Ground Control to Major Tom: Reserves Are in Jeopardy
By Jeff Clark, Senior Precious Metals Analyst, Casey Research
Understanding the concept of “gold reserves” within a mining operation often leads to the assumption that these reserves represent a fixed quantity of ounces. After all, gold is stable; it neither decays nor relocates on its own.
However, such assumptions can be misleading. The reality is that gold reserves across the industry are likely to see a significant decline in the near future.
When gold prices drop, the impact on producers is not only immediate—manifesting as reduced profits and mandatory write-downs—but also long-term, affecting the amount of economically viable gold a company has on record or hopes to extract in the future.
The Bar Is Higher
Reserves are determined by a mix of factors, primarily cutoff grades, projected production costs, and assumptions around metals prices.
For instance, if gold is priced at $1,500 per ounce, a mining project might categorize ore as economically viable at a cutoff grade of 1 gram per tonne (g/t).
However, if the gold price falls to the low $1,300s, that same deposit might now necessitate a higher cutoff grade of 1.5 g/t. This is because the revenue from the lower-grade ore would not cover extraction costs—a scenario that isn’t sustainable for any business.
What Was Once “Ore” Is Now Just Dirt
Higher cutoff grades limit the number of economically mineable ounces, especially if gold prices don’t rebound for a while.
Consider the average gold prices over the previous four quarters:
– Q4 2012: $1,718.89
– Q1 2013: $1,630.45
– Q2 2013: $1,413.64
– Q3 2013*: $1,327.91
*through September 27
This steep decline has compelled many company executives to reevaluate their price assumptions for reserves. As a result, reserves that depend on a gold price of $1,350/oz or higher will likely be removed from the books.
This dynamic explains why high-grade projects tend to have a better chance of weathering adverse conditions compared to low-grade ones. While all projects are less profitable when gold prices drop, higher-grade projects usually maintain stronger margins and experience fewer operational disruptions. Often, they continue to generate substantial profits.
High Grading
Another factor that can diminish reserves is the practice of high grading.
Many mining projects contain both low-grade and high-grade zones. During periods of lower prices, companies may choose to mine only the richer ore to remain profitable. While this may seem short-sighted, it can be a necessary strategy for survival in a weak market. However, this practice can have greater implications for reserves than one might anticipate.
When prices are low, the focus on high-grade ore leads to the temporary neglect of low-grade material. Although this ore still exists, it may never become viable for mining. Some low-grade ore requires blending with higher-grade ore to be economically feasible. If gold prices eventually rise, the absence of high-grade material means these low-grade deposits may never be mined at all. Consequently, they cease to be counted as reserves.
Now You See Them, Now You Don’t
Most companies typically update their reserve estimates at the end of the year and report any changes in the first quarter. If gold prices do not rebound significantly soon, we could witness a considerable decrease in mineable reserves across the industry.
This decline will have implications for the precious metals sector and for investors alike. While some effects may be negative, this situation also reveals investment opportunities that promise significant returns.
Here’s what Major Tom communicates about dwindling reserves and what they could mean for us as investors:
- A decline in the company’s value. Firms with less product to sell will see their valuations drop. The exception will be those producers that can maintain solid cash flow; these will be the firms most likely to remain stable.
- Keep an eye out for companies that report significant write-downs in reserves. Many producers will be compelled to announce lower reserves in early 2014 if gold prices remain stagnant. However, companies showing unusually significant declines may struggle to sustain production levels. Typically, these will be firms with low-margin projects or those reliant on low-grade material rendered uneconomic by high grading. A decrease in production could deter potential investors.
- Reduced reserves lead to decreased supply, which can drive gold prices higher. Global gold production is stagnant. If we witness a substantial drop in available gold ounces due to reserve write-downs, and demand remains consistent, prices will inevitably rise. This trend is already emerging, and if it accelerates, we may see a significant increase in gold prices.
- Promising junior exploration companies could emerge as major beneficiaries. Many producers have had to reduce or eliminate exploration budgets out of necessity. Yet, to ensure their survival, they will eventually need to discover more ounces. As each day passes without exploration, their resources diminish. Enter the junior exploration companies with substantial high-grade deposits. These firms are likely to attract acquisition offers, especially if their projects remain economically viable at lower gold prices. As producers realize their ore supplies are dwindling, competition for these assets will intensify.
- Even if gold prices return to previous highs, it will take years for larger companies that reduced exploration budgets to rebuild their teams and discover new deposits. The urgent necessity will be to acquire existing assets.
Therefore, now is an ideal moment to invest in junior companies that possess robust projects with strong economic fundamentals. Recently, I purchased one…
Casey Chief Metals Strategist Louis James has recommended an advanced-stage gold exploration firm in the latest issue of the Casey International Speculator. This company boasts a large, high-grade deposit in Europe with significant growth potential.
I intend to acquire the most undervalued juniors now and patiently wait for the producers to come calling. A significant surge in the junior sector is on the horizon, and all that is required to benefit is to wait for the inevitable developments.
While reserves may be decreasing, our investment prospects remain promising. For those interested in getting involved, click here to start your risk-free 3-month trial of the International
Speculator.
Sincerely,
Jeff Clark
for Economic Prism
[Editor’s Note: Jeff Clark serves as the Senior Precious Metals Analyst at Casey Research. He comes from a lineage of passionate gold panners and actively manages family placer claims across California, Nevada, and Arizona. His love for gold drives his commitment to both personal and subscriber profitability in the precious metals sector. He continuously analyzes companies, investigates major trends in metals, and seeks safe and profitable strategies for capitalizing on the gold and silver bull market.]
Return from Ground Control to Major Tom: Reserves Are in Jeopardy to Economic Prism
