Grade is King

Masterclass Part 3: Grade is King The number one factor in evaluating Gold and Silver mining stocks is Grade. You see, costs are relatively fixed on a per-tonnage basis. For example, in Mexico all-in costs (including mining, processing, and sustaining capex) are about $175/tonne for a silver miner. So when you run a 2K t/d Mill over a quarter the expense is about $32 mil/quarter ($175 x 2,000 x 90 days) or $128 mil/year. The revenue side of the equation is where miners make their money. Let's assume the silver miner's average grade is 200 g/t with 95% recoveries. The company should generate about 1 mil silver ounces/quarter (200 g/t X 2,000 t/d / 31.1 grams/tonnes X 95% recovery X 95% payability from smelter X 90 days) or 4.5 mil silver ounces per year. Let's assume silver is selling for $25/oz, total revenue is $111 mil (4.5 mil ounces X $25/oz). This miner just lost $16 mil after operating 24/7 for a year. Many miners operate in this manner and plug in the hole in their balance sheets with stock sales, so management and bankers get paid while shareholders suffer. Now, let's assume the deposit's average silver grade is 300 g/t. Production increases to 6.7 mil silver ounces per year worth $167 mil revenue versus the same fixed tonnage cost of $128 mil. Now, the miner just generated a $39 mil profit. Not exactly a windfall, but you get the point. As grades increase, profits grow. High grades are rare. Thousands of geologists scour the earth searching for high grade deposits. Only a lucky few discover the motherlode. MAG Silver's Juanicipio deposit was discovered in its first drill hole. World-famous Silver geologist, Dr. Peter MeGaw, had a hunch. Fresnillo is a miner that owns the Suacito mine in Fresnillo, Mexico. The Fresnillo trend has been responsible for a billion ounces of production, about 25% of the world's total, over the years. Dr. MeGaw bought the rights to land directly adjacent to Saucito that Fresnillo overlooked. Fresnillo believed the silver mineralization was pushed to the surface and eroded away over millions of years. Dr. MeGaw had a hunch that ore was pushed deeper by the faulting, so in his first drill hole he found the best silver ore body in the world on his first drill hole. MAG Silver's average silver grade is about 600 g/t. Needless to say, the Juancipio mine is extremely profitable. Low grade deposits are for suckers. These naive investors believe that when gold increases the low-grade mine will become profitable. Don't hold your breath. You see when gold increases, it is due to inflation and dollar devaluation. Well guess what? When inflation rises, mining costs escalate as well. Labor, machinery, cyanide, oil all cost more. You can't just build a spreadsheet economic model and adjust the gold price higher versus fixed costs. You need to increase your cost estimates as well. A low grade cow pasture now will still be unprofitable even if gold rises to $5,000/oz gold. Let me share with you another way to get exposure to these world-class, high grade assets. One of my favorite companies owns a piece of the best mine in Canada that produces 600K gold ounces per year, a Tier one asset measured by low costs and large reserves, that is beginning production of about 500K gold ounces this year. A mine in Nevada that has been in production for 50 years and sees about 400K gold ounce production to at least 2038. And I cover this company inside of my Golden Portfolio 10X model portfolio, which you can claim access to here. That's it for today… Keep an eye out tomorrow for Part 4 of my Masterclass, where I'll cover how to steer clear of miners that habitually dilute their share prices. Best, Garrett Goggin, CFA Founder, Golden Portfolio unsubscribe