Declining Gold Reserves Benefit Juniors
Eric HommelbergWaiting for the next world class gold discovery ? Betting your money on the better Junior Exploration Companies for the next big hit ? Would such a discovery benefit shareholders even with current gold prices ? Which companies are due for such a 'rare' event ?
In my article "Year of the Junior Exploration Companies" I explained based on historical facts that a POG of $400+ will skyrocket the junior exploration companies. Price increases of 1000% are no fiction but real possibilities. Although I have to admit that the first quarter of 2003 didn't live up the expectations we've had yet, we remain very bullish regarding future gold prices.
The reason is simple, the fundamentals are getting better almost on a daily basis !
Although it's not my intention to go into detail about the fundamentals in the gold market in this article, I will just repeat my summary regarding the critical drivers for Gold which I mentioned in "Year of the Junior Exploration Companies" including some updates.
Higher POG because of
- Weak Dollar
- Negative Real Interest Rates
- Declining Gold Supply
- Increasing Gold Demand
- Covering Short positions
- Recognition of Gold as Money
- Flee from equities to hard assets
475 Billion$ trade deficit which approaches 5% of GDP will buckle the US$ !
Negative Real Interest Rates
Negative Real Interest Rates which we're witnessing today is one of the strongest drivers of a higher POG ! For a detailed report on the correlation between negative Interest Rates and Gold I strongly recommend to read Adam Hamilton's Real Rates and Gold 4. http://www.zealllc.com/2003/realgold4.htm
Increasing Gold Demand
Introduction ETF for Gold ! ASX Stock Exchange, symbol GOLD. This introduction will make it easier for investors to own physical Gold, listings in Europe and US will follow soon !
"In a world first, investors from Friday will be able to buy gold bullion securities directly on the Australian Stock Exchange Ltd (ASX).
The gold bars, lodged in London vaults, will even be available for delivery, if wanted.
In a joint initiative with the World Gold Council, Gold Bullion Ltd will be offering investors the opportunity to own a specific portion of a gold bar." http://www.theage.com.au/articles/2003/03/27/1048653806150.html
Recognition of Gold as Money
Introduction Gold Dinar later this year :
See article in Asian Times: Malysia goes for Gold :
As I said before, It's not my intention to discuss the critical drivers in Gold in detail, except for one !
Declining Gold Supply
I think that a rapid declining Gold supply will have a tremendous effect on the better Junior Exploration Companies, regardless of what the Gold price does !
Please let me explain why.
Current gold production is approx: 2500 ton/year. Studies from Beacon Group Advisors and Standard Bank are indicating a drop in Gold production of 30% in the next 5-8 years. See graph shown below !
This means a drop to 2000 ton/year by 2010 ! Why ? Simple ! Due to lack of exploration during the last 5 years. Will it change soon ? No ! Exploration becomes profitable at Gold prices of 350$+, so why spend money on expensive exploration projects when no profit can be made ?
That's exactly the reason why the exploration budgets have been cut by 67% over the last 5 years. You don't need to be rocket scientist to understand what this means for the Gold Industry.
No Exploration, No New Gold deposits !
This is exactly the biggest problem the Gold Industry faces right now. The industry needs new Gold deposits desperately ! And I really mean desperately ! I know this sounds like an alarmist speaking but please take notice of some media reports last year and judge yourself.
April 2002 : AngloGold
AngloGold also sounds alarm on Gold supply !
Gold Mining companies have warned that supplies of the precious metal are poised to fall sharply. The latest producer to sound the alarm bell that the industry was running out of Gold faster than it could replace it was world number two miner AngloGold, which predicted that the big discoveries of the past 20 years would run dry.
Sept 2002 : Denver Mining Conference.
Gold Executives this week gave anecdotal and numerical evidence of trends the industry has long hoped would boost what has been an ailing industry.
Those trends include steady drops in yearly global output of Gold as Miners merge or "mothball" properties that can't turn a profit at Gold's current price of $322 an ounce !
Sept 2002 : CBS Market watch.
Global Gold output is seen falling 3% this year. It's biggest drop since 1976
Sept 2002 : Reuters
Gold output on slippery slope. Production levels at Gold Mines might not be sustainable because of depleted reserves at mature North American Mine operations and a fall on new mines on steam.
October 2002: The Australian Institute of Geoscientists.
The decline in Australia's Gold Industry continues.
Declining Exploration in Australia's Gold Industry is continuing to hurt production, with Gold dropping a further 8% in the year to June 30.
March 2003 : Barrick VP Exploration Alex Davidsion
"Big mining companies need to spend more on exploration, or else, at current annual production rates, reserves will be depleted in 10 years, he said. It can take six to eight years between making a discovery and starting mine production, and "we're not currently funding exploration at a level required to replace reserves," Davidson said."
Well, you see ? No Exploration leads to depleted Gold reserves within 10 years !
You really think that Gold will be in a bear market by then ? Well, I certainly don't !
Please be aware that the actual decline already started and is no longer subject to just warnings. GFMS just released their annual survey and stated :
World gold mine production in 2002 fell by 36t to 2,587t, the first decline since 1994.
So the major companies are facing a problem. They have to replace their reserves one way or the other. As mentioned before, exploration is too expensive with current Gold prices so the easiest way for the major companies to add Gold reserves is by consolidation, acquisitions, etc…
Although this strategy may help the big companies to avoid expensive exploration programs, the big picture doesn't change at all, depleted Gold reserves within 10 years !
Now please digest this carefully, it's extremely important !
Let's repeat once again what Barrick VP Exploration Alex Davidison said :
"Big mining companies need to spend more on exploration, or else, at current annual production rates, reserves will be depleted in 10 years, he said"
What does it mean for you as an investor in Gold ?
As we saw, Gold reserves of the big Gold companies are running dry coming years. Would you buy a Gold company with declining Gold reserves ? Well, I certainly won't ! Although you can argue that the bigger companies are adding reserves by means of acquisitions (eg Newmont), please consider this : Adding reserves by means of acquisitions inevitably leads to fewer ounces of gold reserves per share. And this is exactly the bottom-line. Big Gold companies are facing a tremendous challenge in order to avoid a decline in ounces of gold reserves/share. Fewer ounces of Gold reserves per share is an unwanted gravity which pulls the share price of the Company down ! The only way to compensate this is a much higher Gold price. So investing in big Gold companies is betting on higher Gold prices. But if a higher Gold price is a necessity in order to generate a nice return on your investment , the Juniors provide better alternatives.
So from an investor's point of view it's important to avoid companies with declining gold reserves per share. So what to do ? Well, find companies which have the potential to increase their proven gold reserves substantially ! In other words, try to find a Junior Exploration Company which is on the verge of a world class gold discovery ! Yes, I know, there are many companies shouting to be on the verge of discovery so how can I as a non-geologist verify those claims ? Simple, I can't ! As an investor the only thing I can do is to identify companies with good Exploration Geologists with a proven track-record. Where to find those good Exploration Geologists ? Let me ask you this : If you were a good Exploration Geologist , would you prefer to work for a big company like Newmont which have to replace 8 million ounce of Gold reserves a year anyhow or for a small Exploration Company where you own a substantial amount of company shares and where a discovery makes you a millionaire in a blink ! Yes, that's exactly the reason why many good Exploration Geologists choose to work for a small Exploration Company. So your first investment rule should be obvious :
1 - Look for Companies with Exploration Geologists with a proven track-record !
Eventually the Major Companies will have to turn to the better Junior Exploration Companies in order to help finding new Gold reserves simply because they are specialized in finding new Gold reserves for reasons mentioned above.
What does that mean ?
The better companies with potential world-class deposits will be a take-over target for the major companies, simply due to the fact that they HAVE to replace their Gold reserves to stay in business ! This will put the better Junior Exploration Companies in the "spotlight" soon, with or without higher Gold prices !
As I said before, investing in big companies is betting on higher Gold prices. Compare this to investing in good Junior Exploration Companies. Either a POG of $400+ will make them fly or a world class gold discovery will make them fly. Needless to say that a world class gold discovery combined with a POG crossing $400 will do unimaginable things to the share price of the winning company !
Yes, I know, there is a tremendous risk when it comes to investment in junior companies. We saw so many companies going bankrupt during the worst years of the bear market in Gold and still up to today, many junior companies are priced at bankruptcy levels.
So your second investment rule is quite obvious as well :
2 - Look for Companies with a rock-solid financial policy ! (How did they surivive the worst years of the bear-market in Gold and can they survive another 2 years of low Gold prices ?)
Your third investment rule is a no-brainer
3 - Look for Companies with potential World Class Gold deposits !
Just see what John Embry of Sprott Asset Management has to say in an interview for the Gold Report on April 11
"If you can find the combination of a reasonably valued mid-cap or small-cap company with an interesting ore body that is in a growth phase, you are going to make an enormous amount on your money. We did that in the recent period, and it was interesting that very few people noticed what was going on. There wasn't a significant inflow into gold funds. That is still to come - I believe in the next up-leg in the gold market, the public will take notice"
It's my strong believe that Gold will be trading over $400+ in 12 month time.
When investors realize that the Gold Bull is for real, the shares of junior companies will follow.
The gold Industry faces a tremendous challenge. Gold reserves are running dry coming years and not enough funding has been taken place for sufficient Exploration in order to replace existing Gold reserves. It takes at least a couple of years of exploration in order to find new Gold reserves. After a discovery, it takes another 5 to 8 years to bring the property into production. So big mining companies are facing fewer Gold reserves coming years which leads to fewer ounces of Gold reserves per share. Adding Gold reserves by means of acquisition inevitably leads to the same result, fewer ounces of Gold reserves per share. This works as an unwanted gravity which pulls the share price of the company down. Eventually the big companies will turn to the better Junior Exploration Companies in order to help find new Gold reserves. So from an investor's point of view it makes more sense to invest in Junior Companies which are increasing their Gold reserves substantially than investing your money in big companies which are facing a decline in Gold reserves and thus a decline in valuation.
The message is clear : The better Junior Exploration Companies will be in the "spotlight" soon , with or without higher Gold prices !
Companies which are on the verge of a "big" discovery will be real winners this year !
April 22, 2003
Comments are welcome at :
Gold Mining Guide
The author maintains a big investment position in some junior mining companies. and is not a professional investment advisor.
Investing in Gold mining equities is a risky endeavor with a very real probability of substantial losses.
Before making any investment decision, do your own research and consult a professional investment advisor.
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