Gold mining cost cutting shows price can drop further
What does gold have in common with iron ore and coal? All three are travelling down the same road of structural oversupply, softer demand growth and severe cost-cutting by their producers.
While exciting for gold watchers, Monday’s mini flash crash, which sent the most-active US gold futures contract to a five-year low of US$1,088 an ounce in thin early Asian trade, is largely irrelevant, unless viewed against a wider backdrop.
The broad picture for gold is that since the spot price reached its peak of $1,920.30 an ounce in September 2011, demand has dropped as supply has risen.
More than anything else this simple dynamic explains why gold has now given up about half the gains of the decade long rally between 2001 and 2011.
Figures from Thomson Reuters GFMS show that in 2011 there was an overall deficit of 154.1 tonnes in the gold market, which fell to a deficit of 77.9 tonnes in 2012, then rose to a surplus of 248.7 tonnes in 2013 and 358.1 tonnes last year.
While not entirely to blame for the rising surplus in the market, mine supply has been on an upward trend, from 2,845.9 tonnes in 2011 to 3,129.4 tonnes last year, according to GFMS data.
Mine supply is now projected to start declining, to 3,124.7 tonnes this year, 3,057 tonnes in 2016 and 2,970.3 in 2017.
This largely reflects the closure of higher-cost operations and the scaling back of exploration expenditure in response to low prices, which curtails new projects.
GFMS uses a robust methodology and has a strong track record, but like all forecasters, it has to assume other factors remain equal, and this is why forecasting is generally fraught with risk.
The main risk, from a supply perspective, is that miners are able to manage costs in such a way as to lower the industry’s cost curve, allowing the price to fall in the absence of a demand-driven rally.
This is why gold may be experiencing a similar dynamic as iron ore and coal, even if it’s not quite as far down the same road.
What we’ve seen in iron ore and coal is that the most common response by mining companies to falling prices for their commodities is to increase volumes and cut costs.
The thinking is that by lowering unit costs the company will be able to weather the period of low prices.
What has happened in practice is markets that were already oversupplied became more so, and the reductions in the industry cost curve simply allowed prices to fall by a similar amount.
Spot thermal coal at Australia’s Newcastle port , a regional benchmark, has lost more than half its value since 2011, while spot iron ore has fared even worse, fetching just over a quarter of what it did at its record high in early 2011.
While gold has also fallen by almost 50 per cent, the miners have been cushioned by fatter margins and it is only more recently that costs will have moved to the top of the list of concerns.
Like their iron ore and coal counterparts, gold mining executives probably thought for a long time that prices couldn’t get any worse and that a demand-led recovery was just around the corner.
But in the absence of rising demand, gold miners will seek to cut costs, a process they have already started and will likely try to accelerate.
The all-in cost of producing gold dropped 23 per cent to $1,331 an ounce in the year to March 2014, according to data from Citigroup.
If that sounds like an impressive decline, consider the latest announcements from some of the top gold mining companies.
Newmont Mining Corp’s all-in sustaining cost for gold was $849 an ounce in the first quarter of this year, down from $1,034 for the same quarter last year.
Barrick Gold Corp had an all-in sustaining cost of $864 an ounce last year, lower than the $890-$920 the company had forecast.
Australia’s Newcrest Mining had all-in costs of A$946 ($700) an ounce in the first quarter, down from A$963 for the same period in 2014.
These aren’t unusual results and show that miners can, and will, cut costs before they trim output.
These are also figures for all-in sustaining costs, defined by the Minerals Council of Australia as designed to reflect the "full marginal cost of gold mining", including ongoing capital expenditure, indirect costs and overheads.
While not viable in the long-term, certain costs within all-in sustaining costs can be discounted, thus allowing companies to continue production even if the operation is loss-making.
What iron ore and coal have shown is that this process can run for far longer than most analysts thought possible, and that miners can weather extreme amounts of financial pain before taking the last step in a painful process, namely shutting down.
There may well be reasons why gold prices will stop declining and rally from this point, but the cost of mine supply isn’t likely to be one of them.