How to Value Mining Stocks: Cut-Off Grade Theory and Practice

Applying cut-off grade to a gold mine to see how it affects mine life

Politics and economic blunders have taken full control of our investments.

Predicting the short term fluctuations of the stock market during an election year, while multiple wars are being fought, is like flipping a coin.

But we’ve gone into the future and have come back with this message: more money will be printed, borrowed, taxed, or inflated. And the price of commodities and metals will climb.

When you have multiple wars going on and leaders spending their way into leadership, it’s inevitable.

This is why mining stocks might finally make a comeback.

When this happens, you better know what to look for.

A few weeks ago, we wrote a piece on the basics of mining valuations titled, “When Things Turn Around, Be Prepared: Mining 101

This week we’ll go more in-depth on this subject as part of a mini-series of letters that will focus on evaluating mining and resource stocks. This week’s topic will be “cut-off” grade – a term you have heard many times before, but is often overlooked or misrepresented.

Yet, it is an extremely important factor in valuing mining stocks.

Cut-off Grade Theory and Practice

Consider a block of ore that weighs 1 tonne and contains 3 grams of gold. At a gold price of US$2000 per ounce the value of the gold in the block of ore is just under $194 ($2000/31 X 3 or $2000 per ounce/ 31 grams (troy ounce) X 3 grams of gold).

Simply put, if it were to cost more than $194 to mine, treat, and extract the gold from that tonne of ore, it wouldn’t make sense to mine it. On the other hand , if the cost were less than $194, it might make sense to mine it.

It’s a simple concept, but it’s not that simple.

Here’s why…

If all the tonnes of ore in a deposit contained the exact same grade of gold, it would be easy to calculate. But not all the tonnes of ore that make an orebody contain the same grade of gold. As a matter of fact, gold deposits may vary the most in terms of consistency due to its “nuggetty” nature.

Take a look at this chart:

Gold Ore Grade Chart
Figure 1

As you can see in Figure 1, in this particular orebody, roughly 30 per cent of the total tonnage has an average grade of 3 grams per tonne, 20 per cent has 2.5 grams per tonne, and so on.

Making the Initial Estimate

Let’s assume that a preliminary feasibility study provides the costs for recovering gold (getting the gold out of the rock) with these numbers:

US$/tonne of ore treated
Overburden removal 12.0
Mining Cost 4.0
Treatment Charge 21.0
Administration and Refining 9.0
Total Cost 46.0

Metallurgical tests also show that only 95 per cent of the gold can be recovered from the ore.

So the question is, what is the minimum amount of gold the project needs in one tonne of ore to make it economically recoverable?

As the table shows, there has to be enough gold to provide US$46 of revenue to cover the costs. In other words, the grade that provides the US$46 is the cut-off grade.

To keep it simple, let’s now assume that the gold price is $1000 per ounce, which is equal to $32 per gram (US$1000/31.1 grams)

The formula is simple: total cost/recovery/price per unit of metal = Cut-off grade

Therefore, in our example: 46/0.95/32 = 1.5 grams per tonne

Now, if we go back to the original tonnage grade distribution as shown in our graph, we can see that roughly 6 per cent of our orebody has a grade of less than 1.5 grams per tonne. Obviously when we mine the orebody, we would try and stay away from mining and certainly would not treat the 6 percent of tonnage below the cut-off grade.

That means, for reserve reporting purposes (see When Things Turn Around, Be Prepared: Mining 101), we have reduced the size of our economic ore down to 94% of our original tonnage.

While we have reduced the tonnage above the cut-off by removing the uneconomical 6% of ore, the remaining average grade will have increased as the lower grade is no longer included.

That means that increasing the cut-off grade reduces economic tonnage, but increases the overall grade.

Now, here is where it gets complicated in assessing the NPV (net present value) of a project. A whole textbook can be dedicated to cut-off grade and assessing the NPV, but we will simplify as much as possible for all intents and purposes.

How to Calculate Mining NPV

First, we determine the mine life.

Let’s assume that the annual treatment capacity can process 10 percent of the original total reserve. With a zero cut-off grade, the original mine life would be 10 years (100%/10%).

If you increase the cut-off grade, you decrease the life of the mine due to diminishing reserves (reserves are ore in a deposit that is economical to extract, but you would increase gold production due to the higher grade.

Now, if we assume that capital cost is relatively fixed, it is possible to estimate the NPV for each cut-off grade because we know the operating cost, the mine life, the gold price, and therefore revenue.

Take a look:

Cut-off Grade 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Mine Life (yrs) 9.9 9.5 8.7 6.7 3.7 2.3 1.5
Relative NPV 1.0 1.04 1.07 1.08 0.9 0.7 0.6

Looking at the table, you can see that as the cut-off grade increases, so does the NPV. This is due to the greater benefit of a higher annual cash flow from the higher annual average grade outweighing the shorter mine life.

However, eventually, the shorter mine life becomes too significant and the NPV declines.

Looking at the table, you can clearly see that a cut-off grade of 4.0 reduces the relative NPV down to 0.6. Again, remember that increasing cut-off grade reduces your mine life as you “throw away” the lower grade ore in your calculations. That means that the higher the cut-off grade, there is even a possibility that the NPV would be negative as the mine life and recoverable ore becomes too small.

The important factor is selecting the cut-off grade that yields the highest NPV.

In our table, that means selecting the 2.5 grams per tonne cut-off grade.

Of course, this is an extremely simplified example using an extremely simplified calculation of NPV we used previously. With the advent of new technology and computing software, the optimum economic recovery of an ore deposit can be fine-tuned even further, especially with additional data (drill results). That means it is quite possible that the optimum cut-off grade in our example is somewhere between 2.0 and 2.5 grams per tonne, before the NPV drops.

In our example, the higher NPV was achieved using a higher cut-off grade, as a result of increased annual revenue outweighing the shorter mine life. However, cut-off grade will vary significantly from one project to another as many factor such as mine capacity, mill capacity, and commodity prices can all affect the NPV.

The next time you hear about a project that is comparable to another successful mine, remember that no deposits are ever the same. A minor gram per tonne variation in cut-off grade can have significant effects on a project’s NPV, and calculations in NPV can vary dramatically from one source to another. That’s why larger projects often have to go through numerous calculations from different sources before proceeding.

When calculating NPV, there are obviously conflicting factors. For example, your capital costs will increase when you increase production, but you need to keep it to a minimum for a given production rate. An increase in annual mine production will generate higher revenue, but it’s subject to available reserves and must be enough to satisfy the capital expenditures. The list of conflicting factors go on so its imperative that calculations are correct to optimize the NPV of a project.

There you have it, the basics of cut-off grade.

Seek the truth and be prepared,

Carlisle Kane

Forward-Looking Statements

This Newsletter and report contains certain forward-looking statements that may involve a number of risks and uncertainties. Actual events or results could differ materially from current expectations and projections. Except for statements of historical fact relating to the project, certain information contained herein constitutes “forward-looking statements”. Forward-looking statements are frequently characterized by words such as “plan”, “expect”, “project”, “intend”, “believe”, “anticipate” and other similar words, or statements that certain events or conditions “may” or “will” occur.

Except for the statements of historical fact, the information contained herein is of a forward-looking nature. Such forward-looking information involves known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievement of the Company to be materially different from any future results, performance or achievements expressed or implied by statements containing forward-looking information.

Although the Company has attempted to identify important factors that could cause actual results to differ materially, there may be other factors that cause results not to be as anticipated, estimated or intended. There can be no assurance that statements containing forward looking information will prove to be accurate as actual results and future events could differ materially from those anticipated in such statements. Accordingly, readers should not place undue reliance on statements containing forward looking information. Readers should review the risk factors set out in the Company’s prospectus and the documents incorporated by reference.

Cautionary Note to U.S. Investors Concerning Estimates of Inferred Resources

This presentation uses the term “Inferred Resources”. U.S. investors are advised that while this term is recognized and required by Canadian regulations, the Securities and Exchange Commission does not recognize it. “Inferred Resources” have a great amount of uncertainty as to their existence, and great uncertainty as to their economic and legal feasibility. It cannot be assumed that all or any part of an Inferred Resource will ever be upgraded to a higher category. Under Canadian rules, estimates of “Inferred Resources” may not form the basis of feasibility or other economic studies. U.S. investors are also cautioned not to assume that all or any part of an “Inferred Mineral Resource” exists, or is economically or legally mineable.

Disclaimer and Disclosure

Disclaimer and Disclosure Equedia.com & Equedia Network Corporation bears no liability for losses and/or damages arising from the use of this newsletter or any third party content provided herein. Equedia.com is an online financial newsletter owned by Equedia Network Corporation. We are focused on researching small-cap and large-cap public companies. Our past performance does not guarantee future results. Information in this report has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. This material is not an offer to sell or a solicitation of an offer to buy any securities or commodities.

Furthermore, to keep our reports and newsletters FREE, from time to time we may publish paid advertisements from third parties and sponsored companies. We are also compensated to perform research on specific companies and often act as consultants to many of the companies mentioned in this letter and on our website at equedia.com. We also make direct investments into many of these companies and own shares and/or options in them. Therefore, information should not be construed as unbiased. Each contract varies in duration, services performed and compensation received.

Equedia.com is not responsible for any claims made by any of the mentioned companies or third party content providers. You should independently investigate and fully understand all risks before investing. We are not a registered broker-dealer or financial advisor. Before investing in any securities, you should consult with your financial advisor and a registered broker-dealer. The information and data in this report were obtained from sources considered reliable. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities. Any decision to purchase or sell as a result of the opinions expressed in this report OR ON Equedia.com will be the full responsibility of the person authorizing such transaction.

Again, this process allows us to continue publishing high-quality investment ideas at no cost to you whatsoever. If you ever have any questions or concerns about our business or publications, we encourage you to contact us at the email or phone number below.

Please view our privacy policy and disclaimer to view our full disclosure at http://equedia.com/cms.php/terms. Our views and opinions regarding the companies within Equedia.com are our own views and are based on information that we have received, which we assumed to be reliable. We do not guarantee that any of the companies will perform as we expect, and any comparisons we have made to other companies may not be valid or come into effect. Equedia.com is paid editorial fees for its writing and the dissemination of material and the companies featured do not have to meet any specific financial criteria. The companies represented by Equedia.com are typically development-stage companies that pose a much higher risk to investors. When investing in speculative stocks of this nature, it is possible to lose your entire investment over time. Statements included in this newsletter may contain forward looking statements, including the Company’s intentions, forecasts, plans or other matters that haven’t yet occurred. Such statements involve a number of risks and uncertainties. Further information on potential factors that may affect, delay or prevent such forward looking statements from coming to fruition can be found in their specific Financial reports.

Equedia Network Corporation is also a distributor (and not a publisher) of content supplied by third parties and Subscribers. Accordingly, Equedia Network Corporation has no more editorial control over such content than does a public library, bookstore, or newsstand. Any opinions, advice, statements, services, offers, or other information or content expressed or made available by third parties, including information providers, Subscribers or any other user of the Equedia Network Corporation Network of Sites, are those of the respective author(s) or distributor(s) and not of Equedia Network Corporation. Neither Equedia Network Corporation nor any third-party provider of information guarantees the accuracy, completeness, or usefulness of any content, nor its merchantability or fitness for any particular purpose.

Total
0
Shares
Comments 2
  1. Most miners that I can afford are young or at a new possible mine site and are reporting drill hole results. I cannot understand the drill hole results they print in newsletters.
    Could you write an article about explaining drill hole results and what results for (gold and silver)
    it takes for a miner to actually invoke the mining process. And why do they drill for years before they start mining. THANKS for all you do to provide quality information.

Leave a Reply

Your email address will not be published. Required fields are marked *

Prev
When Things Turn Around, Be Prepared: Mining 101

When Things Turn Around, Be Prepared: Mining 101

It's unpopular, but mining stocks will be critical in the world's development -

Next
A Billion-Dollar Project on sale for $40 Million?
Battery with electric charge, resonance, pulse

A Billion-Dollar Project on sale for $40 Million?

This company just announced a project worth nearly C$1 billion, but trades at

You May Also Like