Grade is king
- Investing fundamentals – and investor priorities – are shifting as precious metals move from bear market to bull market conditions
- Understanding the relationship between metals prices, grades and resources is crucial to successfully investing in the mining stocks
This is the sentiment that dominates investor thinking in all metals markets, not just gold and silver (most of the time). It is a function of market conditions and basic economics.
In bearish markets, mining companies and mining investors focus on (high) grade above all other factors except, perhaps, jurisdiction. Why?
This is where simple economics comes into play.
A bear market implies lower metals prices. Lower prices mean lower margins. And in a low-margin environment, high grade projects especially stand out for their stronger fundamentals.
The problem is that most metals markets have been limping through extreme
bear market conditions for nearly an entire decade. Consequently, the focus on higher grades in mining has probably never been as intense as it has in the past several years.
Gold and silver mining shift gears
As gold and silver prices continue their recent rise (with no end in sight), this mining paradigm is shifting.
Bull market conditions are returning to precious metals.
Gold began to rally in May 2019. It has now advanced 50% from that price level (~$1,300 per ounce) and hit new all-time highs above $2,000 per ounce.
Silver bottomed later (March 2020) and at an even more extreme low (~$11.50 per ounce). This reflects the even more-depressed conditions in the silver sector.
Since March, the price of silver has more than doubled. The gold/silver price ratio has nearly been halved from the all-time extreme recorded in March 2020 (over 125:1).
The mining stocks have been even slower to rally than the metals themselves. This reflects the fact that conditions in the mining industry have been even more depressed than the metals markets.
Gold mining stocks started rallying first, for obvious reasons.
That rally has been led (in the early stages) by the Senior Producers along with smaller producers with higher grade mines and/or gold deposits.
The Senior Producers are always first to attract investor dollars because their larger scale
is seen as providing greater security for investors. High-grade gold mining companies also start moving early because their higher grades
(margins) provide investors with greater security.
Rising prices signal rotation into lower-grade projects
As the precious metals rally has gained steam, the rally in the mining stocks has steadily become more broad-based: both smaller companies and lower-grade projects are starting to gain traction.
We explained this (familiar) trend in a June 30th article:
Two Low-Grade/Bulk-Tonnage Gold Mining Companies To Watch
If there were two words to sum up the emerging rally in gold and gold mining stocks, those words would be “exciting” and “predictable”.
It’s exciting in that gold itself is emerging out of a long bear market. And gold mining stocks were priced at historic lows in relation to the price of gold as mining companies caught fire.
It’s also predictable…
Now another familiar (predictable) dynamic is entering the picture. Companies with lower grade gold projects are also starting to catch fire. Previously, it has been primarily companies with higher grade projects whose stocks have gotten the most traction.
Why is it “predictable” to see the lower grade projects now starting to take off?
a) With the higher grade projects having already been bid up by the market, lower grade projects are relatively cheaper.
b) As bull market conditions intensify, investors become less concerned with margins and security and more interested in growth potential.
c) Both of these dynamics combine to drive investors into lower grade gold projects.
Lower grade ore provides increased leverage on margins for investors as metals prices rise. This has been explained in several previous articles
As a simple function of arithmetic, margins will rise much faster (in percentage terms) on lower grade ore as metals prices rise.
Rising metals prices automatically increase the size of metals deposits
What far less investors know (and understand) is that lower-grade deposits also provide more leverage on the size of a metals deposit. This requires a more detailed explanation.
When a mining company prepares a formal resource estimate for a metal deposit, it must select a “cut-off grade” for that deposit.
Mineralized ore that is below the cut-off grade is not counted in the resource estimate.
The reason for this is obvious. At any given price level, metal below a certain grade is not economic. It can’t be mined-and-refined for a profit (at that price) so all such ore is excluded from the estimate.
As the price of gold (and silver) rises, the cut-off grade decreases. In general terms, the cut-off grade will decrease proportionately with the increase in metals price.
Decreasing cut-off grades due to higher prices will almost always benefit lower grade metals deposits more than higher grade deposits.
This is a function of both geology and arithmetic.
Geologically, high-grade gold deposits tend to be smaller both in absolute size and also in the total number of ounces contained. In addition, lower grade deposits will almost have much larger percentages of economically marginal ore – and thus gain more from a rise in price.
We can make this point crudely, in hypothetical terms.
A “large” high-grade deposit of gold may contain several million ounces of gold (high-grade deposits above 10 million ounces are rare). A substantial rise in price could add (perhaps) another million ounces of commercially mineable gold to the overall deposit.
Conversely, a “large” low-grade deposit of gold may contain tens
of millions of ounces. A substantial rise in the price of gold could add perhaps another 10 or even 20 million additional ounces to the total size.
What the higher grade project gains in terms of its higher margins cannot compensate for the overall increase in profit potential for the lower grade project as prices rise.
In a rising bull market, lower grade projects win on rising margins and win on increased resource size.
Diversifying within the sector
Does this mean that mining investors should now abandon high-grade producers and leverage to the max with lower grade opportunities? No.
One way in which higher grade producers can add leverage to their operations in a rising price environment is through acquisitions.
We’ve already seen this strategy in play earlier in this rally. High-grade producer, Kirkland Lake Gold
(US:KL / CAN:KL) put its free cash flow to work acquiring low-grade producer, Detour Gold
We could also see bearish intervals in the context of a long-term bull market, where the larger miners and high-grade projects again outperform.
This scenario becomes more likely if mainstream U.S. equities experience their long overdue correction. Bearish sentiment could be expected to spill over into mining stocks, even if precious metals prices continue to rise as this occurs.
The macroeconomic conditions that launched this new precious metals rally – ultra-inflationary monetary policies and ultra-loose fiscal policies – are not going to abate at any time in the foreseeable future.
Investors who have not yet added exposure to lower grade gold and silver companies have a perfect window to do so with the recent correction in metals prices.
With much of the marketplace historically overvalued, gold and silver mining stocks remain historically undervalued
. High leverage opportunities could generate once-in-a-lifetime gains.