It’s well known that a huge chunk of global gold production is performed by a small group of very large mining companies. These mega-miners own the world’s biggest mines, possess the deepest pipelines of projects, and for the most part have large coffers that easily support reserve renewal via organic development and acquisitions.
Incredibly just the 10 largest publicly-traded primary gold miners, Barrick Gold, Newmont Mining, AngloGold Ashanti, Kinross Gold, Goldcorp, Newcrest Mining, Goldfields, Polyus Gold, Harmony Gold, and Agnico-Eagle Mines, accounted for over one-third of the 88m or so ounces that were pulled from the earth in 2012.
While these companies are recognizable to most investors, and are usually the top gold-stock holdings of large institutionals and funds, most folks aren’t really aware of where the other two-thirds of production comes from.
Interestingly the balance of the world’s gold-mine output comes from large state-owned mining companies, other publicly-traded gold majors outside the top 10, the mid-tiers, byproduct production (usually from base-metals and silver mines), junior-level mining companies, and countless artisanal miners.
For the average investor, the majors and mid-tiers available through the stock markets have served well over the course of gold’s secular bull. But for investors looking for high beta to maximize producers’ leverage to the yellow metal, the group responsible for the smallest chunk of production is where it’s at, the junior producers.
For our purposes a junior gold producer is a publicly-traded company that mines gold at an annual rate of up to about 150k ounces. This threshold certainly isn’t definitive, but it tends to be a general rule of thumb in the annals of gold-stock analysis. Now occasionally I’ll tag a miner as a junior even if it produces in the 150k- to 200k-ounce mid-tier crossover range, but this is an exception based on its underlying fundamentals.
High beta naturally comes into play with these juniors not only due to their sector of residence, but their size. Gold stocks in general are more volatile than the average sector since they are slave to the price action of a single commodity. And because the juniors sport such small market capitalizations (an average of around $200m in today’s environment), they are of course subject to more extreme volatility. It doesn’t take much capital flowing in or out of these stocks to move them violently in either direction.
As any seasoned gold-stock investor knows, junior producers have spawned more thrill than trepidation in this bull market. But it is important to realize that this sector serves as more than just a high-beta trading vehicle. We can’t discount its importance to the gold market.
Interestingly junior producers collectively account for only about 5% of the world’s total gold-mine output each year. While these ounces are indeed important in gold’s delicate economic balance, it is juniors’ roles in the gold-mining ecosystem that is their greatest worth.
Juniors have two main roles in this ecosystem. And first is as a source of feedstock for the larger mining companies. Considering gold’s non-fungible nature, it is a constant battle for mining companies to replace their reserves. Despite their best efforts to organically do so, while maintaining production levels, it is quite often necessary to procure replacement via acquisitions.
And being acquisitive is all the more attractive these days considering gold stocks’ depressed prices. It has proven much cheaper to buy an operating mine with an inventory of reserves than to discover, prove up, and develop one from scratch. We’ve seen a ton of activity in recent years, with numerous juniors being taken out by the big boys.
Juniors’ other major role is essentially embodied by the name of their bucket. A junior is small, a youngling, and its natural tendency is to grow. While some juniors will have stunted growth and remain in this category, many of those that don’t get acquired will mature into larger mid-tiers and/or majors that will end up having a material impact on supply.
Most juniors are run by smart folks, managers and geologists who’ve already proven savvy enough to develop a gold mine. And these guys aren’t content upon pouring their first bar of gold. Once their flagship mine is running on all cylinders, they’ll seek to expand existing operations, develop the rest of their pipeline, and/or conduct M&A activity that will grow their company. Eventually they’ll graduate to the mid-tier ranks.
Some of the junior producers profiled in our popular research reports have taken the paths mentioned above in recent years. We’ve seen companies like Metallica Resources, Western Goldfields, Capital Gold, and Minefinders get acquired. And we’ve seen companies like Alamos Gold, Allied Nevada, Endeavour Mining, and B2Gold graduate to the mid-tier ranks.
Junior producer stocks are among our favorites to trade and recommend in our newsletters. And our latest round of research on this sector looked at the current universe that lists in the US and Canada in order to identify the elite bunch that has what it takes to either be feed for the big boys, grow to the mid-tier ranks, or in some cases thrive on the junior circuit.
Given the prolonged slump for gold stocks, one thing we really wanted to focus our research on this time around was operating costs. Even though junior producers are generating revenues, many that struggle to control costs are in a state of despair given the lack of support in the financial markets.
It’s really a simple formula. Higher costs lead to lower margins. Lower margins reduce cash flow. And reduced cash flow translates to less working capital. And working capital is the lifeblood of this sector given mining’s capital-intensive nature. It costs a lot of money to maintain, optimize, and/or expand existing operations. It’s also quite costly to explore for and develop resources in order to secure longevity. If there is insufficient working capital to fund such endeavors, the miners must go to the markets to raise capital.
Going to the markets is not all that uncommon, even for companies that do have solid cash flow. But given that banks are currently being stingy with their lending coupled with super-low stock prices that would lead to heavily dilutive equity financings, raising capital is as tough as it’s been in a long time. The juniors with lower operating costs are thus in a much better position to weather the gold-stock storm and ultimately thrive in their growth efforts.
Now one thing to keep in mind is on balance junior cash costs are higher than those of their larger peers. And this is to be expected considering their lack of capital and economies of scale (juniors are usually only operating a single mine, whereas the larger mining companies are usually operating multiple mines).
Operating multiple decent-sized mines comes with huge benefits, which is why most juniors strive to get to that point. In theory the more mines, the higher the production. The higher the production, the higher the revenue. And the higher the revenue, the greater the capital flexibility.
This capital flexibility not only allows for the ability to optimize and expand operations, but also to absorb problems (operational, geological, geopolitical, etc.) that may arise in a new development or existing operation. An isolated problem wouldn’t break the bank and/or lead to radically higher operating costs for a well-diversified mining company.
This is not the case for juniors though. And provocatively the adverse effects of their capital inflexibility are felt on both the front-end (development) and back-end (operations). On the front-end, a mine build comes with large pre-production capex. And without cash flow, these juniors must fully rely on outside financings (bank and/or equity) to fund their builds.
This wouldn’t be a problem if mine builds were perfectly planned and flawlessly executed. Unfortunately building a mine is far from an exact science, regardless of the efforts put into feasibility studies. And inevitably cost projections and timelines rarely fall into line with initial plans. As a result, front-end mine-build financings are typically insufficient to fund the optimal infrastructure.
Interestingly it takes an average of about 18 to 24 months to construct a mine upon the initial breaking of ground. And as I’ve seen all too often, at some point in the mine build the operator comes to the realization that costs are higher than expected (above and beyond the built-in contingency). They are thus forced to build to budget rather than optimization.
When building to an insufficient budget, corners are cut. And when corners are cut, it usually costs more to wrest an ounce from the ground than what was projected in the feasibility study (hence juniors’ back-end capital inflexibility). Though the good miners will eventually remedy the situation by optimizing operations once cash flow and/or a new wave of financing allows, many juniors do in fact go through a period of post-development growing pains that lead to higher operating costs.
Another reason some juniors have higher operating costs is the lower quality of their deposits. Whether it be low grades or high complexity, the ore in some deposits requires higher gold prices to be economical. There’s actually a fascinating inverse correlation between gold-price levels and average grades for new mines. The higher the prices, the lower the grades.
Though most juniors realize what they are getting into when they bring a lower-quality deposit online, provocatively some don’t realize it until after they’ve built their mines. Notch it up to a combination of inexperience and ignorance, but some juniors just don’t perform enough drilling and metallurgical testing to understand their deposits. And if they don’t understand their deposits, they’ll push through engineering and design that will yield poor grade control and inefficient processing. This naturally leads to higher operating costs.
For these reasons and more junior gold producers tend to sport cash operating costs that are about a third greater than the larger producers. And by my calculations, the juniors’ 2012 weighted-average cash costs came in at a whopping $901 per ounce. This 2012 figure represents a 9% increase over 2011. But while this increase was substantial, it wasn’t abnormal for the greater gold-mining sector considering mid-tiers and majors alike have all seen similar year-over-year increases.
What is substantial though is this higher base. Amazingly as recently as 2008 the average gold price was under $900. Most of these juniors’ operations would not have been economically feasible back then! Fortunately junior producers are adept at thriving regardless of where gold prices are. They made money back in 2008, and they are doing so today.