CHAPTER 2.
Market Capitalization
Fiona Perrott-Humphrey
Market capitalization is the value that the equity market places
on a company or a group of companies. Over the bulk of 2003
to 2008, the FTSE 350 Mining Index (the market capitaliza-
tion of the world’s most important mining equity market) rose
strongly in relative terms against that of the FTSE Med 100
(the top 100 companies listed in London) (see Figure 2.3-1).
This relative rise reflected a belief that the structural growth of
industrial giant China had created a supercycle of demand for
commodities to fuel its development that would last decades.
This investment thesis saw the risk premium of historically
cyclical mining companies reduced as they were treated more
like growth stocks with strong underlying cash flows.
Figure 2.3-1 also shows, however, that since mid-2008,
these same shares have seen a pullback of more than 50%
from their high point, based on fears that the turmoil in finan-
cial markets is feeding into the real economy and that even the
powerful growth engine of China would not offset demand
falls for commodities elsewhere.
These dramatic moves in market capitalization are no
mere lottery. The fundamental driver of valuation is the mul-
tiple the equity market places on the net present value (NPV)
of future cash flows coming from mining projects. To arrive at
the NPV, we need to understand factors affecting both
• Projected cash flows and the discount rate applied to
them, and
• The multiple that the equity market places on that NPV.
By their very nature, mining companies cannot easily be
valued on measures used in industrial and financial sectors—
that is, a straightforward price/earning ratio; EV/EBITDA
multiples (equity plus debt divided by earnings before inter-
est, tax, depreciation, and amortization); and cash flow mul-
tiple or dividend yield of current year’s results, because
• In the early stages of development of a mining resource,
all potential earnings are in future years;
• Each single resource within a mining group’s portfolio
has a finite life and is a wasting asset; and
• Variations of grade within each mineral deposit lead to a
volatile production profile over the life of the mine and
associated differing unit costs.
Fiona Perrott-Humphrey, Consultant to NM Rothschild (mining team), Director of AIM Mining Research & PURE P-H Strategic Consulting, London, UK
65
In addition to these factors, the prices of the commodities
produced by mining companies can vary dramatically over an
economic cycle, affected as they are by movements in demand,
supply, and inventories. At differing points in the economic
cycle, therefore, the multiple that the equity market places on
future projected earnings also varies. Figure 2.3-2 attempts to
encapsulate the influences on the market capitalization of the
miners through an economic cycle.
The bulk of this chapter will expand on the factors that
affect projected cash flows and the discount rate for mining
groups. However, it is worth noting at this point that stock
markets contain a wide range of mining companies. The spec-
trum includes
• Junior exploration companies (ranging from owners of a
resource that shows potential, but is still being proven by
drilling, to companies where a project is under construc-
tion and metal production proposed within a relatively
short-term time period);
• Single commodity companies that nevertheless have a
range of both producing, developing, and exploration
projects, and can spread across more than one geographic
region (e.g., Antofagasta plc; Impala Platinum Ltd.); and
• Large multinational diversified mining groups, spread
across the whole spectrum of project life cycles, but which
also produce a wide range of different commodities and
operate around the globe (e.g., Rio Tinto and BHP Billiton).
Figure 2.3-3 shows a graphic representation of theoreti-
cal valuation of a single mining project. For the investor, his
investment risk (the y-axis) reduces as the knowledge of the
mineral asset is expanded and as better data on the “modifying
factors” that will affect the economic mining of the mineral
asset become more reliable (the x-axis).
vAluATion of junioR MineRS
Figure 2.3-3 certainly applies to the valuation of junior min-
ing groups, which are frequently listed on separate stock
exchanges (e.g., the Toronto Stock Exchange in Canada and
the Alternative Investment Market [AIM] in London). The
regulatory requirements of these exchanges reflect the real-
ity that such start-up companies have no history of profit
66 SMe Mining engineering handbook

1,100
1,000 FTSE Med 100 Index
FTSE 350 Mining Index
900 HSBC Global Mining Index (Diversified)
800
700
600
500
400
300
200
100
0
January October July April January October July April January October July
2001 2001 2002 2003 2004 2004 2005 2006 2007 2007 2008

Source: Bloomberg 2008.

figure 2.3-1 Performance of mining indices versus fTSe Med 100, 2001–2008

or cash flows such as those required by the main board

exchanges. Because some are not yet producing cash flows
Cyclical
or earnings, valuation methods applied to their theoretical Peak
future earnings potential are different from those applied to Corporate Activity
producing miners. Capacity New Project
Valuing exploration and development companies in the Restarts Announcement
Multiples
resource sector is fraught with challenges because of the vari- Compress
ability of the information that becomes available through the
exploration and development phases, and the fact that each
mineral deposit is in some ways unique in its characteristics. Rising Falling
Metal Metal
For investors with relatively limited access to internal com- Demand Gross Gross Inventories
pany information and usually no opportunity for a site visit, Domestic Domestic
Accelerates Spike
Product Product
the process is made even more challenging.
There is an oft quoted, slightly tongue-in-cheek maxim
from the mining world that says: “Why spoil a good deposit by Multiples
mining it?” The implication is that in many ways an explora- Expand
Speculative Capacity
tion junior is like a journey and the stock market believes it is Metal Rally Cuts
better to travel hopefully than to arrive. When you arrive, after
all, and start producing an output that is sold at a fixed price, Cyclical
your company can eventually be valued on the metrics applied Trough
across most other sectors of the stock market—that is, price/
earning ratio; cash flow multiple, and dividend yield. And the
Source: N M Rothschild 2008.
eventual outcome may well be less exciting than the projections
built off limited data through the exploration and development figure 2.3-2 valuation drivers through the economic cycle
phases (e.g., Figure 2.3-3 shows that the theoretical market cap-
italization of a project is likely to take a dip when the project companies in particular, this can be a meaningless figure, for
is commissioned), and probable disappointments occur in the in the early stages of exploration, it reflects no more than the
timing/scale of execution of the project versus targets in the fea- money already spent on the project. This could be overstating
sibility study (termed preproduction gap). This fall can then be its worth (if eventually no economically viable mineralization
reversed once revised production targets start to be met. is found) or severely understating it (if the deposit is proved
In that sense, some commentators have compared anal- up according to early projections or even contains further
ysis of early-stage mining juniors to that of biotech compa- unexpected blue sky potential).
nies—that is, not only are the data patchy in the early days of
the companies’ undertakings, but there also exists a risk that ore in the ground
the final outcome could be a complete failure—either no eco- In the gold industry, a very basic guideline that is used for valu-
nomic mineral body to exploit or no successful biotech prod- ations when little real data are available from the property is:
uct. This is clearly a very different framework from valuation “gold in the ground.” This valuation will obviously shift along
of most other small companies, and the common methods with the ruling commodity price and average industry costs
used to value juniors are listed next. (e.g., in 2007, analysts typically used US$30/oz of reserves for
an exploration property but moved up to US$90–US$120 when
net Asset value the company proved that it could actually produce metal).
In theory, the value of a company equates to the net asset value Companies can frequently trade at premia to the underlying
stated in its report and account. In practice, for junior mining value as calculated on this basis, if investors perceive upside in
 Market Capitalization 67

Increasing Project Value

Investment Risk

Declining Production Potential

Steady-State Production
Project Construction
Reserve Definition

Preproduction Gap

Production Gap
Corporate Vision/Management Selection

Commissioning
Resource Definition

Feasibility
Prefeasibility

Environmental Rehabilitation
Target Definition
Exploration

Discovery

Closure
Stages of Project Development and Mining

Source: Diamond Core Resources 2004.

figure 2.3-3 value of mining project versus investment risk

the probability of resources being converted into reserves in the Probability-Weighted nPv
future. There is thus a case for including some kind of weighted NPV is the most widespread valuation method for resource
value of measured resources as well as reserves, guided by the stocks and in theory is best suited to nonproducing resource
conversion ratio that the company provides. companies, given the nature of the development timeline—
There are, of course, significant weaknesses with this that is, upfront exploration and development spending before
valuation tool, primarily the following: the medium- or long-term benefits flow from producing metal
from the mineral asset. The latest guidance note for mining,
• The wide variances in the actual cost of extracting the
oil, and gas companies listed on the AIM (London Stock
metal from the wide range of different types of deposit.
Exchange 2006), issued by the London Stock Exchange, states
In addition to the mining costs, there are the logistical and
that the Competent Persons Report should include (among
political risk costs associated with operating in a number
other things): “An estimate of net present value (post-tax) at a
of far-flung emerging market regions. Finally, process-
discount rate of 10% of reserves (or equivalent depending on
ing costs vary dramatically according to the metallurgy
Standard used) analysed separately and the principal assump-
required, particularly in the case of platinum group met-
tions (including costs assumptions, effective date, constant or
als, which occur in a combination of five or six elements
forecast prices, forex [foreign exchange] rates) on which valu-
in differing ratios.
ation is based together with a sensitivities analysis.”
• The currency-adjusted cost, which can move significantly
Because of the nature of commodity markets, the scope
as the U.S. dollar moves against the so-called resource
for variances around many of the items previously listed is
currencies, such as the Australian dollar and the South
significant even when the data available on the mineral asset
African rand, and possibly even the Chilean peso.
are becoming relatively well fleshed out. This is clearly so
• The variance in regional categorization of resources
much more the case in the early stages of development, when
and reserves. On AIM, for example, a range of stand-
the geological, and hence all the mining, parameters are prone
ards is used to classify reserves and resources, with the
to major revisions as more data become available.
Russian gold producers and a number of companies in
In the biotech industry, one of the analytical approaches
the former Soviet Union using the Russian categories of
is to develop a discounted cash flow based on the assumption
reserves and resources. No formal publication has been
that the products will be successfully developed and sold in
released to enable investors to translate the more com-
a way that is comparable to established industry peers, and
plex Russian categories into the equivalents provided by
then to weight that outcome based on the probabilities of dif-
the Joint Ore Reserves Committee (Australia), the 43-101
ferent levels of success in order to come to a final valuation.
system (Canada), or the South African Mineral Resource
This approach is also being adopted in different formats in the
Committee.
junior mining sector. The argument for assigning weightings
• The assumed operating margin obviously moves with sig-
to the four key risk factors in the sector’s life cycle based on
nificant shifts in the commodity prices.
68 SMe Mining engineering handbook
probabilities is a compelling one. The risk factors represent
four possible downsides:
1. Geological and exploration risk (versus early estimates of
the nature of the ore body)
2. Development risks
3. Operational risks (versus feasibility study projections)
4. Financial risks
Offset against these factors would be a weighting for a fifth
factor—possible blue sky potential not included in an NPV
based only on proven reserves.
vAluATion of PRoDuCing Mining CoMPAnieS:
exTeRnAl fACToRS AffeCTing CASh floWS
Typically, investors looking at industrial companies have only
one element to consider in interrogating management’s pro-
jected revenue figures: projected sales volumes at a fixed price.
Mining companies provide significantly more of a challenge
in this sphere in which, of the three key drivers of the revenue
line, two are completely outside of management’s control.
(Hedging does not allow one to control pricing, only to protect
against movements in them.) The three key drivers are
1. Commodity prices;
2. Currency trends, which will determine the actual revenue
received in local currency terms translated from U.S. dol-
lar prices; and
3. Production capacity (discussed in the “Valuation of
Producing Mining Companies: Internal Factors Affecting
Cash Flows” section).
Commodity Prices
Quoted in U.S. dollars, commodity prices are typically
determined on terminal markets, depending on cyclical sup-
ply and demand factors. The latter were historically driven
by industrial consumers of the metals, but since the 1990s,
financial investors’ influence at the margin has been grow-
ing. Table 2.3-1 shows the categories of metals and minerals
and how their prices are set. The terminal markets provide the
most visibility on future price trends, whereas those not traded
on terminal markets tend to be relatively opaque.
In order to assess how realistic the management assump-
tions are for future revenue streams, investors are unlikely to
become experts in all of the commodity and currency markets,
but there are numerous sources of external metal price and
currency forecasts, including (but not limited to) most stock-
broking research departments plus independent metal con-
sultancies such as CRU, Bloomsbury Minerals Economics,
and GFMS. The platinum group metals market is covered
by Johnson Matthey in a biannual publication, and diamond
prices for different ranges of gems are available from indus-
try sources, the most well known of which are Rapaport and
Lenco (www.roughdiamondprices.com).
These external sources are useful not only for the abso-
lute price forecasts that they may provide but also for their
information on key aspects of the structure of each spe-
cific commodity market. That is, prices on terminal mar-
kets are influenced not only by overall supply and demand
factors but by shorter-term levels of inventory metal held
either by end consumers or in market warehouses. In bulk
and industrial minerals markets, on the other hand, pricing
negotiations are influenced by the level of concentration of
Table 2.3-1 Price setting for metals and minerals
Category how Prices Are Set
Base metals (Cu, Ni, Al, Zn) Terminal markets such as the London Metal
Exchange (LME)
Precious metals (Au, Pt, Pd, Terminal and bullion markets
Rh, Ag)
Diamonds Influenced by the prices set by largest
distributor, De Beers’ Diamond Trading
Company
Bulk minerals (iron ore, coal, Contract prices set by negotiations with
bauxite, chrome, manganese, large consumers, either annually or more
cobalt, uranium) frequently, while spot prices reflect more
frequent fluctuations driven by short-term
demand and supply factors (and coal
markets starting to reflect some of the
features of terminal markets)
Industrial minerals (titanium Influenced by individual contracts with major
dioxide, borax) consumers
industry production (e.g., iron ore) or consumption among
that market’s players.
To assist with the projection of future mining revenues,
many of the major mining companies provide some kind of
earnings/NPV sensitivities with respect to possible moves in
either currencies or commodity prices. Rio Tinto, for exam-
ple, in its investor presentations will state that, all other things
being equal, a 10% move in the Cu price or in the Australian
dollar would have a consequent percentage impact on net earn-
ings. These are key in running what-if scenarios on future cash
flows at inflection points in the commodity cycles, in view of
the scale of the moves in some commodity prices from the
bottom of the cycle to the peak (see Figure 2.3-4).
Spot or Long-Term Prices
Given the extent to which commodity prices can move over a
cycle, revenue forecasts should be clear as to whether they are
based on spot or average long-term prices. At any juncture,
spot prices should be treated with some caution, as individual
mining companies may have off-take agreements that are tied
into contract prices (as well as volume parameters). This is
particularly true of smaller, more opaque markets such as ura-
nium, cobalt, and molybdenum, where spot prices can vary
significantly from long-term contract prices at some points in
the cycle. In most commodity markets, there is also a slid-
ing scale of prices where premia to quoted benchmark prices
may be available for better-quality or more highly benefici-
ated products.
Finally, it is worth checking whether the theoretical price
will always be available to a mining company operating in a
new frontier region. Three particular issues which need to be
clarified in this regard are
1. Whether there are restrictions on the potential buyers
of the end product, which could influence the price paid
(e.g., gold in Zimbabwe);
2. Whether revenue proceeds are able to be remitted freely out
of the country where the mining operation is located; and
3. Whether the company is being required by any of its
financiers to hedge (sell forward at a fixed price) any ele-
ment of its future production in order to mitigate political
risk considerations.
 Market Capitalization 69

600
London Metal Exchange Copper
London Bullion Market Silver
500 London Bullion Market Gold Bullion
London Metal Exchange Platinum
London Metal Exchange Nickel
400 Hamersley Iron Ore
London Metal Exchange Zinc
London Metal Exchange Aluminum
300

200

100

0
September September September September September September
2003 2004 2005 2006 2007 2008

Note: These are indexes, not prices.

Source: Bloomberg 2009.

figure 2.3-4 Rebased commodity prices, 5-year view

vAluATion of PRoDuCing Mining CoMPAnieS: Table 2.3-2 Production cost standard

inTeRnAl fACToRS AffeCTing CASh floWS
The graphic representation of the life cycle of a mining proj-
ect (Figure 2.3-3) points to the factors that affect cash flows
in a single-project company. Any larger mining group would
simply be a portfolio of such projects, often at very different
stages of development. Those mining groups typically rated
most highly by the equity investors have the right balance
of such projects to ensure that, as a major producing asset
starts to tail off in terms of grade and production life, oth-
ers are waiting to replace it, thus achieving a relatively stable
or growing production profile. This is the part of the revenue
line that management teams are expected to influence, even
as sales and earnings remain vulnerable at another level to the
vagaries of the commodity price cycle.
Two key internal components will affect cash flows from
any mining project:
1. The size and quality of the mineral deposit, which will deter-
mine the production potential. In the early stages of explora-
tion, when confidence is low for geological information, the
potential is expressed as resources. At later stages, when drill-
ing and geological modeling increases levels of confidence,
the potential is expressed as reserves. The size of the eco-
nomic deposit will determine the life of the mine and the
economies of scale to be achieved in mining it, whereas the
quality refers to the grade of metal found in the surrounding
“waste” material (i.e., the higher the ratio of metal to waste in
the deposit, the more economic the project).
2. The cost of extracting and treating the ore to turn it into
a salable product (either an intermediate concentrate that
requires refining by an independent refiner or as a fully
refined end product—for example, a gold bullion bar).
For a given commodity price, the cost of production can
differ substantially between projects (and sometimes
countries), thus affecting the profit margin earned.
guideline features
Cash operating costs All direct and indirect operating cash costs related
directly to the physical activities of producing metals,
including mining, processing, and other plant costs;
third-party refining and marketing expense; on-site
general and administrative costs; and net of by-product
revenues earned from all metals other than the primary
metal produced at each unit
Total cash costs Same as cash operating costs plus royalties and mine
production taxes
Total production costs Same as total cash costs plus depreciation, depletion,
amortization, and accretion of asset retirement
Equity investors thus rate mining companies according
to their relative position on the industry cost curve. Due to
the lack of consistency across the industry in reporting cash
costs of current production, it is worth clarifying what items
are included in various levels of cost categories. Table 2.3-2
contains broad guidelines that are followed by conservative
investment analysts.
In addition to the cost items listed in Table 2.3-2, a num-
ber of other (sometimes indirect) expenses should be built into
any projections that cover the life of the mine:
• Exploration and mine development expenses, which
are typically capitalized. While not related to the cur-
rent production, hence the exclusion from the current cost
per ounce, this expenditure needs to be incurred to ensure
that there are ounces to mine in the future. A key element
of this is stripping. The correct measure of the minimum
cash expenditure required should thus be “total cash costs
plus the essential capital expenditure required for ongo-
ing mining.”
70 SMe Mining engineering handbook
• Financing costs. Although not included in Table 2.3-2,
these costs are a crucial element for junior miners in
particular (because they lack cash flow from produc-
ing assets), both in ongoing total cash costs and in NPV
terms. During the mining boom of 2003–2008, junior
miners had relatively easy access to equity financing,
usually at rising share prices each time, and this element
of costs could thus have been glossed over. Because of
the cyclical nature of the industry, however, all aspects of
the company’s financing issues are also cyclical—access
to debt financing alternatives; current cost of debt alter-
natives and whether this is a fixed or variable element
of costs; nature of debt covenants; whether the lend-
ers demand an element of price hedging, which would
cap the upside of the project in markets of rising prices;
whether the presence of quasi-government lenders on the
book imposes any related constraints on the company
(e.g., International Finance Corporation); whether the
company has fully covered the risks of borrowing heavily
from local banks in some of the emerging markets areas;
and whether companies have raised sufficient capital to
fund their projects to completion.
• Cost escalation over life of mine. Because of the vari-
able nature of each geological deposit, today’s snapshot
of a cost profile day is likely to be subject to significant
change over the life of mine. Factors that can cause quan-
tum moves to the cost profile include shifts in grade or
stripping ratios, or the need to move from open-pit to
underground operations. In addition, the global mining
industry is currently experiencing cyclical cost escalation
on the back of what has been (up to early 2008) the lon-
gest commodity price boom since World War II. It has
driven up both the cost and availability of energy, skills,
contractors, spares (e.g., tires), and materials. Longer
lead times combining with cost escalation in new projects
has seen capital expenditure estimates revised upward
at almost every mining company reporting period, with
implications for both NPV values and financing costs.
• Smelting and refining costs. These can also vary signifi-
cantly over the cycle for a miner that does not have a fully
integrated operation (toll smelting agreements are fixed
or variable). The efficiency of the metallurgical process
in treating more complex metals such as platinum group
metals is a key competitive element among producers, as
is the cost of energy in highly energy-intensive treatment
processes such as aluminum smelting.
• Royalties and taxes. Although in theory these should be
steady factors over the life of mine, in practice, commodity-
related charges tend to be increased by governments as they
watch the products’ prices rise through the cycle or as new
regimes take control in resource-rich nations. This trend of
so-called economic nationalism has been evident on almost
every continent and resulted in a rise in the risk premium
assigned to many companies operating in emerging markets
some 6 months before concerns about a global economic
downturn emerged.
DiSCounT RATeS APPlieD To PRojeCTeD
CASh floWS
Even though this is a key factor in driving the end result of
the NPV, there are no guidelines that hold across the board.
The major areas of difference rest on assessments of cost of
capital, political risk, and project development risk.
Cost of Capital
Although this should reflect a company’s weighted aver-
age cost of capital (equity and debt), estimates have histori-
cally varied between key resources markets, with the North
American analysts tending to use lower figures, ranging from
0% to 5%, in contrast to their counterparts elsewhere who use
numbers ranging from 5% to 10% (and interestingly AIM’s
guideline number of 10% after tax). This whole spectrum of
cost of capital is likely to shift as the long period of easy and
generally low-cost finance of 2003–2008 ends in a cyclical
economic downturn. Within these average statistics, however,
the capital structure of individual companies and the cost of
the financing available will also vary widely.
Political Risk
These discount factors are even more subjective (usually
biased by proximity), primarily because each company is
unique in its aggregate exposure to generic (or sovereign)
country risk (depending on where its many projects are and to
what extent it can benefit from the portfolio effect of one type
of risk offsetting another) and to more specific project-related
risk (still within the context of political risk assessment). In
addition, most investors will be pricing political risk in differ-
ent contexts, depending on their own portfolio spreads, ability
to hedge, and even the requirement for a particular country
exposure (where a mining company’s discount rate is then
priced relative to other sectors in that country, rather than
against other geographic regions).
Project Development Risk
The key elements that equity markets consider most important
in determining the success or failure of the vital development
phase—turning a geological resource into ounces of metal
sold—are the following:
• Security of tenure, given the need for most natural
resource companies to operate in emerging market regions
• Key characteristics of the ore body, particularly grade
• Operating parameters of open-pit versus underground
mine development
• Plant and metallurgical efficiencies
• Logistics, particularly when a mine is located in a remote
region
• Management record in developing projects to production
stage
• Environmental issues that demand increasing amounts
of company time and resources, covering not only the
physical environment (where actual legislation will gov-
ern company requirements) but also the socio-cultural
component (where local communities are capable of
stalling potentially viable ventures if their concerns are
not addressed)
MARkeT CAPiTAlizATion: The finAl eleMenT
Much of this chapter has covered the issues surrounding pro-
jected cash flows for mining companies and determination of
the discount rate used to convert them into an NPV. The final
element of a mining company’s market capitalization is the
multiple which the equity market places on this theoretical
NPV. A number of factors affect it:
• Company profile in terms of the diversity of the asset
portfolio by geography and by product. Typically,
 Market Capitalization
the large diversified groups such as Rio Tinto and BHP
Billiton trade at a premium to their peers because of the
lower risk to cash flows if one commodity or region is
adversely affected. However, it is also true that at certain
points in a rising commodity cycle, investors seek to play
more highly geared or single-commodity companies that
could see higher earnings growth from a lower base. At
these junctures, the diversifieds can be de-rated as “dull.”
• Growth potential. Although large producers may be less
risky, investors also worry that it becomes increasingly
harder for them to achieve earnings growth from a high
base. In a world in which it is a challenge to find new,
large, low-cost resources to replace wasting assets, the
market will frequently rate small or mid-cap producers
more highly than their major peers. This can be particu-
larly true in the gold sector, where the shorter average life
of mine means that wasting reserves need to be replaced
more frequently than in other sectors.
• Point in the economic-and-commodity cycle. Equity
markets discount future earnings as far ahead as
18 months to 2 years. Figure 2.3-2 illustrates that (counter-
intuitively) multiples compress as the economy heats up,
and commodity prices/earnings top out and expand in the
depth of a recession as profitability declines.
• Merger and acquisition activity. Historically, major
upsurges in merger and acquisition activity have
occurred at low points in the economic/commodity cycle.
Companies with stronger balance sheets have sought to
pick up assets at low prices from distressed sellers in
order to cut costs and undertake consolidation/capacity
closures. In the recent upturn, however, mining compa-
nies who believed in the supercycle were worried about
a shortage of new high-quality assets to fuel their future
growth in supply. A rash of activity thus occurred at a
time of historically high metal prices. Either way, a
belief that corporate buyers are seeking to add to their
asset portfolios can distort valuation multiples away from
those based on fundamental analysis.
MARkeT CAPiTAlizATion: DiffeRenCeS
WiTh junioRS
As indicated earlier in this chapter, there can be key differ-
ences in valuing early-stage mining companies and major
producers. Equally, it is the case that at times during the com-
modity cycle, indices of junior shares (such as those listed
on AIM in London) can tend to show relatively high levels
of volatility, not necessarily correlated to the performance
of the FTSE Mining Sector Index. Reasons can include the
following:
• Internal flow of information is the primary share price
driver for early-stage miners, as mispricing frequently
occurs on extrapolation of the earliest data. This is either
followed by disappointments (e.g., Tran-Siberian Gold,
which in 2006 announced that one of its three key depos-
its would not be economically viable on the technology
originally assumed) or upgrades of blue sky potential
(e.g., Peter Hambro Mining, which acquired new licenses
in auctions during 2006, and, as it met development and
production targets on current assets, the market priced in
the upside on a similar basis for newly acquired develop-
ment assets over the following year).
71
• Liquidity is lower than on the main stock exchange
boards, so when new information emerges or when a
small circle of original backers looks to take profits, the
moves either way can be exacerbated.
• Funds flowing into the sector in an up-cycle can exac-
erbate price moves, due to the previous point, but when
the cycle turns decisively or even has a short-term cor-
rection, lack of liquidity can also exacerbate downward
price adjustments.
• Political risk shocks have a much more powerful impact,
given the exposure of many AIM mining companies to no
more than two or three major projects and their current
propensity to explore in the new frontier regions without
the portfolio insurance effect of the majors.
• Investment by a major in a junior can underpin the share
price, but that is not a guarantee that the share price will
be immune to either internal news flows or political risk
shocks.
• Interest rate moves tend to affect those shares and sec-
tors most reliant on future discounted cash flows for their
valuations (rather than more defensive sectors valued on
near-term cash multiples). Exploration and development
mining companies fall into that category.
• Scarcity value can sustain juniors at what seem to be very
high underlying valuations, when there is a perceived
shortage of large new discoveries of a particular com-
modity. This was the case with most diamond juniors dur-
ing 2006–2007, given the dearth of new supply sources
announced in this sector for some years now.
• Primary commodity exposure will also be key over time,
as price rises across the spectrum have not been of the
same scale. In 2005, for example, iron ore price increases
dwarfed those in any other commodities, seeing majors
Rio Tinto and BHP Billiton outperform peers for some
months. This was clearly a commodity in short supply
among the juniors at that time.
• Dividend distribution potential is in most cases a distant
prospect for most early-stage juniors, whereas substantial
capital returns/special dividends have been a major driver
of the main board mining sector during 2006–2008. When
the market is focusing on dividends and immediate cash
returns (usually in bear market phases), this becomes
another potential reason for the two markets to diverge in
their performance trends.
RefeRenCeS
Bloomberg. 2008. www.bloomberg.com. Accessed June 2008.
Bloomberg. 2009. www.bloomberg.com. Accessed January
2009.
Diamond Core Resources. 2004. www.mbendi.com/orgs/cjk7
.htm. Accessed 2004.
London Stock Exchange. 2006. Guidance Note for Mining, Oil
and Gas Companies. AIM 16. www.londonstockexchange
.com/companies-and-advisors/aim/advisers/aim-notices/
aim-notice-16.pdf. Accessed December 2009.
N M Rothschild. 2008. www.rothschild.com. Accessed
September 2008.