An Empirical Methodology for the Valuation Of Risky Gold Cashflows

Introduction The minerals exploration business, like many businesses, is faced with the problem of valuing future, risky cashflows. These cashflows are derived from those mineral deposits which have been successfully commercialized. Many deposits, however, do not have the quantities or grade of ore to be considered economic at the projected metal prices using the traditional tools of the Capital Asset Pricing Model and discounted cashflow analyses. If one calculates the future revenues, costs and cashflows of one these marginal properties, and discounted it at the appropriate risk-adjusted discount rate, it may have a negative present value. Yet such a property may still have real, positive value in the marketplace. Why would a firm pay money for a property with an (apparent) minus present value? Mining properties such as these are bought and sold in arms- length transactions on a regular basis. Why is this so? Part of the reason relates to the nature of ore reserve information. To generate cashflows, the analyst must t assume that the reserve information is known with certainty when, in fact, reserves are not known with certainty. Mineral reserves are a function of commodity price, extraction costs and the level of (usually drilling) information about the reserves. Stated, or currently known, mineral inventories may vastly understate the true state of nature. Some firms may therefore be buying a property based on a completely