Sign up UNITED KINGDOM
Proactive Investors - Run By Investors For Investors

Raiding the "Jewel Box" – Michael Kosowan (continued)

no_picture_pai.jpg

Henry Bonner (hbonner@sprottglobal.com)

Key points: Major mining companies have mined out the best portions of their reserves. Current production is less profitable because of lower grades and higher costs. The strong need for fresh resources could make certain juniors with discovery potential attractive now.

In our previous post, Michael Kosowan, an Investment Executive at Sprott Global Resource Investments and Investment Advisor at Sprott Private Wealth LP in Toronto, described “high grading” in the mining industry, and why he believes it could damage the long-term prospects of big mining companies.

As Michael explained, “high grading” consists in changing a mine plan in order to recover only the best portions of the overall resource. Over the life of the mine, however, there is more waste and less revenue from the deposit.

What tells us that “high grading” is occurring?

There are two indicators of high grading, says Michael:

1.       The fall-off in average grade being mined from the world’s largest gold operations

2.       Development of “bulk underground mining methods”

Michael explains:

The average grade of ore being processed over the last 12 years for the major deposits around the world has fallen by roughly 75% - from 4 grams of gold per ton to 1 gram per ton!

 

There are very few new high grade projects. Current gold production is being fueled by old mines expanding their current operations. The expansion of these mines is generally cheaper than building a new mine. In many cases the production from these old mines is barely profitable (if at all), but to mining companies it is production nonetheless.

 

The Senior mining companies, under pressure to deliver financial results, turned to doing the unthinkable. They mined out and emptied their own “jewel box” – taking out the best of the ore first. Once the highest grade volumes were gone, they expanded operations at the high expense of changing the mine plan, but producing ever lower grades of ore.

 

This is a road to economic oblivion! The long-term prospects of the miners are completely dependent on increasing commodity prices, since the lower-grade material is often unprofitable if the commodity price does not continue to rise.

 

And what if those commodity prices don’t go up? Simply, this model falls flat on its face. Senior gold companies continue struggling to generate profits for many years in the future.

 

This brings me to the second indicator of high grading, which is the broad use of the “bulk underground mining method.” I am highly familiar with this method, since as component of completing my Master’s degree I helped improve the efficiency of the bulk mining technique. I was working at the time for mining giant INCO, in Sudbury, Ontario. INCO ended up adopting the method and putting the theory into practice.

 

At that time, it was being used to mine out remnant pillars in some of the Sudbury basin’s greatest mines. Remnant pillars are by definition ‘low grade.’ Salvaging low grade in world class deposits has economic merit, but I suspected its days were numbered.

 

The problem with the bulk mining method is that it does not allow for full extraction of the deposit – so you are not getting 100% recovery. But the method is cheap on a per-ton basis.

With today’s economic stressors, underground bulk mining has come into vogue again, but at the cost of the overall profitability of a mine throughout its lifetime.

 

Some of the world’s greatest deposits are transitioning from “open pit” to underground mining scenarios. These are truly legacy mines like Freeport’s Grasberg mine, Codelco’s Chuquicamata, and Rio Tinto’s Bingham Canyon.

 

But the process of mining the rest of the deposit is much more expensive than initially planned, and the ore is of much lower grade. This means major mining companies struggle to keep up production, spending higher amounts of money to get to ore of decreasing economic value.

So how we can use this situation to our best advantage?

 

Well, let’s recap what I have said:

 

·         There are many fewer quality ounces of gold left in these aging legacy assets.

·         Senior gold operations are desperate for new discoveries because they have been mining their high grade.

·         Their working business model has now become wholly dependent on rising gold prices.

Shareholders of Senior miners expect the companies to make as much cash as possible each quarter. They often suggest that the miners should not take on exploration risk with their capital, but instead focus on producing efficiently and at low cost.

 

The area of finding new deposits is unarguably the domain of the junior companies.

 

Although Seniors previously undertook exploration on their own, they now utilize the talent in the junior mining companies by subcontracting to them or buying major positions in their shares. Juniors who discover new quality deposits may be well rewarded as a result of the need for fresh ounces to mine.

If you have the ability to take on the risk associated with these companies, Michael believes that juniors who have the potential to deliver a valuable deposit may make interesting investments now.

P.S.: How do you evaluate these companies? Read our investment guide here.

Michael Kosowan has recently moved to Toronto Ontario, where he has joined Sprott Private Wealth team as an Investment Advisor.  Having worked alongside Rick Rule since 2000, he will now lead the investment advisory initiative for resource equities in the Toronto office.  Michael holds a Master’s Degree in Mining Engineering and is a licensed professional engineer. He is also a registered representative in both Canada and the United States.

Michael holds a Master’s Degree in Mining Engineering and is a licensed professional engineer. He is also a registered representative in both Canada and the United States.

With his extensive experience in resource investing, Michael is able to provide insights and knowledge critical in helping clients select and understand their investments.

You will find Michael as a speaker at several natural resource conferences, on webcasts and radio interviews discussing the companies that he follows.

Canadian clients can contact Michael e-mail him at MKosowan@sprottwealth.com or call 1.866.299.9906.

US clients can contact Michael email him at MKosowan@sprottglobal.com or call 1.800.477.7853.

 

Read online >


© Proactive Investors 2015