The outlook for many junior resource companies in 2013 is grim so investors should focus on those who own quality undeveloped gold and silver deposits in safe stable countries. Such companies offer exceptional value in that they provide the best exposure to a rising precious metals price environment – and have the assets the world’s mining companies desperately need. [Let me explain.] Words: 1328; Charts: 15
So writes Richard (Rick) Mills (www.AheadoftheHerd.com) in edited excerpts from his original article* entitled Golden Points To Ponder.
This article is presented compliments of www.munKNEE.com (Your Key to Making Money!) and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.
Mills goes on to say, in part:
You need to find:
- the quality management teams with money in the treasury and the ability to raise more,
- 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 in a geo-politically safe country.
These companies are the world’s future gold/silver producers and of course many will be in the sights of mid-tier and major producers for takeover candidates as reserve replacement targets.
Increasing Exploration Spending
Lagging Production & Discoveries vs. Demand[As the graph to the right shows] the gold mining industry needs to discover 90 million ounces of gold every year just to stay even but despite increased exploration expenditures, a record US$8b in 2011, and an increasing gold price, gold ounce discovery is not keeping up to the rate needed to replace mined ounces.
The Metals Economic Group estimates that the 99 significant discoveries (defined as greater than 2 mil oz) found between 1997 and 2011 replaced only 56% of the gold mined during that same period.
According to the Thomson Reuters GFMS’s Gold Survey 2012 global gold mine production was flat (output rose 0.1% to 1,366 metric tons) in the first half of 2012.
Declining Ore Grades[As can be seen in the chart below] the average grade of ore processed globally dropped 23% from 2005 through the end of last year and is forecast to decline another 4% in 2012.
The declining mined and mineable gold grade is a direct result of the industry’s inability to discover new high grade/high margin deposits.
Rising Costs of Mining
The GFMS 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
Average operating/cash cost figures include only those costs directly associated with the production of the gold such as;
- Cost of energy
- Raw materials such as steel, explosives etc
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.
In Consolidation Since 2011
The long term gold price chart from the World Gold Council [below] shows gold has been in consolidation since late 2011.
Escalating Capital & Operating Expenditures
Capital inputs account for about 50% of the total costs in mining production – the average for the economy as a whole is 21%. Obviously many of the costs, once incurred, cannot be recovered by sale or transfer of the fixed assets.
Mining is an extremely capital intensive business for two reasons:
1. [As the charts show below] mining has a large, up front layout of construction capital called Capex – the costs associated with the development and construction of open-pit and underground mines. There are often other company built infrastructure assets like roads, railways, bridges, power generating stations and seaports to facilitate extraction and shipping of ore and concentrate.
Capex costs are escalating because:
- Declining ore grades means a much larger relative scale of required mining and milling operations
- A growing proportion of mining projects are in remote areas of developing economies where there’s little to no existing infrastructure
2. There is a continuously rising Opex, or operational expenditures [as the graph below shows]. These are the day to day costs of operation; rubber tires, wages, fuel, camp costs for employees etc.
The bottom line? It is becoming increasingly expensive to bring new mines on line and run them. As David Quinlin, European Mining Lead, Deloitte Switzerland says, “In the next few years, escalating costs, talent shortages and competing infrastructure builds will make it very difficult for mining companies to complete their capital projects on time and on budget. These types of cost and time overruns can create significant risks for miners, including the danger of scaring off potential investors.”
Since 2006 the major gold producers have spent 40% of their entire market capitalization building new mines. As you can see in the chart below it isn’t going to get any cheaper – major miners will need to spend 60% of their market capitalization building new mines in order to sustain the same level of production going forward.
The major gold producers desperately need to replace their mined gold reserves yet can’t afford to build many of the large deposits slated to be built.
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
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
Declining Market Capitalization
Junior market caps have been savaged:
- 25% of the stocks on the TSX.V are under $0.05,
- 25% are between $0.05 and $0.10,
- 20%, are between $0.10 and $0.20
- 10% are between $0.20 and $0.30
- 13% are between $0.30 and $1.00 and
- only 7% trade above $1.00
Low Direct Ownership of Reserves
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% of the reserves and resources in the 99 significant discoveries made in the past 15 years.” Metals Economics Group (MEG)
Extremely Poor Financing Environment
The junior exploration sector is presently in the midst of one of the worst financing environments ever experienced by the sector. One market analyst recently said that out of the 1800 companies he tracks, as many as 524 have less than $200,000 in working capital.
With today’s extremely low share prices, financing – if money is even available – is going to massively dilute shareholders forcing a tremendous number of future rollbacks.
Financing for many juniors is going to be challenging – very ironic that just a few short years ago, with gold at only $400 oz, it was much, much easier to raise money then today with gold at $1700.00 oz! Those juniors with some money, and not wanting to excessively dilute shareholders raising more with devastated share prices, will conserve their cash and drastically cut expenditures.
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. The juniors who do have money for exploration and development of their properties, and those few who can get financed, will be well rewarded in the market place for discoveries and bringing the lowest cost projects to production.[That being said,] the outlook for many juniors in 2013 is grim; many will not survive. Expect rollbacks, property sales for cash, shares for debt and mergers and acquisitions (M&A) to become the norm. Exploration will drop, the discovery of the future supply of gold, silver and other metals will be put on hold.
[Nevertheless,] this author believes that there is exceptional…value in junior companies who already own quality assets in safe stable countries that the world’s mining companies increasingly, desperately need.
*http://aheadoftheherd.com/Newsletter/2012/Golden-Points-To-Ponder.htm (Ahead of the Herd has posted a short list of junior resource precious metal companies with defined deposits operating in North America. The AOTH list is free, you may access it here.)
The timing of this article may seem incongruous given the current weak performance of gold and gold stocks but that was the identical situation in each of the past manias – both the metal and the equities didn’t excel until the frenzy kicked in. The following documentation (exact returns from specific companies during this era are identified) is actually a fresh reminder of why we think you should hold on to your positions – or start accumulating them, if you haven’t already. (Words: 1987; Tables: 7)
Hedge fund manager Hugh Hendry has stated, “There is no rationale for owning gold mining equities. It is as close as you get to insanity. The risk premium goes up when the gold price goes up.” Indeed, the notion that adding gold and other commodities to one’s portfolio produces a higher expected return with lower risk failure has failed of late and can be illustrated through the following charts. Words: 808
There is enough risk in investing without the added risk of political instability so why does the investment community often use the same metrics to value the shares of exploration and production of resources companies regardless of their location in the world? This is so very wrong, yet it continues. Frankly, when investing in the stock market you should ALWAYS discount the value of the stock that you are considering buying if the jurisdiction is not historically safe, stable, and economically strong. [Let me explain further.] Words: 746
While juniors, mid-tiers and large producers will usually bottom around the same time, they each outperform at different times. In this missive we look at some charts to decipher when its time to buy [each category and when one or the other] should be avoided. Words: 470
I think the junior gold miners sector could up ten fold over the next few years based on gold just going to $3,000 or $3,500 [let alone to] $5,000 or $10,000 which I think is possible. Here’s why.
We’re invested in gold stocks not just to make money, but for the chance to change our lifestyles and with their lackadaisical [dare I say dismal] year-to-date performance, one may begin to wonder if they’re still going to bring the magic. [Here are my views on the subject.] Words: 740
All you gold bugs out there (and budding gold bugs too!) should find this article of extreme interest. With gold about to make a major move upwards in price NOW is the time to position your gold-investment allocation to maximize your dollars deployed and returns generated. Those in the know will not be investing in physical or paper gold, or even the stocks of the miners, but in the long-term warrants of the very few mining companies that offer such an opportunity. This article provides a primer on the MAJOR advantage that long-term warrants have in a market upleg and identify the specific warrants that are available. Words: 1037
With all the interest in physical gold, silver and other commodities these days, and the large/mid-cap companies who mine the metals and the juniors who are exploring for them, it begs the question: “Why is no one writing about the merits of investing in the long-term warrants associated with a few of those companies?” Merits? Absolutely! Here is a primer on virtually all that you need to know about warrants and how to invest in them for major profits. Words: 3278
With gold recently trading at its nominal high it is only natural that investor curiosity about precious metals mining companies should start to grow and the fact that relatively few investors know much about the various types of companies in this market sector is an indication that this market is many years away from peaking. [This article will change all that.] Words: 1912
While investing in gold mining companies is not quite as simple as novices to this sector might at first conclude, neither is it so overwhelmingly complicated as to make these companies inaccessible to individual, retail investors. Below are a number of things to look for when considering an investment in such companies. Words: 2745
With gold miners, in general, so attractively valued relative to the gold bullion price, the question becomes which stocks are the most compelling and have the best leverage to robust precious metals prices…In order to find the diamonds in the rough, I use what I call “The Five M’s” for mining stocks… Market cap, Management, Money, Minerals and Mine life cycle. [Let me explain each .] Words: 1146
I had previously expressed personal interest in buying into this fund – as a relatively “safe” and diversified investment (within this sector). However, should the fund managers choose to invest heavily into derivative investments, the actual holdings of mining equities could be limited, and thus not offer an amount of diversification to justify experienced investors into putting money in this fund – and certainly the “safety” I had hoped for is also not present. Words: 868
In mining exploration, an “anomaly” is a geological formation that might attract a prospector’s interest. However, one rule of thumb is that you have to look at 1,000 anomalies to find one prospect and fewer than one prospect in a thousand turns into a mine. In other words, finding a mine is a million-to-one shot and that is one reason why junior mining stocks are highly speculative. Another reason is that it’s much easier to launch and promote one of these stocks than it is to build a profitable business. So junior mines attract more than their share of unscrupulous operators and stock promoters. Words: 504
Leverage is the simple answer. It is not uncommon for junior mining companies to experience huge gains (10x or more) very quickly as news of a discovery is made known to the public. Words: 893