As gold continues to climb, you can bet the majors will follow suit as record earnings and cash flows steal the spotlight from the Groupons of the market.


We all know the big names: Goldcorp, Barrick Gold, Newmont, Freeport, Kinross, Eldorado, Yamana...

All of these big names should do well as gold inches closer to $2000 and beyond. But while these companies can give us strong returns in a volatile market - as they have done in the past few months - the major upside still remains in the junior sector.


The biggest risk in the junior mining industry is the need to explore in order to find and define an economic resource on which a mining project can be built.


Most risk capital is lost in the ground. A study by Mackenzie and Bilodeau (1984) found that in the period from 1955 to 1978 a total of $1.6 billion had been spent on exploration (excluding oil and gas) with thousands of mineral occurrences discovered. However only 43 of these discoveries were considered to be economic, with even fewer ultimately being developed. That means an average finding cost of $38 million (1984 dollars) is required per deposit. Adjusted for inflation, this number would be over $100 million.


There's no doubt that our markets are still in turbulent times. If you look at history and think toward the future, commodities and the stock market will always be at the forefront of our economic growth. Not only do we need commodities to grow, we need commodities to survive and we need the stock market to fund those opportunities.


Despite the volatility we have experienced, there are still many opportunities in the market - especially in the juniors. Don't forget that an insurmountable of funds were raised in the mining sector even when our stock market was at its lowest point this year and investors were scrambling to turn paper into cash.


But how do you know what projects are good enough for your investment?


The majority of us aren't geologists, so for us to completely interpret or truly understand everything in an NI 43-101 report is difficult. Even today, the majority of geologists still have a hard time putting a resource together or moving a project from a resource to the feasibility stage. It takes some very special people in this industry to know where to drill and it takes even more special people to know how to put it together.


So while we'll never learn everything, it certainly helps to learn the basics, like how to read 43-101's, how to assess certain projects, and how to understand drill results in much greater detail.


Mining Methods

There are many methods of mining but the one most widely used thus far has been open pit mining. It accounts for more than 80% of mines in the United States.


Open pit/cast/cut or surface mining is a method of extracting ore or mineralization that is found very close to the surface, with a sufficient quantity of ore within a close proximity to make it economically viable to extract.


Think of it as digging a large hole in the ground.


Depending on the geometry and depth of the ore body, open pit mining is generally by far the most economical method of extraction for the recovery of low grade (1g/t up to around 3-4g/t for gold) finely disseminated ore. Ore is simply the naturally occurring concentration of minerals.


The advantage of open pit mining, as opposed to underground, is that it is usually easier, cheaper and quicker to bring into production but generally relies on a larger resource base due to economical and social reasons.

You're digging a big hole in the ground - it better be worth it.??


For example, underground gold mines usually require at least 4-10g/t (grams per tonne) of gold to be considered economically viable (dependent on a lot of factors such as country of origin and geophysical locations.)


If you have invested in any mining company, you will have heard the term cut-off grade. Cut-off grade is the minimum metal grade at which a tonne of rock can be processed on an economic basis and determines the workable tonnage of an ore. In Canada, resource calculations under the 43-101 standard will always include the cut-off grade. (I will go into more detail regarding this extremely important factor in a future letter.)


Companies determine what it costs per ton of material mined and what the ore values is going to be from that tonne. From this, they can determine how much each ounce of gold will cost to mine. For example, in South Africa, the cost to mine is generally between $300-$400 per ounce of gold. At today's current gold price, that is a very profitable operation - and a reason why companies in this region do really well.


However, even with a strong resource, you still have to factor in the size of the mine and what it costs to put the mine into production. Even if you have a small resource that costs less than $400/oz to mine, there is a great chance that financiers may not find the project large enough for their appetite, and thus the mine will not go into production - even at today's high prices.


Let's not forget that you still need approval from the government to proceed. They won't let you pollute their land and water without adequate and substantial economic benefit.


In short, a mine that appears feasible by the numbers may still not go into production - so don't expect every company with a promising NI 43-101 resource to get there.


Before full on production can take place, there are many costly steps involved with bringing a mine into production, even if it is open pit. You have to identify the resource through various sampling methods, determine cut-off grades, and conduct a full on feasibility study before you can even come close to production.


Cut-off Grade Theory and Practice


Consider a block of ore that weighs 1 tonne and contains 3 grams of gold. At a gold price of US$1000 per ounce the value of the gold in the block of ore is just under $96 ($1000/31 X 3 or $1000 per ounce/ 31 grams (troy ounce) X 3 grams of gold)


Simply put, if it were to cost more than $96 to mine, treat, and extract the gold from that tonne of ore, it would be uneconomic to mine. Conversely, if the cost were less than $96, it could be economic to mine.


But it's not that simple.


If all the tonnes of ore in a deposit contained the exact same grade of gold, it would be easy to calculate. But not all the tonnes of ore that make an orebody contain the same grade of gold. As a matter of fact, gold deposits may vary the most in terms of consistency due to its "nuggetty" nature.



Making the Initial Estimate


Let's assume that a preliminary feasibility study provides the costs for recovering gold:



US$/tonne of ore treated

Overburden removal


Mining Cost


Treatment Charge


Administration and Refining


Total Cost




Metallurgical tests also show that only 95 per cent of the gold can be recovered from the ore.


So the question is, what is the minimum amount of gold the project needs in one tonne of ore to make it economically recoverable?


As the table shows, there has to be enough gold to provide US$46 of revenue to cover the costs. In other words, the grade that provides the US$46 is the cut-off grade. Let's once again assume that the gold price is $1000 per ounce, which is equal to $32 per gram (US$1000/31.1 grams)


The formula is simple:


total cost/recovery/price per unit of metal = Cut-off grade


Therefore, in our example:


46/0.95/32 = 1.5 grams per tonne


Now, if we go back to the original tonnage grade distribution as shown in our graph, we can see that roughly 6 per cent of our orebody has a grade of less than 1.5 grams per tonne. Obviously when we mine the orebody, we would try and stay away from mining and certainly would not treat the 6 percent of tonnage below the cut-off grade.


That means, for reserve reporting purposes we have reduced the size of our economic ore down to 94% of our original tonnage. While we have reduced the tonnage above the cut-off by removing the uneconomical 6% of ore, the remaining average grade will have increased as the lower grade is no longer included.  


That means that increasing the cut-off grade reduces economic tonnage, but increases the overall grade.

Now here is where its gets complicated in assessing the NPV (net present value) of a project. A whole textbook can be dedicated to cut-off grade and assessing the NPV, but I will simplify as much as possible for all intents and purposes.


First of all, we determine the mine life.


Let's assume that the annual treatment capacity can process 10 percent of the original total reserve. That means, with a zero cut-off grade, the original mine life would be 10 years (100%/10%). If you increase the cut-off grade, you decrease the life of the mine due to diminishing reserves (reserves are ore in a deposit that is economical to extract, but you would increase gold production due to the higher grade.


Now if we assume that capital cost is relatively fixed, it is possible to estimate the NPV for each cut-off grade because we know the operating cost, the mine life, the gold price, and therefore revenue.


As the cut-off grade increases, so does the NPV. This is due to the greater benefit of a higher annual cash flow from the higher annual average grade outweighing the shorter mine life.


increasing cut-off grade reduces your mine life as you "throw away" the lower grade ore in your calculations. That means that the higher the cut-off grade, there is even a possibility that the NPV would be negative as the mine life and recoverable ore becomes too small.


The next time you hear about a project that is comparable to another successful mine, remember that no deposits are ever the same.  A minor gram per tonne variation in cut-off grade can have significant effects on a project's NPV and calculations in NPV can vary dramatically from one source to another. That's why larger projects often have to go through numerous calculations from different sources before proceeding.  


When calculating NPV, there are obviously conflicting factors. For example, your capital costs will increase when you increase production, but you need to keep it to a minimum for a given production rate. An increase in annual mine production will generate higher revenue, but it's subject to available reserves and must be enough to satisfy the capital expenditures. The list of conflicting factors goes on so its imperative that calculations are correct to optimize the NPV of a project

Some key points to focus on (in most cases) include:

       •       High Grade Levels - the higher the grade level of ore, the                     better the project

•       Cut-Off Grades, Low vs. High - Cut-off grades are essential to determining the economic feasibility and mine life of a project. Increased cut-off grades can reduce political risks by ensuring higher financial returns over a shorter period of time. Conversely, lower cut-off grades may increase project life with longer economic benefits to shareholders, employees, and local communities. In short, a low cut-off grade does not mean a poor project.

•       Easy Access - having easy access to infrastructure including water, electricity, and work force cuts down project costs significantly

•       Proximity to Producing Mines - the closer the proximity to a producer, the less the infrastructure costs may be

•       Indicated and Inferred in NI 43-101's - Indicated estimate has a higher confidence level that such resources exists by estimating from sampling at places spaced closely enough that its continuity can be reasonably assumed. Inferred estimate is an estimate of resource whose size and grade have been estimated mainly or wholly from limited sampling data, assuming that the mineralized body is continuous and thus less confidence is placed on the data

•       Never Rely on Estimates Alone - both indicated and inferred resource estimates in NI 43-101's DOES NOT factor in the feasibility of its resources

•       Place of Operation - a great resource is one thing, but a resource located in an unstable country with an unstable government can spell disaster

•       Access to Capital - a well funded company usually means other professionals not only have done their research but believe in the project

•       Great Management Team - a project can be great but ultimately, a management has to be able to execute

Mineable mineral deposits are rare and to bring a deposit into profitable production is even more so. The chances of bringing a raw prospect into production have been estimated at one in 5,000 to 10,000. That's why there are many instances in which mining companies have revived old prospects and drilled just one more time before a discovery was made.

The great news is that with recent technological advances and the continual growth of resource prices, many projects with low grade ores and past producers are now becoming more economically viable.

Yet, few mining companies have the financial resources to delineate ore reserves too far into the future, which is why the big guns, such as Barrick, continually seek out and invest in other gold juniors to increase their reserves. This is yet another reason why a junior with a nearby producer has a much higher chance of going into production because the costs of production are often too high for a junior to fund by themselves. Economies of scale is a big asset in the mining industry; the ability to use someone else's tailings dam or processing mill can save a junior millions.

Feasibility Studies

There is a common misconception surrounding feasibility studies. We know they're important but their significance is commonly misconstrued. Make one mistake or skip one step of the process and it can have detrimental effects on a mining project.

A mining feasibility study, in short, is an evaluation of a proposed mining project to determine if the mineral resource can be mined economically. But there are many stages of this process before the actual feasibility study or report is finalized.

First off, there are three main feasibility studies: the scoping study, preliminary feasibility and detailed feasibility.

The first one is the order of magnitude, conceptual or what we investors generally call it, a scoping study or Preliminary Economic Assessment (PEA)

Scoping Study or PEA

This first step in the feasibility process is the initial financial appraisal of an indicated mineral resource. This study usually begins once a sufficient level of drilling and sampling to define a resource has been completed, such as a NI 43-101 in Canada. Copying plans and factoring known costs from industry standards and comparable historical data develop scoping studies.

It involves a preliminary mine plan, and is the basis for determining whether or not to proceed with an exploration program, and more detailed engineering work.

The end result of the study is a description of the general features and parameters of the project and an order of magnitude estimate of capital and operating costs. A study of this level is valid to determine whether a project is worth pursuing further but not enough data has been collected for reserve definition. This study is generally 35 -50% accurate.

Don't mistake the term mineral reserves for mineral resources.

Mineral resource is a guess of what's in the ground such as the indicated and inferred resources found in NI 43-101's.

Mineral reserve, on the other hand, is the resource known to be economically feasible for extraction. Few projects survive this part of the study.  The next stage after this is the preliminary feasibility study or "prefeasibility study."

Prefeasibility Study

This study determines the mining and milling extraction methods and rates, the product recoveries, environmental and permitting issues, and preliminary capital and operating cost estimates. It also determines whether or not to proceed with a detailed feasibility study, which is very costly.

As part of this process, areas of concern that need further research during the feasibility stage need to be identified. These areas often include geotechnical studies for mine, waste dumps, and tailings facilities design, metallurgical testing for refining estimates of product recoveries, and waste characterization studies. Identifying these items at this stage can avoid costly delays during the feasibility stage - any additional delays and costs can be detrimental to a project which often translates to shareholders directly. Added costs mean further funding may be required and could add further dilution to shareholders.

Depending upon the level of detail in these studies, and the securities exchange that is involved, reserves can, in some cases, be declared at this point.

This preliminary feasibility study is usually 20-30% accurate and only 50% of the companies that go through this stage pass onto the final stage of the feasibility study or what many call the "bankable" study.

Bankable Feasibility

Detailed or “bankable” feasibility studies are the most detailed and usually determine whether or not to proceed with the project.  General industry standards of this study results in estimates that are within 15 percent accurate.

In essence, this stage is simply a refinement of the pre-feasibility study, which evolved from the scoping study. Key components in the feasibility study are the mine design, production schedule, a detailed process flow sheet, product recoveries, a detailed plant design, consideration of the environmental issues, detailed capital and operating costs estimates, and an economic model of the project. Each of these components is EXTREMELY important.

If a company can make it this far and is feasible after this stage, they can generally take this study to the "bank" for financing purposes.

At this point there is sufficient information to declare reserves, provided the project has positive economics and is noted as bankable. However investors always seem to forget that "bankable" describes only the level of accuracy of the analysis and not necessarily the outcome of the project. Just because a project is feasible, doesn't mean it will get the go ahead for production. Just because a feasible project can make money, the return on investment may not be enough for the company to advance the project.

For example, the profit from the mine may be $100 million but it may cost $95 million to build it out. So is it feasible? Yes. But does it make sense to spend $100 million to make $5 million? I doubt it.  If the benefits do not significantly outweigh the costs, not only may the government deny you permits, but your financiers may pull out.

At this feasibility level, roughly 20% of the companies will fail, and of these most fail as a result of either overly optimistic assumptions or skipped steps. For this step to be successful the scoping study and the pre-feasibility study must be conducted at reasonable estimates; many companies will conduct more than one scoping study to ensure the accuracy of the data. I have seen companies’ shell out a lot more cash and time than they needed to once they hit this stage because they over emphasized their scoping and pre-feasibility studies.

A great emphasis needs to be placed on each and every step with new rules and regulations constantly changing the way feasibilities are done (welcome to the world of regulation)