Mining has a well-worn adage, “grade is king”. While that may be true in
some situations, it’s the opposite in others, where a lower-grade deposit
can actually reap more profits.
This is especially true if the mine is underground, where the high costs
of labor and specialized mining equipment, plus the difficulty mining veins -
digging deep requires a lot of material to be blasted and moved - means that
margins are often squeezed to the breaking point. A steep, sustained drop in
the gold price can spell disaster even for a high-grade underground gold mine
like Pretium’s Brucejack in northern BC (average grade 14.1 grams
per tonne). It’s just too expensive to make a profit in a high-cost,
low-price environment.
In contrast, a low-grade deposit with a lot of scale, or scalability due
to expansion potential, can easily outperform a high-grade beauty, long-term.
The lower grades are made up for in tonnage, and depending on the operation,
processing costs. Oxide gold ore can be heap-leached fairly cheaply, for
example. This combination of factors - low grade + scale + low cost - can
often withstand a price downturn.
It’s a bit like the tortoise and the hare - “slow and steady wins the race”.
This article will take a closer look at low-grade versus high-grade gold
mines, placed into today’s macro-economic climate, which is very bullish for
gold.
Attention! Yield curve inversion!
Smart gold investors follow the Treasuries market. Why? Because they are
backed by the US government, US Treasury bills are the safest financial
instrument out there, so the movements of the T-bond market are a strong
indication of how investors feel about the US economy. This in turn affects
the US dollar and the price of gold. Gold and the dollar move in opposite
directions: As the dollar rises, gold goes down, and vice versa. This is gold
investing 101.
10-year
Treasury yield falls to 14-month low, signaling possible trouble with economy
Gold investing 201 is watching the yield curve. Yields are the amount of
interest a T-bond - which ranges in maturity from one month to 30 years -
will pay. As bond prices rise, yields fall. Normally the “yield curve” slopes
upward, because the longer the term, the more interest the T-bill must charge
to attract investors.
The more interesting thing to watch is when the yield curve starts
behaving out of the norm, like currently. If investors think the US economy
will perform better in the short term than long term, short-term yields (say
one month to two years) increase more than multi-year or multi-decade
T-bills. For economic forecasters, this is a bad sign. It
means that more T-bond market investors believe that the economy is slowing
down. They would prefer to park their money for the time being, to wait it
out and see what happens. They don’t want to be stuck in a long-term
investment. It’s a bit like choosing a one-year or variable rate mortgage
versus a five-year term, if you’re wary of interest rates going up.
Anyway, this is just background to understand what happened on Wednesday,
March 20. Following the US Federal Reserve’s decision not to raise interest
rates any higher in 2019, the yield curve inverted. (well to be more precise,
the yield curve between the 3-month and 2- and 5-year bonds inverted) Yields
for the 3-month bond rose to 2.478%, versus a respective 2.39% for the 2-year
and 2.31% for the 5-year. These don’t seem like large differences, but it’s
all about perception.
Meanwhile the yields on two key long-term bonds, 10-year and 30-year,
dropped, by a respective 2.519% (-8 basis points) and 2.957%.
In fact the 10-year yield plummeted to a 14-month low, showing that
earlier fears of a recession, when the yield curve inverted in December, are
getting downright scary.
On December 3 the 2-year Treasury yield rose above the 5-year yield
(another bad economic sign), and remains at its flattest (a very small
difference between the two) since May 2007, CNBC
reported.
Check out this link to economic forecasting blog Mish
Mash, showing a table of yield curves on December 18 versus March
20. The spread between the 3-month and the 10-year yields is just 8 basis
points. The 10-year bond dropped that much in one day this
week! In other words, this is very close to an inversion. The 10-year and
2-year rates have already inverted, at 2.402% for the 2 and 2.541% for the
10.
Doves beating hawks
Not only is the Fed not going to raise interest rates, which would have
shown confidence in the US economy, it’s going to end the so-called “runoff
of bonds from its balance sheet”. The central bank was doing this in order to
reduce the $4.3 trillion in purchases of Treasury bills and mortgage-backed
securities (MBS) it racked up through quantitative easing. In other words,
it’s been reducing the size of its balance sheet by not replacing maturing
Treasuries and MBS.
When Fed chair Jerome Powell said on Wednesday the runoff would end, the
signal to investors was that the Fed would start buying bonds again. This
increased demand for bonds, which hiked their prices, and lowered yields. The
Treasury yield is the first mover in setting interest rates and mortgage
rates. For example the US 30-year mortgage rate is usually one or
two percentage points above the yield on the 30-year T-bond.
After Powell’s dovish move, mortgage
rates fell, from 4.40% to 4.34%, which is quite a drop from the 5% it hit
in November. Mortgage rates are a key indicator of how the economy is doing
because of their connection to home sales. Falling mortgage rates encourage
spending on houses, typically a family’s biggest-ticket item, so the central
bank is implicitly trying to heat up the economy.
This is in contrast to the Fed’s more hawkish policy since 2015,
when it started raising rates as the economy recovered from the 2008-09
recession. The 2015 raise was the first time that happened since 2006; it’s
been gradually raising interest rates from the near 0% level they had been at
since 2008, to 2.5% in December 2018. Now the Fed has backtracked on further
increases even though it had been suggesting three more in 2019. The doves
are beating the hawks.
Trump’s low dollar and gold
The question is why? Economist Nouriel Roubini, who teaches at
New York University’s Stern School of Business, provides
some explanations.
According to official Fed policy, the interest rate freeze this
year is due to concerns about growth. It now expects the US economy to grow
by just 2.1% this year versus 2.3% it predicted in December. This is not so
much due to problems with the US but problems with its trading partners.
Europe is already in recession, who knows what’s going to happen to the UK
after it finally cuts its ties to the European Union, and China and Japan are
slowing. When America’s main customers are hurting, so is the US.
There is something to this explanation of the Fed’s volte-face, but we
don’t think it’s the real reason. Give you a hint: it rhymes with bump and
lump. Donald Trump has been railing against Fed chair Jerome Powell for
months, over his hawkish rate stance. See the tweet below Trump fired off in
December after the Fed raised rates.
And the White House disagrees with the Fed’s assessment of economic
growth predicting
in its 2020 budget proposal an economy growing at 3.2% in 2019.
Why does Trump want low interest rates? Because he wants a low dollar, to
counter the trade deficit he campaigned on beating.
In fact the opposite has happened. The buck gained against a
basket of other currencies (US dollar index - DXY), rising from April until
December 2018.
What kept the dollar high? It was mostly the purchase of US
Treasuries, a safe haven in response to lots of global uncertainty,
including the stock market correction last fall and Brexit. That increased
global demand for US dollars. The dollar was also lifted by the Fed raising
interest rates.
This was the opposite of President Trump’s plan to keep the dollar low, in
order to make exports cheaper and improve the widening trade deficit.
According to the US Department of Commerce, the country’s trade deficit
was $59.8 billion in December, the widest it’s been in a decade, and $891.3
billion for 2018, the biggest annual trade gap in goods (difference between
goods imports and exports) ever.
Trump wants to bring jobs back to the US after many were exported abroad
to take advantage of lower labor costs, and therefore rebuild the US
manufacturing sector. A low dollar would goose exports and reduce imports,
thus narrowing the trade deficit.
For more on this read our Why
the record US trade deficit is good for commodities
So far this year the dollar has been up and down, neither helped by the
US-China trade war, which has seen US exports like cars and soybeans fall,
nor hindered by the December rate increase.
The question is, will Trump keep hammering away at the trade deficit, by
returning to the low-dollar policy he favors? It certainly appears likely.
The Trump Administration has succeeded in pressuring the US Federal
Reserve from backing off further increasing interest rates, which would push
up the dollar. In fact, there is now talk of even lowering rates. Former Fed
chair Janet Yellen said so when asked for her thoughts on whether the central
bank will pursue a tight or loose monetary policy this year.
Interviewed
on CBNC, Yellen said weakened economies in China and Europe are a threat
to the strong US economy. If that continues, a rate cut might be in the
cards.
“Of course it’s possible. If global growth really weakens and that
spills over to the United States where financial conditions tighten more and
we do see a weakening in the U.S. economy, it’s certainly possible that the
next move is a cut,” she said. “But both outcomes are possible.”
A weak dollar usually means stronger commodities prices. Because the USD
is the reserve currency and commodities are traded in dollars, the value of
the dollar is of crucial importance in determining the value of the commodity
in question.
For gold, a weak dollar usually causes a rise in the gold price. We know
that negative real interest rates (interest rates minus inflation) are
bullish for gold. That would occur if the rate of inflation goes above
interest rates. We’re not there yet, but if the Fed does cut rates and there
is another QE, which is really printing money to buy bonds, we could be
looking at another up-leg in the gold price.
Gold jumped to a near three-week high on Wednesday after the Fed rate
freeze decision. A panel of 22 gold analysts surveyed by Focus Economics sees
the precious metal rising $30 an ounce to average $1,350/oz a year from now.
Analysts
at the World Gold Council also weighed in on the price, stating that
historically, gold tends to do well when the Fed switches from a tightening
(raising rates) to a neutral stance, although gold bulls may have to wait a
few months.
According to Incrementum’s 13th annual compact In Gold We Trust report
released this week, the current uptrend in gold stocks is relatively weak,
leaving “plenty of upside potential” said
MINING.com, quoting from the report.
If we assume that the gold price continues to do well, and it’s not a bad
bet, considering the doves at the Fed are now in charge, the best leverage
against a higher gold price is an investment in junior gold companies.
When a gold junior drills a discovery hole, the stock can pop by 100, 200,
300 percent. Of course timing is crucial, and volatility is high,
but that’s part of the fun…
Obviously, one must choose carefully from the lengthy list of companies
all hoping to hit the motherlode. Considering only one project in a thousand
becomes a mine, the odds are against you. But there are tried and true
criteria. Along with the management team, jurisdiction, nearby infrastructure
and a tight share structure, I focus a lot on grade and scale.
The market loves high grade, and so do we (one of our stocks, Aben Resources
(TSX-V:ABN) rocketed 138% last summer after hitting jewelry-box-style
mineralization), but it’s not the be all end all, as mentioned at the top.
Learn to love low grade
The best example of low-grade success is Nevada’s Carlin Trend. Carlin-style
deposits contain disseminated gold, meaning the gold is microscopic but
spread widely throughout the orebody. The gold is also near-surface and
oxidized, meaning it is amenable to heap-leaching.
Loading the ore onto a heap leach pad and irrigating the pile with cyanide
is one of the least expensive (the only cheaper method is gravity separation)
forms of gold processing. The technology, which started in Nevada, was a
major breakthrough - it put Nevada on the map as the most important
state for gold mining.
According to the US Geological Survey, if Nevada was a country, it would
be the world’s fourth-largest gold producer.
Barrick’s Cortez mine complex personifies the idea that scale trumps
high-grade.
The mine actually consists of the Pipeline open pit and Cortez
Hills, mined via open pit and underground. Between 1969 and 2015 Cortez
produced 20.010 million ounces, but it’s far from done. The most
recent technical report shows 11.2 million ounces of proven and
probable reserves, at a lowly 1.83 grams per tonne.
Compare this to the 10 highest-grade gold mines in the world according
to this
2017 report - 4.5 to 7.6 g/t open pit, and 15.2 to 21.5 g/t
underground.
Barrick is working on two major expansions at Cortez. The Deep South
Project has 1.7 million ounces in reserves, and once in production by 2022,
would add another 300,000 ounces a year. Barrick also has a greenfield
discovery six kilometers from Cortez Hills. The Goldrush deposit has another
8.6 million ounces of measured and indicated resources. Cortez is one of
those mines that keeps on giving, and at around $520-$550 per ounce all-in
sustaining costs, it still makes money despite low grades.
Another example of a low-grade Nevada operation is SSR Mining’s Marigold
mine. At an ultra-low-grade 0.46 g/t, Marigold is a high-margin producer
because since 1989, it’s been a run-of-mine operation. The blasted ore goes
directly onto the leach pad, without crushing or grinding, saving significant
costs. In the third quarter of 2018 Marigold reported AISC of $965/oz,
against a $1,207/oz gold price.
Nova Scotia had always mined its gold underground up until Atlantic Gold
proved it was possible to make a profit from a surface operation. Its Moore
River Consolidated (MRC) project has a 1.5 g/t grade but a very low strip
ratio (0.76:1), allowing the company to save on earthmoving. The 200,000-ounce
operation has an AISC of $528 an ounce, versus $1,250/oz gold, netting a
healthy $717/oz profit. Half of the gold is recovered by extremely low
cost gravity separation and the rest by heap leaching.
The Yukon is a third jurisdiction that proves high-grade isn’t always
king. The site of the Klondike Gold Rush has yet to produce a mine, but its
first one is under construction. Victoria Gold’s Eagle mine has an average
grade of just 0.67 g/t but its 4 million ounces of measured and indicated
gold gives it impressive scale.
Goldcorp’s Coffee project, which it purchased from Kaminak Gold
for $520 million, is no slouch either. Like Eagle the grades are low, just
1.4 g/t, but its 2.1 million ounces of probable reserves were no doubt what
clinched the deal with Goldcorp.
Conclusion
High-grade gold mines are like the girl you ask to dance, but a low-grade
deposit is the one you bring home to mom. High gold grades are what excites
the market, but it’s scale that gives a mine longevity, making the high
capital expenditures worth it.
The US Federal Reserve has indicated no more rate hikes this year. The
inverting yield curve is flashing “R” for recession, an environment that gold
tends to do well in. Even if there’s no recession, and we hope there isn’t,
lower rates will weigh the dollar down, pushing commodities up, including
precious metals.
Now is a good time to be looking at gold explorers with size on their
side. The gold price hasn’t yet enjoyed the run it did last year around this
time, but the economic fundamentals are setting up nicely as companies map
out summer exploration programs.
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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