Friday, September 9, 2016

Disappearing Reserves. Really?

In its last presentation, Major Drilling enclosed the following chart:

source: Major Drilling presentation (slide 15)

The chart tries to evidence that since 2012 gold reserves (held by the biggest, unspecified world miners) have been declining. I think it is only a half-truth.

Le me explain. There are three main factors, which have a huge impact on the way each mining company calculates / updates its gold reserves:

  • depletion
  • price of gold
  • costs of production

Depletion is the main reason reserves go down. A mining business is a finite one - if a miner is not able to replenish its mineral base it has to close down. It is only a question of time.
However, the other two factors are less obvious.

Generally, reserves are that part of the mineral resource, which is economically viable. When gold prices go down some parts of a deposit may become non-viable. For example, lower grade parts of a deposit may be totally uneconomic to extract. Hence, reserves go down (those uneconomic gold ounces disappear from the reserve).

The same with costs of production. For example, if oil prices go up so does the price of diesel oil, which is the main source of energy in open pit mines, especially those located in remote areas. In such a case some parts of a deposit may be economically non-viable, which results in cutting the reserve estimate.

The chart presented by Major Drilling does not take into account these factors (price of gold and costs of production). Although the company is right that reserves went down we have to know that part of this decrease was caused by two less obvious factors discussed above.

When prices of gold go up the reserves may also increase. In other words, when at the end of 2016 gold stays at, say, $1,400 per ounce, many companies may find additional ounces of gold out of nothing. I am writing "out of nothing" but I mean those ounces, which had disappeared before due to lower gold prices. Those ounces did not go nowhere - they are still in the ground waiting for higher prices.

As for costs of production - well, keeping in mind that in the long-term mining companies have a tendency to increase these costs I am not optimistic (any increases of reserves due to lower costs are rather impossible).

Summing up - provided that gold prices continue their march up, I think that it is highly probable to see higher gold reserves. What is more, this increase will have nothing to do with new discoveries. Going further - such an increase should have a negative impact on drilling companies (lower demand for their services due to the increased mineral base).


  1. Thanks for this post, SD.

    I am a shh of RIC; and, informed by your article, I am thinking I should liquidate this holding before Q3 reporting.