Monday, November 11, 2013

On the post that initiated the Silence of Mickeyman

Here's something interesting.

World Complex - junior gold explorers have a structural problem.

The post ends thus:
Clearly the emphasis on gold exploration is anomalous. An anomalously large amount of money being invested in one sector--more than is capable of providing an economic return--is the definition of a bubble. It is painful for me to admit this, as I work in the sector. If we allow ourselves to consider this possibility, we may also recognize the justifying statement--"you can always sell gold"--is equivalent to "house prices always go up" or "just buy the nifty fifty".

Just because a bubble has lasted a long time doesn't mean it will last forever. And just because it deflates from 10x normal to only 5x normal doesn't mean that we have experienced all the pain we will ever experience in the sector. We may have to consider that the current pain we are experiencing in the exploration industry is just the beginning of a return to reality. There could be much more pain to come as 80% of junior gold explorecos disappear.

I don't know what juniors are going to do. They can't really go into base metal exploration, at least not under the current financing regime, as they have no credible ability to raise the large amounts of capital to develop their deposits. It may be that the only way for them to survive will be as wholly- or partly-owned subsidiaries of major mining companies.

Eventually sanity will have to return to the economic system--the financialization will be reversed and goods will be manufactured in the developed countries--and the exploration budgets will favour base metals over gold.

And after this, all went silent at his blog. As if the loss of gold's lustre means his heart can no longer stir at all the beauty of phase space charts and complexity theory and math stuff.

Mickeyman, where have you gone? Please tell us you're still alive!

It's all because of this chart:

And because, if I'm reading him correctly, he feels that capital invested in gold exploration no longer sees a positive return.

Seriously, I've been thinking about that myself, and have awaited a time when some mathy type like him or John Kaiser might bother to investigate the problem in detail. Because this does seem to be a question whose answer is vital for determining whether to participate in the junior scene at all.

How much return on capital is earned for every $1 invested in explorecos?

Or rather, to make it easier to do the math, how much return on capital is earned on $1,000,000, invested equally across all the gold exploration companies on the TSX-V, over some arbitrary timeframe like 5 years?

If you can only get negative return on your money, then yes indeed the gold exploration model in general is broken: if it is not possible for capital to make a profit investing in exploration, then there will be no capital invested in exploration. Capital goes where profit is.

And that's why I've been sending off worried emails to people like Brent Cook and John Kaiser, opining that maybe the TSX-V will die off completely, perhaps replaced by a state-funded model from a totalitarian regime like China or Russia. Cos if exploration offers a negative return, capital will turn its back on exploration, and exploration thus fails within a capitalist system.

But there's something about Mickeyman's assumptions.

In the exploration budgets chart above, gold's share of total does indeed spike after 1980, and yes that's because of the price signal that gold sent to the market.

It seems to start going down after leaching came into existence, which then suggests something.

Why shouldn't gold's share of total exploration have spiked after 1980? The price went up. That means the profitability of deposits went up, the value of ore went up, the possibility of putting g/t deposits into production went up (instead of oz/t deposits).

Was there an equivalent spike in the base metals prices at any time? Can you redraw that chart, but instead of drawing total exploration expenditures as % of total, maybe draw it as each commodity group's price as % of some total annual worldwide consumption basket - and if so, does it maybe look nearly the same?

And just wait a sec.

Leave aside for now the possibility of gold exploration becoming entirely a Soviet & Maoist venture in future. It's an interesting idea, but let's ignore it for now.

If explorers stop exploring, then the pipeline dries up. But then, unless the world stops buying gold, the price of gold goes up as new mined supply disappears. So then, shouldn't money flow back into exploration? I mean, without any gold being mined, there's nothing to stop gold going sky-high, right? Isn't that how free markets are supposed to deal with supply and demand fluctuations in commodities?

So let's look at his chart again:

He thinks we might go back to 1950-1979 level gold exploration as % of total, where base metals become the majority of exploration expenditure.

But here's the thing, Mickey. You said this:
Looking at this chart, the dominance of gold exploration came into effect as a consequence of the rising gold price into 1980; which itself was a consequence of Nixon removing the US dollar from the gold standard. 

Let me rewrite that sentence for you and let's see if it looks different in your eyes:
Looking at this chart, the dominance of gold exploration came into effect as a consequence of the rising gold price into 1980; which itself was a consequence of Nixon removing the artificial price control on gold

There was no such thing as a "gold standard" immediately pre-Nixon. There was simply a price control regime where the government decreed by fiat that gold miners could only sell gold for $35/oz.

Why the hell would anyone back then have wanted to explore for a metal that they could only get $35/oz for? I mean, there aren't many deposits in the world that you could have discovered, which would obviously have been able to be mined profitably at $35/oz, right?

$35 in 1975 dollars equals only $150 today, per US CPI. How many of today's mines turn a profit at Au $150?

So of course nobody wanted to explore for gold pre-1980! It's the old Chicago School story about producer response to price controls, all over again.

If you're saying gold exploration is going to fall to ~10% of total exploration in the future, that seems to suggest that nobody's going to want gold anymore. So the question really does still boil down to what the next 10-20 years are going to bring in China and India.


  1. "Silence" brought to you by the VCMA..

  2. Last I heard it was an all expenses paid trip to Vegas. Maybe someone took him out to see their new prospect in the dessert, I think it was called the Hoffa property

  3. I prefer ice cream for dessert. Though tonight I had fried bananas.

    Thanks for your concern, but I usually only post every three or four days. I usually slow down in late fall and through the winter because I'm partly solar powered.

    Actually, I had been thinking about the issue with gold being under-priced as being part of the reason why gold exploration budgets were so low before 1980. In support of that there is something of a decline from 1950--inflation would reduce the returns from exploring for gold with a fixed price. We need a longer data set . . .

    Still, I think part of the problem is that investors aren't seeing any return in it now--although the reasons why may be different.

  4. I forgot to add--I think the investment in gold has to fall--but that may not be so much that people don't want gold--but I think that if the economic system returns to a state of generating prosperity, there will be much more demand for base metals (and maybe even uranium).

    1. Or sorry, I guess I forgot your context. You're saying investment in gold exploration as share of total exploration has to fall.

      If so, all else remaining equal, price of gold will go up strongly, no?

      I'd think the amount of total exploration money should move to a level where all mining products go up in price at the same rate. Market forces seem to demand this.