Cherry Picking in a Gold Rout Dims Production Prospects

There’s a shadow hanging over the gold industry -- and it’s not just a three-year price collapse.

One of the industry’s responses to lower prices and margins has been to home in on only the most profitable pockets of mines. That’s helped boost global output and bring down costs.

But it’s also one of the reasons why output is set to fall for the first time since 2008, according to the World Gold Council and producers attending this week’s Denver Gold Forum. The idea being that cherry picking mines -- or high-grading -- signals lower grades in the future and shorter mine life.

High-grading is a term that’s benign or pejorative depending who you ask and how it’s done. Goldcorp Inc. Chief Executive Officer Chuck Jeannes said optimizing mines by focusing on high-quality ore is just a good business practice considering that prices have lost about 40 percent from a 2011 peak.

“I’ll be a little bit provocative here: everybody is high-grading and high- grading is not a bad thing,” Chief Executive Officer Jeannes said in an interview. “If you go from $1,300 to $1,100 you have to raise your cut-off grade or else you’re going to be producing ounces that don’t make money.”

Gold futures reached a five-year low of $1,073.70 an ounce in July, slumping 44 percent from a record $1,923.70 in 2011.

Stock Slump

Investors have punished miners as a result, with the 30-member Philadelphia Stock Exchange Gold and Silver Index heading for a fifth straight annual loss, the worst streak since the comparable data begins in 1984. Producers have fought to increase output in a bid to boost revenues. Now, the broad consensus is that production has peaked.

Forecasts for output declines as soon as next year are typically attributed to mine closures and a drop in exploration and development. High-grading has been less talked about.

“Companies are looking to reduce their costs, which means they’re taking higher grades,” Randall Oliphant, chairman of the World Gold Council, said in an interview. “It’s hard to see why gold production would go up from here.”

High-grading is a provocative term in the industry because, depending how it’s done, it can affect the viability of future assets. If, for example, a company dramatically steepens the walls of a pit to get straight at a choice chunk of ore, rather than methodically stripping away less attractive ore from the sides, the site can be rendered unfeasible. Any gold located in the pit walls won’t be accessible until the pit is widened, making it far more expensive to access in the future.

Telltale Signs

“There’s pressure to get those cash flows,” Nordgold NV CEO Nikolai Zelenski said in an interview from the same conference. “I wouldn’t be surprised if people are shorting on maintenance, maybe on stripping here and there. So there’s a risk that when the time comes to ramp up, they have no opportunity to ramp up.”

A spike in a company’s average metal content can be a sign of high-grading. But without a technical analysis of the mine from the ground, it doesn’t tell you if that grading is taking place at the expense of future production.

“If you high grade them too long, those ounces that are in the long-term piece of your production profile are not really there,” Jeff Pontius, CEO of Corvus Gold Inc., said Friday by telephone. “If you go on for five or six years with this scenario, you really don’t have much left.”

Right Balance

For Goldcorp, the largest producer by market value, the key is getting the balance right so future production isn’t jeopardized. What others call high-grading, Jeannes says he calls “optimizing your mine plan.”

“When we look at our mine plans, number one, they have to make money,” he said. “Number two, we want to minimize the potential for sterilizing those lower grade materials that we’re leaving behind.”

In a bear market for gold, reducing future production may not be a bad thing, according to Oliphant.

“We were just producing ounces to produce ounces in a bull market because people thought gold prices were forever going to increase,” he said. “Maybe some of those should be sterilized because maybe they aren’t profitable.”

Past experience suggests increasing production this way is sustainable for about two years following a significant drop in gold prices, BMO Capital Markets analyst Andrew Kaip wrote in a Sept. 16 research note. “If this is so, then 2016 could be the first year of production declines.”

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