Op­ti­mists ver­sus cyn­ics on prospects

Gold com­pa­nies up­beat about 2009 but cur­rent tur­bu­lent times make pre­dic­tions dif­fi­cult

Finweek English Edition - - Companies & Markets - BREN­DAN RYAN

THE CEOs OF GOLD FIELDS, An­gloGold Ashanti and Har­mony are all con­fi­dent about two things, judg­ing by their re­cent Septem­ber quar­terly brief­ings: the gold price will go up next year and their op­er­a­tions will per­form bet­ter in 2009. Well, they would be – wouldn’t they? Af­ter all, they’re gold com­pany CEOs and if you aren’t an op­ti­mist you shouldn’t be in the min­ing busi­ness. The trou­ble is the gold price isn’t cur­rently per­form­ing and an­a­lysts’ opin­ions are split on whether it will con­tinue to un­der­per­form next year.

Gold Fields CEO Nick Hol­land says gold will go above US$1 000/oz and stay there, pri­mar­ily due to fall­ing pro­duc­tion from ex­ist­ing mines. He adds a num­ber of projects be­ing brought on stream by ju­nior min­ers are go­ing to be shelved or post­poned be­cause they can’t find the funds to de­velop them be­cause of the world fi­nan­cial cri­sis, which has dried up all sources of credit.

Hol­land es­ti­mates the “all-in” cost of pro­duc­tion at around $800/oz for the global gold min­ing sec­tor. That cal­cu­la­tion in­cludes money spent on ex­plo­ration, de­vel­op­ment work and cap­i­tal ex­pen­di­ture re­quired to main­tain cur­rent out­put lev­els. Those amounts are left out of the lower “cash cost” of pro­duc­tion that most gold com­pa­nies em­pha­sise in their re­sults. That means much of the gold in­dus­try is los­ing money at cur­rent lev­els and must chop back on op­er­a­tions and/or de­fer new projects.

Hol­land reck­ons world gold pro­duc­tion will drop 5% this year and an­other 5% in 2009. His es­ti­mate on SA’s gold out­put is that it will drop to around 210t this year. SA pro­duced 376t in 2003.

An­gloGold Ashanti CEO Mark Cu­ti­fani holds a sim­i­lar view, point­ing out the world gold in­dus­try has been in de­cline for the past seven years, He ex­pects an­other five years of de­cline to come, dur­ing which world gold pro­duc­tion will drop at an av­er­age rate of around 3%/year. Cu­ti­fani says a price of $1 000/oz is a “long-term sus­tain­able tar­get”.

Har­mony CEO Gra­ham Briggs says: “With eco­nomic de­posits in min­ing lo­ca­tions harder to come by – and ex­plo­ration and de­vel­op­ment bud­gets un­der ex­treme pres­sure – sup­plies of new gold into the mar­ket are likely to con­tinue to shrink.”

Gold an­a­lyst David Davis, of Credit Suisse Stan­dard Se­cu­ri­ties, sup­ports the in­dus­try’s ex­ec­u­tives. In a re­cent re­port Davis com­mented: “We be­lieve the cur­rent floor price is around $850/oz, as we cal­cu­late this price rep­re­sents the ‘all-in’ cost of 50% of global pro­duc­tion. This means that, at cur­rent gold prices of around $753/oz, much of global pro­duc­tion is at breakeven lev­els.”

Davis says fall­ing mine sup­ply – com­bined with lower cen­tral bank sales and pro­ducer de-hedg­ing – will re­duce over­all gold sup­ply while in­vest­ment de­mand from ex­change-traded funds (ETFs) will rise. He ex­pects jew­ellery de­mand to be “volatile” but only over the short term. “We be­lieve the up­swing in the gold price will only be a mat­ter of time.”

Davis does cover his bets on the short­term out­look, say­ing: “On the down­side, we think a fall in jew­ellery de­mand and/or dis­in­vest­ments in gold ETFs year-on-year would very likely lead to a fall in the gold price.”

UBS an­a­lyst John Reade says gold will re­main un­der pres­sure dur­ing 2009 from a com­bi­na­tion of slow­ing de­mand for jew­ellery and dis­in­vest­ments as inflation slows and the US dol­lar con­tin­ues to strengthen.

“Dr Doom” (New York Uni­ver­sity econ­o­mist Nouriel Roubini, who pre­dicted the cur­rent fi­nan­cial cri­sis a year in ad­vance and be­lieves there’s worse still to come) reck­ons the US and global economies face the prospect of stag-de­fla­tion. That’s a re­ces­sion as­so­ci­ated with de­fla­tion­ary forces in which com­mod­ity prices col­lapse and inflation

van­ishes due to the over­all drop in de­mand.

That’s bad for gold – on two counts: given gold’s dual role as a com­mod­ity and as the ul­ti­mate in­vestor pro­tec­tion against inflation.

“So the lead­ing sup­port­ers of the view that the global econ­omy risked ris­ing inflation, ris­ing growth re­fla­tion and sharply higher pol­icy rates to fight this inflation are now pre­dict­ing a global re­ces­sion, global de­fla­tion and sharply fall­ing pol­icy rates. What a dif­fer­ence a year makes,” says Roubini.

Looking at the re­sults of SA’s “Big Three” gold min­ing groups, all are claim­ing progress in their var­i­ous turn­around pro­grammes but all face spe­cific prob­lems.

Briggs says Har­mony is now “well em­barked on its or­ganic growth phase” but as JP Mor­gan an­a­lysts Steve Shep­herd and Al­lan Cooke point out, “more ef­fort will be re­quired to fix some of the prob­lem chil­dren in SA. Eland­srand has been placed on in­ten­sive care and, to­gether with Tar­get, will take six months to re­struc­ture.”

Cu­ti­fani, who took over from for­mer CEO Bobby God­sell a year ago and em­barked on ma­jor re­struc­tur­ing of the group, says he’s now “got the car road­wor­thy and it’s time to work on the en­gine”. His in­ten­tion is that An­gloGold Ashanti will “be the num­ber one value cre­ator in the gold in­dus­try over the next 18 months”.

An­gloGold Ashanti’s most press­ing prob­lem is fi­nan­cial, in the form of the US$1bn con­vert­ible bond that must be re­fi­nanced by end-Fe­bru­ary 2009. Be­fore the cur­rent fi­nan­cial cri­sis that would have been a sim­ple ex­er­cise. Cu­ti­fani com­ments: “We’re fo­cused on nail­ing the re­fi­nanc­ing as our top pri­or­ity.” Op­tions be­ing looked at in­clude sale of as­sets, bridge fi­nanc­ing, lower cap­i­tal ex­pen­di­ture spend and fur­ther debt fi­nanc­ing.

At Gold Fields, Hol­land “bit the bul­let” in the Septem­ber quar­ter, tak­ing a bad knock in gold pro­duc­tion through the clo­sure of the main shaft at Kloof for re­pairs, plus re­ha­bil­i­ta­tion work on two main ac­cess ramps at South Deep. His mes­sage is Gold Fields will be back to nor­mal pro­duc­ing at a rate equiv­a­lent to 4m oz/year from the March quar­ter 2009 and do­ing that at markedly lower cost lev­els.

But Gold Fields also has its prob­lem chil­dren, such as peren­nial un­der­per­former Beatrix, which Hol­land reck­ons is be­ing fixed and from which he says “Gold Fields will make a lot of money”.

We’ll see. What the SA mines both have go­ing for them is the ben­e­fit of the weak­en­ing rand, which boosts rev­enues – un­like mines op­er­at­ing in “dol­larised” economies. Those ben­e­fits will be short-lived if the min­ing groups don’t keep their costs un­der con­trol. Al­though, as Hol­land and Cu­ti­fani point out there’s now re­lief in sight on costs, in par­tic­u­lar be­cause of drop­ping oil prices.

Share prices of all three groups have re­cov­ered from their re­cent 12-month lows, with An­gloGold Ashanti and Har­mony out­per­form­ing Gold Fields.

What hap­pens next will de­pend on how well their man­age­ments de­liver on their prom­ises, along with move­ments in the US dol­lar gold price and dol­lar/rand ex­change rate.

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