kind of valuation without correcting for the grade quality.

Many things affect profitability, but declining grade seems to be is the most ignored or unrecognized source of implosion of value and earnings.

Read More......

Saturday, July 21, 2007

Blog Feature - Commodity News and Mining Stocks

One of the blogs I read regularly is Commodity News and Mining Stocks. Something that I really like about it is that he sends me to look at good articles and reports on the commodity business, and he takes what he learns and applies sound investment strategies to it.

Well, a Globe and Mail reporter also liked his blog and has run a story on him.

Congratulations Arjun!

End of post.

Read More......

Thursday, July 19, 2007

Fantasy Girl Revist - Google Googlplexed

In the fall I was writing my blog over on Stockhouse and I wrote this 10 part series which I titled Fantasy Girl and a subtitle for each post. Half the posts were taking detailed look at why Google's earnings would not keep up, as in the news story Google's Profit Falls Short, Shares Drop. The other half were looking at Goldcorp and the serious valuation problems with that one for investors. Those parts I worked on polishing up further and turned it into my post, How I Discovered the Gold Bubble.

For the Google related part of the series I intended my posts to show how when growth rates are unreasonable large applying that PEG dogma is nonsense by starting with an absurd rate of interest and hoped people would make the connected that their expectations from Google were also absurd.

I like Google's products and services and use the all the time, however, when too many people get on a boat it sinks. Here's my original analysis of Google from November 2006.

Fantasy Girl - Up 10,000,000,000 % Part I

Have you ever had a day where you could say you were up 10,000,000,000%?

Are you sure?

Just what kind of daily percent would you have to make each trading day to make 10,000,000,000% in a year?

Compounding interest is a wonderful thing. I do this math thing where my spreadsheet calculates my percent change for the day, and my annualize change if I did that percent each of the 240 trading days of the year.

The formula if you let D be your day's earnings, O be your day's open is:

Annualized rate of return = (1 + D/O)^240 - 1

The D/O gives you your percent increase for the day, and taking it to the power of 240 compounds it much the same way you might to a simply compounding interest calculation for 10 years.

So, what percent?

Well, I found out yesterday, and wow, what a lesson on compounding interest. 10 billion percent it said, and I went to correct my error, only there wasn't an error. At that point my portfolio was up 8%, and wow, the annualized rate of return if you could do that everyday is 10 billion percent! And a different stock, with a small holding, went up, so I changed it, and wow, up 13 billion %, and up more, and then 33 billion %.

But wait, that's not a lot of extra dollars causing that jump. Huh? I looked at the percents, 8.1% gets you 13 billion, and 8.5% gets you 33 billion, and well, 10.1% gets you over a trillion %.

In absolute terms, the increases are small compared to compounding effects. By comparison, to go from 0%, to 0.1%, the same absolute difference, as 8% to 8.1% the annualized rate goes from zero to 27%, a small percentage difference compared to from 10 billion to 13 billion %.

And herein lies part of the problem in how we can get ourselves into enormous trouble with our portfolio when past growth rates of a company are used to project future valuation. The bigger the growth, the company experienced, ie, already had, the harder it is to ever meet that crazy expectation.

In the next few posts I'll examine the financial difference between using past growth numbers and future growth numbers, and how some of the those past growth numbers are setting investors up for financial ruin.

Fantasy Girl - 300 Billion! Part II

The main idea from the first post in the first Fantasy Girl series was that as the rate gets higher, the magnitude of the difference in compounding increases dramatically with tiny increases in the rate use. The two examples have a mere 0.1% difference in rate. Compounded rate = (1 + daily rate)^240 - 1

Daily rate
Compounded rate
8% 10,000,000,000%
8.1% 13,000,000,000%
B minus A
0.1% 3,000,000,000%
0.0% 0%
0.1% 27%
D minus C

The tiny increase in rate in these two examples is 0.1%, but the absolute difference becomes unimaginable as the rate gets absurd.

But, what would happen if you did that 0.1% per trading day for say, 12 years?

Year Total interest
0 0%

Well, if you started with $10,000, in 12 years you'd have $177,88, and $167,880 of "wealth" has been created.

But, just how did that wealth get created?

There are many paths to that wealth. Some will create wealth that will be sustainable, and some could be described as lying in wait for nuclear melt down.

How about taking a look at say ... Google (GOOG), and later, a much smaller company.

Google's market cap is $153 billion dollars. Google's share price is up about 33% in two months. About $38 billion dollars of market cap.

And just what is the annualized rate of growth if you increase by 1/3rd in 3 months?

(1.33^6 -1) = 213%

Oh boy, if we keep going like this, we should see $1100/share by next summer and a market of $300 billion. What a great company... And wow, this company is everywhere, it can do anything...


Part III a closer look at what Google's financials are saying...

Fantasy Girl - Googlplex 10^100^10 - Part III

Googolplex - 1 followed by a googol of zeros

  • As growth rates increase even marginally, they have exceptionally larger effect on the end numbers.
  • Google has a market cap of $153 billion and its share price is up 33% in two months, creating $38 billion of market cap.
  • To continue at the current growth rate, Google would be up 210% by the end of the year.
Oct 19, 2006

Google Revenues increase 70%

The PEG Ratio says that if price/earning is less than the growth rate, you've got an undervalued stock, although the Motley Fool suggests it should be 0.5 or less to be undervalued ( For correct use, the PEG is dependent on an expectation of 5 years of growth at the rate used for the earnings per share.

So, just what have Google's earnings per share been?

Earnings/ share
1% increase over last Quarter
2Annualized Quarter Growth
3Annual Growth to Q1/05
Q1 2005
Q2 2005
Q3 2005
Q4 2005
Q1 2006
Q2 2006
Q3 2006
1This is a quarterly rate of return (loss). 2The rate must be taken to the 4th power to get the annualized rate. 3This is what the rate of return is if it was constant back to Q1 2005.

The headline said 70% growth, where is it in the earnings?

Seriously, time to apply the PEG ratio, using the 5 year standard that it was based on. So, being optimistic, lets say that overall annual rate of 41% will be continue over the next 5 years. Keep in mind that a 41% annual growth rate means we are looking for 1.41^5-1 = 457% over the next five years. If you don't appreciate why we are looking at 457% growth over the next 5 years, go back and read

So P/E = $505/(2.36+2.33+1.95+1.22) = 64.2

Hmmm, 64.2 is not less than 41. 457% of sales growth over the next 5 years will not be enough. 64.2/41 = 1.56

Double hmmmm. At 1 - 1.3 the Motley fool is saying a stock is overvalued. At 1.7, it is saying short!

But, there is something even more serious to notice here, the gross rapid decline in the quarterly growth rate in 2006. The decline in that growth rate is like a nuclear melt down.

And seriously, 1.642^5-1 = 1094%. To force the PEG to be one, we need 1094% in growth of earnings over the next 5 years. And that's for the current share price to catch up to itself, without growing at this absurd rate of 450% per year. We need even more growth in real sales and real wealth if the stock continues to create market cap out of thin air.

But, given this, I predict the next headline will read an even great rate of growth. Next post I'll explain how the numbers can be used to show this, and I'll even predict when the nuclear meltdown will occur.

And even more seriously, earnings per share are 1.6% of the share price. You can do better in the bank and your money is safe.

Fantasy Girl - Googlplex^Googlplex - Part IV

Googol - 10^100

This is the 4th post in a series on valuation and growth when growth rates are big.

  • Google's 2 month growth rate on share price ($380->$505) is 210% annualized.
  • Correct use of PEG says earning must be expected to increase by 1094% in the next 5 years without any further increase in share price.
  • Quarterly data on earnings per share show dramatic declines in growth.
Perceptions of Growth - Google's Next Quarterly Report

The last quarterly headline read "Revenue Up 70%." And the next report will probably read something like "Earnings up 90%." Remember the 3 billion percent difference in annualize return between 8 and 8.1% from part 1? Yet it didn't seem so extreme using 0% and 0.1%. A large past growth rate easily hides rapidly declining growth. Here's how.

First, we need to look at earnings per share and increases in earnings per share over the previous quarter, and the quarter one year ago.

Earnings/ share
% increase over last Quarter
% increase over Quarter 1 year earlier
Quarter increase annualized
Q4 2004
Q1 2005
Q2 2005
Q3 2005
Q4 2005
Q1 2006
Q2 2006
Q3 2006

If you just compared Q3-06 to Q3-05, you'd see a 78% growth in earnings, and that's exceptional. But, where in the news was the headline:

Google's Growth in Q3 Earnings Decline by 94%

(1-1.3/19.5) * 100% = 94%

We are playing with exponential growth here, so it is fundamentally important to consider the exponential growth consequences.

But, lets look at how the headlines will read for Q4, based on 3 projections I got from MarketWatch, a low estimate of $2.31, a mean of $2.72, and a high of $3.13. Notice earnings in Q4 2005 were down. That's going to be great for punching the numbers to make things look good... Might even be able to get away with increasing projections to $1000 per share!

Q4 2006 Estimate % increase over $1.22
% increase over $2.36
Annualized Growth Rate
PEG = one @
2.31 89% -2.1%-8.2%
2.72 123% 15.3%76.5%
3.13 156% 32.6%209%

So, there you have it, the next headline:

Q4 - Google's Earnings up 89%

And the red elephant hides in plain view. PEG wrongly used supports share prices at a low of $800 and a high of $1500, creating an additional $90 to 300 Billion in market cap, out of thin air. I need one of these money trees in my back yard.

But what of Q1 - 2007? Notice that jump from $1.22 to $1.95 between Q4 and Q1? That's going to play havoc with the numbers. MarketWatch estimates are a low of $2.10, a mean of $2.98 and a high of $3.28

Q1 2007 Estimate % up over $1.95
% up over $2.31
% up over $2.72
% up over $3.13
Annualized Rate Over $2.32
Annualized Rate Over $2.72Annualized Rate Over $3.13
PEG = one @
$2.10 7.7% -9.1% -23%
-32%, -65%
$2.98 53% 29% 9.6%
$3.28 68% 42% 20.6%
307% 111%

There's a lot more red elephants in that chart, and the growth over the same quarter in the previous year is much smaller than what Q4 projects. I predict there's going to be a lot of pain right about here.

One more thing, that by looking at the PEG calculation between three estimates and 2 quarters and finding a share price valuation that varies by a magnitude of TWENTY ($73 vs $1500) simply says the PEG is grossly misused and is best left for Voo Doo economics.

Part V, a different kind of valuation...

Fantasy Girl - Scrooged - Part V

"But you were always a good man of business, Jacob." Ebenezer Scrooge

  • Google's market cap: $153 billion, $38 billion created in past two month.
  • Q4 PEG could support $800-$1500 share price, creating up to $300 billion more market cap.
  • Q1/07 PEG could suggest a share price as low as $73, destroying $130 billion in market cap.
  • Oops, easy come, easy go, $6 billion of market cap gone today 11/27/06.
How does your bank treat you?

Ultimately, sound investment is about a company's ability to generate earnings relative to the investment. Sure, there is tons of money to be made on greed, fear, and speculation, but that isn't realistic or fair valuation.

Your bank:
  • Wants security for 6%
  • Good credit rating for 10%
  • Has legal recourse against you
Google, earnings per share from the last 4 quarters comes to a mere 1.6% of share price, you have no legal recourse and you are risking your savings. By banking standards, for fully secured, earnings per share needs to be in the $30/share range $7.50 per quarter at the very minimum. Currently, Google's earnings per share aren't even keeping up with the rate of inflation!

So, just how much do you expect Google to grow to reach market staturation? At some point all companies reach maturity and have limited growth prospects. Where is that for Google, and how many years?

Say the company grows to earnings of $50 per share in 10 years to reach market maturity, and at that point because Google is a big secure company, that's about where earnings will stay. This is a highly optimistic quarterly growth rate for earnings of 4.3%.

Lets examine 3 examples:
  1. You want 6% return on your money and you are confident Google can to it.
  2. For that kind of speculation, you want 10% return on your investment today.
  3. You think growing to earnings of $50/share is highly unlikely, and you want 15% because of the high risk you are taking because it is highly unlikely.
For $50/share earnings to be 6%, the share price would be $833.

% return wanted (r)
(1+r)^10 Present Value of Shares
6% 1.79 $465
10% 2.59 $321
15% 4.04 $206

So, with a low expectation of return (6%), and highly optimistic growth projections (>400%), a fair share prices would be $465. But wouldn't bonds be safer?

With a 10% expected rate of return, and a highly optimistic growth projection, $321 would be a fair share price.

And finally, if you don't think it is likely, and want 15% return because of the high risk of not making it, $206 is a fair share price.

Some created wealth is sustainable, but some is simply waiting for nuclear melt down. So Barrons called Google richly valued today.

Can we say Google Bubble?

Next a little gold dust fantasy.

Read More......

Subprime, Spending and Lending Laws

In a news story, Bernanke: Subprime hit could top $100B, Bernanke says that if prices drop consumers could cut back spending as much a 9c for every dollar of lost wealth.

So, a half million dollar home declines to $400,000 and the person would cut spending by $9k. A $200,000 home to $160,000 and they would cut by $3.6k.

It looks like businesses of non-essential items are going to be in for a hit.

They also state they are working to strengthen lending regulations. I'm sure they will be marginal at best. Having worked in the banking industry during a period where people lost their homes and were left with further debt to pay back, over the years I have thought dearly about this topic, and I have previously on interest rates, Low Interest Rates - As Destructive as Usury.

I have been a private advocate of strong laws and regulations around lending as interest rates decline due to the crazy amounts that people can borrow based on income. It makes no sense mathematically to apply a fixed standard to borrowing rates that have increasingly leveraged effects on the amounts that people can borrow as rates decline.

Legislation that would protect the consumer would be lending laws that limit the amount a consumer can borrow based on a fixed evaluation of income, down payment, amortization period and interest rates.

I have a 4.4% interest rate mortgage.

Qualifying for a mortgage should not be based on current interest rates. The leverage of the potential increase in payments is utterly enormous when interest rates are down, and the amount of money people quality for at low interest rates is insane. I qualified for 53% more mortgage that I borrowed for interest rates at 4.4%. If they'd been 3%, well, then I'd have qualified for 76% more than I borrowed. Based on the payments I chose to make I'd have qualified for 85% more at 4.4% and 115% more at 3%.

Qualifying for a mortgage should be based on being able to afford the payments with 30% of your income with 25% down and 8% interest for a 25 year mortgage. I'd have actually only qualified for 10% more than what I borrowed with that criteria.

So, then comes the fudging factor on how to change that to change with difference in individual's financial situation. Zero down loans are actually fine, if you afford them with 30% of income at 10% interest. I would not have qualified for my mortgage with this criteria. The maximum I would have qualified for would have been 6% less than I borrowed.

And there's nothing wrong with having it go the other way, say 30% of income at 6% if you have 50% down. Under this criteria I would have qualified for about 30% more mortgage that I took based on the interest rate, but I would not have qualified for the mortgage because I did not have half down.

The actual length of the mortgage should be based on the criteria given. You have a repayment schedule based on a 25 year mortgage at 8%, but with current interest rates you will pay it off in x-years. This criteria would have me paying off my mortgage in 13-14 years. With nothing down my smaller loan qualifying amount with larger payment would be paid off in 12 years. If I had the half down the last example would have had me paying off the mortgage in 19 years.

Anyway, these are guidelines that I've come up with from thinking about the issue over the years. I think qualifying based on fixed criteria, such as 30% of income to cover 8% at 25 years, is how lending should be regulated, but how this fixed rate criteria is set should be open to debate.

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Wednesday, July 18, 2007

Screening commodity stocks

I want to come up with a set of rules to essentially screen stock them according to some unwritten criteria that I currently follow. This post is a walk through and see if I can put that screening criteria into “rules” that work for me. So, what have I been looking at?

Nord Resources on the Pink Sheets

I saw a rumor that Sprott just bought 20% of the company. Often if you can get into a stock at a price close to Sprott you can do well. People follow Sprott and screen their selections and many just jump in driving the price up. This alone can lead to a share price going up just because it has more people looking. And sure enough, Sprott has bought 15,762,450 shares, giving them 20.5% of the company. By extrapolation, the company has about 77 million shares. The site doesn’t say how many shares they have. Prior to the Sprott purchase another investor calculated 87 million fully diluted in June. Another 16 million brings it up to 103 million. At $1/share US the fully diluted market cap is about $103 million. Not finding this information easily is a problem, and I have no confidence that the 103 million is correct.

Looking back at the last 20-day trading activity volume was very low and shares were averaging about 75c. With the Sprott news the shares jumped to $1 and volume is up, but overall liquidity is low, meaning an exit could be more difficult.

The plan is to re-open the Johnson Camp Mine in Tucson, Arizona. The company looks fully financed and it should produce 25 million pounds per year. Press releases going back 3.5 years talk about restarting the mine 8 months after financing. An earlier press release states 20 million pounds of copper from a 9,000 tons of ore per day operation. Reverse calculating suggests a copper grade recovery of 0.3-0.4% which is low, about $30/ton metal values. I am not sure how the production-plan when from 20 to 25 million pounds. Nothing is easy to find with this company through their web site and that has to shy potential investors away.

Their Coyote Springs Project is purely an exploration property and if they could establish they have good cash flow to afford to explore this property that would be good, but the grade question of Johnson Camp left me questioning this ability.

The Mimbres Project mentions 50 foot intervals of 0.5 to 1% copper. That’s 11-22lbs/ton. That is an OK grade for a strip mine but not for an underground mine. This property also needs cash flow to develop, and it would be a long way off.

So, this one steers me away from it. If they have a good quality reserve/resource for their Johnston property, that information should be easy to find.

Grade is a big concern for this one, so what is a reasonable open pit grade criteria?

Going back to past posts, in June I found the grade at Bingham to be worth about $90/ton, and prices have gotten stronger making it worth about $105/ton at today’s prices. Business conditions that make Bingham a lower cost producer include:

  • Economies of scale because of large size

  • Economies of scale because of being start to finished product producer as opposed to selling concentrate

  • Capital cost allocation in deflationary book value dollars as opposed to replacement dollars

Making an assumption that the 2006 prices they got for their sales was in the $90/ton range I get costs including taxes of about $34/ton and about $28/ton without the taxes.

They say they mine approximately 500,000 tonnes of material per day with about 1/3rd being ore. Using their 2006 earnings and cost data and an assumption based on 500,000 tonnes of material I get $17/ton costs and $46/ton in metal values.

These two ways of coming up with an estimate are profoundly different. As an investor I don’t get to see all the data to understand why they are so profoundly different but possible sources are a higher strip ratio, an over estimate of actual material removed and recovery is never 100%. With that high of a grade 63% of revenue went to earnings.

With another example, looking at Goldcorp’s Alumbrera data, their revenues show they got about $43/ton of ore and their costs without taxes was $19/ton, for pre-tax earnings of $24/ton. Proportionately, there was about 25% tax so about $18/ton was earnings, or if you look at the grade actually mined at the $3.58/lb copper and $613/oz gold price the metals were sold at, you get $58/ton metal values. Operating in Argentina, and being a larger operation (400 million pounds/year), they also have some low cost advantages. For this one 42% of revenue went to earning, but if I calculated the metal values per ton based on what they said the mined grade and correct for what they did not sell I get 34%. These numbers did not “add” up, but they demonstrate the amount of error one can end up with in their back-of-napkin calculations.

None of these numbers are directly comparable, but what you can assess is that in a low cost environment like Argentina when you can calculate metal prices to be about $60/ton when prices are strong, the actual earning potential is about 30-35%. The higher grade Bingham in the US was showing 60-65% going to earning. You can not directly compare production and assume all mines will have equal profitability based on the same production. In general, the better the grade, the more profitable.

Johnson Camp is in the higher cost US and would probably also have higher costs already due to being smaller. There are lots of companies to consider and I do not see any reason to consider a company that leaves me wondering if the grade is high enough to even break even, especially if say the price of commodities decline by say 1/3rd. A decline by 1/3rd would still be double the historical average. It looks like it will be a very high cost producer highly dependent on strong prices for the long term.

Screening Conclusions from Nord

So, what steered me away from this one

  1. Grade.

  2. Lack of direct links to feasibility study on the web site.

  3. Lack of information on fully diluted share count on the web site.

  4. Highly dependent on strong prices for success.

Read Sprott’s analysis of the markets, especially on China, They present a case that very strong prices are here to stay. I believe the overall average prices are increasing and over the long-term will out strip inflation because of how the mining business is changing, but I would never invest in a commodity stock dependent on high prices, or at least as high as they are today. There are simply too many other choices. Sprott may like this one, but I did not see anything compelling with how I look at properties.

Screening Rule #1:

  • Ore grade should be $60/ton or more at today’s strong metal prices for open pit mining, about 0.75% copper equivalent for a copper property.

This gives some protection from downward prices and from optimistic reports on websites. Personally, I like to see more in the range of $80/ton in metal values, but other reasons would compel me to consider a property with less that $80/ton.

For this one I spent way too much time looking for information that I never found and grade is probably the most important rule for me, simply because it gives the most leeway for problems, price corrections and the most profitability.

Screening Rule #2:

  • Basic information such as share structure, reserves/resources, feasibility plan and their goals should be apparent within 10-15 minutes.

I hardly stopped to consider their development properties. The 0.5-1% copper drill result barely meets the grade rule and it will be years before this property can do much, and the other had little information. There are simply too many other choices where companies that have existing earnings that can be used to explore development properties and the development properties are stronger in that they have more historical work that supports they have value.

Screening Rule #3

  • Development properties are a low priority if there is no cash flow and no development on them.

Crowflight Minerals CML

This one passed rule 2 very quickly. Fully diluted they have 275.5 million shares and that information was updated in June 07. It is trading at 94c as of Monday, which gives it a fully diluted market cap of $260 million. Looking at the chart, it peaked in May and has pulled back from $1.35.

They have their Bucko Lake project with a complete feasibility study showing 2.5 million tons of nickel at 2.01% and an additional 1.2 million tons with 2.23% nickel. Nickel prices have corrected to more reasonable levels, but they are still strong prices and still have some down risk. But the metal values per ton at that 2% is over $650/ton at these values, something that makes me want to give this company a closer look. At $12/lb metal values are about $530/ton.

It looks like about a 7 year life of mine can be built with the resource and the inferred reserves could extend it an additional 3 years at a production rate of 12.5 million pounds of nickel per year. At the current prices the revenue generated would be about $180 million. It has a year before it would be built so it isn’t ready to cash in on the strong prices now. More recently it has looked at upgrading to produce 50% more which would increase cash flow but lower the life of the mine.

Funding and permitting for building the mine have not been secured. This is a negative as it can result in dilution and investors have no control over how much dilution.

They have some future development prospects, the Aer Kidd Project that has 10 million tonnes with 1.5% nickel, 2% copper and 4.8 grams/tonne PGMs, which is very nice. As a development property, they one has already had investment and gives you an idea of what is there and the grade suggests it will be good.

This one prompted me to look again at FNX, which was the subject of a prior post. The grade they have looks much better than FNX which means it could have the opportunity to have much more of the relative revenue going to earnings. FNX has a market cap of around $3 billion.

All this information was easy to find and there are enough good things about this company that it is worth checking out closer. A comparison of CML to FNX would be a worthwhile activity to get a sense of relative valuation.

They issued 8,450,000 stock options in the last quarter. That is large. This company will need to be watched for dilution.

CML is on my watch list for closer evaluation.

Screening Conclusions from Crowflight

CML pass the ease of finding information test. I spent 1/10th of the time and I certainly wasn’t left to guess work to come up ore grade.

In terms of screening, open pit versus underground mines have very different cost structures. I want to see about $300/ton or more in metal values for me to consider looking further. Production costs tend to be in the $100/ton range and then there are all of the other costs and it is easy to see around $200/ton going to costs.

Screening Rule #4

  • Ore grade should be about $300/ton or more for an underground mine. That’s about 1% nickel equivalent.


The screening rules are to give some basic guidelines for how to separate out what to spend further time checking out and what to pass, at least with the way I look at commodities. I would never then just buy a stock because it has a fantastic grade, good information and good cash flow.

The real work comes next, coming up with some kind of assessment of how realistic their information provided is, how it is valued in the market relative to peers and also assessment that the peers you are using are not valued to what could be considered bubbled levels. Finding a stock is valued at about 1/2 of the price of another does not mean it is a good deal if the peer stock is trading at 3x its worth.

My now written criteria is not necessarily going to be your criteria, but for me, it looks like ore grade and ease of finding information are the most important starting points.

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Saturday, July 14, 2007

IXYS - The beginning of an implosion?

An online acquaintance asked me to check this one out and there were things I found that I did not like.

First, from the Mar/07 financial information gross profit, or operating margin, declined from 31.6% the prior year to 24.1%. Consider that an implosion of sorts...

The next thing I didn't like was in the year prior the operating margin was $20.4 million yet they managed $30.3 million in earnings, or $0.85/share. That tells me something happened to grossly inflate the earnings with respect to the company's true earning potential. My limited experience tells me this kind of thing turns out very poorly for investors. All those investment tools investors use very wrong numbers compared to the reality of the company.

And yikes, out of the $17.9 million operating margin, only $755,000 made it to earnings, or 2c/share.

Next, there was a one time only $29.4 million gain in 2006. Without that the operating income would have been $20 million. Take off another $7.5 million for interest expense and adjusted taxes and you get $12.5 million of earnings. Just using ratios, without that extraordinary item eps would have been about 36c for the year, about 4% and a P/E of 25.

That latest 2c eps extrapolates forward to a shudder in your footsteps P/E of 113. Yuck.

Just to get a clearer picture of how this one is trending, the year before also had an extraordinary item which gave 42.8 million in extra expense or loss. So, before taxes without this item you'd have seen $25.8 million in operating income for the year before.

The year before there were no extraordinary items and the operating income was $25.6 million.

So, a three year picture, using my corrections for those extraordinary items would be the operating income for 2005 was 10.0% of the total revenue. For 2006 the $25.8 million operating income is 10.3%. For 2007 it is 7.0%, a huge decline, (10.3/7)-1 = 47%.

They have reported margins from 2003 that go 21.1%, 23.2%, 31.1%, 32.5% and this last year 29.5%.

The press release blames increase bad debt, which if you dig into the financial reports was $1.3 million. It also said they had more inventory write-offs, an additional $3 million.

Over the last five years the number of shares as increased by 13%. Not hugely excessive, but what did shareholders get for that dilution? If you read the press releases about share buy backs wouldn't you expect to see less shares? Actually, the share count in millions from 2003 went 30.9, 32.4, 35.1, 33.6, 34.8, so 3.4% increase in share count from 2006 to 2007 when they have a share buy back program happening?

Seriously, $18 million spent on a share buyback, that should be about 2 million shares less.

They add an extra 1 million shares per year to those available for options. That's in the range of 3%. Consider inflation to be 3%, that means earning need to increase by 3% per year to keep up with the time value of money. At 3% you essentially break even. Well, with 3% dilution per year you need to increase earnings by an additional 3% to break even, or essentially you need 6% earnings. Alternatively you could hope that they keep 1 million times the share price available for share buybacks every year to pay for the true cost of the options. At the current price that's 3.2% of last year's total sales, and 3.2/29.5= 11% of the operating margin or gross profit.

The financial reports show 35 million shares as of March 31, 2007 and 5 million available to grant for options and 4.5 million options granted outstanding. That's 32% of existing hidden dilution.

I'm looking back at some of their plans. They had a plan to offer $60 million of convertible senior notes and use part of the proceeds to buyback $20-30 million of its common stock. Help me to understand that this wasn't anything but a scam the retail investor plan to pump up the share price? I don't get how that adds value for investors in any way. You are buying shares on one hand and issuing them probably cheaper through convertible debt. Institutions usually want some kind of premium for their backing. It serves no purpose except to temporarily pump up the share price. I take that to mean someone is looking for a handsome, stick it to the retail investor, exit price.

And what else, oh yeah, the outlook is that sales should decline by 3-6%.

Guidance lowered

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Stealing our Children's Future

I live in BC. Our news papers this week boasted that tax cuts work because we had a record win fall in a revenue surplus this past year, and it was significant.

But, here's the truth as I see it. BC's economy was strong in the past because of our commodity based economy. It died a painful death as mines were closed due to poor commodity prices beginning in the 80s.

Commodity prices have been exceptionally strong and the commodity sector has been booming beyond people's wildest expectations. Check out the venture exchange commodity based businesses and read the line-up of Vancouver addresses.

Through this boom that is unmatched in our economic history our provincial debt has increased by $13 billion dollars, from $20 to $33 billion dollars. I am a teacher and I know our wage increases are far below inflation through these boom years. Relative funding for something as important as education has grossly declined through these boom years. Indeed, if you were to contrast our wages to Ontario you would find that BC teachers have a 17% higher workload and a %17 smaller wage, and we have the highest housing costs in Canada. It is enormously scary to see that massive increase in debt and to know we are have stressed important services pretty close to a breaking point, certainly beyond my breaking point as I work towards removing myself from the education sector. It makes me sick to think "what happens in a recession?"

They take credit for their policies for being responsible for our booming economy. $1 copper prices to $3.50 copper has nothing to do with it, it is about their tax cuts. We ought all shudder in our sleep at their inability to assess what has happened beyond their living in box the size of an atom with black hole walls that expand the universe.

So, this year we will see $1.3 billion paying down debt, debt that there was zero excuse to allow to increase in the first place, making us $12 billion further in debt in a booming world economy unprecedented in history.

Furthermore, people ought to know and check out Mr. Campbell's record on debt while mayor of the City of Vancouver.

Debt simply transfers this generations economic responsibility to the next generation and this government has stolen from children at unprecedented levels.

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Tuesday, July 10, 2007

"White Collar" crime in China

You know how they warn against taking or doing drugs of any kind in foreign countries because of harsh penalties...

Well, a story about the consequences of what we would call white collar crime, accepting bribes, really got my attention today.

End of post

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Thursday, July 05, 2007

Looking at Lead - ADA, BN, BWR, TAM, Zinifex

Lead has reached an all time high, about 6 times its low since the start of this bull run. It is a strong price, but it isn’t as strong as say molybdenum which peaked about 18 times its low, or nickel, which peaked at around 12 times its low, or uranium which is about 15 times its low. Strong lead prices will mean unexpected profits for lead producers.

The market is tight for lead Lead Rises to Record for Third Day in London.

[Most Recent Quotes from]

Lead deposits tend to exist with zinc deposits, this post looks at 5 companies that have some lead, Acadian Mining, Blue Note, Breakwater, Tamerlane and the Australian Zinifex. Metal prices are highly volatile and many calculations giving metal values are done here. They are intended to give a relative magnitude for comparison purposes--how good are grades relative to each other; how big are deposits relative to market cap; how much gross income can they bring in relative to each other. Higher grades and larger deposits tend to be more profitable. I have given valuations for metals in the ground at today's prices. In general, I believe that is a poor way to assess the value of a mining company and I look at it purely for a relative valuation. Prices used for metal values per ton calculated are $650/oz for gold, $12.40/oz for silver, $1.50/lb for zinc, $3.50/lb for copper and $1.20/lb for lead.


Zinifex is the largest of the companies and it produced about 5% of the world's 2006 zinc supply, 1.4 billion pounds of zinc, and about 230 million pounds of lead. As with the Australian mining practice, they maintain about a 6-year life-of-mine, and they have one mine has had a six-year LOF since 1893.

Few mines have a higher resource grade than their Rosebery mine, with an average resource of 15.3% zinc, 4.7% lead, 180 g/ton silver, 2.5 g/ton gold and 0.5% copper for an amazing $800/ton in metal values. They have 7.1 million tons of measured, indicated and inferred reserves for close to $5.6 billion in metal values at this grade. The reserves they are currently mining have about $610/ton in metal values.

Their other big property is their Century mine. The resources averages 12.7% zinc, 1.4% lead and 34 g/ton silver, for $470/ton metal values and with 60 million tonnes that’s $28 billion in metal values. Their reserves suggest metal value currently being mined are about $420/ton.

Zinifex’s properties are exceptional and they have further development prospects with their recently acquired Wolfden in Canada’s north, which has properties with metal values per ton of $250-700. They also have Dugald River and South Hercules for development.

In Australian dollars, last year the revenues were over $3 billion and of that $1.1 billion was profit, making $2.20 per share and shares are currently priced at about $19, for a P/E of about 8.6. Zinc prices peaked during this reporting period and have declined, but lead prices are up.

In the US, under the ticker ZFEXF.PK, it trades at $15.90/share and with 488 million shares, it has a US market cap of about $7.7 billion. At $1.50/lb zinc and $1.20/lb lead 1.4 billion pounds of zinc and 230 million pounds of lead would fetch $2.4 billion US gross revenue, or $2.9 billion Australian. Gross revenue potential is close to 1/3rd of market cap. Relatively speaking, with lead production potential of 230 million pounds their leverage to lead is not high; they are about six time more leveraged to zinc, but there is no question that lead’s ascent will be contributing nicely to their bottom line.


Tamerlane is a junior explorer with a fully diluted market cap of about $67 million. Their prize property is the old northern Pine Point Mine, which historical records show they mined 64 million tonnes from 52 deposits with an average grade of 3.1% lead and 7% zinc, or about $310/ton metal values at today’s prices. Currently they have 34 known deposits from non-compliant historical data indicating 70 million tonnes of ore with 4.19% zinc and 1.59% lead, or about $180/ton of metal values at today’s prices. The grades and sizes of the deposits vary greatly.

Their flagship deposit, R190, has grades of 6.3% lead and 12.1% zinc for about $570/ton metal values and there are about 1 million tonnes of ore in this deposit, or about $570 million in metal values.

Tamerlane has plans to start building the mine in Q4/07 and to be in full operation for Q1 2009 and to mine the 240 million pounds of zinc and 120 million pounds of lead from R190 in 12-15 months, or half a billion at today's prices. Six of the 34 deposits are close by and have metal values/ton about $290/ton, so without milling upgrades their second year of production rates would be about half what they get with the R190 deposit.

Financing the mill construction has not been arranged. They are looking to forward sell some of their production to prevent further dilution, and appear to be looking at issuing 30 million in equity and 100 million in financing to move the project forward. They have already run into obstacle in terms of implementing their plan as in April 2006 the plan was to start building in January 07 and be producing in December 07 of this year.

Tamerlane was closed down due to declining metal prices and increased costs due to flooding, and the high cost of maintaining a town for workers in the north. They plan to deal with the flooding by implementing freezing technology around the deposits. As the size of a deposit decreases the relative cost of the freezing technology increases exponentially, just as a ratio of surface area to volume increases as the volume decreases. The economics of each deposit will be highly variable.

Breakwater Resources

Breakwater Resources has a fully diluted share capitalization of 460 million shares for a market cap of $1.5 billion. Their 2007 production forecast is 268 million pounds zinc, 18 million pounds copper, 28 million pounds lead, 2 million ounces silver and 43,000 oz gold or total metal values of $550 million. They also have an interest in Blue Note, which can be taken as shares or as 20% interest of their Caribou mine. At current metal prices that interest could bring an additional $30 million in gross revenue for 2007. Gross revenue has the potential to be around 40% of market cap.

Their Langlois property starting production this year and has a reserve with 10.1% zinc, 0.8% copper and 49g/ton silver, for metal values of $410/ton, for about $1.5 billion in metal values. The resource has comparable metal values/ton and is about twice as big as the reserve for a combined total of about $4.5 billion. The goal for this property is 62 million pounds of zinc, 3 million pounds of copper and 12,000 oz of silver. Metal values per ton mined in Q1 were about $250/ton.

El Toqui has 8.9% zinc and 1.3g/ton of gold for $320/ton in metal values and is also projected to start production for 2007 with a goal of 61 million pounds of zinc, 6 million pounds of lead, 10,000 oz of silver and 2,600 oz of gold. Metal values per ton mined Q1 were about $300/ton. Total reserve/resources is about $4.5 billion.

El Mochito has 6.7% zinc, 2.8% lead, and 97 g/ton silver for $330/ton in metal values. It is projected to produce 60 million pounds of zinc, 20 million pounds of lead and 1.1 million ounces of silver. Actual grades mined in Q1 had metal values of $300/ton. This property holds about $3 billion in metal values.

Myra Falls has resource with 7.2% zinc, 1.2% copper, 55g/ton silver, 0.6% lead and 1.7g/ton gold for metal values of $400/ton and has about $7 billion in reserves/resource. It is projected to produce 84 million pounds of zinc, 15 million pounds of copper, 2 million pounds of lead, 660,000 oz of silver, and 17,000 oz of gold. Actual grades mined in Q1 had metal values of $220/ton.

For Q1 prices Breakwater obtained in $US were $1.56/lb for zinc, $2.70/lb for copper, $0.81/lb for lead, $647/oz for gold and $13.03/oz for silver. Earnings on $78 million of gross revenue were $15 million. They are about 9-10 times more leveraged to zinc than to lead.

Blue Note

Blue Note is an almost producer, currently in the start-up phase of their newly refurbished/built Caribou mine that Breakwater has an 20% interest in. Figuring out their “true” fully diluted market cap is more complicated than for other companies because of the Breakwater interest, which gives Breakwater choices about how they cash in on their interest, either 20% of Caribou or about 42 million shares, and there are hidden shares with debentures that are easily missed. Breakwater must make a decision within one year providing Blue Note does $1.5 million in further exploration on the Caribou property. Fully diluted excluding Breakwater’s interest Blue Note has a market cap of about $172 million. As shares Breakwater’s interest adds an addition $22 million to the market cap.

For 2007 projected production is 68 million pounds of zinc, 35 million pounds of lead, 0.8 million pounds of copper and 850,000 oz of silver, for total metal values of $157 million of which 80% is $126 million or about 3/4rds of the market cap excluding Breakwater. For 2008, with full production, the projection is 104 million pounds of zinc, 57 million pounds of lead, 1.3 million pounds of copper and 1.3 million ounces of silver for $245 million, of which 80% is $196 million and exceeds the market cap.

Metal values per ton in the Caribou/Restigouche reserves are about $370/ton with a total reserve value of about $1.8 billion at today’s prices and the resource, where the life-of-the mine is extended beyond 5 years from, has about $380/ton in resource metal values and about $1.4 billion at today's prices. There is no measure for copper values in the resource, which is 0.34% in the reserves. The cut-off grade used was a profitable 9% combined lead and zinc.

Breakwater previously had problems with poor recovery rates and poor metal prices. Metal prices were low when they decided to sell. Blue Note has installed a milling process shown to dramatically improve recovery rates developed in the last 15 years by Xstrata. Xstrata has used the technology long enough to prove it works and Blue Note has a contract with Xstrata to buy half its zinc concentrate and all of its lead concentrate. Blue Note is still very much priced as a junior explorer. It is in start-up operations currently testing their milling process and will soon be a producer eligible to move to the Toronto exchange. As a new start-up it runs the risks that things will not go as management plans and there are no operational financial reports to review and evaluate.

Blue Note has several exploration properties in the vicinity of the Caribou mine including Armstrong, California Lake, McMaster, Orvan Brook, Rio Road and Woodside Brook.

Blue Note’s relative leverage to metal prices means that every 2c change in lead price has about the same effect as 1c change in zinc price.

Acadian Mining

Acadian Mining is a small new producer with 159 million shares fully diluted as of May 31, 2007, giving it a fully diluted market cap of $191 million. They have two main projects of interest, Scotia Zinc and Scotia Goldfields, and they own about half of Royal Roads, which owns about half of Buchans River.

Scotia Zinc has a 2007 production target of 23 million pounds of zinc and 8 million pounds of lead and a 2008 production target of 45 million pounds of zinc and 19 million pounds of lead, for $44 million of gross revenue in 2007, 1/4 of market cap and $90 million for 2008, almost half of market. The reserves have a zinc grade 3.6% zinc and 1.7% lead, for $160/ton metal values. Total reserves are about $750 million to be mined over 7.5 years. As a new start-up it runs the risks that things will not go as management plans and there are no operational financial reports to review and evaluate.

Goldfields has several properties with about 1.35 million ounces of gold contained in resources that have metal values ranging from about $60/ton with the Beaver Dam property which has about 600,000 oz of gold, to about $350/ton with Goldenville with about 265,000 oz. The metal values may be worth about $900 million, but low grades spread out in several deposits means high extraction costs.

The Royal Roads holding has given them an interest in the Tulks North property. It currently has inferred resources with metal values of about $530/ton, or about $900 million in metal values. With the 1% zinc cut off instead of a 2% zinc there is 2.5 times as many tons of ore, but metal values per ton of ore decline to about $250/ton. This only adds $100 million in metal values to the deposit for an extra 2.5 million tonnes of ore that would need to be processed. This extra could quite possibly cost more to mine and process than the value of the recoverable metals. Acadian's interest is about half of this deposit.

How do they compare?

Zinifex by far has the best grades and looking at their financial data, you can see that about 1/3 of the gross sales ended up as earnings. Contrast that to Breakwater's lower grades and about 20% of their sales ended up as earnings, although Breakwater's earnings were pulled down by Myra Falls' lower grade during the quarter and will likely increase to more like 25% of gross revenue. Zinifex's higher grades and endless deposits justify a higher P/E than Breakwater, but both are nice looking companies. With strong prices there is always more downside risk that prices will decline, so commodity companies in this market commodity companies should never be priced the way a company like Pepsi might be priced, with an expectation the prices will generally always increase. So, 5% earnings might be great for Pepsi, but is a good way to potentially lose your capital with commodity companies. Zinifex currently has earnings of about 11%, which has a safety margin built in and gives them cash flow to fund future growth and exploration.

Breakwater has lower grade and is priced lower relative to market cap. Earnings for Q1 were low, about 5%, but should improve, most likely doubling when their new production that has started shows up in the financial reports. Also, Myra Falls contribution to operational earnings was relatively small as the grade they actually mined for the quarter was much lower than the overall grade their reserves/resources indicate they hold. Breakwater has a safety margin built in and they have good cash flow to fund future growth and exploration.

Tamerlane has a beauty deposit with that R190 deposit but they have a lot of steps to go through to actually get that deposit producing and any revenue possibility is about two years out. The economics of the R190 deposit at today's prices are nice, but it is a minimum of two year out and the further out you go, the more likely projections on everything are going to be wrong.

Blue Note has high grade to mine, an exceptionally high gross revenue potential relative to market cap and good reserves/resources relative to market cap. On this basis it is currently priced at about 1/3rd to 1/2 of the valuation given to Zinifex or Breakwater. The metal values per ton are very comparable to Breakwater's grade, so the simplest projection on earnings by contrasting is that they will be about 20-25% of gross revenue. Octagon has an estimate of 15c/share, or about 30% for this year, and 25c next year, for about 50%, or a P/E of about 2.

Acadian Mining has the lowest start-up production relative to market cap and the lowest grades, less than half that of the other companies profiled. Blue Note has combined open pit and underground mining operation, as does Acadian. In general high grade is what makes a company profitable and low grade is what limits profitability. For Acadian the gold deposits also tend to be low grade and/or small deposits, both of which rarely make money. It has a grade that with a large operation and economies of scale can make money but from reviewing many financial reports of other operations my conclusions are that its small size makes it questionable as to whether it can make money. This one I'd definitely want to see proof of earnings because of the lower grades.

Other details I picked up from looking at the relative deposit size is that Acadian's information indicates that they expect to recover about 90% of their deposit in 7.5 years. Blue Note's numbers indicated about 60% of their deposit will be recovered in 5 years. It is strictly a perception it gives me that there is not much room for error built into Acadian's numbers. Blue Note uses a 9% zinc-lead equivalent cut off which builds in a safety margin for investors in their evaluation. The 1% zinc cut off used for Royal Roads does not.

Note: I am not an investment adviser and I write about investments to help me to evaluate my own investments or potential investments or to better understand investments as a whole. For this post, because I own Blue Note, it was time for me to re-assess it's valuation relative to other companies in the sector. If you've seen something of interest you need to do your own due diligence. Current prices, Blue Note 53c, Acadian $1.20, Breakwater $3.19, Tamerlane $1.62.

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