When metals prices are high, we are generally told that we should lower the cutoff grade. Our cutoff grade versus metal price formula tells us this is the correct thing do. Our grade-tonnage curve reaffirms this since we will now have more ounces of gold in the mineral reserve.
But is lowering the cutoff grade really the right thing to do?
Books have been written on the subject of cutoff grades where readers can get all kinds of detailed logic and calculations using Greek symbols (F = δV* − dV*/dT). Here is one well known book by Ken Lane, available on Amazon HERE.
Recently we have seen a trend of higher cash costs at operating mines when commodity prices are high. Why is this?
It may be due to higher cost operating inputs due to increasing labour rates or supplies. It may also be partly due to the lowering of cutoff grades. This lowers the head grade, which then requires more tonnes to be milled to produce the same quantity of metal.
A mining construction manager once said to me that he never understood us mining guys who lower the cutoff grade when gold prices increase. His concern was that since the plant throughput rate is fixed, when gold prices are high we suddenly decide to lower the head grade and produce fewer and higher cost ounces of gold.
Do the opposite
His point was that we should do the opposite. When prices are high, we should produce more ounces of gold, not fewer. In essence, periods when supply is low (or demand is high) may not be the right time to further cut supply by lowering head grades.
Now this is the point where the grade-tonnage curve comes into play.
Certainly one can lower the cutoff grade, lower the head grade and produce fewer ounces of gold. The upside being an extension in the mine life. A company can report more ounces in reserves and perhaps the overall image of the company looks better (if it is being valued on reserves).
What if metal prices drop back?
The problem is that there is no guarantee that metal prices will remain where they are and the new lower cutoff grade will remain where it is. If the metal prices drop back down, the cutoff grade will be increased and the mineral reserve will revert back to where it was. All that was really done was accept a year of lower metal production for no real long term benefit.
This trade-off contrasts a short term vision (i.e. maximizing annual production) against a long term vision (i.e. extending mineral reserves).