Brent Cook: Investing During the Era of Peak Gold Discoveries

The Gold Report: Brent, you've quoted Goldcorp Inc.'s (G:TSX; GG:NYSE) CEO, Charles Jeannes, saying that we've reached peak economic gold production. What led us to this point?

Brent Cook: That's a big question that really goes back to what was happening in the global exploration sector 20+ years ago. I don't want to get into the peak gold production idea but instead focus on the discovery curve and what's behind the problem we are seeing in the gold sector.

Why aren't we finding as many gold deposits as we used to, or at least as many economic deposits? In 1995 or so, the discovery boom in the gold sector peaked and that success is largely tied to the opening of large areas of earth that were previously off limits to serious exploration. Since then, exploration success and new discoveries have trended down. However, in terms of gold production, it's taken about 20 years for all those discoveries to work their way through the system to come into full production.

So what Charles Jeannes sees is that in 2015 or so, gold production is going to be tapering off as opposed to expanding. That's especially true given the current gold price and cost structure. A lot of these companies aren't making much money, or any money at all. They'll be shutting down loss-making projects over the coming years.

TGR: Are we running out of gold in the world, or did we just not make an investment in a timely manner, say, 20 years ago?

BC: No, we're not running out of gold. We're finding gold deposits, but most of them are not economic. That's really the issue here. For example, there are 20 million tons (20 Mt) gold in the ocean seawater, but it grades about 13 parts per trillion and will never be economic. It's that economic hurdle that is really at issue here.

In the 1990s, the world opened up to exploration. We found a lot of deposits sitting at the surface in jurisdictions that were once inaccessible, basically the low-hanging fruit. But by and large, there is a finite number of outcropping ore bodies and the few remaining are increasingly difficult to find. We've nearly exhausted the surface and are forced to drill for blind deposits through barren rock using really esoteric methods. The odds of success are much lower, and the costs are much higher.

I'll give you an interesting ballpark figure that is based on how geology and the earth work. For every, say, 10 gold deposits of 1 million ounces (1 Moz) grading 1 gram per tonne (1 g/t), the earth formed one deposit of 1 Moz that grades 2.5 g/t. Those are more or less the odds. The problem is that although a 1 g/t deposit may be economic at surface, when it lies under 200 meters of barren cover, it is no longer economic. The unfortunate reality for us explorers is that those odds mean that we are still going to find about ten 1 g/t deposits for every 2.5 g/t deposit. Our economic success rate has to go down, and the data back up that conclusion. That is also the reason we have so many companies boasting NI-43-101-compliant resources that in my view will never be converted to economic reserves—never.

TGR: Isn't there just a lot less investment in exploration happening right now, with companies trying to cut costs?

BC: Yes, that's a really good point. Exploration has been cut to the bone across the sector. In the junior sector, it's almost impossible to raise money for exploration. So, yes, we're not spending enough money to find quality deposits, and this situation is going to get worse. Additionally, consider the fact that new discoveries are going to cost more to make because 1) for the most part they are going to be deeper so they will require more drilling just to have a look, 2) as I mentioned previously, we are going to find more uneconomic or marginal deposits than economic ones, and 3) for the most part those uneconomic deposits will have to be drilled out just to see what they grade. So each new economic discovery will cost the industry more than in the past but we are spending considerably less looking. What does that tell you?

TGR: What's the lag time? When are we going to see the effect of that lack of investment?

BC: I think we'll start seeing it next year and, certainly, into the coming years. My investment thesis is that the mining companies that are currently in production are going to eventually wake up to the fact that they have nothing on-line to replace what they've been mining. That's when they're going to have to go out and buy the few deposits that make money. Those are the deposits you want to own early on.

Now the simple fix for what appears to be a fundamental gold supply-demand equation is, of course, higher gold prices. However, I'm not convinced there is, or will be, a gold supply problem that will translate directly into higher real prices that bail out the miners and their marginal deposits. Almost all the gold that has ever been produced is still available in some form or other and much of it potentially for sale at some price.

So, unless there's a real run on gold, as well as gold hoarding, we may not see the gold price rise to compensate for less economic deposits. Plus, as we saw in the last big boom in the gold price, input costs, labor, equipment, supplies, power—everything—rose in tandem with the gold price. So even with $1,300/ounce ($1,300/oz) gold, miners' margins didn't increase much. I think it's going to get really interesting in 2015, 2016 and 2017.

Some people are theorizing that new technology is going to change the game, as it did for peak oil. I don't see it. Hard rock geology and minerals mining are much more complex and difficult than oil and gas extraction. We can and do continually make small improvements in technology, metallurgy and such that take a few dollars or tens of dollars off the per ounce production costs, but those aren't anything like the fracking technology.

TGR: Even when discoveries are made, is it getting more difficult to get permission to mine in many parts of the world?

BC: That's another consideration. Let's say you do make a discovery. Inevitably, you have social issues to deal with. You have politicians and everyone within a hundred miles yelling for their piece of the pie. You have permitting to go through, and permitting is much more difficult than it used to be. In 1995, it took maybe 10 years to get a big deposit into production. It's now averaging 10–20 years to get a big deposit into production. So these mining companies have to look at a discovery and make some projections, not just as to what the gold price is going to be 15 years down the road but, also, what the labor costs are going to be, what the power costs are going to be. And those unquantifiable risks keep companies from making investments.

TGR: Are there some places that are easier to do business in than others?

BC: Most certainly. I think Canada is pretty good, and Quebec is a great place. In the U.S., Nevada, Utah, Wyoming, parts of Idaho are good places to work. Mexico in general and a lot of places in Latin America are good including Peru and Chile, although with Chile one has to consider water and power issues early on. West Africa is generally good. So there are certainly safer places to work. But there's always a risk things will change politically. We recently saw Zambia raise the royalty on companies from 6% to 20%, and Barrick Gold Corp. (ABX:TSX; ABX:NYSE) shut down its copper mine.

TGR: Based on all of that, what companies are doing exploration the right way, have the right teams in place and have the money to execute on them?

BC: Not that many. If you're looking to buy an exploration company, first off is always the people. That's really critical in an exploration company. Are the technical people on the ground smart enough and competent enough to recognize a good system and explore it properly and, more importantly, do they know when to cut bait? Unfortunately, in this sector, people sometimes keep drilling and drilling and drilling on a project because that's how they make their living. You want to own a company that has a technical team that knows what a deposit looks like and knows what one doesn't look like. Then you need a company that has the cash to keep going—there are getting to be fewer and fewer of those—and a share structure that's not blown out in shape.

TGR: What companies do meet those standards?

BC: Mirasol Resources Ltd. (MRZ:TSX.V) has been successful in Argentina. It sold a deposit and has on the order of ~$20 million ($20M) now in the bank. It has picked up property in Chile that has never really been explored. The company is having some real success early on in defining these new targets.

TGR: Mirasol just released news on that property, the Gorbea property in Chile, and the market seemed to react positively. Does the company have other catalysts coming up?

BC: It has a joint venture with First Quantum Minerals Ltd. (FM:TSX; FQM:LSE) in Chile as well, with First Quantum spending ~$5M testing one of its porphyry copper targets. If that hits, it'll be major. The Gorbea project is very early stage—just trenching, geophysics, geology. But it is finding some really nice-looking targets that I suspect will be drilled in 2015 by a partner.

TGR: Your next name?

BC: Reservoir Minerals Inc. (RMC:TSX.V) has probably made one of the best discoveries in the past few years in partnership with Freeport-McMoRan Copper & Gold Inc.'s (FCX:NYSE) exploration in Serbia. It defined something like 65 Mt grading 3.1% copper equivalent. This thing sits under 400 meters of barren rock. Reservoir has ~$38M in the bank and a number of 100%-owned projects surrounding the discovery that it is testing right now. A successful discovery there would be huge for the company. And they're smart people; they know what they're doing.

TGR: What about the African projects? Are you watching those as well?

BC: In Cameroon, it is very early stage. It turned up some very encouraging early results, trenching rock samples, that sort of thing. It is a company that will probably joint venture most projects. Certainly in Africa, it builds them up to the stage where there's a solid drill target and then brings somebody in to drill it and, if it's successful, mine it.

TGR: Great. Another name?

BC: Pilot Gold Inc. (PLG:TSX) is a very smart group that is doing good work. Its predecessor sold its project in Nevada to Newmont Mining Corp. (NEM:NYSE). This is a project that Pilot didn't actually discover, but it brought it forward, explained it to the market and was able to sell it. Pilot has a project in Nevada, Kinsley Mountain, where it discovered Carlin-style mineralization out where nobody expected it. It's not yet big enough to be economic, but it points to how qualified Pilot is. It has a project in Turkey, TV Tower, in joint venture with Teck Resources Ltd. (TCK:TSX; TCK:NYSE), where Teck is probably going to be contributing 40%. This is a master cluster of porphyry intrusives. I like the look of it. So I think that's certainly something to watch next year. Again, it is financed. It's all set. We don't have to worry about the company going broke.

TGR: What are some other companies that fit your criteria?

BC: Sometime early this year, I think we're going to see a bit of optimism in the mining sector, including the gold sector and the junior sector. I wanted to buy some companies that were in safe jurisdictions, were well known and had the cash to move forward.

Lake Shore Gold Corp. (LSG:TSX) has turned around its deposit in Ontario. It's banking good money. It's paying down its debt. If the market improves, so will the share price. It's not something that I'm going to hold forever. It's just hoping to make 20–50% on something into this year.

Premier Gold Mines Ltd. (PG:TSX) is a very competent group. It has cash. Its Hardrock deposit actually looks like it's going to work. That's something that I think another company should buy. Premier has projects in Nevada and in the Red Lake District of Ontario as well.

Kaminak Gold Corp. (KAM:TSX.V) has made a very nice discovery in the Yukon, ~3 Moz gold. A lot of it is oxidized. It looks as if it will work as a heap-leach operation. Again, it's a safe jurisdiction and it's a good group. I think it will attract attention, should the market improve next year.

TGR: Do all three of those companies have the money to move forward?

BC: Lake Shore and Premier certainly do. Kaminak is putting together a feasibility study, so sometime this year it will probably want to raise money. But it's not going broke, for sure. Ross Beaty and Lucas Lundin just put money into it.

TGR: That's a vote of confidence.

BC: It's pretty encouraging, yes.

TGR: You've commented that the gold price has held up surprisingly well in many currencies, with much of the downside behind us. You even ventured that we could see some temporary optimism. Give us something to be hopeful about.

BC: It's been bad so long that it has to get good. I think it's a reasonable speculation that we're going to see some optimism in 2015, but overall, I'm not terribly positive toward the junior sector or the gold price in the short term. I think 2015 looks a lot like this year did. The upside there is that we're going to have real opportunities to buy the few quality exploration groups and deposits that will be much more valuable come 2016 and 2017.

TGR: Gold prices and junior mining stocks are often very cyclical. You have tax-loss selling, then you have the "January effect" and then "sell in May and go away." Do those clichés still hold up in today's market? Can we expect a January effect in 2015?

BC: I think so. That's my bet on those last three stocks we talked about, but who knows. It's been a pretty crazy couple of years.

TGR: Thanks for sharing your insights, Brent.

BC: My pleasure.