Di­min­ish­ing

Finweek English Edition - - INVESTMENT -

Ayear ago, South Africa’s gold pro­duc­ers were i n the midst of a heavy cost­cut t ing d r ive as the i mpact of t he de­cline i n t he gold price, which had started si x months pre­vi­ously, hit home.

An­a­lysts now think that most of the cor­po­rate and op­er­a­tional cost­cut­ting is out of the way, leav­ing the likes of Gold Fields and An­gloGold Ashanti with lit­tle space to ma­noeu­vre should the gold price weaken fur­ther or the rand strengthen against the dol­lar. If ei­ther of those events takes place, only large-scale re­struc­tur­ing can re­sult.

Ac­cord­ing to David Davis, an an­a­lyst at Stan­dard Bank Group Se­cu­ri­ties (SBGS), it’s a ques­tion of the law of di­min­ish­ing re­turns – an eco­nomic term used to de­scribe the coun­ter­pro­duc­tive ef­fects of adding too many fac­tors to pro­duc­tion. For in­stance, adding too many work­ers to a shop f loor will even­tu­ally re­sult in bot­tle­necks and ma­te­ri­alise as less eff icient pro­duc­tion on a per-unit ba­sis.

“We be­lieve the cost-sav­ings ex­er­cises will likely soon have reached the ‘ l aw of di­min­ish­ing ret urns’,” said Davis in a re­search note dated 7 July. “There­fore, mine right- siz­ing, clo­sure or sale will likely re­sult,” he said.

Since last year, it ’s es­ti­mated that SA’s gold counters have cut their all- i n costs ( AIC), which i nclude t he cost of re­plac­ing reser ves t hrough ex­plo­ration as well as sundry cor­po­rate costs, by 36% to 45% − a mas­sive im­prove­ment, with Har­mony Gold leading the way.

It slashed AIC $573/oz to $1 224/ oz, but at the cur­rent gold price of $1 308/oz that still leaves the com­pany with pre­cious l it t le mar­gin in dol­lar terms. Mer­ci­fully, most of its mines are in SA, so its top-line rev­enue ben­e­fits from rand con­ver­sion.

Gold Fields cut an es­ti­mated $458/ oz while An­gloGold Ashanti re­duced it s AIC by $ 544/oz, l eav­ing both com­pa­nies with a break-even of about $1 114/oz. This is hardly a wealth of mar­gin at the cur­rent gold price, es­pe­cially for Gold Fields which has un­bun­dled most of its SA pro­duc­tion into Sibanye Gold, a com­pany that re­duced its costs the least in the last year, but has the best mar­gin at an AIC of $1 101/oz.

Said Davis: “We be­lieve that these lev­els of sav­ings, es­pe­cially in cap­i­tal ex­pen­di­ture, are not sus­tain­able in the medium to long term at cur­rent pro- duc­tion rates [at low gold prices].”

It is bad for the SA gold sec­tor in terms of its abil­ity to gen­er­ate for­eign ex­change, and ob­vi­ously its em­ploy­ment lev­els, but it’s good for the longterm prospects of the gold price and those left stand­ing to ben­e­fit from it. Davis ex­pects that at an an­nual cost inf la­tion of 10%, the gold price would need to be at around $1 700/oz by 2018.

It’s one of the rea­sons why an­a­lysts con­tinue to show in­ter­est in Sibanye Gold.

Al­though t he share has a l most dou­bled in the last year, its strat­egy of ex­tract­ing as much value as it can in a be­nign gold price en­vi­ron­ment has been un­der­es­ti­mated by the mar­ket, ac­cord­ing to Eu­gene King, an an­a­lyst for Gold­man Sachs in Lon­don.

He be­lieves re­cent ac­qui­si­tions by Sibanye Gold, in­clud­ing its cut-price pur­chase of for­mer JSE gold stock, Wits Gold, will trans­late into higher than aver­age yields of 3.6% and 4.6% in the 2015 and 2016 f inan­cial years, re­spec­tively.

An­gloGold Ashanti’s Cuiaba gold mine in Sabara, Brazil.

Jo­han­nes­burg, the city built on gold

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