In Today's Gold Mining, Less Is More

Includes: DRD, FNV, RGLD, SAND
by: Bruce Pile

The gold mining industry seems to be entering some kind of twilight zone where something fundamental is changing, but you can't quite seem to put your finger on it. The group has become unpopular, but there seems to be something more than just a stagnant gold price over the last year to blame. If you look at the financial performance of the big producing miners, there is not that much to shy away from (click images to enlarge):

This is the kind of steady, powerful growth investors dream of. The consolidating gold price of the last year has just put a relatively small dent in this picture. A quick survey of Morningstar's numbers for the big five -- Barrick (NYSE:ABX), AngloGold (NYSE:AU), Goldcorp (NYSE:GG), Newmont (NYSE:NEM), and Goldfields (OTC:GDFI) -- reveals that they all have brisk growth in cash flow from operations since 2007 with only a minor pull back in the trailing 12 month column. And all this is at price/cash flow ranging from 4 to 9 (except for Goldcorp at 15). The price/cash flow average for the S&P 500 stands at 9.2 with nowhere near the kind of growth exhibited by these miners. So why all the market angst over gold mining?

It's all very complicated, and probably beyond the understanding of any one person. There is the much discussed climb in cash costs. They have been climbing at about the same rate as the gold price, nullifying much of the revenue enhancement. And lately, this problem has gotten much worse as these costs have climbed 19% over just the first half of 2012, far outpacing what gold has done. Gold mining has had the phrase "peak gold" applied to it, and there is a lot of similarity to peak oil. The high grade easy pickins are about all gone. There is plenty left. But what's left is becoming very expensive to extract. Not unrelated, there is another, less discussed problem with gold mining I'd like to focus on -- the crash in ore grades.

Crash? Isn't that a pretty drastic term for something as stable as the ore grades of our earth? Well, I hate to unsettle anyone, but they are crashing. Things have changed a lot since the new Californians could collect gold nuggets with just their pans. It was common a hundred years ago to mine underground gold with ore at 5 to 10 grams/tonne. Anything less than 2 g/t was considered garbage. But look at this chart over the last seven years:

In this year's Visual Capitalist report "Global Gold Mines and Deposits Ranking 2012", they estimate the current global average ore grade of in-production gold to be 1.06 g/t, down about 37 % from 2005. But that's not all. They estimate the yet-to-be-developed deposits average to be down another 37% to 0.66 g/t! When you compare this dive in ore grade to the flat amount of ore processed shown by the blue bars in the chart, it's clear that this widening gap needs a lot of gold price increase and a lot of clever management to keep these companies producing the goods investors want. There seems to be some doubt about that.

I think there will be plenty of gold price increase and clever management to move miners much higher, but the more attractive gold miners of the future may tend to be those that display an ability to make do with low grade ores. GoldMinersPulse recently did a survey of all the Canadian gold miners (TSX/TSXv Gold Miner Valuation Metrics) where they listed all the ore grades for these companies expressed as $/t. I was curious whether there was any correlation between ore grade and stock performance the last two years. I screened out the ones high on the speculation scale and found not only no benefit of having higher grades, but the lower grade names actually did much better. What's up with that? I've been noticing this same type of correlation among other gold companies as well. A new paradigm seems to be taking hold where success with low grade is desirable. When you think about it, the lower the ore grade, the more plentiful the supply is. The market may be coming to a point where it does not want companies anymore that are dependent on a rapidly vanishing supply of high grade ore. The market seems to now want those that are learning to deal with this ore grade problem of the future.

One low grade plentiful supply that immediately comes to mind is the ore grades tossed aside by the miners of many decades ago. Where did they toss them, and how much of it is there? Well, they tossed them anywhere the miners have been the past couple hundred years, and there are vast mountains of it.

This is one of the smaller mountains near Ganes Creek, Alaska. Those ants in the foreground are gold prospectors. These mountains are known as "tailings," and they are the ore that was dug from mining operations of the past that was not economical to put through the separation process. Anything below the cut-off grade at the time was simply deposited on the landscape of which it became a part.

These "garbage" mountains have up to now received very little attention from the gold mining industry. They have done little record keeping on how much of this is out there or what the ore grades are. All their calculation efforts have been on what they were making money with. About the only groups tabulating any numbers on them are the environmentalists, who view them as second only to nuclear waste dumps as a threat to mankind. But they are dormant threats, whereas the open-pit mines of today are the active version of this threat. The threat stems from the fact that the most economical way to separate gold from a heap of ore, as is generated by open-pit mining, is to drizzle cyanide over it and channel the gold bearing solution to a separation plant. This heap leaching is fairly safe if proper leach pads are built and the ore is properly put on them and processed. But the possibility of accidents and abuse with something like cyanide stirs the fervor of any environmentalist worth their sodium chloride. They have been about the only ones paying any attention to these man-made mountains of gold.

But now, as the diving ore grades being laboriously dug out of the earth at profit killing costs are approaching whatever is in the already dug-up tailings of many years ago, the miners may be forced to come to grips with these mountains like the environmentalists are doing. I did a rough estimate on just how much of this ore there is in the world and what the grade might be like. I emphasize the qualifier "rough" because reliable global numbers having anything to do with this waste are very hard to find. It is not one of the "world stats" tracked by anyone. If you put together a guess, you must put on your Columbo trenchcoat, collect bits and pieces of facts, and get creative. So I pieced together the following estimate.

Since there is such a difference between the waste generation rate between open-pit and tunnel mining (around 10 times more for open-pit is the commonly published figure), let's divide the total into these two sections. For the open-pit portion, I refer to the No Dirty Gold calculation of Earthworks, one of the aforementioned environmentalist organizations. They put out a figure of 20 tons of waste to produce a typical gold ring. After adjusting for metric tons (tonnes) and their figure of 0.333 oz pure gold per ring, you get 54.4 tonnes waste per oz. In their explanation later on "How the 20 tons of mine waste per gold ring figure was calculated", they say:

In calculating the figure and developing the methodology, we consulted a number of experts with statistical, technical, academic, and scientific backgrounds. It is based on a representative sampling of publicly available mine data that is reported by mine companies... In developing this estimate, we took a conservative approach:

It does not include an estimate for waste rock from underground mines... we did not find publicly available data for waste rock from underground mines... Because of this omission... the 20 tons figure is certainly underestimated.

The figure does not include any waste reported as overburden, which is the soil and rock on the earth's surface that is moved to reach the ore.

They found no available records for the conventional underground mining that was almost all the waste generation for the hundreds of years before the 1980s, when open-pit heap leaching came about and grew to about 70 % of all gold production now. But I found an estimate for this that can reasonably be projected to a global number. It is in the Journal of the South African Institute of Mining and Metallurgy, April, 1983 issue, "The behaviour of mine tailings during hydraulic deposition". For all of South Africa, they figured the "dry solid waste produced per year" for gold at 100 Mt (million metric tonnes). This is just for one nation -- but South Africa's production in the early '80s was fully half the global total. And in the early '80s, almost all global mining was still underground. So, in lieu of omitting entirely an estimate for underground mines, it would be closer to reality to simply take the South African number as similar to the other half of global production. Using the South African gold output of this time of 21.7 million oz/yr, we get 4.6 tonnes of waste per oz. as the generation rate. This puts our open-pit/underground waste rate ratio at 54.4/4.6 or a little over 10 -- near what other sources (including the Earthworks write-up) say it is.

Now we have ballpark figures for the waste generation rates of both the open pit and underground components of world production. To get some kind of split between the cumulative contribution of each, a steady growth of open-pit from near 0 in 1970 to about 70% now gives roughly a 30000/140000 split of the 170000 tonnes of all gold ever produced as estimated by the World Gold Council. Applying these numbers to get a total global waste ore number (you must click to enlarge):

So we have a figure of 73000 tonnes of gold in all these tailings mountains if the average ore grade is 1g/t. But another contribution to the tailings treasure that should not be overlooked is the artisanal miners. These are the individuals, not part of any mining company, who plunk around small gold deposits too small to be of economic interest to the miners or owned by locals who won't sell. For one reason or another, they are not part of the mining company domain, and thus have even worse records kept on their tailings. The '49er standing in the river with a box or pan comes to mind, but there is an army thousands of times bigger doing this today. They typically are in poor countries where this is one of the best employment games in the village. They go after these very small but often extremely high grade deposits with "panning, magnets, sluicing, spirals, vortexes, centrifuges, shaking tables, and flotation -- in increasing order of complexity and cost". It is estimated that 10 to 20 million people are doing this globally and according to the EPA, they supply 20% of the entire global gold production. But the Artisanal Gold Council feels that this is an overstatement. They have their own estimate:

"The estimate is 330 tonnes of gold per year or 12% of official world production. The estimate considers a variety of types of data from 70 countries. Other higher numbers such as the 20-30% noted in The Global Atmospheric Mercury Assessment: Sources, Emissions and Transport by UNEP in 2008 rely on less data and less types of data. These higher numbers are also more difficult to align with other factors such as financial constraints and the magnitude of mercury consumption needed to produce the gold -- a very large percentage of ASGM gold is produced using mercury." Artisanal Gold Council, World Artisanal Gold Production, June 29, 2011

Mercury is why the EPA and others are so interested in this type of gold mining. When they use mercury to amalgamate with the gold to separate more of it out, they burn this amalgamation in their gold shops, killing and maiming many local people, but also releasing some 400 metric tonnes of airborne mercury each year into the atmosphere, the biggest mercury polluter of any sector. Counting what gets released into streams and other contamination, they think about 1000 tonnes of this deadly metal is released yearly by the gold artisans.

Knowledge about the use of mercury is poor, as this study points out, but by indirect monitoring via things like rain forest damage in artisanal regions, its use seems to have begun in earnest in the 1990s. This is significant to our tailings gold resource estimate in that prior to mercury use, an artisanal model like that of Burkina Faso, West Africa was producing all the artisanal tailings, and they are estimated to be of 8 g/t to 12 g/t ore grade with only the use of hand tools to claim the gold. Mercury extraction leaves around 2 g/t.

The Artisanal Gold Council has done an estimate of all the gold ever produced by the artisans prior to 2000. They come up with a very conservative 7000 tonnes. They also state in the above referenced gold production article that the artisanal contribution to the global total may be climbing beyond 15%. These facts, along with a figure for waste ore production rate for the Burkina Faso model above stated as 17 tons of ore producing 420 grams of gold (1.3 tonnes of waste per oz), allow you to do a calculation similar to the one above to get the global artisanal mining component of tailings gold. The estimates vary from a low of 12% to the EPA's 20%, and there is no hard data on the growth of mercury use, but assuming an average 15% artisanal portion of world production since 2000, and the 7000 tonne figure prior to 2000, and an 8 g/t average tailings ore grade, the artisans have deposited and abandoned some 4000 tonnes of high grade gold on the ground. That's a meaningful contribution to the 73000 tonnes from the regular miners and gives a total estimate of 77000 tonnes.

To put that into mining perspective, compare this resource number to what the USGS gives as the world total gold resource for the miners. This is all the gold ore that's now physically in the earth, currently economical or not. They call this the "reserve base" as opposed to reserves, which are currently producible. This has stayed about the same in recent years as gold produced offsets gold found and is reported as 100000 tonnes. Think of it, total tailings gold is almost the same as what the miners are going after at out-of-control costs and ore grades already down to 1.06 g/t and crashing. The tailings mountains they drive by on their way to work represent a nearly equal size body of gold of roughly equal ore grade, already dug up and sitting on the ground waiting to be plundered. And this ore grade is not crashing!

The ore grade distribution for the tailings of the world must consider that about 27 % of it was put there by the underground mining of a long time ago, when they tossed aside much higher grades than today. Not much record keeping was done, but recent sampling of these old tailings (yes, they are getting interested) commonly produce numbers of 3 g/t or more. The 77000 tonne estimate is at an average grade of 1 g/t, and if you assume about a 0.5 g/t grade for the open-pit part, this puts the underground mined part at a little over 2 g/t for the average of 1 g/t. Nobody knows what those old dumps average, but it could easily be over 2 g/t.

As for an ore grade distribution for the 100000 tonnes of current official gold resource, I offer the comprehensive recent study, Global Gold Mines and Deposits Ranking 2012, referenced above. It gives an ore grade distribution chart showing just how close to the bottom of the barrel miners are scraping nowadays. It looks like this:

Note this is a distribution by the 439 deposits studied. As far as I know, it is not resource weighted (ore grade by tonne of gold) so if the larger deposits are of lower grade, it tilts the actual distribution even more toward low grades. Expressed as volumes in a pyramid, the distribution looks like this:

The USGS world resource estimate of 100000 tonnes is shown in yellow, and our global tailings mountain estimate of 77000 tonnes is shown in black. The 0.82 g/t average world resource ore grade is from the study. All the tailings mountains are getting to be the equivalent of over three quarters of a whole new earth in its present level of depletion. One thing is becoming clear -- the gold mining industry is swiftly descending into the huge bottom layer of the ore pyramid. Many of the prime reserves of the future are going to be the mining dumps of the past, already found, unearthed, partially processed, and waiting to be turned into profit. But this is going to be a tough battleground, perhaps mainly between the miners and the environmentalists.

This all makes it imperative that gold investing of the future be as independent of high ore grades as possible. The market seems to be telling us that. The mining stars of tomorrow don't have to be those sporting the high ore grades. The new rule is "less is more."

How do you factor this into your gold investing? It is one more reason to go light on the tiny miners that are nowhere near production, with only an ore body to advertise. So many of them exaggerate or misrepresent their ore grades. As Mickey Fulp, The Mercenary Geologist, eloquently states it:

"Don't forget that most junior resource companies are simply "mining the stock market". Few have potentially viable Resources let alone economic Reserves. Most don't want to be miners. Of those that aspire to this difficult goal, perhaps 1 in 15 will ever develop a project with Mineral Reserves, and more than half of those will fail."

There are many very small miners with production, and good management, and good cash flows; but the ones with nothing but a property should be generally avoided.

I can think of two good ways to make your gold investing independent of ore grade (other than bullion or ETFs). If you want some leverage on the price of gold, first, there are all the gold royalty companies I've described in other articles (see A Triangulated Forecast For June 2013). They follow a business model that makes them independent of the ore grades their contracted miners must deal with. They ink financing deals that give them a discounted stream of gold that doesn't care what ore it came from. Royal Gold (NASDAQ:RGLD) and Franco-Nevada (NYSE:FNV) are the ones I've discussed before, and there is also Sandstorm (NYSEMKT:SAND). The second way is to find companies that structure their business model on nothing but tailings. This totally does away with the exploration budget, rising cash cost problems with unearthing ore, and a whole bunch of other problems that are scaring investors away from miners. There is only one company I know of like this -- DRDGold (NYSE:DRD). The low ore grade Canadian examples I mentioned above that averaged a much better performance than their high grade counterparts over these last two difficult years can't hold a candle to DRD -- it's up over 50% during that time.

I am writing a separate article on DRD. I've written about it before, but it is a most interesting company that is worth close attention.

Disclosure: I am long DRD, RGLD, FNV, SAND. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.