How Gold Gets Out Of The Ground

May 18, 2009

If you really want to understand how to invest in gold mining companies, you have to understand how mines operate ... and how costs can be controlled.

  • How gold mining works: a primer
  • Open-pit vs. underground
  • What factors influence price?


We talk about gold a lot around here - how to invest in gold, physical gold vs. futures, gold mining companies, juniors, Chinese gold companies. Perhaps most importantly, we talk a lot about gold supply and demand.

But we rarely get down into the details. What exactly is gold supply? That is, where does all the mining happen? How does it work? How do you parse bullion from all the senseless jargon found in the annual reports of leading mine companies?

We thought it worth a deeper look at how our favorite metal gets out of the ground in the first place.


First, Find It

Gold is everywhere on Earth, it's just not commonly found in significant concentrations. The Earth's crust contains approximately 0.004 grams of gold per ton, and there is even a lot of gold in saltwater - but concentrating the trace amounts just doesn't make economical sense. To make money - or at least have a decent chance at it - you've got to look elsewhere.

While you can find gold in your local streambed (especially if you live in California or Nevada), those placer deposits - places where valuable minerals have naturally accumulated over time - aren't typically what the commercial mining companies are looking for. It's not a reliable enough source of steady gold to justify large investments.

Instead, they look in the earth for relatively high concentrations of gold, which can be mined and refined into pure bullion.

Gold is found both close to the surface of the Earth, and underground mixed in with other metals such as copper, silver and lead. Where the gold is located will dictate what type of mining process is used to retrieve it - and what costs will be associated with it.

It all starts with the geologists. By studying the type and formation of the rocks in a region, and taking samples, geologists direct where mining companies need to explore. To determine what exactly is at a site, numerous ore samples are taken, called "diamond drill cores," using (as the name suggests) drill bits tipped with industrial diamonds to create an ultrahard cutting surface.

These core samples are 3.5 cm in diameter and can be the length of a football field. By examining them carefully, geologists can tell engineers exactly where the ore they want is located and how it is combined with other metals and rock. After that, it's up to the engineers to figure out how to get to it.


Definitions In Annual Reports

Two critical stats from the core samples are the grade of ore and size of the find. This is where the terms "proven and probable reserves" or "measured and indicated reserves" come from when we're digging into annual reports.

Probable reserves are areas where gold is known to exist - but where extraction may or may not be economically or technically viable. Proven reserves are just that: The geologists can see the gold in the core samples, and the engineers are positive they can get at it. Measured and indicated reserves are terms that are not recognized by the U.S. Securities and Exchange Commission, but are required by the Canadian government.

When you look at the annual report of a company such as Barrick, it will show the "proven and probable" numbers as well as the "measured and indicated" numbers to satisfy the laws in the countries in which they operate and where their stock is traded. Either way, the numbers give the companies' best good-faith estimate as to the amount of total gold that could be mined from a given area over the life of a mine. It does not guarantee the gold will be mined, or even that it can be mined, but it holds out the possibility.

The higher the grade of ore, the more gold present and the more cost-effective it will be getting to it. As in most businesses, cost-effectiveness is the name of the game, and in mining, that means controlling how you run your mine.


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