How to put a price on gold in the ground...

AT ANY TIME, one ounce of refined gold can be valued at the international Spot Gold, write Louis James and Andrey Dashkov of Casey's International Speculator.

Gold is priced in US Dollars: $1,076.50 per ounce as we go to press. But what about the gold an exploration or Gold Mining company has in the ground – how do we value that?

Given sufficient data, you can estimate a reasonable net present value (NPV) for a mining project, and deduce what each of the company's ounces should be worth. To do this, you need to know annual output of the proposed mine, proposed capital expenditures, energy and other costs, and many more things. But for most deposits held by the junior companies we tend to follow, there's just not enough data available.

Another approach is to compare the value the market is giving a company per ounce of gold in hand against the average value the market gives companies with similar ounces. The most obvious way to define "similar" ounces in the ground is to use the three resource and two mining reserve categories defined by Canada's National Instrument NI43-101 regulations – the industry standard.

Here at Casey Research, we combine these into three broad groups, as we believe the market tends to do as well:

• Inferred: the lowest-confidence category, based on just enough drilling to outline the mineralization.
• Measured & Indicated (M&I): these higher-confidence categories have been drilled enough to establish their geometry and continuity reasonably well.
• Proven & Probable (P&P): These are bankable mining reserves – basically Measure and Indicated resources with established value.

So, what does the market give a company, on average, for an Inferred ounce of gold? M&I? P&P...?

To answer this, we combed through every company listed on the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSX-V) and pulled out the ones with 43-101-compliant gold resource estimates (or mostly gold) – no silver, copper, etc.

Of these, we kept only those with resources that fall almost entirely into only one of our three broad groups: Inferred, M&I, and P&P. In other words, we did not include companies with half Inferred and half M&I resources (though we did include companies with mostly P&P reserves, because most are producers – or soon will be – and are regarded that way). That left us with about 90 companies to calculate some averages on.

That's not a large sampling universe, and we had to make some judgment calls when it came to defining what companies should fall in each category, but it's what we have. So take these averages with a large grain of rock salt, but here they are:

• US$20 per ounce Inferred
• US$30 per ounce for M&I
• US$160 per ounce for P&P

Armed with this information, if you didn't know anything else about an M&I resource (political risk, type of ore, management history and so on...), but you saw that the company which owned it was trading at $10 per ounce, whereas its peers are valued at around $30 an ounce, you could conclude that there must either be something very wrong with the project or the stock is a great speculation.

If on further, closer inspection, there's nothing wrong with the project, there's an implied growth potential in the stock price, based on the difference between what the company is getting per ounce and the market average for similar ounces. In this case, it would be:

$20 x no. of ounces ÷ no. of shares

As a matter of perspective, a few years ago the market was giving a company about $25 per ounce Inferred, $50 for M&I, and about $100 for P&P. Then, when gold ran up over $1000 before the crash of 2008, these valuations went out the window, and some companies were getting over $100 for merely Inferred ounces.

Do we have your attention now?

Conversely, just after the 2008 Lehmans crash, when Gold Prices fell but Gold Mining stocks sank, there were companies having a hard time getting $10 for M&I. That was clearly a sign that it was time to buy, and we did, with gusto.

It's also why, when the Mania Phase of this gold bull market gets underway, we'll be selling into it as gold approaches the top; we will not be attempting to time the top. It's far better in this business to be a day early than a day late.

Today, the market is willing to pay more for advanced and producing stories ($160 P&P) but is discounting earlier-stage stories, hence the lower M&I valuation than in previous years ($30). These figures will change again as the market's appetite for risk changes.

Now let's compare these numbers to those of a few sample gold companies. This table includes the market capitalizations (share price x no. of shares) of our sample gold companies expressed in US Dollars (because that's what gold is priced in), not the usual Canadian Dollars.

The second column has the value of each company's resources, as per the average numbers given above (i.e. [no. of inferred ounces x $20] + [no. of M&I ounces x $30] +[no. of P&P ounces x $160]). The implied growth is a simple ratio of these two numbers, expressed as a percentage.

Gabriel and Coral Gold look pretty cheap, Luiri slightly expensive, but in most cases there are good reasons for this. For example, these averages by confidence category ignore the typically greater cost of extracting gold from low-grade sulfide ore, as compared to high-grade oxide ore.

We don't follow the companies in the table above – they are just examples – but here's our take on their implied growth ratios:

LGL: Luiri's flagship Luiri Hill project, located in Zambia's Central Province, has only 800,000 ounces in total resource, 82% of which fall within the least reliable Inferred category.

Although the current resource estimate is based on lower-grade material, the company's gold looks fairly valued. However, LGL is working to define more high-grade areas of mineralization both within and outside the resource boundaries, and not without success. For example, drilling from the Matala deposit, lying in the heart of Luiri Hill, has delivered high-grade intercepts from the central shallow zones, like the recently published 21.1 g/t Au over 5.6 m (starting from 56 m), including 41.1 g/t Au over 2.8 m (starting from 56 m of the same hole #114).

Conclusion: The company looks a bit expensive at the moment, probably because the market sees Luiri's upside potential coming from the new high-grade ounces being added in forthcoming resource estimates. If the marker were underestimating how much gold Luiri might be adding, it could still be a good speculation, but you'd have to be pretty sure of your calculations projecting that greater value to be added soon.

GBU: Gabriel Resources appears undervalued when using average ounce prices, plus there is a lot of upside outlined in the economic study on the company's Rosia Montana project in Romania, released last March. The study suggests excellent project economics, including low cash cost (US$335/oz), after-tax NPV of almost 1 billion USD at 5% discount, and after-tax IRR of 20.4%, all at an uber-conservative US$750/oz base case Gold Price.

However, the company was sued by environmentalists in September 2007 and suffered regulatory setbacks. GBU shares tanked, and this is why the company's gold is still selling at a discount; there is high political risk. Gabriel's share price has soared recently on words of support from the government officials, but it's still perceived – rightly – as high-risk. If Rosia Montana gets permitted to go into production, GBU shares should make very rapid gains.

Conclusion: The government of Romania has made supportive noises about Rosia Montana before, to no avail, and the company doesn't appear screamingly cheap right now, so the risk-to-reward ratio looks too high to us.

CLH: The company is focused on the Robertson project located on the Cortez Trend in Nevada. Coral Gold has recently revised the project's resource estimate at $850/oz gold (which looks fairly conservative, given the recent price action) to 3.4 million ounces, all Inferred. Our guidelines suggest that these ounces should be worth about US$68 million. Mind you, this gold is contained within what CLH believes to be well-known Carlin-type mineralization in a mining-friendly jurisdiction. Why does the market value these ounces way cheaper then?

We think it's a metallurgy issue. Lacking sufficient metallurgical data from all Robertson targets, CLH used numbers from a deposit called 39A to stand in for the whole project. The problem is that 39A is one of the deeper Robertson deposits, and large-scale heap leach operation, the preferred scenario for Robertson, showed high strip ratio, which would probably result in high capital expenditures and operating costs.

Conclusion: Robertson ounces are cheap due to valid concerns over the project's economics. If the company can fix these problems, its resources could be revalued upward dramatically.

Bottom line? We often get asked what an Inferred, or M&I, or P&P ounce is worth in the ground. The $20, $30, and $160 figures are only rough guides, and you must consider the reasons why some ounces are given more or less by the market, but they're a good starting point.

This is what makes Casey's International Speculator so different from other investment newsletters. You don't just get stock picks, you get an education. Learn more about Casey Research here...

This is the worst post-WWII slump because it's tackling what started after 1945...

WHERE WE ARE NOW is a matter of great debate: Are we in recovery? Or is the depression deepening? asks Bill Bonner in his Daily Reckoning.

No one knows for sure. Investors stumble around in the dark, bumping into data and knocking over lamps. It would be nice if someone would turn on the lights. But that's not how it works.

The best we can do is to try make out the shapes of the biggest pieces of furniture in the room. What else is out there? We don't know.

Broadly speaking, the period we are in is deflationary. It is a period of credit contraction (at least in the private sector), de-leveraging and depression. How can we be sure? Well, let's turn on the lights...

Take a look at this chart, for example. What it shows is not a 'jobless recovery.' It shows no recovery at all.

This slump is worse than any since World War II because it is correcting an expansion that dates all the way back to 1945. Credit began increasing right after the war. It kept increasing until 2007.

Then, in the private sector, it began going the other way. And that trend continues.

It makes sense from a theoretical point of view, too.

Every big credit expansion is followed by a big credit contraction. As credit expands, more and more mistakes are made. You can see how this works by looking at the mortgage industry.

The first borrowers were solid. Subsequent borrowers were not-so-solid, but they were still generally reliable. The last borrowers – at the height of the frenzy in 2006 – often had no jobs, no income, and no plausible way of repaying their mortgages. Those mistakes are now being corrected.

Overall, credit is still expanding – thanks to the US federal government. But credit is contracting sharply in the private sector...where it counts most. Business lending is falling at a 16.6% rate...the steepest plunge since 1948 (when businesses stopped borrowing for war production). But government borrowing is more than making up for the shortfall in private borrowing. Overall, credit- market debt is up 5.5% in the seven quarters since the business cycle peak in December 2007.

Private sector credit down. Public sector credit up. What to make of it?

We can presume that eventually the government will run into the same wall the private sector hit in 2007-09. Looking through the history of economic crises, so well documented for us by Carmen Reinhart and Ken Rogoff in their new book, This Time Is Different, we see that crises in the private sector typically lead to crises in the public sector. As the private sector sobers up...the public sector goes on a spree. It won't be long before it, too, crashes and burns.

We can anticipate how this crash in public debt will come about. This passage, from a brief account of French financial history called The Undying Debt by Francois Velde, is a story of the past. It may also be a story from the future:

With the opening of hostilities [in WWI], the Bank of France suspended the link between Francs and gold, and part of the war was financed with large issues of paper currency.

When France's prime minister Poincare re-established the link in 1928, he could only do so at 20% of its pre- war parity...

In other words, the French got into a fix. They got out by defaulting on 80% of their obligations.

The history of French financial management is not so different from that of any other nation. Time after time, France found itself a little short. And time after time, it defaulted...devalued...and reneged on its promises. Over nearly three centuries, a government debt equal to ten ounces of gold – with a present value of about €7,850 – was reduced, says Velde, to €1.20.

That's about "enough to buy a café crème at the bistro on the way out from the Finance Ministry." (We don't know which bistro Velde is talking about. A café crème in Paris usually costs twice as much.)

Returning to the image we led off with, investing is not just like trying to find your way through a room in the dark. It's like trying to find your way through a room in the dark...when the furniture is all moving! Trouble is, in the here and now, there is so much furniture moving around, it is hard to make a move without tripping over something.

Under these conditions, I'm not sure we can come to any useful conclusions about how one price will move relative to the others. Which will go down most, the Dollar or the Euro? Will copper rise in Dollars? Or fall against cotton? Will bond prices go up before they go down? We can't say.

But we can say that governments are very good at borrowing...and not so good at re-paying. So even if credit-contraction and deflation is the trend of the moment in US financial markets, government credit-creation is rapidly expanding...and that's inflationary.

That's why we are wary of government debt. We own no US Treasuries...nor any other form of government obligation. Shorting US and European government bonds is probably a good speculative play.

The official jobless numbers tell us that 10% of the workforce is unemployed. But here at The Daily Reckoning mobile headquarters, we don't believe any statistic...not unless we twisted it ourselves. Even then, we have our doubts.

What seems likely is that the number of people counted as 'jobless' understates the number of people who are not earning money the way they used to. That's why tax receipts are down...and why so many states are going broke.

Likewise, the latest statistics on housing were mixed – one up, one down. And now comes news that the number of used houses sold in December was disappointing – down 7.6% from a year before. The Washington Post says a housing recovery could take a decade. They're optimists at the Post. Most likely, there will be no recovery to Bubble-Era levels in our lifetimes.

Of course, that is not what the President of the United States of America thinks. He believes a recovery is underway...and that he can now take action to reduce the feds' stimulus. He's announced a partial spending freeze. This spending freeze is not exactly glacial. It's more like a spending breeze. Over the next 10 years it's expected to trim $250 billion from federal spending. Yet, the budget deficit for this year alone is $1.35 trillion. The cuts are negligible, in other words.

Just as we expected. The feds can talk the talk. But they can't walk the walk. Instead, they stumble from one error to a bigger one. From inciting a credit riot in the private sector...they've moved on to instigating a credit revolution in the public sector. When it is finally over...many nations will be broke...and the dollar will be worth a fraction of what it is worth today. What else could possibly happen? Well, nothing that we can see now. But there are always surprises, aren't there?

Most economists think the recession is over. And more investors think there is a bull market on Wall Street, and they expect it to continue. They are all going to be surprised. We are in a depression. It will cause stocks to fall again...probably pushing below their lows of March '09, down to the final bottom.

How can we be so sure? Well, we're not sure of anything. It's just an educated guess. Markets tend to oscillate between fear and greed over long periods of time. In the greed stage, credit generally expands. In the fear stage, it contracts. Obviously, there's a lot more to it than that. But people are, grosso modo, either optimistic and expansive or they are depressed and hunched over.

When they are optimistic, asset prices rise...because they expect everything to get better. When they are depressed, asset prices fall...because they can't imagine that things will ever get better.

That's why August 1982 was such a great opportunity. BusinessWeek announced that the outlook for stocks was so bad it was the "Death of Equities". Death is about as bad as it gets. It couldn't get worse. So, it got better – a lot better, with stocks up 11 times over the next 20 years.

Then at the end of the '90s, a similar announcement was made about gold. We can't remember the source; perhaps it was Newsweek magazine that pronounced gold 'dead' as an asset class. Then, what do you know? Gold rose from the dead and outperformed stocks by five to one.

What's so dead now it's beginning to stink? The only thing we can think of is Japanese stocks. Every time we mention them, readers write to ask if we've lost our mind.

The Japanese are growing old. They are up against not just a retirement crisis; they face extinction. They are not just figuratively dead...but literally dead. The government is headed toward monster debts...with no way to finance them. Already, they borrow more than a dollar for every dollar of tax receipts. Besides, the Chinese work cheaper. And the Chinese have the same technology...and the same access to capital...and a much bigger market.

As if to prove that Japan is dead, Toyota seems to have fouled up its accelerator mechanism. According to press reports, some Toyota automobiles go faster and faster even when you tell them not to. Drivers do not like that kind of insubordination. Only vulture lawyers do. So Toyota has had to shut down its assembly lines in order to mitigate the damages. So investors took a whack at Toyota shares yesterday; they fell 9%.

Is it the end of the road for Toyota...and for Japan?

Probably not. But we wait to see what happens...just like everyone else.

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