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Veteran bottom-fisher John Kaiser shares his view of gold, diamonds, rare earths and more...
JOHN KAISER is a mining analyst with 25-plus years of experience, now producing the highly-regarded Kaiser Research Online.
Now Kaiser says that, when North Americans wake up to the dangers of relying on China and Russia for essential metals – from zinc to antimony, niobium to scandium – the junior miners in those spaces now suffering such anemic stock prices could turn into cash-producing machines.
Here Kaiser tells The Mining Report, sister title to The Gold Report, about how he see everything from gold and diamonds to potash and zinc panning out in the back-half of 2015...
The Mining Report: John, what are the global issues you are watching that could have an impact on commodities, particularly gold?
John Kaiser: There is a risk that the economic growth slowdown already underway can deteriorate further, precipitating major general market declines and causing demand for raw materials to flag. This would worsen the current situation where the supply response from the bull period of the past decade is already, in most cases, exceeding demand and, therefore, resulting in a further glut to depress prices and hurt companies involved in both development and mining of raw materials. At the same time, the subdued global growth outlook is creating domestic stresses that in turn are translating into geopolitical conflicts, which have me thinking about security of supply risks should globalized trade come unglued.
TMR: What effect does political instability in Russia and the Middle East have on gold prices today? History would suggest that uncertainty would drive prices up but that doesn't seem to be the case right now.
John Kaiser: A major market correction and evidence that the world is sliding back into recession would be negative and push gold down toward that $1000 per ounce level. Many projects are not viable even at the current $1200 per ounce level. This would certainly harm the valuations for producers and the near producers.
On the other hand, even if we avoid a global economic downturn, we are still vulnerable to geopolitical disruptions such as Russia's gradual annexation of Ukraine and its increasingly precarious relationships with Europe spinning out of control and creating some serious supply issues in the gas, oil and nickel sectors. In the Middle East we are witnessing a regional power struggle between the Sunni and Shiite branches of Islam with America's ally, the Saudi monarchy, as potential roadkill. If Obama is unable to bring Iran out of its pariah status and establish a balance of power between Sunni and Shiite, we could see major oil supply disruption.
Meanwhile, China continues to assert its dominance in its neighborhood, as seen by the creation of man-made islands within the Spratly Island chain in the prospective oil rich South China Sea. This expansion of China's footprint is largely at the expense of American influence in that part of the world. That could be geopolitically destabilizing if the US attempts to push back.
TMR: But wouldn't that hurt the Dollar and, therefore, be good for gold?
John Kaiser: China pushing against the US would have the perverse effect of boosting the Dollar higher because the US is still the biggest economy and the military superpower controls the world's shipping lanes. It can function as an island unto itself, especially if it forges a closer relationship with South America. In fact, its attempts to end the cold war with Cuba are part of this initiative. I would say that cases of this sort of instability would cause the Dollar to rise and gold to go up. The main hope for a gold uptrend that is beneficial to gold developers and producers because it is not just a reflection of a declining US Dollar or global inflation is geopolitical uncertainty. Bad news for gold would be a scenario where the world peacefully sags into a depression.
TMR: You have talked about gold as a store of energy. What does that mean?
John Kaiser: I point that out in reference to people who call gold money. Money is an information system, which keeps track of credits and debits. It allows an economy to go beyond the barter system by enabling the exchange of goods and services extended through space and time. Gold has in the past served as a guarantor of the integrity of money, but that is not the same as money, which is an information system whose underlying cost should be as low as possible. Gold requires a fair amount of energy and time to bring it out of the ground into concentrated form. In that sense, gold is a form of stored energy that cannot be unleashed to produce work in any other form. If you wanted more gold aboveground to back the expansion of economic turnover, you would have to invest energy.
Unfortunately, the energy required to bring incremental gold out of the ground is rising as we deplete the low-hanging fruit at the surface of the earth. That, by the way, is a key problem with the gold sector in general. We are now producing 89 million ounces (89 Moz) annually, the highest ever in history, and the price to bring this gold out of the ground is also at an all-time high. Gold makes sense as an asset class because it is a reservoir of expended energy, and the ability to "make" more gold today requires a higher input of energy per unit gold than ever before. The existence and size of an abstract information system such as money should not be linked to the cost of energy.
TMR: How are companies pulling gold out of the ground creating value when the input costs keep going up, but prices aren't rising?
John Kaiser: In a lot of cases, companies are simply shutting operations. Where they can, they are rationalizing the costs. Low oil prices are helping some companies, particularly those in remote locations dependent on diesel, provided they did not hedge the future cost of fuel. They may benefit down the road if they are hedging their future consumption at the current levels, for it's unlikely that oil prices will stay at low levels for long.
Some miners are grade flexing. They mine higher grades when the price is low and lower grades when the price goes up. Companies have to be careful not to damage the mineability of the lower-grade portions being saved for later. Some are running the risk of destroying the longevity of the resource, and therefore the future of the company.
TMR: Is security of supply becoming a more important story particularly for materials like antimony, tungsten and scandium?
John Kaiser: Yes, for multiple reasons. I think the assumption that globalized trade is going to be with us forever is flawed. We are already seeing extensive use of trade sanctions instead of physical warfare. The side effect of using sanctions is that it fragments the global supply chain. I also see a retrenchment of parts of the world into their own trading arenas. One example is the Asian Infrastructure Investment Bank, a development bank that China is inventing as an alternative to the World Development Bank and the International Monetary Fund, that every country except the US and Japan have decided to join. Its goal is to develop infrastructure in Southeast Asia where China expects to be the dominant player.
Another reason unrelated to geopolitical conflict is government environmental policy. There are no Chinese leaders declaring, "I am not a scientist" when asked about the cause of climate change. They understand that without changes China will move from being the second biggest source of the problem to the biggest source. They are also getting tired of their self-appointed role as the world's toilet for industrial emissions. An environmental awakening similar to what swept the United States during the 1960s is underway.
The result could be a shrinking supply of critical metals as Chinese mines are forced to shut down or increase their cost of production by following environmental rules. The resulting supply gap will push up metal prices that will not be greeted by new Chinese supply. Projects elsewhere in the world that are sitting idle because their operations must meet environmental standards will end up in the money and receive a development green light.
Yet another reason to think about security of supply is the innovation surge accompanying the rush to deal with environmental policy goals. China's crackdown on pollution is disruptive of metal supply, but its adoption of climate change-related greenhouse gas reduction goals is a demand driver as new energy-related technologies get developed. The innovation frontiers are alternative energy and energy efficiency. Personally I much prefer to see metal prices rising because of environmental policies rather than geopolitical conflict.
TMR: Let's talk about some of those supply and demand equations for the individual materials. Start with tungsten and what companies could meet that demand.
John Kaiser: Tungsten is an important metal. It is used as a hardening agent largely in the tool industry and has seen considerable demand growth during the shale drilling boom. But demand tends to follow the global economic trend, so it is suffering a bit from the worldwide slowdown. It is, however, also a war metal used in weapons and as a hardening agent for armor. If we do end up in a period of conflict that encourages an arms buildup, we could see demand for tungsten go up dramatically.
TMR: When we talked in October, you were waiting for an environmental report. Did that work out as you'd hoped?
John Kaiser: There are many stages in the environmental process. I don't expect to see final approvals until the end of this year, maybe early next year. 
There is another concept that people don't think very much about. That is the idea of natural depletion. In the zinc market, major Western mines are shutting down because they have run out of ore and there is not much in the pipeline to replace this lost production. But no one has really cared because China has increased zinc production 3,000% from 160,000 tonnes in 1980 to 5 million tonnes in 2014. Its global share has expanded from 3% to 38%. China's mines tend to be small scale, poorly operated, aging and polluted. And it is getting more expensive to access Chinese antimony, tungsten and zinc deposits as high-grade near-surface zones get mined out.
Nobody except perhaps the Chinese know what the Chinese zinc cost curve looks like. Production was unchanged in 2014. I suspect that we will see a decline in output and an increase in the price of zinc. I think we will see the same happen with other metals such as antimony, tungsten and graphite in which China dominates. If China has the geological capacity to switch from "small and messy" mines to "big and clean" mines, it will take quite a few years to happen.
Although gold does not fit into a security of supply framework because all 5.4 billion aboveground ounces are scattered all over the planet and theoretically for sale immediately, the Chinese depletion and environmental policy themes also apply to gold mining. China has grown from 225,000 oz production in 1980 to 14 million ounces in 2014, representing 16% of global supply. Yet nobody has heard of a world-class Chinese gold mine. Goldbugs may finally get some price upside as government regulations put China's small scale gold mining entrepreneurs out of business.
I'm of the view that this is an ideal year to look at advanced projects. The stock price downtrend since 2011 has bottomed. If they have sufficient money to carry on for another year, this is a time to buy these stocks, tuck them away with a one-year or longer time horizon in mind, and monitor global affairs for developments that may disrupt the supply or boost the demand for the metals these companies hope to produce in the future.
TMR: What about the supply and demand story for scandium?
John Kaiser: Scandium is an unusual metal in that demand is restricted by available supply, which is only 10-15 tons per year of scandium oxide from a variety of byproduct sources, such as in situ uranium leaching, titanium dioxide waste stripping and byproduct from the Bayan Obo rare earth mine. None of these sources is scalable in a serious way, and all of them tend to have fairly high costs, even for the recovery circuit needed to strip the scandium out as a byproduct.
So it's a pitifully small market worth about $20-50 million annually depending on price, which can range from $2,000 to $7,000 per kilogram. But scandium is to aluminum what niobium is to steel. It makes aluminum stronger, more weldable, corrosion resistant with a higher melting temperature and doesn't affect the conductivity. These factors enable scandium-aluminum products to save energy, which plays right into the greenhouse gas emission reduction movement, as well as universal cost consciousness. So scandium is a potential important player if it can become available on a scalable basis.
In the last seven years, deposits have been recognized in Australia's New South Wales that have grades three to six times higher than what was mined in the Zhovti Vody deposit in Ukraine by the Soviets during the Cold War. The aircraft industry alone would harvest a 15% weight savings for its aircraft by replacing all its aluminum parts with aluminum-scandium. The automotive industry has potential to adopt aluminum scandium alloy in parts of cars where strength might be needed or where the melting point is an issue, such as in brake rotors that are still made of cast iron and weigh double the aluminum equivalent. The rail industry could also benefit from using stronger aluminum scandium alloy to pull less of the train's own weight and more cargo weight and save fuel.
Scandium is a story that is going to explode with demand going up to 1,000 tons per year in about 10 years from next to nothing simply because juniors have discovered deposits that no one thought could exist at this grade. These companies are investing the time and effort to sort out the metallurgy and going through the feasibility demonstration stages. We will probably see the first small-scale mine in production in 2017. When the industry sees that scandium oxide can be produced at $2000 per kilogram or less, from a deposit where production can be scaled up to whatever level demand requires, then end users will start to commercialize all these applications that are sitting on their drawing boards.
TMR: Are scandium and niobium similar to the rare earth elements (REEs) where the value is less in the mining than in processing and supply chain management?
John Kaiser: It is largely a processing problem that only grade can overcome, and it is the high grade of the Australian deposits that is the game changer for primary scandium supply that can respond to demand growth. Scandium tends to be very low grade. It is quite abundant in the crust, but it does not concentrate like chromium, so you get very low grades, and you have to crack the host rock to liberate scandium mixed with a lot of other elements. And each flowsheet has to be a custom design because the composition of the other elements can have negative effects in the chemical reaction, impacting the required amount of acid and heat, the two primary input costs.
For example, niobium is generally present as the mineral pyrochlore to whose cracking the flowsheet will be dedicated. But 30-40% of a deposit's niobium grade reports to other minerals that are not cracked and disappear into the tailings pile. In that sense scandium and niobium are similar to rare earth mines. What is different is that rare earths because of their similarity drop out of solution as a mixed oxide concentrate that has to go through a second expensive separation stage to yield individual rare earth oxides that are marketable.
TMR: Is the world also facing a potash shortage?
John Kaiser: Potash does not so much have a depletion problem as a supply disruption problem. A good chunk of the world's supply comes from Belarus and its neighbor Russia. If this shoving match between Russia and Europe over Ukraine spins out of control, we could end up seeing supply disruption for potash pushing prices higher. 
TMR: Give us a story that brings the conflict and depletion cycle together and could get investors excited again. What's something that you would want to write home to mother about?
John Kaiser: Diamonds are a luxury good, which means that if all the gem diamonds for some mysterious reason flash evaporated, it would leave a lot of unhappy people behind, but the world would carry on as though nothing happened. Its demand is driven by fashion, and thus driven by a growing economy, especially where the growth is in the form of an expanding middle class, such as is the case in China and no longer in the United States. If we assume emerging markets will remain the main component of global economic growth, demand for natural gem diamonds will expand. That's a problem because although 5 trillion carats have been mined since the South African diamond fields were discovered, diamonds tend to just disappear.
Unlike gold, where the 5.4 billion ounces that have been mined in the last 10,000 years are all sitting there in vaults or hanging from people's necks ready to be melted down and resold when the price is right, diamonds seem to disappear into nooks and crannies from which they never emerge to flood the market. Although the stones are valuable, they do not get recycled. That's an issue for the jewelry industry because there have been no giant new discoveries made in the last 15 years, and the big mines like Jwaneng and Orapa in Botswana and others in Russia will be depleting in the next 20 years.
Unless diamonds fade as a coveted luxury good, a supply-demand imbalance will emerge that drives prices higher at a greater rate than inflation. This is important because if a junior owns a diamond deposit whose development costs have been established, the profitability of the mine will increase over time because the revenue side of the equation increases at a greater rate than the inflation-based increase of the operating costs. This is not done with a gold project because the main reason to expect a higher gold price is inflation. Adjusting revenues and operating costs by the same inflation rate is frowned upon because it mathematically boosts the present value of the cash flow. And there is no empirical basis to project a higher real price for gold. Diamond projects have been out of favor while gold was in an uptrend, but now that gold has stabilized at $1200 per ounce in a low inflation environment, diamond projects are set to sparkle again.
TMR: What is the one thing investors should be doing to shift to a security of supply-focused portfolio?
John Kaiser: They should forget about expecting the sort of instant gratification that big exploration discoveries or dramatic gold price moves generate for shareholders of resource juniors. Not enough drilling is being done on high-risk, high-reward targets to give us the Voisey's Bay type of surprise that ignites a market frenzy. There also is nothing on the horizon to justify a sharply higher gold price except geopolitical developments that belong in the category of things we would wish had not happened.
Resource sector investors need to adopt a longer time horizon and choose resource juniors where the stock price would respond to identifiable future developments whose emergence can be monitored by reading the international news and becoming a globally plugged in citizen. It is wonderful if people do this for its own sake, but it is better when they can convert their understanding of global affairs into implications for a portfolio of resource juniors with security of supply-linked projects. You can see the benefit to your pocket if something goes wrong in Russia or if China undergoes an environmental awakening. That will make investing fun again.
TMR: Thanks, John, for your time.

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