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Another Reason to Love the Juniors

by John Rubino on September 27, 2011 · 10 comments

Yes, gold got whacked last week. But that was nothing compared to what happened to the emerging gold miners. On the chart below, the green line is GLD, an ETF that tracks the gold price, and the blue line is GDXJ, an ETF that contains the shares of a representative basket of small, emerging gold miners.

Based on this divergence alone you’d be justified in either going long the juniors and short gold (on the assumption that no matter what happens the juniors should outperform gold to bring the relationship back into balance) or just buying a bunch of juniors in the expectation that gold will soar while the juniors soar even higher.

But there’s another reason for loading up on juniors, courtesy of the Daily Reckoning. It seems that they have what the rest of the industry needs:

The Biggest Threat to the Gold Mining Industry

09/26/11 My friend Brent Cook is buying gold right now… But not for the reasons you’d expect.

Brent is no “doom and gloom” gold bug. He doesn’t think the dollar is going to collapse any time soon.

Brent simply knows the world is running low on gold… which could drive the price of his favorite stocks much, much higher.

He has unique insight into the gold business. He’s one of the best mining geologists in the world…and he spends an extraordinary amount of time visiting mines and analyzing mining data. He shares his thoughts in his Exploration Insights newsletter.

Last week, Brent told readers about the latest on a huge story happening in the gold business: Gold companies are spending enormous amounts of money to explore for gold…with little to show for it.

According to numbers from the world’s largest gold miner, Barrick Gold, the entire industry is having more and more difficulty finding new gold deposits.

Here’s how Brent summed up the situation…

Current global mine production is in the order of 85 million ounces per annum, whereas…the last time the industry found that many ounces in a year was 1999.

This dearth of new discoveries is despite the significant increase in exploration spending since 2002. Particularly disconcerting (to the larger mining companies at least) is the decline in discoveries since 2006 notwithstanding exploration spending has more than doubled from $2.5 billion to over $5 billion.

The years from 1850 through 1900 were incredible for gold discovery. That’s when prospectors found the giant goldfields in Australia, Canada, South Africa, Colorado, and California. However, the modern era of discovery didn’t begin until the 1960s.

Geologist Forbes Wilson found the world’s largest gold mine, Grasberg, in 1960 in Papua, Indonesia. Geologists John Livermore and Alan Coope discovered the largest gold producing region in the United States, Nevada’s Carlin Trend, in 1965. Since then, we’ve scoured the planet for the “easy gold” — the stuff that sticks up out of the ground in relatively safe, functional countries.

But now, all of the “easy gold” has been found. (It’s a lot like the situation in oil, which I’ve told you about here.) Mining and exploration companies are still finding some good deposits… They’re just generally in inhospitable, remote, or downright scary places.

For example, one “top 10 in the world” deposit that I like, Seabridge Gold’s KSM Deposit, is a monster gold deposit… The only problem is that it’s in a far-off corner of British Columbia. To mine this deposit, the company needs to build a long tunnel…just to get the construction equipment in. I still like owning the stock. But it will take billions of dollars of capital investment to develop the deposit.

Another monster gold and copper deposit, Alaska’s Pebble Deposit, is next to a pristine wildlife area. This creates just as large a hurdle as a lack of roads.

Plus… The costs of gold production (things like fuel, labor, and infrastructure) has more than doubled from 1997 to 2009. The price tag to build a new mine these days can run into billions of dollars. The mine must be able to repay that cost within a year or two and then produce a reasonable return on the investment. The huge upfront costs set the bar high in terms of the size and quality of deposits that big gold companies are willing to pursue.

This just means the highest-quality, large, undeveloped gold deposits in the world are getting increasingly valuable. As $1,500-plus gold sends a surge of profits into the coffers of big gold miners, you’ll see fat premiums paid for great projects.

Mining giant Newmont paid a big premium in 2010, when it spent $2.3 billion to acquire junior explorer Fronteer Gold. One day, Fronteer was worth about $10 per share. The next day, it was worth $14. Investors doubled their money in a few weeks on that deal.

In sum…the world is running low on gold. The “easy gold” has already been found. That’s why Brent is scouring the world looking for great gold projects…

Right now, he’s a fan of investing in deposits in Mexico… Although you hear lots of negative “gang related” headlines from mainstream media sources, Mexico is actually a great jurisdiction for miners. And he’s made good money by owning shares of Almaden Minerals, which is exploring a promising gold project called Ixtaca.

Potential deposits like that aren’t easy to find… But they’ll be worth hundreds of percent more in the coming years.

Some thoughts:
Gold doesn’t have to soar for there to be a takeover orgy in this space. As long as the price stays high enough to make production profitable, the big miners have to get reserves from somewhere, and this is apparently the only game in town.

Juniors are always relatively cheap in terms of ounces in the ground because a lot can happen between discovery and consistent, low-cost production. But that’s less of an issue during a buyout binge, since the acquiring companies will take responsibility for the transition.

The upshot is that juniors with proven, accessible deposits don’t really have to do much from here on out. They can just hang around and wait for the offers to roll in. Before it’s over, they’ll be the dot-coms of this generation.

  • W G Thompson

    It bothers me that GLD and SLV are
    holders of paper receipts for Au & Ag,
    not the physical metal. CEF is the
    only outfit I know of that has the
    real stuff locked away. If you know of
    any others, you might let us know as
    a footnote somewhere.
    vty, W. G. Thompson

    • mike lentin

      Here in Canada, the Sprott organization has a number of funds that hold either physical gold or physical silver.
      Sprott is a Canadian company run by Eric Sprott..a top investor in precious metals for many years.
      Try sprottmoney.ca
      ,or just google his name.

      regards,
      mike.

  • SvetlanaBabe

    I don’t trust ‘paper’ at all. I hoard a lot of silver and gold, so my home security is like Fort Knox, seriously.
    I just don’t trust GLD, I reckon it’s a scam.

  • Agent P

    “(It’s a lot like the situation in oil, which I’ve told you about here.)” Oh boy… Here we go – ‘peak gold’, right?

    I have a question: The peak oil ideologues (and make no mistake – if you have been following some of the commentators on this topic for the past 3 – 5 years as I have, you would have noticed that ‘peak oil’, much like ‘climate change’, has transmorphed from a thought construct to an Ideology – much like religion, with all its attendant howls & cries of impending doom, calamity and shortage, to be rectified only by Massive intervention through the preferred proxy of choice, Government…)

    The Peak Oil ideologues talk incessantly about the ‘science’ that proves ALL of the world’s discoveries of ‘easy’ (light sweet crude) oil have been exhausted. Really. I just heard it yet again the other day with this guy doing the book ‘O the month club tour called ‘The End of Growth’. Yet another calamity scam posing as ‘concern’ that the world (collectively, of course) must ‘Do Something’ about peak-everything, with a special and reoccurring theme of over-population which, albeit a topic for another discussion, is ultimately where all roads to ‘peak’ anything lead when you scrape the thin ‘gold’ plating off their arguments and dig a little deeper, but I digress.

    If all of the easy finds of light sweet crude oil have been found – according to the ‘peak’ theorists, then by logical extension, it means that every square mile on this planet has been sonar, radar, test-drilled and computer-modeled/mapped, and the results have all come back negative, correct? It means that what we have in terms of light sweet crude deposits/finds/wells, is it – no more; no way, no how.

    According to this chap (The End of Growth), we have by extension also, ‘peak minerals’ – although he did backpedal on that a bit and I am not sure why. I mean, if the lid is down on light sweet crude by way of our existing technology to detect large pools, there must be a way to verify the ‘finiteness’ of mineral deposits too, right?

    And the Gold ‘shortage’? How is it that I read (on a daily basis), ‘new’ finds of ore – both ‘indicated’ and/or ‘inferred’ from exploration companies and seemingly endless swaths of ‘potential’ from drill results in the vast acreage of myriad miners and exploration companies…?

    Something doesn’t quite smell right to me in the world of ‘peak’… Although, I sure wish we were looking forward to ‘peak’ Government… That – is a ‘resource’ that will Never be in shortage unfortunately… Never mind of course, that environmental regulatory restrictions preclude most of new discoveries – at least in the U.S., so how in the Bloody Hell could we know for sure to begin with!

    Have all the questions been answered (truthfully), or is it that the Right questions have never been asked…?

    • Bruce C.

      I think you’re over-complicating the issue. Regardless of the reasons, the junior gold miners with known reserves are simply becoming more valuable as the costs of finding more gold increase.

      Generally speaking, barring a new technology, production costs of just about anything, and especially natural resources, increase with increased demand. “Peak X” doesn’t necessarily mean the resource is physically limited, it means that the marginal extraction cost for each additional unit increases substantially.

      That is not the same thing as saying the supply of the resource is decreasing. However, those two concepts are often conflated in the “peak X” meme. In economic terms, it really doesn’t matter what higher production costs are due to.

      Using your own example about oil, it doesn’t matter that every square mile of the earth hasn’t been “sonar, radar, test-drilled and computer-modeled/mapped”. The point is that oil would cost a lot more than it does now IF that had to be done (or were done), assuming any new discoveries could even be extracted at today’s production costs.

      I know what you mean about everything being labeled a crisis or a shortage but in almost every case the “optimists” are implicitly counting on some new technology to solve the problem. For example, maybe it’s true that the only reason that it seems like there’s less gold available to mine is because we don’t have the technology to discover it. Well…okay, so until we do for all practical purposes gold availability is decreasing AT CURRENT PRICES.

      As for all of those new “finds”, “indications” and “inferences” that mining companies are always claiming, most of them lead to nothing after you “dig a little deeper” and “scrape the gold plating” off of their evidence. Gold mining companies are notoriously risky and poorly managed.

  • ShawnB

    No one will ask those questions. They don’t want the answers. Everyone wishes their old shiney silver coins and the silver bars they bought at $48 an ounce will one day pay off their house or debt….. I always wondered if it only costs $15 an ounce to mine silver, and $400 an ounce for gold how are these current targets of 100+10,000+ (respectively) going to be obtained when the mining companies are getting shafted by the paper market. If you watch Peter schiff or any of those characters, I advise you to step back from the PC, stop watching you tube all day and get back to reality.

  • http://www.thepreparationstation.com prepster411

    I’m still a bit leary of the gold stocks. Overall it’s a very small market. The PTB can influence big markets and they can completely control and manipulate little ones. I’m also looking for when the HUI starts to diverge from the big indexes. That being said, with the dollar rallying recently, physical gold and the minors are on sale. Might as well pick up a little if nothing less.

  • http://www.thepreparationstation.com prepster411

    Also, GLD and most of the other ETF are simply derivatives backed by…wait for it…T-bills! If T-bill die, so do the ETFs. That’s would be pretty catastrophic and highly unusual, but hey, Black Swans have been flying around in large flocks these days. Physical is best.

  • John Williams

    So as far as the peak argument for juniors goes, is it a short term investment? I would imagine that when costs go up for exploration then investment into technology to bring those costs down will follow, eventually making prior technology that was infeasible due to costs become feasible. This principle seems to always be the counterbalance to Malthusian disaster scenarios. Will that be the case here in the next few years also?

  • Eric Dubin

    John,

    The divergence is more stark than then GDXJ paints because GDXJ is a poor representation of true Jr. companies. For example, Hecla is in the top ten holdings. Not many would call them a Jr.

    The lack of a quality Jr. index to reference has been an issue for a long time. Some like looking at the TSX venture index overall. For example, see this:

    http://stockcharts.com/h-sc/ui?s=$CDNX:GLD&p=D&b=5&g=0&id=p54805131931

    But that’s not perfect either.

    Best,

    Eric Dubin
    Independent Buyside Analyst/Manager


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