A few years ago, I had the opportunity to visit the battle site of Waterloo, near Brussels. In June 1815, after conquering a large chunk of Western Europe, Napoleon Bonaparte’s 105,000 strong army squared off against a largely English force led by the Duke of Wellington (89,000 strong) and supported by a 68,000 Prussian force under Field Marshall Blucher. The fate of England’s financial markets lay in the balance.

The House of Rothschild, financiers of kings and governments, had a big stake in the result. Its courier arrived in London with news of the battle’s result 20 hours ahead of any other messenger. In reality, Napoleon had lost and this would have been very bullish for the debt market. Instead, the Rothschilds spread the rumour that Napoleon had won! The debt market in England fell sharply, the Rothschilds bought at bargain basement prices and when the real news arrived and buoyed the markets, they sold at handsome profits.

The Rothschilds began business in 1743 as German goldsmiths, putting a Roman eagle on a red shield over the door (Rothschild is ‘red shield’ in German). They grew to be so powerful that Mayer Amschel Rothschild (the founder of the dynasty) said: “Let me issue and control a nation's money and I care not who writes the laws.”

Why might this be relevant? Because the prestigious private bank, N.M. Rothschilds & Sons, announced in mid-April that they would no longer chair the twice-daily fixing of the London gold price. This is a ritual begun in 1919, whereby five men met in Rothschilds offices, talked on their cell phones for 10 minutes to assess market conditions, lowered tiny Union Jacks at the desk (?) and fixed the gold price at 10:30am and 3pm.

The reason given for this exit after 200 years in the business is that commodities trading constitutes a small part of Rothschilds revenues and were declining. Rothschilds specialised in hedging, which is the forwarding selling of gold (effectively betting that the price of gold will fall) and which critics say has helped suppress the price of gold over the last decade.

The official reason is noted above but, as with Waterloo, could there be more to it? Could it be that Rothchilds anticipates gold prices rising in the future and has it decided to go long?

Mining is a highly knowledge based and capital-intensive business. Exploring for, and mining, metals is a complex, arduous task in generally inhospitable conditions all around the world.

The nature of ore bodies containing minerals and the numerous prospecting tools that geologists use to try to identify the location and quantity of metals are complex (e.g. spontaneous polarization, telluric current methods, radiometric methods, etc.) and makes for wonderful bedtime reading if you want to fall asleep quickly. I will gradually introduce basic concepts over time, to be able to help assess risk and manage your risk-reward trade-offs.

Let’s assume that a geologist has found evidence of the presence of gold or silver (or other mineral) in a particular location. His basic task is to then estimate the quality and quantity of the metal in the ground. To do this, he uses sampling to estimate the potential value of the deposit. The geologist uses prospecting data to guess what the layout and depth of the orebody or ore deposit is (defined as a natural concentration of valuable minerals) and then systematically drills in various locations to extracts samples.

These samples are then sent to a lab for assaying (analysis of what are the constituents of the sample), which then provides clues about the nature of the deposit. Continued sampling helps to calculate the amount of the resource with increasing confidence and to determine if there is sufficient economic value in the deposit to mine it.

Geologists use this data to create three-dimensional images of the likely nature of the ore deposit.

Sampling also leads to an important financial calculation: the amount of resources contained in that location. There are strict regulatory guidelines from regulators on how this is to be done, since the valuation of the company depends heavily on these estimates.

There are two categories of estimates: Reserves and Resources. Reserves are an estimate (using strict engineering and governmental rules) of the total amount of economically mineable mineral in a specific location. Reserves are further categorised as Proven, Probable and Possible. Only the first two categories are used in feasibility studies to determine the viability of building a mine.

Resource estimates are less reliable than reserve estimates, and are stepping stones in the determination of actual reserves. Again, there are three categories, with decreasing levels of confidence: Measured (drill holes closely spaced and tonnage reasonably certain), Indicated (significant drilling done but some zones not fully tested) and Inferred (information based on widely spaced drill holes). Inferred resource is a very preliminary estimate.

Mining is a worldwide phenomenon, with about 7,000 mines in the world. According to a report by PricewaterhouseCoppers, the top 30 mining companies in the world have a combined market capitalisation of US $ 390 billion. These companies account for 80% of global market capitalisation, and their valuation has doubled in the past 18 months.

Cumulative profits increased by 95% to US $ 11.5 billion. Net margins have climbed from 6.4% to 10.1%. Capital expenditure climbed by 21% in the past year to US $ 13.7 billion.

Companies dedicated to gold mining account for 19% of these top 30 mining companies, while 59% of companies have diversified production.

These companies are all listed in the following countries: Canada, Australia, England, USA and South Africa. The top ten global mining companies mining for all minerals are, in order of market capitalisation (March 2004):

1.	BHP Billiton	(US $ 60 billion)
2.	Anglo American	(US$ 48 billion)
3.	Rio Tinto	(US $ 42 billion)
4.	CVRD	(US$ 22 billion)
5.	Newmont	(US$ 20 billion) – the world’s largest gold producer
6.	MMC Norilsk	(US$ 17 billion)
7.	Barrick Gold	(US$ 10 billion) – Canada’s largest gold producer
8.	Amplats	(US$ 10 billion)
9.	AngloGold	(US$ 10 billion)
10.	Xstrata	(US$ 10 billion)

The basis for valuing mining companies is both similar to, and different from, other industries. Analysts use traditional performance measures, such as Price/Earnings and Price/Cashflow ratios, earnings growth, liquidity, margins, intangible values, etc.

However, the largest asset that mining companies have is the minerals in the ground, which they will extract for sale in the future. How would you value a company with sales of, say, $ 10 million and a net profit of $ 1 million, but perhaps with an inventory of $ 100 million! You get the point.

Under accounting rules, companies cannot even show these assets on their balance sheets, only the costs capitalised in the process of exploring for them. So, apart from earnings and balance sheet metrics, investors use an important valuation basis, namely market capitalisation per ounce of proven and probable reserves (see how handy the technical information above was!).

So, value is a mix of current earnings, projected earnings, the quality of the assets, growth potential, political risk, currency risks, etc.

Let’s get a feel for the valuation of some of the largest gold and silver mining companies.

(Note: silver amounts are converted to gold equivalents based on prevailing Au/Ag [chemical symbols for gold and silver.])

Top 5 CANADIAN COMPANIES* (by market capitalisation)

*All these companies are also quoted on the Toronto Stock Exchange

Top 5 Non-CANADIAN COMPANIES (by market capitalisation)