In-situ value

In-situ valuation is a fairly straightforward method of valuing miners. In essense it is simply the value of all mineral resources (measured + indicated + inferred) that mining company owns.

Of course the value of a company is not simply the value of the resources it owns in their mined and processed state. It is therefore more common to use the value of the mineral resources to construct a valuation ration: the ratio of market cap to in-situ value.

An alternative is the multiple of in-situ value at which recent trade sales of mines have taken place.

The ratio above provides a rough correction for one flaw of in-situ valuation, that it does not take into account the cost of mining and purifying the resource. However, this is a far from perfect correction as it does not take into account variations in the cost of mining.

In-situ valuation has many other flaws. It does not even take into account whether the reserves are economically viable (it may cost more to extract them than the value of the end product). This is easily corrected, but there are more problems.

In-situ valuation does not take into account other factors that affect the value of the company, as opposed to its resources, most importantly its other assets and liabilities. It is possible to correct for much of this by looking at the balance sheet, but if we apply all these it is no longer a simple method of valuation.

The best valuation method in theory (as always) is a DCF, but this approach is even more difficult in the case of miners because the volatility of commodity prices makes forecasting future selling prices (and therefore revenues) far more difficult.

Buying miners is an indirect way of investing in commodities, so it is an unpredictable as investing directly in commodities. Some analysts resort to valuing miners at a weighted average of multiple valuation methods (e.g. DCF and market cap/in-situ value, often multiple valuations based on different weights.

The soundest method is probably a DCF based on a model of future prices: if you do not have a model you believe for future prices you probably should not be (actively) investing in this sector.

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