Investors wishing to directly invest in a gold mine operation instead through the stock market, are required to undertake quite some extensive financial analysis to become comfortable with the financial feasibility of such investment. Gold Mining is a risky activity by definition as either the metal is there or not. Especially new mines bear a high risk of failure as the history of the mine is less understood. Furthermore many gold mine sites are located in developing countries impacted by political turbulences, posing ongoing security issues and many logistical challenges.
From a financial point of view a solid valuation framework will be needed, which today mostly is the analysis of the Internal Rate of Return (IRR) or Net Present Value via a Discounted Cash Flow (DCF) consideration. Therefore a financial model is needed (e.g. Gold Mine Investment Model Template) to calculate the Project IRR (based on Free Cash Flows to Firm) and Equity IRR (by using bank financing) which normally is higher due to the effect of financial leverage.
In order to evaluate a gold mine investment, an easy to use financial model which focuses on the essential key value drivers for investor returns can be very helpful. Such a model provides the basis for a meaningful discussion about the risks and returns of such project. From a financial modeling point of view, important is to design the model in a way that a sensitivity analysis can be performed to see how a change of the main assumptions affect the valuation / IRR and what are the risks.
- Gold price – This is the most important variable, as any change in the gold price will impact the profit margin. Therefore the investor will need to take a view on the future gold price development.
- Gold content of the ore – the more gold can be extracted per ton, the more profitable the mining operation will become. Thus an investor will want an experienced geologist take samples of the material to have a solid assumption about the gold content of the ore. The higher the gold content, the better the profitability and the better the risk protection against an eventual fall of the gold price or rising mining costs.
- Waste to ore ratio – The more waste materials need to be moved around in relation to the ore, the higher the costs are.
- Mining Costs – measured in USD / ton, are the costs to extract the material from the mine. If the costs are low, it offers a buffer to profit in case the economy negatively affects the gold price. Mines with high mining costs per ton are first to close down in case the economy turns bad.
- Milling Costs – same as mining costs, the lower the better and less risky,
- CAPEX – The size of the required capital expenditures (CAPEX) to build the mine and mill also significantly impacts the IRR, especially as the costs are at the beginning.
- Debt financing – While the use of debt financing will not impact Project IRR; debt financing can significantly increase the Equity IRR as the size of the Equity Tickets gets smaller and the shareholders can benefit from lower cost of debt than what they would have to pay to use Equity Financing.
Another factor impacting the financial returns is the foreseeable Mine Life. Mine life can be extended when undertaking additional exploration activities. A mine with a large deposit of proven reserves will offer a better chance of success than when the resource deposit are only probable or still needs to be discovered.
For a more detailed understanding of the impact of key value drivers towards a gold mine investment we refer to the Excel financial model template.