November 10th, 2009
In Part 1, I introduced readers to the different categories of miners, and outlined some of the basic characteristics which these companies possess. In the second part, I will provide some guidance on what to look for in separating the "contenders" from the "pretenders".
Naturally, the starting-point in looking at the quality of any mining company is the quality and quantity of ore in their property(s). The quality or "grade" of the ore will go a long way in telling us about the profitability of a miner (or the potential profitability of an exploration company).
For gold miners, the starting point would be to look at ore with 1 gram of gold per ton of ore. That's right, ore with as little as 1 gram/ton is potentially rich enough to support commercial mining. Of course, with this low level of concentration of gold, it will generally require both vast tonnages and favorable geology for ore of such a low grade to support commercial mining operations. Generally speaking, what exploration companies are looking for is ore with several grams of gold per ton.
As stated, grade alone is never the sole determinant on whether a particular ore-body is commercially viable. What companies looking for gold (and mining gold) need to see is enough tons of such ore to justify all the preliminary drilling, the resource estimate, the feasibility study, and ultimately the construction (and operation) of a mine.
Even when looking at the quantity of gold in an ore-body, tonnages alone do not tell the whole story. Companies drilling for gold sometimes go down a mile or even further beneath the ground. What companies (and investors) want to see is for the quantities of gold in these ore-bodies to be compressed within a relatively narrow range of depth.
For example, let's suppose that two companies have identical grades and tonnages of gold in their properties. The "veins" of gold for Company A start at 50 feet below the surface, but continue all the way down to 5,000 feet below the surface. With Company B, on the other hand, the gold doesn't start until 200 feet beneath the surface, but the mineralization only goes down 1,000 feet.
It would obviously require much more excavation for Company A merely to get access to all its ore, and likely much more ore extracted to mine all the gold. All of this additional blasting and digging dramatically erodes the potential profitability of the mine, so how the gold is distributed within an ore-body is a factor which investors must note in their research.
Much of this information is revealed to us in the drilling samples which mining companies extract and analyze. A drilling core sample is a vertical cross-section of the ore which ideally is perpendicular to the vein in question - so that the sample represents a "true width" of the particular vein. Since veins of ore can exist at various angles relative to the surface, and can also bend and twist through the Earth's crust, it can be very challenging for the miners doing this drilling to produce such ideal core samples.
Assuming this is the case, when you examine the drilling results of a mining company, the data is generally presented as a series of "intervals" in each core sample, with each "intercept" representing a separate vein of gold. Thus, the drill samples will tell miners (and investors) the grade of the ore, the thickness of veins, and the number of veins - over the total depth of the drilling sample. This means that an ideal core sample would demonstrate high grades (i.e. averaging several grams per ton), thick veins, and (hopefully) many such veins. Since these intervals can be very thick, in some cases exceeding 100 feet, the grades within veins can vary considerably. Where the concentrations are unequal, the person evaluating the core sample will generally also list sub-intervals within the intercept - and indicate the especially rich segments of such intervals.
There is an incredible amount of variation in veins of ore. In the extreme, very rich ore can contain hundreds or even thousands of grams per ton. While veins of ore can (and do) exceed a hundred feet in thickness, such veins can also be extremely narrow - sometimes only a few feet thick. Indeed, it is not uncommon in the case of "high grade" ore for the geological formation to be a series of very rich grades, but very narrow veins.
Naturally, this incredible geological diversity means that there are numerous methods for mining ore. Our primitive ancestors (and modern "prospectors") got most of their gold through "panning" or "dredging" gold that has reached the surface - and been washed into the beds of rivers and streams. For gold that is near, but still beneath the surface, the preferred method of mining is generally an "open pit" operation. As the name describes, this is where instead of constructing a true "mine" under the ground, a mining company will simply start at the surface and strip-off one layer of rock after another.
The advantage of open-pit mining is that it avoids the costs and engineering challenges of constructing an underground mine. Secondly, pit-mining operations are generally very large-scale operations - requiring vast tonnages of ore to justify all the equipment and manpower necessary to run such an operation. However, as companies go deeper and deeper with their pit-mining, extracting gold becomes relatively more expensive. As a result, in the case of ore-bodies which start at the surface, but continue to considerable depths, it is not uncommon for a mining company to initially extract ore in an open-pit operation - and then after the near-surface ore is extracted, construct a conventional mine to extract the remaining ore in the most economical manner.
Generally speaking, a company will need to find higher grades of ore to economically justify an underground mine than an open-pit mine - although as I mentioned earlier, open-pit mines are generally only economically feasible where there are vast tonnages of gold for extraction.
While veins of gold are relatively narrow, the length of these veins can run for miles beneath the Earth's surface. Some of the world's largest/oldest mines end up as vast labyrinths of tunnels occupying areas of many square miles. As a result, even more important than the data which is obtained vertically through each individual drill-sample are the number of such drill-holes produced in a drilling program.
It is the accumulation of dozens (and often hundreds) of drilling samples which map-out the dimensions of any given ore-body. Obviously, if such holes are placed closer together, the data obtained is more precise. However, with drilling being a very expensive process, there is a large economic incentive for companies to space-out the holes quite widely (at first) to gauge the overall dimensions of an ore-body. Then subsequently once those dimensions are identified, companies will "fill in the gaps" with more drilling within this perimeter - in order to provide geologists with enough data for a "resource estimate".
With drilling ore-bodies being such a capital-intensive process, drilling always begins tentatively. Modern "imaging" technology and other forms of geographical analysis (including near-surface "trenching") will provide companies with some initial "targets" for there first drilling efforts. Also, since every extra foot which these drills bore into adds to the costs, an initial drilling program will generally involve only a dozen drill-holes or so (sometimes even less) and unless the geologist has reason to suspect that mineralization is very deep, those first drill-holes will also be quite shallow.
For potential investors viewing the results of such drilling, there are two indicators which they typically look for. First (and most obviously), they want to see most if not all of the drill-holes showing significant levels of mineralization (i.e. several grams of gold per ton in each intercept). Of nearly equal importance, investors want to see evidence of even greater mineralization. Specifically, they will look to see if the drilling reports that mineralization is "open" (i.e. it continues beyond the scope of the original drilling).
Mineralization could be "open" in any direction laterally, and also potentially "open at depth" - meaning that mineralization still continues lower at the deepest depth reached by the drill hole. The miners themselves are naturally even more interested in such data - since this information will guide them in deciding where to drill their next holes, how many such holes they should drill, and how deep they should go with subsequent holes. The nature of the "game" is to try to learn (and demonstrate) as much about an ore-body as possible - with the least possible expenditure of capital.
Since exploration companies generally have no sources of revenue, being efficient (and a little lucky) with their drilling can and does determine which of these companies will survive and thrive, and which will struggle to stay afloat or simply fold.
Once a drilling program has identified a body of ore with the potential to support a commercial mining operation, this is only the starting point of analysis. A "feasibility" study must be done to evaluate a number of other factors (a more preliminary form of this analysis is called a "scoping study").
Sulphides and Oxides
Ore containing gold falls into two categories of chemical/geological composition: sulphide-based ores and oxide-based ores. Gold "oxides" are preferable for mining since the chemical "bond" which locks the gold to other chemical elements is not as strong. As a result, processing such ore is cheaper, easier, and generally yields a higher "recovery" rate than with gold sulphides.
The "recovery rate" is self-explanatory. It is the percentage of gold contained in a given quantity of ore which is successfully extracted, and ready for further processing (and ultimately refining into bullion). In simple gold oxides, a recovery-rate above 90% is not unusual. However, because gold oxides contain gold that is cheaper and easier to extract, most of the world's easily accessible gold oxide deposits have already been mined - meaning that modern miners are forced to obtain much more of their gold in sulphide-based bodies of ore.
With gold sulphides, the much tighter chemical bond between the gold and other elements is much more technically challenging. Attempting to extract the gold using the same methods of extraction as with gold oxides would result in vastly inferior recovery-rates - closer to 50% recovery. Primitive methods of secondary processing of such ore were developed, which improved recovery rates, but resulted in vast quantities of highly-toxic waste.
Unless such "tailings" were collected and contained very carefully, the result was generally environmental devastation. Such primitive gold-sulphide mining operations have been among the worst "offenders" when it comes to mining-based pollution. Fortunately, modern technology has devised new methods for extracting gold from sulphide deposits - which are not only much more environmentally "friendly" but also yield higher recovery-rates.
Thus, while it is generally preferable for a mining company to mine gold oxides, sulphide deposits are no longer as problematic with respect to both costs and permits as they were in the past. Which leads to another important issue for gold miners, and mining, in general - permits.
It doesn't matter how many millions of ounces of gold a mining company discovers if it is never allowed to mine it. Thus, potential investors must look at the location of any gold deposit both in terms of local and national considerations. Locally, deposits which are close to large populations or environmentally sensitive sites will generally have more difficulty (and need to provide better operational guarantees) to obtain approval for a commercial mining operation.
However, just as looking for gold in districts which have a history of successful mining tends to provide better chances of success, similarly it is more likely for miners to obtain the necessary permits and approval for a new mine in areas which have previously approved other mines in the vicinity.
Potential investors should not simply assume that mining companies are necessarily big polluters, and the enemies of local inhabitants. I was fortunate enough to go on a mining tour of one of the world's largest and oldest silver mines. More than one billion ounces of silver have been taken from this one, huge mining complex - stretching over a period of more than 400 years.
A small city has literally been built around this mine. Even though the city has been named a U.N. "world heritage site" I admit to expecting to see a grubby city and at least some signs of environmental degradation. Instead, I was totally surprised to discover a clean, beautiful city - with no visible signs of long-term mining operations. In fact, an old "tailings dump" was now the site of the new athletic complex for a local university.
This means that potential investors should not assume that investing in a gold miner, or silver miner means putting your money into a harmful business - like investing in a tobacco company. Modern, responsible mining operations can co-exist with human habitation, and even be compatible with all but the most-sensitive natural habitats.
Despite this fact, the receptiveness of national governments toward mining operations varies dramatically from nation to nation. Some governments have a strong aversion to any mining, either through previous, negative experiences with other primitive or reckless miners, or simply due to an out-dated fear of such problems. New companies seeking to obtain permission for a future mine can face sometimes insurmountable problems here, so potential investors must take note of the jurisdiction where a particular deposit is located.
Up to now, I have been discussing hypothetical bodies of ore with the unstated assumption that they only contain one commercially valuable mineral. In fact, most bodies or ore which contain gold or silver will generally contain one or more other mineral elements with commercial value.
These "byproducts" will add additional complications to the processing of ore, although modern metallurgy has progressed to the point where these problems are nothing more than minor considerations. Typically what occurs is that the metallurgist will seek to maximize the recovery-rate of the primary metal (gold or silver) with secondary processing yielding lower recovery-levels for the other metals contained.
Naturally, these byproducts will offset the production costs of the primary metal, through the "credits"obtained by selling these other metals. This lowers the production costs for each ounce of gold/silver (the "cash costs"), however it also dilutes the "purity" of the miner.
For example, a gold miner which obtains 25% of its revenues from copper also contained in the ore, or a silver miner which also produces large amounts of lead and zinc (both very common scenarios) are no longer the "pure plays" which are favored by investors. Such companies generally receive inferior valuations relative to revenues/profitability, and also are affected by price-changes for these other metals.
Even where geological conditions are favorable, and national and local governments are amenable, satisfying these many criteria still does not guarantee that a mining company will be able to capitalize on these factors, and construct and operate a profitable mine.
Mining is one of humanities most capital-intensive industries, and investors in mining companies were made aware of this fact in the most brutal manner possible - after most of the global banking industry simply cut off all capital to this industry. Many smaller companies were literally destroyed. Some were forced into formal bankruptcy, while many others exist much like the large collection of zombie-banks: while they are still in operation, they are so starved for capital that it will be years (if ever) before these companies can regain their previous health and momentum.
Now that capital markets have again opened up for the mining industry, financing becomes more of a strategic factor for investors. Pure exploration companies will have to raise new capital each time their last source of funding begins to dwindle. Companies at a more advanced stage will typically seek a new infusion of capital each time they seek to make another major step in going from finding a deposit to mining it. Thus investors must keep track of both the current cash position of these companies, and what stage they are in with respect to development of their property.
Hopefully this discussion has demonstrated that while investing in these companies is not quite as simple as novices to this sector might first conclude, neither is it so overwhelmingly complicated as to make these companies inaccessible to individual, retail investors. Those investors who do their homework, diversify into a "basket" of these companies, and exercise discipline in their buying and selling should expect to be able to leverage the gains of precious metals and obtain a higher rate of return than in bullion, alone - over the long term. However, the volatility of these companies is not for the timid - make sure you're ready for the "ride" before you choose to get on one of these "roller-coasters".
© 2009 Jeff Nielson
ABOUT THE AUTHOR
Bullion Bulls Canada. He studied economics for four years, before going on to obtain his law degree from the University of British Columbia in 1989. His site provides precious metals commentary, and general economic analysis.
is writer/editor of |
The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and I encourage you to complete your own due diligence when making an investment decision.
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Posted in Metals & Mining, Guest Commentary, Jeff Nielson