In 2011 gold-mine production came in at an all-time record high. And in
2012 experts anticipate production to be even higher, edging above the
previous year’s 87m-ounce tally. From the looks of it, the major source
of gold’s supply is in fine fettle. But is the gold-mining industry
truly healthy?
In attempting to answer this question it is important to understand how
we got to the production levels we’re at today, and then take a look at
some of the structural fundamentals that may impact this industry going
forward. And in terms of how we got here, it was nothing short of remarkable.
Interestingly mine production had actually been on a pretty alarming
decline for a large portion of our current secular bull. Many folks forget
that it was just in 2008 that production volume had fallen to a 12-year low,
and that the miners were producing a full 10m ounces less than what they were
at this bull’s 2001 beginning.
Finally after many years of increased capex
towards exploration, development, and overall upgrades to this
industry’s infrastructure, 2009 delivered the first production increase
in years. And a now-three-year-running increase is something to behold.
Since 2008 gold-mine
production has experienced an average annual growth rate of a
staggering 6%. And this is especially impressive considering the
relatively static nature of mine production. Increasing output is not as
simple as turning a dial on a factory floor, as it takes many years of
development to build a new mine and/or increase capacity at an existing mine.
And when you take the natural depletion cycle into account, this 6% growth
rate is all the more impressive. A lot of big new mines and expansion
projects have come online in the last few years!
But though impressive, it doesn’t take a rocket scientist to
realize that this recent production growth rate is unsustainable. In fact,
some recent fundamental unveilings raise questions as to whether even the
existing rate of production is sustainable over time.
One major tell on the inner workings of the gold-mining industry is
exploration spending. Exploration spending is essential in feeding the
pipeline of next-generation mines, those that will be built to replace the
ones that are depleting. And depletion is of course accelerated on higher
production volume like we are seeing today. Faster-depleting reserves lead to
more pressure on the replenishment front, which naturally leads to the need
for more exploration spending. It’s a simple formula!
As one can imagine, gold’s secular bull has spawned a huge increase
in exploration spending. According to prominent research house Metals
Economics Group (MEG), gold exploration spending had seen a whopping 400%+
increase from its 2002 low to 2008 (~$3.2b). And though there was a huge dip
in 2009 as a ripple effect of the global economic crisis, spending has been
strong and on the rise ever since. But has it been enough?
Provocatively there’s an alarming trend unfolding on the
exploration-spending front that is likely to have a major fundamental effect
on the gold market. MEG points out that while exploration spending
hasn’t declined, there’s an interesting shift in the types of
projects attracting the capex.
It notes that over the last few years only about a third of exploration
spending has been directed towards greenfield (early-stage/generative)
exploration, with the majority going towards brownfield (near-mine)
exploration. Even more troubling than this historically-low ratio is the fact
that this industry-wide shift hasn’t resulted in a proportionate
increase in assets advancing through the development pipeline. Typically in
brownfield work the availability of infrastructure allows for fast-track
development, yet we aren’t seeing this.
On one hand I can see why the miners have become more risk-averse
considering the state of the global economy. It’s definitely less risky
to prove up reserves where positive mining economics are known to exist. But
this trend will have consequences on the reserve-renewal front.
While miners will occasionally make big discoveries via brownfield
efforts, for the most part the biggest discovery in a brownfield zone has
already been made. In general the major multi-million-ounce discoveries that
this industry needs in order to effectively renew reserves are a product of
greenfield exploration. And this brownfield bias has led to a lack of major
discoveries.
Interestingly there are a couple different ways we can put this lack of
major discoveries into context. First is some fascinating intelligence from
MEG’s latest study on gold-reserves replacement. According to this
study, there have been 99 gold discoveries of significance (deposits
containing 2m+ ounces) since 1997. MEG added up all the reserves, resources,
and production from these discoveries as of the end of 2011. And assuming a
75% resource conversion rate and 90% production recovery rate, the total sum
only had the potential to replace 56% of the gold mined during this
timeframe.
As MEG’s data clearly implies, gold discoveries are not even close
to keeping pace with mine production. There are of course numerous factors
contributing to this revelation. But the one that likely trumps them all is
the simple fact that large gold deposits are getting harder and harder to
find.
As gold’s scarcity rears its face, miners must expand their
exploration efforts. They must drill deeper, venture to places with rougher
terrains, and enter borders that may be hostile to their endeavors. These
conditions are characteristic of greenfield exploration, and are obviously
much more costly than brownfield work. And this cost differential perhaps
explains why spending is not where it needs to be on the greenfield front.
Drilling down on MEG’s study even more, this 56% replacement rate
is likely well on the high side considering some very liberal assumptions.
Even MEG acknowledges that the viability of this discovered gold is subject
to a lot of variables that could hamper its mineability.
Economics is of course the biggest variable. Many of these deposits are
of low-enough grade or high-enough geological complexity that their higher
extraction and/or processing costs require a much higher gold price to be
economical. If the price of gold retreats much, these reserves/resources
would quickly lose their economic viability.
Geopolitical risk is also a major variable. There are numerous amazing
deposits that have been discovered over the last decade that will likely
never be mined due to their location. Miners are constantly thwarted by
deep-pocketed environmentalists, unruly locals, over-regulation, and greedy
governments.
So you see even though 99 major discoveries seems like a lot over a
period of 15 years, in actuality it is nowhere near what is needed to replace
the gold that is being mined. And if the major deposits at best
are only able to replace just over half of production, I can only imagine how
many smaller deposits need to be discovered to fill the gap.
Speaking of gap fillers, this MEG research got me wondering more about
the world’s gold deposits. Wouldn’t it be nice to have a better
understanding of the asset base that supports current and future production?
And wouldn’t it be nice to have some intelligence on the biggest tier
of gap fillers, those in the 1m- to 2m-ounce range?
Thankfully our friends at Natural Resource
Holdings were in this same wonderment. So CEO Roy Sebag and his team actually took to the task of compiling
this information. After painstaking research that likely took thousands of
hours, NRH now has the most comprehensive database of the world’s large
gold mines and deposits that I have ever seen. And its 2012 ranking offers an
invaluable fundamental read on the world’s
asset base of gold deposits.
As part of its research NRH identified 439 deposits throughout the world
that currently contain over 1m ounces of resources (all categories). And in
looking at this data, I was smacked by the reality of how scarce this
precious metal really is. Of the tens of billions of dollars being spent just
to find gold, there are only 439 deposits of meaningful size on the planet to
show for it.
Interestingly in scrubbing up with MEG’s data NRH identifies 312
deposits that hold 2m ounces or more, which tells us that over two-thirds of
the world’s largest deposits had been discovered more than 15 years
ago. And of these 312 deposits, provocatively only 150 are currently being
mined.
On one hand it can be seen as encouraging that there is a large pipeline
of undeveloped major deposits for future use. But on the other hand it can be
seen as disturbing that there are so many deposits, especially numerous over
15 years old, that haven’t found their way to production in the current
market environment. The fact is many of these deposits will never see the
bottom side of a shovel, for reasons discussed above and more.
Of the world’s 127 gold deposits in the 1m- to 2m-ounce range, 39
are currently being mined. Again it is encouraging to see so much potential
for the next generation of mines. But I’m afraid the same variables of
uncertainty will again prevent many of these deposits from ever coming
online.
This NRH data also allows me to put into perspective the relevance of
deposits in this 1m- to 2m-ounce range. Interestingly these 127 deposits hold
a combined 181m ounces of resources. If all of these resources were converted
to mineable reserves with a 100% recovery rate, this would only be enough to
cover just over two years’ worth of mine production.
And to put deposits of this size into even more perspective, consider
their average annual run rates. To be very conservative, let’s assume
that these deposits are able to produce an average of 150k ounces per year.
In such a case the 39 operating mines would combine to contribute only 5.9m
ounces, which is less that 7% of total mined volume each year. While this
next tier of deposit size seems large, in the grand scheme of things they
collectively only make a small dent in the total supply. And this realization
clearly shows the need for major deposits.
Per NRH, of the major deposits 33 hold greater than 20m ounces (19 in
production), 41 hold between 10m to 20m ounces (24 in production), 74 hold
between 5m to 10m ounces (40 in production), and 164 hold between 2m to 5m
ounces (68 in production). Though this provides the gold-mining industry with
an inventory of 162 major undeveloped deposits that have the potential to
replace production and reserves, it’s just not enough.
And to make matters worse, there’s another prevailing trend that
doesn’t bode well for the structural integrity of the mined gold
supply. With much higher input costs and uncertainty with the global economy,
many miners have been holding off on the development of their major deposits.
Even if these deposits are economically viable with high rates of return,
lenders and investors are hesitant to fund the $1b+ it would take to build a
decent-sized mine.
So circling back around, is the gold-mining industry healthy?
Unfortunately if you peel away the excitement of record production in recent
years, I’d say no. Gold discoveries are not keeping pace with mine
production, exploration spending trends are not conducive to finding major
deposits, the inventory of large-sized deposits is thin, and development capex is harder to come by. The future looks bleak for
reserve renewal and ultimately sustaining current production levels.
So as investors, how can we apply this information to our investment
strategies? First is these major structural issues offer huge support for
gold’s long-term fundamentals.
So long as the demand for gold stays strong, which it ought to, supply
will be strained as the lack-of-major-discovery-spawned lower-reserve-renewal
rate catches up with the gold miners. And this will keep gold prices high!
Gold stocks should also continue to be great tools to leverage
gold’s strength. Most of the world’s largest producers are
publicly traded. And according to MEG it is the big ones that are doing the
best job replacing their reserves, with the top 26 producers (600k+ ounces in
annual production each) collectively replacing 208% of their production over
the last decade. But though this replacement rate is impressive, the larger
gold stocks aren’t necessarily the best investments.
Interestingly only about half of these top-26 producers had actually made
a major discovery over this timeframe. With a collective two-bagger
replacement rate for the group, there are obviously some miners that made
elephant-sized discoveries to cover more than their share. But to no
surprise, a large chunk of this replacement was via acquisitions. With robust
treasuries and easy access to credit, these major producers aren’t
afraid to swing around their financial weight to get what they need.
From an investment perspective it isn’t actually the large
slow-moving majors that offer the greatest returns, but rather the smaller
mining companies that act as feedstock for the big boys. And the juniors
especially offer huge potential considering their bias towards
greenfield-style exploration. Some of the biggest and best major discoveries
have come at the hands of the junior explorers.
Now if you’ve been at all attuned to the gold-stock sector, you
know that juniors are in a tough place right now. Their stocks have been
getting crushed with the rest of the commodities sector. And with a business
model that relies on equity investment, their losses are way outsized. But as
a critical component of the global gold supply chain, the majors simply
couldn’t survive without them.
Juniors’ fortunes are bound to change soon as the gold-mining
industry starts to realize its shortcomings. And because they are so beaten
down, investors now have one of the best opportunities in gold’s bull
to buy them for cheap.
At Zeal our last several research reports
profile our favorite high-potential gold juniors. So if you’re
wondering which junior gold stocks are likely to thrive in the years ahead, buy your report today! And to find out which ones
we are specifically recommending in our acclaimed
weekly and
monthly newsletters, subscribe today.
The bottom line is the gold-mining industry has done a fine job rising to
the challenge of increasing production in order to meet higher demand. But
behind the curtains are some health issues that ultimately lead to a lack of
fundamental support for the future of this industry.
The fact is major gold deposits are getting harder and harder to come by.
And this is reflected by a global development pipeline that is woefully short
of where it needs to be. Until exploration spending rises and the miners hit
the hills for more greenfield discoveries, reserve renewal will continue to
be a major challenge.
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