The growing 90% club and why gold production is going to go to zero

Welcome to the 90% club, membership is free but you don’t want to join.

Gabriel Resources, a typical demise in the mining sector.

 

 

The news last month that Romania had blocked Paulson-backed Gabriel Resources (GBU US) Ltd gold mine project led to a decline of 54% in the share price and is one of the latest entries in our DOWN 90% club. Since its highs in July 2011 at $8.65, it has fallen 92% to close at 0.68c on September 9th. Even after that fall the market capitalisation is still $260mm. Even by BBC severance pay, those are some serious big numbers. Gabriel’s CEO Jonathan Henry believes they have a very, very robust legal case and believes that they can claim up to $4billion from the Romanian state.  I think you will have more chance of humans living on Mars next year than getting that cash but that’s just my opinion.

 

We now have 109 mining companies in our ‘club list’ whose share price has fallen by 90% or more since the heady days of 2010/2011 when the gold mining conferences were standing room only.

 

Well-known names like Petropavlovsk PLC POG, Peter Hambro’s brainchild and Allied Nevada Gold feature as well as a multitude of once up and coming juniors like Claude Resources, International Tower Hill and Jaguar Mining. With harsh logic and rationale, any stock that is down more than 90% is most probably going to be down 100% soon enough and turning the lights off. Talking of turning the lights off, hot off the press is this news. This is how the death of a mining company looks like and the rest of the industry not far behind.

 

American Bonanza Suspends Operations at Copperstone Mine

 

October 11, 2013 – American Bonanza Gold Corp. (TSX: BZA) (“Bonanza” or the “Company”) is placing the Copperstone Mine in Arizona on care and maintenance status until further notice. The Company has made this decision in order to cut costs while it reviews operations with a view to improving operational efficiencies, and while it seeks additional capital to fund performance improvements in order to meet designed capacity of the Copperstone Mine. Declining gold prices also factored in the Company’s decision to suspend mining and milling operations at this time.

Wall Street Journal, October 11th 2013

 

Unfortunately the club is looking like it is going to have to hire a bigger venue for its next AGM as we have new members making their way up to the check- in desk every day. We currently have 58 gold mining companies down between 80-90% with once giants like Kinross Gold and Novagold among their ranks. This on-going tragedy in the mining sector is showing no sign of letting up but at this gold price it is unlikely to do so. The reason why mining companies are falling by 70-100% in the hundreds now is very simple. In our analysis, it costs over $1750 to mine an ounce of gold if you add in all the costs of running a mining company, not the published cash costs or the all in sustaining costs.  The mining industry can argue till they are blue in the face that their costs are $800 or $1200/ ounce but if you only produce negative cash flow (that’s a LOSS to the non-analysts) when gold is below $1750, then it’s pretty clear in my books what is happening. This is going to be far worse than the late 1990s I’m afraid. We have many friends in the mining business and this is a true tragedy for the industry. Whether you believe it is a bullion bank or central bank conspiracy in forcing the gold price lower, it doesn’t matter, we have to deal with the reality. As the old hired gun said in the famous film with John Wayne, aptly named “El Dorado”,

 

“Faith can move mountains, but it can’t beat a faster draw”

 

Maybe for many people this needs to be clearer. Imagine you have “discovered” 1 million ounces of gold in your garden, 200m below surface.  Wow, you have won the lottery.  You check the current price of gold in the FT at $ 1256/ ounce and realise you have $1.25 bln of gold . Start ordering the yacht!!

 

Unfortunately when you get 3 independent quotes from your local mining company to extract it ,the quotes come in at $1.75 bln to get the gold out of the ground. Hmmm..so that windfall is now a loss if you chose to go ahead.   As flippant as this sounds, this is exactly the problem facing the mining companies.  It costs more to mine than you can sell it for so the only smart move is to close.  The problem is all very well for the private companies who own the land, close doors, wait for new cycle, go and pursue other interests. Much less so when we are talking about more than 2000 public companies with 500,000 employees, with experience and careers in the mix.   Every CEO is now talking about cutting costs everywhere. From general office costs to exploration , mining high grade , you name it they are cutting. Over the last decade of the bull market there have been excesses built up so there is some easy meat to trim but I would argue that even if you cut like a mad Yukon axeman, most mining companies cannot get anywhere close to break even, let alone a profit at this gold price so it is no surprise that share prices are dropping like proverbial stones.

 

N.B. If you cannot sell your product for more than the cost to produce, your company is worth nothing.

 

In the resource business where the price of gold changes by the second, there is always the possibility that in the future the price will rise above the production price and so there is an inherent call option in the stock price. Unfortunately this has to be offset by the carrying cost of the asset. If it’s in your back garden, carrying cost is pretty minimal. If you are having pay even skeleton salaries, keep up permitting, ownership rights, pay listing fees etc, then these carrying costs will eat in to the call option value pretty quickly. Production over the last decade has been relatively constant at between 2500-2800 tonnes a year (80-100 million ounces).

 

 

If gold prices stay at the current levels for a prolonged period of time, do not be surprised if gold production falls much closer to zero. From an investor’s perspective it is a treacherous minefield. Of course, there are companies who really do have high grade ore reserves who can really claim to mine at $800/ ounce but these are very rare, maybe less than 5% of the 2000 quoted companies. The Northern Miner writes that out of their survey of 1400 Toronto listed firms, 721 currently have less than $200k cash in the treasury.

 

While the big caps that make up the GDX index are unlikely to go out of business in the short term and may offer some trading opportunities for a bounce here, the very nature of this desperate business remains. Huge capital is required a long time before there is even the sniff of future cash flow.  All companies can go to zero but mining companies get there much faster than most. Strangely it might well be the demise of 1000 mining companies over the next year that is the most bullish reason for the survivors.

 

If gold production really does fall off a cliff, the standard laws of supply and demand should be a huge positive factor for the price of gold.   The sentiment in the gold market is horrendous led by the media and the price action. It is down 25% on the year. If you were looking for an asset class with a high margin of safety, (production cost) that was universally hated with no speculative long positions for a long term value portfolio allocation, you could do a lot worse than gold bullion at $1250 ounce.

 

Appendix

 

The full 90 percent club

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