In a moderately optimistic environment for global economy, a voice stands out of the crowd: the one of gold miners.
The latest of a long series of alarms on the effects that falling gold price is having on the extraction business was launched by Nick Holland, CEO of Gold Fields. “The industry is not sustainable at $1,230 an ounce, which is where the gold price is at the moment,” Holland reportedly said.
Sheer price level is only half of the problem for the industry. The gold market is notoriously countercyclical compared to the global economy. When things get bad for the overall economy, people invest in gold; when the economy is good people sell it. This is not only valid for the actual metal, but also for the extraction companies that revolve around it.
When gold peaked at $1900 an ounce in 2011, many investors thought that the extraction business could prove extremely lucrative and poured literally billions of dollars in it. As expected, mining companies decided to use this money to expand their operations. More than $50 billion were spent on new projects in the last five years, and at least half of that was scheduled for the near future before the recent crisis struck.
But the mining process has its own pace, which is much slower than stock investors are used to. Expanding mining operations, let alone finding viable concessions and opening a new mine, requires years in terms of planning, preparation and execution; profits are nowhere to be seen for a decade. Indeed, despite massive investments, gold output has been fairly steady in the last quinquennium.
In the meanwhile, the global economy is recovering faster than experts initially expected. As a result investors completely changed their attitude towards the yellow metal. When, after the global economic crisis, banks were paying such low interest rates, gold seemed to be a better investment than saving accounts and state securities. Plus, in a period of strong inflation gold held value better than cash.
Now on the other hand, with growing GDP and declining unemployment rates, gold has ceased being an optimal investment, generating a downward trend.
Federal Reserve Chairman Ben Bernanke probably gave the final blow to a decade-long gold rampage in June. Bernanke declared that in light of recent improvements in the economic outlook, the FED could soon review the elephantine dose of cash (over $80 billion) pumped in the US economy every month. Should this happen, the reduced supply of money would certainly push interest rates up and inflation further down.
The effects are even more dramatic if we consider that not only private investors, but also states (by far the largest category of gold buyers) are now selling their reserves. Strong buyers such as Russia, Germany and Turkey are selling their gold assets for sound currency in an attempt to limit losses and circulate more money.
With gold price crashing, investors in the extraction business panicked and decided to get rid of their stocks at all costs. In such a hostile environment, all of a sudden mining companies saw their titles traded like junk. Their stocks plunged by 45% since the beginning of the year, which is almost two times the decline in gold price.
Major producers had no other choice than operate dramatic cuts, while reducing the prospects for mining assets acquired during promising years. Less productive mines have been shut down or temporarily frozen, while exploratory researches have been shed and their results locked away in a drawer.
The situation for junior miners is much bleaker. Usually involved in high-risk/high-rewarding projects, they are now stuck with uneconomical investments in exploratory research or nearly depleted mines. The sudden U-turn in gold price might well be the death toll for many of them.
It is, in all effects, a paradox. Thanks to high prices, the industry had the opportunity to expand its activities, but this also produced a raise in extraction costs, which are not compatible with current price levels. That is why today gold at $1,200 an ounce is considered a catastrophe, while ten years ago half of that price was more than enough to keep the industry on track.
Nick Holland forecasted that at prices below $1,500 an ounce the industry is not sustainable and even slighter optimistic figures, such as those given by Deutsche Bank, set the red line at $1,300. This is $100 above the actual gold price level, with the bullion still on a free fall.
In the meanwhile The World Gold Council, an organisation that comprises all the leading gold mining companies, released a guideline on mining production costs. The document is “intended to provide further transparency into the costs associated with producing gold”. It is aimed at helping investors understand the actual value of gold mining stocks and the economics behind the industry.
The guidelines make a clear distinction between “sustaining costs”, which refer to current production costs, with “all-in costs”, which explore the varying costs of gold extraction over the life-cycle of a mine, from exploratory mining and concession costs to depletion.
The hope is to finally bring some stability in the apparently incompatible worlds of gold mining operations, which require careful long-term planning, and the hustle of investors always in search of easy profits.
Matteo Butera, Rough&Polished
