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As a general rule, the most successful man in life
is the man who has the best information
In 2001 and 2002
miners were producing gold for sub-$180 cash
costs - the operational cost of the mine divided by the ounces of production. By 2005 cash costs had risen 45 percent to US$250. Data from GFMS shows world gold production costs for
the first half of 2009 averaged $457/oz. Average cash
costs in 2011 were US$657.
According to the Thomson
Reuters GFMS’s Gold Survey 2012 global gold mine production was flat (output rose 0.1 percent to 1,366 metric tons) in the first half of 2012. The
average grade of ore processed globally dropped 23 percent from 2005 through
the end of last year and is forecast to decline another four percent in 2012.
The
report also said the average cash cost across the gold mining industry for
mining an ounce of gold is a record $727 per ounce. The average cash margin dropped to $872 an ounce in the second quarter
from as much as $1,032 an ounce in last year’s third quarter.
Operating costs, the bullshine
the industry is publishing as cash costs, are increasing, yields are
declining and total expenditure has grown in line with the gold price.
Average
operating/cash cost figures include only those costs directly associated with
the production of the gold such as;
- Wages
- Cost of energy
- Raw materials such as steel, explosives etc
Thomson Reuters GFMS
But there’s
more, a lot more to costs than most realize.
A complete breakdown of costs, an all-in cost figure, courtesy of CIBC,
shows cash operating costs pegged at $700 an ounce, sustaining capital, construction
capital, discovery costs and overhead at $600. Add in $200 for taxes and you
get US$1500.00 as the replacement cost for an ounce of gold. Using the all-in figure provides a more accurate and
definitive picture of actual mining cost and profit. Also, according to CIBC World Markets, the sustainable number gold miners
need is $1,700/oz. As I write this gold is trading at $1726.00/oz.
The reasons behind flat-lining gold
production, and record cash and all-in costs, are numerous:
- Production declines in mature mining areas
- Slower than expected ramp-ups of
output
- Development time
up
- The entire resource extraction industry suffers
from a lack of skilled people
- Extreme weather
- Labor strikes
- Protests
Additional challenges include:
- Increasingly more remote and lacking in
infrastructure projects
- Higher capex costs
- Increased resource nationalism
- Increased environmental regulation
- More complex metallurgy
- Lower cutoff grades
The biggest worry the industry has is that despite a
significant investment in exploration (a record $8b in 2011) there’s a
lack of discovery with few large high grade deposits being discovered.
 
Here’s
some excellent insight from Brent Cook, explorationinsights.com.
“Major gold mining companies are facing a big problem. They are
unable to find and develop enough ounces to keep up with demand, for the
simple fact that economic gold deposits are extremely rare. Production shows
a very simple trend: it rose until about 2000 and has fallen since then. This
reduced production occurred even as the price of gold has increased nearly
400% in the past ten years. This incongruity tells us something fundamental:
there’s a problem.
There are three main reasons why gold production
increased up to 2000 despite declining gold prices.
- The first is the
advent of new mining and processing technologies that made previously
uneconomic low grade deposits economic. This was mostly a result of heap
leach technology and bulk mining methods. Meaning, mining companies
could now scrape up large areas of low grade mineralization and sprinkle
a cheap solution of cyanide on the rock to recover the gold. This primarily
worked on near surface oxidized deposits in relatively dry climates.
- The second is that
vast regions of the world that had previously been closed for various
reasons were opened up to exploration. These new areas include much of Latin
America, Africa, and the former Soviet Union. I was part of that
movement; we were able to walk onto obvious deposits with new eyes and
rapidly drill out those resources. It also became markedly easier to get
into these areas, so we were able to go deeper into the jungles and
deserts.
- The third is that
geologists had a whole slew of new exploration tools with which to scan
the earth. These include satellite imagery, geophysics, and more
sensitive chemical tools.
The net result was that new technologies kept old
deposits going longer and made previously uneconomic ones viable, thereby
ramping up production into the early 90’s. New deposits in previously
unexplored and off-limits areas kept that production going until about 2000.
All well and good but the industry is not finding as many new deposits as
they need to in order to maintain current production levels. And, although we
can expect incremental technological improvements in processing, mining, and
exploration, there is nothing revolutionary on the horizon.
This is a worrisome slide for major gold
producers—they are unable to sustain themselves. For the most part they
are surviving via old deposits that are running out of ore and newer deposits
that are quickly headed into the “old” deposit category. Reserves
from these aging deposits are not being replaced by new discoveries.
Producers’ problems are further exacerbated by rising exploration and
development costs, plus the significant time it now takes to permit and
finance a new deposit.”
Here’s
Paul van Eeden (paulvaneeden.com) on reserve
replacement, this was written in 2001:
“Worldwide
gold production from mining is approximately 80 million ounces per year. A
few years ago, a world-class gold discovery, which rarely occurs, would have been
anything over a million ounces. Perhaps a few such deposits are discovered in
a decade yet we mine the equivalent of 80 such deposits a year. Due to recent
mergers and acquisition in the mining industry, the bar has been raised and
the major mining companies now require deposits to be in excess of 5 million
ounces before they become excited. Perhaps only one or two such discoveries
are made in a decade.
Anglogold mines over 6 million ounces of gold a
year. Newmont mines roughly 4 million ounces of gold a year, Barrick 3, Harmony almost 3, Normandy 2, you get the
picture. Each of these companies need to make a
world-class discovery every year, and some of them need several, just to
prevent the natural depletion of their mineral reserves from retiring the
entire business. Note that mergers and acquisitions do not add any new
resources to the mining industry, it merely changes
the ownership of mines. The gold mining industry needs to discover 80 million
ounces of gold every year just to prevent it from shrinking and it is highly
unlikely that we will ever discover 80 million ounces in any given year,
never mind do so on a continuous basis.”
Barclays Plc
predicts global gold mine output may increase 0.7 percent in 2013, the
slowest pace since 2008, while forecasting total physical supply may shrink
0.4 percent in 2014.
Gold miners have been
able to survive rising costs because of rising gold prices – if gold
prices do not start going up marginal projects are not going to get funded
and a whole lot of forecasted gold production is not going to come on stream.
Global gold demand in Q3
2012 was 1,084.6 tonnes (t), slightly above the
five year quarterly average of 984.7t, according to the World Gold Council's
Gold Demand Trends Report.
“Gold is beginning to re-establish itself as
part of the fabric of the financial system. In the medium term, the
quantitative easing initiatives in the West and the continuing growth story
in the East, particularly in India and China, coupled with the seasonally
strong quarter coming up in Asia, are excellent indicators for further growth
in the gold market…it is clear from five year rising demand trends that
gold's fundamental property as a vehicle for capital preservation continues
to endure, as evidenced by this quarter's increase in global ETF investment,
up 56% and continued purchasing by central banks, the ultimate long term
investors.” Marcus Grubb, Managing Director, Investment at the
World Gold Council
From
Sy Harding, over at streetsmartreports.com, comes
some important information on the state of the U.S. economy:
“The
CFNAI is an index comprised of 85 established economic indicators and trends
drawn from all areas of the economy. It was first compiled in 1967 and has a
remarkable record for identifying early on when the economy has entered a
recession.
The numbers are
reported monthly. A positive level for the index indicates the economy is
growing, while a negative number indicates the economy is slowing.
The index has
been of concern for a while. The monthly reading of the index was in negative
territory for five consecutive months before improving to the flat-line at
0.0 in September.
Unfortunately, that
improvement lasted only one month. The report this week shows a sizable drop
to -0.56 in October.
More ominously,
it’s more important 3-month moving average also dropped to -0.56 in
October from -0.36 in September. It was its 8th straight month of
negative readings, and getting ominously close to the -0.70 level the Fed
considers “an increasing likelihood that a recession has begun.”
It is the solid line in the Fed’s chart.
The index has
only dropped beneath the recession warning level of -0.7 eight times since
1967. That was in 1970, 1974, 1980, 1981, 1989, 1990, 2001, and 2008. Each
time the economy was indeed in a serious slowdown, usually a recession, and
seven of those eight times the stock market was already in a bear market or
soon rolled over into one. The most recent occasions were in 2001 and 2008,
certainly not pleasant memories for the country.
The financial
media and investors don’t pay much attention to the CFNAI, and most of
the time it is not of much importance.
But with the 3-month
moving average in negative territory for 8 straight months, and now at -0.56,
so perilously close to -0.70, it should have everyone’s
attention.”
From Axel Merk, over at merkinvestments.com, comes three key reasons to support an investment in gold:
- A form of protection against inflation
- Safe haven investment
- Minimize downside deviations in the value of an overall
portfolio, reduce overall volatility, and enhance returns
“Over recent years,
gold has performed remarkably well relative to other asset classes, in terms
of both absolute performance and risk-adjusted performance. Over the
preceding 10 years, an investment in gold would have significantly
outperformed a corresponding investment in the S&P 500 Index or U.S.
bonds, not to mention international and emerging market equities. Over the
past 10 years, gold outperformed U.S. equities by over three times.
On a risk-adjusted basis,
gold has produced superior returns, as measured by the Sharpe ratio. Over the
10-year period ended September 30, 2012, gold’s performance generated a
Sharpe ratio of 0.85. In comparison, the S&P 500 Index generated a Sharpe
ratio of just 0.30, as did international equities.
Gold’s Sharpe ratio
was nearly as high over the five year period, as it was over the 10-year period
ended September 30, 2012, while comparable equity indices produced negative
Sharpe ratios. In fact, over each time period analyzed, gold outperformed
domestic and international equities on a risk-adjusted basis.”
merkinvestments.com
“The disadvantage of fiat money [.i.e.
non-convertible money], relative to commodity money, rests precisely in the
fact that its scarcity, being thus contrived, is also contingent. A matter of deliberate
policy only, it is subject to adjustment at the will of the monetary
authorities or, if those authorities are bound by a monetary rule, at that of
the legislature. Consequently, although a fiat money can be managed so as to
not only preserve its purchasing power over time, but also so as to achieve
the greatest possible degree of overall macroeconomic stability, there is no guarantee that it will be so
managed, and market forces themselves offer no effective check against its arbitrary mismanagement.” economist George Selgin
Conclusion
It’s very clear that over the last
decade gold has been a very good investment, and will continue to be so for
the foreseeable future, but there is one asset class that will do even better
then bullion, a lot better.
As mentioned previously,
producers are not able to replace their reserves because there’s a lack of discovery, few large high grade
deposits are being discovered and most of those that have been discovered
aren’t owned by producers …
“Today, the major producers and their
majority-owned subsidiaries hold 39 percent of the reserves and resources in
the 99 significant discoveries made in the past 15 years.” Metals Economics Group (MEG)
Only 39 percent, so who owns the other 61 percent, who actually owns
the worlds future gold supply?
A Junior exploration company’s place in the food chain is to
acquire and explore properties. Their job is to make the discoveries that the
mid-tiers and majors takeover and turn into mines. Junior exploration
companies own the majority of the world’s future gold mines.
But the bottom
line is, new exploration, despite a record amount of money being thrown at
it, is not keeping up with reserve depletion. Juniors are not getting enough
funding to do the necessary exploration to keep up - from June 2011 to June 2012 funding for juniors has dropped by $9b.
It’s time
to be a stock picker, you need to find the quality management teams with
money in the treasury, the ability to raise more and having the advanced
projects that are well along the development path towards a mine. A mine that
is going to be a long life, lowest quartile all-in cost producer. These
companies are the world’s future gold producers and of course most will
be in the sights of mid-tier and major producers for takeover candidates as
reserve replacement targets.
I’ve got
several precious metal juniors that fit that very specific bill on my radar screen, do you have any on yours?
If not, maybe
you should.
Richard (Rick) Mills
rick@aheadoftheherd.com
www.aheadoftheherd.com
Richard is the owner of Aheadoftheherd.com and
invests in the junior resource/bio-tech sectors. His articles have been
published on over 400 websites, including:
WallStreetJournal, SafeHaven, MarketOracle, USAToday, NationalPost, Stockhouse, Lewrockwell, Pinnacledigest, UraniumMiner, Beforeitsnews, SeekingAlpha, MontrealGazette, CaseyResearch, 24hgold, VancouverSun,
CBSnews, SilverBearCafe, Infomine, HuffingtonPost, Mineweb, 321Gold, Kitco,
Gold-Eagle, The Gold/Energy Reports, Wealthwire, CalgaryHerald, ResourceInvestor,
Mining.com, Forbes, FNArena, Uraniumseek,
FinancialSense, Goldseek,
Dallasnews, SGTReport, Vantagewire, Resourceclips, Indiatimes, ninemsn, ibtimes, jsmineset and the Association of Mining Analysts.
If you're interested in learning more about
the junior resource and bio-med sectors, and quality individual
company’s within these sectors, please come and visit us at www.aheadoftheherd.com
***
Legal Notice / Disclaimer
This document is not and should not be
construed as an offer to sell or the solicitation of an offer to purchase or
subscribe for any investment.
Richard Mills has based this document on
information obtained from sources he believes to be
reliable but which has not been independently verified.
Richard Mills makes no guarantee,
representation or warranty and accepts no responsibility or liability as to
its accuracy or completeness. Expressions of opinion are those of Richard
Mills only and are subject to change without notice. Richard Mills assumes no
warranty, liability or guarantee for the current relevance, correctness or
completeness of any information provided within this Report and will not be
held liable for the consequence of reliance upon any opinion or statement
contained herein or any omission.
Furthermore, I, Richard Mills, assume no
liability for any direct or indirect loss or damage or, in particular, for
lost profit, which you may incur as a result of the use and existence of the
information provided within this Report.
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