-- Posted Wednesday, 18 September 2013 | | Disqus
Source: Karen Roche of The Gold Report
Many mining companies find themselves in a high-grading dilemma, according to Brent Cook, publisher of Exploration Insights. As companies deplete higher grade reserves, they have to acquire new deposits. But unless you are a geologist, don't look to NI 43-101s to always give you reliable information about the quality of a resource. They often don't provide the data needed to make intelligent decisions, says Cook in this interview with The Gold Report. Cook is interested in investing only in world-class deposits.
The Gold Report: Brent, in your August newsletter, you rant about high grading. For our readers who are not familiar with that practice, can you give us a brief explanation?
Brent Cook: Most mine plans or mine reserves are laid out using an economic cutoff grade based on a specific gold price and specific production cost assumptions. Using an example of 0.5 grams/ton (0.5 g/t) as a cutoff grade, any rock pulled out of the mine under 0.5 g/t is waste; you lose money mining it. That's the difference between waste and ore. With ore, you make money. With waste, you lose money.
Say a company based its cutoff grades on a gold price of $1,500/ounce ($1,500/oz). When the price drops below that level, some of the rock that used to be ore becomes waste. To fix that problem, a company goes to its mine plan and selectively mines the higher grade portions of the deposit. That makes perfect sense and the company needs to do that. But down the road, the grade of the material that was meant to be mined but was instead left in the ground is likely to be too low to be mined economically, barring significantly higher metal prices.
The net result is that, unless gold prices go way up, a company's stated reserves will decrease with the lower gold price assumption. The total number of ounces in the reserve will decline because the grade of the remaining rock, the rock that was left behind during the high grading of the deposit, was marginal to begin with and is now probably uneconomic.
TGR: If the reserves go down, there would be a corresponding decrease in the value of the company. Is there anything wrong with management keeping a company viable, even if the share price has to go down a bit?
BC: There's nothing wrong with that, and it is what management has to do. But it means the ounces the company was going to mine in the future go away. Its business has shrunk. The company has to find more ounces to replace what was lost by high grading a deposit. And again, I want to emphasize this is all gold-price and production-cost dependent.
TGR: Are companies high grading just to prove out a project, to position it for sale?
BC: No. Most active mines have the ability to adjust the mine plan to current price conditions, unless they are marginal and uniformly low grade to begin with. When the gold price changes or operating costs go up, the whole mine plan changes. What was probably scheduled future production may no longer be economic. That's the problem.
TGR: Is that good news for advanced explorers and near-term producers?
BC: It depends on the quality of what the junior companies own. As a whole, the major mining companies are producing about 80 million ounces gold (80 Moz)/year. My expectation is that, at some point in the near future, they will be in desperate need of new economic deposits because they don't have the reserves to keep production at the same level. This is particularly true of companies with deposits that are marginal at, say $1,400/oz gold. Those companies are high grading out of necessity now and more than likely sterilizing significant portions of their deposits.
This loss of quality reserves is leading to an ideal setup for speculators in the junior mining industry who are identifying and buying those few deposits that make money at lower gold prices. I'm convinced that once mining companies come out of their foxholes, they will want to acquire the few high-grade, high-margin deposits held by juniors.
This is an opportune time for us in the junior end of the business, even though it doesn't feel like it.
TGR: What will motivate mining companies to get out of their foxholes, as you say?
BC: I think it will be the realization that they lack the high-margin reserves needed to keep making money. They weren't ready for the shock of gold dropping from $1,800 to $1,200/oz. In response, they cut exploration and development dramatically and have started high grading.
All of that will bite them, because without new deposits, without new reserves, they don't have a business. As I have reiterated many times in Exploration Insights, one day the board of directors will turn to company management and say; "All right, bring on the new high-margin deposits. We are running out of ore." At that point management will have to explain that it fired all the geologists, shut down exploration, curtailed development and ain't got nuthin' new. There is only one solution: Go out and buy a good deposit.
TGR: At what gold price can lower grade mines become profitable? Do we need a $1,500/oz gold price to stop the high grading?
BC: It depends on the individual deposit. Previously, the gold industry talked a lot about cash costs—what it costs on a cash basis to produce an ounce of gold. However, cash costs don't include all of the other costs that go into keeping a mine going: general and administrative expenses, taxes, exploration and development costs, and sustaining capital costs.
Now companies are switching to reporting all-in sustaining costs, which includes just about everything it takes to produce that ounce of gold. Depending on the company, all-in costs are between $1,300 and $1,500/oz, even $1,700/oz. You can see the problem. Companies can cut costs by laying people off, stopping exploration and development, but that kills their business. It goes back to the need for high-margin deposits.
If readers of The Gold Report contact us, I'll send a newsletter detailing sustaining costs and cash costs, what it really costs to mine an ounce of gold. Just select the "Contact Us" tab at www.explorationinsights.com and request the gold cost letter.
TGR: You've told us that before people start investing in exploration and speculative companies, they need to know what a company is looking for. That includes understanding the test results and being able to compare them to expectations. One way to do that is through NI 43-101 reports, but you believe that NI 43-101s provide a false sense of security. How do investors know what information to use?
BC: That's a really good question, and there's no single answer. The NI 43-101 reports are predominately intended to provide sufficient disclosure for an educated investor to make an informed investment decision. It's a regulatory document that describes what you can and can't say. But here's some interesting results from a review of 50 NI 43-101 reports by the Ontario Securities Commission: Eighty percent had some sort of error; 40% had a serious error or were missing information that should have been included.
What it comes down to is that a lot of companies are not giving us the data we need to make intelligent decisions, be it detailed cross-sections, or detailed information on how costs were calculated. That needs to be addressed because all of us in the mining sector need to have confidence in a report's conclusion based on the backing data.
In my opinion, too many resource estimates do not adequately address geological and structural controls to mineralization. Computer jockeys who are really good at plugging numbers into spreadsheets are coming up with results that do not honor the basic geology. That gives people a false sense of security that because the resource is in a spreadsheet with lots of fancy math it has to be legitimate. One needs to be careful.
TGR: What additional data would help investors make intelligent decisions?
BC: Too few NI 43-101s provide the cross-sections to prove where the company draws the line between ore and waste—what the criteria are and how these decisions were arrived at.
Admittedly, a lot of this is subjective and bear in mind the resource estimator is extrapolating the resource from very limited data that, volume-wise, represents less than 1% of the rock. For instance, I could look at 100 drill holes and come up with a different resource than somebody else. It's tough to know who's right or wrong and that is just the nature of the beast.
TGR: How does someone who's not an expert make more informed decisions, short of becoming a geologist?
BC: It isn't easy. Ultimately you do have to rely on the NI 43-101s: Is the documentation there and correct? Who did the documentation and who paid to have it done? Many reports are just sales documents and all too often an engineering firm will assign a less exciting job to its "B" team.
Essentially, you have to rely on an expert. That could be a newsletter writer, an analyst, a relative in the industry or your brokerage firm. You need the advice of someone who knows the industry.
TGR: I like the way you concluded one of your recent rants, "High-quality, high-margin metal deposits are going to become increasingly valuable as current operations are depleted and production begins to decline. This eventuality makes our jobs relatively straightforward. Own the best deposits and discoveries and hope like hell some government doesn't steal them." Which companies have the best deposits?
BC: There are two aspects to answering that question: The first is owning the best deposits. The second is identifying them early on and buying at the right price. There are projects that are great deposits, but are over- or fully valued now.
TGR: How much additional upside is there if the copper or gold price begins to rally?
BC: I would say a fair bit. If copper or gold rallies, anyone with a deposit stands a chance of going up. We saw that in late August when the rising tide took most companies up, good or bad.
TGR: Are you looking at any other new metals or projects?
BC: I looking at something every day. Nothing has come across the radar screen lately that really excites me and hasn't been discussed in my letter.
TGR: Here's hoping you find some excitement soon. Brent, I appreciate your time and your insights.
Brent Cook brings more than 30 years of experience to his role as a geologist, consultant and investment adviser. His knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. Brent's weekly Exploration Insights newsletter focuses on early discovery, high-reward opportunities, primarily among junior mining and exploration companies.
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-- Posted Wednesday, 18 September 2013 | Digg This Article
| Source: GoldSeek.com
