Gold Majors Struggle to Reign in Costs

While gold has recovered about $150 per ounce of the $200 it lost on April 15, outflows from gold ETFs continue, and many gold market observers are predicting the end of the 12-year gold bull run as the fundamentals for gold price appreciation — inflationary pressures, poor economic performance among industrialized countries and a low US dollar — become less compelling.

That has forced the relatively small number of companies that produce gold in significant quantities to re-evaluate their cost models to account for a lower gold price in the near future.

The two largest gold producers by market capitalization, Goldcorp (NYSE:GG,TSX:G) and Barrick Gold (NYSE:ABX,TSX:ABX), have both said they will take steps to control costs. Barrick, which faced the recent wrath of institutional investors for a $11.9-million signing bonus to co-chairman John Thornton, has said it will cut at least $500 million from spending on major projects this year and sell non-core assets. Exploration spending will also be curtailed by $100 million. Perhaps most significantly for Barrick, its Pascua Lama project, up to now an albatross around the company’s neck due to over $5 billion in cost overruns, is being reconsidered.

Goldcorp has been less drastic on its plans to cut costs, with CEO Chuck Jeannes saying last week that the company is “…looking at spending priorities to determine where we would make reductions or deferrals in our spending programs in the event of a lower sustained price.” The company has a contingency plan that will defer capital spending should deteriorating market conditions warrant. That could include shutting down higher-cost mines. However, according to an article in Mining Markets, if gold stabilizes at $1,500 per ounce, Goldcorp’s current plans will be unaltered, and even at $1,400, “some belt-tightening would occur, but current projects being built (three in total) would go ahead as planned.” These include Cerro Negro in Argentina, Eleonore in Quebec and Cochenour in Ontario. Mining Markets reported Jeannes as stating that Goldcorp is “over the camel’s hump” on these projects with $3.1 billion already invested.

Turning to South Africa, Gold Fields (NYSE:GFI) said in its 2012 annual report that cost inflation is among the top six issues facing the sector.

“According to the gold miner,” reported Mineweb, “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 [a skills shortage in South Africa] pushes up wages and replacement ounces become harder to find.”

Harmony Gold Mining (NYSE:HMY), in its attempt to deal with the cost issue, said it plans to “reduce services and corporate costs in South Africa by R400 million and would cut overall capital expenditure locally and in Papua New Guinea by R1.4 billion for the 2014 financial year,” according to financial publication BusinessReport. While no mines are expected to close, up to 500 jobs could be cut, said Harmony Gold’s CEO, Graham Briggs.

Meanwhile, concerns are being raised that the falling gold price will have a significant effect on the economy of South Africa, the world’s second-largest bullion producer. AlJazeera reported in a video segment that although South Africans are taking advantage of lower prices to buy gold jewelry, mine owners are struggling with high production and energy costs, and are threatening to close shafts and lay off workers. That could stoke worker discontent and force more workers out of an industry that is already struggling to keep up. As noted above, the skills shortage is adding to wage inflation in South Africa.

Randgold Resources (LSE:RRS), despite being one of the best gold companies in terms of meeting production targets, has reported a drop in gold production and sales compared to last quarter, and that has forced the company, which is focused on West and Central Africa, to look at its operations, particularly in light of the recent fall in the gold price.

Mineweb reported Randgold CEO Mark Bristow as stating that the company is “re-assessing all its operations and expenditure flows and where capital savings and operational cost cuts can be implemented they will be put in place.”

“This has already led to the decision to bring Kibali initial oxide ore process plant completion forward to September this year, while deferring the main sulphide processing section until early 2014.”

Gold miners in the United States have not been spared from the cost conundrum either. Newmont Mining (NYSE:NEM), the country’s largest gold producer, said the company has seen costs surging 40 percent between 2010 and 2012 due to rising prices for raw materials, equipment and labor. Bloomberg reported that Newmont’s all-in sustaining costs last quarter were $1,115 an ounce, 6.6 percent higher than the year-ago quarter.

What does all this mean for gold investors? Market participants should keep an eye out for the cost figures cited by major gold producers in their quarterly and annual reports. Increasing costs signal a lack of adherence to cost-control measures, which could negatively impact the company’s share price and in some cases, its dividend payout. Producers that can match cost reductions with steady or increased production will win investor confidence and should see their shares rise if not immediately, then within a reasonable time frame.

Securities Disclosure: I, Andrew Topf, hold stock in Goldcorp.