GOLD & JUNIORS is chapter IX of the Gold Drivers report and focus on the relation between gold and junior gold mining companies. History suggests that investments in junior mining companies which are on the verge of discovery in a rising gold environment can be extremely profitable. This chapter discusses the two pillars carrying the juniors which are the price of gold and the desperate need for new major discoveries.
1. Juniors & declining gold reserves. Why should they benefit ?
World wide declining gold reserves will benefit the juniors because their senior brothers will have to go after them. Why ? Because the senior gold producers will be struggling in order to replace their dwindling gold reserves coming years. Sounds pretty alarming right ? So how bad this situation really is? Isn't this whole issue of declining gold reserves a bit exaggerated ? Well, just see what some of the leading industry experts have to say regarding declining gold supply.
Alex Davidson (Vice President Exploration Barrick Gold) is on record by saying :
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". END.
The awareness of a dwindling Gold supply is growing : Dow Jones News Service reported late last year :
"Merrill Lynch Investment Managers have a favorable outlook for gold, underpinned primarily by emerging pressures on supply".
Merill Gold fund manager Evy Hambro said :
"We've got a situation where the mined production of gold is going to be declining for the foreseeable future,". END.
Further more Hambro said that falling mine output over the coming years was one of the reasons to to prolong the rally in U.S. dollar gold prices. Hambro is not a crank, his seven-member team is one of the world's largest managers of gold equity investments, overseeing about US$6.5 billion spread between several mining funds.
The main reason for this situation to exist was a lack of Exploration during the 1997 - 2002 period. Exploration budgets had been slashed by 67% during this period. Fortunately the Exploration sector attracted more investment capital again since 2003 but the sad truth is that it doesn't matter how much money you'll throw at exploration, no matter what the gold price is, it still takes three to five years from scratch before a big discovery can be made and after that it still takes four to seven years before a mine can be opened in order to mine the new discovery.
Newmont president Pierre Lassonde said :
"The 20-year bear market in gold has weeded out marginal gold producers and significantly curbed exploration and production.". "If gold was $1,000 an ounce, it still takes four to seven years to open a mine," END.
Barrick CEO Greg Wilkins said more or less the same, he said (Nov 2004) :
"The average lead time for a large discovery to go on-stream with production was around five to seven years but that seven to 10 years was probably more realistic. ". "The industry isn't going to be able to respond immediately to higher gold prices. It is going to take a long time." END.
Trevor Steel, partner at Baker Steel Capital Managers told delegates at a two-day Euromoney gold seminar :
The way I like to think of it is that the gold industry is in overdraft. It's been relying very much on discoveries that were made many, many years ago and it is not replacing the reserves it is mining every year. END
Despite this, Steele said the industry needed to spend more money on exploration to find big enough deposits to replace production.
It is going to be a major challenge for the majors . . . yes of course they can acquire, but they all want to find the large assets and there just aren't that many of them around. END.
Paul Burton, editor of World Gold said :
But the industry needs major new finds to replenish the inventory pipeline. What we need to reinvigorate the industry is some major new finds. Such discoveries are rare. END.
Let's repeat the last sentence here :
What we need to reinvigorate the industry is some major new finds. Such discoveries are rare. END.
Indeed, such discoveries are rare. According to Alex Davidson (Vice President Exploration Barrick) only a very few major deposits (5+ million ounce) have been discovered since 1999.
Industry consultant Ralph Bullis is worried about a drastic decline in Gold production as well. Bullis fears that the very large Gold producers won't even survive at current extraction rates over the next five .. to 10 years.
His calculation is straight forward, he says that the top 5 Gold producers are each pulling between 3.5 million and 7 million ounces out of the ground every year. In order to keep up with the current production rate the miners need to replace their mined-out reserves through exploration . But that's exactly the problem. In order to replace 3.5 - 7 million ounces of Gold each year you'll have to find a major world class gold deposit ( > 5 million ounce) each year which is highly unlikely.
Bullis refers to the U.S. Geological Survey's database of global gold deposits and notice that of the 792 discoveries listed of greater than 100,000 ounces, only 6 percent contained 5 million ounces of gold or more. This is in line with earlier comments from Barrick Gold Vice President Exploration Alex Davidson who said that since 1999 only a very few world class gold discoveries have been made.
Bullis goes on and says that even if a big discovery is made, it can take anything between three and 10 years to permit a mine in Canada and the United States, prospective areas where the major miners are looking for gold. This is in line with earlier comments from Piere Lassonde and Greg Wilkins who made it clear that the Gold Industry isn't going to respond immediately to higher Gold prices.
(Ralph Bullis was Exploration Director of Echo Bay Mines for more than a decade and was a member of the Canadian Institute of Mining committee, which helped set up guidelines on how to estimate mineral resources and reserves)
Now many gold analyst do suggest that this whole supply decline projection is exaggerated since there are still gold reserves available for another 10 years of supply at current production rates. That should give the producers plenty of time to find new gold reserves.
Well, the point is that production rates are going down because the high-grade mines are running out of ore. This has led to a production decline by over a third in South Africa the past decade (see for details chapter IV 'GOLD & SUPPLY'). Another point that most analysts are unaware of is that gold mines typically do not mine out all of their "ore reserves". A former senior geologist of Barrick Gold wrote me :
Late in the life of mines, the typical case is that for a variety of reasons ("high-grading", gold price and labor cost fluctuations, etc.) the mine shuts down early, with a large amount of "reserves" still showing on the "books". A good recent case in point was the Homestake Mine in South Dakota, which was shut down with a large base of ore "reserves" (millions of ounces) still on the books. Many mines start up very slowly but come to an end falling off a cliff and hitting the ground with a resounding thud! Watch out for South Africa, in this regard.
The decline in gold production is already well underway. The year of 2003 showed supply decline of 4.4% compared to 2002. The year 2004 showed a supply decline of 5% compared to 2003.
It should be obvious that the Gold industry is desperate for new major discoveries. But where to find them ? Remember that 75% of all discoveries are made by junior mining companies so it ain't difficult to understand where the big producers are heading to. The trend is obvious :
Barrick opened an office in Vancouver in order to monitor Junior companies.
"Barrick Gold's New Office Tracks Junior Exploration Cos."
"Barrick Gold Corp. (NYSE:ABX) has opened a Vancouver office to monitor junior exploration projects, executive vice-president Alex Davidson said at an exploration conference. Davidson said two or three employees in the office are tracking junior projects, and visiting managers of companies and their exploration sites. The local office also handles Barrick's exploration efforts around Eskay Creek, its 100%-owned gold mine in northern B.C."
And what about Anglogold ?
AngloGold CEO Bobby Godsell :
It is the end of big picture gold consolidation; there is no compelling logic to combining anymore. The real challenge now is how to replace your ounces for the future." The race to replace ounces is about to begin. It will take the form of takeovers of small producers with long reserve lives and high quality junior mining companies with large in ground reserves that can be mined economically. END.
A few month later these thoughts were echoed by Sam Jonah, the company president :
Where will AngloGold by next ?
Sam Jonah, the company president says small gold companies will be the point of entry.
"We will look at juniors that have attractive assets in there portfolios and require our expertise and capital to move these projects forward." END.
And what about Newmont ? Are they interested in Juniors ? It seems they are ! They took an interest in Gabriel Resources Ltd. last year.
Newmont adds muscle to Gabriel gold find, stock up
"VANCOUVER, British Columbia, - Shares in Gabriel Resources Ltd. leapt as much as 54 percent on Monday on news that the world's biggest gold producer plans to buy a stake in it -- a major credibility boost for the small Canadian miner that owns Europe's largest gold deposit. "
"At a time when the world's biggest producers are mining out reserves more quickly than they are replacing them, the project is regarded as a big and important future source of gold, and rumors have surfaced frequently that a major may buy it." END.
And what about Goldfields ?
Gold Fields: Investing in juniors make sense
Ian Cockerill : "We invest in 10 juniors in the hope that one or two of them come up trumps, and the value you get off the table there will pay for the other eight that do not. But you are spreading your exploration dollars, It increases your chance of success."
"It has been a very successful program," Cockerill declared. He estimated that Gold Fields invested $30 million to $40 million in the junior exploration company process, converted $120 million in value, of which $40 million was harvested." END.
So the majors are simply forced to look to juniors in order to acquire the exploration opportunities that they themselves can't find. When you realize that one of the most important factors to increasing the odds of making a discovery is to have experienced and qualified geologists with a proven track record plus the fact that juniors continue to steal the top geologists of the major companies then it's easy to understand why 75% of all discoveries are made by Juniors. This issue is described in detail by Rick Redfern, a former senior geologist of Barrick Gold who wrote me :
In 1998, the companies started laying off geologists, steadily and more each year. This continued through 2002. At that point, the bottom of the gold market, they thought they had it made in the shade. What they didn't realize at that time was that they had lost much of the cream of the industry, since they were very picky about hiring the best people in the industry to start with. At the bottom, of course, they realized that soon, if the market recovered, that they were going to have to rehire geological and engineering staff. The only problem was that many of these people retired and took city jobs at Home Depot, with the government, etc. These people were out of the market. The companies could not find easily top notch people to hire…… The gold price started to move up, and went up steadily (the breaking of the "cup and handle" pattern). The big companies gave a weak effort trying to find new employees, at sub-par salary levels (e.g. Newmont Elko). The gold price kept going up, and,,,,, all of a sudden,,, there was a new force in the market. Junior companies.
Now something unexpected happened, the Juniors started stealing the remaining top level geologists that the big companies had, such as Alan Branham (Midway Gold) and Marcus Johnston (Victoria Resources) of Newmont. Even Barrick just lost one of its top two mine geologists at Goldstrike to a barite exploration company! Another large company has hired geologists from peripheral government staffs to make up a shortfall.
Right now, the majors are faced with in-house staffs of declining quality due to continuing departures, in a market that demands that they hire more top quality geos to replace their declining ore reserves. They can't compete with the juniors, who pay higher salaries, give more stock options, and have better work positions to attract new people with. In the meantime, the juniors will continue to steal the remaining good big company geos! In this no-win scenario, the major companies, especially Newmont and Barrick, will be forced to look to juniors to acquire the exploration opportunities that they themselves will not be able to find or explore for. It is a supply-demand situation that the majors cannot win. END
Now in an environment where major producers are desperate for new major discoveries it ain't difficult to understand what a major discovery could do to a junior. Needless to say that the discovery phase of any exploration project provides the greatest return on investment. Now here's a crucial point from an investors point of view. Some investors argue that they won't invest before a discovery is being made. After discovery there's certainty that the company will grow further during the development, feasibility and production phases. Sure those investors are right ! It's all about risk/reward. Some investors who don't mind taking some more risk will try to pick the juniors on the verge of discovery and simply hope that they will live up to their expectations. When they do, the reward could be phenomenal.
But here's the catch. Only one out of every thousand exploration projects will make it to a mine. So if you're investing in junior mining companies who find themselves still in the exploration phase, you've to diversify a lot in order to increase your chances of success. Now let's take a look at a graph which visualizes the different stages of a typical exploration project and how it effects the company's share-price.
It's obvious that the greatest reward for the investors is upon discovery indeed. A major historic example is Arequipa Resources which found 7 million ounces of Gold on their La Pierina project. Its share price exploded from about 1 CAD$ all the way up to $35 in just 6 month time, see chart below :
Ah you'll say, Arequipa, but that was 1996, a time when gold stocks were 'hot' indeed. A time when discoveries were extremely well rewarded, but these days aren't 1996. Didn't you notice that juniors are bleeding tremendously these days, didn't you notice that most gold analysts are bearish on gold stocks these days ? Didn't you notice that investors gave up on juniors since no excitement has been created last couple of years (no major discoveries)? Well, good questions, but I would like to show you that discoveries will pay off anyhow, no matter how bad sentiment is.
We all know how bad the junior sector has performed over the last 6 months right ? Juniors losing 50 to 80% of their 2003 highs are no exception. Needless to say that sentiment isn't quite rosy these days among junior investors. Nevertheless, juniors which came out with impressive drill results during the last 6 months were rewarded tremendously despite the extreme bearish sentiment, see charts below :
Now you've seen a couple of examples which simply prove that even in a negative sentiment discoveries will pay off.
When we take a look at the Year to Date junior ranking table below you'll see again that even in an extreme bearish sentiment (as we're witnessing these days) there're plenty of juniors doing well based on solid exploration results:
It seems that the awareness among Gold analysts regarding exploration opportunities is growing. The Wall Street Journal quoted John Bridges, a senior gold analyst at J.P. Morgan Chase & Co who said :
If you are lucky enough to buy into an exploration company that makes a discovery, you can effectively buy your own auto teller machine. Some of these things are just phenomenally profitable. END.
Conclusion :
Declining Gold reserves is a strong pillar for the junior mining industry and juniors able to make major discoveries will be rewarded tremendously, no matter what current sentiment is.
2. Juniors and the price of gold. What Influence ?
After discussing the first major pillar for the junior mining industry (declining gold reserves) it's time now to discuss the second pillar for the junior mining industry which is of course the price of gold itself.
Gold mining equities do have a strong correlation with the price of gold. Higher gold prices means higher gold stock valuations, it's as simple as that (see also Gold/HUI Divorce part II). Since the junior mining equities are much more volatile as the senior mining equities they tend to rise much faster on rising gold prices but also the opposite is true, on declining gold prices they'll drop like a stone.
Now let's look back at what happened in the nineties when excitement kicked in ('93 and '96) due to higher gold prices and what happened next when gold resumed its bear-trend.
The chart below is a typical example of a junior mining stock in the nineties.
This chart doesn't need any further explanation, fast rising gold prices could launch the juniors.
But what about last year, didn't the price of gold moved sideways more or less ? So how to explain the continued decline of the gold mining equities while gold remained more or less the same ?
It's all about valuation : Sometimes the gold mining equities are undervalued against gold and sometimes they are overvalued against gold. In other words, sometimes they're a bit too enthusiastic (gold-stocks) and run too far ahead from the price of gold (eg Dec 2003) and sometimes the gold mining stocks are a bit too pessimistic and lag the price of gold (eg May 2005).
It's like a pendulum, mining stocks continue to swing from overvaluation to undervaluation (against gold) and back all the time which I've described in detail in my pieces 'Gold/HUI Divorce ? part I and part II'.
So the current extreme undervaluation of the junior mining stocks will morph itself (sooner or later) into an overvaluation against gold again, it happened over and over in the past and it will happen over and over again in the future.
So is this a time to buy junior stocks ?
That's a very difficult question, but I would like to make a few remarks on that :
First of all I think you shouldn't buy juniors just for short-term speculation, that's a dangerous game. Just let your company do their exploration, that's imo the reason why you should have bought them in the first place. If their exploration efforts are successful , you'll be rewarded. Needless to say this requires patience from the investors side.
Again be aware that only a very few juniors will ever be successful at all. (see discovery-chart). Only one out of every 1000 projects will make it to a mine. That's why it's so important to track juniors with high qualified geologists with proven track records and to diversify into several juniors. Just listen again what Ian Cockerill of Goldfields said :
We invest in 10 juniors in the hope that one or two of them come up trumps, and the value you get off the table there will pay for the other eight that do not. But you are spreading your exploration dollars, It increases your chance of success.END.
3.Juniors & volatility. How to approach ?
To junior investors I would say :
Get used to the high volatility surrounding the junior sector. Just hold your shares and let them do their Exploration. That's why you should have bought them in the first place, not for short term speculation. Give them the time needed to complete their exploration programs. Yes, your shares will be subject to sudden panic sell offs every now and then, that's all in the game but they'll recover just as they recovered from previous panic sell offs. Why ? Because we're in a bull market in gold. The big move in junior mining stocks is still ahead of us.
Highlights :
Eric Hommelberg
The Gold Drivers Report
Email : ehommelberg@golddrivers.com
Web-site : www.golddrivers.com
May 30, 2005