While I'm bullish on gold, the very real problem of skyrocketing production costs has cast a pall over the near-term prospects of top-tier producers. Coupled with weaker bullion prices, investor sentiment has turned neutral/negative, resulting in a "cascade effect" all the way down to junior explorers, some of which are 90% off their two-year highs.
That's great news for those of us who are buying. And while it's true that exceptional value can be found in select exploration stocks, that's not my focus in this post. Rather, I want to point to the emerging producers as a niche opportunity which could pay-off handsomely for patient investors. Here's why:
Established gold producers are reeling from chronic inflation, resulting in total cash costs of around $1,100 USD per ounce, on average. Some analysts put the number higher. Miners' operating costs plus capital expenditures, per ounce produced, have risen about 15% each year for the past several years. And although energy, equipment, and general inflation have all played a role, I see the cost of skilled labor as the most serious issue.
As a result of runaway costs, new projects have been delayed or indefinitely shelved. As an example, last year the world's largest miner, Barrick (ABX), said it would postpone $4 billion in planned spending, and that its Pascua Lama mine would end up costing more than $8 billion rather than the $3 billion that was originally supposed. Of course, the carnage hasn't been limited to Barrick --- all major producers have felt the pain.
This has led to weak stock performance, and several top executives being replaced --- see here and here. Investors have temporarily abandoned the producers, from top-tier right down to emerging --- and that's their mistake. For those who are willing to sift through the research, there are some gems, especially amongst the junior miners. By "junior" I'm not meaning explorers but rather those junior mining companies which are producing but at a rate of less than 100 thousand ounces per year. That number is arbitrary on my part. The business model for these companies is to either transition to mid-tier status or be acquired.
As far as production costs go, it can be all over the map. A junior producer's cost per ounce is often significantly higher than its larger counterparts because it lacks economies of scale. Plus, their deposits can tend to lower quality --- in grade, metallurgy, or both.
But where the junior producer excels is in its ability to survive, remain nimble, and move projects forward. It will tend to outperform a major because it has more room to grow. To go from 100 thousand to 200 thousand ounces per year is more achievable than a major going from 5 million to 10. The small company provides more upside, faster --- but naturally has greater risk.
Examples of companies which have succeeded at this game are plentiful. Alamos Gold (AGI) comes to mind --- it began producing 6 years ago at around 100 thousand ounces per year. It's now expecting to produce 180 thousand ounces in 2013. A comparison chart vs. ABX:
Another one, smaller than Alamos, is Argonaut Gold (ARNGF.PK). It began trading three years ago, and was producing about 50 thousand ounces per year. It's now expecting to produce 120 thousand ounces in 2013. A comparison chart vs. ABX:
Comparing Argonaut and Alamos to Barrick is only to make a point. Junior producers offer more bang than majors, when selected carefully. Sure they've already risen considerably, but I'd still rather be holding Argonaut or Alamos than Barrick. But then my risk tolerance is not the same as yours.
But neither Argonaut nor Alamos are junior producers anymore, by my definition. They've crossed the 100 thousand ounce threshold. So what companies am I looking at?
Northern Vertex is one (NEE on the TSX Venture or OTCQX:NHVCF in the U.S.). One of the fellows behind it is Jim MacDonald, who co-founded National Gold which later merged with the above-mentioned Alamos, on whose board Jim sat after the merger. Another key player on the team is Dick Whittington, who took Farallon Mining from discovery to commercial production, and then sold the company for more than $400 million to Nyrstar which is one of the world's largest zinc producers. These two men are looking to repeat their former successes, and Northern Vertex is the vehicle.
The company isn't producing yet. But it's expecting to commence pilot plant work (Phase I) this quarter, which is expected to be followed by Phase II commercial production. The people seem to be of high caliber. The project is in a mining-friendly jurisdiction (Arizona). The company has plenty of cash and has been able to raise considerable capital, even when others couldn't.
But there are risks, like with all emerging producers. They'll need plenty more capital. The metallurgy is so-so. The grades aren't high. Permitting could cause delays. But they've just released their Preliminary Economic Assessment, and I think they've done a fine job of it. They're not amateurs. Will they be the next Alamos Gold or Argonaut? That's the speculation.
Yes, I think we're headed into a mania phase for gold stocks, and the smaller players will be the big winners. And while it's true that I'm bullish on the explorers, they carry more risk than the emerging producers --- which if selected properly can really add horsepower to a portfolio. I especially favor the companies whose projects are in the U.S. or Canada, for several reasons which go beyond this post. For investors who have the foresight and tenacity to take positions now while the niche is temporarily weak, I think it's an excellent speculation.