Example 1: An Acute Shortage of Nickel
Despite nickel mine production running at an all-time high this year, demand is projected to be limited by supply – so much so that we could see rationing in the near future. Yes, rationing. The world is using more nickel than it can currently produce, and some of us will have to go without new stainless steel pots and pans. Highlighting this point in a recent analyst conference call, Falconbridge (FL.T) announced a downward revision of its 2005 nickel demand forecast from 7.4% to 4.6%, primarily because "a lack of supply is acting as a cap on consumption". Inco (N.T), the world's 2nd largest nickel producer, also stated that "nickel demand is expected to be limited by supply over the next few years" and went on to assert that the industry is working at full capacity and there is virtually no "shut in capacity" to fill the gap. Renowned metals analyst Raymond Goldie commented that there may be no nickel price high enough to clear the market!
Nickel demand growth in the U.S. is projected at 10% due to increased use in the defense, aerospace and energy industries. Further, nickel demand growth, driven by stainless steel production, is forecast to be up 7.7% in Europe, 3.6% in Japan, 11.2% in Korea and Taiwan, and 24.7% in China and India. China alone is expected to surpass Japan as the leading nickel consumer in 2005, representing 15% of global demand.
Assuming a very conservative 6% increase in demand for 2004 (vs. the 8.5% a consensus of metals analysts are predicting), demand should total 1.33 million tonnes. Supply should come close to 1.27 million tonnes. That leaves a net deficit of 59,000 tonnes of nickel, or about 4% of 2004 production.
Example 2: Copper Stockpiles are Going Fast
Global copper consumption has been increasing steadily since 2001 and is forecast by experts to total ~17 million tonnes in 2004, escalating to ~18.4 million tonnes by 2006. Assuming full utilization of smelters, refined copper from mine production is estimated at ~14.5 million tonnes for 2004 and is anticipated to come in around 16.2 million tonnes in 2006. The deficit is being made up by scrap metals and inventory. However, the supplies filling the deficit won't last forever. The accompanying chart dramatically documents the rapid decline in copper supplies and the concomitant rise in price.
Discoveries are Not Keeping Up with Depletion
Chris Bain, a geologist and mineral economist who has investigated the past 50 years of minerals exploration and discovery, released an interesting study (Exploration Mining Geology, Vol.9, 2000) during the depths of the metals bear market. He pointed out that, at year 2000 rates of production, the industry's annual discovery requirements were roughly:
- Gold: Fifteen 5 million oz. deposits assuming a $25/oz discovery cost, $50/oz development cost and sustainable production costs of under $150/oz production cost.
- Copper: Two high-grade, world class porphyry deposits containing 5Mt of recoverable copper, each equating to about 500Mt @ 1.3% Cu, located near favorable infrastructure.
- Silver: Ten deposits containing 60 million oz. each
- Diamonds: Six deposits containing 20Mcts.
Using copper as a case in point, and assuming the nearly 18 million tonnes of copper consumption a year holds, the world is burning through the equivalent of almost one Bingham Canyon copper deposit a year. Put another way, the world needs to find about 18 million tonnes of economically mineable copper metal a year to stay even or, at the very least, add an additional 2 million tonnes of production just to keep up with increased demand. This deficit will be made up to some degree by increased production at some of the larger deposits, however, depletion at other mines will offset these increases.
So where and how fast are these new deposits being discovered and developed? In the copper category, the 18 million tonnes of annual production about matches the measured, indicated and inferred resources of Ivanhoe's (IVN.T) massive Oyu Tolgoi deposit. It's important to point out that substantially less, if any, of those 18 million tonnes of copper in Mongolia will be economically mined – but for the moment let's say we've covered ourselves for a year. I don't know what year Oyu will go into production, but I do know a discovery of this size doesn't come around every year.
The 2 million tonnes of anticipated increase in annual copper demand will chew up the roughly 4 million tonnes of copper at BHP's Spence deposit in two years. Spence is an interesting example, showing how much time it takes to bring a deposit into production. It was an essentially blind discovery made in 1996 after decades of regional exploration in Chile. It has taken 8 years to define and permit, and it still won't come on line until 2007. Spence is a very rich deposit that will produce 200,000 tonnes of copper cathode a year after about $1 billion in capital expenses.
Back to Nickel, Inco's Goro deposit is expected to come on line in 2008 and produce about 60,000 tonnes of nickel, just enough to cover this year's deficit. Voisey's Bay, one of the world's richest deposits, is expected to come into full production in 2011 and supply another 60,000 tonnes of nickel to the market. As both of those mines are years away from production and demand will likely only increase from here, it is obvious that we are falling behind in replacing depleting resources. And one should never forget that mines are not made in a day: the norm from discovery to production is a decade or more.
Why are there fewer grassroots discoveries?
Economic hurdles are becoming higher and higher, due to steadily increasing real operating and capital costs, and the sheer size of the deposits needed to keep up with production. Add to this the exploration maturity of most favorable geologic terrains that see fewer explorers looking, and the answer becomes obvious. Exacerbating the problem, the lack of determination and steady funding of exploration is detrimental to this already difficult scientific endeavor. Exploration funding is just now beginning to become available from the industry or equity markets, meaning new projects and ideas are just beginning to surface. Even flow-through funds in Canada are going begging, as there are so few "respectable" drill ready projects available.
On the business side, the accountants and bankers running the mining companies have justly concluded that exploration is a money-losing proposition. Replacing production through acquisitions and expansions provides a much more quantifiable resolution than the uncertainties of paying a pack of degenerate geologists to go running around in politically questionable environments. Fortunately, the apparent deficit in discoveries has, for the most part, been made up by "brownfield" discoveries at existing operations (brownfield meaning adjacent to, or near) that were discovered by an older pack of degenerates. As an aside, many of the mines currently in production would not be economic if discovered today. However, there are geologic limits to how much ore these giant deposits can give, and we will ultimately see these limits reached. Looking forward, how many more Escondida copper deposits (annual production capacity 800,000 tonnes per year) are still out there? One? Ten? Fifty?
Going back to Bain's 2000 study, he concluded that sooner or later, the scarcity in discoveries will become a force acting on real metal prices and that at that point, the trend in real price declines will reverse. This should then create a more favorable environment for investment in exploration. Big Kudos to Chris; the time is nigh.
But there's a big predicament here: giant ore deposits, the foundation of the major mining companies, are geologically unique beasts. Discovery is unpredictable, risky, costly and time-consuming, with no guarantee of success. Even when a discovery is made, political and permitting issues can delay a project indefinitely.
Imagine the dilemma mining company executives will be facing: rising metals prices, declining mine lives, increasing production profiles, no new giant ore deposits or potential discoveries, and ample evidence that their current group of geologists have been wholly unsuccessful at anything but spending money.
So how and where do the CEO's find the next deposit, given the rising economic threshold for mining operations, the increasing exploration maturity of the favored terrains, and the escalating exploration costs and discovery risks due to the more "esoteric" techniques required to detect hidden mineralization?
Anywhere they can and at any price they can! Meaning: the junior exploration companies capable of legitimizing their exploration concepts will be heavily courted through more and more favorable alliances or flat-out takeovers. Upshot: picking the right juniors will produce terrific returns on investments in the coming years.
This article orginally appeared in Doug Casey's International Speculator