The Problem with Gold
April 03, 2008
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In the past I've looked into a number of gold stocks and I have consistently not liked them. The grade of gold being mined is so low, the costs are out rageous. When I was researching stocks, and many mining stocks, what I was noticing was the downward trend in grade.
When base metal prices boom, you get massive exploration and in general the world's reserves increase far, far faster then they are needed. So, if you look at uranium, for example, a metal in its infancy for exploration a half century ago, it had its boom over the first nuclear plants and the arms race, and then it had a very, very long retraction due to uranium in weapons being recycled into the open market for nuclear plants. The price got so low, there was virtually no exploration, yet with the recent boom, enough uranium has been found to supply the world with nuclear power for the next 100 years, and that's taking into consideration the many plans for expansion of nuclear power plants.
Gold is one of the most explored metals, going back thousands of years. Every gold rush gold is mined to the limits of technology. Take a look at history and go visit some of the old gold mining sites and you see gold mining machinery of the era just left behind when the limits of technology no longer kept up with the declining grade of gold. It means there are lots of places where gold was known to have been mined in the past, but the places have pretty much had the cherry pickins of the gold already mined.
I did an exercise in studying the effects on costs for declining grades because of gold and because of the ya-ya-hurray that seemed to happen to gold shares when gold reserves were added, even if the reserves were, to me, of grossly questionable quality. I go back to Goldcorp because I have spent many, many hours looking at that one and it still comes up like a pig on my radar. Goldcorp has seen costs absolutely skyrocket due to the declining grade of gold problem and they've replace the reserves that once had them mining in a range of 70g/ton down to perhaps 1g/ton. There are many, many gold stocks out there that ultimately grade means then need today's gold prices to remain solvent as they were cannibalizing other assets and riding the exuberant optimism to remain solvent and to pay for the losses from mining uneconomical gold "resources/reserves."
Another practice that many did as gold prices went up was they redefined "resources/reserves" by lowering the definition of economical, so you have these amazingly low cut-offs for gold grade and yippie press releases stating "reserves/resources" have increased. Floridabuilder did an excellent post demonstrating how the builders fudged feasibility plans, take off a few cents on costs of items, slightly under estimate the labour, etc. Well, in the homebuilders this is a linear problem, with declining grade, it you look at the graph on the "declining grade of gold problem," it is an exponential problem and a little bit of fudging on a low grade mine has enormous cost implications. I've seen some gold mines that have come in losing hundreds of dollars per ounce mined.
I get so off track. What prompted me to write about gold was a piece I saw today about gold hedges. Well, actually it is looking at the cost of hedges in a single mine, Anglogold. I think it does a pretty good job of looking at that problem. They have 10.4 million ounces of gold hedge which will result in a price decline of about 20% from spot for2008, should price remain at about $900/oz. That is up from being 13% below spot in 2007.
Barrick is very sophisticated in their press releases, promoting that they have no hedged gold mines in production. This is true, but they have hedge promises at something like $300 or $400 for properties that do not yet have mines built. It potentially means that when this catches up to them instead of increasing profits, they will have mines that are total sinkholes at the same time other mines will be coming to the end of their mine life. This is not apparent when you look at their financial reports. I certainly did not see it my first look and I liked Barrick my first look. The hedges are a disaster.
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