Big Gold is About to Go Shopping

April 29, 2009

We don't often think about where gold mines come from. But if we did... we'd realize that gold mines don't have infinite supplies of gold and when the gold runs out they need to find a new source of gold...  or go out of business.

So where do gold mines get new gold? 

In the old days, the big gold mines had geologists on staff to help find new gold.  But these days things are different.

In this article Jon Herring explains where that supply of new mines comes from.  It is a bit funny to think that the Miners have "minors".  But just like Baseball teams have a "minor league"  major gold producers have to have a source for their "minors". -- Editor

By Jon Herring

From 1980 until 2001, there was a deep bear market in precious metals and most other natural resources. Commodity prices were under constant pressure, and as the years dragged on, many of the companies that mined and produced natural resources went out of business. The larger mining companies were able to weather the storm, but with little incentive to find new resources, they cut their exploration staffs to the bone.

But just as the longest winters eventually turn to spring... so do the deepest bear markets eventually give way to the bulls. Spurred by soaring global demand, the tide turned and a new global commodities bull market finally arrived.

For six years, commodities were the place to be as the bull market pushed prices higher and higher. Then came the financial crisis and a downturn in the economy. Demand for everything from copper and molybdenum to oil and gas took a hit, and prices fell sharply. It’s hard to find a bull market anywhere these days, especially in commodities.

Gold is different, however. While there are some industrial uses for gold and, of course, jewelry, gold is a monetary metal. And in that sense, the demand for gold has remained robust… if not record-setting.

But despite record demand and the fact that the price of gold has risen for eight straight years, production of the yellow metal has been falling. In fact, gold production has fallen every year since 2001. In addition, reserves are not being replaced… not by a long shot.

Consider this: the gold industry produces about 80 million ounces per year. A “world-class” gold discovery is defined as 5 million ounces or more. That means the world’s gold mines deplete the equivalent of 16 “world-class” discoveries every year. But in the last 15 years, there have been fewer than five such discoveries.

Without a doubt, the big gold companies NEED new deposits. After all, mining is a depleting business. A mining company that doesn’t replenish reserves is like a store that doesn’t restock its shelves… they will soon be out of business.

So surely with all their cash, technology and human resources, the major gold (and silver) producers can just go out and find some more resources and put them into production, right?

Not so fast…

It takes years to explore for minerals... prove that the deposit is economical... overcome the environmental hurdles... and then build the infrastructure to produce the finished product.

But the real hurdle is that the best and the brightest in the field no longer work for the major mining companies. Why would they? When the biggest mining companies curtailed exploration and laid off their most talented rock hounds in the 1980s and 1990s, those that didn’t retire from the business altogether went out and started their own companies.

And why not…

If a geologist or executive working for a major is involved in a discovery, he might get a pat on the back and a bump on his Christmas bonus. The same guy working for his own company can make $10 million... $100 million... or even more!

That is why most of the best geologists in the world – those with the greatest track record of successful discoveries – don’t work for the big miners anymore. This is also why the junior resource companies (the small producers and exploration outfits) are absolutely essential to the natural resources industry.

The major mining companies MUST replenish their diminishing reserves. And in most cases, the only way to do that is to buy out or joint venture with the juniors. With cash pouring in from high gold prices, the mining companies are salivating over the undervalued juniors. In the months and years ahead, there will be a flood of mergers and buyouts as the cash-rich producers go shopping.

In a recent story on this topic, The Canadian Press writes, “Nearly half of the large mining companies interviewed for a recent study by Ernst and Young said they need to make acquisitions to meet their aggressive growth targets. 90% said they expect to make an acquisition in the next two years.”

You have probably heard that investing in junior resource companies can be very risky. It can be. But there are ways to stack the deck decidedly in your favor and generate a better risk to reward ratio than almost any other investment. My colleague Dr. Rusty McDougal has mastered this sector, closing out dozens of gains in the 500% - 5,000% range… and some even higher. Yes, dozens.

So what does he do to pick the winners in this sector? He has written two in-depth reports, which outline his strategy in great detail and are available to subscribers of Resource Windfall Speculator. But I’ll give you some of the highlights here…

• First and foremost, spread your risk among multiple companies. It is possible to buy a meaningful stake in most of these companies with just a few thousand dollars. So spread your money around to reduce your company-specific risk.

• Second, only invest in companies whose management has a successful track record. In most cases, it is more important to know the PEOPLE involved than the projects. The management team should have a high level of experience and a track record of success.

• And third, focus on project generators. These are the companies whose operating plan is to discover resource assets, maintain an ownership interest, and then turn those properties over to joint venture partners for development and production. These companies take on a lot less risk than those that choose to engage in costly and problematic mining and production on their own.