Lack of mines to squeeze supply

January 24, 2019

Pat Heller

What a difference a decade makes! Ten years ago, gold and silver prices were on a roll. The price of silver had increased 41 percent from Dec. 5, 2008, to Feb. 11, 2009. The price of gold rose 1 percent from Jan. 7, 2009, to Feb. 11, 2009.

With gold around $900 and silver above $12 per ounce 10 years ago, mining companies were enjoying expanded profit margins above their marginal costs. In that environment, gold and silver mining companies were eagerly looking to find and develop new mines. Once a potential mine site was discovered, a mining company would bring in an independent geologist to confirm that the minimum amount of recoverable metal would make the development of a mine economically feasible. Demand for geologists to confirm these discoveries was so strong that it was not unusual for the mining companies to wait 18 months before these specialists worked through their backlog of jobs.

The geologists’ reports, produced in the industry’s standard format, would then be used to seek financing for the costs of establishing the mine site. At the time, the span from finding a possible new mine to developing the infrastructure to going into production was starting to lengthen from its previous average of about three years. The financiers had to consider the risks of such a delay before they could see a return on their loans in determining whether to extend the credit and what interest rate they would charge. But with the then-high profit margins, financing tended to be available for those in the mining industry with a proven track record.

Annual mine output of gold hit bottom in 2008 and has grown almost every year since. However, much of the increase has happened in China, which is now far and away the world’s largest gold production nation (Numbers 2 through 7, in order, are Australia, Russia, the United States, Canada, Peru, and South Africa). Absent the increased output from China, global gold production is actually on the decline.

Yes, prices of gold and silver today are higher than they were 10 years ago. However, the capital costs of developing mines and the marginal operating costs have increased to a greater degree. Now, from the time of a new discovery (other than in China) until a mine can go into production, it takes an average of at least 10 years! There are three main reasons that development time has more than tripled in the past decade. First, the geographically most accessible mine locations have been developed, meaning that new discoveries tend to be more remote and require more infrastructure to be built just to be able to get to the location. Second, a greater number of environmental regulations add to the time it takes for mining companies to jump through all the hoops to get permits. Third, the general political milieu worldwide is less supportive of encouraging new mine development than in years past.

The higher costs and the lengthening of the time it takes from finding a new mine site until it goes into production adds extra financial risk. Mining industry profits have stagnated or even declined. As a result, exploration activity has fallen sharply over the past few years. As existing companies exhaust the recoverable ore at their mines, they are less able today to bring new mines into operation to replace the lost production volume.

In a current economy where they are facing lower sales volume, what are the major mining companies doing today to boost profits? Instead of ramping up exploration activity, the trend has recently been for them to merge with each other to try to reduce administrative and overhead costs per ounce of output.

In September, Barrick Gold Corp. acquired Randgold Resources Ltd. to form what was, at the time, the world’s largest gold mining company. Last week, Newmont Mining announced that it was buying Goldcorp Inc. for $10 billion to form an even larger gold mining company.

On Tuesday this week, Gold Fields Ltd. filed a document with the Johannesburg Stock Exchange that the company wants to discuss a possible merger with AngloGold Ashanti Ltd. Apparently, no talks have yet been held. However, if such a combination occurred, the resulting company would be the world’s third largest gold producer.

As for the silver industry, its economic situation is somewhat different than for gold. Only about 30 percent of newly mined silver comes from primary silver mines. The other 70 percent of silver output comes as a by-product or co-product from mines that produce gold, copper, lead, zinc, and other metals. Even this distinction of primary silver mines is somewhat fuzzy. Hecla’s Greens Creek Mine in Alaska is classified as a primary silver mine, America’s largest silver producer, but 56 percent of the mine’s revenues come from gold, zinc, and lead sales.

According to the U.S. Geological Survey, the world’s largest silver-producing nations in 2017, in order, are Mexico, Peru, China, Russia, Poland, Australia, Chile, Bolivia, Kazakhstan, and the United States.

I have a brother-in-law who works at the Red Dog Mine above the Arctic Circle in Alaska. This mine is the world’s largest producer of zinc (and also has the world’s largest reserves of zinc) and is a major producer of lead. But it also produces silver as a by-product and is America’s second-largest silver producer. The operation of this mine depends primarily on the price of zinc and, to a lesser degree, on the price of lead. As silver sales only account for about 6 percent of the mine’s revenues, the price of silver has no impact on how much of the metal this mine will produce.

Government-owned KGHM is a Polish copper mining company. As a by-product, it happens to be one of the world’s largest producers of silver (it was second largest in 2015). Still, silver sales account for only about 15 percent of the company’s revenues. While this is somewhat significant to the company, it is the price of copper that influences production levels, including that of silver.

About 95 percent of China’s silver output is derived as a by-product, almost certainly from the nation’s gold mines.

With diminished exploration for new gold and silver mines, other than in China, new supplies of these metals could trend downward within a few years. This could result in greater shortages of the physical metals, adding pressure for higher prices despite any political or financial machinations that may occur. Higher prices would then stimulate higher exploration efforts, but supply shortages would continue for at least another 5-10 years.