Low prices to weigh on gold production – Metals Focus

Low prices to weigh on gold production – Metals Focus

London based specialist precious metals consultancy, Metals Focus, presents its views on the likelihood of mine closures in its latest weekly Precious Metals Focus letter.  A lightly edited version of its letter, plus some additional comment, follows:

With the gold price sitting under $1,100/oz for the first time since early 2010, a significant portion of global production is now operating at a loss. At first glance with costs during Q1 15 averaging $687/oz on a total cash cost basis (TCC) and $878/oz on an all-in sustaining (AISC) basis, it would appear that the industry should be in good shape. However, the cost curve published in the consultancy’s latest gold report tells a different story.

Looking at the global cost curve, which represents some 1,650t of annual production. On a TCC basis, at $1,100/oz just 4% of the cost curve finds itself under water, although if gold was to fall to $1,000/oz, this would increase to 10%. However, on an AISC basis the proportion of loss making mines at $1,100/oz swells to 24%, or circa 400t of annual gold production.  Obviously a higher proportion would fall into the category at lower gold prices.

But before we draw to the conclusion that production is therefore about to fall dramatically, there are a whole multitude of factors that need to be considered reckons Metals Focus.

Firstly, closing a mine in itself is often a very costly undertaking. The workforce for instance, may be entitled to some redundancy or retraining payments. Meanwhile, decommissioning of the process plant and mining equipment, as well as reclamation of the land and watercourses and any necessary environmental remediation has to be accounted for. Because of this, rather than closing an operation, mining companies will often be prepared to operate at a loss in the short term in the hope that commodity prices recover.

When looking at the potential of mine closures, it is also worth considering the geographic distribution of these loss making operations. On an AISC basis, 20% of current unprofitable production is based in South Africa, where as has been witnessed in the platinum industry cutting production is a particularly difficult process, thanks to the high levels of union representation and the country’s already high unemployment rate. Currently there is the potential for disruption as Unions and the mining companies remain well apart in the latest round of wage negotiations.  In contrast, Australia, which hosts 18% of the loss making production, is a more likely candidate to see some production cuts. This said, closing a mine is often the last choice, instead companies are looking at other ways to lower costs.

One of the main constituents of the AISC is corporate costs (G&A). This metric has already been a major target of cost reduction. In our Gold Peer Group Analysis Report, average G&A costs have fallen from a peak of US$53/oz in Q1 13 to US$36/oz in Q1 15. However, for some smaller producing companies G&A costs are still over $100/oz. One way in which G&A costs can be lowered is through company consolidation, allowing duplicated services at the head office level to be cut. This in our view is helping to prompt some of the recent increase in M&A activity. Oceana Gold’s proposed takeover of Romarco Minerals is a good example, during 2014.  Oceana’s G&A costs per ounce of gold production was $112, but by 2017 Oceana is aiming to produce 540koz, which would lower G&A costs to $64/oz, assuming head office costs remain fixed.

Furthermore, as was the case in 2014, depreciating producer currencies continue to be key in helping miners cut US dollar denominated costs. Both the Rand, Canadian and Australian dollars, are currently close to or more than 20% weaker than the 2014 mean rates. In particular, weakening domestic currencies tend to have the greatest impact on higher cost operations, which are often more labour intensive, and as such gain most from the effect decline in salary costs on a US dollar basis. That said, for some of those at the top end of the cost curve the future looks bleak, and closure now seem inevitable. Over the 12 months Metals Focus estimates that there will be around 75t of cost related closures globally.

At lawrieongold we are not sure whether even this level of closures will be any help in salvaging gold prices from their current low level, or in helping prevent further falls.  To put it into context this is only around the level of the amount of physical gold that passed through the Shanghai Gold Exchange in the last reported week’s trading.  (See: Enormous physical gold demand on at least three continents), so will it have any significant effect.  We somehow doubt it.  But the longer prices stay down, or fall further, the closure numbers, either through company initiated shutdowns because of costs, or natural wastage through declining reserves, coupled with the accompanying fall in building of new projects may begin to have an effect, but this could yet be another year or more away even if prices were to remain at current levels or lower.

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