Dr. Quinton Hennigh taught me how to use this simple formula that he uses when he wants to figure out what a company really has in the ground, before any types of economic studies have been published on it, as that gives him an advantage to his competitors (other retail investors).

If you are looking at a company that doesn’t provide all of the data that you need for this formula, you should be able to use the data from comparable deposits. Of course, this will have you basing your calculations on a lot of assumptions, so I think it’s safe to calculate at least three to five scenarios, each time with a larger discount to your assumptions. I’ll provide an example below.

The formula is rather simple:

**Volume x Density x Grade x Discount Factor (optional)**

**1. Volume**

You have to have basic geometry knowledge to start with this formula. You have to be able to understand the form of the body of rock that the company is hoping to drill, and then calculate its volume. The earlier in a company’s existence you can figure this out, the larger your advantage.

Here are a couple of examples of the figures I’ve come across the most:

**2. Density**

Density is a measure of the mass of a substance per unit measure.

You probably remember the old tricky question:

“What’s heavier, a pound of rock or a pound of cotton?”

The answer, of course, is that they both have the same weight, but because they have a different density, the volume of a pound of cotton is greater than the volume of a pound of rock.

Cotton has a density of 1.54 – 1.56 g/cm³, while most common rocks (like quartz) have a density of 2.6 – 3.0 g/cm³.

If you want to be very precise in your calculations, you might want to figure out the minerals that compose the type of rock that the company is planning to drill, and then use a simple Google search to calculate the density.

**3. Grade**

If you take the volume of the body that the company wants to drill, and multiple that by the density of the rock (2.8 is what I generally use. 2.7 for the worst, 2.9 for the best-case scenario), then you’ll get the tonnage of rock that the company owns.

What’s left for you to figure out is how much ore there is in that tonnage. The rest, by the way, is called “waste”. The most important thing, in natural resource investing, according to Dr. Hennigh and other experts I’ve spoken to, is to figure out how much of what the company owns is waste, and how much really is ore. Companies will, of course, try to deceive you by providing the best-case scenario, or sometimes unrealistic scenarios, in their investor presentations. It’s up to you to catch their game.

So, after you understand how much rock there is in the ground, you can apply grade to that. Be careful not to take the absolute highest grade that the company has reported so far, and keep in mind what the cut-off grade is, on comparable assets.

Cut-off grade is simply the lowest economical grade for that given project. If the company has reported a cut-off grade of 1 g/t AU, that means that any rock containing less than that will be considered waste.

Be careful not to fall victim to management lies. Some companies might report very optimistic cut-off grades during times of high metals prices. There’s a few ways to check if the management is being honest, and one of my favourite ways to do that is by looking at what cut-off grade comparable assets worked with in real-life historic situations.

Another way to deal with the deceptive techniques of the management is to calculate for it. Bake in a margin of safety for yourself. As a rule of thumb, I like discounting the reported cut-off grade by 20%. I’ve no idea if that’s correct or not as I lack the experience but you can make that out for yourself.

This is where you can make three scenarios: a best, an average, and a worst. You can then discount the cut-off grade by 0% (not discount it) for the best, 10% for the average, and 20% for the worst-case scenario, for example.

If the company hasn’t reported the grades properly yet, you can look at comparable deposits, preferably in neighbouring areas, and again, use three different scenarios.

When you find a comparable asset in a neighbouring, or a geologically similar area, look at the graphs provided in the company’s PEA (or other economic studies). What you’re looking for are rock designs, drawings with colourful blocks like blue, green, yellow, etc. Those will show you what the grades are across the body of rock of that company. Take an average, discount in for the three scenarios and you will get an idea of what type of grades are realistic for the company you’re looking at.

When you multiply the number (the tonnage) from step #2 to the grade, you will have an idea how many grams of gold (and/or other metals) there are beneath the ground owned by the company.

**4. Discount factor**

Technically, you could stop at #3, and you’ll likely have a better guess than most of your competitors (other retail market participants), but Dr. Hennigh suggests taking it a step further and applying a discount factor to the entire calculation, for conservativeness.

That way, if your calculations tell you the value of the ore that the company is sitting on is much greater than the price of that company, you’ll be okay, and might end up making more money than expected, which is always fine. On the other hand, if your calculations are wrong, and the value of the rock is not as high because you, for example, used a higher grade than what the company came up with, if you didn’t use a discount factor, you might be left disappointed. If you did use a discount factor, you’ll have a downside protection.

For example, as I’ve suggested above, I like making three calculations, with different discount factors. This does not mean I would go into a stock only if the worst-case scenario is very positive, but these discount factors work like conviction builders for me. If the worst-case scenario tells me the company is undervalued by 1000%, then I’d definitely have a stronger conviction than if the calculation without a discount factor told me it has the same upside. In the end, though, you cannot base your entire conviction solely on this.

Usual discount factors revolve around the 80-20 rule. I just assume that, if it’s a respectable company with a known management team (otherwise why even bother doing these calculations?), they tell mostly the truth, with some marketing sprinkled on top. So, a 20% discount just makes sense to me. You can change that and increase it for conservativeness, or decrease it if you’re willing to take on more risk.

**Example**

Dr. Hennigh gives a great example in this video.