In its Annual Review for 2012, Gold Fields recaps the biggest issues facing the sector and what they imply.
Anyone that has followed the gold sector over the last 12 months should be fairly aware of the challenges gold miners faced last year.
As a significant producer, across a number of continents, Gold Fields is probably better aware of them than others and, in its Annual Review for the year to end December 2012, it paints a fairly gloomy picture, outlining 6 issues that kept management up at night last year and are likely to continue to pose problems in 2013.
The first issue Gold Fields lists, Industrial action in the South African mining sector, is the least important from a global point of view, as it only affects those gold miners with operations in the country. Gold Fields is of the opinion that some of the fears around the longer term implications of the strikes on South Africa’s viability as a mining destination have been overdone.
But, it does point out that: “The strikes (and associated violence) acted as a powerful reminder that despite the obvious cultural and legal transformation that has taken place since South Africa’s democratic transition, there are significant socioeconomic challenges that (for the majority of citizens) remain largely unchanged. As such, there is increasing consensus within South African society that genuine transformation of wider society is required – above and beyond the relatively narrow boundaries of existing Black Economic Empowerment legislation.”
The continued rise of resource nationalism was the second issue posing problems for Gold Fields. This challenge is by no means a new one, but, as the gold miner points out, the sector has done itself few favours by persistently underreporting its costs, a situation governments have been happy to accept at face value and impose ever higher royalty rates.
“Consistently high mineral prices that give the impression that extracting companies are making excessive profits… Related misconceptions around the costs involved in the extraction of gold. A failure by gold mining companies to report their ‘true’ costs in terms of Notional Cash Expenditure (NCE) margin has been detrimental in this respect,” the miner writes.
Adding, “Resource nationalism has the potential to introduce operational uncertainties and delay, escalate project costs, render project development or production targets unfeasible, and may even result in a loss of ownership or control.”
And, while Gold Fields accepts that the communities and countries that own the mineral resources should benefit, it warns, “Poorly modelled government imposts have the potential to materially undermine the economics of existing or new operations. This can force the suspension or closure of production and/or development work – with serious impacts on local employment, revenue generation, socio-economic development programmes and other forms of shared value. Even if such imposts are commercially endurable in the short term, they can introduce a degree of uncertainty that investors will generally eschew – with long-term consequences for host countries.”
The third issue is also one that has been on the global mining worry list for some time – skills.
The reasons behind this skills shortage are well known but, what concerns Gold Fields most on this topic is that the sector is facing significant demographic challenges as a significant proportion of its most skilled and experienced managers and technical specialists are becoming eligible for retirement – with no equivalent new cadre of younger workers to replace them.
The fourth challenge – cost pressures – has also been well reported but, the numbers remain staggering.
According to the gold miner, Deutsche Bank has estimated that cost inflation averaged between 5% – 7% a year over the last 10 years and accelerated to 10% – 15% in 2011 – a trend that is expected to continue over the next few years, as the skills shortage mentioned above pushes up wages and replacement ounces become harder to find.
As Gold Fields points out, ore grades are falling across the gold mining industry, “with average yields amongst major producers falling by around 5% a year over the last five years. At the same time, the industry has also faced an estimated increase in capital expenditure per ounce mined of 32% per year over the past ten years – driven by spending on sustaining greenfields exploration and development projects.”
These costs, Gold Fields says, “are destroying much of the leverage gold mining companies would otherwise enjoy to higher gold prices”, a problem that is not often well communicated, especially with the sector’s continued reliance on cash costs as its main reporting metric.
As Gold Fields says, “It is estimated that ‘all-in’ Notional Cash Expenditure (NCE) for the industry has doubled over the last five years. As a result, the profits being made by most gold producers are relatively modest – and remain contingent on further increases in the price of gold. In this context – and amidst rising costs in general – many within the industry are reviewing their existing production portfolios, with more marginal mines likely to face divestment or even closure. Likewise, existing capital expenditure plans are being seriously undermined by ever-higher capital costs.”
This flows directly into the fifth challenge facing the sector, that of challenges posted by new growth environments outside of the bounds of traditional mining jurisdictions.
These, so-called, non-traditional jurisdictions pose all sorts of technical, poltical and infrastructure risks that can cause delays and often push up costs.
The final risk outlined by Gold Fields is the one posed by the gold price itself.
“Despite current signs that they may now be stabilising, average gold prices in 2012 were 91% higher than in 2008. Nonetheless, the gold mining sector has not fully capitalised on historically strong gold prices due to its failure to deliver optimal leverage over the gold price to investors.”
Gold Fields says that the demand and supply fundamentals at play in the sector imply that the price of gold is more likely to either maintain or increase on its current levels. But, it says, “the gold mining sector is not delivering optimal leverage over the gold price to investors – primarily due to the high costs involved in extraction, Mineral Resource and Mineral Reserve replacement, and growth (p96). As a result, investors are increasingly seeking to profit from Exchange TradedFunds (ETFs), which provide straightforward access to the gold price ‘upside’. Unfortunately, this is diverting away investment that would otherwise be targeted at gold mining companies.”
None of the issues outlined above are new but, as gold miners reflect on the performance of the first quarter of 2013, many of them with new management teams at the helm, it would serve everyone well to remember just how many challenges remain in place.