Gold News

Gold Mining Investment: Watch Those Costs!

Some miners are struggling to profitably mine gold...

RICK MILLS isn't looking for huge producers with so much overhead that they can't profitably mine an ounce of gold. Instead, Mills, the publisher, editor and president of, seeks out the smaller mines with low capital costs. That's where the money will be made in the next two years, he tells The Gold Report

The Gold Report: Rick, is this a good time to be buying gold?

Rick Mills: There are three key reasons to have exposure to gold bullion. The traditional reason is to protect against inflation. We're printing money. More quantitative easing has taken place and inflation looks to be coming down the pike. I buy groceries. I pay for gas. I can see inflation. I firmly believe it's going to get higher over the coming months and years. Buying gold as a protection against inflation is realistic. 

The second reason investors have traditionally bought gold is as a safe-haven investment. There's a lot going on in the world—from secession talk in the US to turmoil in Israel, Iran, Syria, the South China Sea region and Turkey. 

One of the things that most investors don't know about gold is that adding a gold allocation to your portfolio, especially over the last decade or so, has provided substantial enhancements to the portfolio's return.

Gold helps minimize the downside deviations in an overall portfolio. In 2002, the S&P 500 was down 23%. Emerging market equities were down 6%. International equities were down 16%. Yet gold was up 25%. 

TGR: That was early in the bull run in gold. 

Rick Mills: Even in 2008, the S&P 500 was down 37%, international equities were down 43% and emerging market equities were down 53%. However, gold was up 8%.

TGR: It felt like the end of the world in 2008. Gold has saved the portfolios of a lot of investors who were smart enough to start collecting it in 2001 and onward. However, there are investors who don't believe that gold has the multiples now.

Rick Mills: It's true. I believe gold producers have shot themselves in the foot because of their reporting methods. They use cash cost for reporting. In 2001 and 2002, miners were producing gold for below $180/ounce (oz). By 2005, cash costs had risen 45% to $250/oz. Data from research consultancy Thompson Reuters GFMS shows that world gold production costs for the first half of 2009 averaged $457/oz. In 2011, they were $657/oz. GFMS' Gold Survey 2012 says it's now $727/oz. 

But if investors have been looking at that, they've been misled because that's not really the cost of producing gold. These average cash-cost figures include only the costs directly associated with the production of gold, such as wages, energy and raw materials. 

The problem is that gold cash costs are not the only costs associated with mines. Investment bank CIBC just produced a complete breakdown of costs. Yes, operating costs are $700/oz, but there is also sustaining capital, construction capital, discovery costs and overhead. CIBC pegs those at an average of $600/oz. Add in $200/oz for taxes on average, and you're looking at $1,500 to produce an ounce of gold.

TGR: In that environment, many of the gold mining producers would be out of business.

Rick Mills: The gold price is $1,700/oz. Companies are not making a lot of money here. The funny thing is that the sustainable costs for gold—the sustainable number gold miners need—according to CIBC, is $1,700/oz. You can see why investors are leery to jump into the space with numbers so tight. 

TGR: But you're a gold bull. You believe that people should be investing in bullion. The bullion has to come from somewhere. What's an investor to do when he believes in the fundamental reasons for owning gold, but doesn't understand how the equities can perform?

Rick Mills: Historically, the precious metals equities have given investors the most leverage to a rise in gold and silver prices. We need to have a rise in gold and silver price. We need to get into that environment again, like it was from 2001 to 2006 when gold equities went up 900%.

Let's look at why companies aren't making a profit. One of the biggest reasons is capital expenditures (capex), which is the basic cost of building a mine and its supporting infrastructure. There are lower grades being mined—down 23% over the last five years and expected to drop another 4% this year—and more complex metallurgy. Companies are increasingly going into more remote areas that lack infrastructure. Environmental regulations are increasing. We are seeing more money-grabbing governments and resource nationalization. There's a serious shortage of skilled personnel and labor unrest is pretty much everywhere: strikes, protests and unions demanding higher wages. Everything you can imagine is working in a perfect storm to increase costs and risks on mining companies. 

Costs are going through the roof, yet gold is stuck in a holding pattern at $1,700/oz. Then, when people want exposure to the sector, they buy an exchange-traded fund (ETF). In the past, a lot of that money would have gone into mining equities.

There's a huge increase in exploration spending—more than $8 billion ($8B) in 2011—but a serious lack of new discovery. There have been very few large, high-grade deposits discovered during the past few years. 

The number of annual gold discoveries of more than 5 Moz since 2007 is six in 2007, one in 2008, one in 2009, three in 2010 and one in 2011. None is producing yet. A lot of people who think that they're going to produce are in for a disappointment because of resource nationalism, permitting problems, environmental problems, lack of water, labor unrest and protests.

TGR: Assuming gold demand will continue to escalate due to macroeconomic pressures, will the price of gold continue to increase?

Rick Mills: Gold demand is still rising. Five-year average quarterly demand is rising, so that's correct.

TGR: What do you forecast for the 2013 gold price? 

Rick Mills: That's a mug's game, trying to predict gold prices, but it'll be higher. 

TGR: You believe the price of gold can only go up.

Rick Mills: That's right. Inflation, world events, diversification—gold does offer leverage. So do equities, or at least they will again. I'm not looking at huge mines with billions and billions of Dollars in capex. I'm much more comfortable with the smaller mines with lower capex and under-control operating expenditures. I like the lowest-cost producers. That's where the money is going to be made over the next two years.

TGR: Canada, the US and some places in Latin America are the preferred jurisdictions for risk reduction, infrastructure, rule of law and reliability of government.

Rick Mills: Absolutely. Look at the Muslim Brotherhood in Egypt canceling a nearly 20-year-old license for a mining company. In Madagascar, a DJ gets elected president and the first thing he wants to do is cancel permits and do a review. That's not happening in Canada, the US or politically stable places like Greenland. There is enough risk in this business as it is without intentionally inviting more.

TGR: Given that backdrop, what are some companies you find interesting right now? 

Rick Mills: Let's stick with soon-to-be producers or companies that are going to be very low-cost producers. They're all in geopolitically acceptable countries with superior management teams.

According to a July 2012 research report by Natural Resource Holdings, there are only 164 undeveloped gold deposits globally, with more than 1 Moz of gold in all categories, that are owned by non-major mining companies. The average grade of all these deposits is 0.66 grams per ton (g/t). Since we're mining +80 Moz a year, that makes these non-major-owned deposits quite valuable. 

TGR: Do you foresee a problem with the rise of the green movement and First Nations issues?

Rick Mills: Most of the companies in British Columbia that have had problems with the First Nations created their own problems by not getting the First Nations involved in the projects early. They show disrespect to the traditional ways. A company that engages the First Nations, is willing to work with them and is willing to provide jobs and help them, isn't likely to be road-blocked by them. The First Nations are not against resource development. They want jobs. Engage them early in a project and you won't have a problem.

TGR: Thanks, Rick.

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