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Mining Deal Club

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Option Value vs. Net Present Value

An asset can be valued in two ways: option value and net present value (NPV). A marginal project can have significant option value.

If you have a permitted mining project with a 22% or 30% IRR discount, reasonable capital costs, and a decent management team, the project will trade on a NPV basis. It will trade on the concept of what cash flows can be expected.

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Gold Prices vs. Construction Costs

I am having a hard time balancing record gold prices with the rapid growth in capital costs. On one hand, record gold prices should be able to support new mine development, but on the other hand, the huge expansion of oil & gas development in Alberta and continued development in other Canadian industries have driven costs so high to a point where very little is feasible.

Looking at the stream of new company press releases, the mining industry has gone into a panic-and-shock stage of project development. It seems nothing will move forward unless construction has already been started.

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Market Connectivity

Financial markets have become more and more correlated. Everything seems to be trading up or down based on what the overall market is doing.

The current market connectivity is bad for junior mining stocks. Copper risk/reward used to be separated from aluminum, but today aluminum, copper, and Greek credit default swaps move up or down together. Investors currently have many more liquid options to buy volatility, so money is flowing to other investments.

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Thoughts on Bankers

I have spent a lot of time with senior bankers in the last month or so, and I have learned of their bias towards junior mining companies. Senior bankers do not like an economic model where 95-98 out of 100 company projects will not result in a mine, and the remaining 2-5 companies will not have the capital to build a mine for a good project.

At the $100 million to $1 billion level of check writing, banker types dislike the fat tail distribution of the junior sector. Many bankers finance mining companies without dropping down into the junior space.

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Reduce, Reuse, Recycle (Chinese Style)

China is going to start scrapping lots of things built before 1995. The first wave of Chinese construction went up quickly and cheaply, and many buildings will be torn down to make way for new, perhaps more tasteful buildings one to three times the size.

The old building only had one electric outlet per room, and the new one will have three. The old one had painted steel, but the new one will use stainless or galvanized steel. What can be recycled from the old will be recycled. The Chinese did not build the old to last forever, but the new one will be built with a 50-year life in mind, as long as the building manager does not take a bribe or three and go cheap on the rebar or electrical wire gauge.

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