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December 11, 2012

End of Commodity Super Cycle Bullish for Gold Miners

By Russ Winter 

A plausible theory is circulating that the commodity super cycle driven by China and India will be more “differentiated”  among raw materials, depending on supply-demand balances. Citigroup’s head of global commodities research, Edward L. Morse, believes the “super cycle” of commodity price gains is ending as China’s economy moving toward slower growth and an increase in supplies. Morse thinks prices won’t climb “sharply” higher even though quantitative easing from global central banks lifts gold bullion demand. The S&P’s GSCI Spot Index of 24 raw materials, which has increased four fold since 2001, is up just shy of 1% this year evidenced by sluggish growth in global economies including China. Looking at the different commodities, one realizes Morse was not exactly bearish on the outlook for most.

This mix will be more favorable for mine developers, who have been damaged by the non-precious metal part of the super-commodity cycle. Going a step further, I believe gold will start noticeably outperforming other input commodities. Gold may take off because of monetary considerations (flight to real money) at the same time economies significantly weaken because of bad faux-growth monetary policies. I think that’s what’s in store. This is also consistent with my thesis on a China and Japan bust. For those who may want to hedge on the energy side of the Morse equation, use uranium (CCJ, DNN and STHJF), which is highly depressed.

Materials costs for everything from fuel to tires to steel and metal alloys are a major component of mine construction. Just as raw materials prices have soared, so have mine construction capex costs. If development projects can find a new sweet spot for some price relief on costs combined with higher prices for gold, the leverage could be considerable. Right now, new projects need to squeeze every dime to produce a decent return. Energy makes up about 25% of the cost of copper and gold production. That’s why you are seeing projects like Metates (CHK.V) and Donlin Creek (NG) may bring in natural gas pipelines.

In relation to porphyry deposits — which the market now thinks are unlikely to be developed — the 2008 median-grade of 422 porphyry was 0.44% copper, according to the U.S. Geological Survey database of worldwide porphyry deposits. Only two-thirds of these deposits contained gold, and their average gold grade was 0.21 g/t. Comparably, 0.44% Cu and 0.21 g Au are worth $45 currently and those would probably be top quartile (100 best in the world) deposits.
The big porphyry deposits that have gotten my attention have the following characteristics:

1. Good jurisdictions

2. Higher precious metal weighting versus base metals, with copper functioning as a credit to the main course

3. Extremely neglected valuations

The downside is that all large porphyry projects are expensive to construct; however, if the cost side improves relative to the output product, Katie bar the doors.

Seabridge’s (SA) massive KSMs reserves show a value of $49: 0.55 grams per tonne of gold, 0.21% copper and 2.74 grams per tonne of silver. So there is evidence that KSM — in addition to being one of the largest porphyry deposits ever found — has above-average grades skewed toward gold.

The game changer at Deep Kerr: “DRILL HOLE K-12-21 INTERSECTS 473 METERS GRADING 0.90% COPPER AND 0.31 GPT GOLD.” At Camp Zone: “A second hole, C-12-02, intersected 22.0 meters averaging 8.94 grams per tonne of gold and 41.6 grams per tonne of silver. This hole returned a 2 meter intercept of 66.7 grams of gold per tonne and 287 grams per tonne of silver. A third hole into this zone, C-12-03 drilled 900 meters to the northeast of C-12-02, returned 98.7 meters at an average gold grade of 2.11 grams per tonne. There is also a third target McQuillan that got a nice bulk deposit whiff from the only drill hole conducted: 68 m of 0.99 gm Au and 0.26% Cu.

These strong indications at Deep Kerr and Camp Zone have the potential of leveraging a very good project into one of the very best. This explains what SA is up to:
“Seabridge Chairman and CEO Rudi Fronk noted that ‘everything we have learned in the current program tells us that the core should be close to KSM’s existing deposits at a reasonable depth. We are finding the markers that favor a discovery. Both positive and negative results have been helpful in narrowing the search. Although we are quite excited by the unanticipated discovery of the Camp Zone, we are committed to this search for the core zone. It may take more than one season to find the prize but this effort offers the potential to dramatically improve project economics.’”
Exeter’s (XRA) Caspiche is a little different in that it is primarily a gold porphyry: 0.48g Au 0.18 Cu 1.12 Ag, which average 0.81g Au or 23.53 million oz Au equivalent. In comparison, the nearby Cerro Casale Gold-Copper Deposit (considered one of the best out there) has reserves of 26.3 million ounces of gold at a grade of 0.50 grams per tonne (“g/t”) and 5,782 million pounds of copper grading 0.22%. Yet Mr. Market values Caspiche at a insulting $50 million enterprise value.

Nova Gold’s (NG) second property (up for sale), a prophyry Galore Creek is strangely also considered an afterthought and has reserves of 5.45 million oz of 0.32 grams of AU, and 1.020 million oz and 8.9 billion of 0.5% CU and a very nice AG grade of 6 gm Ag (102 million oz) to boot. There is considerable exploration upside left.

In Cheasapeake Gold’s case, it has the silver and zinc credits that give this deposit some kick. Almost 20 million oz of gold at 0.50 gm , but 9 million oz equivalent silver at 0.73 gm equivalent plus 0.16% zinc.

About The Author - Russ Winter is a veteran investor, financial writer, world traveler, and he blogs at Winter Watch.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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