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 mining companies?

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


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.


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.


The open-pit mining process is used when the gold is located close to the surface and the site makes an open pit economically and environmentally feasible. It is exactly what it sounds like - a giant hole dug in the ground with roads leading around and up to the top of the mine to facilitate getting machinery in and getting ore out of the mine.

Excavation is done with explosives and heavy machines - both of which have high costs associated with them. (Diesel fuel alone can account for 25% of a mine's costs.)

Each ton of ore that is hauled out of a good pit mine may contain about a tenth of an ounce of gold. With gold at, say, $900 an ounce, that makes a ton of ore worth $90, tops. Considering that the huge trucks used at some mines can hold up to 300 tons or more on each run, a truckload of ore coming out of the mine can be worth around $27,750. Of course, reality doesn't really work that way: Some loads are richer than others, and many turn out to be literally worthless.


When an open-pit mine doesn't make sense because the gold is located much farther underground, or other concerns limit the mining, an underground mine is used.

Shafts are dug with tunnels branching out, leading to the load deposits. The mining process is straightforward, yet technical and a lot of hard work - you have to drill holes for explosives, set off those explosives and then haul out all of the resulting blast debris. The days of picks, shovels and wheelbarrows have given way to explosives, muck machines and trucks or rail haulage - though I'm sure there is a lot of back-breaking shovel work involved as well.

The cash costs associated with underground mining include not only similar things as used in open-pit mining (explosives, diesel fuel, machinery and labor) but also electricity. Without electricity, there is no air underground, and no transportation of workers, machinery or ore in or out. To meet this need, some companies (such as Barrick) have situated solar or wind farms close to their mines to help ensure a steady supply of this important resource, although diesel generators are the more common solution where grid power is not available. Remember: Many gold mines are located in difficult-to-reach areas, where reliable power is a long-off dream.


Once the ore has been liberated from the ground, the gold will need to be extracted. The processing consists of taking the big pieces of ore and making them smaller, until it reaches the consistency of beach sand. At this point a cyanide solution is added to the mix and milled further into a muddy, watery mix.


A weak cyanide solution combined with air dissolves gold, freeing it from the other rock and metals in the ore. Once cyanide dissolves what gold it can into the solution, the fluid is pumped off while the remaining solids are transferred into agitation tanks where the remaining cyanide continues to dissolve the remaining gold into the water with the help of air bubblers. The heavier materials sink to the bottom and the pregnant solution is combined with fluid and zinc to precipitate the gold out of the solution.

This process, called cyanide milling, is fairly efficient - recovering 95% to 98% of gold from the ore. It can be done economically using ore with less than one gram of gold per ton (depending, of course on the price of gold).

When lower-cost extraction is needed, heap leaching is used. Ore is piled in a lined, prepared area and then treated with dilute cyanide. As the solution works its way down through the pile, gold is dissolved and drains to the bottom. The solution is collected, the gold precipitated out and then refined. The drawback to heap leaching is that not only is it a lengthy process, but only 65% to 85% of the gold present in the ore is extracted using this process.

Refining takes place in the smelter where the gold and a chemical cocktail called flux - magnesium dioxide, fluoride, silica flour, borax and sodium nitrate - are combined and heated to 1,600 degrees Celsius. This process separates the gold from impurities (slag) so that it can be poured into bar-shaped molds. The resulting bars are 80% pure. Further refining purifies the gold to 99.9% pure - the Gold Standard.

After all of the processing of the ore and extraction of gold, the companies are left with a lot of leftovers - the tailings: ground rock and processing by-products that contain a lot of nasty things like mercury and cyanide. Companies store these tailings in surface containment areas or use them as backfill in mined-out voids where possible.

Between the explosives, caustic chemicals and huge machinery, is it any wonder that gold companies spend a lot of time talking about safety, environmental concerns and oil prices in their annual reports?


For shareholders, of course, what matters is the all-in costs: how much it takes to remove gold from the ground and prepare it for sale.

It varies by company, depending on its mix of mining and its operational efficiencies. For Barrick, gold cost on average $443/ounce to pull out of the ground in 2008.

Companies can't really influence the price of gold much, but they can contain their costs. So conserving energy, locking in cheap fuel prices, negotiating cheap labor, keeping the mines safe and open, controlling waste so as not to pay fines or money on lawsuits - these are the nitty-gritty parts of running a gold mining business.

Now that you know a bit more about where those cost come from, you might gain a bit more insight the next time you're reading through the annual report. Or at least you'll know what makes up the total cash costs per ounce accounting line item, which will determine (as much as the gold price itself) what profits your company delivers.

Published courtesy of Hard Assets Investor - www.hardassetsinvestor.com

HardAssetsInvestor.com (HAI) is a research-oriented Web site devoted to sharing ideas about hard assets investing. The site has been developed as an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures and gold (the three major components of the hard assets marketplace). The site focuses on hard assets investing without endorsing or recommending any particular investment product or approach.