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Industry Overview: Gold Mining & Exploration


By Derrick M. Irwin CFA               Printer Friendly Version

February 2, 2005

Harbinger Research


Summary and Investment Opportunity


Despite the recent volatility of gold prices, the longer term price rally in gold and the weakness of the U.S. Dollar have kept gold in the spotlight. However, gold mining share prices have generally failed to keep pace, and as long as gold prices remain near current levels, we believe the medium-term outlook for gold mining shares is quite good.

The large budget and trade deficits are currently driving meaningful dollar depreciation against many of the U.S.'s trading partners. Should the dollar show continued weakness, it will likely benefit the price of gold and, eventually, the price of gold mining equities as well.

We believe gold stocks are currently favored by most industry fundamentals, such as declining gold production, expanding exploration budgets (especially at the major gold producers), and potentially slower central bank gold sales.

Investing in gold exploration and mining equities has traditionally been, and continues to be, a risky proposition. However, given the ongoing need of major producers to replenish their increasingly-depleted reserves, and given the strong fundamentals the industry is currently experiencing, we believe many good investment opportunities exist in the shares of exploration and junior gold-producing mining companies.

The purpose of this industry report is to provide an overview of the gold mining industry, discuss some of the factors affecting the price of gold and gold mining shares, and provide a brief description of some promising gold exploration & mine development companies.








Overview of the Gold Mining Industry

Humans have mined for gold for thousands of years, and mining continues today on almost every continent. The size and complexity of gold mining operations ranges from the relatively small, simple mine, to the massive, complex operation that extends miles beneath the surface and produces millions of troy ounces per year. In the aggregate, on a worldwide basis, gold mining operations produced 2,600 tons of gold during 2003, according to Gold Fields Mineral Services.

While gold is produced on every continent except Antarctica, the top three gold producing countries in the world are South Africa, the United States, and Australia. According to Goldfields Mineral Services, South Africa accounted for 14% of gold production in 2003, with the U.S. and Australia producing 11% each. China and Russia are also large gold producers, and South American countries (particularly Peru) and Canada remain major players.

Much of the exploration and new mine production is happening in locales such as Ghana, Chile, and Peru, with successful smaller scale exploration occurring throughout Africa, Latin America, and Asia. There continues to be significant active exploration in Canada and the Western United States as well.

Source: USGS 2002 World Mine Production, by Country

Gold production appears to have leveled off in recent years, largely as a result of low gold prices, which discouraged exploration and development activity at the major mining houses. With gold prices currently on the rise in U.S. Dollar terms, we are seeing a resurgence of exploration activity in large and small gold mining companies alike.

Source: USGS, World Gold Council

The gold mining industry can be broadly categorized in terms of three groups. The first category is that of "the major gold producers." While the exact definition of what constitutes a major player is not precisely agreed upon, a "major producer" is typically a company with multiple gold-producing locations and an annual output measured in millions of troy ounces per year. It is notable that the bigger companies continue to grow over time, as the top-end of the gold mining sector continues to experience significant consolidation. Today, the top ten gold mining companies produce roughly 50% of the world's annual output, up from 40% in the early 1990's.

The next group of companies is the minor gold producers, which represent roughly 80% of the operating mines worldwide, although only 50% of the worldwide gold production. These companies operate in various nations and economies around the globe, and are often acquisition targets of the major producers.

Finally, the smallest group of companies is comprised of exploration and development ventures, which focus on finding economically-viable ore deposits through either greenfield or brownfield exploration. These tend to be small, highly risky ventures, created in hopes of creating a massive payoff if a new economically-viable gold deposit is discovered.

Gold Mining Life Cycle

Gold mining and exploration is a time consuming, expensive, and frequently risky endeavor. Exploration for new gold deposits is often very difficult, given the metal's relative scarcity and the often remote location of new gold deposits. Furthermore, with many new deposits being found in developing countries, political risk can also be an important consideration. Once an economically viable deposit is discovered, bringing a mine on line can take ten years or more, and entail massive capital investment. However, the financial returns created by a successful mine development project can be extremely high, and often more than compensate for the risks and investment capital involved.

The rough life-cycle of a gold mine is as follows:

Gold Exploration
Worldwide, gold mines produce about 2,600 tons of gold each year, meaning that mining and exploration companies need to discover an additional 2,600 tons of new gold just to keep reserves even. Because of this, exploration is an important (albeit risky) part of a mining company's operations. Interestingly, as a result of low gold prices, gold exploration has languished since peaking in 1997, signaling a gradual depletion of gold reserves that may now be reversing.

Source: Metals Economics Group

As a result of lower exploration spending, fewer large gold deposits have been discovered in recent years. Given the rally in the price of gold since 2001 and the need to replace current and future production, gold mining companies and their investors are beginning to focus on exploration activity once again. Most of the major gold companies have increased gold exploration budgets in 2004 and indicated that they plan on maintaining active exploration programs in 2005.

The Gold Exploration Process

The initial stages of gold exploration revolve around locating ore bodies that have the potential to be economically viable. Exploration is normally done by highly trained geologists and geophysicists, and the overall ability of the geologists associated with an exploration venture is a key factor in determining its chances of success. Broadly speaking, there are two categories of exploration, commonly referred to as greenfield exploration, and brownfield exploration. Greenfield exploration focuses on finding minerals in previously unexplored areas or in areas where gold is not already known to exist. In brownfield exploration, geologists look for deposits near or adjacent to previously discovered deposits. They may also assess previously explored areas, using more sophisticated techniques than had been previously available. Generally speaking, greenfield exploration is riskier and frequently more expensive than brownfield exploration, although the discovery of an entirely new, economically viable ore deposit can be very lucrative. The benefit of brownfield exploration is that geologists are able to use existing data, building upon it when necessary. This is generally much cheaper, and, given that much brownfield activity occurs near proven ore bodies, tends to be much more productive.

While on-the-ground analysis still plays a big part in the exploration process, much exploration is now done via aircraft, particularly during the early stages. Geologists frequently evaluate the physical properties of a potential ore body using aircraft-borne remote sensing devices, which allow them understand the magnetic, gravitational, and radioactivity characteristics of a prospective ore body. By understanding these characteristics, geologists can make more educated guesses as to whether or not the geology of a specific locale is likely to contain economically viable concentrations of gold.

Once a promising area is located, geologists conduct ground-based seismic surveys, allowing them to develop a "picture" of underground deposits. They also create detailed geologic maps, allowing them to interpret the exposed structures and the nature of the cover above potential ore bodies. These and other techniques allow geologist to get a preliminary picture of the structure of rocks in a given area and determine whether they are likely to contain ore bodies.

If geologists determine that an area has potential to produce economically viable ore, they take extensive samples to determine in more detail the economic viability of a particular site. Sampling is commonly done by drilling for rock samples or, in some cases, digging trenches and examining surface outcroppings. Types of drilling include rotary air blast, aircore reverse circulation, and diamond drilling. Drill cores are chemically sampled to determine the precise content and distribution of minerals with the rock, allowing geologists to determine if it will be economically feasible to develop a mine. If so, they create a feasibility study, which estimates the cost of developing a mine and the potential production once the mine is built.

The Gold Mining Process

Once a company determines that a deposit is economically viable, a mine must be developed at the site. Broadly speaking, there are two major types of gold mines: open pit and underground. Open pit mining, as the name suggests, employs large pits, whereby the ore is removed by truck and processed to extract the gold from it. The benefit of this type of mining is that massive amounts of ore can be processed quite inexpensively (on a per ton basis), allowing mines to profitably operate while processing much lower grades of ore. Underground mining techniques are employed when the overburden is too thick to economically penetrate with earth moving equipment. Here, miners dig shafts into the ground to access the ore deposits. Not surprisingly, this type of mining is more expensive and is generally associated with higher-grade ore than open pit mining.

Once ore is extracted, miners treat it remove the pure gold. The ore is crushed and milled to a powder fine enough, which allows almost all of the gold to be extracted. The gold is then dissolved into a cyanide-based solution, from which it can be recovered through a number of processes, including the addition of zinc to the solution or the technique of carbon-in-pulp. Some open pit mines use a technique called heap leaching to remove the metal from the ore. While less efficient than traditional methods, heap leaching allows a huge volume of ore to be processed at a very low cost. A more recently developed method of extraction is called bio-leaching, which uses bacteria to oxidize and break down the ore for treatment. The ore is then smelted and sent to a refiner for final processing.

Factors Affecting the Price of Gold

Not surprisingly, the price of gold is a main driver of gold mining share prices. Gold rallied strongly through early 2004, peaking at U.S.$427/oz in April before pulling back over the summer. In recent months, amid investor concern over the strength of the dollar and softer-than-expected economic growth, the metal has retraced it steps and is currently trading at $422.50, up 3.9% in the last 12 months. We believe the main drivers of the price of gold are: investor perception of U.S. and global economic growth prospects, the strength (or weakness) of the U.S. Dollar, the supply of gold available for sale, and physical demand from consumers and investors. Obviously, these factors are interrelated, making a simple analysis difficult to complete.

U.S. Dollars: The Most Important Driver of Gold Prices

Over the last four years, the price of gold has shown a high inverse correlation with the value of the U.S. Dollar. While not a perfect relationship (correlation was not nearly as strong in the early 1990s, and the relationship has seemingly decoupled in recent weeks), we believe that investors view gold as a "safe haven" from dollar weakness and that any expectations of a further decline in the dollar will cause gold prices to strengthen.

Source: World Gold Council, FactSet

We note that the dollar's peak in July 2001 coincided closely with the cyclical bottoming of gold prices.

There are a number are a number of other economic factors that we believe have a meaningful impact on the price of gold. First, GDP growth continues to be a wildcard in regards to gold prices. Slowing economic growth in the U.S. is likely to be good for the price of gold, as investors look for safe-haven investments. Further, we look at inflation, which is of course tied to the value of a dollar. While inflation appears to be under control, the risk remains that inflation will get ahead of the Fed's efforts to control it through increasing interest rates. Third, many investors feel that rising interest rates would be bullish for the dollar by increasing the return on dollar assets. While any Fed tightening is liable to provide a short term boost to the dollar (and, by raising the return of dollars versus gold, be negative for the price of gold), this has historically been a weak indicator of dollar movements, notably in the mid-1990's when Fed tightening led to a weaker dollar and in 2001, when repeated cuts in the interest rate let to a stronger dollar.

Real Interest Rates

Some market watchers believe that the real interest rates (actual interest rates less inflation) are a better measure of the effect of interest rate hikes on the U.S. Dollar than the Fed funds rate (or longer-term rates) in isolation. We generally measure real interest rates as the 90-day T-bill less CPI. The chart below presents the rate history of real interest rates, which remain at recent historical lows. Should CPI growth (inflation) accelerate faster than interest rates rise, it could be negative for the dollar and positive for gold and other non-dollar assets.

Source: Bureau of Labor Statistics

The Current Account Deficit

Perhaps the major source of concern regarding the potential for further weakening in the dollar is the United States' record-high current account deficit. When looked at as a percentage of GDP, the current account deficit is currently running at what many economists believe to be unsustainably high levels. Effectively, foreign investors are financing U.S. consumption, by buying dollars and U.S. Treasury debt. Should foreigners no longer choose to invest in U.S Dollar denominated assets, or begin selling their dollar reserves, it would likely cause a substantial further weakening in the dollar.

Source: St. Louis Fed Economic Data

Supply and Demand Fundamentals
As noted earlier, gold production has been relatively flat over the last several years. As many larger mines have begun to produce less, and with limited new production coming online in the near future, it is likely that overall mine production will continue to remain relatively stagnant over the next few years. GFMS expects that mine supply will peak in 2005 at levels only slightly higher than those seen in 2004, and then decline by approximately 30 tons per year through 2010, or roughly 1.2% per year. While additional supply could come into the market in the form of scrap gold sales, which may be inspired by recently higher gold prices, we doubt these sales would materially impact gold supply going forward. Recent data suggests confirms this, suggesting that new scrap sales are not yet a major contributing factor to supply growth. Another piece of the supply puzzle in recent years has been the unwinding of hedging strategies by major gold producers, who sold gold forward in the declining price environment of the late 1990's. As they unwound their hedge books over the last few years, the additional supply from forward sales dried up and actually became net demand over the past few years. While de-hedging activity by major producers appears to be slowing, it should continue to remain a source of demand, not supply over the next few years. We discuss the effect of de-hedging by gold producers later in this report.

On the demand side of the equation, jewelry consumption has surged in 2004, as a function of a stronger U.S. economy and economic growth in China and India in particular. The World Gold Council reports that consumer demand for gold rose 6% year-over-year in Q3'04, the third consecutive quarter of increasing consumer demand. This was highlighted by 16% growth in demand from Indian consumers, who seem to spend a disproportionate percentage of their disposable income on gold and gold jewelry.

The World Gold Council data in the table below summarizes gold supply and demand trends over the last few years.

Source: World Gold Council, GFMS

A wildcard in the demand/supply equation is the effect of central bank sales. According to GFMS, net gold sales by central banks has accounted for approximately 13% of the annual supply of gold over the last five years. It is such an important piece of the global supply and demand equation that the major central banks agreed in 1999 to limit sales of gold reserves to no more than 400 tons per year in the following five years. This agreement, known as the Central Bank Gold Agreement (CBGA), was updated in early 2004 to allow for sales of up to 500 tons per year. While initially a concern, there is some question among gold investors regarding whether the signatories of the agreement are interested in selling the full allotment of 2,500 tons over five years, suggesting the changes may put less pressure than expected on gold prices. It remains to be seen whether policy changes will drive more or less central bank selling going forward. We note, however, that numerous countries are not party to the agreement, which could cause the tons of gold sold by central banks to vary even more year-to-year.

Investing in Precious Metal Stocks

Traditionally, investors interested in profiting from increases in the price of gold have been faced with few investment options. The recently issued gold exchange traded fund (ETF) appears to offer a way for investors to easily participate in gold price movements, but the main vehicle for gold investing remains gold mining stocks. However, it is important that investors understand that the value of gold mining companies is dependent on much more than just the price of gold. Gold mining companies operate like any other business; they generate revenue (determined by how much gold they sell and at what price), which is offset by the cost of operating the business. As a result, the income available to shareholders is subject to a number of variables that need to be considered, and the value of the each company can be basically unrelated to the value of the gold it produces.

In the following section, we outline a number of these factors and discuss their importance to investors interested in investing in gold mining securities. We also discuss the special considerations affecting gold exploration companies.

Resources/Reserves and Production: How is revenue generated?
On the most basic level, the value of a gold company is driven by how much gold it can pull from the ground. This is generally measured by a company's resources and reserves. Appendix A goes into more detail on the definition of resources and reserves, but broadly speaking, resources represent the amount of gold is in the ground without regard to whether it can be economically mined, whereas reserves are gold that can at least theoretically be economically produced at an assumed market price of gold. Because of the importance of reserves and resources to the value of a mining company, the calculation of these statistics is highly regulated, and must be done under the supervision of qualified geologists. Changes in resources or reserves, such as when a company discovers a major now ore system or adds to its estimate of an existing ore body, can have a major impact on the value of a gold mining company's share price.

Of course, gold must be mined before it can be sold and converted to revenue. Therefore, the pace of extraction is also an important determinant of the value of a gold mining firm. Because the value of a mine is often estimated based on the net present value (NPV) of estimated future cash flows, the pace of mining will have a meaningful impact on that value. A mine with very large reserves that are only slowly being mined may not be as valuable as a smaller mine that producing gold at a very high rate, all other things being equal. Gold companies can increase their production either by using more efficient extraction techniques, or by expanding existing mines and/or opening new mines. However, as discussed below, the rate at which a mining company extracts gold from the ground can also have a negative effect on is share price, unless through exploration it is able to at least hold proven and probable reserves steady.

The Critical Role of Reserve Replenishment
A critical point to understand when examining gold companies is that, while by definition an individual mine has a finite life, most gold companies are run as going concerns. This means that they must continually replace reserves that they pull from the ground. Gold producers can increase their reserves in one of three ways: they can expand "known" deposits at existing mine sites, find new gold deposits, or they can buy discovered but un-mined deposits from other companies. Regardless of how they do it, it is critical for a gold mining company to replace what it takes out of the ground, or its days as a going concern are sure to be limited.

Cost Structure: Mining Gold is Not Cheap
Running a gold mining company is expensive, and the cost of extracting gold from the ground is a critical input in the process of establishing the value of a mine or mining company. The standard measure for determining the cost structure of a gold producer is known as "cash cost", and it refers to the sum of production costs, royalties, marketing and refining charges, and all administration expenses at the operating level. Notably, it does not include previously capitalized costs (i.e. depreciation expenses), which include the majority of previous exploration expenses for most (but not all) companies. Generally cash cost is expressed "cash spent per once extracted." While cash costs can vary dramatically between different mines and individual companies, major producers' cash costs appear to have been running in the $225-$250 range for quite some time now.

It is important to consider the variables the make up cash cost in order to effectively analyze mining companies. A main diver of cash costs are fuel costs (which were largely responsible for driving cash costs up in 2004). Another factor is the recovery rates, i.e. how effectively a company can remove pure gold from ore. The higher the recovery rate, the lower (generally) the cash cost per ounce. Related to this, the ore grade (number of oz. gold per tone) will have a dramatic effect on cash costs. Finally, the type of mining operation needs to be considered, with open pit mines generally having lower cash costs than underground mines. However, different mine types have different sensitivities to various inputs. For example, since open pit mines use incredibly large trucks to haul ore, fuel costs tend to have more of an impact on open pit operations than they do on underground endeavors.

Fluctuations in foreign currency exchange rates are important as well. For companies with international mining operations, local (foreign) currency appreciation has the effect of increasing cash costs for that firm.

Hedging: A Double-Edged Sword
To protect against fluctuations in the price of gold, many producers hedge their production by selling gold forward at a pre-determined price. It is important to understand the effect of hedging on a gold mining company's stock. Generally, the stock of a producer that is heavily hedged will be less affected by changes in the spot price of gold, as the price at which it sells its production is fixed well into the future. While this is beneficial in an environment of falling gold prices, it means that a hedged producer will not really experience any near-term gains in revenue or profitability growth due to increases in the price of gold. A good gauge of the extent to which a company is "forward hedged" is a company's average realized price per ounce of gold sold. As the average price of gold rises, a heavily hedged producer will continue to show a lower average realized price than an unhedged producer. According to GFMS, the global hedge book of 60.4 million ounces is equivalent to 75% of annual world gold mine production, and the average realized price for major producers last year was approximately $396/oz, significantly lower than the average spot price of gold.

Hedging was particularly prevalent in the late 1990s, as an increasingly weak gold price made companies anxious to lock-in the current price for future gold sales. As the price of gold recovered over the last few years, many producers began to unwind their forward sales positions by buying out the contracts. The global hedge book, as calculated by GFMS, declined by 17% year-over-year in Q3'04, evidencing a well established de-hedging trend. It is important to not that this activity added to the overall net demand for gold as producers bought back supplies that they had previously sold forward, likely lending some support to the price of gold.

Political Risk
Gold mining companies operate mines all over the world, and are therefore subject to a wide range of regulations and laws, and depending on the countries in which they operate, varying degrees of political and legal risk. Many gold-rich nations lack stable governments and well-developed legal processes, making mining gold there a politically risky proposition. Political risk-events can include expropriation, arbitrary taxation, the actions of corrupt local politicians, and arbitrary (and capricious) enforcement of local laws. Also, conflict with local residents around a mine can be a major risk, as illustrated by Newmont Mining's Yanacocha project in Peru, which was severely disrupted this Fall over exploration drilling related conflicts with locals. Because of these myriad risks and, it is critical to understand the political context within which a mine operates. This is particularly important with small exploration companies, which, due to their small size and low profile, officials may find easier to push around than a major mining company. Many firms add well-connected local business people or scientists to their board, in the hopes of using those individuals' influence to mitigate political risk.

Political risk is not just a consideration for companies operating in developing countries. Developed nations frequently have somewhat onerous environmental and other regulations that can make the development of an otherwise feasible project un-economic. Even with a functioning legal system, challenges to a company's operations can take years to progress through the courts, adversely affecting the value of a project to a company and its investors.

Special Considerations for Investing in Exploration Stocks
Investing in gold exploration stocks is the riskiest form of gold mining investment. Exploration companies generally have negative operating cash flow, necessitating frequent rounds of new investment in order to fund continued explorations. Without known reserves or resources, these stocks do not lend themselves to common (more quantitative) methods of valuation. Exploration stocks tend to be a "binary" investment: either the company finds gold and produces a (usually healthy) return for investors, or it does not locate economically viable resources, and the company stops operating as a going concern. Still, given the potentially huge return on an investment in a successful exploration venture, exploration stocks merit attention from investors who are comfortable with the risks they entail. In the absence of more traditional methods of valuation, an investor should evaluate more qualitative factors to determine if there is a meaningful chance that a company will find "the big one."

We believe the most important factor to consider when evaluating an exploration company is the quality of management. In analyzing mining companies, we evaluate managements' experience in the exploration industry, and their track record for discovering gold deposits in the past. This is particularly relevant in regards to the geology team members, who will need to make important decisions regarding where to look for gold anomalies and how to proceed with drilling. On the management side, can the team attract continued investment to fund ongoing exploration activities? Are they capable of negotiating agreements with vendors and, if part of their strategy, larger producing companies, to help bring a mine to development? Do they understand and are they able to maneuver within the political and economic environment in which the company's projects are located? These factors are largely subjective, but are critical to the success of an exploration venture. Gold exploration may seem to be a game of chance, but the right management team can tilt the odds in its (and your) favor.

Project Portfolio
For companies that already have an existing project portfolio, it is important to understand the nature of each property and its potential for becoming economically viable. We believe there is a fine line between having too many and too few projects under development. On one hand, a single-project-company's success depends on its sole location containing an economically viable ore body. While a single project benefits from having managements' complete attention, in general, we are more comfortable investing in companies with more than one significant project. At the other end of the spectrum are companies with a large number of projects, some of which may be un-developed at any given time. While there is no magic number, we are generally concerned when a company has too many projects. It can spread management's time and valuable exploration resources too thin to allow the firm to sufficiently develop any single opportunity. On the whole, we think companies that can manage a reasonable number of promising properties in various stages of development constitute the most attractive investments, all other things being equal.

We also look closely at the geologic and geographic setting of a company's projects. We are generally more excited by projects located near existing mines or known ore bodies, as this proximity tends to increase the chances of a experiencing a successful discovery. True "greenfield" exploration in areas where gold has not been discovered in the past, while potentially viable, is far riskier in our view. Furthermore, projects near existing mines are less likely to have serious infrastructure issues, as it is likely at least some of the necessary infrastructure has already been built. Also, with regard to geology, it is important to understand the geologic differences and similarities between a company's projects. Generally, we would prefer that a company explore claims of similar geology. It does not stretch the geologists' efforts as thinly, and, while difficult to quantify, we believe that lessons learned at one site can more readily be applied to another area of similar geology. A possible exception to this rule could be exploration for complementary minerals, such as companies that have both platinum group mineral and gold mining exploration projects. The benefit of project portfolios of this type is that the exploration company is not totally dependent on the price of a single commodity. However, if a company has exploration projects pertaining to more than one type of mineral, we would also attempt to ascertain whether they have the scientific staff to effectively prospect for both commodities.

From a geographic point of view, we believe there is a little more room for latitude. A small exploration company should probably not have projects scattered all over the globe, as it would create a strain on resources, and would mean that the company will have to contend with a wide range of regulatory environments and cultural hurdles. We generally prefer to see companies focus on a relatively contained area, particularly those with operations in centered in developing countries. A good example of this is St. Jude Resources, a company that has focused its efforts on properties located in West Africa. While its properties are actually located in three countries, they are still relatively proximate to each other, and the company seems able to manage the local regulatory environments quite well.

However, when companies are unable to explore a given region during certain times of the year, having geographies with uncorrelated (or inversely correlated) weather conditions can be a distinct benefit. For instance, many companies exploring for gold in Canada are only able to explore for part of the year, due to limited wintertime access. Many of these companies also have properties in the U.S. or in Mexico, so they can extend their exploration season to the full calendar year. This makes good sense, not only because this allows them to generate a steady stream of exploration results, but also because it makes it easier to keep geologic teams together if they can work year round.

Insider Ownership
In our view, significant insider ownership is one of the most promising indicators of a healthy exploration company. Management is close to the exploration process and clearly understands how encouraging exploration results actually are, or what the status of agreements with vendors and development partners actually is. We also view management participation in follow-on offerings as a sign of continued faith in the prospects of an exploration company. We do not look at a "threshold" level of management ownership, but we do place higher value on larger ownership percentages. Also, we look for depth of ownership among management - does the whole board and management team hold significant shares, or are the shares concentrated in the hands of a founder or one large owner? A strong board and management team with significant share ownership is one of the most positive signs that an exploration company is healthy, in our view.

Evaluating exploration company stocks is a very difficult prospect, much like that of evaluating any startup business. We caution that exploration is inherently risky, and although returns can often compensate for that risk, many exploration companies never create any financial return for their investors. We prefer a taking a portfolio approach, investing in shares of several carefully selected companies, rather than betting on just one or two projects or companies. We feel that carefully analyzing candidate portfolio investments can dramatically improve the odds that a portfolio of exploration stocks will yield a good investment return.

Investing in gold mining stocks in general and gold exploration stock in particular is inherently risky. However, the stage appears to be set for gold mining stocks to outperform going forward. The economic environment is not supportive of the dollar, which should help keep the price of gold at current levels, and demand fundamentals suggest further support for gold prices. With consolidation continuing in the gold mining sector and major players beginning to increase exploration budgets, we believe high quality producers and top-caliber exploration companies are undervalued, particularly with regard to underlying commodity prices. Good opportunities exist for investors willing to do their homework and accept the volatility associated with mining and exploration stocks.

Appendix A: Resource & Reserve Definitions

Mineral Resource: A mineral resource is a concentration or occurrence of natural, solid, inorganic, or fossilized organic material in or on the Earth's crust in such form or quantity and of such grade or quality that it has reasonable prospects for economic extraction. The location, quantity, grade, geological characteristics, and continuity of a mineral resource are known, estimated or interpreted from specific geological evidence and knowledge. Mineral resources are sub-divided, in order of increasing geological confidence, into inferred, indicated, and measured categories:

  Inferred Mineral Resource: that part of a mineral resource for which quantity and grade, or quality, can be estimated on the basis of geological evidence and limited sampling; and reasonable assumed (but not verified) geological and grade continuity. The estimate is based on limited information and sampling gathered through appropriate techniques from locations such as outcrops, trenches, pits, workings, and drill holes.


Indicated Mineral Resource: an indicated mineral resource is that part of a mineral resource for which quantity, grade or quality, densities, and shape and physical characteristics can be estimated with a level of confidence sufficient to allow the evaluation of the economic viability of the deposit. The estimate is based on detailed and reliable exploration and testing information gathered through appropriate techniques from locations such as outcrops, trenches, pits, workings, and drill holes that are spaced closely enough for geological and grade continuity to be reasonably assumed.



Measured Mineral Resource: A measured mineral resource is that part of a mineral resource for which quantity, grade or quality, densities, shape and physical characteristics are so well established that they can be estimated with a confidence level sufficient to allow the appropriate application of technical and economic parameters, to support production planning and evaluation of the economic viability of the deposit. The estimate is based on detailed and reliable exploration, sampling and testing information gathered through appropriate techniques from locations such as outcrops, trenches, pits, workings and drill holes that are spaced closely enough to confirm both geological and grade continuity.

Mineral Reserve: A mineral reserve is the economically mineable part of a measured or indicated mineral resource demonstrated by at least a preliminary feasibility study. This study must include adequate information on mining, processing, metallurgical, economic, and other relevant factors that demonstrate (at the time of reporting) that economic extraction can be justified. A mineral reserve includes diluting materials and allowances for losses that may occur when the material is mined.

Probable Mineral Reserve: A probable mineral reserve is the economically mineable part of an indicated, and in some circumstances, a measured mineral resource demonstrated by at least a preliminary feasibility study. This study must include adequate information on mining, processing, metallurgical, economic, and other relevant factors that demonstrate, at the time of reporting, that economic extraction can be justified.

Proven Mineral Reserve: A proven mineral reserve is the economically mineable part of a measured mineral resource demonstrated by at least a preliminary feasibility study. This study must include adequate information on mining, processing, metallurgical, economic, and other relevant factors that demonstrate, at the time of reporting, that economic extraction can be justified.

Source: Canadian Institute of Mining, Metallurgy and Petroleum ("CIM") definitions as defined in the CIM Standards on Mineral Resources and Reserves - Definitions and Guidelines as required by National Instrument 43-101 of the Canadian Securities Administrators, Standards of Disclosure for Mineral Projects. Taken from


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