Gold: Time to invest?
Michael Forrest talks to Paul Burton, Senior Equities Analyst at Thomson Reuters GFMS, about the price and production of gold
Gold has always been a source of fascination, both for those that seek it and those that wish to own it. Despite this interest, most gold is not used – the great majority of it is stored in banks as bullion or in private hands in the form of jewellery. In fact, it is estimated that most of the cumulative production of the world’s gold mines, some 166,000 tonnes, is in some kind of vault.
Gold is popular today for the very reasons it was popular in the past: as a store of wealth. Its untarnished reputation always rises when the currencies that define its value lose their attractiveness to investors, and this is precisely what is happening today. Gold is priced in US dollars, as are most of the world’s commodities. But as the US economy has weakened, along with many other indebted nations, so the price of gold has risen to unprecedented levels.
This has stimulated exploration and mining companies to find and produce more, and as a result gold has regained pole position in terms of exploration dollar expenditure, beating base metals that briefly held the title. More companies than ever are looking for gold and over a wider geographic range. The nature of exploration has also changed, with junior companies leading the way often in new physically and politically challenging environments, while the major companies are content with brownfield exploration that is near and around existing gold mines. After all, the larger firms can always buy the successful junior company, an outcome often welcomed by both sides.
According to Paul Burton, Senior Equities Analyst at Thomson Reuters GFMS, ‘the mined production of gold increased in 2010, up 3% on the previous year to 2,500 tonnes and forecast to rise another 4% in 2011’. However, the geographic spread has changed and the dominance of South Africa, and particularly the Witwatersrand where some 30% of the above ground gold originated, has faded to almost 50% of its 1970 peak production of 1,000 tonnes. Although there are high grades still to be exploited, they have a high cost implication. The losers in the annual production of gold are Russia, South Africa, Peru and Indonesia with the winners being Argentina, USA, Peru and China. It is the latter that has reached pre-eminence in primary production. This may be surprising to many, but at least half the production comes from the smelting of base metal concentrates that fuel the Chinese industries.
More than 60 countries now produce gold, although the top 20 are responsible for 87% of mined production. However, the top five are now being eclipsed by the rest of the world category with countries such as Kazakhstan, Eritrea and Burkina Faso adding to the record 2011 first half global production of 1,343 tonnes, along with a revival from Canada (Malartic and Meadowbank mines) and the Cortez mine in the USA.
When the price is right
Burton explains, ‘The current high gold price has outpaced the rising cash costs of gold mining’. These rose 12% in the first half of 2011 to US$602/oz, but cash margins rose 37% to US$834/oz with all-in costs (cash plus capital costs) rising to US$900/oz. These represent a step change, as cash costs have risen from $200/oz 10 years ago while margins have risen from $92/oz in 2001 to $834/oz in the first half 2011. The geographic spread of cash costs has not been even, with South Africa posting the highest – reaching up to $800/oz – and Australia second at $650/oz, while North and South American mines have relatively flat costs at around the $400/oz mark. In terms of companies, the largest producer in 2010 was Barrick Gold at 7.8 million ounces, followed by Newmont 5.4, AngloGold Ashanti 4.5, Gold Fields 3.5 and Gold Corp 2.5.
But it is not just cash costs that are increasing. There are a number of examples of escalating capital costs in developing gold mines. The capital cost at Pueblo Viejo in the Dominican Republic increased to US$3.6–3.8bln (up from US$3.3–3.5bln), and at Pascua-Lama (in Chile and Argentina) the pre-production capital requirement is now estimated at US$4.7–5bln from a 2009 feasibility study estimate of US$2.8–3bln. At Cerro Casale (a gold and copper mine in Chile), pre-production capital is now estimated at around US$6bln, up from US$4.2bln as outlined in the 2009 feasibility study. El Morro, another gold and copper mine in Chile, has seen costs rise to US$3.9bln against US$2.5bln in the 2008 feasibility study.
A similar cost escalation is apparent when exploration expenditure is reviewed. Despite an estimated record level of expenditure of US$18.2bln in 2011, with more than 50% devoted to gold, the number of new gold finds has dropped significantly over the period 2001–2008 only to match past success in the last two years, despite a tripling of exploration expenditure. There have been very few major finds in the past decade, despite a rising trend over the last 50 years.
So what of demand during this period of cost rises? Gold has always been a safe haven for investors when currencies have lost their shine, and today’s financial turmoil is no different. Gold sales were particularly buoyant in 2010, clawing back some of the demand that peaked at the millennium. India has seen jewellery demand rise 38% to an all-time high of 645t in 2010 and rise again by 16% in the first half of 2011. Chinese demand also grew and signalled a trend from adornment to investment.
It is this sector, however, that has seen the greatest increase. 2009 was a record year for gold investment, where consumption of production (44%) surpassed jewellery (41%) for the first time since 1980. In 2010 it was lower, but still the second highest year. Recently central banks have again been purchasing gold for reserves, another sign of the investment sentiment. ‘The increase of gold production cost margins have not resulted in an increase in the share price of major gold mining companies, with all but a few showing a share price decline over the past 12 months,’ says Burton. Overall the gap between equities and the gold price has widened irrespective of stock exchange. There are a number of reasons for this: buying physical gold rather than stocks, the popularity of exchange traded funds, and perhaps the sentiment that the gold price has reached its peak. The answer may lie in the behaviour of the gold companies. Perhaps if they paid dividends, instead of recycling profits into ever larger mergers and acquisitions, investors may return to the gold equity market at a time when the macroeconomic backdrop remains highly supportive for gold investment.