More Gold Unearthed

The broad division within the gold industry is between the explorer and the producer, although some of the larger-cap names take on some of both functions. The best companies on the production end are those with the best internal growth as reflected in the growth of their reserves, and the best way to grow reserves is to discover them. This is in contrast to purchasing them by acquiring another company and its reserves with it. This cycle of dependency is fairly intuitive, let's take a closer look.

The most important barrier going forward is the availability of capital to develop the projects once proven reserves are established. This difficulty is exacerbated by licensing requirements that consist of a "Contract of Work" (COW), which gives the company the title to perform the labor. Less developed countries with unstable mining laws contribute to the difficulty of actually beginning work. In the early 1990s Venezuela was touted as rich in opportunity, but political instability derailed multiple mining efforts.

Exploration can be divided into three categories. Grass roots exploration is a search for ore in an area that has the correct geological characteristics, although no ore has been previously found in the setting. Headframe exploration is the search for a separate ore body within an existing mine site, and definition exploration searches for extensions to an ore body that has already been discovered.

Reserve levels are determined by two methods. Proven reserves are classified as such when a quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes. This quantity is extrapolated from a detailed sample that is examined under rigorous conditions. Probable reserves are reserves that are computed from information similar to that gathered for proven reserves. The important difference is that the sites for inspection, the sampling, and the measurement are all farther apart, which reduces the assurance of set amounts of ore.

Once ore is found it is given a grade. The grade is the amount of valuable mineral in each ton of ore, expressed as gram per ton for precious metals. The various grade calculations include: reserve grade, with estimated metal content based on reserve calculations; cut-off grade, the minimum content level at which an ore body can be economically mined; and recovered grade, the actual metal content of ore determined after mining.

For companies that actually mine the ore, both production and stripping are deferred costs that are capitalized over the amount of time that reserves are to be mined. Investors looking at these figures should make sure that the time period matches the time it would take to mine the estimated reserves. Another important calculation that deserves note is the cash cost per ounce figure. This includes site costs for all mining (except deferred mining and stripping costs), processing, administration, and resource taxes, but does not include royalties, capital, exploration, depreciation, and financing costs. By-product revenues are deducted from total cash costs and divided by payable gold ounces produced to arrive at net cash cost per ounce. This figure is important when comparing similar production operations.

The ultimate goal for the investor is to find companies that are trading at a substantial discount to their proven reserves, coupled with a "proven" ability to grow their reserves over many years. Employing a cash flow analysis over several years will determine which companies are consistently generating the kind of returns that investors want, regardless of the price of gold.

-Alex Schay (TMF Nexus6)

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