Dog days for miners

David McKay | Tue, 03 Sep 2013 11:41
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[] – ON Friday afternoon of April 12, traders in London and Johannesburg were winding down for the weekend. In New York, however, it was 8am and the action was just about to kick off.

The Big Apple’s gold futures market opened to a wall of selling – 100 tonnes of metal, equal to 3.4 million ounces - which took the price of gold down to $1,540/oz.

This was an important level because it represented the threshold which had several years earlier confirmed gold was in a bull market: it also represented gold’s low in 2012. “In many traders minds, it stood as a formidable support level; the line in the sand,” says Ross Norman of Sharps Pixley, a UK bullion broker.

A mere two hours after the initial selling, which was rumoured to be routed through Merrill Lynch’s floor team, a further 10 million ounces of gold was sold. The trading was concerted, at a time when New York was at its most liquid, and in the full glare of traders in London which was still open. The odd ‘rogue’ trader was also suspected of assisting “the assault” which announced in the phrasing of Norman: “you are long and wrong”.

All in all, gold worth $20bn had been sold, equal to 15% of world production. The price of the metal, which had opened in New York at $1,542/oz slipped to around $1,535/oz where it stabilised for a few hours. By 10.25am, however, it skidded further, to about $1,495/oz. It was at that point, the gold bull market, in progress for about 13 years, had officially come to an end.

“There is no other way to put gold’s recent sell-off: nasty,” said Edel Tully, an analyst for UBS. All eyes turned to gold bulls, the longs, to see if they could revive the metal’s fortunes.

It was not forthcoming.

Before the weekend had begun, holders of gold-backed exchange traded products (ETNs) sold 680,000 ounces of gold. It was inevitable ETN holders would liquidate; in fact, they had been selling since February precipitating a $200/oz decline since January. Now, however, the liquidations accelerated.

The metal dropped a further $300/oz to $1,200/oz by late June before staging a minor recovery. In the second quarter alone, gold’s activity was described as the worst quarterly performance since 1900; certainly the worst since the start of modern trading in the Seventies.

The fallout was significant.

Wall Street Journal’s MarketWatch reported ‘gasps’ on Twitter to news that John Paulson’s gold fund had lost 65% of its value in 2013. By early July, gold ETNs fell below 2,000 tonnes, the first time since 2010.

"There is no other way to put gold’s recent sell-off: nasty”
Stockbrokers said the outlook was bleak including Michael Haigh, an analyst at Societe Generale who had earlier forecast an average bullion price of $1,150/oz for next year. Worse was to come, he said: gold price weakness would continue well into the future, even when other metals regained price momentum as the super-cycle resumed.


The performance of gold capped a miserable 18-month period for the metals markets as economic growth slowed in China, recovery in the US was hesitant at best, while Europe was firmly on the slab, its sovereign debt crisis continuing.

Reporting the period from April 2011 to December 2012, consultancy PwC said net profits for the world’s 40 largest listed mining companies had fallen 49% to $68bn.

The major players such as BHP Billiton, Rio Tinto, and Anglo American among others, rushed to shore up their balance sheets. Some $108bn in debt was raised including $43bn worth of bonds. Net gearing increased to 24% from 13% previously, and executive management was replaced.

Half of the top 10 mining companies replaced their CEOs which included Marius Kloppers at BHP Billiton, Tom Albanese at Rio Tinto, and Anglo American’s Cynthia Carroll. Capital expenditure was slashed a fifth and miners turned towards corporate austerity whilst also becoming more returns-focused than ever during the heady days of the supercycle in an effort to retain the faith of investors. Dividends increased 7% to $39bn, said PwC.

Investors weren’t impressed. Share prices for the top 40 mining companies in the first half of the year dropped 20%.

This is how markets and then companies have responded to macro-economic factors, but there’s a number of analysts who aren’t calling time on the commodities markets owing to fundamental social factors. One is the most fundamental social factor of all: population growth.

According to Macquarie Research, while the rate of population growth is slowing – to 1.2% a year from 2006 to 2012 from 1.8% a year in the six years before that – absolute population numbers are increasing from an average of 76 million from 2000 to 2006 to a forecast 82 million a year from 2012 to 2018.

This is reflected in the actual tonnes of demand growth for certain commodities such as steel, aluminium and base metals. In the case of carbon steel, the rate of global demand growth is forecast to slow over the next three years to 3.1% a year from 3.3% in 2006 to 2012.

In tonnage terms, however, and taking into account base effects, demand for steel amounts to an average of 50 million tonnes a year over the next six years from 45 million a year in the last six years.

One of Macquarie Research’s analysts, Jim Lennon, counters that the rate of urbanisation is even more important that population growth.

“Since 1913, the world population has risen five-and-a-half times from 1.3 billion to seven billion people, while the world’s urban population has risen almost 17 times to 3.7 billion people,” he said.

“The world population is predicted by the United Nations to grow a further 1.3 times between now and 2050 to around nine billion people and then to level out – however, the urban population is projected to grow 1.7 times to 6.3 billion people or so.

“This suggests further steady growth in demand, albeit at a slower growth rate than in the recent past, concentrated in China and developing countries, including India, the Middle East, Eastern Europe and Africa – the role of Western Europe, the US and Japan will continue to diminish year by year,” he said.


While urbanisation is likely to underpin demand, there are other indications that suggest the commodity markets are in fact, just adjusting, not imploding.

Macquarie Research estimates there will be a 20% decline in global mining capital expenditure this year following the 34% rise seen in 2012 while certain commodities, such as gold and thermal coal, are only in the foothills of capex cuts. “Longer term, the substantial pull-back in mining capex, particularly for longer-dated projects, is setting the scene for a 2016/17 commodities price uplift,” it said.

Stronger construction activity is likely through 2013 as China’s real estate sector benefits from improved financial conditions in the country. Since Chinese construction remains the single largest driver of commodities demand growth, there may be potential upward revisions to steel demand forecasts for 2013 and for copper in 2014.

According to Kevin Norrish, an analyst for Barclays Research, it wasn’t correct to see the decline in metal prices as a single event for all commodity classes.

The synchronous price upswing in commodity prices between 2004 and 2008 was unlikely to be repeated because commodities would be driven more by specific supply and demand fundamentals in a return to former behaviour before the ‘supercycle’. “What we expect is a return to commodity risk,” he says.

Commenting on short-term conditions in the commodity market, Norrish said the recent sell-off had been “overdone”. When the broader upswing for commodities returned it could be “surprisingly strong,” he says.

It was supply, however, that was likely to lead to a less uniform market in the future owing to cutbacks in capital projects by the world’s major mining companies - falling to just over $40bn in 2015 from a peak of $70bn in 2012 - as well as to infrastructure and delivery constraints.

“Longer term, the substantial pull-back in mining capex, particularly for longer-dated projects, is setting the scene for a 2016/17 commodities price uplift”
Infrastructure and logistics availability was styled by Norrish as ‘the new commodity battleground’ with supply growth in some regions so rapid that it was overwhelming available infrastructure. There was little chance of rapid response from infrastructure owners owing to the cost and lead times of building rail and port facilities.

“With diverse supply outlook and varying degrees of infrastructure shortage, expertise in individual commodities is going to become important once again,” says Norrish. Barclays had deployed about 30 analysts to help determine the destiny of the commodity complex, he said.

From a demand perspective, soft commodities such as rice, wheat and soybeans would be most affected by the managed reduction in Chinese consumption, although platinum and silver were also thought to be the biggest losers in terms of Chinese demand.

While the market has eased, some pressures from the supercycle have remained. One of the features of the commodity boom was the lack of skills (as well as crucial parts such as wheels for large yellow machinery) available to even the major mining companies.

According to Martin Pike, MD of Sub-Saharan Africa for executive search firm, Pedersen & Partners, the dearth in mining skills has not eased with experienced engineers and finance skills with mining knowledge still thin on the ground – especially as retirement beckons.

“The majority of mining projects in the supercycle was driven by the junior sector which was largely staffed by older engineers. At this time many of these skills are feared to be considering retirement, especially with the financial pressure currently being experienced and the lack of finance to progress projects or fund junior exploration,” says Pike.

Major mining companies have similar problems, he says. “Some projects will progress but the human capital resources needed for building and constructing these large projects is also critically short.”


For mining companies operating in these conditions, life is uncomfortable. There have been eleven new appointments to top mining companies in the past year, according to Anglo American CEO, Mark Cutifani, of which he is the only external appointment.

Interestingly, the average age of new CEOs appointed to run the top three mining companies – BHP Billiton, Rio Tinto, and Anglo – is 57 years compared to 48 years of their predecessors who were all appointed in 2007 as the supercycle was in full swing.

It’s almost as if the move by company boards is to abandon the exuberance of youth in favour of old heads, and operationally savvy ones at that.

“Across the board, companies are reassessing their project pipelines and capital allocation decisions, and reprioritising their capital programme to focus on core, high-margin projects,” says Christopher Lyon, mining leader in Chile for Deloitte.

"We estimate that by FY18 about 50% of global production is likely to require a breakeven gold price of $2,400/oz"
In the gold mining sector, conditions are especially difficult. According to David Davis, an analyst for Standard Bank Group Securities (SBGS), at least 60% of the top leading 30 mining companies, representing some 45% of global gold production, are operating at breakeven levels of $1,500/oz, well above the price of gold at the time of writing.

This assumes gold mining companies adopt the World Gold Council’s new reporting measure of All-In Sustaining Costs (AISC) which now asks gold companies to include the cost of development and exploration as well as other corporate costs rather than the cash costs as the ultimate measure of the cost of extracting gold.

According to Davis, cash costs have misrepresented the profitability of the gold mining sector, an omission masked by the high gold price. In a sense, the council’s AISC reveals a gold industry in much more reflective mood especially as it attempts to establish an understanding of the sustainability of gold production and the prospectivity of resources and reserves.

“We estimate that by FY18 [2018 financial year] about 50% of global production is likely to require a breakeven gold price of $2,400/oz at a year-on-year unit mining inflation rate of 10%,” says Davis.

From a South African perspective, the gold industry is in dire straits. In a presentation of the economic prospects for the sector ahead of wage negotiations, Roger Baxter, chief economist and strategist for the Chamber of Mines of SA, said the country risked producing less than 100 tonnes of gold a year by 2020, an 8.2% annual decline. This compares to South African production of 1,000 tonnes in 1970.

The deterioration is partly owing to the maturity of South Africa’s gold resources, but it’s also largely due to increases in costs about which the industry was helpless to control, says Baxter. These are so-called administered costs such as electricity, water and the international pricing of steel and diesel.

In fact, between 2007 and 2012, there has been a 238% increase in the electricity price to 61 cents per KiloWatt hour (c/kWh) from 18c/kWh. Crucially, there has been a 12% increase in average remuneration paid per worker which is some 5% higher than producer inflation, Baxter says.

In the context of a gold price that seems stuck around $1,300/oz (at the time of writing), cost cutting and restructuring seems inevitable for the sector that needs to re-establish a grip on productivity. This has enormous consequences for South Africa’s precious metals sector as a whole, not just gold.

“In order to return to average productivity levels, we estimate both sectors (gold and platinum) would need to increase mining activity by 30% which we see as unlikely; or reduce employment by about 25%, a more likely scenario in our opinion – driven by the closure of unprofitable mines,” said Kane Slutzkin, an analyst for UBS.

“What we’ll see is mines being re-modelled so that they will be smaller, produce less volume, and end up paying less taxes,” says Nick Holland, CEO of Gold Fields. “There will potentially be a write-off in reserves. It will be a watershed year for reserves.”

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