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September 09, 2006

Peak Gold - Response to Critics
by Roland Watson

My last article entitled "The Limits to Gold and Silver Growth" resulted in various emails both supportive but also critical of my position that global production of gold may have peaked back in 2001.

To summarise, the article compared geological reserves estimates between 1970 and 2005 and showed that the 1970 estimates proved to be woefully short. Nevertheless, it was my conclusion that an equal leap of 35 years to 2040 would in no wise have us making the same conclusion about 2005 reserve estimates. The reserve growth we saw during the last three decades will not happen in the years ahead. Rather it was my contention that declines in gold mine production would be the rule rather than the exception for the future.

That drew some emails that said that I was wrong and they stated why. It is their reasons and one or two others I have read that I wish to refute here in defence of Peak Gold.

As I finished the Hubbert linearization of gold depletion for my newsletter, further confirmation of the status of formerly dependable gold producing nations was highlighted by Australia. The news was that Australian gold output had declined to new lows of 251 tonnes. Here is how the USGS charts the recent history of Australian gold.

As one can see, production has dropped steadily since its high of 312 tonnes in 1998 and is now 20% off that high. Paradoxically, its reserve base has increased in that time by 28%. Evidently, the reserves are not proving adequate enough to bring on new supply.

With that point in mind, allow me to look at the main objections raised as to why declining production worldwide is not to due to a "Hubbert's Peak" in gold.

1. Production is falling because exploration budgets were slashed in the 1990s.

This is the most common reason given for a decline in production. Indeed, the analysts who reported on the above Australian decline cited this as the reason for it. However, if you look again at the USGS data above, it is clear that the reserve base for Australian gold has been increasing since 1995 and perhaps before that. But the critic of Peak Gold may retort that it is not so much the stating of reserves but the accessing of them that matters.

Using Australia as a test case, we find that new production is coming online from the re-opening of old mines, expansion of current mines and fast-forwarding of old projects that are now economic. But still depletion is running at a faster rate.

What is needed we are told are new finds with fresh gold reserves to offset these mature operations. Indeed, whereas gold formed 60% of mineral exploration budgets in Australia in the late 1990s, it is now about 30% of that total. That statement from Surbiton Associates may give the impression that budgets are down whereas on closer inspection the amount spent on gold exploration is actually about the same as the late 1990s; it is the base metals budgets that have taken off.

What does equal exploration budgets but declining production rates suggest? It suggests gold is harder to find in quantity as well as quality. That is a natural consequence of Peak Gold, and peak is reached when the ores simply become too uneconomical to extract and refine.

I put forward another reason that budgets are not going up and it is not because of depressed gold prices six years ago but because a lack of good finds is acting as a negative feedback loop to exploration budgets. Ergo, the easy gold is gone in Australia and I also suggest for the world. This brings us to the second argument.

2. Gold companies are finding economic reserves but they are not exploiting them.

This has more of the conspiracy theory about it. The idea here is that gold companies do indeed have good reserves of gold just waiting to be dug up, but they fear that flooding the markets with their produce will depress the price.

Now mining companies holding back on production because the price of gold was too low to make them economic makes complete sense. But I have never heard of companies holding back because the price was too high. That leaves me scratching my head and asking at what not-too-low and not-too-high price do they intend to go into production? It is a futile exercise and is outweighed by the not so technical maxim of "making hay while the sun shines". Any company that tries to postpone present profits based on a crystal ball approach to gold prices is in my view dicing with corporate death.

So how much "hidden reserves" are these companies allegedly understating? And just what is being claimed as hidden anyway? Are they measured, indicated or inferred resources? Or perhaps they are the meatier proven and probable reserves? The difference is important if not crucial. No one is saying, because by definition is it hidden and therefore beyond analysis. To be frank, I don't work with non-existent data and neither should any other serious analyst.

I suggest this doesn't matter anyway. In a study conducted by the consultancy company Beacon Advisers in 2002, known resources associated with current mines were just over 38,000 tonnes. At that time the USGS was estimating a reserve of 42,500 tonnes and a reserve base of 89,000 tonnes. If there are hidden reserves, the USGS figures more than compensates for them. We move onto the third argument.

3. A rising gold price will bring out new mine supply.

This is a based on a free market truism that demand in the form of a rising price will adjust supply. However, free market theory does not state that increased demand will increase supply. For example, if there was suddenly a demand for Picasso paintings worldwide, the price may rise but it will in no way increase the number of Picasso paintings (except for fakes and reproductions).  Now the same set of Picasso paintings may be recirculated through the markets as they are sold repeated times but that is more akin to the scrap recycling side of the gold market.

As it happens, gold mine production has steadily decreased as the price of gold has increased. Evidently, something is stopping theory and practice going hand in hand. I say Peak Gold but others will invoke the arguments we are examining here.

4. The increasing price of energy is dampening production levels.

This is one explanation I am prepared to give some credence to. Mining employs vast amounts of energy; some estimate that 5% of the world's energy is devoted to mining. Is it any wonder then that increases in the price of crude oil, natural gas and electricity will hurt the cash cost per ounce of a mine? I call it Peak Oil dating Peak Gold.

There is one caveat though. Since energy costs are still a small proportion of a company's overheads, it cannot be employed as the sole reason for a decline in mining output. Mining is still very profitable with gold at $650 and oil at $70. Going by the large profits declared by various gold producers recently, energy costs are not a major obstacle and will only hurt at the fringes of marginally economical deposits.

5. New technology and new frontiers will increase production.

The first problem with this assertion is that new technology has clearly not increased production in the case of Australia but also South Africa, the USA and a host of various other countries. At best, technology is doing no more than slowing the decline rate in these countries.

The other solution is to boldly go where no gold explorer has gone before. In the forging ahead to new areas of exploration we have to understand two things. The first is that no one would be going there if it weren't proving more difficult to find gold on less hostile dry land.

Secondly, increasing reserves in exotic areas does not imply increasing production. By the very nature of their inaccessibility, the gold may be down there but getting it out will not prove to be as rapid as an open mine operation on dry land.

Let me use an example from the Peak Oil debate. The Athabasca tar sands in Alberta have been estimated at 175 billion barrels of proven reserves. That is second only to mighty Saudi Arabia. However, Saudi Arabia is producing at 9 million barrels per day and companies in Alberta are only at 1 million barrels per day with a projection to 2 million barrels by 2010.

Why the painfully slow progress in accessing 175 billion barrels? It is simply because it is harder to get at and harder to refine. Even with improving technology, they can only go so fast. The same goes for gold in exotic locations, the reserves may look good and the technology may be there, but the technology is only bringing these reserves up at profitable levels, not traditional production levels. The bottom line for any company is profit levels first and production levels second.

Let me point out that I am not decrying technology. Without it, we would not have seen the rise in production levels we have seen in the last century. But there is a limit to technology and it is reached when the quantity-quality of gold ores decreases faster than the rate at which mining technology increases.

But to be more specific let us look at some suggested solutions.

Ultra-deep mining. Here we are talking about mining to depths of up to twice the current record depth of over 3.5km at the Savuka and TauTona mines in South Africa. I will note right away that the energy requirements are great. Compared to a normal shaft mine scenario, the energy requirements for extra lifting, ventilation and cooling increased by 74% when the depth increased from 3km to 5km (see link). A solution based on hydropower and turbines was seen as the best approach to increased energy recovery and efficiency. I suspect their costing was not based on a scenario of increasingly higher energy prices and I for one always assume costs will come in higher than projections suggest. Furthermore, a rock lift of 13,150 tonnes per calendar day is required to make the operation profitable.

Compare this to the mature deep mine at TauTona. In 2002, it mined 643,000 ounces of gold at a recovered grade of 0.34 oz/ton (see link), which equates to a daily rock lift of 5,181 tonnes. Clearly, this kind of energy intensive operation will be threatened by increasing energy costs.

At greater depths up to 10km, automated technology will be required since the environment is too intolerable for humans. By the time this advanced technology ever comes into play, world gold production would have dropped so much that its impact may increase production but it will not bring gold to the previous highs. Think Prudhoe Bay and US oil production. That was a huge find in Alaska but it did nothing more than dent the overall decline in American oil production.

Underwater mining. This shows more promise than ultra-deep mining though the obstacles are similar in that we have an inhospitable environment to overcome. The use of modified submersible devices from the deepwater oil industry has helped accelerate the technology curve and high ore grades are hoped for.

To demonstrate the infancy of this mining approach we have Nautilis Minerals Inc. (see link) that is working at depths of up to 1600 meters off the coast of Papua New Guinea. The company is talking about dredging up 2 million tons of rock per annum which presumably must be the amount required to make it a profitable exercise even at suggested grades of 10g per ton. This computes to 5,479 tons per calendar day, which is comparable to the deep mines mentioned above though Nautilis claims that production costs will be lower than traditional mines due to such factors as softer rocks and no overburden.

However, attempts to find statements on starting dates for production let alone proven reserves figures failed. The sector is very much in its infancy and once again I wonder how far global gold production would have declined before this form of mining begins to have an impact. It reminds me of the oil strikes in the deep waters of the Gulf of Mexico. This was a bonanza for America but once again it did nothing to stop the decline in American crude oil production. After over thirty years, deep-water oil production still only constitutes about 25% of world production. How will it be for aquatic gold?

Underwater mining will have its day and Nautilis is a company favoured by metal investors, but the jury is still out on whether this sector will have a significant impact on arresting the overall decline in global gold production.

There are other far more exotic sources of gold such as seawater and asteroid-planets but patently these approaches are so far from being mainstream production that they are beyond the timeframe that we are considering.

So in conclusion, Peak Gold threatens. Of course, I may be wrong in saying peak has passed but the production and reserve numbers serve as a warning that demand is increasingly not going to be met by mine supply. As the new consumers of China and elsewhere express their new found wealth in the form of precious metal purchases, I expect the matter to come to a head and once it is realized that there is NO "gold in them thar hills", a new gold rush for existing above ground will begin in earnest. If you wish to participate in that rush, consult Gold Investments at www.gold.ie for further information!

I thank you for listening and invite further critiques of the Peak Gold position.

Roland Watson writes the investment newsletter The New Era Investor that can be purchased for an annual subscription of $99. To view a sample copy of the newsletter, please go to http://www.newerainvestor.com/ and click on the "View Sample Issue Here" link to the right.
Comments are invited by emailing the author at newerainvestor@yahoo.co.uk.

Roland Watson
http://silveranalyst.blogspot.com

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